(b)lines Ask the Experts – Replacing a non-ERISA with an ERISA Plan

“However, the old plan still has custodial account assets in it that have yet to be distributed.  I am aware of the rule that prevents contributions to a new 403(b) within 12 months of distribution of assets from a terminated 403(b) plan, but does that rule apply since a non-ERISA 403(b) plan is being replaced by an ERISA 403(b) plan? If the rule applies, does the plan sponsor have any alternatives to restore an active 403(b) plan option?”  

Michael A. Webb, Vice President, Retirement Plan Services, Cammack LaRhette Consulting, answers:  

Your question addresses a dilemma with respect to 403(b) plan termination.  First, note that terminating a 403(b) plan requires that all assets be distributed as soon as administratively practical.  Generally, that means within a year of the date of termination.  It is often difficult to distribute all of the assets from terminated 403(b) plans, especially where custodial accounts are present, which must actually be liquidated (as opposed to annuity contracts, where a delivery of a fully paid individual insurance annuity contract is treated as a distribution).   

Thus, if either a complete distribution of plan assets is not possible or the ultimate intent is to establish a new 403(b) plan for future contributions within a year of the final distribution of assets, terminating a prior 403(b) is typically not a good course of action.  Consequently, if there are still assets not distributed years after the original plan was terminated, you may have an issue as to whether the that termination was effective.     

ERISA status has no bearing on the rule regarding asset distribution. Under the Code rules, termination of the plan is only permitted if no contributions are made within 12 months following distribution of all assets of the terminated plan, regardless of whether the terminated or replacement plan is ERISA or non-ERISA.    

Is there an alternative in the situation that you describe so that contributions may resume to a 403(b) plan? Possibly, if NO distributions have been made from the prior plan on account of plan termination to participants who were not otherwise eligible to receive a distribution. In this case, there was no need to terminate the prior plan at all; it can simply be continued (or merged into) an ERISA plan, with a resumption of contributions. However, if even one participant has received a termination distribution who would not otherwise be eligible for a distribution, resumption of contributions to the plan is not an option (and it would also probably be wise to make sure that the other assets of the terminated plan not yet distributed be distributed as soon as practical).    

Finally, it should be noted that a non-403(b) plan (such as a 401(k) plan) could be established within 12 months of the distribution of assets from a terminated 403(b) plan. However, other plan types come with their own sets of advantages and disadvantages, which should be considered prior to their establishment.    

For more detail regarding 403(b) plan terminations and when contributions to a new 403(b) plan may be made see Revenue Ruling 2011-7.