(b)lines Series: Permissible Funding For 403(b) Arrangements

As outlined by the Groom Law Group, the regulations reflect the general requirement that 403(b) amounts be invested exclusively in insurance company annuity contracts and mutual fund custodial accounts. They also address several other situations, discussed below.

Timeliness of Contributions

Similar to the final 457(b) regulations and following the proposed regulations, the final 403(b) regulations impose an ERISA-type rule that contributions should be transferred to the insurance company or entity holding the custodial or retirement income account within a period that is no longer than reasonable for the proper administration of the plan, using the example of transferring elective deferrals within 15 business days following the month in which the amounts would otherwise be paid to the participant.   However, it appears that this is not a safe harbor for contributing salary reduction amounts subject to ERISA, and the ERISA rules (if the plan is subject to ERISA), as well as 415 rules coordinating the timing of contributions with limitation years, must also be followed.

Grandfather For Certain Self-Insured State and Local Plans

Rev. Rul. 82-102 clarified that 403(b) plans had to be invested in commercial annuity contracts, but permanently grandfathered certain self-insured state and local government annuity plans in existence on or before May 17, 1982, including for new participants.   As was proposed, the final regulations continue this grandfather, where (1) benefits under the contract are provided from a separately funded retirement reserve subject to supervision by the State insurance department, or (2) benefits are provided from a fund separate from the fund used to provide statutory benefits under a State retirement system that is part of a State teachers retirement system (including a State university retirement system) to purchase benefits that are unrelated to the basic benefits provided under the State retirement system, and the death benefit provided under the contract at no time exceeds the larger of the reserve or the employee’s contributions.

Church Retirement Income Account Plans

The final regulations also reflect provisions of the proposed regulations that incorporated a number of rules for church retirement income account plans under Code section 403(b)(9) that were previously found only in the legislative history to TEFRA, the 1982 law which created them.   Perhaps the most important of these is an “exclusive benefit” rule. The final regulations incorporate language previously found in the preamble to the proposed regulations that this means, for example, that employers may not borrow assets from a church retirement income account.   A special effective date provides that in the case of a loan or other extension of credit to the employer that was entered into under a church retirement income account before July 26, 2007, the plan will not fail to satisfy the exclusive benefit requirement of the regulations on account of the loan or other extension of credit if the plan takes reasonable steps to eliminate the loan or other extension of credit to the employer before the applicable effective date for the regulations for the plan or as promptly as practical thereafter (including taking steps after July 26, 2007 and before the applicable date).

The final regulations also follows the proposed regulation by clarifying that a church retirement income account will be subject to the 403(b)(1) annuity rules (for example, for distribution restrictions) rather than the 403(b)(7) rules, even though invested in mutual funds.

The final regulations also allow a life annuity to be provided from a church retirement income account without purchase of a commercial annuity contract if the distribution has an actuarial present value at the annuity starting date equal to the participant’s accumulated benefit, and the plan sponsor guarantees the annuity.   Such self-annuitization is common among older church 403(b)(9) plans.

The final regulations also follow the proposed regulations to provide that, to the extent permitted by future IRS guidance, assets held in custodial accounts and church retirement income accounts may be invested in a group trust with trust assets held under a qualified plan or IRA.   This follows several private letter rulings issued in the past, and hints at a future solution to the omission of 403(b) plans in Rev. Rul. 2004-67, the most recent update of the IRS' "group trust" ruling (Rev. Rul. 81-100).

The final regulations also reflect the rule under the legislative history to TEFRA that church retirement income account assets are permitted to be commingled in a common trust fund with amounts devoted exclusively to church purposes (giving as an example a fund from which pension payments can be made), but provides that no assets of the plan sponsor other than retirement income account assets can be combined with custodial account, qualified plan or individual retirement plan assets.   As with the proposed regulations, it remains unclear whether this is intended to restrict practices among church plans, based upon the TEFRA legislative history, of commingling retirement account plan assets with church endowment funds and church 401(a) plans, provided that the amounts belonging to each can be separately accounted for and the plans are subject to the exclusive benefit rule.

Tax-Exempt Status of Church Retirement Income Account Trust

The final regulations also clarify that a trust holding church retirement income account assets is tax-exempt.

- Groom Law Group, Chartered

This feature is to provide general information only, does not constitute legal advice as part of an attorney-client relationship, and cannot be used or substituted for legal or tax advice.