two thousand eight ISSUE BROCHURE 403(b) Plans Frequently Asked Questions

Brochure 2-403bFAQs 11x17 - FINAL:Fact Sheet 2008.qxd 10/29/2008 11:04 AM Page 1 National Association of Government Defined Contribution Administrators, Inc. two thousand eight ISSUE BROCHURE 403(b) Plans Frequently Asked Questions PLAN GOVERNANCE AND FIDUCIARY RESPONSIBILITIES What discretion do public 403(b) plan sponsors have over the design and administration of a 403(b) plan? What can employee advisory committees do to affect these decisions? Subject to any limitations under state or local law, a public sector 403(b) plan sponsor has a great deal of discretion regarding how they want to design and administer the 403(b) plan. The plan sponsor also has discretion to delegate the responsibility for operating the plan to any individual, committee or board that it considers appropriate to manage the plan. It is not uncommon for a 403(b) plan sponsor to retain control over the plan, but seek input from employee advisory groups or committees. In this case, the advisory committee would be able to provide input and recommendations but would not have any substantive control over the plan. advice of legal counsel in this area. It is instructive, however, to examine how federal ERISA law applies to private sector entities faced with the same question. For private sector entities, the rules are summarized in the recent DOL Field Assistance Bulletin 2007-02, which provides that a private sector entity is not a fiduciary if it does not establish or maintain the 403(b) plan. The DOL has issued a safe harbor regulation at 29 C.F.R. 2510.3-2(f) which provides that a 403(b) plan is not established or maintained by the employer (and therefore the plan sponsor is not a fiduciary) if the following factors are met: National Association of Government Defined Contribution Administrators, Inc. 201 East Main Street, Suite 1405 Lexington, KY 40507 Phone: (859) 514-9161 Fax: (859) 514-9166 info@nagdca.org www.nagdca.org How does an employer select a Third Party Administrator or limit the number of 403(b) vendors without taking on fiduciary responsibility? Public sector 403(b) plan sponsors need to look to the laws of their state to determine what fiduciary standards may apply in the selection of service providers for the plan. Public entities should seek the NAGDCA 201 East Main Street, Suite 1405 The DOL safe harbor identifies the only activities an employer can engage in without becoming a fiduciary for the 403(b) plan. These include ministerial functions such as: Participation of employees is completely voluntary, All rights under the annuity contract or custodial account are enforceable solely by the employee or beneficiary of such employee, or by an authorized representative of such employee or beneficiary The sole involvement of the employer is limited to certain optional specified activities, and The employer receives no direct or indirect consideration or compensation in cash or otherwise other than reasonable reimbursement to cover expenses properly and actually incurred in performing the employer s duties pursuant to the salary reduction agreements. Lexington, KY 40507 (859) 514-9161 Permitting annuity contractors to publicize their products Requesting information concerning proposed funding media, products, or annuity contractors Compiling information to facilitate review and analysis by the employees Entering into salary reduction agreements, collecting contributions and remitting them to the providers Maintaining records of contributions Holding group annuity contracts in the employer s name covering its employees and exercise rights as representative of its employees under the contract The DOL safe harbor also allows employers to limit funding media or products available to employees, or annuity contractors who may approach the employees, to a number and selection designed to afford employees a reasonable choice in light of all relevant circumstances. Fax: (859) 514-9188 www.nagdca.org

The DOL regulation states that relevant circumstances may include, but are not necessarily be limited to, the following types of factors: The number of employees affected, The number of contractors who have indicated interest in approaching employees, The variety of available products, The terms of the available arrangements, The administrative burdens and costs to the employer, and The possible interference with employee performance resulting from direct solicitation by contractors The DOL Field Advisory Bulletin identifies another circumstance in which a private sector employer subject to ERISA could limit the number of providers. It could limit the permitted vendors to providers whose annuity contract or custodial account complies with the Code requirements and who agree to the plan s division of tax compliance responsibilities among the employer, provider and participant. Note that a private sector entity that wanted to limit the number of 403(b) vendors for other reasons would no longer be within the safe harbor and would be at greater risk for becoming a fiduciary. Once again, for public sector 403(b) plan sponsors, the first step is to identify any state or local fiduciary laws that may apply. In many cases, the state or local law may be similar to the general fiduciary standards under ERISA and the DOL regulations so the safe harbor rules may prove useful. Revenue Ruling 90-24 Transfers Made Between September 24, 2007 and January 1, 2009 Must Satisfy New Rules. The final 403(b) regulations placed significant restrictions on 90-24 transfers made after September 24, 2007. In particular, the new regulations distinguish between post-9/24/2007 transfers that preserve the qualified status of the participant s 403(b) account and transfers that could cause the participant s entire account balance to become taxable on January 1, 2009. A compliant post- 9/24/2007 transfer is one made to a vendor who will either (1) have a payroll slot for receipt of plan contributions or (2) have entered into an information sharing agreement with the employer by January 1, 2009. A non-compliant post-9/24/2007 transfer is one made to any other vendor. Fortunately, Rev. Proc. 2007-71 gives participants an additional six months to correct a non-compliant transfer. Re-exchanges Available Until July 1, 2009: In Rev. Proc 2007-71, the IRS provides a self-correction mechanism for any participant who made a noncompliant transfer as described above between September 25, 2007 and January 1, 2009. Under these new re-exchange rules, a participant can preserve the tax-deferred status of his or her account by re-exchanging the contract for one issued by a vendor within the employer s plan. The re-exchange must be completed no later than July 1, 2009. 2

A vendor that received a 90-24 transfer after 9/24/2007 and is not within the employer s plan (e.g., has a payroll slot or signed an ISA with the employer by 1/1/2009) is a treated as holding a transitional contract. A vendor with a transition contract must make a reasonable, good faith effort to obtain information from the employer prior to making a loan or distribution to the participant. 90-24 Transfers Not Permitted After December 31, 2008. Contract Exchanges Replace Them on January 1, 2009: Under the final regulations, 90-24 transfers become obsolete on January 1, 2009. In place of transfers the final regulations provide for contract exchanges effective 1/1/2009. The new rules are complicated and distinguish between asset allocation changes and contract exchanges. The IRS points to the model plan language in the Appendix to Rev. Proc. 2007-71 to clarify the difference. If a participant moves money from one payroll vendor s contract to another payroll vendor s contract, that is treated as an asset allocation change. On the other hand, if a participant moves money from a payroll vendor s contract to a contract with a vendor that does not have a payroll slot for receipt of contributions, but does have an ISA with the employer for the receipt of exchanges, that is treated as a contract exchange. A couple of examples may assist in explaining the differences. Example One: On and after January 1, 2009, Vendors 1 and 2 have payroll slots and receive contributions from the employer and Vendor 3 only has an ISA with the employer for the receipt of exchanges. A participant who moves money between the contracts offered by Vendors 1 and 2 is treated as making an asset allocation change, not a contract exchange, since both Vendors 1 and 2 have payroll slots. Example Two: Under the facts set out above, participants who move all or portion of their account balances from Vendor 1 or Vendor 2 into a contract held by Vendor 3, will be treated as making a contract exchange. All three vendors are treated as being within the plan due to having a payroll slot or an ISA with the employer. Under current guidance, it is unclear whether participants with money in a prior vendor s contract will be allowed to move those funds to any other vendor as of January 1, 2009. PRIOR VENDOR ORPHANED OR GRANDFATHERED CONTRACTS A prior vendor is defined as any vendor that does not have a payroll slot or an ISA with the employer to receive contract exchanges on January 1, 2009. Revenue Procedure 2007-71 contains transition rules for prior vendor contracts, sometimes referred to as orphaned or grandfathered contracts. Grandfathered contracts are those that ceased receiving contributions from the employer on or before December 31, 2004. Orphan contracts are those that ceased receiving contributions from the employer between January 1, 2005 and December 31, 2008. Information Sharing Agreements do not apply to these prior vendor contracts. 3

CONTRACTS CEASING TO RECEIVE CONTRIBUTIONS ON OR BEFORE DECEMBER 31, 2004 Under the Revenue Procedure, the final regulations do not apply to any vendor contract that ceased receiving contributions before January 1, 2005. Such contracts are grandfathered and the participant accounts will remain in that contract until the participant experiences a triggering event that allows the participant to request a distribution. The rules in existence prior to the issuance of the final regulations will continue to apply to such contracts. There is no requirement for the employer to enter into an ISA with a grandfathered vendor and the regulations do not change how such contracts operate. CONTRACTS CEASING TO RECEIVE CONTRIBUTIONS IN 2005 2008. Under the Revenue Procedure, vendors who received one or more contributions in 2005, 2006, 2007 and/or 2008, but are not are receiving contributions or contributions will cease by December 31, 2008, are subject to a transitional rule. These orphan contracts are subject to a reasonable, good faith standard rule for sharing information necessary to determine the participant s right to request a loan or a distribution. Under one alternative approach, the employer may make an effort to get all prior vendor contracts back within the plan. Alternatively, the orphan contract vendor must make a good faith effort to acquire information from the employer that is necessary to determine whether a participant with money in the orphan contract is entitled to a loan or distribution. The final regulations do not allow the vendor to rely solely on participant self-certification. CONTRACTS HELD FOR FORMER EMPLOYEES OR BENEFICIARIES. If, as of January 1, 2009, a vendor with an orphan contract holds account balances for former employees or for beneficiaries, that vendor must make a reasonable good faith effort to obtain loan and distribution information from the employer. If the employer is out of business, the vendor may rely on the participant s self-certification, unless it is unreasonable to do so. SERVICE PROVIDER CONSOLIDATION May school districts choose just one 403(b) provider and if so, how can participants insure there is at least one no-load, low fee provider that offers mutual funds as an investment choice? There is no federal law that addresses the number of 403(b) vendors a plan sponsor can or must offer. This is a state law issue. Some states have any willing provider laws that do restrict the ability of a plan sponsor to limit the number of vendors. On the other hand, a state could pass a law establishing a mandatory single 403(b) plan vendor for all school districts. Absent a state law to the contrary, a public sector 403(b) plan sponsor has discretion to design an investment structure in any way desired as long as it is permitted under IRC Section 403(b). A no-load, low fee mutual fund structure could be used so long as it complies with IRC Section 403(b)(7). Keep in mind, however, that the more a plan sponsor becomes involved in and assumes discretion over picking investment providers to the 403(b) plan, the more likely they may become a fiduciary regarding those decisions under state law. Taking on fiduciary roles regarding the 403(b) plan may be perfectly acceptable to a plan sponsor as a means of achieving the desired investment structure. Again, the key here is to be aware of the fiduciary issue under state law and seek the advice of legal counsel. DELEGATION OF COMPLIANCE RESPONSIBILITIES Can a 403(b) plan sponsor require that the current vendors be charged with the compliance requirements? A 403(b) plan sponsor may, be contract, require vendors to administer many of the compliance requirements as a condition of being an approved vendor. However, the level of compliance delegated to a vendor will depend on a number of factors including: The number of vendors serving the plan, Other tax-deferred savings plans that are offered (e.g., 457(b) and 401(k) plans) For example, if there is a single vendor and no other tax-deferred savings plans, then many 403(b) plan compliance functions can be delegated to the vendor so long as the plan sponsor provides the vendor with the necessary information and vendor agrees to do assume the delegated responsibilities. A plan sponsor could require the vendor to take full responsibility with regard to administering many functions including the contribution limitations, distributions, qualified domestic relations orders, loans, and hardship withdrawals. The plan sponsor will still need to provide the vendor with the information it needs to for these purposes. However, if there are multiple vendors and/or multiple plans, any one vendor is usually not in possession of all of the information necessary to ensure the compliance requirements are met for the overall plan. Alternatives in this situation include designating a single provider 4

or other third-party entity to act as a compliance coordinator to manage these multiple vendor situations. Keep in mind that the regulations do require that the approved vendors be listed in the plan document or enter into information sharing agreements with the employer to share all information with the plan sponsor necessary to keep the plan in compliance with the final regulations. 403(b) LIMIT MONITORING How do school mergers affect the 15-year catch-up deferral rule? If schools merge, how is longevity within the organization determined? While there are arguments in favor of allowing the merger of service in this situation, the final regulations do not directly address this issue. It is recommended that the advice of legal counsel be sought to determine whether the service with both organizations should be merged for purposes of the 15- year rule. Can the plan provisions allow age 50+ catch-ups but not the 15 yr additional deferral? Yes. The 15-year catch-up is an optional plan feature. ADMINISTRATIVE FUNCTIONS Once an employee leaves an organization what are the employer s ongoing responsibilities? A 403(b) plan sponsor will continue to be responsible for ensuring the proper administration of distributions, loans, and Qualified Domestic Relations Orders (QDROs). It will also need to continue to administer any transfers within the plan between approved vendors (contract exchanges or investment changes) and monitor plan-to-plan transfers (if the plan permits). How do you determine if an employee is part-time (i.e., <20 hr/week - <1,000 hr/yr) for employees not working in a typical 9 to 5 position, like a college faculty member teaching a limited number of courses (adjunct faculty) where classroom time is less than 1,000 hr per year but other things like class preparation or office hours may come into play? Regulation Section 1.403(b)-4(e) provides detailed rules for determining years of service for parttime individuals. This regulation does address, in part, the situation involving part-time professors. It provides: (6) Work performed. For purposes of this paragraph (e), in measuring the amount of work of an individual performing particular services, the work performed is determined based on the individual s hours of service (as defined under section 410(a)(3)(C)), except that a plan may use a different measure of work if appropriate under the facts and circumstances. For example, a plan may provide for a university professor s work to be measured by the number of courses taught during an annual work period in any case in which that individual s work assignment is generally based on a specified number of courses to be taught. How do the new regulations, Revenue Procedure 2007-71 and DOL Field Assistance Bulletin 2007-02 address the topic of Qualified Domestic Relations Orders (QDRO s) for public 403(b) plans? The final regulations and Revenue Procedure 2007-71 address QDROs by establishing rules and corresponding model written plan provisions that provide a distribution made to satisfy a QDRO: 1. Is generally taxable income to the recipient participant or beneficiary. 2. Is subject to the rollover and direct rollover requirements. 3. Will not be a violation of the inservice distribution restrictions. 4. Will not be a violation of any antialienation provision that applies. In addition, the new written plan rules will require a provision relating to how QDROs will be handled under the plan and that the provisions of the written plan must be consistent with the underlying 403(b) funding contracts. DOL FAB 2007-02 does not directly apply to public sector 403(b) plans. Generally, the FAB addresses what kind of activities a private sector 403(b) plan sponsor can engage in that may make the entity a fiduciary under Title I of ERISA regarding the 403(b) plan. Interestingly, the FAB states that certain discretionary activities will make the plan sponsor a fiduciary for the 403(b) plan: Examples of such discretionary determinations are authorizing plan-to-plan transfers, processing distributions, satisfying applicable qualified joint and survivor annuity requirements, and making determinations regarding hardship distributions, qualified domestic relations orders (QDROs), and eligibility for or enforcement of loans. (Emphasis supplied) Again, the FAB does not apply to public sector entities. Public entities should seek the advice of legal counsel on the types of discretionary activities that may impose fiduciary duties on a plan sponsor under applicable state and local law. Absent a state or local law to the contrary, however, public sector plan sponsors should expect that state and local laws will generally follow similar standards when applying fiduciary responsibilities to plan 5

sponsors. The key here again is to seek the advice of legal counsel on this issue. PLAN DESIGN ISSUES The sample plan document from the IRS does not mention the Roth 403(b). Can these plans be offered and what section should it be under in the plan document? Public sector employers can offer a Roth 403(b) account and permit participants to designate eligible contributions as after-tax Roth contributions. The model plan document provided by the IRS in Revenue Procedure 2007-71, however, does not have model provisions for designated Roth contributions. If a plan sponsor wanted to add a Roth feature to its 403(b) plan, appropriate plan language would need to be added. Keep in mind, however, that adding Roth language to the IRS model plan document for public entities may impact the ability of the plan sponsor to rely on the document as approved by the IRS. The advice of legal counsel should be sought it a Roth 403(b) feature is involved or being added. Rev. Proc. 2007-71, Section 4 Can a school district s plan include the provision that an employee must roll their monies out of the district s 403b plan and into an IRA? It depends on the funding vehicle used. Generally, 403(b) annuity contracts are individually controlled and a 403(b) plan sponsor cannot force a distribution after termination of employment. If the contract is controlled by the employer as in some annuity contracts or custodial accounts, the plan sponsor may require a distribution after termination. This assumes that there are no spousal rights under state law. PLAN TERMINATION Can a public 403(b) sponsor terminate its 403(b) plan? How? What are the consequences? The final regulations ( 1.403(b)-10) allow for the termination of a 403(b) plan. A plan may be terminated prior to January 1, 2009 without adopting a plan document, so long as the annuity contracts and/or custodial accounts are in compliance with all of the requirements of the final regulations. To terminate a plan on or after January 1, 2009, the written plan must permit plan termination. If a plan is terminated, the assets of the plan must be distributed to the plan participants and beneficiaries as soon as practicable. Distributing the annuity or custodial contract to the recipient as a non-taxable transfer meets the distribution requirement. Distributions from the contract will be treated as taxable income unless the employee elects a regular or direct rollover to another eligible retirement plan, including an IRA. A plan sponsor terminating the 403(b) plan may not establish a new 403(b) plan for 12 months. The advice of legal counsel should be sought regarding any state law that may impact the ability of a public entity to terminate a 403(b) plan. If a participant transfers funds that were invested with an approved provider from another 403(b) plan to our 403(b) plan, would we be expected to impose the provisions of a plan-to-plan transfer, or of an inplan contract exchange? The mechanism for moving the assets from a current employer to a new employer will be a plan-to-plan transfer. The final 403(b) regulations distinguish contract exchanges from plan to plan transfers on and after January 1, 2009. See Regulation Section 1.403(b) 10 (b). Under the final regulations, both the receiving employer s and transferring employer s plans must have written provisions allowing the transfer to take place. The receiving employer s plan must impose the withdrawal restrictions at least as stringent as the restrictions in the prior employer s plan. In addition, because of the additional recordkeeping that this requires, some plan sponsors may consider not accepting plan-to-plan transfers. It is far easier for the participant to process a direct rollover to the new employer s plan if the plan accepts rollovers. Employees who have invested with a vendor that is no longer an approved vendor after the new plan document is adopted: Do they have the choice of keeping their 403(b) funds with the old vendor or rolling these into the new plan s approved vendor? Revenue Procedure 2007-71, Section 8 addresses the situation when employees hold 403(b) contracts that are no longer approved under the new plan. Rev. Proc. 2007-71 provides that in the case of a contract issued after December 31, 2004, and before January 1, 2009, by a vendor that does not receive contributions under the plan in a year after the contract was issued (e.g., due to the vendor having been discontinued under the plan or the vendor having become a vendor under the plan due to the contract having been issued in a post-september 24, 2007, exchange permitted under Rev. Rul. 90-24), the contract will not fail to satisfy section 403(b) for the year merely because the contract is not part of a written plan if the employer makes a reasonable, good faith effort to include the contract as part of the employer s plan. The revenue procedure describes two alternative methods of meeting this reasonable, good faith effort requirement. For this purpose, a 6

reasonable, good faith effort to include those contracts as part of the employer s plan includes: The employer collecting available information concerning those vendors (information is not required to be collected for vendors that ceased to receive contributions before January 1, 2005) and notifying them of the name and contact information for the person in charge of administering the employer s plan for the purpose of coordinating information necessary to satisfy section 403(b), or The vendor taking action before making any distribution or loan which constitutes a good faith effort to contact the employer and exchange any information that may be needed in order to satisfy section 403(b) with the person in charge of administering the employer s plan. An employee with an orphan contract may transfer his or her account balance into the contract of approved vendors under the plan (subject to the terms of the orphan contract) but is not required to do so. Please talk through an example of a plan-to-plan transfer under the new regulations. Regulation Section 1.403(b)(10)(3) provides the following requirements where there is transfer from a contract issued under a current employer s plan to a contract issued under another plan of a new employer: 1. In the case of a transfer for a participant, the participant is an employee or former employee of the employer for the receiving plan. 2. In the case of a transfer for a beneficiary of a deceased participant, the participant was an employee or former employee of the employer for the receiving plan. 3. The transferor plan provides for transfers. 4. The receiving plan provides for the receipt of transfers. 5. The participant or beneficiary whose assets are being transferred has an accumulated benefit immediately after the transfer that is at least equal to the accumulated benefit of that participant or beneficiary immediately before the transfer. 6. The receiving plan provides that, to the extent any amount transferred is subject to any distribution restrictions under 1.403(b)-6, the receiving plan imposes restrictions on distributions to the participant or beneficiary whose assets are being transferred that are not less stringent than those imposed on the transferor plan. 7. If a plan-to-plan transfer does not constitute a complete transfer of the participant s or beneficiary s interest in the section 403(b) plan, the transferee plan treats the amount transferred as a continuation of a pro rata portion of the participant s or beneficiary s interest in the section 403(b) plan (for example, a pro rata portion of the participant s or beneficiary s interest in any after-tax employee contributions). MISCELLANEOUS ISSUES Is there anything in the new Regulations that prohibit or discourage monthly investment unit values as opposed to daily pricing of unit values? The final regulations do not address this issue. Are distributions from 403(b) allowed after termination of employment as early as age 55 without additional penalty? Taxable, but no early withdrawal penalty? Yes. IRC Section 72(t) allows a distribution after termination of employment after age 55 without being subject to the 10% early withdrawal penalty. For this purpose, severance from employment may occur anytime during the calendar year in which the participant attains age 55. Neither NAGDCA, nor its employees or agents, nor members of its Executive Board, provide tax, financial, accounting or legal advice. This memorandum should not be construed as tax, financial, accounting or legal advice; it is provided solely for informational purposes. NAGDCA members, both government and industry, are urged to consult with their own attorneys and/or tax advisors about the issues addressed herein. Copyright 2008 NAGDCA 7