Business of Benefits : Employee Benefits Lawyer & Attorney : Law Office of Robert J. Toth, Jr. : 403(b) Plans, Annuity & Insurance Law : Business of Benefits Blog

 The IRS issued its long awaited guidance on the termination of 403(b) plans, with Revenue Ruling 2011-7. TEGE was well attuned to the challenges of terminating 403(b) plans, and its staff moved quickly to address some of the basic issues related to this "newly found" ability, provided by the 403(b) regulations, to treat the 403(b) plan termination as a distributable event. The delay in the final issuance of this guidance was due to factors well beyond the control of the TEGE, which had pressed to have it approved much earlier.

A number of practitioners are likely to be disappointed by the limited scope of this ruling. However, it establishes a fundamental structure within which to work, and clarified things at which we could only guess in the past.  A number of issues are left unresolved, which I hope will be addressed over time by the IRS. But this provides us with an important starting point.

In dealing with anything as complex and new as a 403(b) termination, guidance will be a mixed bag. Here, there are Clarifications and things that still leave us In the Fog. 

Clarifications

1. We now know the process to be followed under which the IRS will recognize a plan as being terminated and as a distributable event occurring: a binding resolution; notification to participants and beneficiaries of the termination; 402(f) notice of rollover rights; cessation of all 403(b) contributions to other 403(b) plans within the controlled group (or at least, per the regs, 98% of the group); and distributions are made within 12 months, including distributions of  "a fully paid individual insurance annuity contract."
2. Certificates under a group annuity contract will be considered as the distribution of  a "fully paid individual insurance annuity contract" as long as all of the other rules are met.
3. The distributed annuity contract will still be considered a 403(b) contract.
4. Amounts from this distributed contract can still be rolled over.
5. The IRS formally recognized the legitimacy of the group custodial arrangement

In the Fog

1. The revenue ruling is silent on whether or not, or under what conditions, the distribution of a custodial account can be treated as a "fully paid individual insurance annuity contract." I would hesitate to treat this silence as meaning it can't be done, as the ruling doesn't change the legal basis used by those who distribute custodial accounts. it may exist. But the custodian must agree to the "distribution"  treatment if that is what you choose-and, in any event, the revenue ruling doesn't provide support for this position.
2. It cites "Situation #3," where a participant elects payments from a custodial account upon termination of the plan, either cash or in kind. It is silent on what happens when no election is made. I assume the termination then fails, but this is unclear. 
3. There is no guidance on what constitutes delivery of a "fully paid" contract. Hopefully, in the case of an individual contract, it merely means notifying the individual that the contract is no longer part of the plan. 
4. It creates some confusion on vesting in non-ERISA governmental plans: the tax regs don't seem require full vesting of non-vested amounts on termination, as they are treated as 403(c) monies. It only requires that 403(b) amounts be non-forfeitable. I THINK all this ruling says is that the 403(c) amounts can never become 403(b) upon termination if they do not vest-but that is unclear.
5. The ruling is silent on what happens to the distributed (and rolled) amounts if all of the assets cannot be distributed by the end 12 month period-which can be a real problem for 403(b) plans which generally doesn't exist for 401(k) plans.

AND, perhaps the Grandest Fog:

How does a distributed contract, with no employer being responsible for it, maintain its status as a 403(b) contract? A colleague has pointed out that it appears to require a permanent grandfather of the rules as of the date of  distribution-which is incredibly unworkable from a vendor view given the amount of change that occurs in this area. Or, as my good friend and mineral collector Evan Giller colorfully puts it, it preserves each year's then current rules "like bugs in Amber..." (though, as Evan also points out, Amber is not really a mineral).

There are other questions along the same lines.  Can you roll funds into it, as permitted under 403(b)? Can you process loans, and can the vendor rely upon participant representations? What of transfers and exchanges?

This Revenue Ruling also raises a related question, for future guidance, that is, the question on whether or not there will be a determination letter process for 403(b) terminations.

This is a nice start. But there is still a lot of work to be done.

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The DOL's newly delayed 408(b)(2) regs are particularly striking in that they demonstrate a growing sophistication, and efficiency, on the part of the EBSA staff in its approach to retirement plan financial products and services. The regs are short, by almost any measure of federal regulations, yet they are packed with meaningful rules which will apply in different ways to different product and services.  

The marketplace is a fast moving one, with complex instruments and services being used in new and unusual ways. Keeping up with this whirlwind is a challenge for the industry and employers, let alone a government regulatory agency which must somehow craft rules which have broad application to ever-shifting, complex and unanticipated circumstances.  Though not always successful, the DOL is approaching its learning curves impressively-including the way in which continues to seek to know and understand what it does not.

A prime example of this is the manner in which the 408b2 rules apply to variable investment accounts within the annuity contracts used to fund 403(b), 401(k) and other 401(a) plans. What is fascinating is that the word "annuity" only shows up with regard to IRAs;  the words "individual," "group," "variable," "fixed," "registered," or "non-registered"-all of which are descriptors of a variety of different sorts of annuity contracts- never show up; and the word "insurance" only appears once. Yet, it provides clear guidance on how these investment products are to be regulated. 

Lets take a quick look at the way the rules apply differently to registered variable annuity separate accounts (lets call these "Type 1" for purposes of this blog) typically used in the 403(b) market, and the way they apply to non-registered variable annuity separate accounts (which I'll call "Type 2") typically used in 401(k) plans.

This, by the way, is important for plan sponsors to know because they have to sort out whether they are receiving the disclosures they need, and report it to the DOL if they are not.

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