It would be hard to accuse the IRS of moving too hastily when it comes to issuing regulatory guidance under Section 403(b) of the Tax Code. The IRS issued comprehensive regulations governing “tax-sheltered annuities” (or “TSAs”) in 1964. Not until 2004 did the IRS propose a comprehensive rewrite of those regulations — despite a host of intervening statutory changes. Those proposed regulations have only now been finalized, and they are not generally effective until 2009.
Now that these final 403(b) regulations are out, sponsors of TSA arrangements will want to familiarize themselves with them. For employers who have deliberately taken a “hands-off” approach to their TSAs, these regulations may come as a shock. For instance, they will require a written plan document — even for “non-ERISA” arrangements. Although the final regulations state that a 403(b) plan document may incorporate other documents by reference (such as annuity contracts or custodial agreements), the IRS clearly intends that any employer whose TSA offers investment options from multiple vendors maintain a “master plan document” coordinating the administrative responsibilities of the employer and each vendor.
Although the Department of Labor has advised (in its recent Field Assistance Bulletin 2007-02) that compliance with these IRS regulations will not necessarily render a TSA subject to ERISA, it seems all but certain that many previously non-ERISA arrangements will now be subject to ERISA. Among other things, this would implicate ERISA’s fiduciary duty and annual reporting requirements. (Of course, public schools could continue to rely on ERISA’s exemption for governmental plans.)
There are other respects in which these final regulations will make 403(b) plans look and act more like 401(k) plans. For instance, it will now be possible to terminate a 403(b) plan — and distribute all account balances in connection with that termination. Some TSA sponsors may wish to take advantage of this option to substitute a 401(k) plan for an existing (perhaps even frozen) 403(b) plan.
On the other hand, the regulations also make clear that many Tax Code rules unique to 403(b) plans remain in place. Dealing with these special rules will remain a challenge for the foreseeable future.