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The 403(b) Plan Document

This article originally ran on April 1, 2015.

By Robert J. Toth, Jr.

Plan documents continue to demand the attention of the advisor because of the transitional period in which we find ourselves until the IRS begins approving prototype and volume submitter plans sometime next year.

Advisors can help their 403(b) plan sponsors understand two particularly important plan document issues, as we wait for the IRS to approve plan documents.

LRM Housekeeping

The first issue relates to the package of changes the IRS introduced with its March amendments to the list of required modifications (LRMs) for 403(b) pre-approved plans. The LRM is the roadmap the IRS will use when determining whether or not to approve any prototype or mass submitter plans which are submitted by April 30, 2015. For the most part, these changes accomplished some basic housekeeping — cleaning up a few technical issues — but they also provided some important guidance which will affect plan sponsors even before the pre-approved plans show up. The following summarizes the LRM changes:

1. The IRS clarified once and for all their often stated position that, for 403(b) elective deferrals, “once in, always in.” Plan sponsors often ask this question since the publication of the 2007 regulations. Before those regulations, employees who were reasonably expected not to serve more than 20 hours per week could be excluded from making elective deferrals to the plan. This rule was replaced by the regulations with a “hard” 1,000 hour rule: if even a part-time employee passed the 1,000 hour threshold in one year, he or she becomes eligible to make elective deferrals the next year. What this LRM change did is to make it clear that this eligibility becomes permanent for those employees, even in those subsequent years where they may not complete 1,000 hours of service.

2. A participant will incur a separation from service from a tax-exempt employer even if they go to work for a related employer if that related employer is an ineligible organization. This is particularly important to know in the health care industry, where 501(c)(3) orgs are often in the same controlled group as for profit employers. This means an employee transfer from, for example, the tax-exempt hospital to its for-profit medical records subsidiary will incur a separation from service — and have a distributable event.

3. The IRS clarified its position on public school district employees, for purposes of separation from service. It had seemed to have taken the position that all of the  public school districts within a state are all related employers. This meant, for example, if a school teacher transfers from a public school district to a separate intermediate school district (with a different 403(b) plan), no separation from service would have occurred. NTSA had requested removal of this reference, and the IRS concurred. 

4. The IRS clarified that separate investment accounts will not be required in order to maintain different vesting schedules on different sources of money. Before this, the language in the prior LRMs looked like it was effectively requiring different investment contracts for different sources of money. This clarification was also one NTSA had requested.

5. A “vendor” of an “investment arrangement” under a plan is either a vendor to which new contributions can be made, or vendors that can take part in an exchange. 

6. The LRMs clarified that the plan document could incorporate by reference the definition of disability which is contained in the underlying annuity contract or custodial account.

7. The LRM changes updated all of the contribution limits to reflect the changes that occurred at the beginning of the year.

Plan Document Errors

It is still too early to submit to the IRS any 403(b) “plan document errors” that a 403(b) employer may find in its document for correction under the Employee Plans Compliance Resolution System (EPCRS, the IRS’ correction program). Technically, EPCRS does currently call for plan document errors to be submitted to the IRS. However, as a practical matter, your client should not do this until after the IRS releases the first pre-approved plans. This is because the IRS will announce at the time it first releases those plans the date the first remedial amendment period (RAP) will end. Any plan document error which had occurred before the end of this first remedial amendment period — including current errors — can be self-corrected up to the end of that period.

Keep in mind that a plan document error is a very specific kind of error. It merely refers to a plan term which does not meet the requirements of law. So, for example, a 403(b) plan document term which levies a one year of service waiting period before allowing elective deferrals would be considered a plan document error which otherwise would need to be corrected by the end of the RAP, and after that, as a filing under EPCRS. However, for a plan to make loans even though the plan document does not have terms permitting them would not constitute a plan document error. Rather, it would be an operational error.

Learning how the coming pre-approved plan documents work will continue to be a challenge for plan sponsors, something for which advisors are best positioned to provide assistance.

Robert Toth is Principal, Law Office of Robert J. Toth, Jr., LLC.