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Breaking Up Is Hard To Do, But a 403(b) Plan Termination Checklist May Help

This article originally ran on June 19, 2015.

Linda Segal Blinn, J.D.

In its Code Section 403(b) regulations, the IRS provided the authority for an employer to terminate its 403(b) plan. 

According to IRS guidance, an employer looking to terminate its 403(b) plan must distribute all amounts from the plan to plan participants, as well as to any alternate payees and beneficiaries maintaining accounts under the 403(b) plan. If the 403(b) plan invested in annuity contracts, the regulatory requirements are satisfied if the distribution takes the form of a paid-up annuity contract or paid-up annuity certificate (which may occur if the contract under the 403(b) plan was a group annuity contract). If the amounts under the terminating 403(b) plan are held in a 403(b)(7) custodial account, amounts would be distributed to plan participants (and, if applicable, beneficiaries and alternate payees). Amounts distributed pursuant to a 403(b) plan termination may be rolled over to another eligible retirement plan in accordance with Internal Revenue Code requirements. 
As is usually the case, the devil may be in the details. If a 403(b) plan termination is defective, then individuals receiving amounts from the erstwhile termination may not meet the IRS criteria for having a distributable event for a 403(b) plan. And that could have a further ripple effect if the individual has rolled over amounts to another eligible retirement plan or to an IRA. 
Considering the following questions can help assist an employer who intends to terminate its 403(b) plan:  
What is contemplated — deselection of a product vendor or a complete termination of the 403(b) plan?
Terminology matters. There is a difference between discontinuing contributions to a product vendor and terminating a 403(b) plan. 
If the employer no longer will be remitting 403(b) contributions to a product provider, that vendor is no longer approved to receive contributions under the 403(b) plan (and presumably the employer would amend the 403(b) plan document to reflect this). In such a scenario, the focus is on the products available, rather than looking at the 403(b) plan as a whole. 
However, a 403(b) plan termination requires the distribution of all amounts under that plan to participants (and, if applicable, beneficiaries and alternate payees maintaining accounts under the plan). In addition, the IRS 403(b) regulations require that, in general, the employer (taking into account all related employers or employers under common control) is prohibited from making contributions (including remitting employee deferrals) to any 403(b) contract that is not part of the terminated 403(b) plan for a 12-month period beginning with the date of 403(b) plan termination and ending 12 months after distribution of all assets from that terminated plan. 
There is an exception to this general rule — the ability of an employer to make contributions to another 403(b) contract not associated with the terminating 403(b) plan is allowed if fewer than 2% of the employees who were eligible to participate in the 403(b) terminated plan are eligible to participate in another 403(b) plan of that employer.
Is there sufficient authority to terminate the 403(b) plan?
If the employer is a public school or other governmental entity, state and/or local law must provide that employer with the authority to terminate a 403(b) plan. Since the concept of 403(b) plan termination is relatively recent, state and/or local law may be silent as to whether a public plan sponsor has the authority to terminate its 403(b) plan. 
And, regardless of whether the plan sponsor is a governmental entity or a 501(c)(3) nonprofit organization, employment contracts and collective bargaining agreements should be reviewed. If a contract or agreement addressees the 403(b) plan, the employer may need to assess whether an amendment to that document is warranted before the employer proceeds with terminating the 403(b) plan, and that, in turn, may entail opening up negotiation with the impacted employee group(s). 
If the employer determines that it has the authority to terminate its 403(b) plan, then a board resolution would be needed to put in motion the formal termination of the 403(b) plan and the 403(b) plan would need to be amended to reflect termination. 
Do all products under the 403(b) plan recognize 403(b) plan termination as a distributable event?
Since the IRS 403(b) regulations require that all amounts be distributed to constitute a 403(b) plan termination, the employer should confirm that all products under the 403(b) plan recognize (or can be endorsed to authorize) termination of the 403(b) plan as a distributable event. 
Must participant accounts vest upon plan termination?
A participant is always vested in his employee contributions (whether pre-tax or Roth), rollovers to the 403(b) plan, and associated earnings. So, vesting only comes into play if there are employer contributions made to the 403(b) plan that are not fully vested when contributed.

If the 403(b) plan is subject to ERISA, then amounts must be fully vested upon plan termination. However, for non-ERISA 403(b) plans, the answer is less clear-cut. However, the IRS has taken the position, both in its 403(b) List of Required Modifications and under the fact patterns assumed in Revenue Ruling 2011-7, that a 403(b) plan document would provide for full vesting upon plan termination. 

The IRS also walks 403(b) sponsors through the steps required to terminate a 403(b) plan through content on its site.  
Linda Segal Blinn, J.D.*, is vice president of Technical Services for Tax-Exempt Markets at Voya Financial. In this capacity, Blinn leverages over 25 years of experience administering and designing defined contribution plans to provide general legislative and regulatory information to assist public and non-profit employers in operating their retirement plans.
This material was created to provide accurate information on the subjects covered. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. These materials are not intended to be used to avoid tax penalties, and were prepared to support the promotion or marketing of the matters addressed in this document. The taxpayer should seek advice from an independent tax advisor. 
* Linda is not a practicing attorney for Voya Financial.