Tip of the Week: General Requirements for Plan-to-Plan Transfers and Exchanges

Editor’s Note: This is an occasional feature in the NTSA Advisor. It is drawn from The Source, a book that covers technical, compliance, administrative and marketing aspects of the 403(b) and 457(b) markets. More information about The Source is available here.
 

1. The withdrawal restrictions applicable under the receiving vendor’s 403(b) account must be at least as restrictive after the transfer or exchange as they were before the transaction. For example, if a 403(b)(7) mutual fund value is moved to a 403(b)(1) annuity, it cannot “pick up” the grandfathering of pre-1989 annuity account values which are unrestricted (all of the values in custodial accounts are restricted).
2. The accumulated benefit of the 403(b) account after the exchange or transfer must be no less than the accumulated benefit immediately before the transfer or exchange. However, normal product charges such as surrender charges or sales loads are permitted. While the requirement for exchanges and transfers are relatively clear, there are several issues that naturally emanate from application of these rules

The following issues should also be considered when evaluating exchange and transfer rules:

• An exchange can be done without severance from employment, age 59½ or any other distributable event. Plan-to-plan transfers may require severance from service when the transfer is between plans of different employers. These transactions are not distributions and income tax reporting is not required. Before permitting plan-to-plan transfers or exchanges, vendors will need to check that the employer’s written plan does permit the exchange or transfer and that the receiving vendors are included in the employer’s plan.
• There is no requirement that the insurance or mutual fund companies honor a request for a plan-to-plan transfer or exchange, unless their contracts require conformity with such requests.
• Exchanges may be made by participants or by their beneficiaries. Beneficiaries that want to retain the 403(b) account as an inherited account and “stretch” distributions over their own life expectancy may want to change the investment choices made by the deceased.
• Partial account values can be transferred or exchanged. It makes no difference whether the partial value is an annuitized installment payment, the annual free withdrawal corridor (usually 10%) or simply a designated lump-sum portion of the full value. This provides a great deal of flexibility to help participants meet their specific goals.
• Plan-to-plan transfers or exchanges must be done directly from one provider to another. Only eligible rollover distributions can be done directly or indirectly.
• There is no requirement that a 403(b) plan permit either exchanges or plan-to-plan transfers. There are valid reasons to permit these options and equally valid reasons for employers not to include one or both features in their 403(b) plans. However, this decision will have a significant impact on plan participants.
• Once participants are eligible to receive distributions (for example at age 59½ or upon separation from service), it is likely that rollovers will be the primary means of moving 403(b) account values since 403(b) plans must permit direct rollovers and provide notice of the participant’s right to directly rollover the distribution to avoid the mandatory 20% federal tax withholding applied to indirect rollovers.