Tip of the Week: Required Language in Annuity Contracts vs. Custodial Accounts

Editor’s Note: This is the first appearance of what will be 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.

There is a difference in the language that must be included in annuity contracts compared to the language required in custodial accounts. In addition to plan document requirements, the final regulations include qualification requirements that apply to the underlying annuity contracts and custodial accounts.

To qualify as a 403(b) annuity contract or a 403(b)(7) custodial account, the funding vehicle must include provisions that satisfy the requirements of the following Internal Revenue Code Sections:

• 401(a)(30) (the annual elective deferral limitations);
• 401(a)(31) (the rollover distribution requirements); and
• 401(a)(9) (the minimum required distribution requirements and incidental benefit rules).

In addition, 403(b) annuity contracts must also satisfy the requirements of Section 401(g), which require 403(b) contracts to ensure that rights under the contract are nontransferable.

It is also important to remember that the underlying funding vehicles also will include operational features to support their operational compliance efforts. While these specific features may not be required by the regulations, they may be required by the product provider as a condition of that annuity product or custodial account.

And the final regulations do require the funding vehicle to track excess 415 contributions as separate accounts which shall be treated as a separate contract for purposes of Internal Revenue Code Section 72 and to also similarly segregate amounts not yet vested under the plan.  If the terms of the contracts do not accommodate this segregation requirement, then, under the final regulations, these funding vehicles will not qualify as 403(b) annuity contracts or 403(b)(7) custodial accounts.

In addition to the above, remember that the restatement deadline for the 403(b) plan document (March 31, 2020) also applies to updating the annuity contracts and the custodial agreements. This requirement is to make sure that the product provider’s annuity or custodial account will go with the new IRS approved plan documents. For example, we know that if the custodial account or annuity contradicts the plan, the plan will rule. The underlying contracts must have that language as well.