Though not as well known as 401(k) plans, 403(b) arrangements hold a large portion of American workers’ retirement savings. And while they have largely avoided regulatory scrutiny over the last several decades, the IRS and DOL are increasing their oversight, in part through new guidance – the final 403(b) tax regulations that went into effect this year are the best example – and greater audit activity. This is the first of a two part article addressing issues that private sector 403(b) sponsors need to be concerned about, with some recommendations on how to deal with them.
First, some background: 403(b) plans are the retirement savings vehicle for public educational institutions and 501(c)(3) tax-exempt entities. They must comply in form and operation with provisions of the Internal Revenue Code and the new tax regulations. However, only the plans of certain tax-exempts fall outside the DOL’s “safe harbor” rules and become subject to ERISA – e.g., where the employer makes contributions or exercises control over the plan, e.g., by selecting a single investment provider or approving loans, hardship distributions or QDROs.
So what are some of the common issues for ERISA-governed 403(b) plans?
- ERISA Plan – The Problem: Many tax-exempt entity plans fall outside the “safe harbor” rules for avoiding ERISA coverage, but fail to recognize it. The Consequences: ERISA imposes requirements in addition to those under the new tax regulations, including reporting and disclosure rules, fiduciary duties and prohibited transaction restrictions. Failure to comply can impose personal liability and penalties on plan officials. Recommendation: Have the plan reviewed by a knowledgeable expert and take immediate corrective action to come into compliance if required.
- Non-Amender – The Problem: The 403(b) regulations require all plans – both ERISA and non-ERISA – to have a written plan by the end of 2009, but it’s likely that at least some won’t meet the deadline. The Consequences: If the plan fails to comply, IRS officials have said, “there is no 403(b) plan” – which means employees lose their tax savings. Recommendation: Create a written plan as soon as possible. While there is no current IRS correction program that permits retroactive adoption of a plan, we believe the IRS will adopt one in 2010, though it will require payment of a penalty to use it.
- Governing Documents – The Problem: ERISA plans must contain certain provisions in addition to those required in the tax regulations. ERISA also requires that plans adopt a participant loan policy (if loans are permitted) and a QDRO policy, and an investment policy statement is highly desirable. The Consequences: Failure to have an ERISA-compliant document can expose the employer and plan officials to liability and penalties for breach of fiduciary duty. Recommendation: Have the plan document reviewed by a knowledgeable expert to ensure compliance with ERISA requirements if required.
- Deposit of Deferrals – The Problem: ERISA and the tax regulations require employee deferrals to be deposited on a timely basis – as soon as practicable after pay day in the case of ERISA plans. The Consequences: Failure to deposit the funds timely requires the plan sponsor to add lost earnings when they are put into the plan and can also cause penalties and potential loss of the tax benefits of a 403(b) plan. Late deposits must be reported on the annual Form 5500 by ERISA plans. Recommendation: Set up procedures to deposit the funds timely. For any late deposits, correct the failure immediately and add lost earnings (the DOL has a “calculator” on its website for figuring out how much to deposit). The DOL has a correction program that should be used in some cases, and we anticipate that the IRS will add this to its voluntary correction programs in the future.
403(b) plans haven’t become more complicated; they’ve always been subject to a lot of rules, especially if they are covered by ERISA. Until now, however, the enforcement of those rules has been somewhat lax. That’s changing and 403(b) plan sponsors are well-advised to understand how to comply.
In the next issue, we’ll discuss additional issues and how to handle them.
Disclaimer Required by IRS Rules of Practice:
Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.