Retirement Plans FAQs regarding 403(b) Tax-Sheltered Annuity Plans

These frequently asked questions and answers provide general information and should not be cited as any type of legal authority. They provide the user with information responsive to general inquiries. Because these answers do not apply to every situation, yours may require additional research.

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General
Participation
Contributions
Plan Investments
Loans and Distributions
Written Plan Requirement
Coverage and Nondiscrimination
Termination of Plan

General

1. What is a 403(b) plan?
2. Which employers can establish a 403(b) plan?
3. Who can participate in a 403(b) plan?

What is a 403(b) plan?

A 403(b) plan, also known as a tax-sheltered annuity plan, is a retirement plan for certain employees of public schools, employees of certain Code §501(c)(3) tax-exempt organizations and certain ministers. A 403(b) plan allows employees to contribute some of their salary to the plan. The employer may also contribute to the plan for employees.

Which employers can establish a 403(b) plan?

Generally, public schools, Code §501(c)(3) tax-exempt organizations or churches can set up 403(b) plans.

Who can participate in a 403(b) plan?

• Eligible employees of Code §501(c)(3) tax-exempt organizations;
• Eligible employees of public school systems. A public school system is defined in Code §170(b)(1)(A)(ii) as an education organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly conducted. Included in this category are employees of:
  • Public schools
  • State colleges
  • Universities
    
    
• Eligible employees of churches;
• Employees of public school systems organized by Indian tribal governments;
• Ministers employed by Code §501(c)(3) organizations;
• Self-employed ministers, treated as employed by a tax-exempt organization that is a qualified employer; and
• Ministers (chaplains) who meet both the following requirements:
  

1. 1. They are employed by organizations that are not Code Section 501(c)(3) tax-exempt organizations, and
   2. They function as ministers in their day-to-day professional responsibilities with their employers.

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Participation

1. What are the benefits of participating in a 403(b) plan?
2. When can an employee join a 403(b) plan?
3. Can a 403(b) plan automatically enroll employees in the plan?

There are significant tax advantages for participants in a 403(b), including pre-tax contributions to a 403(b) plan and earnings on these amounts are not taxed until they are distributed from the plan.

The terms of the employer’s 403(b) plan govern when an employee may enroll. However, a 403(b) plan is generally required to allow all eligible employees to participate in the plan as of their employment commencement date (the universal availability rule). Employees should check with their employer to determine how to enroll in the plan.

Yes, a 403(b) plan can automatically enroll employees if the plan allows employees to contribute to the plan, the plan’s provisions contain an automatic contribution arrangement and the employee does not opt-out (affirmatively elect not to participate) of the plan’s automatic enrollment.
 

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Contributions

1. What types of contributions can be made to a 403(b) plan?
2. May an employer sponsoring a 403(b) plan exclude any employee from contributing in the plan?
3. What is the maximum amount of elective deferrals an employee can contribute to a 403(b) plan?
4. Does the employer have to contribute to a 403(b) plan for employees?
5. What is the maximum annual combined amount that the employer and employee can contribute to a 403(b) plan for an employee?
6. Can an employer contribute to a 403(b) plan for a former employee?
7. When must the plan sponsor send an elective deferral to the vendor?

• Elective deferrals - employee contributions made under a salary reduction agreement. The agreement allows an employer to withhold money from an employee’s salary and deposit it into a 403(b) account.
• Nonelective employer contributions - contributions other than those made under a salary reduction agreement that include matching contributions, discretionary contributions and certain mandatory contributions made by the employer. The employee pays income tax on these contributions only when they are withdrawn.
• After-tax contributions - contributions (otherwise referred to as voluntary contributions that are not designated Roth contributions) made by an employee, which are reported as compensation in the year contributed and included in the employee’s gross income for income tax purposes.
• Designated Roth contributions - elective deferrals that the employee elects to include in gross income. The plan must keep separate accounting records for all contributions, gains and losses in the designated Roth account.

• employees who will contribute $200 or less annually;
• employees who participate in a 401(k) or 457(b) plan or in another 403(b) plan of the employer;
• nonresident aliens;
• employees who normally work less than 20 hours per week; and
• students performing services described in Code §3121(b)(10).

The maximum amount of elective deferrals an employee can contribute annually to a 403(b) is generally the lesser of:

• 100% of includible compensation; or
• $17,000 (in 2012; $17,500 in 2013 and subject to annual cost-of-living increases).
  

However, this general limit is reduced by the amount of elective deferrals an employee makes to:

• 401(k) plans;
• SIMPLE IRA plans;
• Salary Reduction Simplified Employee Pension (SARSEP) plans;
• other 403(b) plans; and
• Code §501(c)(18) plans.
  

If the plan allows:

• an employee who has worked for a qualified organization for 15 or more years may, if he or she meets certain requirements, be able to make additional contributions of up to $3,000 for up to 5 years (see 15-year rule in Pub. 571, Tax-Sheltered Annuity Plans (403(b) Plans); and
• an employee who is age 50 or older may make an additional catch-up contribution of $5,500 (in 2012 and 2013 and subject to annual cost-of-living increases), reduced by the amount of catch-up contributions made to other plans.

No. An employer may, but is not required to, contribute to the 403(b) plan for employees.

What is the maximum annual combined amount the employer and employee can contribute to a 403(b) plan for an employee?

The maximum combined amount both the employer and the employee can contribute annually to the plan is generally the lesser of:

• $50,000 for 2012 ($51,000 for 2013 and subject to annual cost-of-living increases); or
• an employee’s includible compensation for his or her most recent year of service.
  

Employees meeting certain requirements and plan participants may be eligible to make additional contributions.

Can an employer contribute to a 403(b) plan for a former employee?

Yes, if the plan allows, an employer can make nonelective contributions, up to the annual limits ($50,000 for 2012; $51,000 for 2013 and subject to annual cost-of-living increases), to a former employee’s account for 5 years after the date of severance. However, no portion of these contributions can come from money otherwise payable to the former employee by the employer and must cease at the death of the former employee.

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Plan Investments

1. How are 403(b) plan assets invested?
2. What are the rules on in-service transfers or exchanges?
3. Do the new in-service transfer rules also apply to custodial accounts and church retirement income accounts?

How are 403(b) plan assets invested?

Assets in a 403(b) plan can be placed in any of the following investment types:

• an annuity contract provided through an insurance company;
• a custodial account invested in mutual funds; or
• a retirement income account set up for church employees.

What are the rules on in-service transfers or exchanges?

Contract exchanges with a non-payroll slot vendor are permitted if:

• the plan permits the exchange;
• the accumulated benefit after the exchange is at least the same as before the exchange;
• the employer and the non-payroll slot vendor agree to share information regarding employment and the plan’s terms;
• any pre-exchange benefit restrictions are maintained after the exchange; and
• the vendor complies with the plan’s terms.
  

Plan-to-plan transfers between 403(b) plans are permitted if:

• the terms of the transferring and receiving plans allow these transfers;
• the transferred assets belong to a current or former employee of the receiving plan’s sponsor;
• the accumulated benefit after the exchange is at least the same as before the exchange; and
• any benefit restrictions of the transferring plan are maintained by the receiving plan.
  

Rev. Proc. 2007-71 contains additional details on contract exchange and transfer rules.

Only eligible rollover distributions can be transferred between a 403(b) plan and a qualified plan (for example, a 401(k) plan) or a 457 plan).
 

403(b) plans subject to the Employer Retirement Income Security Act of 1974 (ERISA) should also consult the Department of Labor’s rules for additional conditions on in-service transfers.

Do the in-service transfer rules also apply to custodial accounts and church retirement income accounts?

Yes.

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Loans and Distributions

1. Can employees take loans from their 403(b) account?
2. Can employees get a hardship distribution from their 403(b) account?
3. When can employees take money out of a 403(b) plan?
4. How are benefits paid to an employee from a 403(b) plan?

Can employees take loans from their 403(b) account?

Yes, a 403(b) plan may, but is not required to, allow loans. If permitted by the plan, employees may obtain a loan to the extent and in the manner allowed by the plan.

Can employees get a hardship distribution from their 403(b) account?

A 403(b) plan may, but is not required to, allow hardship distributions. If permitted by the plan, participants may obtain a hardship distribution to the extent and in the manner allowed by the plan.

When can employees take money out of a 403(b) plan?

In addition to loans and hardship distributions, a 403(b) plan may allow employees to take money out of the plan when they:

Employees may also receive a qualified reservist distribution.
 

Eligible distributions may be rolled over to another plan or an IRA.
 

The employee will have to pay taxes on any amount of the distribution that was not from designated Roth or after-tax contributions and may have to pay an additional 10% early distribution tax unless an exception to this tax applies.

How are benefits paid to an employee from a 403(b) plan?

403(b) plans may provide employees with a choice on how benefits will be paid. For example, an employee can choose to have benefits paid in a lump sum.
 

Certain distributions may be eligible for rollover to another plan or an IRA.

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Written Plan Requirement

1. What is the “written plan” requirement?
2. Are there any vendor contracts that are excluded from the 403(b) written plan requirement?
3. What is the deadline for having a written 403(b) plan?
4. Do 403(b) plans have to amend their plan documents to comply with changes in the law?
5. Does having a written plan cause a non-ERISA 403(b) plan to become subject to ERISA?

What is the “written plan” requirement?

A 403(b) plan must be maintained under a written program which contains all the terms and conditions for eligibility, benefits, limitations, the form and timing of distributions and contracts available under the plan, and the party responsible for plan administration which satisfy Code §403(b).
 

The written plan requirement does not mean that the plan must be contained in a single document. For example, the plan can consist of multiple documents that contain the various plan provisions regarding salary reduction agreements, contracts that fund the plan, eligibility rules, how the plan will pay benefits and the nondiscrimination rules.
 

Church plans that do not contain any retirement income accounts are exempt from having a 403(b) written plan.

Are there any vendor contracts that are excluded from the 403(b) written plan requirement?

Yes. The following contracts are excluded:

• contracts issued before December 31, 2004 to which contributions have ceased; and
• contracts issued between January 1, 2005 and December 31, 2008:
  • that are no longer receiving contributions;
  • which the employer has made a good faith effort to include as part of the employer’s plan by collecting available information about the issuers; and
  • the employer has notified the issuers of the plan administrator’s name and contact information to coordinate information necessary to satisfy the requirements of Code §403(b).

What was the deadline for having a written 403(b) plan?

The deadline for 403(b) plan sponsors to adopt new written plans or amend their existing written plans that were effective in 2009 was December 31, 2009. The IRS considers 403(b) plans as having timely adopted a written plan if the plan sponsor:

• adopted or amended a written plan by December 31, 2009, intended to satisfy §403(b) and the 403(b) final regulations, making it effective January 1, 2009;
• operated the plan during 2009 using a reasonable interpretation of the 403(b) final regulations; and
• made its best effort to retroactively correct, by the end of 2009, any operational failure that happened in 2009 to conform to the written plan, based on the general principles of correction in the IRS’s Employee Plans Compliance Resolution System.

Do 403(b) plans have to amend their plan documents to comply with changes in the law?

Yes. However, 403(b) plans do not have to amend their plan documents until after the commencement of the initial remedial amendment period described in Notice 2009-89.

Existing 403(b) plans will have a remedial amendment period retroactive to January 1, 2010, or the effective date of their plan, if later, to correct form defects in their plan documents retroactive to January 1, 2010 if the employer:

• adopted a written plan document no later than December 31, 2009, and
• timely adopts a pre-approved plan with a favorable opinion letter (or timely applies for an individual determination letter for the 403(b) plan once this is available).
  

As of January 1, 2010, employers with existing 403(b) plans can rely that the form of their plan documents satisfy the 403(b) requirements if they retroactively correct plan defects during the plan’s remedial amendment period.

Reliance for employers who establish a 403(b) plan on or after January 1, 2010, is retroactive to the plan’s effective date if the employers either:

• timely adopts a pre-approved plan with a favorable opinion letter, or
• timely applies for an individual determination letter and corrects any form defects retroactive to the plan’s effective date
  

once these programs are available.

Does having a written plan cause a non-ERISA 403(b) plan to become subject to ERISA?

For guidance on what may cause a 403(b) plan to be subject to ERISA, please consult the Department of Labor’s rules.

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Coverage and Nondiscrimination

1. What is “universal availability”?
2. Which employees can be excluded from the plan?
3. Are there nondiscrimination rules that apply to employer contributions?

What is “universal availability”?

Generally, universal availability means that if an employer permits one employee to defer salary into a 403(b) plan, the employer must extend this offer to all employees, other than those whom the law allows to be excluded.
 

Universal availability also requires the plan to give meaningful notice to employees of their right to make elective deferrals. The notice must notify the employees of:

• their right to make elective deferrals;
• when to make an election; and
• when and how often during the year they can change that election.
  

A 403(b) plan generally may not place conditions on an employee’s right to make elective deferrals. For example, the plan sponsor cannot require that an employee take out a certain level of health insurance before being allowed to make elective deferrals to the 403(b) plan.

Which employees can be excluded from the plan?

A 403(b) plan may exclude certain employees from universal availability for elective deferrals:

• Employees who normally work less than 20 hours per week (this does not necessarily mean all part-time employees);
• Employees who will contribute $200 annually or less;
• Employees who participate in a 401(k) or 457 plan, or in another 403(b) plan of the employer;
• Non-resident aliens; and
• Students performing services described in §3121(b)(10).

Are there nondiscrimination rules that apply to employer contributions?

Yes, nongovernmental and non-Church 403(b) plans must satisfy the nondiscrimination requirements for both employer nonelective and matching contributions.

An employer’s nonelective contributions must satisfy all of the following nondiscrimination requirements in the same manner as a qualified plan under Code §401(a):

• Code §401(a)(4) – relating to nondiscrimination in contributions and benefits;
• Code §410(b) – relating to minimum coverage;
• Code §401(a)(17) – limiting the amount of compensation that can be taken into account; and
• Code §401(m) – relating to matching and after-tax employee contributions.

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Termination of Plan

1. Can an employer terminate a 403(b) plan?
2. What happens to a participant’s assets when a when a 403(b) plan is terminated?

Can an employer terminate a 403(b) plan?

Yes, subject to the termination guidelines in Treas. Reg. §1.403(b)-10.

What happens to a participant’s assets when a 403(b) plan is terminated?

Generally, a terminating 403(b) plan must distribute all accumulated benefits to the participants and beneficiaries as soon as administratively feasible. Revenue Ruling 2011-7 provides examples of how to terminate a 403(b) retirement plan funded in different ways and explains when the terminating plan’s distributions are taxable.

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