403(b) Plan Termination
Rev. 10/31/08, E-mail Alert 2008-14

403(b) Final Regulation Provisions for Plan Termination
Plan termination is a distributable event under the final 403(b) regulations 1.403(b)-10(a). Prior to 2009, a written plan does not have to be adopted as long as a reasonable effort is made to follow the plan termination provisions of the final 403(b) regulations. After 2008, a written plan is required to terminate and should contain successor plan provisions.

Successor Plan Rules
The successor plan rules require that no contributions be made to a 403(b) as of the termination date of the 403(b) plan being terminated or to any 403(b) of the employer for 12 months after all distributions have been made from the terminated 403(b) plan.

2% exception
If during the period beginning 12 months before the termination and ending 12 months after distribution of all assets from the terminated plan, fewer than 2 percent of the employees who were eligible under the section 403(b) plan as of the date of plan termination are eligible under the alternative section 403(b) contract, the successor plan rule is disregarded.

403(b) Plan Termination, Prior to the Final Regulations
Employers who ceased contributions to a 403(b) plan or attempted to “terminate” their 403(b) plan prior to the 403(b) final regulations, have to take action if they wish to actually terminate their plan. In our discussions with high-ranking IRS representatives they have made it clear that since a 403(b) plan termination was not possible prior to the final 403(b) regulations, an employer who stopped 403(b) contributions (and may have even issued a board resolution to “terminate” the 403(b) prior to the final regulations) has not terminated the 403(b) plan because there was no plan termination event prior to the final 403(b) regulations.

403(b) plans "frozen" or attempted to be "terminated" prior to the final 403(b) regulations still exist and thus need action now.

To terminate now, the employer would have to follow the termination processes described in this article, including the requirement that all the 403(b) assets be distributed within 12 months of the termination for it to be a valid termination. Since the plan, at this time, would be continuing to exist into 2009, the most conservative method of the employer protecting the 403(b) plan would be to adopt a 403(b) plan before January 1, 2009.

If the employer does not wish to terminate the "frozen" plan, the employer must adopt a 403(b) plan to be in compliance with the final 403(b) regulations by the end of 2008.

403(b) Final Regulations Create Plan Termination Distributable Event
After issuance of the final regulations, an employer may terminate a 403(b) plan. The final regulations make a 403(b) plan termination a distributable event. A 403(b) plan termination requires the employer to take plan termination steps, such as, a board resolution and notification of employees.  The termination is subject to the 403(b) successor plan rules above. However, a 401(k) plan may be established immediately as this is not considered a successor plan to a 403(b). Note that a 403(b) plan may not be merged into a 401(k) plan, nor any qualified plan.

403(b) Plan Termination Steps

• Board resolution to terminate the 403(b) plan
• Cease all contributions as of termination date
• Notifying Employees of plan termination
• Distribution forms and 402(f) notices provided
• Form 5310 is not to be filed as there is no qualification upon termination
• Distribute assets within 12 months – This is the challenging step

Can Employer Meet Requirement to Distribute Assets within 12 Months?
Like a qualified plan, a 403(b) plan termination requires all the plan assets to be distributed within 12 months of plan termination date. Unlike a qualified plan, 403(b) contracts have historically been titled in the name of the individual employees. Vendors distribute only on authorization from each employee. The employer has previously had limited or no say in the distribution of an individual’s contracts. Thus, unresponsive employees cannot be automatically rolled to IRA.

Managing Employer Expectations About a 403(b) Plan Termination

Plan termination as a distributable event requires:

• Employer understanding of the issues
• All employees make timely distribution
• Assets under the plan may not be distributed unless there is a plan termination, i.e. distributable event.
• A failed plan termination causes distributions to have occurred without a distributable event and thus the result is immediate tax inclusion.

If a 403(b) plan termination is invalid due to failure of all employees to take a distribution within 12 months, then rollovers to an IRA are invalid rollovers. 

In speaking with high-ranking IRS representatives, they indicated that they hope to address a correction procedure for this in the next update of EPCRS.

Bill Grossman, QPA