403(b) Termination
Rev. 05/20/11; E-mail Alert 2011-8

403(b) Plan Termination Guidance
The 403(b) plan termination guidance, Revenue Ruling 2011-7, was issued February 22, 2011. The ruling consists of:

> IRS law and regulatory background;
> Four examples of 403(b) plan terminations; (each example has another type of investment)
> IRS analysis of each situation explaining how each satisfies a 403(b) plan termination;
> IRS holding on 403(b) plan termination, which reiterates everything.

Relevant Regulations Provisions
For a §403(b) plan to be considered terminated under §1.403(b)-10(a), all accumulated benefits under the plan must be distributed to all participants and beneficiaries as soon as administratively practicable after termination of the plan.

For rules relating to when distributions to all participants and beneficiaries are made as soon as administratively practicable after plan termination in the case of a plan qualified under §401(a), see Rev. Rul. 89-87.

For this purpose, delivery of a fully paid individual insurance annuity contract is treated as a distribution.  

The mere provision for (and the making of) benefit distributions to participants or beneficiaries upon plan termination does not cause a contract to cease to be a §403(b) contract.

Section 1.403(b)-7 provides rules regarding the tax treatment of benefit distributions, including §1.403(b)-7(b)(1) under which an eligible rollover distribution is not included in gross income if paid in a direct rollover to an eligible retirement plan or if transferred to an eligible retirement plan within 60 days. 

Fact Set for Situation 1

• The Plan is a DC, Governmental Plan, which is not subject to ERISA
• Contributions limited to employer nonelective and pretax elective deferrals (no designated Roth or after-tax)
• Satisfies §403(b) and regulations (just prior to action to terminate the plan)
• Distributable events limited to severance or plan termination
• Funded solely by fully paid individual annuity contracts issued by an insurance company
• Employer has no other 403(b) plans and there are no related employers
• No contributions to any other 403(b) plans are permitted within 12 months after termination

On or before January 1, 2012, the employer sponsoring the Plan takes the following actions to terminate the Plan:

1. Adopts a binding resolution to cease 403(b) contributions effective January 1, 2012, (i.e. no future purchases of annuity contracts under the Plan), and to terminate the Plan.
2. The resolution provides that:

• All benefits are fully vested on January 1, 2012,
• All benefits are to be distributed as soon as practicable thereafter.

      4. §402(f) notices are provided; and

      5. Distributions are made as soon as is practicable after the termination date.

      6. Distributions are “effectuated by distribution of fully paid individual insurance annuities” to all participants.

Some contracts permit single-sum payments at plan termination which are made as soon as practicable after January 1, 2012. Eligible rollover distributions may directly transfer to an IRA (account or annuity) or other eligible retirement plan

IRS Analysis of Situation 1

1. The employer timely adopted a binding resolution to cease contributions and terminate the plan at a specified date, including full vesting for all benefits as of that date.
2. Contracts under the plan remain 403(b) contracts at plan termination because the employer took action to fully vest at the date of plan termination. Required by §§1.403(b)-3(d)(2) and 1.403(b)-10(a)(1).
3. Such contracts may permit benefits to participants to commence immediately upon plan termination, or, at a later date to the extent provided in the plan document and the termination resolution, subject to applicable Code (and ERISA) rules where applicable.
4. Distribution was made by delivery of a fully paid individual annuity contract or a single-sum payment to each participant or beneficiary as soon as practicable after the termination date. Following plan termination, participants and beneficiaries who hold fully paid insurance annuity contracts are entitled to payments in accordance with the terms of the contracts (which may permit single-sum payments in connection with plan termination or which may permit distributions to commence at a later date from the annuity).
5. As the plan is funded solely with fully paid individual insurance annuity contracts, no further action is required to be taken in order to distribute the contracts.
6. The successor plan rules forbidding contributions for 12 months after the last distribution is followed.

The actions taken by the employer to terminate the plan and distribute accumulated benefits satisfy the requirements of §403(b) and §1.403(b)-10(a).

Fact Set for Situation 2

The facts are the same as in Situation 1, except that the Plan is funded by a group annuity contract in addition to individual annuity contracts.

1. Distribution from the group annuity contract is effectuated by issuing individual certificates to each participant evidencing a fully paid interest in his or her benefits under the contract as soon as practicable after January 1, 2012.
2. Some participants receive a single-sum payment as a liquidating distribution from the contract in accordance with the terms of the contract.

IRS Analysis of Situation 2

1. In Situation 2, the same actions were taken as in situation 1, except the employer provided an individual certificate evidencing fully paid benefits under the contract to each participant whose accumulated benefits are funded by a group annuity contract. 
2. The issuance of this certificate to each participant constitutes a distribution of the participant’s accumulated benefit in the group annuity contract for purposes of §1.403(b)-10(a).
3. As in situation 1, no amount is included in gross income until amounts are paid out of the policy.

Fact Set for Situation 3

The facts are the same as in situation 2, except that Plan A is funded not only by individual annuity contracts, and by a group annuity contract, but also by one or more regulated investment companies (mutual funds) in custodial accounts that are treated as annuity contracts for purposes of § 403(b).

1. Custodial accounts are maintained either under individual or group agreements. Distribution from custodial accounts made as soon as practicable.
2. Depending on the participant’s election, custodial account distributions are made (in cash or in-kind) to: the participant, an IRA established for the participant, or to another eligible retirement plan. Distribution to an IRA or to another eligible retirement plan is by direct rollover.
3. Each custodial account provider permits an eligible rollover distribution (as described in §402(c)(4)) to be paid by a direct transfer to an IRA account or annuity or  an other eligible retirement plan.

Fact Set Situation 4

The facts are the same as in Situation 3, except:

1. The 403(b) plan is a money purchase pension plan subject to ERISA;
2. The qualified joint and survivor annuity rules apply;
3. If the custodial account amount is paid in the form of an annuity, the distribution is made by purchase and distribution of a fully paid individual insurance annuity.
4. Prior to termination, the plan complies with ERISA.
5. The plan files a final Form 5500 after the final distribution.

IRS Analysis – Situation 3 & 4

In Situations 3 and 4, the employer distributed all amounts in the individual and group custodial accounts by payment:

1. either to the participant or beneficiary, or,
2. to an IRA established by the participant (or beneficiary), or
3. to another eligible retirement plan, in accordance with §1.403(b)-7(b) of the 2007 Regulations, or
4. by delivery of a fully paid individual annuity contract.

Amounts paid to the participant from custodial accounts due to the termination are not included in gross income to the extent those amounts are rolled to an IRA or other eligible retirement plan.

Actions taken by the employer satisfy §403(b) and §1.403(b)-10(a) for plan termination.

IRS Holding – Situation 1 through 4

In each situation, the plans were terminated in accordance with the rules of the Final 403(b) regulation §1.401(b)-10(a).

If termination includes delivery of a fully paid individual annuity contract to participants or beneficiaries, or of an individual certificate evidencing fully paid benefits under a group annuity contract, there is no inclusion in gross income until amounts are actually paid to the participant or beneficiary out of the contract, so long as the contract maintains its status as a §403(b) contract.

The §403(b) status of any such contract is generally maintained if the contract thereafter adheres to the requirements of §403(b) that are in effect at the time of the delivery of such contract.

Any other amount paid to a participant or beneficiary, such as a single-sum payment, is included in the gross income of the participant or beneficiary, unless rolled over to an IRA or other eligible retirement plan by a direct rollover or by a transfer made within 60 days after the distribution. 

For more on this subject, incuding all our commentary and
the comments from an IRS Representative on our commentary
come to our
Retirement Plan Insights seminar,
or come to our eSeminar on 403(b) Update

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