403(b) Transfers and Exchanges
Rev. 07/15/11; E-mail Alert 2011-10

The final 403(b) regulations changed the terminology for “transfers” and “exchanges” that take place on or after September 25, 2007. This impacts the methods used to move 403(b) accounts of participants and beneficiaries.  An "exchange" is the movement of a 403(b) account from one funding vehicle within a plan to another funding vehicle within the same plan.  A "transfer" is used to either move participant assets from one employer’s 403(b) plan to another employer’s 403(b) plan or to a governmental defined benefit plan in order to purchase service credits (purchasing additional years not yet worked). 

Exchanges and transfers have two similarities. First, they are not considered distributions and income tax reporting is not required.  Second, they may be made before a separation from employment has occurred, and no amount exchanged or transferred is includible in income for tax purposes.  This article will highlight the requirements that must be met in order for transfers and exchanges to qualify for favorable tax treatment.

Exchanges
A 403(b) contract under a 403(b) plan may be exchanged for another contract under that same 403(b) plan provided the following conditions of Treas. Reg. §1.403(b)-10(b)(2) are met:

• The plan under which the contract is issued permits for exchange;
• Benefits after the exchange are at least equal to the benefits immediately before the exchange (satisfying IRC §414(l)(1));
• Applicable distribution restrictions are maintained after the exchange; and
• The employer enters into an agreement with the issuer of the new contract to share information needed for compliance purposes

Information Sharing Agreement
This agreement must provide that the employer and the new issuer will share employment information for purposes of determining:

• Eligibility for a distribution of withdrawal restricted assets due to severance of employment;
• If the plan provides for hardship withdrawals whether the hardship rules have been satisfied, and to coordinate the suspension of deferrals requirement; and
• Whether the conditions of IRC §72(p)(2) are satisfied (i.e. amount of outstanding loans so additional loans can be calculated correctly, thus avoiding deemed distributions).

Restrictions
A 403(b) contract may not be exchanged for an annuity that is not is not qualified under section 403(b).

Transfers
A 403(b) plan may provide for the transfer of its assets, including a custodial or retirement income account, to another 403(b) plan provided the following conditions of Treas. Reg. §1.403(b)-10(b)(3) are met:

• If the transfer is for a participant, the participant is an employee or former employee of the employer for the receiving plan; or
• If the transfer is for beneficiary of a deceased participant, the deceased participant was an employee or former employee of the employer for the receiving plan;

In addition, the following conditions must be met:

• Transferor plan has a provision permitting transfers;
• Receiving plan has a provision permitting the receipt of transfers;
• Accumulated benefit immediately after the transfer is at least equal to the benefit immediately before transfer;
• Distribution restrictions are maintained after the transfer by the receiving plan; and
• If the transfer is not the entire participant’s interest in the 403(b), the transferee plan treats the amount transferred as continuation of the pro rata portion of the individual's pre-tax and after-tax amounts.
  NOTE: This is unlike the ordering rule for partial direct rollovers that applies to qualified plans. In those plans, pre-tax contributions transfer first and than after-tax accounts.

Restrictions
Transfers are not permitted between a 403(b) plan and a qualified plan or 457(b) governmental plan. A rollover must be performed first  to move assets from a 403(b) plan to either a qualified plan for 457(b) governmental plan.

Purchase of Permissive Service Credits
Under Treas. Reg. §1.403(b)-10(b)(4), a 403(b) plan is permitted to provide for the transfer of assets relating to the purchase of permissive service credits in a qualified defined benefit plan maintained by a governmental entity (as defined in §414(d)). To qualify, the transfer must be either:

• For the purchase of permissive service credits (as defined in §415(n)(3)(A)) under the receiving DB plan, or
• A repayment of cash-outs under a government plan to which §415 does not apply by reason of §415(k)(3). This may include any amounts previously refunded upon a forfeiture of service credit under the plan.

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