Advisory Committee Suggests Additional Guidance for 403(b)s

The Internal Revenue Service (IRS) Advisory Committee on Tax Exempt and Government Entities (ACT) has issued a report of recommendations to the IRS.

In the report section about 403(b) plans, the committee makes recommendations covering:

• Universal availability – The report says a review of the universal availability rules and history provides a backdrop for a discussion of the key areas that need “soft” guidance and/or expanded outreach programs.
• “Orphan” 403(b) contracts – Unlike the majority of qualified plans, 403(b) participants held individual contracts which, prior to the issuance of the 403(b) final regulations, may have been placed with any number of vendors. If these participants severed their employment prior to 2009 and no additional contributions were made to the plan account after that time, based on guidance from the IRS, a plan sponsor need not list these contracts in its plan. The report says the impact on the rest of the 403(b) plan should these “orphan” plans fail to comply with the Internal Revenue Code requires clarification.
• Minimizing contract leakage – The lack of ownership taken by certain 403(b) plan sponsors seeking to avoid the “fiduciary” moniker has led to a challenge for vendors when faced with a withdrawal request from a participant. Providing guidance to vendors that would allow them to take certain actions would help to preserve retirement assets.
• 403(b) plan terminations – Given the many practical problems that are a by-product of the nature of the 403(b) structure, additional guidance is needed to address the more technical issues. However, there are opportunities for the IRS to supply assistance through expansion of the online tools that are already available that cover termination issues, the committee says.
• Employee Plan Compliance Resolution System (EPCRS) improvements – In light of the many firsts experienced by the 403(b) community in the past decade, including the upcoming restatement onto new pre-approved documents, there is a need to update EPCRS to encourage use of the program and compliance with the Internal Revenue Code. Possible improvements discussed include allowing certain loan failures to be self-corrected, broadening the use of the Department of Labor (DOL) online calculator, creating additional application schedules for 403(b) issues and discounted fees.

NEXT: Universal availability issues.

The ACT fielded surveys of 403(b) plan sponsors and providers, and more than half of the respondents identified compliance with the universal availability rule as the most significant operation issue that they face.

The survey found there is much confusion about how the eligibility exceptions apply to workers who do not exactly fit the permissible exception to the universal availability rule. For example, employers often exclude from participation in the plan student workers who continue to work over the summer (and thus, reach the 1,000 hours threshold). There is confusion about the application of the 20 hours per week and 1,000 hours rules and how to deal with temporary employees.

Survey respondents identified other universal availability issues, including:

• The inability to exclude certain other generally non-benefits eligible employees, specifically part-time faculty under the 403(b) plan;
• Universal availability for non-Employee Retirement Income Security Act (ERISA) plans, especially for employees whose hours are not tracked, but usually work less than 20 hours per week (e.g., adjunct faculty); and
• The lack of detailed information with ample examples regarding excluded employees and the 20 hours per week and 1,000 hours rules with an explanation about what happens when employees exceed those hour limits.

The ACT report recommends the IRS consider providing additional educational outreach, in more detail, on at least the following issues in order to assuage continuing plan sponsor uncertainty, confusion and ignorance about the application of the universal availability rule and resultant noncompliance:

• Treatment of adjunct faculty at universities;
• Treatment of part-time, seasonal and temporary employees;
• Providing some type of relief from the tracking of hours burden for tax-exempt employers (which frequently have very limited budgets and few staff);
• The meaning of the phraseology “reasonably anticipate” in terms of the 1,000 hours threshold; and
• How the less than 20 hours per week standard is meant to apply.  For example: Can employees who work less than 20 hours per week, who could be tested separately under Code Section 410 coverage rules because they do not meet the minimum age and service requirements, be permitted to make salary reduction contributions even in the absence of a specific reference to Code Section 410 in the portion of the 403(b) final regulations addressing the exclusion of employees who work less than 20 hours per week from the universal availability rule?

NEXT: “Orphan” contracts.

In response to the 403(b) plan survey, a number of respondents commented that there continues to be considerable confusion and uncertainty as to what are a 403(b) plan sponsor’s obligations regarding “orphan” contracts. This concern was also expressed by members of the 403(b) vendor community with whom the committee had separate discussions about 403(b) plans. 

Rev. Proc. 2007-71 addressed the treatment of two types of orphan contracts, for plan document compliance purposes:

• The vendor for a pre-2009 contract held by a former employee need not be listed in the plan document (and the contract is not subject to the information sharing requirements) if no contributions are made to the contract after 2008; and
• Employee contracts issued from 2005 to 2008 can be excluded from listing in the plan document (and not be subject to the information-sharing obligations) if no contributions are made after 2008 and reasonable, good faith efforts to otherwise “include” such contracts as part of the plan (presumably for operational purposes) are made.                        

According to the ACT report, while the guidance did not address pre-2005 contracts to which no contributions have been made since 2004, the general assumption has been that such contracts are also not subject to plan document compliance (and the information-sharing rules) where contributions have not been made to the contract after 2004 (sometimes called “grandfathered” contracts).

The committee recommends the IRS consider issuing guidance that clarifies:

• The impact of operational violations under an individual’s orphan contract on any other contracts that the individual may have with the same employer; and
• How pre-2009 frozen contracts issued to current employees before 2005 should be handled for compliance purposes.

NEXT: Plan leakage and “lost” contracts.

Concerns have been raised with the committee regarding the unnecessary leakage in several respects under orphan and other contracts. First, given the lack of guidance as to what can be done when there is no longer an employer (or where the employer has no legal involvement), it has been observed that often the only distribution option vendors are willing to make available to the contract holder is a total distribution. In these circumstances, many vendors are apparently unwilling to allow loans, partial withdrawals or transfers/rollovers to another 403(b) contract to the extent employer approval is required.

Second, respondents to the ACT’s survey, as well as members of the 403(b) vendor community with whom it had separate discussions, expressed concerns that orphan and other older annuity contracts are going unclaimed or otherwise getting lost. What they are seeing is that contract issuers are often not making sufficient efforts to keep in contact with the contract holders, resulting in “lost” contracts. 

The committee was told this is happening because there is no clear-cut obligation for issuers of old fixed annuity contracts to maintain current, or otherwise find, information/records regarding the holders of these contracts. 

The report makes the following recommendations:

• Greater certainty is needed as to what the vendor can do under a contract in terms of withdrawal and distribution where there is no employer involvement. Therefore, the committee recommends that the IRS consider issuing guidance that clarifies that the vendor can act as the decision-maker (in lieu of the employer) for rollover and other withdrawal/distribution purposes under contracts where the employer no longer exists (or is no longer legally involved).
• The committee says it is of the view that issuers should generally be required to do more to ensure that orphan annuity contracts do not go unclaimed. Required minimum distribution (RMD) rules could, in the committee’s view, provide a potential avenue for the IRS to encourage this. While recognizing that the regulations generally provide that the required RMD for one contract can be made from another contract held by the individual, it nevertheless believes the IRS could issue guidance that requires issuers to provide reasonable advance notice to contract holders on the RMD requirements, and if the issuer does not have current contact information, make reasonable efforts to locate the contract holder. 

  NEXT: Terminating plans with individual custodial accounts.

Survey respondents repeatedly mentioned there are problems terminating 403(b) plans with custodial accounts. The IRS has taken the position that annuity contracts could be distributed to a participant without the participant’s consent; whereas a custodial account not be distributed similarly. If a participant refuses to take a distribution, or cannot be found to take a distribution, the custodial account remains in the plan. The report says the absence of a practical solution for terminating 403(b) plans that includes custodial accounts is causing 403(b) plan sponsors additional legal and operational costs and the need to follow questionable solutions.

The ACT says the IRS should explore with Chief Counsel whether it has legal authority to create good faith or de minimis rules or provide other solutions to address the practical problems of terminating a 403(b) plan. If the IRS does not have legal authority to solve the practical problems, Treasury should seek legislation addressing the problems or giving the IRS authority to address the problems in guidance.

Regardless of the results of that recommendation, the ACT says the IRS should expand its web page with information about terminating a 403(b) plan. The current web page explains how to terminate a 403(b) plan but does not recognize or address the many practical problems sponsors and practitioners face when they actually try to do a termination. The IRS’s revised web page should identify these issues and suggest possible solutions. 

In addition, the report recommends the 403(b) Fix-It Guide should be expanded to address appropriate corrections for situations where termination distributions have been made and rolled over, only to see the termination fail because all assets cannot be distributed.

NEXT: EPCRS improvements.

The IRS has made changes to its Employee Plans Compliance Resolution System (EPCRS) to allow 403(b) plans to correct certain errors. But the ACT makes recommendations for further improvements to the EPCRS.

The report recommends the IRS allow certain participant loan errors to be self-corrected. Currently, the IRS’s self-correction program (SCP) does not permit the self-correction of errors involving participant loan transactions of any sort. Such errors can only be corrected through the voluntary correction program (VCP) or Audit CAP (closing agreement program). 

The committee notes there are several complexities specific to participant loan error issues faced by 403(b) plans that enhance the importance of devising a self-correction option. In a typical 403(b) plan scenario, the assets may be scattered among multiple vendors with each participant having an individual account. It is also a frequent scenario that plan sponsors discover a participant loan error with one vendor and then a few months later find another participant loan error with another vendor. This creates a perpetual cycle, and excessive costs, of having to file through VCP for these types of corrections.

Another unique quality of the 403(b) plan sponsor that drives the recommendation to allow participant loan failures to be corrected through SCP is embedded in the structure of 403(b) arrangements. Many 403(b) plans are not subject to ERISA. These types of 403(b) plan sponsors are very careful not to engage in activities that might result in it being subject to ERISA and its fiduciary rules. One such activity that they fear would trigger this is the policing of participant loans and, if they ultimately become delinquent, the filing of a VCP application. So, the report says, while there may be an important public policy goal of having loan failures corrected, the plan sponsor, which is the entity that is in the best position to take the steps toward that goal, has a competing interest that prevents it from doing so.

Another specific class of issues deals with problems that 403(b) plan sponsors experience with vendors who are uncooperative or unresponsive to efforts to correct errors reaching across multiple contracts or individual contracts that do not recognize the role of the plan sponsor. Many of these contracts are written as agreements between the service provider and the participant, which the employer agrees to facilitate through its payroll system. There is no provision for the administration of plan-wide matters by the employer. In other cases, with many legacy contracts or arrangements, the terms do not facilitate the fix that is prescribed by EPCRS for the “plan” and the employer doesn’t have the ability to force the account holder (participant) to take the actions necessary to bring the contract into plan-level compliance.  

Among other recommendations, the ACT recommends the IRS develop additional schedules for the VCP filing to allow for correction of the most common 403(b) operational failures.  For example, the IRS should develop a schedule specifically addressing a universal availability failure with clear instructions about the correction options (similar to Schedule 5 and the loan corrections). 

The report also recommends the IRS implement a document amnesty program for any 403(b) plan sponsor that adopts a pre-approved plan so that no correction of prior documents is required and reduce the filing fees for the 403(b) community, if only for a reasonable period of time, to allow compliance errors in the remedial amendment period to be discovered and corrected. 

The committee’s report is here.