IRS to Permit Determination and Termination Letters for 403(b) Plans

Starting in June 2023, the IRS will permit sponsors of individually designed 403(b) plans to request a determination letter for a new plan or for terminating a plan using the same program currently used by 401(k) plans and other plans qualified under Section 401(a).

The announcement of Revenue Procedure 2022-40 expands one of the IRS and Treasury programs for approving retirement plans, allowing 403(b) plans—which are used by certain public schools, churches, and charities—to apply for the same tax-favored treatment as qualified retirement plans.

The implementation of the new rule will be staggered by Employer Identification Number. Sponsors with an EIN ending in 1, 2, or 3 may begin requesting determination letters starting June 1, 2023. Those ending in 4, 5, 6, or 7 must wait until June 1, 2024; and those ending in 8, 9, or 0 must wait until June 1, 2025. Terminating 403(b) plans may request a plan termination letter without regard for EIN beginning June 1, 2023.

Determination letters are often used by qualified retirement plans to seek official approval from the IRS, according to Robert Abramowitz, an employee benefits attorney and partner at Morgan Lewis. Though these letters are not required by law, it is standard practice for larger plan sponsors of 401(a) qualified retirement plans.

These letters are essentially an insurance policy against IRS audits or legal flaws in the plan design because the sponsor can rely on previous IRS approval. It also permits a sponsor to catch an issue quickly by referring it to the IRS before they invest heavily in a flawed plan. Also, sometimes a third party, such as creditor, will ask a sponsor to obtain or share their determination letter as a condition of service, explains Abramowitz.

Under Revenue Procedure 2022-40, the determination letter process will now become available to 403(b) plans. Abramowitz describes it as “a big change” for 403(b) plans, and a change to their benefit. It will streamline the process of plan adoption and make it more similar to the process for qualified retirement plans, like 401(k) plans.

David Ashner, an employee benefits attorney at Groom Law Group, says that individually designed 403(b) plans could not get formal approval from the IRS prior to this change.

Abramowitz cautions however, that though this is “good news for many,” those sponsors of long-standing 403(b) plans that seek determination letters may have long-standing flaws revealed as part of the process. He explains that sponsors of older plans should “be careful what you ask for. The IRS looks at things carefully.”

He notes that sponsors normally seek determination as part of initial plan adoption to avoid having to correct issues down the road.

Ashner adds that many 403(b) sponsors are institutions such as universities which often have highly unique plans that go back decades. This change is something that 403(b) sponsors have wanted for a long time, and there should “be a lot of interest” in acquiring determination letters.

Ashner explains that the change also allows 403(b) sponsors to apply for determination letters when terminating a 403(b) plan. This allows them to get approval from the IRS to close out a plan properly. Though rare, Ashner says that if a plan is terminated and the IRS later determines that the plan was not qualified, then the sponsor as well as the participants could face onerous tax consequences because the plan would no longer be considered tax advantaged.

The full text of Revenue Procedure 2022-40 can be found here.