Compliance News | February 12, 2021

Guidance on Terminating a 403(b) Plan with Mutual Funds

The IRS has issued guidance that provides a framework for certain tax-exempt and public sector entities that are terminating 403(b) plans invested in custodial accounts (i.e., mutual funds) to distribute those accounts.

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Background

Since 2009, when 403(b) arrangements were first considered to be plans under the IRC, sponsors have wrestled with how to terminate these plans, which can be structured as a series of arrangements with different investment providers. If the investment is in individual or group contracts, IRS Revenue Ruling 2011-7 made it clear that the contract or a certificate representing an employee’s fully-paid investment in the contract may be distributed to the employee. However, that option was not available to investments in custodial accounts.

The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) requires the Secretary of the Treasury to issue guidance allowing distribution of custodial accounts without current taxation — similar to the rules for individual annuity contracts. For tax purposes, the distributed custodial account is treated as if the 403(b) status is still maintained, as long as the person receiving the distributed custodial account continues to follow 403(b) custodial account requirements for the permissible time to pay out the account. (The SECURE Act applies the tax treatment to distributions after the 2008 taxable year.)

The guidance

IRS Revenue Ruling 2020-23 interprets how the SECURE Act provision for 403(b) plans works. It clarifies that while sponsors of 403(b) plans are not generally subject to the IRC spousal-consent rules, non-governmental 403(b) plans may be subject to ERISA’s spousal consent rules if:

  • There are employer contributions, or
  • The employer exercises discretionary control over the arrangement.

In concurrently published IRS Notice 2020-80, the IRS asked for comments on the following:

  • Whether spousal consent should be required at the time the contract is distributed to the employee or when payments start under the contract
  • How this issue is currently being addressed in the absence of guidance

 

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This page is for informational purposes only and does not constitute legal, tax or investment advice. You are encouraged to discuss the issues raised here with your legal, tax and other advisors before determining how the issues apply to your specific situations.

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