Exempt Organizations Advisory - IRS Releases Final Rules on Tax-Sheltered Annuity Contracts

By:    Anne E. Moran

Today, the IRS issued final regulations that provide guidance for section 403(b) contracts of tax-exempt organizations and public schools (i.e., so-called tax-sheltered annuity contracts, custodial arrangements and certain retirement income arrangements for employees of churches).  These long-awaited regulations finalize the proposed regulations issued in 2004.  They reflect updates for changes in the Internal Revenue Code that have occurred over the past 40 years.  These updates include explanations of (1) the requirement that a 403(b) arrangement generally be embodied in a written plan, (2) changes in the law reflecting maximum contribution limits, rollovers, plan distributions and contract exchanges and transfers, (3)  nondiscrimination requirements that apply to such contracts, including the so-called “universal availability requirement” that applies to deferrals under such plans, (4)  the rules determining how to establish who is the “employer” for purposes of nondiscrimination testing, and (5) how section 403(b) plans can be terminated.

• The regulations are generally effective starting in 2009.  However, many of the requirements embodied in the regulations were effective earlier by statute.  The regulations include a number of special transition rules to deal with these various effective dates, and some transition rules may require prompt action.
• Note that ERISA exempts a limited category of Section 403(b) arrangements from Title I of ERISA (but not from Internal Revenue Code requirements).   The major ERISA exemption applies to arrangements that contain only salary deferrals and that are not “established or maintained by the employer.”  In light of the need for employers to review 403(b) arrangements to ensure that they comply with IRS requirements (in particular, the  “written plan” requirement), some otherwise exempt employers expressed concern that their arrangements may cease to be exempt.  The Preamble to the final  regulations states that the DOL still believes that compliance would not in all circumstances deny otherwise eligible employers of the DOL exemption, but cautions that each arrangement must be analyzed on a case-by-case basis.  The Preamble does state, however, that the DOL will be issuing a Field Assistance Bulletin to provide some additional guidance on the interaction of its requirements and the requirements of the final IRS regulations.