IRS Issues Guidance to Correct Defective 403(b) Plans
Written Plan Document Requirement
Colleges and universities, school corporations, churches, and tax-exempt organizations under 501(c)(3) are eligible to establish and contribute to a 403(b) plan. While 403(b) plans have been around a long time, historically they were often treated as a collection of individual contracts in which employers had little role, and they were largely left alone by Congress and the IRS. This changed dramatically when the IRS issued final regulations for 403(b) plans in 2007. For the first time, employers were required to adopt written plan documents that comply with 403(b) and the final regulations both in form and in operation.
Under transition relief, employers were given until December 31, 2009, to adopt a written plan document containing all the material terms of the plan effective January 1, 2009. To assist plan sponsors in complying with the final 403(b) regulations, the IRS published model plan language that public schools and other employers could use to satisfy the 403(b) regulations. The IRS also permitted employers to meet the plan document requirement by treating multiple separate documents as the plan document, the so-called "paper clip" approach.
Pre-Approved Plan Program
In 2013, the IRS established a 403(b) pre-approved plan program to further aid employers in establishing compliant 403(b) plan documents. Under this program, vendors or other parties could apply to the IRS for pre-approval of their 403(b) plan documents. The IRS is expected to issue the initial letters under this program beginning March 31, 2017. Employers can then adopt the pre-approved plans to meet the written plan document requirement and they will generally have assurance that the form of the plan meets the requirements under 403(b) and the final regulations. IRS pre-approval is particularly valuable in that the IRS does not have (and does not intend to establish) a determination letter program for 403(b) plans, which would allow an employer to apply for a letter that its individually designed 403(b) plan complied in form with 403(b) and the final regulations.
The IRS also announced the adoption of a remedial amendment period – or RAP – during which employers can correct 403(b) plan form defects. The RAP will begin January 1, 2010 or, if later, the effective date of the plan, and will end March 31, 2020.
In order to take advantage of the RAP, the employer had to adopt a written plan document by December 31, 2009. Assuming the employer did so, any 403(b) plan form defects (including any defects in documents incorporated by reference into the plan) can be retroactively self-corrected
in one of two ways:
The employer can adopt a 403(b) prototype document which has been pre-approved by the IRS by no later than March 31, 2020, retroactive to January 1, 2010 (or the plan's effective date, if later). An employer that adopts a pre-approved plan will have reliance that the form of its plan meets the applicable requirements for favorable tax treatment.
The employer can amend or restate its individually designed 403(b) plan document by no later than March 31, 2020, retroactive to January 1, 2010 (or the plan's effective date, if later). An individually designed plan is any plan that does not have pre-approval. A plan sponsor that amends or restates an individually designed plan will not have reliance that the form of its plan meets the applicable requirements for favorable tax treatment.
In either case, the plan document must reflect all amendments, including their effective dates, that have been made since January 1, 2010, and reflect the plan's actual operation during the RAP (assuming it complies with 403(b)).
For many employers, adoption of a prototype plan document when they become available will be the best approach. It ensures that the plan document satisfies the 403(b) requirements both retroactively and prospectively. It will also facilitate IRS audits since the plan has already received IRS approval. However, employers that sponsor more complicated 403(b) plan designs may not be able to adopt a prototype plan document without significantly changing the terms of their plans. This is because many terms of a pre-approved plan are "fixed" and employers will only have limited choices available. Where plan design changes are not possible due to statutory requirements, collective bargaining agreements, plan cost, or other concerns, an employer will need to amend or restate its individually designed plan.
403(b) Plan Non-Amenders
Failure to timely adopt a written 403(b) plan by December 31, 2009, cannot be self-corrected during the RAP. Rather, the 403(b) plan is no longer a tax-advantaged retirement plan, e.g.
contributions cannot be excluded from gross income, and the employer must withhold applicable taxes from any amounts contributed to the 403(b) plan. However, the employer can correct its plan (and avoid plan disqualification) under the Voluntary Correction Program (VCP), which is part of the IRS' Employee Plans Compliance Resolution System (EPCRS). VCP requires the employer to submit the failure and pay a compliance fee to the IRS to correct.
How to Get Started
Although three years may seem like a long time for employers to restate or amend their plans, keep in mind that amendments must be retroactive to January 1, 2010, so a correction could cover a lot of years.
If a plan was administered based on a defective plan document, that failure would also need to be corrected retroactively using EPCRS. Employers will need to collect information from 2010 forward as to what amendments have been made to the 403(b) plan and when, as well as to whether operation was consistent with those plan terms. Employers should consider starting this process sooner rather than later to minimize the period of correction and to ensure sufficient time to make all required corrections.
Keep a look out for our next e-bulletin discussing the action steps you should be taking now to protect your 403(b) plan and employees.
For more information, contact Mary Beth Braitman
, Tara Schulstad Sciscoe
, Chris Sears
, Ann O’Hara
, Raven Merlau
, or the Ice Miller Employee Benefits
attorney with whom you work.
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.