In Revenue Ruling 2011-7 (the “Ruling”), the Internal Revenue Service (“IRS”) provides guidance on terminating a 403(b) plan in accordance with the applicable regulations, and on whether amounts distributed to participants in connection with the termination are included in gross income.
In the Ruling, the IRS presents four situations in which a 403(b) plan attempts to terminate, and applies the following rules to those situations. The key point is that the termination must meet the requirements of Treas. Reg. Sec. 1.403(b)-10(a). These requirements are:
–The 403(b) plan may be amended to eliminate future contributions for existing participants, or to limit subsequent participation to existing participants. All benefits must be vested upon termination.
–The 403(b) plan may contain provisions that allow plan termination, and allow benefits to be distributed upon termination.
–If the plan holds amounts in section 403(b)(7) custodial accounts, or has accepted elective deferrals, the following applies: the 403(b) plan may terminate and distribute benefits only if the employer (considering the employer aggregation rules of Code section 414(b), (c), (m) or (o)) does not make any contributions to another 403(b) plan during the “applicable period.” The “applicable period” is the period which starts on the date of the 403(b) plan’s termination, and which ends12 months after the completion of the distribution of benefits from that plan. For this purpose, if at all times during the period beginning 12 months before the date of termination, and ending 12 months after the completion of the distribution of benefits, less than 2% of the employees who were eligible to participate in the terminating 403(b) plan (as of the date of termination) are eligible to participate in that other 403(b) plan, the contributions to that other 403(b) plan are disregarded.
–All benefits must be distributed as soon as administratively practicable after the 403(b) plan’s termination. For this purpose, the distribution of a fully paid individual insurance annuity contract, or of an individual certificate evidencing fully paid benefits under a group annuity contract, is treated as a distribution.
The Ruling indicates that benefits are taxable when paid. However, the tax on benefits paid as an eligible rollover distribution is deferred to the extent that the distribution is rolled over, as a direct rollover or otherwise. The issuance of a fully paid individual insurance annuity contract, or of an individual certificate evidencing fully paid benefits under a group annuity contract, is not a payment for this purpose, and therefore is not a taxable event. Amounts are taxable only when actually paid from the annuity contract.