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The IRS and Treasury are expected to issue final regulations on tax-sheltered annuities by June 30, 2007, according to IRS Tax Law Specialist Bob Architect. Speaking at the Washington Nonprofit Legal & Tax Conference on March 1, 2007, Architect said that these will be the first revisions of the regulations since 1964. He expects the new regulations to take effect January 1, 2008.
Subject to the new regulations, employers will be required, for the first time, to maintain written plans that satisfy Code Sec. 403(b) in form and operation. Plans will then have to be updated to reflect subsequently-issued guidance, as well as changes to the Code. Architect expects the IRS to issue a revenue procedure with sample plan language shortly after the regulations are published.
The regulations will require that a plan and the accompanying annuity contain the following restrictions: the annuity must be nontransferable; the employee cannot elect excess contributions; the employee must have the right to roll over the benefit; and the annuity must comply with the required minimum distribution rules and the incidental benefit rules. Similar provisions will apply to a custodial account, Architect said.
Under current rules, employers have up to a year to transfer deferred funds to annuity providers. This dates back to a 1967 revenue ruling, Architect explained. The regulations will shorten this period considerably. An example in the proposed regulations would require the transfer within 15 days after separation from service.
The regulations will also include a simple nondiscrimination test for tax-sheltered annuities known as “universal availability,” which will be based on whether or not an employee has worked 1,000 hours in the year. Employers will bear the responsibility for tracking the hours, Architect noted. He expects the final regulations to remove exclusions for collectively-bargained employees, students, visiting professors, nonresident aliens, and other categories of employees.
Employees will not be able to use their deferrals to maintain separate life insurance contracts. Architect noted, however, that the annuity can include a death or disability benefit, provided it is incidental to the annuity.
Another provision in the final regulations will address exempt organizations under common control (except churches), based on an 80% overlap of directors or trustees, which will affect deferral limits and nondiscrimination rules. There will also be rules about nontaxable exchanges of annuities and suspension of deferrals after a hardship distribution.
Cheryl Press of the IRS Office of Chief Counsel said that she is working on guidance that defines a “substantial risk of forfeiture” under Code Sec. 457(f) , which concerns deferred compensation plans of tax-exempt entities. She noted that Code Sec. 409A, which overlaps with Code Sec. 457(f), has a “tight” definition of “substantial risk of forfeiture.” She expects the guidance to be out by June 30, 2007.
Press discussed some of the issues that come up on audits of 457 plans. For example, participants cannot increase their deferrals under the catch-up rules unless their limits were under-utilized in prior years. If the limits were not under-utilized, no catch-up is allowed, Press stressed.
Participants must have designated a normal retirement age, Press noted. They can then “catch up” their deferrals in the three years preceding normal retirement age. The designated normal retirement age does not have to correspond to the time of actual retirement. However, there must be documentation of normal retirement age, or it must be specified in the plan.
Another problem Press brought up is the use of multiple plan documents, which causes confusion with regard to normal retirement age and the applicable Code Sec. 457(b) limits. Some plans allow emergency withdrawals under the less restrictive rules that apply to 401(k) and 403(b) plans. Plan administrators must not mix the provisions, she cautioned.
Finally, she said that nongovernmental employers must understand that their 457 plans are unfunded. This means there can be no loans and no rollovers of benefits.
For more information on this and related topics, consult the CCH Pension Plan Guide.
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