Department of the Treasury

                                                                                                                               July 26, 2007

                                                                                                                               Part III

                                                                                                                               Department of the
                                                                                                                               Internal Revenue Service

                                                                                                                               26 CFR Parts 1, 31, 54 and 602
                                                                                                                               Revised Regulations Concerning Section
                                                                                                                               403(b) Tax-Sheltered Annuity Contracts;
                                                                                                                               Final Rule
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41128              Federal Register / Vol. 72, No. 143 / Thursday, July 26, 2007 / Rules and Regulations

                                         DEPARTMENT OF THE TREASURY                               Department of the Treasury, Office of                 are confidential, as required by 26
                                                                                                  Information and Regulatory Affairs,                   U.S.C. 6103.
                                         Internal Revenue Service                                 Washington, DC 20503.
                                                                                                    The collection of information in
                                         26 CFR Parts 1, 31, 54, and 602                          § 1.403(b)–10(b)(2)(i)(C) of these final                 Regulations (TD 6783) under section
                                                                                                  regulations was not contained in the                  403(b) of the Internal Revenue Code
                                         [TD 9340]
                                                                                                  prior notice of proposed rulemaking.                  (Code) were originally published in the
                                         RIN 1545–BB64                                            For this reason, this additional                      Federal Register (29 FR 18356) on
                                                                                                  collection of information has been                    December 24, 1964 (1965–1 CB 180).
                                         Revised Regulations Concerning                           reviewed and, pending receipt and                     Those regulations provided guidance for
                                         Section 403(b) Tax-Sheltered Annuity                     evaluation of public comments,                        complying with section 403(b), which
                                         Contracts                                                approved by the Office of Management                  had been enacted in 1958 in section
                                         AGENCY:  Internal Revenue Service (IRS),                 and Budget in accordance with the                     23(a) of the Technical Amendments Act
                                         Treasury.                                                Paperwork Reduction Act of 1995 (44                   of 1958, Public Law 85–866 (1958),
                                                                                                  U.S.C. 3507(d)) under control number                  relating to tax-sheltered annuity
                                         ACTION: Final regulations.
                                                                                                  1545–2068. Comments concerning this                   arrangements established for employees
                                         SUMMARY: This document promulgates                       additional collection of information                  by public schools and tax-exempt
                                         final regulations under section 403(b) of                should be sent to the Internal Revenue                organizations described in section
                                         the Internal Revenue Code and under                      Service, Attn: IRS Reports Clearance                  501(c)(3). Since 1964, additional
                                         related provisions of sections 402(b),                   Officer, SE:W:CAR:MP:T:T:SP,                          regulations were issued under section
                                         402(g), 402A, and 414(c). The                            Washington, DC 20224, and to the                      403(b) to reflect rules relating to certain
                                         regulations provide updated guidance                     Office of Management and Budget, Attn:                eligible rollover distributions 1 and
                                         on section 403(b) contracts of public                    Desk Officer for the Department of the                required minimum distributions under
                                         schools and tax-exempt organizations                     Treasury, Office of Information and                   section 401(a)(9).2 See § 601.601(d)(2)
                                         described in section 501(c)(3). These                    Regulatory Affairs, Washington, DC                    relating to objectives and standards for
                                         regulations will affect sponsors of                      20503. Comments on the collection of                  publishing regulations, revenue rulings
                                         section 403(b) contracts, administrators,                                                                      and revenue procedures in the Internal
                                                                                                  information should be received by
                                         participants, and beneficiaries.                                                                               Revenue Bulletin.
                                                                                                  September 24, 2007. Comments are
                                                                                                                                                           On November 16, 2004, a notice of
                                         DATES: Effective Date: July 26, 2007.                    specifically requested concerning:                    proposed rulemaking (REG–155608–02)
                                            Applicability Date: These regulations                   Whether the proposed collection of                  was published in the Federal Register
                                         generally apply for taxable years                        information is necessary for the proper               (69 FR 67075) that proposed a
                                         beginning after December 31, 2008.                       performance of the functions of the                   comprehensive update of the
                                         However, see the ‘‘Applicability date’’                  Internal Revenue Service, including                   regulations under section 403(b) (2004
                                         section in this preamble for additional                  whether the information will have                     proposed regulations), including:
                                         information regarding the applicability                  practical utility;                                    amending the 1964 and subsequent
                                         of these regulations.                                      The accuracy of the estimated burden                regulations to conform them to the
                                         FOR FURTHER INFORMATION CONTACT:                         associated with the proposed collection               numerous amendments made to section
                                         Concerning the regulations, John                         of information (see above);                           403(b) by subsequent legislation,
                                         Tolleris, (202) 622–6060; concerning the                   How the quality, utility, and clarity of            including section 1022(e) of the
                                         regulations as applied to church-related                 the information to be collected may be                Employee Retirement Income Security
                                         entities, Robert Architect (202) 283–                    enhanced;                                             Act of 1974 (ERISA) (88 Stat. 829),
                                         9634 (not toll-free numbers).                              How the burden of complying with                    Public Law 93–406; section 251 of the
                                         SUPPLEMENTARY INFORMATION:                               the proposed collections of information               Tax Equity and Fiscal Responsibility
                                                                                                  may be minimized, including through                   Act of 1982 (TEFRA) (96 Stat. 324, 529),
                                         Paperwork Reduction Act                                  the application of automated collection               Public Law 97–248; section 1120 of the
                                           The collection of information in                       techniques or other forms of information              Tax Reform Act of 1986 (TRA ’86) (100
                                         § 1.403(b)–10(b)(2)(i)(C) of these final                 technology; and                                       Stat. 2085, 2463), Public Law 99–514;
                                         regulations has been approved by the                       Estimates of capital or start-up costs              section 1450(a) of the Small Business
                                         Office of Management and Budget in                       and costs of operation, maintenance,                  Job Protection Act of 1996 (SBJPA) (110
                                         accordance with the Paperwork                            and purchase of service to provide                    Stat. 1755, 1814), Public Law 104–188;
                                         Reduction Act of 1995 (44 U.S.C.                         information.                                          and sections 632, 646, and 647 of the
                                         3507(d)) under control number 1545–                        An agency may not conduct or                        Economic Growth and Tax Relief
                                         2068. Responses to this collection of                    sponsor, and a person is not required to              Reconciliation Act of 2001 (EGTRRA)
                                         information are required in order to                     respond to, a collection of information               (115 Stat. 38, 113, 126, 127), Public Law
                                         provide certain benefits.                                unless it displays a valid control                    107–16. The 2004 proposed regulations
                                           The estimated burden per respondent                    number assigned by the Office of                      also included controlled group rules
                                         varies among the plan administrator/                     Management and Budget.                                under section 414(c) for entities that are
                                         payor/recordkeeper, depending upon                         The estimated burden per respondent                 tax-exempt under section 501(a).
                                         individual respondents’ circumstances,                   varies among the plan administrator/                     Following publication of the 2004
                                         with an estimated average of 4.1 hours.                  payor/recordkeeper, depending upon                    proposed regulations, comments were
                                         Comments concerning the accuracy of                      individual respondents’ circumstances,                received and a public hearing was held
                                         this burden estimate and suggestions for                 with an estimated average of 4.1 hours.               on February 15, 2005. After
                                         reducing this burden should be sent to                     Books or records relating to a                      consideration of the comments received,
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                                         the Internal Revenue Service, Attn: IRS                  collection of information must be                     the 2004 proposed regulations are
                                         Reports Clearance Officer,                               retained as long as their contents might              adopted by this Treasury decision,
                                         SE:W:CAR:MP:T:T:SP, Washington, DC                       become material in the administration
                                         20224, and to the Office of Management                   of any internal revenue law. Generally,                 1 See   TD 8619, September 22, 1995 (60 FR 49199).
                                         and Budget, Attn: Desk Officer for the                   tax returns and tax return information                  2 See   TD 8987, April 17, 2002 (67 FR 18987).

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Federal Register / Vol. 72, No. 143 / Thursday, July 26, 2007 / Rules and Regulations                                                  41129

                                         subject to a number of changes, some of                  requirements of section 403(b). Other                 Explanation of Provisions
                                         which are summarized below in this                       aggregation rules apply both on an                    Overview
                                         preamble.                                                individual and aggregate basis. For
                                           Section 403(b) was also amended by                     example, the section 402(g) limitations                 Like the 2004 proposed regulations,
                                         sections 811, 821, 822, 824, 826, and                    on elective deferrals apply to all elective           these final regulations are a
                                         829 of the Pension Protection Act of                     deferrals during the year with respect to             comprehensive update of the current
                                         2006 (PPA ’06) (120 Stat. 780), Public                                                                         regulations under section 403(b). These
                                                                                                  an individual and the limitations of
                                         Law 109–280. These final regulations                                                                           regulations replace the existing final
                                                                                                  section 401(a)(30) apply to all elective
                                         reflect these amendments.                                                                                      regulations that were adopted in 1964
                                                                                                  deferrals made by an employer to that                 and reflect the numerous legal changes
                                         Sections 403(b) and 414(c) Statutory                     employer’s plans with respect to an                   that have been made in section 403(b)
                                         Provisions                                               individual during the year. The                       since then and many of the positions
                                            Section 403(b) provides an exclusion                  contribution limitations of section 415               that have been taken in interpretive
                                         from gross income for certain                            generally apply on an employer-by-                    guidance that has been issued under
                                         contributions made by specific types of                  employer basis.                                       section 403(b).
                                         employers for their employees and by                        Section 403(b)(12) requires a section                As was noted in the preamble to the
                                         certain ministers to specified types of                  403(b) contract that provides for elective            2004 proposed regulations, the effect of
                                         funding arrangements. The employers                      deferrals to make elective deferrals                  the various amendments made to
                                         are limited to public schools and section                available to all employees (the universal             section 403(b) within the past 40 years
                                         501(c)(3) organizations. There are three                 availability rule) and requires other                 has been to diminish the extent to
                                         categories of funding arrangements to                                                                          which the rules governing section
                                                                                                  contributions to satisfy the general
                                         which section 403(b) applies: (1)                                                                              403(b) plans differ from the rules
                                                                                                  nondiscrimination requirements
                                         Annuity contracts (as defined in section                                                                       governing other tax-favored employer-
                                         401(g)) issued by an insurance                           applicable to qualified plans. These                  based retirement plans, including
                                         company; (2) custodial accounts that are                 rules are discussed further in this                   arrangements that include salary
                                         invested solely in mutual funds; and (3)                 preamble under the heading ‘‘Section                  reduction contributions, such as section
                                         retirement income accounts, which are                    403(b) Nondiscrimination and Universal                401(k) plans and section 457(b) plans
                                         only permitted for church employees                      Availability Rules.’’                                 for state and local governmental entities.
                                         and certain ministers. Except as                            A section 403(b) contract is also                  However, there remain significant
                                         otherwise indicated, an annuity                          required to provide that it will satisfy              differences between section 403(b) plans
                                         contract, for purposes of these final                    the required minimum distribution                     and section 401(a) and governmental
                                         regulations, includes a custodial                        requirements of section 401(a)(9), the                section 457(b) plans. For example,
                                         account that is invested solely in mutual                incidental benefit requirements of                    section 403(b) is limited to certain
                                         funds.                                                   section 401(a), and the rollover                      specific employers and employees
                                            The exclusion applies to employer                                                                           (namely, employees of a public school,
                                                                                                  distribution rules of section 402(c).
                                         nonelective contributions (including                                                                           employees of a section 501(c)(3)
                                         matching contributions) and elective                        Many section 403(b) arrangements of                organization, and certain ministers) and
                                         deferrals (other than designated Roth                    employers that are section 501(c)(3)                  to certain funding arrangements
                                         contributions) within the meaning of                     organizations are subject to the                      (namely, an insurance annuity contract,
                                         section 402(g)(3)(C) (which applies to                   Employee Retirement Income Security                   a custodial account that is limited to
                                         section 403(b) contributions made                        Act of 1974 (ERISA), which includes                   mutual fund shares, or a church
                                         pursuant to a salary reduction                           rules substantially identical to the rules            retirement income account). Also,
                                         agreement). The exclusion applies only                   for qualified plans, including rules                  section 403(b) contains the universal
                                         if certain requirements relating to                      parallel to the section 414(l) transfer               availability requirement for section
                                         availability, nondiscrimination, and                     rules, the section 401(a)(11) qualified               403(b) elective deferrals and provides
                                         distribution are satisfied. Section 403(b)               joint and survivor annuity (QJSA)                     consequences for failing to satisfy
                                         arrangements may also include after-tax                  transferee plan rules, and the anti-                  certain of the section 403(b) rules
                                         employee contributions.                                  cutback rules of section 411(d)(6)                    (described in this preamble under the
                                            Section 403(b)(1)(C) requires that the                (which apply to transfers). See sections              heading ‘‘Effect of a Failure to Satisfy
                                         contract be nonforfeitable (except for the               204(g), 205, and 208 of ERISA. However,               Section 403(b)’’) 3 that differ in
                                         failure to pay future premiums),                         as discussed in this preamble under the               significant respects from the
                                         regardless of the type of contribution                                                                         consequences applicable to qualified
                                                                                                  heading ‘‘Interaction Between Title I of
                                         used to purchase the contract. Section                                                                         plans.
                                                                                                  ERISA and Section 403(b) of the Code,’’                 The final regulations, as did the 2004
                                         403(b)(1)(E) requires a section 403(b)
                                         contract purchased under a salary                        Title I of ERISA does not apply to                    proposed regulations, require the
                                         reduction agreement to satisfy the                       governmental plans, certain church                    section 403(b) contract to satisfy both in
                                         requirements of section 401(a)(30)                       plans, or a tax-exempt employer’s                     form and operation the applicable
                                         relating to limitations on elective                      section 403(b) program that is not                    requirements for exclusion. The final
                                         deferrals under section 402(g)(1). In                    considered to constitute the                          regulations also require that the contract
                                         addition, all contributions to a section                 establishment or maintenance of an
                                         403(b) arrangement, when expressed as                    ‘‘employee pension benefit plan’’ under                  3 Other differences between the rules applicable

                                         annual additions under section                           Title I of ERISA.                                     to section 403(b) plans and qualified plans include
                                                                                                                                                        the following: the definition of compensation
                                         415(c)(2), must not exceed the                              Section 414(c) authorizes the                      (including the five-year rule) in section 403(b)(3);
                                         applicable limit of section 415.                         Secretary of the Treasury to issue                    the special section 403(b) catch-up elective deferral
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                                            Section 403(b)(5) provides that all                   regulations treating all employees of                 in section 402(g)(7); and the section 415 aggregation
                                         section 403(b) contracts purchased for                                                                         rules. An additional difference relates to when a
                                                                                                  trades or businesses which are under                  severance from employment occurs for purposes of
                                         an individual by an employer are                         common control as employed by a                       section 403(b) plans maintained by State and local
                                         treated as purchased under a single                      single employer.                                      government employers. See § 1.403(b)–6(h) of these
                                         contract for purposes of the                                                                                   regulations.

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41130              Federal Register / Vol. 72, No. 143 / Thursday, July 26, 2007 / Rules and Regulations

                                         be maintained pursuant to a written                      eligibility criteria for other employees,             recognize the importance of performing
                                         plan as described in the next section.                   nor can the issuer by itself coordinate               these actions (including not fully
                                           The final regulations, like the                        those Code requirements that depend on                appreciating the tax consequences of
                                         proposed regulations, provide rules                      other contracts, such as the loan                     failing to perform the responsibility).
                                         under which tax-exempt entities are                      limitations under section 72(p). The                  Second, an individual employee may
                                         aggregated and treated as a single                       issuer must rely on information or                    have a self-interest in a particular
                                         employer under section 414(c). These                     representations provided by either the                transaction. In addition, while there are
                                         rules apply to plans referenced in                       employer or the employee for                          various factors that will often cause an
                                         section 414(b), (c), (m), (o), and (t), such             employment-based information that is                  employer or issuer to have an interest in
                                         as plans qualified under section 401(a)                  essential for compliance with section                 procedures that ensure that the
                                         or 403(a), as well as section 403(b)                     403(b) provisions, such as the                        requirements of section 403(b) are
                                         plans.                                                   limitations on elective deferrals in                  satisfied (including income tax
                                           Comments on the 2004 proposed                          section 402(g) and the requirements of                withholding requirements), an
                                         regulations raised a number of questions                 section 72(p)(2) for a plan loan that is              employee generally bears the income tax
                                         and concerns about:                                      not a taxable deemed distribution. In                 exposure and other risks of failing to
                                           • The requirement in the 2004                          addition to providing a central locus to              comply with rules set forth in the plan.
                                         proposed regulations under which a                       coordinate those functions, the                       The IRS and Treasury Department
                                         section 403(b) contract would be                         maintenance of a written plan also                    believe it is important to prevent
                                         required to be maintained pursuant to a                  benefits participants by providing a                  failures in advance so as to minimize
                                         written plan;                                            central document setting forth their                  the cases in which the adverse effects of
                                           • The elimination of certain non-                      rights and enables government agencies                a failure fall on the employee. See the
                                         statutory exclusions that a section                      to determine whether the arrangements                 discussion in this preamble under the
                                         403(b) plan was permitted to have under                  satisfy applicable law and, in particular,            heading ‘‘Contract Exchanges.’’
                                         Notice 89–23 (1989–1 CB 654) for                         for determining which employees are                      In response to comments, the final
                                         purposes of the universal availability                   eligible to participate in the plan.                  regulations clarify the requirement that
                                         rule;                                                       The 2004 proposed regulations would                the plan include all of the material
                                           • The elimination of Rev. Rul. 90–24                   have required that the section 403(b)                 provisions by permitting the plan to
                                         (1990–1 CB 97), which allowed a                          plan include all of the material                      incorporate by reference other
                                         section 403(b) contract to be exchanged                  provisions regarding eligibility, benefits,           documents, including the insurance
                                         for another contract; and                                applicable limitations, the contracts                 policy or custodial account, which as a
                                           • The controlled group rules under                     available under the plan, and the time                result of such reference would become
                                         section 414(c) for entities that are tax-                and form under which benefit                          part of the plan. As a result, a plan may
                                         exempt under section 501(a).                             distributions would be made. The                      include a wide variety of documents,
                                         These final regulations include a                        proposed regulations would not have                   but it is important for the employer that
                                         number of revisions to reflect the                       required that there be a single plan                  adopts the plan to ensure that there is
                                         comments received, as described further                  document. However, under the                          no conflict with other documents that
                                         in this preamble.                                        proposed regulations, the written plan                are incorporated by reference. If a plan
                                         Written Plan Requirement                                 requirement would be satisfied by                     does incorporate other documents by
                                                                                                  complying with the plan document                      reference, then, in the event of a conflict
                                            These regulations retain the                          rules applicable to qualified plans.                  with another document, except in rare
                                         requirement from the 2004 proposed                          Some comments raised concerns that                 and unusual cases, the plan would
                                         regulations that a section 403(b) contract               the written plan requirement would                    govern. In the case of a plan that is
                                         be issued pursuant to a written plan                     impose additional administrative                      funded through multiple issuers, it is
                                         which, in both form and operation,                       burdens. In response, the final                       expected that an employer would adopt
                                         satisfies the requirements of section                    regulations make a number of                          a single plan document to coordinate
                                         403(b) and these regulations. This                       clarifications, including that the plan is            administration among the issuers, rather
                                         requirement implements the statutory                     permitted to allocate to the employer or              than having a separate document for
                                         requirements of section 403(b)(1)(D),                    another person the responsibility for                 each issuer.
                                         which provides that the contract must                    performing functions to administer the                   Finally, comments also indicated that,
                                         be purchased ‘‘under a plan’’ that                       plan, including functions to comply                   while section 403(b) contracts that are
                                         satisfies the nondiscrimination                          with section 403(b). Any such allocation              subject to ERISA are maintained
                                         requirements delineated in section                       must identify who is responsible for                  pursuant to written plans, there may be
                                         403(b)(12).                                              compliance with the requirements of the               a potential cost associated with
                                            The existence of a written plan                       Code that apply based on the aggregated               satisfying the written plan requirement
                                         facilitates the allocation of plan                       contracts issued to a participant,                    for those employers that do not have
                                         responsibilities among the employer,                     including loans under section 72(p) and               existing plan documents, such as public
                                         the issuer of the contract, and any other                the requirements for obtaining a                      schools. To address this concern, the
                                         parties involved in implementing the                     hardship withdrawal under § 1.403(b)–6                IRS and Treasury Department expect to
                                         plan. Without such a central document                    of these regulations.                                 publish guidance which includes model
                                         for a comprehensive summary of                              Additional comments recommended                    plan provisions that may be used by
                                         responsibilities, there is a risk that many              that certain responsibilities be permitted            public school employers for this
                                         of the important responsibilities                        to be allocated to employees. The IRS                 purpose. Because the requirement for a
                                         required under the statute and final                     and Treasury Department have                          written plan will not go into effect until
                                         regulations may not be allocated to any                  concluded that it is generally                        2009 (see the discussion under the
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                                         party. While a section 403(b) contract                   inappropriate to allocate these                       heading ‘‘Applicability date’’),
                                         issued to an employee can provide for                    responsibilities to employees for a                   employers would be expected to adopt
                                         the issuer to perform many of these                      number of reasons. First, employees                   a written plan (including applicable
                                         functions by itself, the contract cannot                 often lack the expertise to systematically            amendments) no later than the
                                         satisfy the function of setting forth the                meet these responsibilities and may not               applicability date of these regulations.

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Federal Register / Vol. 72, No. 143 / Thursday, July 26, 2007 / Rules and Regulations                                         41131

                                         Contract Exchanges, Plan-to-Plan                         and immediately transmitted the cash                  Contracts), or notify the employer about
                                         Transfers, and Purchases of Permissive                   proceeds for contribution to the                      loans. Other comments included a
                                         Service Credit                                           successor contract to which all                       recommendation that the employer be
                                            The final regulations, like the 2004                  subsequent employer contributions                     involved to ensure that the exchange is
                                         proposed regulations, provide for three                  would be made. This ruling was                        within the plan. Comments also
                                         specific kinds of non-taxable exchanges                  replaced by Rev. Rul. 90–24 which does                suggested that a grandfather may be
                                         or transfers of amounts in section 403(b)                not provide for the first contract to be              necessary for exchanges made before the
                                         contracts. Specifically, under the final                 cashed in but allows section 403(b)                   applicability date of the restrictions
                                         regulations, a non-taxable exchange or                   contracts to be exchanged, without                    imposed by the final regulations.
                                                                                                  income inclusion, so long as the                         These final regulations include a
                                         transfer is permitted for a section 403(b)
                                                                                                  successor contract includes distribution              number of changes to reflect these
                                         contract if either: (1) It is a mere change
                                                                                                  restrictions that are the same or more                comments. The regulations allow
                                         of investment within the same plan                                                                             contract exchanges with certain
                                                                                                  stringent than the distribution
                                         (contract exchange); (2) it constitutes a                                                                      characteristics associated with Rev. Rul.
                                                                                                  restrictions in the contract that is being
                                         plan-to-plan transfer, so that there is                                                                        90–24, but under rules that are generally
                                         another employer plan receiving the                         The 2004 proposed regulations would                similar to those applicable to qualified
                                         exchange; or (3) it is a transfer to                     have imposed additional restrictions on               plans.
                                         purchase permissive service credit (or a                 contract exchanges by limiting tax-free                  Unlike the 2004 proposed regulations,
                                         repayment to a defined benefit                           contract exchanges to situations in                   these regulations permit an exchange of
                                         governmental plan). If an exchange or                    which the new contract is provided                    one contract for another to constitute a
                                         transfer does not constitute a change of                 under the plan. The proposal was                      mere change of investment within the
                                         investment within the plan, a plan-to-                   intended to improve compliance with                   same plan, but only if certain conditions
                                         plan transfer, or a purchase of                          the Code requirements that apply on an                are satisfied in order to facilitate
                                         permissive service credit, the exchange                  aggregated basis because, without                     compliance with tax requirements.
                                         or transfer would be treated as a taxable                coordination, it is difficult, if not                 Specifically, the other contract must
                                         distribution of benefits in the form of                  impossible, for a plan to comply with                 include distribution restrictions that are
                                         property if the exchange occurs after a                  those tax requirements. These                         not less stringent than those imposed on
                                         distributable event (assuming the                        requirements include certain                          the contract being exchanged and the
                                         distribution is not rolled over to an                    distribution restrictions, including the              employer must enter into an agreement
                                         eligible retirement plan) or as a taxable                rule that requires the suspension of                  with the issuer of the other contract
                                         conversion to a section 403(c)                           deferrals for a plan that uses the                    under which the employer and the
                                         nonqualified annuity contract if a                       hardship withdrawal suspension safe                   issuer will from time to time in the
                                         distributable event has not occurred.                    harbor rules for elective deferrals, and              future provide each other with certain
                                         See the ‘‘Effect of a Failure to Satisfy                 the section 72(p) rules for loans. In                 information. This includes information
                                         Section 403(b)’’ section in this preamble                addition, these changes make it easier                concerning the participant’s
                                         for discussion of section 403(c)                         for employers to respond to an IRS                    employment and information that takes
                                         nonqualified annuity contracts. In any                   inquiry or audit. For example, where                  into account other section 403(b)
                                         case in which a distributable event has                  assets have been transferred to an                    contracts or qualified employer plans,
                                         occurred, a participant in a section                     insurance carrier or mutual fund that                 such as whether a severance from
                                         403(b) plan can always change the                        has no subsequent connection to the                   employment has occurred for purposes
                                         investment through a distribution and                    plan or the employer, IRS audits and                  of the distribution restrictions and
                                         non-taxable rollover from a section                      related investigations have revealed that             whether the hardship withdrawal rules
                                         403(b) contract to an IRA annuity, as                    employers encounter substantial                       in the regulations are satisfied.
                                         long as the distribution is an eligible                  difficulty in demonstrating compliance                Additional information that is required
                                         rollover distribution. Note, however,                    with hardship withdrawal and loan                     is information necessary for the
                                         that an IRA annuity cannot include                       rules. These problems are particularly                resulting contract or any other contract
                                         provisions permitting participant loans.                 acute when an individual’s benefits are               to which contributions have been made
                                         See section 408(e)(3) and (4) and                        held by numerous carriers. Such                       by the employer to satisfy other tax
                                         §§ 1.408–1(c)(5) and 1.408–3(c).                         multiple contract issuers are commonly                requirements, such as whether a plan
                                            Any contract exchange, plan-to-plan                   associated with plans in which Rev.                   loan constitutes a deemed distribution
                                         transfer, or purchase of permissive                      Rul. 90–24 exchanges have occurred.                   under section 72(p).
                                         service credit that is permitted under                      Commentators generally objected to                    These regulations also authorize the
                                         the final regulations is not treated as a                the proposal to limit exchanges allowed               IRS to issue guidance of general
                                         distribution for purposes of the section                 under Rev. Rul. 90–24. They argued that               applicability allowing exchanges in
                                         403(b) distribution restrictions (so that                such exchanges enable participants to                 other cases. This authority is limited to
                                         such an exchange or transfer may be                      change funding arrangements and                       cases in which the resulting contract has
                                         made before severance from                               claimed that these exchanges have                     procedures that the IRS determines are
                                         employment or another distribution                       generally been responsible for improved               reasonably designed to ensure
                                         event).                                                  efficiency and lower cost in the section              compliance with those requirements of
                                                                                                  403(b) market. Comments often                         section 403(b) or other tax provisions
                                         Contract Exchanges                                       included specific suggestions, such as                that depend on either information
                                           Rev. Rul. 73–124 (1973–1 CB 200) and                   limiting any restrictions on exchanges to             concerning the participant’s
                                         Rev. Rul. 90–24 (1990–1 CB 97) dealt                     active employees and effectuating                     employment or information that takes
                                         with contract exchanges. Rev. Rul. 73–                   compliance with loan restrictions by                  into account other section 403(b)
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                                         124 had allowed section 403(b)                           alternative methods, such as having the               contracts or qualified employer plans.
                                         contracts to be exchanged, without                       issuer report loans on, for example, a                For example, the procedures must be
                                         income inclusion, if, pursuant to an                     Form 1099–R (Distributions From                       reasonably designed to determine
                                         agreement with the employer, the                         Pensions, Annuities, Retirement or                    whether a severance from employment
                                         employee cashed in the first contract                    Profit-Sharing Plans, IRA, Insurance                  has occurred for purposes of the

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41132              Federal Register / Vol. 72, No. 143 / Thursday, July 26, 2007 / Rules and Regulations

                                         distribution restrictions, whether the                   section 403(b), then the portion of the               the year, provided that those age 50
                                         hardship withdrawal rules are satisfied,                 contract that includes the excess will                catch-up contributions do not exceed
                                         and whether a plan loan constitutes a                    fail to be a section 403(b) contract (and             the catch-up limit under section 414(v)
                                         deemed distribution under section                        instead will be a contract to which                   for the taxable year ($5,000 for 2007). In
                                         72(p). By contrast, procedures that rely                 section 403(c), relating to nonqualified              addition, a section 403(b) plan may
                                         on an employee certification, such as                    annuity contracts, applies) and the                   provide that an employee of a qualified
                                         whether a severance from employment                      remaining portion of the contract that                organization who has at least 15 years
                                         has occurred or whether the participant                  includes the contribution that is not in              of service (disregarding any period
                                         has other outstanding loans, would                       excess of the section 415 limitations is              during which an individual is not an
                                         generally not be adequate to meet this                   a section 403(b) contract. This rule                  employee of the eligible employer) is
                                         standard, because such a certification is                under which only the excess annual                    entitled to a special section 403(b)
                                         not disinterested, and also because of                   addition is subject to section 403(c) does            catch-up limit. Under the special
                                         the lack of employer oversight in the                    not apply unless, for the year of the                 section 403(b) catch-up limit, the
                                         certification process to ensure accuracy.                excess and each year thereafter, the                  section 402(g) limit is increased by the
                                                                                                  issuer of the contract maintains separate             lowest of the following three amounts:
                                         Plan-to-Plan Transfers
                                                                                                  accounts for the portion that includes                (i) $3,000; (ii) the excess of $15,000 over
                                            The final regulations expand the rules                the excess and for the section 403(b)                 the amount not included in gross
                                         in the 2004 proposed regulations under                   portion (which is the portion that                    income for prior taxable years by reason
                                         which plan-to-plan transfers would                       includes the amount that is not in                    of the special section 403(b) catch-up
                                         have been permitted only if the                          excess of the section 415 limitations).               rules, plus elective deferrals that are
                                         participant was an employee of the                          With respect to section 403(b) elective            designated Roth contributions; 4 or (iii)
                                         employer maintaining the receiving                       deferrals, section 403(b) applies only if             the excess of (A) $5,000 multiplied by
                                         plan. Under the final regulations, plan-                 the contract is purchased under a plan                the number of years of service of the
                                         to-plan transfers are permitted if the                   that includes the elective deferral limits            employee with the qualified
                                         participant whose assets are being                       under section 402(g), including                       organization, over (B) the total elective
                                         transferred is an employee or former                     aggregation of all plans, contracts, or               deferrals made for the employee by the
                                         employee of the employer (or business                    arrangements of the employer that are                 qualified organization for prior taxable
                                         of the employer) that maintains the                      subject to the limits of section 402(g). As           years. For this purpose, a qualified
                                         receiving plan and certain additional                    in the 2004 proposed regulations, the                 organization is an eligible employer that
                                         requirements are met. However, the                       final regulations require a section 403(b)            is a school, hospital, health and welfare
                                         final regulations retain the rules that                  contract to include this limit on section             service agency (including a home health
                                         were in the 2004 proposed regulations                    403(b) elective deferrals, as imposed                 service agency), or a church-related
                                         prohibiting a plan-to-plan transfer to a                 under sections 401(a)(30) and 402(g).                 organization.
                                         qualified plan, an eligible plan under                   For purposes of the final regulations, the               The 2004 proposed regulations
                                         section 457(b), or any other type of plan                term ‘‘elective deferral’’ includes a                 defined a health and welfare service
                                         that is not a section 403(b) plan, except                designated Roth contribution as well as               agency as either an organization whose
                                         as described in the next paragraph.                      a pre-tax elective contribution. These                primary activity is to provide medical
                                         Similarly, a section 403(b) plan is not                  rules are generally the same as the rules             care as defined in section 213(d)(1)
                                         permitted to accept a transfer from a                    for qualified cash or deferred                        (such as a hospice), or a section
                                         qualified plan, an eligible plan under                   arrangements (CODAs) under section                    501(c)(3) organization whose primary
                                         section 457(b), or any other type of plan                401(k).                                               activity is the prevention of cruelty to
                                         that is not a section 403(b) plan.                          Any contribution made for a
                                                                                                                                                        individuals or animals or which
                                                                                                  participant to a section 403(b) contract
                                         Purchases of Permissive Service Credit                                                                         provides substantial personal services to
                                                                                                  for a taxable year that exceeds either the
                                         and Certain Repayments                                                                                         the needy as part of its primary activity
                                                                                                  section 415 maximum annual
                                                                                                                                                        (such as a section 501(c)(3) organization
                                           The final regulations, like the 2004                   contribution limits or the section 402(g)
                                                                                                                                                        that provides meals to needy
                                         proposed regulations, include an                         elective deferral limit constitutes an
                                                                                                                                                        individuals). In response to several
                                         exception permitting a section 403(b)                    excess contribution that is included in
                                                                                                                                                        commentators’ requests, the final
                                         plan to provide for the transfer of its                  gross income for that taxable year (or, if
                                                                                                                                                        regulations expand this definition to
                                         assets to a qualified plan under section                 later, the taxable year in which the
                                                                                                                                                        include an adoption agency and an
                                         401(a) to purchase permissive service                    contract becomes nonforfeitable). The
                                                                                                                                                        agency that provides either home health
                                         credit under a defined benefit                           final regulations, like the 2004 proposed
                                                                                                                                                        services or assistance to individuals
                                         governmental plan or to make a                           regulations, provide that the section
                                                                                                                                                        with substance abuse problems or that
                                         repayment to a defined benefit                           403(b) plan (including contracts under
                                                                                                                                                        provides help to the disabled.
                                         governmental plan.                                       the plan) may provide that any excess
                                                                                                                                                           Like the 2004 proposed regulations,
                                                                                                  deferral as a result of a failure to comply
                                         Limitations on Contributions                                                                                   the final regulations provide that any
                                                                                                  with the section 402(g) elective deferral
                                           The final regulations, like the 2004                   limit for the taxable year with respect to              4 A technical correction was made to section
                                         proposed regulations, provide that the                   any section 403(b) elective deferral                  402(g)(7)(A)(ii) by section 407(a) the Gulf
                                         section 403(b) exclusion applies only to                 made for a participant by the employer                Opportunity Zone Act of 2005 (119 Stat. 2577), Pub.
                                         the extent that all amounts contributed                  will be distributed to the participant,               L 109–135, to clarify that the aggregate $15,000
                                         by the employer for the purchase of an                                                                         limit on such contributions was reduced not only
                                                                                                  with allocable net income, no later than              by pre-tax elective deferrals made pursuant to the
                                         annuity contract for the participant do                  April 15 or otherwise in accordance                   special section 403(b) catch-up rules, but also by
                                         not exceed the applicable limits under                   with section 402(g).                                  designated Roth contributions. Treasury has
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                                         section 415. The final regulations retain                                                                      recommended that this language be further changed
                                         the rule in the 2004 proposed                            Catch-Up Contributions                                to reflect the intent that the reduction for
                                                                                                                                                        designated Roth contributions at section
                                         regulations that if an excess annual                       A section 403(b) plan may provide for               402(g)(7)(A)(ii)(II) be limited to designated Roth
                                         addition is made to a contract that                      additional catch-up contributions for a               contributions that have been made pursuant to the
                                         otherwise satisfies the requirements of                  participant who is age 50 by the end of               special section 403(b) catch-up rules.

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Federal Register / Vol. 72, No. 143 / Thursday, July 26, 2007 / Rules and Regulations                                                41133

                                         catch-up contribution for an employee                    treatment of distributions from section               amendments to be adopted by plans that
                                         who is eligible for both an age 50 catch-                403(b) plans. Comments raised no                      are subject to ERISA. Section 1.403(b)–
                                         up and the special section 403(b) catch-                 objections to the various rules that were             10(c) has been clarified to indicate that
                                         up is treated first as a special section                 proposed in 2004, other than concerning               in order to be treated as a distribution
                                         403(b) catch-up to the extent a special                  the general rule requiring the                        under this section, the distribution must
                                         section 403(b) catch-up is permitted,                    occurrence of a stated event. The 2004                be pursuant to a QDRO as described in
                                         and then as an amount contributed as an                  proposed regulations generally would                  section 206(d)(3) of ERISA and the
                                         age 50 catch-up (to the extent the age 50                have required the occurrence of a stated              Department of Labor’s guidance.
                                         catch-up amount exceeds the maximum                      event in order to commence
                                         special section 403(b) catch-up).                        distributions of amounts attributable to              Severance From Employment
                                                                                                  employer contributions to section 403(b)                 The final regulations, like the 2004
                                         Timing of Distributions and Benefits
                                                                                                  plans other than elective deferrals or                proposed regulations, define severance
                                            The final regulations, like the 2004                  distributions from custodial accounts.                from employment in a manner that is
                                         proposed regulations, contain                            The stated event rule is substantially the            generally the same as the regulations
                                         provisions reflecting the statutory rules                same as the rule applicable to qualified              under section 401(k) (see § 1.401(k)–
                                         regarding when distributions can be                      defined contribution plans that are not               1(d)(2)), but provide that, for purposes
                                         made from a section 403(b) plan.                         money purchase pension plans (under                   of distributions from a section 403(b)
                                         Distributions of amounts attributable to                 § 1.401–1(b)(1)(ii)), so that a plan is               plan, a severance from employment
                                         section 403(b) elective deferrals may not                permitted to provide for a distribution               occurs on any date on which the
                                         be paid to a participant earlier than                    upon completion of a fixed number of                  employee ceases to be employed by an
                                         when the participant has a severance                     years (such as five years of                          eligible employer that maintains the
                                         from employment, has a hardship,                         participation), the attainment of a stated            section 403(b) plan. Thus, a severance
                                         becomes disabled (within the meaning                     age, or upon the occurrence of some                   from employment would occur when an
                                         of section 72(m)(7)), or attains age 591⁄2.              other identified event (such as the                   employee ceases to be employed by an
                                         Hardship is generally defined under                      occurrence of a financial need,5                      eligible employer, even though the
                                         regulations issued under section 401(k).                 including a need to buy a home).                      employee may continue to be employed
                                         In addition, amounts held in a custodial                    However, the final regulations make a              by an entity that is part of the same
                                         account attributable to employer                         number of changes relating to                         controlled group but that is not an
                                         contributions (that are not section                      distributions. First, the final regulations           eligible employer, or on any date on
                                         403(b) elective deferrals) may not be                    clarify that after-tax employee                       which the employee works in a capacity
                                         paid to a participant before the                         contributions are not subject to any in-              that is not employment with an eligible
                                         participant has a severance from                         service distribution restrictions. Second,            employer. Examples of the situations
                                         employment, becomes disabled (within                     the regulations address comments that                 that constitute a severance from
                                         the meaning of section 72(m)(7)), or                     were made regarding certain disability                employment include: an employee
                                         attains age 591⁄2. This rule also applies                arrangements by clarifying that, if an                transferring from a section 501(c)(3)
                                         to amounts transferred out of a custodial                insurance contract includes provisions                organization to a for-profit subsidiary of
                                         account to an annuity contract or                        under which contributions will be                     the section 501(c)(3) organization; an
                                         retirement income account, including                     continued in the event a participant                  employee ceasing to work for a public
                                         earnings thereon.                                        becomes disabled, then that benefit is
                                            The final regulations, as did the 2004                                                                      school, but continuing to be employed
                                                                                                  treated as an incidental benefit that                 by the same State; and an individual
                                         proposed regulations, include a number                   must satisfy the incidental benefit
                                         of exceptions to the timing restrictions.                                                                      employed as a minister for an entity that
                                                                                                  requirement applicable to qualified                   is neither a State nor a section 501(c)(3)
                                         For example, the rule for elective                       plans (at § 1.401–1(b)(1)(ii)). Third,
                                         deferrals does not apply to distributions                                                                      organization ceasing to perform services
                                                                                                  changes were made to reflect elective                 as a minister, but continuing to be
                                         of section 403(b) elective deferrals (not                deferrals that are designated Roth
                                         including earnings thereon) that were                                                                          employed by the same entity.
                                                                                                  contributions, discussed further later in
                                         contributed before January 1, 1989.                      this preamble under the heading,                      Section 401(a)(9)
                                            The final regulations, as did the 2004                ‘‘Requirement of Certain Separate
                                         proposed regulations, reflect the direct                                                                         The final regulations, like the 2004
                                                                                                  Accounts Under Section 403(b).’’                      proposed regulations, require section
                                         rollover rules of section 401(a)(31) and                 Fourth, § 1.403(b)–7(b)(5) has been
                                         the related requirements of section                                                                            403(b) plans to comply with rules
                                                                                                  added referencing the automatic                       similar to those in the existing
                                         402(f) concerning the written                            rollover rules of section 401(a)(31), in
                                         explanation requirement for                                                                                    regulations relating to the required
                                                                                                  accordance with section 403(b)(10). See               minimum distribution requirements of
                                         distributions that qualify as eligible                   Notice 2005–5, 2005–1 CB 337, for rules
                                         rollover distributions, including                                                                              section 401(a)(9), but with some minor
                                                                                                  interpreting this requirement. Fifth, a               changes (for example, omitting the
                                         conforming the timing rule to the rule                   cross-reference to certain employment
                                         for qualified plans.                                                                                           special rules for 5-percent owners).
                                                                                                  tax rules was added, discussed under                  Thus, section 403(b) contracts must
                                            In addition to the restrictions                       the heading ‘‘Employment Taxes.’’
                                         described in this preamble, the final                                                                          satisfy the incidental benefit rules.
                                                                                                  Sixth, in response to comments, the                   Guidance concerning the application of
                                         regulations generally retain, with certain               final regulations provide that the
                                         modifications, the additional rules from                                                                       the incidental benefit requirements to
                                                                                                  general rule requiring the occurrence of              permissible nonretirement benefits such
                                         the 2004 proposed regulations relating                   a stated event in order for distributions
                                         to when distributions are permitted to                                                                         as life, accident, or health benefits is
                                                                                                  to commence does not apply to                         contained in revenue rulings.6
                                         be made from a section 403(b) plan,                      insurance contracts issued before
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                                         including the restrictions described in                  January 1, 2009, and a special rule has                 6 See, for example, Rev. Rul. 61–121 (1961–2 CB
                                         this preamble imposed by section                         been added allowing conforming                        65); Rev. Rul. 68–304 (1968–1 CB 179); Rev. Rul.
                                         403(b)(7)(A)(ii) and (11) on distribution                                                                      72–240 (1972–1 CB 108); Rev. Rul. 72–241 (1972–
                                         of amounts held in custodial accounts                      5 See, for example, Rev. Rul. 56–693 (1956–2 CB     1 CB 108); Rev. Rul. 73–239 (1973–1 CB 201); and
                                         and elective deferrals, and the tax                      282).                                                 Rev. Rul. 74–115 (1974–1 CB 100).

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41134              Federal Register / Vol. 72, No. 143 / Thursday, July 26, 2007 / Rules and Regulations

                                         Loans                                                    Section 403(b) Nondiscrimination and                  nondiscrimination requirements for
                                                                                                  Universal Availability Rules                          matching contributions in the same
                                           The final regulations adopt the                                                                              manner as a qualified plan. Thus, a non-
                                         provisions in the 2004 proposed                          Nondiscrimination
                                                                                                                                                        governmental section 403(b) plan that
                                         regulations relating to loans to                            Section 403(b)(12)(A)(i) requires that             provides for matching contribution must
                                         participants from a section 403(b)                       employer contributions, other than                    satisfy the nondiscrimination
                                         contract.                                                elective deferrals, and after-tax                     requirements of section 401(m). The
                                                                                                  employee contributions made under a                   nondiscrimination requirements are
                                         QDROs                                                    section 403(b) contract satisfy a                     generally tested using compensation as
                                            The final regulations also adopt the                  specified series of requirements (the                 defined in section 414(s) and are
                                                                                                  nondiscrimination requirements) in the                applied on an aggregated basis taking
                                         2004 proposed regulations’’ limited
                                                                                                  same manner as a qualified plan under                 into account all plans of the employer.
                                         rules relating to QDROs under section                    section 401(a). These nondiscrimination
                                         414(p). Section 414(p)(9) provides that                                                                        See the discussion under the heading
                                                                                                  requirements include rules relating to                ‘‘Treatment of Controlled Groups that
                                         the QDRO rules only apply to plans that                  nondiscrimination in contributions,                   Include Certain Entities.’’
                                         are subject to the anti-alienation                       benefits, and coverage (sections                         The nondiscrimination requirements
                                         provisions of section 401(a)(13), except                 401(a)(4) and 410(b)), a limitation on the            do not apply to section 403(b) elective
                                         that section 414(p)(9) also provides that                amount of compensation that can be                    deferrals. Instead, a universal
                                         the section 414(p) QDRO rules apply to                   taken into account (section 401(a)(17)),              availability requirement, discussed
                                         a section 403(b) contract. The final                     and the average contribution percentage               further in the next section, applies to all
                                         regulations, like the proposed                           rules of section 401(m) (relating to                  section 403(b) elective deferrals
                                         regulations, clarify that the QDRO rules                 matching and after-tax employee                       (including elective deferrals made under
                                         under section 414(p) apply to section                    contributions).                                       a governmental section 403(b) plan).
                                         403(b) plans. The Secretary of Labor has                    Notice 89–23 discusses these
                                                                                                  requirements and provides a good faith                Universal Availability for Elective
                                         authority to interpret the QDRO                                                                                Deferrals
                                         provisions, section 206(d)(3), and its                   reasonable standard for satisfying these
                                         parallel provision at section 414(p) of                  requirements. The 2004 proposed                          The universal availability requirement
                                         the Code, and to issue QDRO                              regulations would have eliminated the                 of section 403(b)(12)(A)(ii) provides that
                                         regulations in consultation with the                     good faith reasonable standard for                    all employees of the eligible employer
                                         Secretary of the Treasury. 29 U.S.C.                     satisfying the nondiscrimination                      must be permitted to elect to have
                                                                                                  requirements of section 403(b)(12)(A)(i)              section 403(b) elective deferrals
                                         1056(d)(3)(N). Under section 401(n) of
                                                                                                  for non-governmental plans. Comments                  contributed on their behalf if any
                                         the Internal Revenue Code, the
                                                                                                  acknowledged the need for and the                     employee of the eligible employer may
                                         Secretary of the Treasury has authority
                                                                                                  IRS’s authority to make this change.                  elect to have the organization make
                                         to issue rules and regulations necessary                 Accordingly, these final regulations do               section 403(b) elective deferrals. Under
                                         to coordinate the requirements of                        not include the Notice 89–23 good faith               the 2004 proposed regulations, the
                                         section 414(p) (and the regulations                      reasonable standard.                                  universal availability requirement
                                         issued by the Secretary of Labor                            However, as discussed in this                      would not have been satisfied unless the
                                         thereunder) with the other provisions of                 preamble under the heading ‘‘Treatment                contributions were made pursuant to a
                                         Chapter I of Subtitle A of the Code.                     of Controlled Groups that Include                     section 403(b) plan and the plan
                                         Taxation of Distributions and Benefits                   Certain Entities,’’ the Notice 89–23 good             permitted all employees of an employer
                                                                                                  faith reasonable standard will continue               an opportunity to make elective
                                         From a Section 403(b) Contract
                                                                                                  to apply to State and local public                    deferrals if any employee of that
                                            The final regulations, like the 2004                  schools (and certain church entities) for             employer has the right to make elective
                                         proposed regulations, reflect the                        determining the controlled group.                     deferrals.
                                         statutory provisions regarding the                       Although the general nondiscrimination                   The rules in the final regulations
                                         taxation of distributions and benefits                   requirements do not apply to                          relating to the universal availability
                                         from section 403(b) contracts, including                 governmental plans (within the meaning                requirement are substantially similar to
                                         the provision that generally only                        of section 414(d)), these plans are                   those in the 2004 proposed regulations.
                                         amounts actually distributed from a                      required to limit the amount of                       The final regulations clarify that the
                                         section 403(b) contract are includible in                compensation to the amount permitted                  employee’s right to make elective
                                         the gross income of the recipient under                  under section 401(a)(17) for all purposes             deferrals also includes the right to
                                                                                                  under the plan, including, for example                designate section 403(b) elective
                                         section 72 for the year in which
                                                                                                  the amount of compensation taken into                 deferrals as designated Roth
                                         distributed. The final regulations also
                                                                                                  account for employer contributions, and               contributions (if any employee of the
                                         reflect the rule that any payment that
                                                                                                  are required to satisfy the universal                 eligible employer may elect to have the
                                         constitutes an eligible rollover                         availability rule (described in this                  organization make section 403(b)
                                         distribution is not taxed in the year                    preamble under the heading ‘‘Universal                elective deferrals as designated Roth
                                         distributed to the extent the payment is                 Availability for Elective Deferrals’’). A             contributions).
                                         rolled over to an eligible retirement                    non-governmental section 403(b) plan                     The preamble to the 2004 proposed
                                         plan. The payor must withhold 20                         that provides for nonelective employer                regulations requested comments
                                         percent Federal income tax, however, if                  contributions must satisfy the coverage               regarding certain exclusions that have
                                         an eligible rollover distribution is not                 requirements of section 410(b) and the                been permitted under transitional
                                         rolled over in a direct rollover. Another                nondiscrimination requirements of                     guidance issued in 1989. Specifically,
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                                         provision requires the payor to give                     section 401(a)(4) with respect to such                Notice 89–23 had allowed, pending
                                         proper written notice to the section                     contributions.                                        issuance of regulatory guidance, the
                                         403(b) participant or beneficiary                           These final regulations, like the 2004             exclusion of the following classes of
                                         concerning the eligible rollover                         proposed regulations, require a section               employees for purposes of the universal
                                         distribution provision.                                  403(b) plan to comply with the                        availability rule: Employees who are

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Federal Register / Vol. 72, No. 143 / Thursday, July 26, 2007 / Rules and Regulations                                         41135

                                         covered by a collective bargaining                       appropriate, preclude the plan                        (iii) the assets held in the account
                                         agreement; employees who make a one-                     maintained by the home university from                cannot be used for, or diverted to,
                                         time election to participate in a                        treating the visiting professor as an                 purposes other than for the exclusive
                                         governmental plan described in section                   eligible employee of the home                         benefit of plan participants or their
                                         414(d), instead of a section 403(b) plan;                university.                                           beneficiaries. For this purpose, assets
                                         professors who are providing services                       The discussion in this preamble                    are treated as diverted to the employer
                                         on a temporary basis to another public                   under the heading ‘‘Applicability date’’              if the employer borrows assets from the
                                         school for up to one year and for whom                   describes transition relief for any                   account. A retirement income account
                                         section 403(b) contributions are being                   existing plan that excludes, in                       must be maintained pursuant to a
                                         made at a rate no greater than the rate                  accordance with Notice 89–23,                         program which is a plan and the plan
                                         each such professor would receive                        collective bargaining employees,                      document must state (or otherwise
                                         under the section 403(b) plan of the                     visiting professors, government                       evidence in a similarly clear manner)
                                         original public school; and employees                    employees who make a one-time                         the intent to constitute a retirement
                                         who are affiliated with a religious order                election, or employees who work under                 income account.
                                         and who have taken a vow of poverty                      a vow of poverty.                                        If any asset of a retirement income
                                         where the religious order provides for                                                                         account is owned or used by a
                                                                                                  Rules Relating to Funding Arrangements
                                         the support of such employees in their                                                                         participant or beneficiary, then that
                                         retirement.                                                 These regulations retain, with certain             ownership or use is treated as a
                                            The comments submitted in response                    modifications, the rules in the 2004                  distribution to that participant or
                                         to the request generally requested to                    proposed regulations relating to the                  beneficiary. The regulations also
                                         have these exclusions continue to be                     permitted investments for a section                   provide that a retirement income
                                         allowed. However, after consideration of                 403(b) contract. In general, a section                account that is treated as an annuity
                                         the comments received, the IRS and                       403(b) plan must be funded either by an               contract is not a custodial account (even
                                         Treasury Department have concluded                       annuity contract issued by an insurance               if it is invested in stock of a regulated
                                         that these exclusions are inconsistent                   company qualified to issue annuities in               investment company).
                                         with the statute and, accordingly, they                  a State or a custodial account held by                   A life annuity can generally only be
                                         are not permitted under these                            a bank (or a person who satisfies the                 provided from an individual account by
                                         regulations. Nonetheless, as described                   conditions in section 401(f)(2)) where                the purchase of an insurance annuity
                                         further in the following paragraphs,                     all of the amounts in the account are                 contract. However, in light of the special
                                         other rules may provide relief with                      held for the exclusive benefit of plan                rules applicable to church retirement
                                         respect to individuals who are under a                   participants or their beneficiaries in                income accounts, the final regulations,
                                         vow of poverty and to certain university                 regulated investment companies                        like the 2004 proposed regulations,
                                         professors affected.                                     (mutual funds) and certain other                      permit a life annuity to be paid from
                                            Rev. Rul. 68–123 (1968–1 CB 35), as                   conditions are satisfied (including                   such an account if certain conditions are
                                         clarified by Rev. Rul. 83–127 (1983–2                    restrictions on distributions). Additional            satisfied. The conditions are that the
                                         CB 25), generally excludes from gross                    rules apply with respect to retirement                distribution from the account has an
                                         income, and from wage withholding,                       income accounts for plans of a church                 actuarial present value, at the annuity
                                         income of an individual working under                    or a convention or association of                     starting date, that is equal to the
                                         a vow of poverty for an employer                         churches as discussed in the next                     participant’s or beneficiary’s
                                         controlled by a church and the                           section.                                              accumulated benefit, based on
                                         individual is treated as working as an                   Special Rules for Church Plans’                       reasonable actuarial assumptions,
                                         agent of the church, not as an employee.                 Retirement Income Accounts                            including assumptions regarding
                                         While these regulations do not provide                                                                         interest and mortality, and that the plan
                                         an exclusion from the universal                             The final regulations, like the 2004               sponsor guarantee benefits in the event
                                         availability requirement for individuals                 proposed regulations, include a number                that a payment is due that exceeds the
                                         working under a vow of poverty,                          of special rules for church plans. Under              participant’s or beneficiary’s
                                         individuals who work for an institution                  section 403(b)(9), a retirement income                accumulated benefit.
                                         that is controlled by the church                         account for employees of a church-
                                                                                                  related organization is treated as an                 Termination of a Section 403(b) Plan
                                         organization and whose compensation
                                         from the employer is not treated as                      annuity contract for purposes of section                 The final regulations adopt the
                                         wages for purposes of income tax                         403(b). Under these regulations, the                  provisions of the 2004 proposed
                                         withholding under Rev. Rul. 68–123                       rules for a retirement income account                 regulations permitting an employer to
                                         may be excluded from the section 403(b)                  are based largely on the provisions of                amend its section 403(b) plan to
                                         plan without violating the universal                     section 403(b)(9) and the legislative                 eliminate future contributions for
                                         availability requirement because they                    history of TEFRA. The regulations                     existing participants, and allowing plan
                                         are not treated as employees of the                      define a retirement income account as a               provisions that permit plan termination
                                         entity maintaining the section 403(b)                    defined contribution program                          and a resulting distribution of
                                         plan.                                                    established or maintained by a church-                accumulated benefits, with the
                                            With respect to an exclusion relating                 related organization under which (i)                  associated right to roll over eligible
                                         to visiting professors, if an individual is              there is separate accounting for the                  rollover distributions to an eligible
                                         rendering services to a university as a                  retirement income account’s interest in               retirement plan, such as an individual
                                         visiting professor, but continues to                     the underlying assets (namely, it must                retirement account or annuity (IRA).
                                         receive his or her compensation from                     be possible at all times to determine the             Comments on the rules in the 2004
                                         his or her home university and elective                  retirement income account’s interest in               proposed regulations regarding plan
rmajette on PROD1PC64 with RULES2

                                         deferrals on his or her behalf are made                  the underlying assets and to distinguish              termination were favorable. In general,
                                         under the home university’s section                      that interest from any interest that is not           the distribution of accumulated benefits
                                         403(b) plan, the final regulations do not,               part of the retirement income account),               is permitted under these regulations
                                         for purposes of section 403(b) and in                    (ii) investment performance is based on               only if the employer (taking into
                                         any case in which such treatment is                      gains and losses on those assets, and                 account all entities that are treated as a

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