Final 403(b) Regulations

1. Final 403(b) Regulations Focus on Impact for K-12 Schools

2. Overview of Presentation • Provide summary of relevant features of final 403(b) regulations • Discuss impact on public education employers and employees • Planning strategies and action steps • Update on deferred compensation and constructive receipt issues for public employers

3. A Little Background… • In November, 2004, the IRS issued proposed 403(b) regulations • Hinted at shift away from payroll accommodation programs • Focus on employer as sponsor of retirement plan • Many new responsibilities for employers • IRS received many comments from the public

4. Final Regulations Issued • On July 23, 2007 • Published on July 26, 2007 • General effective date for most provisions is January 1, 2009 • Different effective dates for specific provisions (more specifics later)

5. Overall Impressions • Committed to treating 403(b) programs as employer “plans” • IRS referred to a “change in culture” recognizing the 403(b) as an employer plan • As often as possible implemented rules to make 403(b) plans as similar as possible to other “elective deferral” plans • Incorporated many 401(k) requirements and interpretations into regulations

6. General Impact • Shifts full control to the school district • Specific elements may become negotiated with bargaining • But plan document will determine features, not product contracts • Will reduce employees freedom to change investment products • Does NOT affect rollovers • Employers become the nexus between employees and the product providers

7. Biggest Changes Under the Regs… • Written plan documentation requirement • Restrictions on employee changes in investments • Currently, changes are based on the products used to fund the 403(b) accounts • Based on Rev. Rul. 90-24 which established criteria for transferring 403(b) accounts • Employers and product providers will have different relationships • Clarifications on certain issues change current practices • Consequences of defects or errors

8. Changes for Employers • More contact with product providers to coordinate responsibilities • Annual notice requirements • Communicating the plan to employees • Evaluating product provider performance under the plan • Determine “partner” relationships for compliance purposes

9. Product Changes • Providers have to have direct relationship with employers (or their representatives) • No access to employees unless named in the plan document • Sharing information on the accounts • Reporting factual information about employees • Self certification by employees not acceptable • Will need independent verification of information on many plan transactions

10. More Product Issues • 403(b) products will have to be changed • Separate accounting requirements for vesting and excess contributions • Products must be able to link participants accounts with specific employer • New contract for each employer, even if same product • Unless current and former employer’s plans permit transfers

11. Now, About the Regulations… • General effective date for most provisions is taxable years beginning after December 31, 2008 • Delayed effective dates • For 403(b) plans maintained pursuant to a collective bargaining agreement in place on July 26, 2007, effective date is earlier of expiration of contract or July 26, 2010 • For governmental plans if authority to amend plans is held by legislative body, effective date is earlier of close of 1st legislative session that begins after 12/31/09 or January 1, 2011 • School board could be “legislative body” based on facts and circumstances

12. Different Effective Dates • Prohibition on using separate life insurance contacts in 403(b) plans effective for contracts issued after September 24, 2007 • 90-24 transfers permitted under current rules until September 24, 2007 • Thereafter significant changes • Will cover on later slides • Restrictions on in-service withdrawals of employer contributions to annuity contracts not effective for any contract entered into prior to January 1, 2009

13. New “Plan” Requirements • The 403(b) plan must satisfy a list of specific qualifications • Requirements for written plan documentation • Separate requirements for underlying custodial accounts and annuity contracts • Operational requirements (new) • Failure of any of these elements causes the employee to lose the “exclusion from income” otherwise provided under 403(b)

14. What Happens if There is an Defect under the Plan? • General Rule • No exclusion from income • How much is lost depends on type of error • Entire plan (all accounts under the plan) is disqualified if the employer • Fails to maintain the written plan document or • Fails to satisfy the universal availability requirements • Or, if the problem is not an “operational” problem • An operational problem occurs if the plan does not follow the terms of the plan document

15. What Happens For “Operational” Errors? • Employees’ contracts fail individually due to operational errors • But an operational failure by one product provider can affect ALL contracts held for that employee under the plan • Regs state that all contracts held by a participant under the “plan” are considered as one account contract • Exception to aggregation rule if contract language does not satisfy separate accounting rules for unvested amounts and excess 415(c) contributions (over the $45,000 limit in 2007) • Only that contract fails • Does not affect other contracts

16. An Overview of the Plan Document Requirements • Two Requirements • Written plan documentation required which includes all material terms and conditions for: • Eligibility • Applicable limitations (Contributions) • Benefits • Distributions • “Contracts” available under the plan • The plan must adhere to the 403(b) requirements in both “form and operation”

17. Plan Documents May… • Allocate administrative duties to responsible parties • BUT, no provision for shifting liabilities • Would still need a “hold harmless agreement” that protects the school district’ • Use multiple documents, but regs recommend a single document for multiple vendor plans • Incorporate by reference the underlying contracts and custodial accounts • But, must include procedure for resolving conflicting provisions

18. Plan Documents May… • Include optional features, such as: • Employer contributions • Roth contributions • Hardship withdrawals • Loans • Acceptance of rollovers • In service withdrawals • “Exchanges” to 403(b) products approved within the plan • Plan to plan transfers (in or out)

19. Plan Documents May… • Exclude features to limit simplify compliance or reduce liabilities, such as • Excluding 15 years of service “catch up” limit • Prohibiting financial hardships • Allowing every employee to participate in the plan • Restricting the number of product providers and require providers to take on certain administrative responsibilities

20. Where to Get a Plan Document? • IRS will release “model” language that school districts can use to create a plan document that meets the requirements of the regulations (if used and followed, will comply) • Vendors will offer their documents • TPAs will offer their documents • Issue- Following the terms of the document • The employer must read it to identify the terms and responsibilities

21. Key Concepts to Understand • Terms of plan document must be followed • “Operational error” consequence • Just the affected participant • Employers, employees and vendors must know terms of the plan document • Employers will have to choose strategy for plan administrative services • Self administration • Work with vendors • Work with Third Party Administrator

22. How Will This Requirement Affect 403(b) Plans of K-12 Employers? • Puts focus clearly on the employer • Employer will be responsible for document • Including maintenance and updates • Consideration when selecting document provider • Employer reactions to requirement? • Liabilities and responsibilities • Probably more restrictive plan options • Uncertain about “information sharing” role

23. More Considerations for Document Requirement • Product Provider Issues • Will vendors be able to follow each employers plans’ terms? • Can products be amended and reregistered to satisfy requirements? • Customer service and administrative support must shift to plan level • Vendors will have to: • take responsibility for “optional” features such as monitoring distributions and loans, or • be able to work with TPAs

24. Next Big Issue… • The regulations impose severe restrictions on employees’ rights to change investment products during employment • Transfers and Exchanges • Rollover rights NOT affected • Include transition period for changes • First transition period ends September 24, 2007 • Employers will need to consider options quickly to communicate changes to employees

25. Transfers and Exchanges • Lesson on New Terminology After 9/24/07 • “Transfer” is moving a 403(b) account under one employer’s plan into investment products permitted under another employer’s 403(b) plan • “Exchange” is change of investment products among investment options under the current employer’s 403(b) plan • “Rollover” is removal of account from employer’s 403(b) plan into any other “eligible retirement plan” • Only available after the employee experiences a “distributable” event such as severance from service or age 59 ½.

26. Transfers Taking Place By September 24, 2007 • Regs state that Rev. Rul. 90-24 will be repealed by future guidance • Employee initiated transfers under Rev. Rul. 90-24 are permitted until September 24, 2007 • Current rules continue for 60 days from publication date • IRS spokespersons said that transfer would be deemed to be completed if necessary paperwork was completed even if the transfer check is not issued by 9/24/07 • Employers need not be involved in these transactions

27. Transfers and Exchanges Between 9/25/07 and 1/1/09 • Permitted only if employer and vendorreceiving the proceeds from another vendor enter into an information sharing agreement and • The written plan document must include provisions that “ratify” the exchanges that occurred during the interim and permit exchanges and/or transfers • Both these actions must be completed by January 1, 2009 • Next slide

28. New *Exchange Rules • Employer’s plan document would have to permit exchanges, and to be a tax free exchange… • The value of the “accumulated benefit” is not less after the transfer • Contract charges are permitted. Special transfer fees are not. • The receiving contract has distribution restrictions at least as restrictive as the sending contract • same as “old” rules • Employer and receiving vendor have an information sharing agreement for compliance purposes *Exchange of one contract for another within the “plan”

29. After December 31, 2008… • No transfers or exchanges unless permitted by the plan document • Exchanges restricted to only those products named in employer’s plan document • No transfers outside of authorized products during employment • Plan could authorize different vendors for exchanges than for payroll access • After employment, employees could transfer to another employer’s 403(b) plan if both plans permit

30. Informal Clarification • According to Bob Architect (IRS spokesperson): • Before 9/25/07, 90-24 transfers permitted under current rules • After 9/24/07 and before 1/1/09 • Employees can make 90-24 transfers so long as the plan, as adopted by January 1, 2009 retroactively permits the “exchange” by allowing it in the plan document and executing an information sharing agreement with the recipient product provider • Risk of compliance lies with the employee for interim transfers • “they have to be confident that their employer will permit exchanges and will enter into an agreement with that vendor” • After 12/31/08, only new rules apply

31. Implications on Marketplace? • Severely restricts “transfer” marketplace after Sept. 24, 2007 • Employee would have to acknowledge risk that employer may not approve exchange later, or • Employer would have to permit exchange by entering into an agreement with the recipient before the exchange • Absolutely unclear what happens to 403(b) accounts that are not named under an employer’s plan on January 1, 2009

32. Other Changes Under the Regulations • Catch up contribution ordering ratified • Anything over annual deferral limit • First – looked at as part of 15 years of service catch up, if employee is eligible • Then – aged 50+ catch up considered • Investment Restrictions on 403(b)s • Limited to Annuity Contracts and 403(b)(7) Custodial Accounts • Life Insurance contracts issued after September 24, 2007 are NOT permitted

33. Post Employment Employer Contributions • Employer contributions for former employees permitted for up to 5 years after year of severance from service • No post employment employer contributions after the month of retiree’s death • Monthly compensation to be determined based on 1/12 of annualized compensation • IRS auditors are looking to see if there is constructive receipt or “hint of FICA avoidance” scheme • Is it really treated as an employee option rather than an employer contribution?

34. Impact • Post-employment contribution agreements need to be reviewed prior to 1/1/09 • Determine if contracts require payments after death • To 403(b) account, or • To beneficiary • If contracts requires post mortem payments, amendments will be required prior to applicable effective dates

35. Salary Reduction Contributions From Payments Received After Employment Ends • Follow the 415 regulations to permit employees to make elective deferrals from amounts received after severance from service, so long as: • Proceeds are received by the later of the end of the year or 2½ months following severance date, and • Payments are for amounts employees would have received if they had not severed service • Accumulated leave payments okay • ERIs or severance benefits may not be used for deferrals unless received as part of final paycheck

36. Universal Availability • General Rule: If employer allows any employees to participate, then all employees must be allowed to participate • Certain exceptions apply • Regs clarify “universal availability” requirements • 20 hour per week exclusion based on actual hours worked • If reasonable expectation that employee will not work 1000 hours in year of hire, can exclude during 1st year • Thereafter, have to look back to count hours to determine if employee actually worked at least 1,000 hours • Effectively requires schools to count actual hours of service for all employees if they want to exclude employees with fewer than 20 hrs/week

37. Universal Availability • Requires “meaningful” written notice to employees of eligibility to participate at least annually • Employees must have “reasonable opportunity” to make deferral elections at least once per year • Violations of universal availability requirements result in plan failure

38. Financial Hardships • Clear authority to rely on 401(k) regulations for guidance on financial hardships • But, vendors are required to notify employer of withdrawal • Salary reduction contributions must be stopped for 6 months • To ALL vendors and allplans (such as 403(b) and 457(b)) • Personal Comment…I expect employers will prohibit hardships under the plan document

39. Frozen and Terminated Plans • No change from proposed regulations • Employers may “freeze” plans, not allowing future contributions • But still have to follow rules for 403(b) plans on frozen accounts • Employers may terminate §403(b) plans and make distributions from the terminated plans without violating the restrictions on early distributions • If the employer follows the requirements • Difficult to do unless plan uses group contracts or trust because of mandatory distribution requirement

40. Issues Related to the Plan Termination Provisions • To allow distributions, contracts and custodial accounts would have to be amended • Consideration will have to be given to who controls the assets of “terminated” plans • Regs permit “fully paid up” contracts to be treated as distributed • But, no relief for custodial accounts • Must employees consent to distributions? • What about outstanding loans and the 10% early distribution penalty if there is a cash distribution?

41. Other Issues • Requires that elective deferral contributions be remitted to the insurance company or custodian as soon as administratively possible • Suggests standard of no later than 15 business days in the month following reduction of salary • States may have stricter standards for deposits • NJ - 5 days • May require changes to employer’s procedures

42. What The Regulations Do Not Do… • The regulations do not impose a fiduciary duty on employers • IRS does not have authority to do so • Public schools are exempt from ERISA, so ERISA duties do not apply • However, every state has established certain standards for appropriate behavior between employers and employees and when “handling” assets on behalf of another • May be potential litigation…just have to wait and see

43. New Considerations for K-12 Employers… • Impact of “consultants” on school district decisions • Preferences and relationships • RFPs in larger school districts • Finding competent service providers • Understanding administrative requirements and liabilities as part of the 403(b) • Working under new “information exchange” agreements • Working under new “hold harmless agreements” • Picking quality “partners” • Compensation issues for partners • Recognizing that 403(b) plan is employer responsibility

44. OK….Now Take a Breath… • Help is on the Way!!! • Schools will have to decide how to address new responsibilities • Some will ignore the changes and continue as before • Some will “do it themselves” • Some will have product providers provide the services • Coupled with a hold harmless • Some will use a third party administrator (“TPA”) • “captive” or owned by a provider • Independent TPA

45. Third Party Administrators • Broad range of service providers • “Captive” TPAs • Owned by product provider • Usually structured to provide product provider with marketing opportunities • Privacy issues • Cooperation with other vendors • Internal administration of clients only • Will agree to be responsible for their clients • Either will not take responsibility for other product’s clients or will charge a fee • Who pays?

46. More on TPAs… • Providers of traditional TPA services • Coming from 401(k) and ERISA marketplace • Lack of expertise and systems not coordinated with individually owned contracts • Consulting companies • Some have TPA relationships • Will consistently recommend the same service providers • Base recommendations on product fees and ratings • Developing 403(b) TPAs • Usually unrelated to products • Can offer broad range of services • Usually not an “all or nothing” approach • Focus on distribution issues • Many can provide education for employees • Flexible/modular approach to services

47. More on TPAs This Afternoon I don’t know about you, but I need a break!

48. But We’re Not Enron! Unfortunately, §409A Still Affects Public School Employers

49. An Update From Last Year… • Surprises in Deferred Compensation • Final 409A regulations were also released • FAQ list released that caused some confusion in public schools • Constructive Receipt • Final Section 125 cafeteria plan regulations also released • Very clearly establishes “constructive receipt” boundaries

50. Quick Review …Unexpected Deferred Compensation • New law (American Jobs Creation Act of 2004) affects all compensation “deferred” after 12/31/04 • But regulations give employers until 12/31/07 to correct contracts and plans • Industry asking for delay to 12/31/08 • A new section added to the federal income tax code (§409A) establishes requirements for all deferred compensation arrangements • There are certain exemptions available under §409A • Any arrangement not exempted must satisfy the requirements of §409A