Two recent pieces of IRS guidance address issues for terminating 403(b) plans, as required by the Setting Every Community Up for Retirement Enhancement (SECURE) Act (Division O of Pub. L. No. 116-94). Rev. Rul. 2020-23 provides guidance on making distributions of 403(b) custodial accounts in kind, while Notice 2020-80 requests comments on the application of ERISA's annuity and spousal rights provisions. Comments on the notice are due Feb. 3.
Under 2007 final regulations, a terminated 403(b) plan generally must distribute its assets within 12 months after the plan termination date. Under IRS Rev. Rul. 2011-7, plans can satisfy this requirement by making distributions of annuity contracts in kind. These distributions allow participants to receive — and be taxed on — their benefits on a later date, as long as the contracts are maintained as 403(b) annuity contracts.
Rev. Rul. 2011-7 also says assets held in 403(b) custodial accounts can be liquidated and distributed in cash or in kind (i.e., the mutual fund shares are distributed directly to the participants). But the ruling doesn’t address distributions of custodial accounts in kind as it does for annuity contracts. Many custodial agreements prohibit forced liquidations. So sponsors of plans funded with custodial accounts may have difficulty terminating their plans if participants don’t consent to liquidation or a rollover.
To rectify this problem, the SECURE Act directed IRS to issue guidance on how 403(b) plans could distribute custodial accounts in kind — that is, in individual 403(b) custodial accounts maintained by the custodian on participants' behalf after plan termination. Rev. Rul. 2020-23 provides that guidance.
Under the new ruling, a 403(b) plan funded with individual custodial accounts can distribute the accounts and notify participants that their accounts are now being maintained outside of the plan. If the plan is funded with a group custodial account, the plan can distribute individual custodial accounts to each participant, along with a document that evidences the custodial account, including the accumulated value of the participant’s interest in the accounts maintained under the group agreement and the associated rights and responsibilities of the participant and custodian. The accounts will retain 403(b) status after the distribution in kind as long as they continue to meet the Section 403(b) requirements in effect on the plan termination date and the employer doesn't retain any material rights to the accounts. Like annuity contracts that have been distributed in kind, benefits held in compliant custodial accounts won't be taxable to participants until funds are actually paid out.
Rev. Rul. 2020-23 is effective retroactively for taxable years beginning after Dec. 31, 2008, so plans that already made in-kind distributions don't need to take corrective action.
Certain 403(b) plans maintained by nongovernmental exempt entities must comply with the annuity and spousal rights provision of ERISA Section 205. In Notice 2020-80, IRS requests comments on how these provisions should apply to distributions of individual custodial accounts in kind upon plan termination. IRS and Treasury are particularly interested in: