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This is the fifth in a series of articles examining the SECURE Act. Here we will focus on its unique provisions for 401(b) and 457(b) plans. The Setting Every Community Up for Retirement Enhancement Act makes numerous changes (including a variety of enhancements) affecting qualified retirement plans, 403(b) and 457(b) plans, individual retirement accounts, and other employee benefits. Some of the changes are effective immediately, while others are effective in plan or tax years beginning on or after January 1, 2020.

The Act provides for a remedial plan amendment period that does not end until the last day of the 2022 plan year (the 2024 plan year for governmental plans). Therefore, plan sponsors generally have sufficient time to amend plan documents to comply with any required or optional changes.

The provisions unique to 403(b) and governmental 457(b) plans encompass two changes that apply solely to tax-sheltered annuity plans under Code Section 403(b) and one change that applies solely to governmental 457(b) plans.

Treatment of Section 403(b) custodial accounts upon termination

Prior to the SECURE Act, employers wishing to terminate a Section 403(b) tax-sheltered annuity arrangement had only three options for making "distributions" upon termination of the plan:

Delivery of a fully paid (individual) annuity contract
Delivery of a certificate of fully paid benefits under a group annuity contract
Distributions (in cash or in kind) of the investments held in an annuity contract or a Section 403(b)(7) custodial account — an account that is expressly limited to investment in mutual funds, and that is treated as an annuity contract for purposes of Code Section 403(b)

Unfortunately, under most individual custodial accounts (as opposed to group custodial accounts), the employer does not have the right to "force" a distribution upon termination of the plan. Consequently, if one or more participants do not consent to a liquidating distribution from their individual (b)(7) custodial account, the plan cannot be terminated.

Under the SECURE Act, the Secretary of the Treasury is directed to issue guidance (within six months of the date of enactment) providing that, if an employer terminates a 403(b) plan funded in whole or in part with individual (b)(7) custodial accounts, the plan administrator or custodian may distribute or deliver the actual custodial account to the participant or beneficiary, and the account shall thereafter be maintained by the custodian on a tax-deferred basis as a 403(b)(7) custodial account — similar to the treatment of fully-paid individual annuity contracts under Rev. Rul. 2011-7 — until the amounts held in the account are actually paid to the participant or beneficiary in cash or in kind.

The guidance is to provide that 1) the custodial account will maintain its tax-favored status so long as the account adheres to the requirements of Code Section 403(b) that were in effect at the time of the distribution of the account (from the plan to the participant); and 2) the custodial account will not be considered to be "distributed" if the employer retains any material rights under the contract.

This affects Section 403(b) plans that are funded, in whole or in part, with individual 403(b)(7) custodial accounts but is optional and applies retroactively to taxable years beginning on or after January 1, 2009.

This guidance should be welcome relief to those 403(b) plan sponsors who have been unable to terminate their 403(b) arrangements solely because they lack the authority to mandate distributions from individual (b)(7) custodial accounts (or to those who previously distributed fully paid-up accounts notwithstanding the guidance in Rev. Rul. 2011-7).

Plans intending to distribute individual custodial accounts should be amended to allow such distributions, and distribution paperwork should be revised accordingly.

403(b) plans funded through retirement income accounts — clarification for church-controlled organizations

Under Code Section 403(b)(9), churches and certain church-controlled organizations are allowed to fund their 403(b) plans through a "retirement income account" as an alternative to 403(b)(1) annuity contracts or 403(b)(7) custodial accounts invested solely in mutual funds.

A retirement income account may hold investments other than annuity contracts and mutual funds, and the assets of a retirement income account may be commingled with the general assets of the church sponsoring the plan so long as they are accounted for separately.

Church plan sponsors and their advisors have for years assumed that both "qualified" and "non-qualified" church-controlled organizations — also known as "QCCOs" and "non-QCCOs" — could participate in a church 403(b) plan funded with a (b)(9) retirement income account.

However, when the IRS developed its program of "pre-approved" 403(b), it took the position that a non-QCCO could not participate in a 403(b)(9) retirement income account, and, because a QCCO could, under certain circumstances, become a non-QCCO, the IRS took the position that a pre-approved 403(b) plan such as a prototype or volume submitter plan)funded with a (b)(9) retirement income account could not allow participation by either a QCCO or a non-QCCO.

The SECURE Act amends Code Section 403(b)(9) to specifically provide that a retirement income account may cover both employees of the church (or convention of churches) sponsoring the arrangement, and employees of any organization which is exempt from federal income tax under Code Section 501 and which is controlled by or associated with the church or a convention of churches.

Thus, this minor change to the Tax Code clarifies that both QCCOs and non-QCCOs may participate in a 403(b)(9) retirement income account maintained by a church.

This is optional, and church plans are not required to extend participation to their church-controlled affiliates. This is effective for all tax years both before or after the date of enactment.

This legislative clarification is welcome relief to sponsors of church plans that are structured as 403(b)(9) retirement income accounts. Hopefully, the IRS will issue guidance before the March 31, 2020 deadline mentioned above allowing QCCOs and non-QCCOs to participate in Section 403(b)(9) retirement income accounts maintained by a church or a convention or association of churches that uses a "pre-approved" 403(b) plan document.

457(b) plan in-service distributions now permitted at age 59 1⁄2

Prior to the legislation which includes the SECURE Act, distributions under governmental Section 457(b) "eligible deferred compensation plans" could only be made upon the participant's death, disability, severance of employment, or attainment of a relatively advanced age (age 70½).

As a result, many governmental 457(b) plans do not allow "in-service" distributions — other than distributions of small, inactive accounts, as specifically permitted under Code Section 457. Those plans that allow in-service distributions may do so only after the participant attains age 70 ½.

Under the Miners Act portion of the legislation that includes the SECURE Act, governmental 457(b) plans may now allow in-service distributions as early as age 59½.

This allows participants who remain employed after 59½ the option of taking a distribution at any time. This new rule does not extend to unfunded Section 457(b) plans maintained by tax-exempt organizations for a select group of management or highly compensated employees.

This affects Section 457(b) eligible deferred compensation arrangements maintained by state or local governments and is optional for distributions in plan years beginning on or after January 1, 2020. Plan amendments will be required, and distribution paperwork must be updated, if an employer chooses to allow in-service distributions at this new age.

Rob Browning is of counsel at Spencer Fane LLP in the firm's Overland Park, Kansas office.

Instant Insights /

SECURE ACT – How does it affect 403(b) and governmental 457(b) plans?

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