'Distributing' 403(b) Annuities

New 403(b) Regulations Raise More Questions Than Answers

Written by: Bob Toth

The IRS's decision to permit the termination of 403(b) plans, and the distribution of its assets, raises a new issue which vendors, plans and plan participants have never had to deal with in the past: can you distribute an annuity upon 403(b) plan termination, how do you do it, and how is such a distribution treated?

The distribution of annuities has long been a feature of 401(a) plans, in the form of something called a "qualified plan distributed annuity contract," (see, for example, Sec. 31.3405(c)-1 Q-13). Few people outside of the insurance industry are familiar with these creatures, but they have served as the basis for distributing assets from terminating defined benefit plans for over 70 years. They are also able to be used for distributions from defined contribution plans and those amounts are not includable in income until actually distributed from the contract.  Though they are not IRAs, assets can be rolled into and out of them as if they were part of a plan.

Under the new 403(b) regulations (a topic about which we have blogged several times: here, here, and here), however, the IRS tells us that we can distribute a "fully paid individual insurance annuity contract" from a terminated 403(b) plan (see, e.g. 1.403(b)-10(a)(1)).  How is this done? Presumably its done by an internal transfer (where group arrangements are in place, or where mutual funds are involved), then followed by a distribution.  With individual contracts, it seems to be merely a recordkeeping entry that would need to be done.  Is it correct to assume that the terms of information sharing agreements would reflect that such contracts are no longer subject to their terms?

According to the new regulations, this distributed annuity does not lose its status as a 403(b) contract. Does this mean that we'll have a class of annuity contracts for which no employer is involved, and to which the current rules do not apply? Can the vendor now rely upon employee representations related to hardships and loans? What of the lack of a written plan document? Can these contracts be transferred into another 403(b) plan at the participant's election? Upon the distribution of the contract, does the amount need to be reported on Box 8 of the 1099-R?

The regs clearly do not address these and other questions related to the distribution of annuity contracts upon the termination of the 403(b) plan, but we will need to find answers.