Tax Sheltered Annuity, or TSA
under Internal Revenue Code Section 403(b)
A 403(b) tax-sheltered annuity (TSA) plan is a retirement plan offered by public schools and certain tax-exempt organizations. An individual’s 403(b) tax-sheltered annuity can be obtained only under an employer’s TSA plan. Generally, these annuities are funded by elective deferrals made under salary reduction agreements and nonelective employer contributions.
Who can establish a 403(b) tax-sheltered annuity plan?
You are allowed to establish a 403(b) plan if you are a:
- Public school, college or university or
- Charitable entity tax-exempt under section 501(c)(3) of the Code.
How do 403(b) plans work?
403(b) plans are very similar to 401(k) plans offered by for-profit businesses. Just like with a 401(k) plan, a 403(b) TSA plan lets employees defer some of their salary. In this case, their deferred money goes to a 403(b) plan sponsored by the employer. This deferred money generally does not get taxed by the federal government or by most state governments until distributed.
What are the advantages of participating in a 403(b) plan?
There are significant tax advantages for participants in a 403(b) tax-sheltered annuity:
- Contributions to a 403(b) annuity are made on a before tax-basis,
- Earnings on the retirement money are tax deferred, and
- The annuity can be carried with the participant when he/she changes employers or retires.
On July 23, 2007, the first comprehensive regulations in 43 years were issued. The regulations package reaches out beyond 403(b) to also provide guidance on 414(c) common control for certain tax-exempt organizations.
The general effective date is for taxable years beginning after December 31, 2008, with some notable exceptions. The portion of the regulations dealing with the grandfathering of incidental life insurance contracts applies to contracts issued up to 60 days after the publication date. Similarly, the new in-service contract exchange rules do not apply to a contract received in an exchange that occurred on or before 60 days after the publication date. Churches sponsoring 403(b)s and collectively bargained situations may experience a later effective date.
So let us explore the highlights of the regulations:
Existing IRS positions that have been acknowledged:
- 403(b)s that provide for vesting.
- Age 50 catch-up applies only after the 402(g)(1) (employee elective deferral limits) and 402(g)(7) (15 years-of-service catch-up) dollar limitations.
- The nonelective nature of post-severance contributions (up to 5 years).
- Meaningful notice is needed to satisfy universal availability for salary reduction contributions.
- Hardship distributions follow the 401(k) rules.
Brand new highlights:
- Requirement that a 403(b) program be maintained pursuant to a written defined contribution plan which satisfies 403(b) in both form and operation and contains all the terms and conditions for eligibility, limitations, and benefits under the plan.
- Elective deferrals for 403(b) and 402(g) purposes are limited to contributions under a cash or deferred election as defined under 401(k).
- The good faith reasonable standard of Notice 89-23 for nonelective nondiscrimination is no longer maintained.
- Non-grandfathered contracts not subject to distribution restrictions may offer distributions only after severance of employment or upon the occurrence of an event such as after a fixed number of years, the attainment of a stated age under the plan or disability.
Additionally, the regulations provide that:
- Contribution amounts (in non-ERISA plans) must be transferred to providers within a period no longer than is reasonable for proper plan administration, such as transferring elective deferrals within 15 business days following the month in which these amounts would have been paid to the participant.
- Incidental life insurance, unless grandfathered, may not be part of a 403(b) plan.
- These plans may terminate and distribute assets with full rollover ability, as well as recognize the occurrence of an employment severance where an employee no longer works for an employer eligible to maintain a 403(b).
- In-service, plan-to-plan 403(b) asset transfers are limited to situations where the participant is an employee or former employee of the employer sponsoring the receiving plan.
- Church 403(b)(9) retirement income accounts will be expected to be maintained pursuant to a written plan which affirmatively states the intent to be a retirement income account.
Finally, the 414(c) regulation addresses aggregation to determine the employer for control group benefit purposes for all exempt organizations (not governments), except churches, based upon an 80% director or trustee common control test.
So, welcome to a new world for 403(b).
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