IRS Issues 403(b) Plan Guidance Under the SECURE Act | Practical Law

IRS Issues 403(b) Plan Guidance Under the SECURE Act | Practical Law

In Revenue Ruling 2020-23, the Internal Revenue Service (IRS) provides guidance, as directed by the SECURE Act, on the distribution of individual custodial accounts upon the termination of Internal Revenue Code Section 403(b) plans. In Notice 2020-80, the IRS requests comments on the application of annuity and spousal rights provisions related to distributions from 403(b) plans.

IRS Issues 403(b) Plan Guidance Under the SECURE Act

Practical Law Legal Update w-028-0878 (Approx. 4 pages)

IRS Issues 403(b) Plan Guidance Under the SECURE Act

by Practical Law Employee Benefits & Executive Compensation
Published on 09 Nov 2020 • USA (National/Federal)
In Revenue Ruling 2020-23, the Internal Revenue Service (IRS) provides guidance, as directed by the SECURE Act, on the distribution of individual custodial accounts upon the termination of Internal Revenue Code Section 403(b) plans. In Notice 2020-80, the IRS requests comments on the application of annuity and spousal rights provisions related to distributions from 403(b) plans.
On November 5, 2020, the IRS issued guidance on terminating Internal Revenue Code (Code) Section 403(b) plans that fund benefits through Code Section 403(b)(7) custodial accounts. This guidance, which reflects changes made by the SECURE Act, includes:
  • Revenue Ruling 2020-23, which provides that 403(b) plans funded through individual or group 403(b)(7) custodial accounts can be terminated through the distribution of individual custodial accounts to participants and beneficiaries.
  • Notice 2020-80, which requests comments on the application of annuity and spousal rights provisions related to distributions from 403(b) plans, which is a topic not addressed in Rev. Rul. 2020-23.
To learn more about the SECURE Act, see the SECURE Act Compliance Chart.

Termination of 403(b) Plans and the SECURE Act

The SECURE Act requires the Treasury Secretary to issue guidance providing that:
  • If an employer terminates a 403(b) plan, the plan administrator or custodian may distribute an individual custodial account (ICA) in kind to a plan participant or beneficiary.
  • The distributed custodial account will be maintained by the custodian on a tax-deferred basis as a Code Section 403(b)(7) custodial account until amounts are actually paid to a plan participant or beneficiary.
  • The custodial account is not considered distributed to the participant or beneficiary if the employer has any material retained rights under the account.
  • The guidance will be retroactively effective for taxable years beginning after December 31, 2008.
To learn more about 403(b) plan terminations, see Practice Note, Code Section 403(b) Plans: Overview: Plan Termination and Plan Freezes.

Revenue Ruling 2020-23

Rev. Rul. 2020-23 addresses two hypotheticals involving 403(b) plans.
In Situation 1, an employer sponsors a 403(b) plan that is funded solely through the use of 403(b)(7) accounts maintained under individual agreements. The employer adopts a resolution to terminate the plan at a specified date, including full vesting for all benefits as of that date. Participants and beneficiaries who do not elect to receive a distribution of their account balance at termination receive the distribution of ICAs in kind that are no longer part of the plan. These distributed ICAs are maintained by the plan custodian as 403(b)(7) custodial accounts until actually paid to the participants or beneficiaries.
Situation 2 involves the same facts as in Situation 1, except that the plan is also funded by custodial accounts maintained under group agreements. For participants and beneficiaries who do not elect to receive a distribution, amounts held in custodial accounts maintained under a group agreement will be distributed through an ICA in kind to each participant and beneficiary. These distributed ICAs are also maintained by the plan custodian as 403(b)(7) custodial accounts.

Analysis and Holding

In its analysis of Situation 1, Rev. Rul. 2020-23 explains that:
  • All custodial accounts under the plan are 403(b) contracts upon plan termination.
  • The employer's actions to terminate the plan and distribute accumulated benefits satisfy the requirements of Code Section 403(b) and Treasury Regulation Section 1.403(b)-10(a) (26 C.F.R. § 1.403(b)-10(a)) for plan termination.
Regarding Situation 2, Rev. Rul. 2020-23 states that the distribution of the ICA in kind constitutes a distribution for purposes of Treasury Regulation Section 1.403(b)-10(a).
Under Rev. Rul. 2020-23, in both Situation 1 and Situation 2:
  • The employer has no material retained rights under the ICA after it has been distributed.
  • The plan was terminated according to Treasury Regulation Section 1.403(b)-10(a).
  • The distribution of an ICA in kind to a participant or beneficiary is not immediately includible in gross income. Amounts are includible only when paid to the participant or beneficiary from the custodial account, as long as the ICA maintains its status as a 403(b)(7) custodial account. Any other amount distributed from a custodial account following a 403(b) plan termination is includible in gross income.

Notice 2020-80

The IRS also issued Notice 2020-80, in which the IRS requests comments on the application of the annuity and spousal rights provisions under ERISA Section 205 (29 U.S.C. § 1055) to a distribution of an ICA in kind under Section 110 of the SECURE Act following a 403(b) plan termination. Rev. Rul. 2020-23 does not address this point.

Practical Impact

Rev. Rul. 2020-23 provides clarity on the distribution of ICAs in kind upon the termination of a 403(b) plan, which will further the ability of 403(b) plan sponsors to terminate those plans. In doing so, Rev. Rul. 2020-23 modifies Rev. Rul. 2011-7, which provides guidance on 403(b) plan terminations.
Comments on Notice 2020-80 are due February 3, 2021.