In an effort to streamline the regulation that governs how
retirement accounts can be used, the IRS has proposed a change for 403(b) plans
— a type of workplace retirement plan use mostly by public and non-profit
employees. Employer-sponsored plans are powerful retirement tools and boast
specific requirements regarding required minimum distributions and tax
treatment that vary depending on the type of account. But soon your 403(b) may
resemble the more-common 401(k). If you have a 403(b) retirement plan, you
might need to change how you’ve planned for retirement and how your plan
beneficiaries will receive their funds. Here’s what you need to know.
IRS Proposes 403(b) RMD Changes
In accordance with the Setting Every Community Up for
Retirement Enhancement (SECURE) Act of 2019, the IRS is proposing updates to
the existing retirement plan code that governs required minimum distributions
(RMDs).
Currently, 403(b) plans are still treated differently from
401(k) plans, with provisions that trigger special exemptions for the
non-profit and service-sector organizations that sponsor these plans for their
employees. The IRS historically treated 403(b) plans like individual retirement
accounts (IRAs), not requiring account holders to withdraw all their funds over
their lifetime and allowing savers to invest in a wide variety of financial
products with tax-deferred dollars. However, with changes ushered in by the
SECURE Act, both 401(k) plans and IRAs now require the participant to take
minimum required distributions by age 72. Roth IRAs continue to be an
exception.
In order to make 403(b) plans more like the other defined
contribution plans, the IRS is proposing a new requirement: starting age 72, or
upon retirement, account holders will be required to take minimum distributions
based on published life expectancy guidelines. If the account owner passes away
before the funds are fully distributed, the beneficiary must take all the funds
within 10 years of the owner’s passing.
What Retirement Savers Need to Know
To align 403(b) plans with other employer-sponsored and
individual retirement plans, the IRS is proposing changes to rules governing
RMDs. Going forward, any non-profit sponsoring a 403(b) plan for their
employees must take RMDs or risk employees paying a hefty tax penalty on the
balance not withdrawn.
The National Law Review notes that the proposed changes
appear to pose both administrative and legal challenges. 403(b) plans can be
invested in a variety of funds, including both group and individual annuity
contracts, and so the requirement to take RMDs could create contractual issues.
For example, employers are not involved in the
administration of individual 403(b) contracts, and so their ability to take
RMDs would be substantially limited, potentially violating the new rule from
the very beginning. Even more unclear, in order to partake in safe harbor
exemptions, regulation limits employer involvement in retirement plans to
specific activities. If the proposed IRS rule goes into effect and employers must
then actively negotiate with providers to administer RMDs for participants,
this could be a violation of those requirements and inadvertently subject
employers to regulation and reporting from which they were previously exempt.
As a result, employees may not know if or when they may be
required to take distributions from their 403(b) plans. The IRS directs plan
sponsors to administer RMDs, but ultimately it is the participant’s
responsibility to ensure accurate and timely withdrawals. If the participants do
not take distributions as required, they may end up owing as much as 50% of
their calculated RMD in taxes.
The IRS is reviewing the proposed rule and has asked for
feedback. Interested parties may submit comments through the Federal Register
portal before May 25, 2022, and a hearing on the regulation will be conducted
on June 15.
Bottom Line
The IRS is proposing a new rule to require 403(b) plan
participants to take RMDs. The proposed changes may cause administrative and
legal difficulties, especially with regard to ERISA-exempt regulations.
Penalties for failing to take RMDs can be harsh, so understanding what rules
apply to you as a 403(b) plan participant is important. Comments regarding the
proposed rule can be submitted through May 25, 2022.
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