“Plan disqualification” is a well understood and managed feature of the 401(a) landscape, complete with great history, a long line of guidance and rulings, and a well developed set of correction programs. We all know what happens when a 401(a) rule is violated, its affect on plan qualification, and (ususally) what to do about it.
We would be badly mistaken if we were, though, to apply those same concepts, experiences and rules to managing problems arising from the violation of a 403(b) rule. 403(b) “plan disqualification” isn’t what you might otherwise think. It is truly a curious matter.
403(b) itself only has 2 things that will cause all participant accounts to lose their 403(b) status(something I guess you could loosely call “plan disqualification”): the plan being sponsored by an ineligible employer and the plan’s contributions being discriminatory (which includes violating the universal availability rule). Period. Nothing else does it.
The new regulations have levied a third “disqualification” rule in that, in order to qualify for 403(b) treatment, a contract must be part of a written plan which conforms in form with all of the 403(b) and other operational rules. Thus, for example, if a plan does not limit contributions to the 415 limit, no contract under the plan will qualify for 403(b) tax treatment even if the 415 limit was never exceeded. (I have always had a problem with this part of the reg, by the way, because of the lack of statutory authority for it -but it is truly not an argument worth making).
OK, so you ask, what happens if the plan document is proper, you have an eligible employer and you have non-discriminatory contributions? Will a plan’s operational error (such as a loan violation) potentially “disqualify” the plan, like it would for a 401(k) plan?
No.
Only the accounts or contracts which are affected by the operational error are affected. Thus, for example, only the contract or account from which the excess loan is made will be at issue, not the entire plan. And the regs treat all of the contracts of the participant as a single contract, for these purposes.
So the next question is whether or not the entire contract’s 403(b) status is affected by the operational error, or is it just the portion of the account in violation? The regs make it clear that vesting, 415 and 402(g) operational errors only affects those amounts within the contract related to the error, not the 403(b) status of the contract itself. The IRS, in making these choices, appears to have closely followed the statutory language (unlike what it did when imposing the “form” rule for plan disqualification!). So what if you failed to correct a 402(g) or 415 excess? The 403(b) contract still will not lose its favored status under 403(b), but the uncorrected excess will continue to suffer tax penalties, presumably under the individual tax rules.
And then there’s the notion of the 403(b) “plan disqualification” itself. Even should the sponsor be an ineligible employer, even if the contributions were discriminatory, and even if the plan document violated the “form” rules, if the contract also qualifies as an annuity contract under other sections of the Code, it appears that the earnings on those (now taxable) deposits to the contract may still well enjoy deferred taxation until they are distributed-in accordance with the rules governing “non-qualified” annuities.
It IS interesting the more we keep peeling this onion…..
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