In an effort to streamline the regulation governing how retirement accounts are used, the IRS proposed a change for 403(b) plans — a type of workplace retirement plan used primarily by public and nonprofit employees. Employer-sponsored plans are powerful retirement tools and have specific requirements regarding required minimum distributions and tax treatment that vary by account type. But soon your 403(b) may look like the more common 401(k). If you have a 403(b) retirement plan, you may need to change how you’ve planned for retirement and how your plan beneficiaries will receive their money. Here’s what you need to know.
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IRS Proposes 403(b) RMD Changes
Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, the IRS is proposing updates to the existing retirement plan code governing required minimum distributions (RMDs).
Currently, 403(b) plans are still treated differently than 401(k) plans, with provisions triggering special exemptions for nonprofit and service sector organizations that sponsor these plans for their employees. The IRS has historically treated 403(b) plans like individual retirement accounts (IRAs), not requiring account holders to withdraw all of their funds during their lifetime and allowing savers to invest in a wide variety of financial products with tax-deferred dollars. However, with the changes introduced by the SECURE Act, both 401(k) plans and IRAs now require the participant to take minimum required distributions by age 72. Roth IRAs are still an exception.
To make 403(b) plans more like other defined contribution plans, the IRS is proposing a new requirement: starting at age 72 or after retirement, account holders must take minimum distributions based on published guidelines for life expectancy. If the account holder dies before the funds are fully distributed, the beneficiary must get all the money within 10 years of the holder’s death.
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 the rules governing RMDs. Going forward, any nonprofit sponsoring a 403(b) plan for its employees must take RMDs or risk having employees pay a hefty tax penalty on the balance not withdrawn.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 mutual funds, including both group and individual annuity contracts, so the requirement to take RMDs could create contractual issues.
For example, employers are not involved in the administration of individual 403(b) plans, and so their ability to take RMDs would be substantially limited, potentially violating the new rule in the first place. Even more vaguely, in order to participate in safe harbor exemptions, the regulation limits employer participation in pension plans to certain activities. If the proposed IRS rule goes into effect and employers must then actively negotiate with providers to manage RMDs for participants, this could be a violation of these requirements and inadvertently subject employers to regulations and reporting from previously excluded.
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 manage RMDs, but ultimately it is the participant’s responsibility to ensure accurate and timely withdrawals. If participants do not take distributions as required, they may end up owing up to 50% of their imputed RMD in taxes.
The IRS is reviewing the proposed rule and has requested comments. Interested parties can submit comments through the Federal Register portal before May 25, 2022, and a hearing on the rulemaking will be held on June 15.
The IRS is proposing a new rule requiring 403(b) plan participants to take RMDs. The proposed changes may cause administrative and legal difficulties, particularly with respect to regulations exempt from ERISA. The penalties for failing to take RMDs can be stiff, so it’s important to understand what rules apply to you as a 403(b) plan participant. Comments on the proposed rule can be submitted until May 25, 2022.
Retirement Planning Tips
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