One-Time Irrevocable Elections Under Code Section 403(b) Plans—Error in 2007 Regulations Should be Corrected

Tax regulations must follow the terms of the Internal Revenue Code and must be internally consistent. These rules were violated in 2007 tax regulations defining a “one-time irrevocable election” for purposes of 403(b) plans. The 2007 regulations require an employee to make the election “on or before … first becoming eligible to participate under the employer’s plans.” This wording is more restrictive than the Internal Revenue Code and previously issued regulations, which allow an employee to make an irrevocable 403(b) election “at the time of initial eligibility to participate in the agreement.” The IRS should address this error in the 2007 regulations as part of the guidance the IRS is expected to provide for 403(b) plans in 2013. The following paragraphs explain the issue in more detail.

Use of the “One-Time Irrevocable Election” Definition. The “one-time irrevocable election” offers a useful option in retirement plan design. It allows an employee to commit to making employee pre-tax contributions to a retirement plan without regard to complex rules and limits that apply to “elective” 403(b) or 401(k) contributions. A “one-time irrevocable election” under a 403(b) plan may be a particularly attractive option for government 403(b) plans, where contributions are not subject to discrimination testing. Defining a “one-time irrevocable election” is critical to the use of this approach to 403(b) plan contributions.

Code Section 402(g) and Regulations Clearly Defined a “One-Time Irrevocable Election” for 403(b) Plans Before the 2007 Regulations. Internal Revenue Code section 402(g)(3) includes the following definition of a “one-time irrevocable election” for 403(b) plans:

…[a contribution to a 403(b) plan] shall not be treated as an elective deferral…if under the salary reduction agreement such contribution is made pursuant to a one-time irrevocable election made by the employee at the time of initial eligibility to participate in the agreement [emphasis added] or is made pursuant to a similar arrangement involving a one-time election specified in regulations.

Treasury Regulation section 1.402(g)-1(c) follows the Code provision, stating:

(c) Certain one-time irrevocable elections. An employer contribution is not treated as an elective deferral under paragraph (b) of this section if the contribution is made pursuant to a one-time irrevocable election made by the employee:

(1) In the case of an annuity contract under section 403(b), at the time of initial eligibility to participate in the salary reduction agreement [emphasis added].

2007 Regulations Contradict the Code and Prior Regulations. In contrast to the Code and regulations cited above, 403(b) regulations issued in 2007 redefine a “one-time irrevocable election” under a 403(b) plan. The 2007 regulations state that a “one-time irrevocable election” must be made “on or before the employee’s first becoming eligible to participate under the employer’s plans” [emphasis added]. Treasury Regulation 1.402(g)(3)-1(b). The 2007 regulations incorrectly use the same definition for 403(b) plans as Treasury Regulation 1.401(k)-1(a)(3), which defines a “one-time irrevocable election” for purposes of 401(k) plans. Applying the 401(k) definition to 403(b) plans contradicts the clear terms of Internal Revenue Code section 402(g)(3). Treasury Regulation 1.402(g)(3)-1(b) is invalid and should be corrected to state that a one time irrevocable election must be made “at the time of initial eligibility to participate” in the 403(b) agreement, not before eligibility to participate “under the employer’s plans.”

New IRS Procedures for Correcting 403(b) Plan Errors

New IRS procedures for correcting retirement plan errors add important new correction methods for 403(b) plans. (See Rev. Proc. 2013-12 at http://www.irs.gov/Retirement-Plans/New-Revenue-Procedure-Updates-EPCRS )  This is good news for employers who sponsor 403(b) retirement plans. Here are some key points regarding the application of this correction program (which the IRS calls EPCRS) to 403(b) plans: 

• Failure to Adopt Plan Document by December 31, 2009. If an employer did not adopt a 403(b) plan document by December 31, 2009 (as required by IRS Notice 2009-3), the employer should take advantage of new IRS procedures to correct this error. To encourage employers to make such corrections this year, the IRS offers a 50% discount in filing fees if the 403(b) plan document is filed under the “EPCRS” program by December 31, 2013.
   
• Failure to Follow the Terms of a 403(b) Plan Document. If the operation of an employer’s 403(b) plan document did not follow the terms of the document, the employer may use the new “EPCRS” program to correct the operational error. A checklist of common 403(b) errors appears at:

  http://www.irs.gov/pub/irs-tege/pub4546.pdf  

• Errors in Plan Document. The new “EPCRS” program permits employers to submit corrections for errors in 403(b) plan documents. However, the IRS will also permit corrections of 403(b) plan documents within a “remedial amendment period” to be announced in the future. Because the IRS has not developed a system for reviewing 403(b) plan documents for compliance with all tax law requirements, the IRS allows employers who timely adopted written 403(b) plan documents to wait for future IRS guidance before submitting plan documents for detailed IRS approval. This new “EPCRS” program states that it should be used to correct a 403(b) “plan provision (or the absence of a plan provision) that, on its face, violates the requirements of section 403(b).” For example, a 403(b) plan document that states incorrect limits on contributions or compensation could be corrected under the new “EPCRS” program.