The U.S. Department of the Treasury and the Internal Revenue Service (IRS) have issued guidance for employers and employees related to terminating 403(b) plans that fund benefits through 403(b)(7) custodial accounts.
As explained by the Treasury and IRS, the guidance reflects changes provided for in the Setting Every Community Up for Retirement Enhancement (SECURE) Act. In short, the landmark retirement legislation, which was passed last year, directed the IRS to issue guidance providing that individual custodial accounts (ICAs) may be distributed to participants in-kind upon plan termination, eliminating the requirement of a cash distribution. The SECURE Act requires the guidance to be effective retroactively for tax years beginning on and after December 31, 2008.
Sources say this change will allow for distributions of custodial accounts under rules similar to those that have been available for annuity contracts under a 403(b) plan.
Specifically, the IRS Revenue Ruling (Rev. Rul.) 2020-23 now provides that 403(b) retirement plans funded through individual or group 403(b)(7) custodial accounts can be terminated through the distribution of individual custodial accounts. The guidance establishes that, if a distributed custodial account continues to comply with certain requirements, no portion of the distributed custodial account is includible in gross income until such amounts are actually paid out of the account to a participant or beneficiary.
The text of Rev. Rul. 2020-23, as is commonly the case, presents a number of theoretical situations to assist in plan sponsor compliance. In one of these situations, the guidance explains that, after the occurrence of an in-kind distribution, the custodial account will be maintained as an ICA of the participant or beneficiary, and it is no longer part of the 403(b) plan from which it came. The distributed ICA is to be maintained by the custodian as a Section 403(b)(7) custodial account that adheres to the requirements of Section 403(b) in effect at the time of the distribution of the ICA—again until amounts are actually paid to the participant or beneficiary. Additionally, the guidance explains, the employer has no material retained rights under the distributed ICA after it has been distributed.
Published alongside Rev. Rul. 2020-23 was Notice 2020-80, which requests comments on the application of annuity and spousal rights provisions related to distributions in certain plans described in Rev. Rul. 2020-23.