Long awaited. Comprehensive. Complex. These are just some of the words being used to describe new final IRS regulations that apply to Section 403(b) tax-sheltered retirement arrangements. The regulations will affect nearly every public school and tax-exempt organization that offers employees a 403(b) retirement arrangement.

In this publication, we summarize the new regulations and other recent developments that will have an impact on your 403(b) arrangement. Complying with the rules will require employers to take certain steps — and those steps can be complicated. As a result, you will want to seek professional assistance to ensure that you meet every requirement.

The good news is that the IRS has given employers some time to bring their 403(b) arrangements into compliance with the new regulations. In general, they become effective for taxable years that begin after December 31, 2008 (in most cases, in 2009). Some exceptions apply, as explained later. However, employers may choose to operate their 403(b) arrangements under the new regulations prior to the 2009 effective date, as long as the rules are applied on a consistent and reasonable basis.

Background

Section 403(b) arrangements — or “403(b) plans” — offer participating employees important tax benefits. When all tax law requirements are met, both plan contributions and any earnings on those contributions are excluded from an employee’s gross income until those amounts are distributed from the plan.

Only certain types of employers may offer 403(b) plans. Plan sponsors are limited to public schools, including colleges and universities, and tax-exempt 501(c)(3) organizations, which include organizations formed and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals.

Section 403(b) applies to three categories of funding arrangements:

• Annuity contracts issued by an insurance company,*

• Custodial accounts invested solely in mutual funds,** and

• Retirement income accounts (permitted only for church employees and certain ministers).

Plan contributions generally consist of employer nonelective contributions, employer matching contributions, or employee elective salary deferrals. Some plans also allow employees to make after-tax contributions.

* Annuities are long-term financial products. Generally, annuity policies have limitations and charge for early withdrawals. Guarantees are based upon the claims-paying ability of the insurer.

** Mutual funds involve risk and are offered by prospectus only, which should be read carefully before investing. Because fund values fluctuate, redeemed shares may be worth more or less than their original value. Consider investment objectives, risks, charges, and expenses prior to investing. The prospectus, available from a registered representative, will include this and other information.