Rev. Rul. 82-102

Advice has been requested whether, under the circumstances described below, employer contributions under an arrangement administered by a credit union constitute the purchase of an annuity contract under section 403(b) of the Internal Revenue Code.

An educational organization described in section 170(b)(1)(A) of the Code entered into a salary reduction agreement with its employees under which the employee's monthly compensation was reduced by an amount which does not exceed the exclusion allowance provided by section 403(b) of the Code. The respective amounts thus obtained are contributed on behalf of each employee to a credit union described in section 501(c)(14) of the Code that maintains separate nonforfeitable special share accounts for each employee. The funds are invested in loans to members of the credit union and in other investments appropriate for credit union funds. On retirement, each employee may receive periodic partial payments or a single-sum payment.

Section 403(b)(1) of the Code provides that if an annuity contract is purchased for an employee who performs services for an educational organization described in section 170(b)(1)(A)(ii), by an employer which is a State, a political subdivision thereof, or an agency or instrumentality, then amounts contributed by such employer for such annuity contract on or after such rights become nonforfeitable shall be excluded from the gross income of the employee for the taxable year to the extent the aggregate of such amounts does not exceed the exclusion allowance for the taxable year. Section 403(b)(7) provides, in general, that amounts paid by such an employer to a custodial account which satisfies the requirements of section 401(f)(2) shall be treated as amounts contributed for an annuity contract for an employee if the amounts are paid to provide a retirement benefit for the employee and are to be invested in regulated investment company stock to be held in that custodial account.

Section 403(b)(7) was added to the Code by the Employee Retirement Income Security Act (ERISA), Pub. L. 93-406, 1974-3 C.B. 1, to permit contributions to custodial accounts for regulated investment company stock to be treated as contributions for annuity contracts. The House report on ERISA explains this addition, as follows:

"Under present law, contributions to a section 403(b) plan (a plan funded by employers for the benefit of teachers or employees of tax-exempt organizations) may be invested only in insurance contracts. The committee believes that it would be desirable to provide more flexibility in this area, and, accordingly, the committee bill provides that these contributions may also be placed in qualified custodial accounts if these funds are to be invested in mutual funds." (H.R. Rep. 93-807, 93rd Cong. 2d Sess. 162 [1974], 1974-3 Supp. C.B. 236, 397).

The Committee Report cited above indicates Congressional intent to expand the traditional method of funding 403(b) annuity contracts by insurance companies. In section 403(b)(7) of the Code, Congress added an exception to the general rule that section 403(b) annuities must be purchased from insurance companies. However, the exception applies only when the contributions are placed in qualifying custodial accounts and invested in mutual funds. If entities other than insurance companies had been able to provide such annuities, section 403(b)(7) would not have been needed to permit such arrangements to be offered under custodial accounts. Therefore, the arrangement in this case does not meet the requirements of section 403(b)(1) because it is not funded by insurance contracts. Furthermore, it does not meet the requirements of section 403(b)(7) because the funds are not to be invested in regulated investment company stock.

Accordingly, contributions administered by the credit union in this case do not constitute the purchase of an annuity contract for purposes of section 403(b) and are not excludable from the gross income of the employee.

Rev. Rul. 67-361, 1967-2 C.B. 153, and Rev. Rul. 67-387, 1967-2 C.B. 153, which conclude that certain arrangements that are not funded by insurance contracts may be treated as annuities under section 403(b)(1) of the Code, are revoked.

However, employers may have established tax-sheltered annuities in reliance on these revenue rulings. Therefore, pursuant to the authority contained in section 7805(b) of the Code, this revenue ruling will not be applied to an arrangement established by an employer on or before May 17, 1982, if (1) the contract(s) issued pursuant to the arrangement (including self-insured arrangements) would have met the requirements of section 403(b) except that the contract(s) was not purchased from an insurance company, and (2) the arrangement only covers current and future employees of that employer. However, this section 7805(b) relief shall not apply to any employee who becomes covered for the first time under such arrangement after May 17, 1982 if the Internal Revenue Service had previously issued any written communication (either to an employer or financial institution) to the effect that the arrangement under which the contract was issued did not meet the requirements of section 403(b).