If a participant has taken distributions from a custodial account under 403(b) in violation of 403(b)(7)...what effect on the participant and the plan as a whole? Here, the plan is employer-money only (and is therefore an ERISA plan). Does the participant have income inclusion with respect to contributions only for the year of the violation? Or is the custodial account "tainted" until correction is made? Are there any negative effects on the plan as a whole (including taxability of custodial accounts with respect to participants who did not receive impermissible distributions), or are only the custodial accounts at issue affected?

Also, violations of 403(b)(7) are considered operational failures under Rev. Proc. 2003-44 (EPCRS). But what would be an acceptable correction method? Ask the participant for the money back?

To answer my own question, the Internal Revenue Manual indicates this sort of failure is a defect with respect to the custodial account at issue, not the plan as a whole. It also appears that the IRS considers the account "broken" until appropriate correction has been made (rather than merely "broken" for the taxable year of the failure).