A few years ago, the idea of eliminating the differences between 403(b) plans and 401(k) plans seemed to make obvious sense.
Barriers were falling between France and Germany, between banks and insurance companies, and even between Paul Simon and Art Garfunkel. If Simon and Garfunkel could converge, why not the rules for for-profit employers’ defined contribution plans and nonprofit employers’ defined contribution plans?
Now, the euro is shaky, regulators are prying banks and insurers apart, and Simon and Garfunkel have canceled their comeback tour.
The effort to remake the 403(b) plan in the 401(k) plan’s image has also run into troubled water, with no bridge to be seen.
The problem is that the conventional wisdom–that a 403(b) plan is just a 401(k) plan for an employer with an annual fundraising banquet–is wrong, 403(b) plan specialists say.
At 403(b) plans, “there was very little, if any, employer involvement,” according to Susan Diehl, a member of the leadership council at the National Tax Sheltered Accounts Association (NTSAA), an affiliate of the American Society of Pension Professionals & Actuaries (ASPPA), Arlington, Va. “They never had control for 40 years. Now, 40 years later, everything kind of blows up.”
Today, 403(b) plans hold about $778 billion in assets for about 11 million plan participants, according to figures from the Investment Company Institute, Washington, and Cerulli Associates Inc., Boston. The 403(b) plan attracted a little media attention in May 2008, when The Slate reported that Michelle Obama has a 403(b) plan account left over from her stint as an administrator at the University of Chicago Hospitals.
Policymakers and others tend to talk about the 403(b) plan as if it were a copy of the 401(k) plan, but the 403(b) plan is much older the 401(k) plan, which first came into widespread use until the 1980s.
President Eisenhower added the Section 403(b) tax-sheltered annuity provision to the Internal Revenue Code when he signed the Technical Amendments Act of 1958. Supporters of the provision wanted to help nonprofit employers provide a simple, low-cost retirement savings program. Congress expanded the list of potential 403(b) plan sponsors over the years, and the Internal Revenue Service (IRS) released the first collection of final 403(b) plan regulations in 1964.
In most cases, plan participants bought individual annuities straight from insurers. Employers simply let the insurer in the door and collected the participant contributions. Sponsors later began using group annuities and mutual funds as funding vehicles. The money managers often had contracts directly with the individual participants, and the money managers tracked the participants and handled compliance.
Because the employers had only an informal relationship with the plan, many plans had no formal written documents.
Later, in the 1990s, policymakers began talking about eliminating the distinctions between 403(b) plans and 401(k) plans, in part because of concerns that the fees 403(b) plan providers charge may be far too high.
The IRS responded to that push for transparency and administrative simplification by releasing a proposed 403(b) plan regulation update in 2004 and a final version of the proposal in 2007.
The IRS exempted some plans, but it required affected plans to have written plan documents. The final version “basically turned the Section 403(b) world on its head,” the IRS Advisory Committee on Tax Exempt and Government Entities says in a recent report. “The final regulations made it clear that it was the employer’s responsibility for Section 403(b) compliance and not the Section 403(b) vendor’s (unless a vendor agrees to act as the employer’s designee for that purpose.) Not surprisingly, a measure of chaos ensued.”
Meanwhile, the U.S. Labor Department, which helps to oversee 403(b) plans, has started to require 403(b) plan sponsors subject to ERISA to file Form 5500 plan reports, and it has required plans with more than 100 employees to provide independent audits of their financial statements.
The Employee Benefits Security Administration (EBSA), an arm of the Labor Department, has released Field Assistance Bulletin 2010-01, a document that explains which 403(b) plans are and are not subject to ERISA and ERISA-related plan requirements. An employer can offer features such as plan loans without making the plan an ERISA plan, but, if the plan hires a third party administrator to make discretionary decisions, or the plan offers only a narrow investment menu, then the plan will become an ERISA plan.
The penalty for violating the new rules may be just a few hundred dollars in some cases, but even that amount can be a burden for a small nonprofit group, Diehl said.
“It’s bad,” Diehl said. “Everybody’s scrambling.”
When the IRS developed its 401(b) plan regulations, it did not include any kind of economic impact analysis–or even a rough estimate of how many 403(b) plans there might be–in either the draft rule released in 2004 or the final rule released in 2007.
“It has been determined that this Treasury decision is not a significant regulatory action,” officials said in the preamble to the final rule.
Originally, the IRS said the regulations would apply for most individuals starting Jan. 1, 2009. Eventually, the IRS moved the Jan. 1, 2009, compliance deadline back to Dec. 31, 2009–and 403(b) plan professionals suspect that the percentage of 403(b) plan sponsors complying with the requirements today is low.
The Labor Department received about 6,000 403(b) plan Form 5500 filings in 2009; many 403(b) plan professionals say they believe the real number of 403(b) plans may be several times higher than that number.
Spreading the word about the new requirements is difficult, in part because 403(b) plan sponsors are a varied bunch, and no one organization reaches all, or even a large minority, of the sponsors’ benefits managers, Diehl said.
Public schools have a business officials group that did a great job of explaining the changes, but at meetings of other groups, such as hospital groups, “they never talked about retirement plans,” Diehl said.
Congress and federal regulators have added to the reporting problems by using complicated rules to divide 403(b) plan sponsors into subgroups and determine which sponsors must file what documents.
Church plans, for example, are not required to be ERISA plans, but some choose to be.
A public school district 403(b) plan is not an ERISA 403(b) plan, but a 403(b) plan for a private school is an ERISA plan.
Diehl tells the story of a nonprofit with about 110 employees and offices staffed by employees in several cities. Salaries are low, and only 35 of the employees participate in the 403(b) plan.
A review showed that, even though the nonprofit had just 35 403(b) plan participants, more than 100 employees were eligible to participate, and that meant the group had to provide audited financial statements, Diehl said.
The nonprofit had hired an outside administrator, or third-party administrator (TPA), to run the plan, and the nonprofit discovered that the simple decision to hire the auditor had made the plan subject to the reporting requirements imposed on ERISA plans.
The nonprofit started out thinking it would need to spend just $1,500 to get into compliance with federal requirements, but that figure soon rose to $13,500, Diehl said.
The nonprofit would like to shut down the plan.
“Unfortunately, nobody will have a retirement plan,” Diehl said.
For now, Diehl said, the plan lingers on in an undead state, because the plan uses mutual funds to provide the investment options. The IRS explained in May how to shut down a 403(b) plan that uses individual annuities as the funding vehicle, but it has not yet come up with a termination strategy for plans that use mutual funds. The IRS wants to avoid terminating sponsors force plan participants to take taxable distributions, Diehl said.
ASPPA and the NTSAA are asking regulators to solve the puzzle by letting sponsors turn the custodial accounts over to the participants without requiring participants to pay taxes on the transferred assets.
Craig Hoffman, ASPPA general counsel, said he sees goodwill at the federal agencies
“I do believe our government regulators understand the importance of this 403(b) marketplace,” Hoffman said.
But, in many cases, the same agency staffers who are handling 403(b) plan issues are handling issues such as implementation of the Patient Protection and Affordable Care Act (PPACA, and the work on those other issues also takes time, Hoffman said.
ASPPA and the NTSAA have come out with a number of recommendations for making the new 403(b) plan rules easier for small employers.
o Change the definition of “employee,” to reduce the odds that a nonprofit will be classified as being big enough to have to get independent audits of their financial statements.
o Get a committee of industry experts to review the current audit guidelines for 403(b) plans.
o Create a mechanism for shutting down plans, to get rid of the undead 403(b) plan problem.
o Make more of an effort to limit how far back in time a plan must search for records to comply with the new requirements for historical data. “Plan sponsors have difficulty getting information because the products are owned by the participants,” Hoffman said.
ASPPA also would like to see regulators draw a brighter line between ERISA and non-ERISA plans, by for example, eliminating the risk that simply hiring a TPA to help interpret and apply the 403(b) rules will transform a non-ERISA 403(b) plan that is subject to only limited reporting requirements into a full-fledged ERISA plan.