Established under the corresponding section of the Internal Revenue Code, 403(b) plans are retirement savings plans for employees of tax-exempt organizations, as well as for certain public school employees and ministers. There are several advantages to 403(b) plans for not-for-profit employers. They are not subject to nondiscrimination testing or audit requirements, and plan sponsors have the ability to avoid Employee Retirement Income Security Act (ERISA) regulations, which set certain standards for private industry retirement plans.
New 403(b) Plan Rules In response to concerns that participants in 403(b) plans might be receiving less guidance and administrative support from plan sponsors than participants in other employer-sponsored retirement plans, the U.S. Treasury Department and the IRS initiated a comprehensive overhaul of the rules for 403(b) plans, rendering them similar to 401(k) plans. These rules went into effect for most 403(b) plans as of January 1, 2009, although under certain conditions organizations have until the end of 2009 to fully comply with the regulations.
Under the new rules, all 403(b) sponsors must have a written document that outlines the plan’s key features, including the benefits provided, eligibility requirements, contribution limits, investment options, and distributions. The document must clarify the plan’s policies regarding loans, hardship withdrawals, and rollovers. Also under the new rules, 403(b) plan sponsors are required to communicate with service providers regularly, providing them with all relevant participant information. These new requirements may significantly increase the administrative responsibilities of plan sponsors.
In addition, the new rules include stricter criteria for 403(b) plans that choose to avoid ERISA regulations. In order to avoid ERISA under the new rules, a 403(b) plan can have no employer contributions, must be completely voluntary, and must have minimal administrative involvement by the plan administrator. This means that the plan sponsor will have little influence over many features of the plan, which will instead be determined by a third-party service provider.
Is It Time to Switch? These new rules may increase the paperwork, cost of administration, and potential liability of sponsoring a 403(b) plan. Therefore, many nonprofits are considering the switch to a 401(k) plan. If a nonprofit prefers to avoid ERISA regulations, this can be accomplished only through a 403(b) plan, under the tighter regulations. However, if an organization considers its retirement plan as a vital piece of its recruitment and retention strategy and prefers to provide an employer contribution, a comparison of the 403(b) and 401(k) plan may reveal fewer advantages to maintaining a 403(b) plan.
For example, a 403(b) plan may be more expensive to administer, as each participant has an individual account. If a 403(b) plan sponsor changes service providers, account holders must be permitted to continue to use the previous provider. Therefore, under the new regulations, the plan sponsor must continue to communicate regularly with both past and current service providers. By contrast, a 401(k) plan sponsor can transfer all of the plan’s assets to the new provider, thus ending the previous relationship. Additionally, all ERISA-compliant 403(b) plans with 100 or more participants must file audited financial statements with their Form 5500.
Another important consideration is plan offerings. A 403(b) plan is permitted to offer participants a limited range of annuity and mutual funds as investment options.
However, a 401(k) plan can provide participants with a much wider array of investment options in addition to mutual funds and annuities, including stocks, bonds, and certificates of deposit.
Finally, fewer service providers support 403(b) plans. As fewer providers compete in the 403(b) market, the demand for 401(k) plans is growing. Due to the size of the 401(k) market, vendors may offer services that can help to ease administrative burdens, such as prototype plans pre-approved by the IRS, software and IT support, and educational materials.
In light of the new 403(b) plan regulations, choosing to continue to sponsor a 403(b) plan or switch to a 401(k) plan can be complex. Not-for-profit organizations considering their options are advised to consult with their financial advisors.