I can tell the flu season is still raging, judging by all the empty desks in our office. We all know one of the best ways to stay healthy is good old-fashioned hand washing with soap and water. A similar type of thorough clean-up work has been going on with 403(b) plans to keep them healthy.
First, we saw significant activity around plan design review and changes when the final 403(b) regulations came out in 2007. By the time the regulations were effective in 2009, a significant number of 403(b) plans had reviewed their ERISA status, changed plan design features, reviewed – and in many cases eliminated – various investment choices and service provider choices and modified administrative procedures to take into account the requirements of the regulations.
The clean-up that happened then was out of regulatory necessity. Flash forward to today. We are again seeing 403(b) plan sponsors interested in reviewing their plan designs. This time it isn’t because they have to; rather, plan sponsors are looking to further clean up the initial steps that were taken just a few years ago. This additional work is based on their own experience with compliance under the final regulations, as well as the administrative lessons they’ve learned.
Is termination the answer?
One question we continue to hear throughout this process is whether the plan sponsor should terminate the 403(b) plan and start a 401(k) plan. While that may appear to be a quick fix, like using a “plan sanitizer” of sorts, that approach can cause an outbreak of issues.
First, terminating a 403(b) plan isn’t easy. While the final 403(b) regulations permit plan terminations and consider it appropriate to distribute assets to participants upon a plan termination, that doesn’t mean it is possible to do so.
That’s because contractual or plan restrictions may prevent cash distributions. Even though the regulations permit a “deemed distribution” of individual annuities (meaning, the contract is simply considered or “deemed” owned by the participant), this methodology may not work if there are group annuity contracts.
And, if there are mutual fund accounts, the regulations don’t permit the “deemed distribution” I just mentioned above. If all assets are not distributed from the plan, it’s not considered terminated. In fact, the plan sponsor could now have two plans that require administration – the newly adopted 401(k) plan, and the 403(b) plan that failed to terminate. In the two-plan scenario, it is simply impossible to merge the two plans. Although a rollover is permitted by a participant from one tax-favored plan type to another, a wholesale transfer or merger of different plan types (403(b) and 401(k) is not permitted under the law or regulations.
Plus, there are still advantages of a 403(b) plan over a 401(k) plan:
There is no ADP non-discrimination test for a 403(b) plan. All that is required for employee elective deferrals is to have universal availability of deferrals to all employees (with a few exceptions). This means expensive safe harbor provisions are not required, and highly compensated employees don’t have to worry about getting their deferrals back each year.
For participants in 403(b) plans of certain qualified organizations (not every 403(b) plan sponsor), an additional catch-up contribution may be available to participants with over 15 years of service. This is in addition to the age 50 catch up. 401(k) plans do not have a 15 year catch-up provision.
In most cases, elective deferrals to 403(b) plans do not count as “annual additions” to be combined with employer contributions toward the maximum allowable contribution under Internal Revenue Service Code Section 415. This used to be more valuable when Section 415 limited contributions to 25% of salary, but nevertheless it is still an advantage.
403(b) plans allow for the provision of continuation of contributions on behalf of a participant for up to five years after separation from service. This can be a valuable planning tool for helping retirees.
403(b) plans, like some other savings plan vehicles, should periodically scrub up by reviewing the design and administrative processes, just to make sure the plan is meeting the needs of the plan sponsor and the participants. But always keep in mind the potential consequences of letting all your administrative and compliance efforts go down the drain in favor of a 401(k) plan.
So….is your 403(b) plan healthy? Let’s discuss in the comments.
Friedman is the tax-exempt national practice leader with the Principal Financial Group, an investment management and retirement leader. A noted expert on 403(b) plan design, he has been consulting with tax-exempt organizations for over 20 years and has been in the retirement plan business since 1986. This blog originally ran on The Principal blog. Follow Aaron on Twitter @1AaronFriedman1
Insurance products and plan administrative services are provided by Principal Life Insurance Company. Securities are offered through Princor Financial Services Corporation, 1-800-547-7754, member SIPC and/or independent broker dealers. Securities sold by a Princor® Registered Representative are offered through Princor. Princor and Principal Life are members of the Principal Financial Group® (The Principal®), Des Moines, IA 50392.
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