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Page 1: A Compliance Blueprint for 403(b) Plan Sponsors · Consulting | Retirement 1 I. Introduction II. Where We’ve Been III. The New 403(b) Environment IV. Roadmap for Compliance and

A Compliance Blueprint for

403(b) Plan Sponsors October 2010

Date

Aon Hewitt

© 2010 – Aon Corporation

Brief Description: Final 403(b) regulations have given plans sponsors significant

compliance and administration challenges. In this article we provide 403(b) plan sponsors

with a roadmap to comply with these regulations.

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Consulting | Retirement 1

I. Introduction

II. Where We’ve Been

III. The New 403(b) Environment

IV. Roadmap for Compliance and Beyond

Final 403(b) regulations have significantly changed the administration and compliance requirements for

sponsors of 403(b) plans. The rules are particularly challenging for sponsors of 403(b) plans which offer

multiple investment service providers. The final rules were generally effective January 1, 2009 and apply

to both ERISA 403(b) plans (with employer contributions) and non-ERISA 403(b) plans (employee

contributions only). Plan sponsors already should have taken action to comply with these regulations. If

you are one who has not, however, the time to act is now. The objective of this paper is to:

Describe the historical context in which 403(b) plans have traditionally been administered;

Summarize the compliance requirements that 403(b) plan sponsors must be aware of;

Outline steps to bring a 403(b) plan into compliance; and

Discuss best practices for 403(b) plan sponsors.

Where We’ve Been….

To understand how complex the new regulations are, it helps to have some background on how 403(b)

plans have been handled in the past. Historically, most 403(b) plan sponsors paid very little attention to

their plans. Plan documents were loosely prepared and often not written down. In some situations, the

plan was essentially made up of individual contracts negotiated directly between employees and the

investment service provider. Participants were left to fend for themselves.

There was very little, if any, oversight of plan administration, eligibility, or participation, and there were

typically limited efforts to communicate the plan to employees. In fact, administrative requirements were

often unclear and misunderstood, and therefore ignored. There was also virtually no oversight of plan

investments. Plan sponsors took the position that by offering multiple investment service providers they

were mitigating their risk because employees had virtually unlimited choices. In essence, investments

were uncontrolled, unlimited, and often duplicative. In short, prior to the promised enforcement of the

regulations, 403(b) plan sponsors took a hands-off approach with the belief that this would minimize their

responsibility and thus limit their risk.

The New 403(b) Environment

The final 403(b) regulations changed nearly every aspect of plan administration and oversight. Gone are

the days where “less is better” when it comes to monitoring things such as plan administration in general,

compliance with plan provisions, and investment performance. Plan documents must be written and in full

compliance with IRS and DOL requirements. The administration of the plan must be coordinated across

all vendors including monitoring employee participation requirements, limits on contributions and pay, and

investment selection and performance. The requirements are quite daunting and include the following:

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Consulting | Retirement 2

Written Plan Document – The plan must be memorialized in a single written plan document that

meets all of the requirements of the final regulations in both form and operation. Plan sponsors need

to inventory all current vendor contracts, resolve any inconsistencies, and develop a single plan

document incorporating and clearly defining all the key provisions of the plan (i.e. eligibility, vesting,

contributions, loan provisions, etc.), so that a participant can understand. For many plans, this

means that not only formal language that has been in place needs to be documented, but also

informal agreements that may not have been written anywhere. The IRS has developed a prototype

document for 403(b) plans, but this prototype covers only the most basic of situations, so many

sponsors will be left on their own to develop compliant documents.

Coordinating Administration Across Multiple Vendors – What many sponsors considered

prudent in the past is now backfiring on them. In the days of no real rules and no regulatory

oversight, large numbers of sponsors took the position that by allowing as many vendors as were

interested in serving the plan participants that they were not exercising their discretion and weren’t

even responsible for plan oversight. The final regulations essentially force the plan sponsor to have

a means for coordinating plan administration across all vendors. For 403(b) plan sponsors, oversight

is now a requirement and the fewer providers that they need to monitor the better. But, how will they

decide which vendors to eliminate? How will they communicate these changes to plan participants?

Do the existing contracts have back-end fees that will be assessed against participant’s account

balances if they are forced to move from one provider to another? These and other similar questions

are part of the new 403(b) world. Among other things, plan sponsors are now being encouraged to

have Information Sharing Agreements (ISA) in place with each provider to facilitate the coordination

of plan provisions and legislative limitations. Examples include:

• Limits on contributions must be tracked across all providers.

• Plan-to-plan transfers may only be made to approved service providers with whom the plan sponsor has an ISA in place.

• Severance and termination information must be communicated across all vendors for processing distributions and calculating vesting.

Perhaps the most complicated aspect of the regulations is loan administration. Loan limits apply on

an individual participant basis, so in determining the amount available for a loan (i.e. generally lesser

of 50% of the vested balance or $50,000) all balances and all loans with every provider must be

taken into consideration.

Also, loans repayments must be parsed out to each provider with whom the participant has an

outstanding loan. Sponsors must have a solution in place for the physical parsing of repayments and

transmission to each provider.

Even plans not subject to ERISA have aggregation requirements for administration and coordination

of contribution limits, loans, withdrawals, plus certain additional provisions. This requires every plan

sponsor to monitor, at some level, the administrative work done by each of its vendors. This

requirement becomes significantly more important for plans that are subject to ERISA and have a

fiduciary obligation to ensure that services are delivered in accordance with contract terms and that

the associated fees are reasonable. Fiduciaries are required to ensure the plan is being

administered and maintained in the best interest of participants and according to the contracts,

agreements, and any other legally binding documents.

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Consulting | Retirement 3

Controlled Group Considerations - Another important consideration is the determination of

whether an organization is part of a controlled group of organizations. Generally, where there is at

least 80% common ownership among two or more organizations (i.e. sister organizations, wholly-

owned subsidiaries, etc.), the organizations must be treated as a single employer for purposes of

coverage testing and nondiscrimination testing. In the tax-exempt arena, this distinction is often

vague. Consolidating employee data from multiple business units for testing can be very tedious and

complicated. This typically requires pulling participant and plan data from multiple sources and

multiple vendors, and identifying one vendor to aggregate the information and perform the required

testing. It is common for large not-for-profit hospitals to have a for-profit entity under common

ownership. The for-profit entity must also be taken into consideration for controlled-group

determination. The existence of a for-profit entity requires special consideration for testing purposes.

Failure to accurately assess the ownership and controlled group issues could have significant

compliance implications. Failure to comply could have significant financial consequences for both

plan participants and the organization.

Monitoring Investments – The historical hands-off approach of permitting numerous investment

vendors to participate in the 403(b) plan has now created significant issues for many plan sponsors.

Most sponsors will now have a hands-on fiduciary obligation to monitor each investment and each

investment provider to determine their appropriateness for inclusion in the plan. Further, they should

establish procedures for ongoing selection and monitoring of investment offerings.

Monitoring Vendor Performance – As was the case in the past with respect to investment fund

monitoring, 403(b) plan sponsors did not feel any type of urgency to monitor vendors or their

services. Many sponsors treated the vendor arrangements as an agreement between the employee

and the vendor, and the employee would control their movement from one vendor to another if they

deemed it appropriate. The final regulations place significantly more responsibility and accountability

for monitoring vendor performance on the plan sponsor.

Form 5500 and Audit Requirements – Audit and Form 5500 requirements have changed. Plans

that previously had to file only a limited scope Form 5500 are now required to prepare a Form 5500

filing that is consistent in scope with what has historically been the standard for 401(k) plans. Annual

audits by an independent outside firm are now required of most 403(b) plans where that was not a

responsibility that a sponsor had to consider in the past. Smaller plans may be eligible for the Form

5500-SF, – Short Form Annual Return/Report of Small Employee Benefit Plan. The advantages of

filing this Form include considerably less preparation time and don’t require audited financial

statements, as with the Form 5500. Generally, eligible plans must: cover fewer than 100 participants,

hold no employer securities, maintain 100% of its assets in investments with a readily ascertainable

fair market value, and not be a multi-employer plan.

Roadmap for Compliance and Beyond

The key question is how we get from where we have been to where we need to be. We suggest the following as a starting point, but each situation is different and needs careful review. This outline is intended to help sponsors comply with 403(b) regulations.

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Consulting | Retirement 4

Step 1 - Educate Yourself About 403(b) Requirements – The first step towards compliance with

the rules is to educate yourself on the details of the regulations. Seeking the advice of a consultant

or attorney who has specific expertise with 403(b) plans is perhaps the best way to get up to speed

on the rules.

Step 2 - Review Current Operational Procedures and Vendor Relationships – The next step is

to do a complete assessment of where you are today. This involves developing an inventory of all

investment providers, provider contracts, investment options, current administrative policies, forms

and procedures, and current plan provisions.

Step 3 - Assess Vendor Relationships – Once you understand what is expected and where your

organization is, the “gap” analysis starts. An initial step in that analysis is assessing current vendor

relationships. The decision whether or not to continue forward in a multiple-vendor arrangement is

one of the most critical. Most 403(b) plan sponsors are taking this as an opportunity to assess all

current relationships and decide to what extent, if any, they want to streamline plan administration.

There are a number of issues with the decision to keep or eliminate vendors. Keeping multiple

vendors creates risk for the organization in terms of potential non-compliance, inefficiency, and

added costs. This must be weighed against the effect on employees who will be disappointed at the

elimination of their favorite vendor or investment options. Many sponsors have decided to continue

to include multiple vendors. Most are reducing the number and taking control of the service offerings

and investment options in order to keep the administration manageable and to mitigate risk under

the new requirements.

Step 4 - Ensure Plan Document is Written and Accurate (both in form and operation) – The

403(b) prototype program developed by the IRS will fit only a very limited number of situations. As

such, drafting the plan document will likely require the assistance of an ERISA attorney. It is critical

not only to make sure the plan document complies with the regulations, but also that the terms are

consistent with what has been done in operation. Recordkeepers who have drafted plan documents

will submit their versions to the IRS for approval. Consultants can assist, coordinate, and review final

documents to ensure consistency with plan operations and participant communication materials.

Step 5 - Monitor Participation and Eligibility – The regulations specify very clearly the

requirements for “universal availability”. It is important that a 403(b) plan sponsor review their entire

organization for controlled group considerations to ensure the plan covers the right people and that

the eligibility requirements are properly applied across the entire organization.

Failing to fully understand the coverage and nondiscrimination testing requirements could result in

significant financial penalties for the organization. Failing to cover the right people is often only

correctable by adding in additional participants for whom the plan sponsor must fund a special

contribution. It is important to assess any common ownership and determine how that affects the

coverage requirements. The most common cause of emerging coverage issues is a change in the

controlled group structure through acquisition, divestiture, or change in level of ownership. The

regulations give organizations time to fix this, but the benefits or human resources function is

frequently not informed of such changes. Such delays in internal communications leave

organizations with fewer corrective mechanisms at their disposal.

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Consulting | Retirement 5

Step 6 - Oversee Vendors and Monitor Plan Administration – Specific procedures should be put

in place to oversee all vendors who work with the plan. The plan sponsor should meet with each

vendor periodically to review participation trends and demographic data, vendor performance

relative to stated service standards, and to address any technical or compliance issues. We

recommend meeting with each vendor at least annually. For sponsors who use outside consultants

to help with vendor selection and monitoring, the outside consultants should be included in such

meetings.

Step 7 - Form 5500 and Annual Plan Audit Completed Accurately – The Form 5500 is generally

due at the end of the seventh month following the end of the plan year, although extensions of an

additional two and one-half months are easily available. Plan sponsors should be sure it is clear who

will be preparing the form. In single vendor arrangements, this will often be the recordkeeper. In

multiple vendor arrangements, this may be the firm that conducts the audit or a benefits consulting

firm. Regardless of who prepares the form, processes should be in place to identify who will review,

sign, and electronically (now a requirement) file the completed form. The regulations also require

403(b) plans to have an annual plan audit consistent with those required for 401(k) plans. The

completed audit must be filed with the Form 5500.

These initial steps are intended to address the minimum requirements to be compliant. Many plan sponsors want to do more. Those sponsors that want to do more than just comply should consider a “best practices” approach that includes a number of additional actions.

Develop Proper Governance Procedures – Establish roles and responsibilities for the ongoing

oversight of the plan including:

• Establish a fiduciary committee with appropriate members;

• Allocate appropriate authorities between the committee and the board of directors;

• Develop guidelines for the committee that clearly spell out its responsibilities and processes;

• Establish a disciplined approach for conducting committee meetings;

• Maintain clear documentation of the committee’s actions and decisions; and

• Keep the board informed on the committee’s actions.

Communicate With Participants – Ensure that participants who are affected by vendor

consolidation or plan changes understand what has changed and how it will affect them. Target

communication campaigns to non-participants or participants that are not taking full advantage of the

employer match. Consider communications to participants that focus on retirement readiness. Make

sure that participants understand the size of the retirement benefit that they are on target to receive.

Conduct an Independent Periodic Review of Plan Investments – Many plan sponsors rely on

their recordkeeper to help them monitor and select plan investments. A best practice would include

establishing a fiduciary committee to go through a disciplined process to select an independent, fee-

only investment adviser to meet with them periodically to review detailed due diligence on each

investment in the plan. Most plans should meet at least quarterly but no less frequently than semi-

annually. The investment adviser should consider factors beyond just investment performance and

include cost, risk adjusted performance, manager tenure, etc. The adviser should be willing to make

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Consulting | Retirement 6

recommendations to change, add, or eliminate investment options. The investment adviser should

also acknowledge in writing that they are a fiduciary for the investment advice they provide.

Consider Reducing the Number of Recordkeepers – Many plan sponsors are taking 403(b)

compliance as an opportunity to review existing vendor relationships and reduce the number of

vendors. The rules are burdensome and the burden seems to increase exponentially with each

additional vendor. Some plan sponsors are simply looking to eliminate vendors where there is low

utilization. Others are looking to completely streamline the program by selecting one vendor. The

rules allow participants to transfer assets from one provider to another. Plan sponsors should fully

understand the requirements and the potential effect on participants before undertaking the process

of consolidating vendors. Contract termination penalties should be carefully reviewed and disclosed

to the plan sponsor as well as participants.

Benchmark the Plan to Comparable Organizations to Assess Competitiveness – In an effort to

offer the most appropriate plan possible, it is important to know how your plan stacks up. Is the plan

design consistent with your organization’s goals and philosophies? Consultants with broad industry

knowledge can help sponsors to assess this through benchmarking. It may also be helpful to get a

sense for how your employees view the 403(b) program and what they value most. Knowing where

your retirement benefits stand relative to other comparable organizations, as well as what your

employees value most, are important in managing the retirement program and maximizing employee

appreciation for benefit dollars spent.

Conclusions

The final 403(b) regulations completely changed the landscape for compliance and administration. Plan

sponsors can no longer take a hands-off approach when it comes to their 403(b) plan. Rather, plan

sponsors must craft a comprehensive strategy with the help of independent advisors and take careful

steps to ensure their plans are, and remain compliant.

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Consulting | Retirement 7

Contact Information

Eric Brager

Vice President

Aon Hewitt

+1.610.834.2138

[email protected]

Craig C. Harris

Vice President

Aon Hewitt

+1.336.728.2622

[email protected]

Terri Vaughan

Vice President

Aon Hewitt

+1.336.728.2683

[email protected]