Is the 403(b) Plan Dying?Michael A. Webb, AIF®, CEBS Vice President, Cammack Retirement Group

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In a recent webinar, I was rather shocked when a participant posed the following question: “Given the recent regulatory changes that eliminate some of the differences between 403(b) and 401(k) plan, would you anticipate 403(b) disappearing entirely as a separate plan type in the not-so-distant future?”

I guess my shock is related to the fact that I am predominately a 403(b) practitioner, so the very mention of the elimination of 403(b) would presumable constitute a threat to my livelihood, which, needless to say, I take extremely seriously!

After getting over the initial shock of the question, I did want to take a step back to examine its validity. Certainly, it should not come as a surprise to me that someone would contemplate a future without 403(b) plans. Many unique features of 403(b) plans, such as many of the special contribution limits (remember the exclusion allowance?) and limited 5500 reporting for ERISA plans have gone by the wayside, and hardly a year goes by without a legislative proposal for a uniform defined contribution plan for ALL entities, with no 403(b) OR 401(k) distinction.

But before we all start updating our resumes, we should also examine the differences between 403(b) and 401(k) plans, many of which remain substantial. The following comprises a list of the remaining distinctions.

1. LACK OF NONDISCRIMINATION TESTING ON SALARY DEFERRALS FOR THE HIGHLY COMPENSATED

The major reason why many tax-exempt entities continue to use 403(b), as opposed to 401(k), plans (another change from a few years ago is that 501(c)(3) organization are permitted to utilize both plan types) is that it is not necessary to test 403(b) salary deferral employee contributions. As a result, highly

compensated employees (defined in 2011 as those who earned in excess of $110,000 in 2010) have no additional limitations imposed on their ability to save (other than the overall IRS 402(g) limitations). Plan sponsors of 401(k) Plans must collect data each year and test the 401(k) plan to determine the average contribution made by all non-highly compensated employees. (This average includes contributions for noncontributing lower paid per diems, part-timers, and environmental staff with more than one year of service).

Typically, at nonprofits, unmatched deferrals for non-highly compensated employees average about 2%. At this level, HCE’s in a 401(k) plan would be limited to 4-5% of pay, rather than regular IRS limits of 100% of pay up to $16,500 per year ($22,000 if age 50 or older).

This difference is generally considered to be a “deal breaker” for any tax-exempt with Highly Compensated Employees considering a 401(k) plan rather than a 403(b) plan; once it is explained that funds many need to be returned to such employees in a 401(k), consideration of the 401(k) plan type generally ceases.

2. ABILITY TO BE EXEMPT FROM ERISA COVERAGE

Another defining feature of 403(b) plans is that plans of private tax-exempts can be exempt from ERISA, which is not possible for 401(k) plans of such organizations (it should be noted that public education institutions and churches are not subject to ERISA regardless of plan type), In order to be exempt, the plans must permit elective deferrals only (no employer contributions) and satisfy several other requirement which generally restrict employer involvement in the plan. For such plans, no Summary Plan Descriptions (SPDs) are required, no annual 5500’s or SAR’s need to be filed and

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distributed, and an annual accountants opinion is not necessary (the annual audit alone can be a significant cost factor, as well as an administrative burden). The exemption is not as attractive as it once was due to new regulatory requirements, but remains an important option for 403(b) plans that does not exist in the world of 401(k).

3. INVESTMENTSAnother important distinction in 403(b) plans is that they are limited with respect to the types of investments that can be offered. Many types of investments that are permitted in 401(k) plan, such as individual securities, are prohibited in 403(b) plans, which are limited to 403(b)(1) fixed/variable annuities and 403(b)(7) custodial accounts (mutual funds).

4. UNIVERSAL AVAILABILITYUnique to the 403(b) plan is the Universal Availability requirement, which means that all employees (with limited exceptions) MUST be permitted to make elective deferrals from date of hire. In 401(k) plans, eligibility to make elective deferrals can be restricted, subject to nondiscrimination testing requirements.

5. 15-YEAR CATCH-UP ELECTIONA holdover from the days of the maximum exclusion allowance is a feature unique to 403(b) plans; the 15-year catch-up election, whereby a plan can permit employees with 15 years or more of services who satisfy additional requirements to defer up to an extra $3,000 over and above the 402(g) limit of $16,500 ($22,000 if age 50 or older) in 2011.

This election, however, is nearly as complicated as the exclusion allowance to calculate, as it requires a complete history of elective deferrals for all of an employee’s years of employment to calculate. Defects with respect to the calculation of such elections are a frequent IRS audit issue, which is why such an election has disappeared from many 403(b) plans.

6. POST-EMPLOYMENT CONTRIBUTIONS401(k) plans do not permit post-employment contributions, but 403(b) plan permit post employment EMPLOYER contributions (NOT elective deferrals) to be made for up to five tax years following termination of employment. .

7. PROVIDER AVAILABILITYThere are a myriad of providers who service 401(k) plans. 403(b) assets, however, are concentrated among a relatively small selection of providers. This relative lack of competition can affect pricing and marketplace advancements but for large plans 401(k) and 403(b) product/service offerings will often be quite comparable.

There are several other 403(b) plan distinctions (state taxation in NJ, employer eligibility, and top heavy testing to name a few), but the above list captures the distinctions of most significant impact to plan sponsors.

CONCLUSIONThough 403(b) plans have become more and more like 401(k) plans in recent years, the aforementioned distinctions illustrate the large gap between 403(b) and 401(k) plans that has yet to be bridged. How much time it will take to bridge this gap is for the future to determine, but it would appear that 403(b) plans are far from taking their last breath.