Tag: 403(b)

Solving the Money Purchase / 403(b) Plan Conundrum

Do you have both a money purchase plan and a 403(b) plan? Unsure how you got here and where to go next? Are you challenged to administer both plans? Do you have multiple audits? Many of our clients have been in your shoes and after some background we share what they did to solve this problem.

It was common place many years ago to have both a money purchase plan and a 403(b) plan in place. One of the challenges with this legacy plan structure is that the plan sponsor is left to administer two separate retirement plans, which may demand two audits if the plans have more than 120 participants.

Why did this structure exist? Much has to do with the history of 403(b) plans.


A brief history of 403(b) plans

1958 – Congress adds section 403(b) to the Internal Revenue Code (IRC) to establish a tax-deferred retirement vehicle for non-profit entities.
1974 –403(b) plans are allowed to invest in both annuity products and mutual funds. 403(b) plans were commonly referred to as “Tax Deferred Annuities” prior to 1974. This term is a bit outdated today, as the investment options available have widened.
1986 – Several changes are made to modernize 403(b)s, similar to those applicable to other qualified plans, like 401(k) plans. These changes include a 10% penalty tax for pre-59½ withdrawals, required minimum distributions, annual contribution limits and non-discrimination rules.
1996 – Non-profit employers are eligible to sponsor 401(k) or SIMPLE IRA plans as well. Employers need to understand the advantages and disadvantages under each plan type.
2009 – 403(b) plans have come under many of the same rules and regulations that 401(k) plans have. For those that have come from the for-profit world, the 401(k) and 403(b) now look like close cousins. 403(b) plans are required to have a plan document. IRS applies other regulations to all 403(b) plans, effectively shifting more responsibility to employers. The real challenge is to adapt the previous 403(b) environment to fit the new regulatory environment.


What’s the difference between ERISA and non-ERISA 403(b) plans?

The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that governs the administration of retirement and health plans.

Generally speaking, churches and government entities are exempt from the requirements under ERISA. However, many non-ERISA plans have started to adopt best practices from their ERISA counterparts because more prudence and better process has driven better outcomes for the plan participants!

For any other non-profit entities sponsoring a 403(b) plan, to maintain non-ERISA status, the following requirements must be met:

  • The plan must be voluntary for participants.
  • There can be no employer contributions.
  • The plan sponsor must have minimal administrative involvement with the plan.


What to do now…

Many plan sponsors want to move toward a one-plan solution for several reasons:

  1. Reduced investment costs – Participants can benefit from lower cost investments under an institutional contract, rather than the individual contracts prevalent in the 403(b) marketplace.
  2. Ease of administration – Reporting contributions to just one contract.
  3. Reduced audit costs – If the plans require one audit, rather than two.
    Unfortunately, the IRS does NOT allow a 401(a) money purchase plan to merge with a 403(b) plan, as they are separate and distinct money types.

One solution for the money purchase plan / 403(b) scenario is to restate the money purchase plan as a 401(k) plan, allowing all future contributions (both employee and employer) to flow into the new 401(k) plan. This preserves the employer contributions, which were previously contributed under the money purchase plan. The plan sponsor then terminates the 403(b) plan, left with just one plan to administer. The impact to participants is reduced investment costs and simplified account management.


So, what’s the downside of moving to a 401(k)?

1. Non-discrimination testing
One non-discrimination test that 401(k) plans are subject to, but not 403(b) plans, is the Average Deferral Percentage test. This test is designed to ensure that the highly compensated employees do not benefit from the plan to a greater extent, relative to the non-highly compensated employees.

  • If a plan’s non-highly compensated group has low participation or low savings rates, the highly compensated employees may be limited in their ability to contribute to the plan.
  • At times, this is addressed by establishing a non-qualified plan to address the needs of the highly compensated group.

2. Distributable event for the 403(b) balances

  • A second concern is related to the termination of the 403(b) plan. Because the IRS does not allow for 403(b) plans to be merged into 401(a) or 401(k) plans, the plan termination becomes a distributable event for active employees, meaning they will have option to take a distribution or roll their balance into the new 401(k) plan (or an IRA).
  • This is an individual decision, with no way to force their hand. A thorough education plan can effectively educate participants about their options and many will likely elect to roll their balance into the new plan.


Where do you go from here?

Plan sponsors should regularly evaluate their current plan designs to confirm that they continue to meet the needs of the employer and their participants. Many plan sponsors have made plan design changes to simplify and streamline retirement plan administration. The most significant change is to consider moving to a one-plan solution and evaluating whether a 401(k) or 403(b) plan is a better fit. The most important consideration is understanding not only what plan design you have, but also why you have that particular plan design. If you would like to speak with a plan sponsor who has undergone this analysis, we would be happy to connect you.