Five common misperceptions about 403(b) plans
Kind of similar, but really different, 401(k) plans and
403(b) plans are the fraternal twins of the retirement plan universe. People
think that 403(b) plans are just a funny version of a 401(k), but that is not
true, says Evan Giller, a member in the New York law firm of Giller &
Calhoun LLC. While the rules for the two different types of plans are similar,
there are significant differences, and advisers need to know the differences,
says Terry Richardson, Director of PwC Human Resources Services in Chicago.
Here are five common misperceptions and misunderstandings about 403(b) plans
(and how they compare with their 401(k) brethren):
The rules are exactly the same for 403(b) and 401(k) plans.
The key differences between 401(k) and 403(b) plans, says
Richardson, include 1) special contribution limit rules for 403(b) plans, 2)
that 403(b) plans have a special 15-year catch-up contribution rule, and 3)
that 403(b) plans also have a special rule that allows contributions after
someone leaves employment. There are also differences in the nondiscrimination
rules and permissible funding vehicles.
For example, the rules under Internal Revenue Code 415 for
the combined limit on employer and employee contributions differ between the
two types of plans, says Richardson. Although the 415 rules apply to both types
of plans, he says, how they apply differs. In a for-profit company, he says,
401(k) elective deferrals are combined with contributions from various other
qualified retirement plans the company sponsors, and there is only one 415
limit. If a university, however, has both a 403(b) plan and a 401(a) plan with
employer contributions, the university’s 401(a) plan is subject to the 415
limit, but the 403(b) plan has a separate 415 limit. The 403(b) plan and the
401(a) defined contribution plan are not combined to determine the 415 limit,
says Richardson, so there are, in reality, two 415 limits.
Additionally, there is a misconception that if a 403(b)
investment provider is changed, all the old money in A can be mapped over to B,
explains Giller, and that is not always the case. Legacy 403(b) products are
usually individual-based products, he explains, and because 403(b) plans are
often funded by individual annuity contracts, the plan sponsor does not have
authority under the contracts to move the money to new investments.
This means that, when 403(b) investment providers are
changed, the money has to be moved over individually by each participant, says
Chris Cumming, Senior Vice President of Defined Contribution Markets for
Great-West Retirement Services in Greenwood Village, Colorado. This makes it
difficult to move investments. “You have to roll over assets one participant at
a time, and you may not get all the assets over time,” says Cumming. This is
important, he says, because often the pricing for new investments is based on
the assumption that all the old money will be coming over.
Additionally, notes Giller, the 403(b) plan structures
differ in that they generally are funded by annuity contracts with their own
terms and conditions. So, when reviewing a 403(b) plan, advisers need to look
at not only the plan documents, but also the annuity contracts, to determine
how to administer a plan properly.
Conversely, many advisers are not aware of how similar
403(b) and 401(k) plans are. At one time, the rules for the two types of plans
were very dissimilar, says Cumming, but that has changed in the last few years.
There have been a number of changes to the 403(b) rules over the last 10 years
to make them more similar to 401(k) plans, says Richardson. In fact, many
nonprofit entities, says Cumming, have ERISA-based plans, so there are really
very few differences between the two types of plans.
Furthermore, says Cumming, some of the differences actually
make 403(b) plans easier to administer. For example, 403(b) plans are not
subject to the average deferral percentage (ADP) testing that 401(k) plans are.