(b) Prepared

Since the Internal Revenue Service (IRS) issued the long-awaited final regulations for 403(b) plans in July 2007 there has been much contemplation and discussion among plan advisers, sponsors, and providers but, with the looming January 2009 effective date, for most provisions, it is time to get down to business.

Employers eligible to have 403(b) plans include 501(c)(3) tax-exempt organizations, public-school districts, and public colleges and universities. Public-school districts are exempt from the Employee Retirement Income Security Act (ERISA), and few have chosen to manage their 403(b)s actively, but private charities have had a choice of whether or not to offer plans governed by ERISA.

Under the old rules, the traditional 403(b) model generally was characterized by minimal plan sponsor involvement and multiple vendors; much of this has been changed by the new rules (see “403(b) aware,” PLANADVISER, Fall 2007). Problems with this model unearthed in IRS audits led to the new rules, which demand involvement and monitoring by plan sponsors—and that could lead to the use of fewer vendors within plans.

Richard Turner, Vice President and Deputy General Counsel, AIG Retirement­ Services, notes that the final rules are almost a non-event for those 403(b) plans already governed by ERISA, so much of the focus is on public sector plans, especially those in K-12 space where a large part of the IRS requirements are new. The regs require assigning responsibility for all administrative functions such as eligibility determination, contribution rules, and adhering to Internal Revenue Code Section 72(p) loan maximums.

Therefore, implementation of the regulations will be a huge undertaking for some sponsors and they will need help; that is where advisers and providers step in. “I think this creates a great opportunity for advisers and plan sponsors to positively affect the outcome for plan participants,” says David Hinderstein of White Plains, New York-based Strategic Retirement Group Inc., an NRP member firm. Hinderstein says advisers are communicating with 403(b) plan sponsor clients about the new rules via written communications, Web sites, and one-on-one meetings. He felt a single newsletter would not address points specific to each client, so he sent separate letters to clients describing the impact the regulations will have on their particular plan.

Advisers looking for help in understanding and communicating the impact of the regulations will find plenty of help from the provider community. For example, ING has launched a Web site (www.ing.com/us/403bregs) devoted exclusively to the new 403(b) regulations; it is continuously updated with additional guidance and tools. AIG has gone so far as to establish a call center and e-mail address to field questions from both advisers and sponsors, according to Bruce Corcoran, Senior Vice President, National Markets, Education, AIG Retirement Services. The firm also is distributing an education compliance kit that includes a 403(b) provider service agreement delegating responsibilities, a number of letters sponsors can use for participant communications, and compliance and due diligence questionnaires.

What To Know

The new regulations affect most significantly the area of plan documents, plan exchanges, and distributions.

The IRS now requires that all 403(b) plans, not just those governed by ERISA, must have a written plan document in place. For advisers with clients or prospects that find this change daunting, Turner suggests encouraging them to think of the requirement as putting a structure around plan provisions that already have existed. Additionally, it need not be an arduous undertaking at the outset since the IRS allowed for a plan “document’ that consists of a number of contracts or agreements that are pulled together. Longer term, of course, advisers may well want to work with sponsors to craft a more cohesive solution.

Linda Segal Blinn, Vice President of Technical Services at ING, points out that, as with plans governed by ERISA, the written plan must include specifics regarding who is eligible, distributable events, observation of contribution limits, and identification of those responsible for administering the plan as well as the scope of their responsibilities. However, the plan document requirement unique to 403(b) plan structures is the identification of all contracts available under the plan.

This flexibility to offer multiple investment vehicle types and vendors is the thing that has most set 403(b)s apart from their ERISA-governed 401(k) counterparts. In some cases, 403(b) sponsors have allowed participants to work with dozens of providers. Pulling back the reins on this feature not only will be a large undertaking for plan sponsors, but also could be troubling to participants who liked the flexibility and to providers who lose a plan’s business.

Turner warns that contracts and providers not identified in the plan document will not be recognized as part of the plan and, if used, there will be consequences. He says there is a little uncertainty about what the consequences for sponsors will be, if any, but, as of January 1, 2009, new assets in accounts with unidentified providers will be taxable to participants.

The provisions of the regulations that cause the most anxiety for plan sponsors and create the greatest potential for administrative change are the requirements and limitations for distributions and plan transfers. The new provisions for so-called 90-24 exchanges (named after IRS Revenue Ruling 90-24 that permitted the transfers to providers outside the defined plan) were effective September 24, 2007—60 days after the final regulations were published. These new rules must be communicated to participants, since they now will have to go to a third party, such as the plan sponsor or administrator, for approval of the transaction, stresses Segal Blinn.

Segal Blinn points out that transfers from one annuity to another, or contract exchanges, will require information-sharing between the provider receiving the assets and the sponsor to ensure number and frequency limitations are being followed. Contribution limitation provisions in the regulations also will require coordination among providers to make sure limitations are being met, Segal Blinn says. Plan sponsors should know that the new rules “will make it much easier for the IRS to catch you,” she warns.

Segal Blinn thinks the distribution and transfer provisions within the final regulations will lead to recordkeeping accounts within 403(b) plans, even if phantom, to keep track of the total of participants’ holdings. “It will give rise desperately to the need for someone to step in and give administrative services on the plan level, not the product level,” she says. Turner agrees, saying there will “absolutely be an emergence of plan-level recordkeepers.”

Turner notes that, under the new rules—just as 401(k) plan sponsors do now—403(b) sponsors will have to remit deferral contributions and loan repayments to plans as soon as administratively feasible, but no later than 15 business days following the month in which they were withheld from participants. He points out that sponsors also will have to pay attention to how to order different types of catch-up contributions under the new regulations.

The nondiscrimination provisions do not present many changes for 403(b) plans, but what is underscored by the final regulations is proof that the plan complies with the universal availability requirements by annual notifications to all eligible employees, according to Segal Blinn. The law requires that all public-school employees expected to work 20 hours per week be offered the opportunity to participate in a 403(b) plan if the school or district sponsors one. The IRS said typical noncompliance involves excluding participation by certain classes of employees, such as substitute teachers, janitors, cafeteria workers, and nurses. Turner adds that, if plans do not comply, the IRS can wipe out all contracts for the year, making asset additions for the year taxable to participants, or even wipe out the plan itself, turning everything into taxable money.

What To Do

Segal Blinn suggests telling sponsors to start by taking a look at what their 403(b) program already offers and deciding what they want to keep, modify, or delete. Hinderstein says that, when he meets with clients, he tells them to decide what their goals and objectives are for offering a 403(b) program and understand what they already have. Deciding what their program will look like will help sponsors with the next biggest decision: plan administration.

Corcoran says there are three approaches 403(b) sponsors can choose for plan administration: centralized, decentralized, or a hybrid. Turner explains that, with a centralized approach, one party would coordinate the information exchange and determinations on the plan level of compliance with distribution, contributions, and transfer limits among all providers. This is a daunting task, since the new rules dictate that any provider that has received contributions since 2005 is considered part of the plan—a reason plan sponsors may desire the centralized approach. With the decentralized approach, providers will share information between each other to ensure that activity is within limits. A hybrid approach allows a sponsor to make providers responsible for coordinating some things, while it handles others.

An important point to remember, however, is that, no matter what approach sponsors choose, they ultimately are responsible for ensuring monitoring is being done and plan requirements are being met.

Ken Morris, a retirement plan adviser with Raymond James Financial Services, suggests establishing some type of plan investment committee, deciding on who the plan decisionmakers will be, and educating them on what it means to be a fiduciary. Once the committee is in place, he recommends it should build an investment policy statement from a plan sponsor perspective and not a vendor perspective.

The next step is to go to the marketplace and see what vendors meet those investment policy guidelines. Advisers can quarterback this process for sponsors, making sure the search includes evaluation of whether each vendor is capable of handling the requirements of the new regulations, Morris says.

Once the plan vendors and product choices have been decided, the next step will be participant communication, according to Morris. He says sponsors want participants to view him as a resource that is on their side, so explaining the investment choices to participants and letting them know he is watching the vendors will gain their trust and lead to better plan participation.

What To Keep in Mind

Inconsistency among providers is the biggest roadblock to implementing the new rules, says Hinderstein; some are ready, and some are not.

Therefore, as tens of thousands of plans now are doing due diligence on existing vendors, advisers should look for those providers with a proven track record and the administrative capability to handle the new rules, Corcoran says. Vendors also should be able to provide proof of compliance and advisers should ask providers if they are allocating capital to having solutions in place and maintaining them, he continues.

In Morris’ opinion, the biggest roadblock is time. He says his experience with tax-exempt organizations has indicated they have multiple decisionmakers and more bureaucracy, and decisions tend to be drawn out. That, combined with the need to update provider and administrative systems and educate sponsors and participants, creates the need for a significant amount of implementation time, he says.

Although Morris anticipates future relief on the effective date, questioning whether everything realistically can be done by January 1, sponsors cannot rely on that. Even if the IRS provides an extension of deadlines for formal compliance, it is likely that plans will be expected to operate in accordance with the new rules.

There is a lot of work to be done. “Sponsors don’t want to pull it together at the last minute,” Segal Blinn says. “This is one of those “slow and steady will win the race” things I think.” The number one recommendation Hinderstein has is that advisers should encourage their plan sponsor clients to start today.

Despite the challenging road ahead, Corcoran concludes: “I think it will be a very exciting year and, with advisers, there is tremendous opportunity to work with sponsors to discuss the regulations and type of administration, get them headed in the right direction, and establish trust with them for the future.”

*Illustration by Craig LaRotonda