June 12, 2012 (PLANSPONSOR (b)lines) – At the recently completed 2012 PLANSPONSOR National Conference, David Powell of Groom Law Group and Michael Webb of Cammack LaRhette Consulting conducted a “live” version of the Ask the Experts Column, fielding questions on 403(b) and related topics from audience members.
For the next few weeks, Ask the Experts will highlight some of the questions posed at this session.
“In another conference session, we heard about some of the advantages of 401(k) plans over 403(b) plans. Should I convert my existing 403(b) plan to a 401(k)?”
Michael A. Webb, vice president of Retirement Plan Services at Cammack LaRhette Consulting, answers:
Probably not, but not due to the fact that 401(k) plans can have some advantages over 403(b) plans (though the experts would argue that the reverse is true as well). Though the experts did address this subject back in 2009 (see “Ask the Experts - Replacing a 403(b) with a 401(k)") it is worth revisiting as 401(k) plans and 403(b) plans have become even more alike (e.g. both now require full 5500s and audits).
The reasons that plan sponsors are not rushing to replace their 403(b) plans with 401(k) plans , as discussed back in 2009, remain valid; with the major issues being that a) 401(k) plans still require nondiscrimination testing, known as ADP testing of elective deferrals, the failure of which generally requires refunds to senior executives (and senior executives tend not to think highly of such refunds!), and b) it remains a burdensome process to terminate a 403(b) plan. Thus, although a 401(k) may have many positive features, these barriers to transition have caused many plan sponsors to retain their 403(b) arrangements.
So what types of plan sponsors may be switching? Smaller sponsors who do not have any highly compensated employees (defined In 2012 as those individuals who earned in excess of $110,000 in 2011), and thus not be subject to the ADP testing barrier described above might be viable candidates. Plan sponsors who have extremely high voluntary participation (75% or higher) in their 403(b) plans might also be a candidate for a 401(k) since they should be easily able to pass such testing. Plan sponsors with such features who employ a substantial number of individuals who file tax returns in New Jersey (the only state in the nation that taxes 403(b) deferrals, but not 401(k) deferrals) might even a more suitable candidate for migration to a 401(k) plan.
However, even for these sponsors, termination of the 403(b) plan might still serve as a significant barrier to transition, at least in the current regulatory environment.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.