Exercising Fiduciary Authority and Control over the Investment Menu in ERISA 403(b) Plans

Many employers sponsoring 403(b) plans recently modified their arrangements as a result of the final regulations under Section 403(b) of the Internal Revenue Code (New IRS Regulations), which generally became effective on January 1, 2009.

In accordance with one of the requirements under the New IRS Regulations, plan sponsors must adopt a written 403(b) plan document.[1]  Before these rules became effective, employers were only required to adopt plan documents to the extent the 403(b) plan was covered by the Employee Retirement Income Security Act of 1974, as amended (ERISA).  The U.S. Department of Labor (DOL) has clarified that the adoption of a 403(b) plan document to comply with the New IRS Regulations will not automatically cause the plan to become subject to ERISA.[2]  However, in the course of modernizing their arrangements to comply with these new tax rules, various 403(b) plan sponsors have assumed greater control over their plans, thereby becoming subject to ERISA.  

Prompted by the New IRS Regulations, many tax-exempt organizations investigated and made changes to their 403(b) arrangements with the assistance of their service providers.  As a result of this process, a substantial number of employers decided to transform their 403(b) plans from a “no cost” perk offered as a convenience for employees, to a meaningful benefit program designed to help employees through their retirement years.  For example, sponsors implemented automatic enrollment features, added matching contributions, and initiated communication campaigns to promote retirement savings.  However, with this added level of involvement in plan design and administration, these employers in effect enlisted to serve their plans as ERISA fiduciaries.  

403(b) plans are generally subject to ERISA if the plan is “established or maintained” by a tax-exempt organization on behalf of its employees.[3]  As provided under a regulatory safe harbor, a 403(b) plan will be not deemed to be established or maintained by the employer if (1) employee participation is completely voluntary, (2) all rights under the 403(b) plan’s annuity contracts or custodial accounts are enforceable solely by the employee, (3) the involvement of the employer is limited to publicizing the program without endorsement and to collecting contributions through payroll deductions, and (4) the employer receives no compensation, other than reasonable reimbursements for payroll deduction costs.[4]    

Conversely, a plan will become subject to ERISA if the employer encourages participation, makes non-elective employer contributions, or exercises any kind of discretionary authority with respect to plan operation (e.g., determining eligibility for hardship distributions).  As a consequence of their providing meaningful 403(b) plan benefits to their employees, a large number of tax-exempt organizations have converted their 403(b) arrangements into ERISA plans, and they are now subject to the fiduciary requirements and standards of care under ERISA.  

Under ERISA 403(b) plans, the plan sponsor and other fiduciaries are responsible for the management of the plan and its investments in accordance with the demanding standards of ERISA Section 404.  There are four central duties under this provision, which require fiduciaries to act:  (1) for the exclusive purpose of providing benefits and paying reasonable plan expenses, (2) in accordance with the “duty of prudence,” (3) by diversifying plan investments so as to minimize the risk of large losses, and (4) in accordance with the plan’s documents.  In the case of an ERISA 403(b) plan, the plan’s participants are typically permitted to make the investment allocation decisions for their personal accounts.  But even though investments may be participant-directed, the plan sponsor remains responsible for these investment allocation decisions, unless the conditions of ERISA Section 404(c) are met.[5]  Once these conditions are satisfied, the plan fiduciary is responsible for the prudence and diversification within the plan’s investment menu, but is not responsible for the actual investment allocation of participants’ accounts.    

To foster compliance with these fiduciary standards, it is customary for plan sponsors to appoint fiduciary committees to oversee the management of the plan’s investment menu.  It is also a recommended practice for the committee to have a written charter to provide guidance on its composition and designated duties.  Since the procedural aspects of the duty of prudence contemplate an objective process for selecting, monitoring and changing the plan’s investment line-up, the DOL encourages the adoption of an investment policy statement (IPS) to assist the investment committee or other plan fiduciaries to discharge these duties solely in the interests of the participants and beneficiaries of the plan.[6]  To comply with the substantive aspects of this duty, which is sometimes called the “prudent expert” rule, plan sponsors should seek the assistance of a qualified adviser, such as a registered investment adviser (RIA), if it lacks the necessary expertise and experience to carry out a prudent evaluation of the investment menu.[7] 

[1] Adoption of the 403(b) plan document was permitted to be delayed until December 31, 2009, provided the plan sponsor operated the plan during 2009 in accordance with the requirements of IRS Notice 2009-3.  

[2] Field Assistance Bulletin 2007-02. 

[3] 403(b) plans can also be sponsored by, or on behalf of, public schools and churches.  However, governmental plans are automatically exempt from ERISA, and church plans are similarly exempt unless ERISA coverage is elected. 

[4] Section 2510.3-2(f) of DOL regulations. 

[5] To satisfy the requirements under ERISA Section 404(c), participants must have an “opportunity to exercise control” over their accounts, which also requires sufficient investment-related disclosures, and the plan must offer a “broad range of investment alternatives” within the meaning of the related DOL regulations. 

[6] DOL Interpretive Bulletin 08-2, Interpretive Bulletin Relating to the Exercise of Shareholder Rights and Written Statements of Investment Policy, Including Proxy Voting Policies or Guidelines, 29 CFR 2509.08-2. 

[7] See, e.g., Liss v. Smith, 991 F.Supp. 278 (S.D.N.Y.1998). 

Furthermore, investment meetings and reviews should be properly documented.[1]  Fiduciary reviews should also ensure the prudent selection of service providers to the plan, including a proper evaluation of the reasonableness of fees.    

If a 403(b) plan is subject to ERISA, it is imperative for the plan sponsor to retain control over the plan’s investment offering to participants.  Consistent with its responsibilities under ERISA Section 404, the plan sponsor must have the power to make changes to the 403(b) plan’s menu in accordance with the prudence and diversification standards under ERISA.  Employers who recently converted to, or otherwise “establish or maintain,” ERISA 403(b) plans should confirm with their service providers that they possess this necessary authority and control over plan investments.  Historically, non-ERISA 403(b) plans typically have not conferred any control over plan investments to the plan sponsor.  With the rollout of the New IRS Regulations, employers participating in non-ERISA 403(b) plans were effectively required to “centralize” plan administration with the cooperation of their service providers, but these changes generally did not impact or increase the sponsor’s control over the plan menu.   

Thus, if a 403(b) plan provider is not operationally equipped to handle the fiduciary needs of ERISA 403(b) plans, it could conceivably prohibit a plan sponsor from making changes to the plan’s investment menu, even though they may be deemed essential for fiduciary reasons.  For example, a service agreement might state that the plan’s investment menu must always include the standard offering of funds available through the provider.  Other arrangements might give sole investment authority to participants, leaving the plan sponsor without any contractual right to restrict the participant’s investment choices.  Although these types of arrangements may be sufficient for a non-ERISA 403(b) plan, once the plan becomes subject to ERISA, such restrictions can put plan fiduciaries at risk.  

In the event the plan’s fiduciaries conclude that an investment menu change must be made (e.g., replacement of a problem fund in an asset category), if the provider does not permit such change for contractual reasons or due to a lack of fund availability, the plan sponsor will have little recourse but to move to another provider.  Of course, plan sponsors should endeavor to make any necessary investment changes with the incumbent provider’s cooperation, before incurring the administrative costs of moving to another provider that can accommodate their fiduciary needs. A plan sponsor could, in theory, allow participants to keep their existing investments in the incumbent provider’s problem fund, and merely require new contributions to be invested in a replacement fund available through a different provider.  However, this approach carries liability risks for the plan sponsor, to the extent it might be held responsible for allowing the problem fund to continue in the plan’s investment line-up (even if it is closed to new contributions).    

Although it may require wrangling with historical contracts and administrative arrangements, ERISA 403(b) plan sponsors should make every effort to coordinate with their providers and participants, to ensure they maintain the appropriate authority and control over the plan’s investment menu.   

Daniel M. Boardman is a principal of Hickok & Boardman Retirement Solutions, an independent registered investment advisor that advises companies on their 403(b) and 401(k) plans. For more information, please visit www.hbbenefits.com . Securities offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. 

Marcia S. Wagner is the managing director of The Wagner Law Group, a law firm specializing in ERISA, employee benefits and executive compensation law.  For information, kindly visit www.erisa-lawyers.com. 


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. 

[1] DOL Interpretive Bulletin 08-2.