If you are an average 403(b) plan sponsor, I suspect that whether a contract is a group or individual contract might not appear front and center on your radar screen. In fact, this issue may not appear on your radar screen at all! However, this distinction between contract/custodial agreement types is a critical question for many ERISA 403(b) plan sponsors.
Did you know that whether a contract is group or individual can affect the ability of a plan sponsor to fulfill its fiduciary duty under ERISA to remove an investment from its 403(b) plan, should such an investment become imprudent? The distinction is also significant in addressing the new Form 5500 reporting requirements for ERISA 403(b) plans.
Group and Individual Contracts Defined
Group contracts/custodial agreements generally name the plan sponsor as contract holder. While each participant holds an interest in his/her account, the group contract gives the employer, as plan sponsor, the right to move assets to a new contract. Thus, the group contract operates much like a qualified plan (401(k) or 401(a) trust), where the employer controls the investment of trust assets. In an individual contract/custodial agreement, the contract holder is the participant; only the participant, and not the employer, can transfer assets to a new contract.
A World of Difference
Why is this distinction important? Suppose I conduct a request for proposal process whereby I discover that my current vendor X is offering a product that is no longer the most prudent choice, even though it may have been appropriate at one time. If I have a group contract with that vendor, I can move all assets under that contract to vendor Y, the winning RFP bidder (subject to a possible charge for contract termination), which would be consistent with ERISA. If, however, I were holding an individual contract, as a plan sponsor, I could only direct future deposits to vendor Y; each participant would individually need to request assets to be transferred from X to Y.
Realizing that, vendor Y might set pricing and other contract terms less favorably than if it had been able to capture all of the assets of the vendor X product. In addition, the plan sponsor’s cumbersome task will now be to monitor two sets of investments, vendor Y’s investment plus the inactive investments in the vendor X contract. Thus, the existence of individual contracts not only decreases the plan sponsor’s purchasing power, but increases the plan sponsor’s administrative burden. In consequence, group contracts/custodial agreements are generally far more desirable from a fiduciary perspective.
Form 5500/Audit Issues
It should also be noted that it is often much more difficult for a plan sponsor to obtain employer-level financial data for a 403(b) plan when assets reside in individual contracts. The Department of Labor has therefore exempted individual contracts (or any contract where the rights of the contract are 100% enforceable by the participant) from the 2009 5500 reporting and audit requirements, if contributions to such contracts ceased prior to January 1st, 2009. For more details on this exemption, please refer to the DoL/EBSA Field Assistance Bulletins 2009-02 and 2010-01.
It is important for plan sponsors to ascertain whether the contracts/custodial agreements in their plans are individual, group, or both. Plan sponsors should be particularly cautious about falling victim to assumptions. Plan sponsors are often shocked to learn that their assets are invested in individual rather than group contracts/custodial agreements. Contracts that appear to be "group" on their face may provide exclusive rights to participants through individual certificates, which would prevent plan sponsors from transferring assets.
The issue is not unique to insurance companies; mutual fund companies have also been known to provide individual custodial agreements. If there is any doubt as to the identity of a contract in this regard, plan sponsors should call upon benefits counsel with specific 403(b) plan expertise to review agreements.
Michael Webb, Vice President, Retirement Services, Cammack LaRhette Consulting
Cammack LaRhette is an independent HR benefits consulting firm specializing in non-profit industries.
NOTE: This article is for general informational purposes only, is not intended to be taken as legal advice or a recommended course of action in any given situation. Readers should consult their own legal counsel before taking any actions suggested in this article.
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