CARES Act Special Considerations for 403(b) Plans

Participants invested in annuity contracts may face charges for distributions and limits on amounts they can take as a distribution or loan that they may not be aware of.

Participants in 403(b) plans may not be able to take as much in distributions and loans as provided for in the Coronavirus Aid, Relief and Economic Security (CARES) Act. In addition, they may not enjoy the savings provided by the elimination of tax penalties for early distributions in the same way other plan participants will.

A blog post from Hall Benefits Law points out that 403(b) plan participants invested in annuities may be required to pay surrender charges, up to 12%, for any distributions. Bob Forman, lead ERISA [Employee Retirement Income Security Act] counsel at Hall Benefits Law in Atlanta, notes that while these participants save money on premature distribution penalties, that savings will be washed out by surrender charges taken on top of the distribution amount.

While many service providers have waived transaction fees for coronavirus-related distributions (CRDs) and loans during the COVID-19 pandemic, Michael A. Webb, vice president of Retirement Plan Services at Cammack Retirement Group in New York City, says he has not seen annuity providers waive surrender charges on annuity contracts.

Forman says surrender charges do not apply to every investment; it depends on the provider and the investment features. Also, surrender charges may decrease over the years. “In one product, the surrender charge declines to 0% after 10 years, so how long the participant has been in the plan or the investment is a consideration in taking a distribution,” he says.

“A surrender charge can be bad enough, but there is more than one major vendor that locks up annuity money so participants can’t even take it with a charge,” Webb points out. He explains that some products are set up so that participants can only get a portion per year over seven or 10 years. For example, a participant could only take out one-seventh of his account per year. “Even if a participant has a coronavirus need and is in dire straits, he wouldn’t be able to take all that he needed out,” Webb says.

Webb says there is a similar issue with loans. “One of the largest contracts in the market only allows an individual to borrow 45%,” he says.

Webb says the reason for these restrictions may be that fixed annuities pay above the market rate—in exchange for earning an above-market rate of return, the participant is restricted on distributions and borrowing. “I wouldn’t expect COVID-19 to change that. Providers are subject to state laws, so they would have to get the state to approve,” he says.

Forman says participants may be unaware of these fees. “I don’t think these fees would be included in a 403(b) plan’s SPD [summary plan description]. Typically, investment features are not reflected in the SPD,” he says. “They may be included in participant fee disclosures, but I think those are mostly geared toward ongoing investment fees.” Plan sponsors can make participants aware of these fees in ancillary participant communications.

The Hall Benefits Law blog post suggests that it may be better for 403(b) plan participants affected by COVID-19 to take a loan rather than a distribution. However, it notes that loans from insurance products are collateralized.

“Insurance companies will set aside a certain amount of funds to secure the loan obligations and will use those funds to get a return and make a profit,” Forman explains.

In addition, many 403(b) annuity contracts have qualified joint and survivor annuity (QJSA) requirements, so participants have to get spousal consent for loans and distributions, Webb says. He adds that with non-ERISA 403(b)s, annuity providers will tell plan sponsors the QJSA requirement is an option, so plan sponsors can ask to get rid of it if they have it. But, for ERISA plans, plan sponsors will be told it’s a requirement so it’s hard to eliminate. “We’ve been helping clients get rid of it,” Webb says.

But, Webb says, it’s not all bad news. “Unlike a lot of 401(k)s, 403(b)s have always grown up as a relationship between the participant and provider, so there’s no elaborate process for loans. Participants can usually just get a check and they can stop and start loans easier than 401(k) participants,” he says. “This is not just for annuity contracts, but also individual mutual fund contracts. There’s not a lot of sponsor involvement, historically.”