What Do the 403(b) Regulations Really Require? – Part I

March 30, 2010 (PLANSPONSOR.com) - Soon after publication of the final 403(b) regulations in 2007, as the marketplace sorted out the requirements, the implications, and the intent of the new regulations, there was a fair amount of confusion over some very basic issues.

The new regulations left plan sponsors asking:  

Did the regulations subject all 403(b) plans to Title I of ERISA?    

The obvious answer for public employers is no, and even for private tax-exempt employers the answer is that compliance with the regulations did not automatically trigger ERISA for a plan that was not previously subject to ERISA (although the regulations did make some challenging issues yet more difficult).    

Did the regulations impose fiduciary standards of conduct?  

The obvious answer to this for all employers is no.  Moreover, the assumption that some fiduciary standards will always apply was also an incorrect one.  Any fiduciary standards applicable to 403(b) plans – and in many cases there will not be any – must come from somewhere other than the Internal Revenue Code.  In the case of plans subject to Title I of ERISA, the obvious source of these requirements is ERISA.  In the case of public employer plans, the application of certain state model investment fiduciary standards is rather tenuous at best for many of these employers.  However, certain undertakings by those public employers – such as restricting a plan to a single provider – might actually cause one or more of those state model laws to apply.  

Did the regulations prescribe the investments (type or number), the plan structure, or the plan features that a plan sponsor must select?  

Once again the obvious answer is no.  What the regulations did was to establish a set of requirements, which employers could satisfy in any way they chose, including any qualifying investment arrangement and any plan features, within any plan structure that otherwise met the requirements.

Today, more than a year after the 403(b) regulations first became effective, some of the confusion over what they really require remains, and is seen in a fuzzy delineation between requirements of the Internal Revenue Code (Code) and Title I of ERISA.    

In an effort to help provide additional clarity, the following list identifies a number of plan requirements or attributes and for each one identifies, very simply, whether it originates in the Code, in ERISA, or both:  

  • Written plan: Code and ERISA
  • Summary Plan Description (SPD): ERISA only
  • Employer and employee eligibility: Code only
  • Investment alternatives: Code and ERISA.  There are three primary alternatives for 403(b) plans – annuities, custodial accounts, and church retirement income accounts. 
  • Contribution limitations: Code only
  • Coverage, participation and other nondiscrimination rules: Code and ERISA 
  • Vesting rules: ERISA only.  (The final 403(b) regulations provide direction as to the proper accounting for non-vested amounts.)
  • Distributions: Code only
  • Loans: Code and ERISA
  • Spousal consent: ERISA only
  • Transfers/exchanges: Code only
  • General fiduciary standards and prohibited transaction limitations: ERISA only
  • 404(c) status of plan: ERISA only
  • Participant tax reporting: Code only
  • Plan reporting: ERISA only (Form 5500 reporting requirements)
  • ERISA Safe Harbor:  ERISA only (Safe harbor for certain 403(b) plans sponsored by private tax-exempt employers)
  • Plan termination: Code and ERISA

Of course, each of these requirements could be the subject of a separate article.  As a general matter, a public employer may disregard the requirements listed as "ERISA only."  In addition, a public employer that may be thinking about voluntarily assuming one or more of those otherwise inapplicable requirements should consult with their counsel before doing so.  While the public employer might assume that doing so would provide predictability, in reality the courts would be under no obligation to apply ERISA precedents outside the scope of an ERISA plan.  Thus, such a decision might actually introduce new elements of unpredictability.  

The process of adapting to the new world of the final 403(b) regulations continues, one year later.  An important part of that process is determining what exactly those new rules are, and how they relate to other overlapping sets of rules, such as Title I of ERISA.  After all, knowing which rules apply is a critical step toward ensuring that a plan’s procedures are in compliance with those rules.

- Richard Turner, Vice President and Deputy General Counsel, VALIC