The IRS’s proposed rules for 403(b) plans would make them more like 401(k)s. That’s not entirely a good thing.
The Internal Revenue Service wants to make 403(b)s -- retirement plans for public schools, hospitals and other nonprofit organizations -- more akin to 401(k)s, their popular private sector counterparts. The paradoxical upshot could be fewer 403(b) plans but more 403(b) participants -- and a more attractive market for mutual funds, which have ceded much of this territory to annuity providers.
The IRS’s concern, of course, is strictly tax compliance. Unlike the corporations sponsoring 401(k)s, nonprofits are not required to centrally administer employees’ contracts with investment services providers. Indeed, a 403(b) arrangement may consist of a grab bag of contracts between employees and providers. Nonprofits typically pass along contributions withheld from their employees’ paychecks to providers or plan administrators.
“Usually, nonprofit employers don’t feel responsible for the plan,” says Michael Weddell, a retirement consultant at Watson Wyatt Worldwide. “They say, ‘I’m just a bystander, passing payroll data to the plan provider.’” If the IRS proposals are implemented, Weddell believes, “employers are going to end up assuming more oversight for their plans.”
Should the IRS enact these proposals, nonprofits would have to supply the tax agency with more information about plans and participants. More important, these organizations would have to start assuming fiduciary responsibility for managing employees’ retirement savings. In addition, the agency would bar a key escape hatch for disgruntled 403(b) holders: the right to transfer their accounts to other 403(b) providers.
The new provisions would take effect in January. The IRS is reviewing comments from more than 1,000 sponsors, participants and providers -- many of which criticize the suggested changes. Financial providers, including AXA Financial, Prudential Insurance Co. of America and TIAA-CREF, fear that the cost of meeting the rules would be too great, forcing many employers to drop 403(b)s.
Nonprofits would have to draw up documents spelling out their 403(b)s’ policies. “Employers can’t speak to the propriety of loans or distributions if they don’t know where the money is,” says an IRS official.
David Powell, an attorney with Washington-based Groom Law Group, notes that “plan documents can protect the employer as much as the employee, and we frequently recommend them to our nonprofit clients.”
Requiring nonprofits to exercise even minimal oversight of 403(b)s should lead to a better choice of providers and to more favorable fees, says Michael Beczkowski, a senior consultant with Bolton Partners, an employee-benefits consulting firm in Baltimore. As it is, 6.8 million employees of public schools and other nonprofits have 403(b)s, and the plans’ assets total $580 billion. Yet only 50 percent of eligible employees join 403(b)s; roughly 75 percent of eligible employees sign up for 401(k)s.
“We’re willing to provide employers with plan documents, but the real issue is whether the regulations would impose obli-gations on sponsors that will make it harder for them to maintain their programs,” asserts Richard Turner, associate general counsel at AIG Valic, a 403(b) annuity provider based in Houston.
Big annuity providers have lots to lose: Eighty percent of 403(b) assets are invested in annuities, according to Chicago consulting firm Spectrem Group. The proportion of defined contribution assets held in annuities: 10 percent. The average variable annuity charges mutual fund and insurance fees totaling 138 basis points annually; the average equity mutual fund charges 78 basis points, notes Eleanor Lowder, a consultant to the National Tax Sheltered Accounts Association.