Should Nonprofits Switch From a 403(b) Plan to a 401(k) Plan Because of the Final 403(b) regulations?
With the new requirement for a 403(b) plan document starting in 2009, some nonprofits may be considering switching to a 401(k).
403(b) plans may be sponsored by nonprofits, public schools, or ministers. States, local governments and ministers do not have the ability to sponsor 401(k) plan in addition to a 403(b). This article is, therefore, directed at nonprofits that are not an agent or instrumentality of a state or local government and not created for the benefit of a minister.
The new final regulations make 403(b) plans look and feel very similar to 401(k) plans but some very important differences remain. For those nonprofits that choose to retain a 403(b) plan, the choice will depend on the type of plan features and investments they want to offer employees and whether the advantages of a 403(b) plan outweigh the disadvantages. After describing some of the considerations for nonprofits to weigh when deciding whether to switch to a 401(k) plan, we will briefly summarize the 403(b) document options available to plan sponsors.
Considerations for nonprofits deciding whether to change from a 403(b) plan to a 401(k) plan include the following:
1.) 403(b) Plans Have Limited Investment Options.
403(b) plans are restricted to custodial accounts (which must be invested in mutual funds), annuity contracts issued by an insurance company and retirement income accounts (for church-related organizations only).
2.) 403(b) Plan Elective Deferrals Are Not Subject to Nondiscrimination Testing.
Elective deferrals in a 401(k) plan are subject to nondiscrimination testing (the ADP test). 403(b) plan elective deferrals are not subject to the ADP test. This means that highly compensated employees in a 403(b) plan will not need to receive refunds of elective deferrals because of a failed ADP test. ADP refunds are typical in situations where the deferral rates among rank and file employees are low.
In place of the ADP test, 403(b) plans must make elective deferrals universally available to all employees. There are a few exceptions to this general rule in that 403(b) plans may exclude employees:
- whose maximum elective deferrals would not exceed $200;
- who are eligible to participate in another employer-sponsored 401(k) or 403(b) plan, or in an eligible governmental 457(b) plan which permits elective deferrals;
- who are nonresident aliens;
- who are students performing services for a school, college, or university;
- who normally work fewer than 20 hours per week
If the plan is sponsored by a church that is not subject to FICA taxes, the universal availability requirements (and nondiscrimination requirements in general) of a 403(b) plan do not apply.
3.) 403(b) Special Catch-up Contributions.
For employees of a qualified organization that have completed 15 years of service, up to $3,000 per year may be deferred as an catch-up elective deferral above and beyond the regular 403(b) limits ($15,500 in 2008) - and age 50 catch-up contributions ($5,000 in 2008).
Qualified organizations eligible to provide special catch-up contributions include:
- educational organizations (which normally maintain a regular faculty, curriculum, and a regularly enrolled body of pupils or students attending class in a specific location);
- health and welfare service agencies (including home health service agencies);
- church-related organizations; and
- employees of a tax exempt organization controlled by or associated with a church.
4.) No Approval Letter Program (yet).
Currently there is no approval letter program for 403(b) plans. 401(k) plans, in contrast, do have an approval letter program available - allowing plan sponsors to use pre-approved 401(k) plans. Plan sponsors that want approval for their 403(b) plan from the IRS must go through a private letter ruling - a process that can be fairly expensive and time-intensive. However, the IRS has informally indicated that it may provide an approval letter program for 403(b) plans but no timeline or formal announcement has been made.
NOTE: ftwilliam.com's "limited scope" document is based heavily on the IRS model plan document. The "full scope" document uses the IRS model language whenever possible and appropriate and any additional language is based heavily on the ftwilliam.com 401(k) volume submitter plan document that has received a favorable advisory letter from the IRS.
5.) Non-ERISA Option for Nonprofits.
Governmental Plans and Church Plans are automatically exempt from ERISA. Non-profit organizations may offer a 403(b) plan that is exempt from ERISA - an option not typically available in a 401(k) plan. In order for the 403b plan to be exempt from ERISA, employer involvement must be very limited.
A safe harbor was created in 1979 by the Department of Labor ("DOL") for nonprofits wishing to have a 403(b) plan that was not subject to ERISA. The safe harbor regulation, (29 CFR 2510.3-2(f)), requires that employers have limited involvement in the operation of their 403(b) plan. When the final 403(b) regulations were issued in 2007 with some dramatic new requirements for 403(b) plan sponsors (e.g., requiring a plan document and extensive information exchanges with plan vendors) the DOL safe harbor was called into doubt. The DOL issued Field Assistance Bulletin 2007-02 in conjunction with the final 403(b) regulations and clarified that the safe harbor for a non-profit under the DOL regulation is still available even after the final 403(b) regulations.
The Field Assistance Bulletin clarified that under the new final 403(b) regulations employers may do the following and still not be subject to ERISA: (i) adopt a 403(b) plan, (ii) perform duties as necessary to ensure tax compliance (e.g. nondiscrimination testing), (iii) ensuring maximum contribution limits are not exceeded; (iv) perform information collection and compilation duties; and (iv) terminate a plan. According to the Field Assistance Bulletin, "The employer could not, however, consistent with the safe harbor, have responsibility for, or make, discretionary determinations in administering the program." Examples of such discretionary determinations provided in the Field Assistance Bulletin include:
- authorizing plan-to-plan transfers,
- processing distributions,
- satisfying applicable joint and survivor annuity requirements,
- making determinations regarding hardship distributions,
- making determinations regarding QDROs,
- eligibility for or enforcement of loans, and
- “[n]egotiating with annuity providers or account custodians to change the terms of their products for other purposes, such as setting conditions for hardship withdrawals, would be a form of employer involvement outside the safe harbor.”
Although it is still possible for nonprofits that are not governmental and not a church to provide a 403(b) plan that is not subject to ERISA, the new 403(b) regulations and Field Assistance Bulletin 2007-02 make it more difficult for plan sponsors to ensure the plan stays out of ERISA's grasp. To avoid ERISA, our recommendation is to maintain a plan that is as simple as possible (Roth elective deferrals are not permitted, etc.). However, this is still no guarantee that the Plan will not be subject to ERISA since the determination depends on the day-to-day operations of the plan. This means employers will need to be trained on what they can and cannot do (no signing off on plan distribution or hardship forms) and reminded to seek assistance if they are unsure about a given course of action in the future.
Nonprofits that want to be exempt from ERISA should use a limited scope 403(b) plan document (such as the one provided by ftwilliam.com described below) that does not permit any company contributions and limits the duties of the plan sponsor to those permitted under the DOL rules. As noted above, use of a limited scope document is no guarantee that the Plan will not be subject to ERISA since the determination depends on the day-to-day operations of the plan.
Although 403(b) plans look and feel similar to 401(k) plans, important differences between the plans remain. The main advantage of a 403(b) plan for nonprofits may be the exemption from ADP testing and/or the ability to continue to have a (very) simple plan that is not subject to ERISA.
ftwilliam.com 403(b) Document Options
ftwilliam.com provides two 403(b) plan documents that have been updated with the final regulations:
- The "full-scope" 403(b) plan document has an ERISA/non-ERISA option that allows sponsors to provide matching, non-elective contributions and elective deferrals. This document has a large variety of options available - similar to a traditional 401(k) plan.
- Our "limited-scope" 403(b) plan document provides only for elective deferral contributions and is intended to be used for a non-ERISA plan. This document is an option for non-profits wishing to follow the safe harbor described in Field Assistance Bulletin 2007-02 or other organizations wanting a very simple plan based on the model IRS document.
Both documents have hardship withdrawals, loans and Roth Elective Deferrals as optional provisions under the plan. Both documents also include context-sensitive help buttons, forms and amendments, streamlined data import and export, and online error correction.
If you have any questions please feel free to contact us at firstname.lastname@example.org or call 800.596.0714.