WHAT SEPARATES A 403(b) from a 401(k)? The difference is narrowing, now that the U.S Treasury Department and the IRS have released their updated regulations for 403(b)s, which are aimed at aligning the program more closely with 401(k)s.

The revisions are the first comprehensive update of 403(b) regulations since 1964. They incorporate 40 years of legislative and regulatory developments, including amendments stemming from ERISA, the Small Business Job Protection Act of 1996 (SBJPA), the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), and the Pension Protection Act of 2006.

While there are a number of changes, those most critical to plan sponsors include:

·         Newly created written plan document requirements, and

·         Restrictions on allowable contract exchanges.

Although the general effective date for the regulations is January 1, 2009, several key provisions have transitional effective dates that started on September 24^th.

Here are some key elements to these changes that advisors should know.

Plan documentation

For the first time, 403(b) plan sponsors will be required to ensure that their program is administered in accordance with the terms of a written plan document. As in 401(k)s, the document will outline the program’s rules and restrictions, such as eligibility, types of contributions, and whether hardship withdrawals, loans, and transfers are allowed.

A number of additional pieces may accompany the written plan to become the Plan document. These additions may include but are not limited to: a list of approved providers for ongoing contributions and transfers, a procedure manual, vendor contracts, applicable plan forms, etc. Sponsors are also now required to annually notify all employees of their eligibility to participate in the plan.

If they have not already done so, employers may choose to reduce the number of approved providers and/or products offered within their Plan. There is no magic number for how many is appropriate. It simply depends on the size of the employer and the number of staff available to administer the Plan.

Transfer and exchange limitations

Under the new regulations, transfers and exchanges will continue to be permitted, but with greater limitations and not without employer involvement.

After September 24, 2007, plans may permit exchanges from one investment product to another as long as the employer has entered into an information sharing agreement with the receiving vendor no later than January 1, 2009. The IRS has indicated that the information sharing agreement does not have to be executed now, but if the employer fails to do so by January 1, 2009, transfers done in the interim will be disqualified.

Periodic transfers (monthly or annual over a period of several years) that were initiated prior to September 24, 2007 and that do not require annual renegotiation will be grandfathered and allowed to continue.
 

New 403(b) accounts may not be established under an employer’s plan if the individual no longer has an employment relationship with the employer.

What does it all mean?

The new regulations will add some administrative burdens on plan sponsors, who will be expected to take a more hands-on approach providing more structure and fiduciary oversight for their plans.

Employees will benefit from more structure and transparency, but will lose some flexibility. Under the former regulations, employees had nearly complete control over their 403(b) account. There may be some reduction in the number of approved vendors within the plan, but there will be greater oversight of the vendors and investments.

Going forward

These are only a few of the changes that you and your clients need to be aware of. While the final regulations were slightly less restrictive than some of the initial proposals suggested, plan sponsors will need to take a greater role in facilitating and managing their plans.

The blurring of the lines between 403(b)s and 401(k)s presents opportunities for advisors who have expertise in the 401(k) marketplace. Many providers who may not have been as focused in the 403(b) market are choosing to exit the market entirely. This narrows the playing field for the advisor, but also opens up opportunity for new clients.