Dear Gail-

I’m employed as a minister by my church, which has a small 403(b) plan for about a dozen employees. We’ve heard that the rules that apply to these retirement plans have just changed. Can you tell us what this means? Will we have to make changes to our plan?

Thanks,
Gerald

Dear Gerald,

Depending upon how your 403(b) plan is set up, there’s a good chance that some significant changes are coming. However, your church has a year and a half to comply with the new regulations.

403(b) plans have been around since the 1950s, which means they pre-date 401(k)s by nearly three decades. Both are considered “defined contribution” plans, because they spell out how much employees and employers can contribute each year.* Money that goes into your account is invested and grows tax-deferred until it is withdrawn in retirement.

However, there have always been significant differences between these two types of retirement plans. The first is that 403(b)s are only available to employers/employees of colleges, universities, public schools and/or non-profit organizations, such as hospitals and charities. Another difference is that, since mutual funds weren’t widely available 50 years ago and insurance was, the sole or primary investment in many 403(b) plans is a tax-sheltered annuity.

In addition, when 403(b) plans were introduced, we didn’t have the strict laws currently in effect that spell out exactly how retirement plans have to be run. It wasn’t until 1974 that the Employee Retirement Income Security Act (ERISA) was passed, setting standards of conduct, reporting and obligations for retirement plan sponsors. However, since ERISA only covers plans offered by companies in the private industry, teachers and those working in the non-profit sector have enjoyed none of these protections.

Over the years, the I.R.S. and Department of Labor have extended a number of the regulations governing private-sector retirement plans to include 403(b)s, but the rules were a patchwork and far from comprehensive. The new regulations issued at the end of July are a welcome breath of fresh air that a) clarifies the conditions that 403(b) plans must meet and b) strengthens the protections for employees.

It’s hard to believe, but, unlike 401(k)s, there has never been a requirement that 403(b)s have a plan, i.e. a written document that spells out such things as how the program is set up, how it will be operated, who is eligible, the limits of the plan, the type of benefits that will be paid, etc.

This is one of the biggest changes. Starting January 1, 2009, generally every entity sponsoring a 403(b) must operate it according to a written plan document. Some plans may be eligible for an extension on this deadline. For instance, those established under a union contract. Another exception are church plans where a church convention is responsible for establishing the plan and has the authority to amend it, as opposed to the individual church itself.

As 401(k) providers know, the plan document spells out the meaning of various terms, when someone becomes eligible to participate, whether there are employer contributions, the kinds of investments that are available, whether “hardship” loans are permitted and under what circumstances, whether there is a vesting schedule, etc. Additionally, if a church is the plan sponsor, the document must specifically state that the plan is intended to be a retirement savings vehicle.

In the coming weeks, the I.R.S. will be releasing a model plan that 403(b) sponsors can adopt. It will contain the “language that would enable a sponsor of a 403(b) to put together a very simple, basic 403(b) program.”

It’s important to note that 403(b) plans provided by government entities — public schools, colleges, government-run hospitals, etc. — are still exempt from ERISA. And, according to the I.R.S., just because a tax-exempt organization, such as a church, adopts a formal plan, this would not make it subject to ERISA.

Other changes coming to 403(b) plans include:
- Procedures that must be followed if an employer wants to terminate a 403(b) plan. Assets may be rolled over to an IRA or other retirement plan.
-“Elective deferrals” (the contributions that employees make to their accounts) and “hardship withdrawals” follow the same rules as their 401(k) cousins.
- Life insurance that is part of an annuity contract is allowed, but “incidental” life insurance cannot be part of the plan unless it is grandfathered in.
- Employees may no longer transfer their account balances to another provider while they are still employed at the entity sponsoring the 403(b).

It’s important to note that many large 403(b) plans already comply with all or many of these new regulations. The impact will largely be felt by smaller non-profits and public schools.

Many mutual fund companies have the means to efficiently administer 403(b) plans. They also have big staffs to make sure they are in compliance. You might consider contacting one of these firms for assistance.

Hope this helps,
Gail

*(As opposed to “defined benefit” plans, where a formula dictates the amount of income that will be provided at retirement. These are also referred to as “pensions plans.”)

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