403(b) plans expanding their reachReprints
Often overshadowed by their far better-known cousins — 401(k) plans — 403(b) plans are playing an increasingly important role in providing retirement benefits to millions of employees.
By federal law, 403(b) plans can be offered only by nonprofit employers. While the realm may appear narrow, the plans are in widespread use, especially by health care systems and educational institutions, such as colleges, universities and private secondary schools, as well as libraries, museums and religious institutions, such as Catholic dioceses.
“Almost every institution of higher learning has one,” said Dan Schwallie, a senior Aon Hewitt associate partner in Cleveland.
Like 401(k) plans, the amount of money employees can contribute to 403(b) plans through salary deferrals is laid out by federal law. This year, for example, the maximum pretax contribution employees can make to 403(b) plans is $18,000, while employees 50 and older can make an additional $6,000 in so-called catch-up contributions.
Though like 401(k) plans in many aspects, 403(b) plans are significantly different in one key way: They are, under federal law, exempt from federal nondiscrimination tests that employers must run annually to compare salary deferrals of so-called highly compensated employees — those earning at least $120,000 in 2015 — with rank-and-file workers. One reason frequently given for 403(b) plans’ exemption from the nondiscrimination tests includes much fewer highly compensated employees compared with those in 401(k) plans.
“That is a big deal,” according to Tammy Hughes, a principal with Mercer L.L.C. in Chicago, referring to 403(b) plans’ exemption from nondiscrimination testing.
“They are more flexible than 401(k) plans,” added Gregg Levinson, a senior consultant with Towers Watson & Co. in Philadelphia.
Another difference between 401(k) plans and 403(b) plans is that the latter typically are offered to virtually all of a plan sponsor’s employees, including part-time workers, new hires and those covered by collective bargaining agreements. By contrast, 401(k) plans generally are offered only to full-time employees.
“All employees, full- and part-time, are eligible to make personal salary deferral contributions to the plan,” said a spokesman for the Archdiocese of Philadelphia, which set up a 403(b) plan in 2014 following the freeze of its defined benefit pension plan.
“All our employees are eligible to participate, even temporary substitutes,” said Dianne Howard, director of risk management and benefits at the School District of Palm Beach in West Palm Beach, Florida.
Like private-sector employers, many 403(b) plan sponsors are freezing their defined benefit pension plans, making the plans the sole employer-sponsored retirement plan offered to employees.
That makes employee participation more important if they are to accumulate a significant amount of savings for retirement.
To increase that likelihood, more employers are adding automatic enrollment features to the 403(b) plans. Under those, employees are automatically enrolled in the plans unless they specifically tell their employers or plan administrators that they want to opt out, which few employees — often less than 5% to 10% — do.
“We are adding automatic enrollment in January to help employees build up accumulations” for retirement, said Don Mortenson, senior vice president for planning and administration at Seattle Pacific University in Seattle.
Under Seattle Pacific’s automatic enrollment feature, employees defer 3% of salaries to the plan in the first year, with the amount increasing by one point annually until hitting 6%.
Automatic enrollment, perhaps not surprisingly, can make a big difference in employee participation in 403(b) plans.
For example, at the Archdiocese of Chicago, employee participation in its 403(b) plan leaped to about 80% from around 35% when it added automatic enrollment in 2008 after freezing its defined benefit plan, said Chris Cannova, director of personnel services with the archdiocese.
Automatic enrollment isn’t the only way 403(b) plans have come to resemble 401(k) plans.
For example, Internal Revenue Service rules that took effect several years ago require the plans to have official documents that detail administrative responsibilities and benefit features. That ended the longtime hands-off approach to the 403(b) plan, with employers offering the plans passing that authority on to mutual funds and insurance companies providing investment options to plan participants.
Without centralized employer control and direction, participants, for example, would ask the investment fund providers for hardship withdrawal of funds, leaving employers unaware that such requests were made or whether the participants were legally eligible for the distributions.
In some situations, experts say, employees may have received hardship withdrawals from multiple investment providers because of a lack of coordination among the providers.
But IRS rules that took effect in 2009 require employers with 403(b) plans to ensure that that federal withdrawal and other rules are followed.
With those and other requirements set out by the IRS, such as maintaining formal plan documents, 403(b) plans now more closely resemble 401(k) plans from an administrative vantage point, said Mercer’s Ms. Hughes.