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Combining 403(b) and 401(k)


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Can a Plan Sponsor that sponsors a 403(B) plan and a 401(k) plan, merge the 403(B) plan with the 401(k) plan in light of EGGTRA?

Assuming they want to terminate the 403(B) plan, what are the main issues to consider?

Can the participants be directed to roll their 403(B) money into the 401(K) plan in light of EGGTRA? Will the termination constitute a distributable event?

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Guest Tom Geer

No, you can't merge them. The rollover rules allowing 403(B) money into a 401(k) and vice versa only apply to distributions and direct transfers in place of distributions.

In a situation where the sponsor is trying to reduce the number of plans, the first decision is which plan to eliminate. 403(B) plans have some very real advantages over 401(k) plans, and sometimes very real disadvantages. These need to be evaluated, but my guess is that most of the time the 403(B) should be the ongoing plan.

If you want to terminate the 403(B), you may have more difficulty than in a 401(k) plan termination. 403(B) plans are much more likely to be funded with allocated assets, where the employee rather than the employer has the power to make decisions about investments, terminations, etc. Where this is true, the employees can just leave tyheir 403(B) accounts in place and frustrate the intent to reduce the number of plans.

Outside of that, the major issues relate to the need to vest employees if they are not already fully vested (which is also relevant to the decision of which plan to terminate), what distribution options the plan allows or will add on, and what, if any, asset charges (market value discounts, deferred sales charges, etc.) may be incurred

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by way of background this organization is a for profit that controls a not for profit. in light of your answers, can you adopt a new plan which is a 401(a)/403(B) where employees of both for profit and not for profit entities defer and receive matching contributions all under one plan, and also permitting those who wish to roll over their 403(B) balances into the plan. ie. is their a need for a distributable event?

what are large organizations in cases like this doing in order to simplify their plan design?

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Guest Tom Geer

The constraints imposed by that corporate structure probably make the decision one to go with the 401(k) alternative. There are ways to get some economies of scale, but they are themselves complicated, and involve master custodial account arrangements.

On the administration side, whether the plans can be commonly administered depends on what software the TPA uses; any software would require some tricks, but ours can do this with appropriate setup. Even so, you can't get away from having to file two 5500s per year, so it's never going to be as cheap as one plan.

If the two plans have different TPAs, you probably can save some money by hiring a common TPA. Since you only have to deal with census data once, most TPAs will do this.

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There is a need for a distributable event before the 403(B) funds can be rolled into the 401(a) plan-as there is a need for distribution before the "a" funds can be rolled to a "b."

The variable 403(B) products are also registered products, and attempting to "default" a rollover from the "b" to the "a" upon a distributable event may cause security law problems-which are not present when doing a default rollover to a "b" plan from the nonregistered "a."

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Guest Tom Geer

Good point. I freely admit to a lack of knowledge on securities issues. What if the 403(B) were an annuity, as most older ones still are? In an annuity, you are going to have contract issues, but if I am following you there should not be any securities law implications.

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For Tom (a few notes back), any variable annuity contract out there is registerred. If you have a fixed only annuity, you will not be faced with the same security law challenge.

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it would seem to me that since the IRS allows rollovers and transfers among different 403(B) plans, the new law will expand this provision to allow for rollovers from b plans to K plans of the same employer without a "triggering event." at a minimum a letter ruling could be obtained authorizing this. do you agree or disagree?

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I disagree, because there still is a fundamental difference between the markets served by 403(B)s and 401(a)s. b's still provide a low cost way for tax exempt employers and schools (with their limited hr administration budgets) to help their employees (who are generally not as well paid as their private sector counterparts, and who are pursuing the public good) to save for retirement.

So even though there is some movement among large 403(B) employers to make some of their plans look somewhat similar to 401(a) plans, a large portion of the market still is based upon the individual-rather than the employer-choosing and controlling a tax favored savings vehicle. Indeed, the bulk of these custodial agreements and annuity contracts do not allow the employer to exercise the kind of control you advocate. Even securities law are geared to prevent the employer's control.

403(B)s are not just 401(k)s for tax exempts. When you work through the details, you find a large number of technical differences between the two kinds of plans-even after egtraa. And most of the differences arise from the different purposes served by the 403(B) plan.

There is then little wonder that there is not a statutory basis upon which the IRS to base a PLR or Rev Rul allowing such mergers. There are just too many statutory impediments, which are all well based in policy.

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assuming your reasoning is correct (i am not disagreeing, just looking for a solution) then i read the law to say that a B participant can freely rollover employer money; the distribution restrictions (59 1/2, separation from service etc.) apply only to distributions made pursuant to a salary reduction agreement.

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That is true, provided the assets are in 403(B)(1) annuities - not true if in 403(B)(7) custodial accounts. Plan rules, however, might prohibit distribution of the employer contributions to the annuity, even though Code permits it.

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Guest Tom Geer

I agree that there are still major differences between 403(B) and 401(a), but I would also argue that these differences are decreasing over time. For example, most of the MEA calculation complexity is neing eliminated with EGTRRA, and on maximums at least 403(B) starts to look more like a 401(k). The rollover rules clearly tend in the same direction.

I would also note that the corrections programs for 403(B) and 401(a) were effectively merged this year. Last, the intensity of audits for 403(B) has increased and you are starting to hear about substantial penalites.

In my view the last two points push employers towards at least some employer-level efforts, like application of the 402(g), applicable amount and 415 limitations to multiple vehicles. Since the IRS can make arguments that 403(B) arrangements that allow limits to be exceeded aren't 403(B) arrangements at all, and more clearly that excess salary reduction can blow up the salary reduction arrangement, this pressure can be substantial.

Clearly, it is in the best interests of the IRS to push 403(B) sponsors into a single mold, with the capacity to do effective and efficient audits and to hold the employer responsible for problems. A good parallel would be the historical process resulting in the dominance of portotype plans for qualified plans; the IRS has made it so easy to use a prototype, and so hard not to, that you need a pretty goos design reason to go outside the system. And, this year alone, the IRS announced (1) that prototypes and volume submitters do not need determination letters for plan language, with determinations limited to operational discrimination, and (2) they would allow volume submitter cross tested plans. My strong guess is that this is a response to the elimination of user fees for many plans, and that this same cost/benefit pressure will drive the IRS to treat 403(B) arrangements more and more like 401(a) plans over time.

And, frankly, I'm not sure that's a bad thing. There are lots of advantages to making the vendor selection process more intelligent and less political (in the broad sense). There are also advantages to having somebody prevent 403(B) participants from buying some of the very poorly structured products they get now. I make part of my living by getting people out of bad annuity contracts and other investments with deferred sales charges, adjustments and the like, but that doesn't mean I think they are a good idea.

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It is clearly in the IRS interest to be knowledgeable of the law and to fairly enforce it-and they have worked hard and have recently made significant strides on both these points in the 403(B) area. In my experience, the IRS staff doesn't vew it their mandate to "push" any "mold."

As an example of the differences which are important to tax exempt employers, lets take plan documents. An employer adopting a 401(a) plan must go though the expense of adopting a document, maintaining it and making sure administrative practices meet the plan's terms. Failure means disqualifiaction, correction programs, and difficulties on audit. And just for a tax exempt's salary deferral only plan, you'll also need a TPA.

A tax exempt org rarely has the resources to perform those functions or pay for a TPA, nor do most school districts. So, a 403(B) plan where only elective deferrals are involved is ideal.

This is just the tip of the iceberg.

But I do agree with you that there are bad custodial contracts and annuity contracts out there that are unsuitable for the purchasers, with unreasonable terms. But be careful when comparing them and labeling any of them as abusive.

Though annuity contacts will usually charge a set "M&E" fee, it is a wrap for a set of services. It covers custodial fees, many plan admin fees, trading between separate accounts managed by multiple unrelated investment managers, face to face support and advice, funds with a guarantee of principal with enhanced rates and the opportunity to purchase a lifetime income stream.

Mutual funds take a different approach to the market. You basically are buying a la carte. Separate custodial fees can be charged, there are usually fees for trading outside of the fund family, the stable value funds usually have a lower rate of return without a guarantee, there is litttle if any admin services and little individual support.

And there are some vendors now offering a combination of mutual funds and annuity contracts with daily trading between them, all on a group basis.

There are choices. Its a matter of what you want.

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Ok so back to the orginal question. If a hospital sponsors a 403(B) and 401(a) and decides to terminate the B plan in favor of a new 401(k), is it true that participants can only roll the 401(a) portion into a new 401(k) or can they roll both sources.

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Participants can roll the terminated 401(a) money, and, effective 1/1/2002, can roll those 403(B) funds for which they have had a distributable event.

The real question is why would a tax exempt hospital even want a 401(k)?

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Even if you did that, there is a serious question about whether existing money could be moved from the existing annuity or custodial account under the 403(B) plan to the trust under the 401(k) plan. See my note on this subject elsewhere on this board.

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The opinions of my postings are my own and do not necessarily represent my law firm's position, strategies, or opinions. The contents of my postings are offered for informational purposes only and should not be construed as legal advice. A visit to this board or an exchange of information through this board does not create an attorney-client relationship. You should consult directly with an attorney for individual advice regarding your particular situation. I am not your lawyer under any circumstances.

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