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Convert 403(b) Plan to 401k

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Plan sponsor has 403(b) plan which complies with ERISA, and each participant has individual account.  Plan sponsor makes matching contributions each payroll.   Wants to convert plan to 401k administered by Paychex.   Plan sponsor does not have  HR director, and feels it would be easier to have the same payroll company and TPA.    Assume 403(b) plan termination occurs as of 6/30/2021, and want to start new 401k  7/1/2021.  

Are there any special legal issues in terminating the existing plan or starting the new plan, considering that participants are not terminating employment

Is there a required 12 month wait between the termination date and the new plan starting date.

How must the individual accounts of the 403(b)  be handled.     Do participants have a choice of taxable distribution, rollover to IRA, or rollover to new 401k plan, or a combination of choices.   

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As long as the 403(b) is completely terminated and all assets distributed, there are no legal issues.  There are, however, two ways in which employers get tripped up on this. 

  • Some 403(b) providers (particularly annuity issuers) have restrictions on the investments which may prohibit distributions except at the participant's direction.  This can in some instances make it impossible to distribute assets, and thus to get the plan completely terminated.  In some instances but not all, you can get around this by distributing the annuity contracts rather than cash, but you really have to look at the contracts.
  • Some employers want to just move all the existing money to the 401(k) plan.  You can't do that, because there is no provision for plan to plan transfers from a 403(b) to a 401(k).  You can give participants a choice of taking the money in cash or rolling it over to a vehicle of their choice (which could include the new 401(k) plan), but you can't restrict their choices.

There is no required 12 month wait.  The rules that prevent distributions from a 401(k) if you set up a new 401(k) too soon do not apply if the old plan is a 403(b).

Employee benefits legal resource site

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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From a practical stance....

Don't forget about the benefit of no ADP test in the 403b.  Often the non-profits have poor participation and the ADP test can get ugly real quick.

I can think of a couple situations in my experience where the 403b was the best choice, but a 401k was done.  So don't get sold a 401k because that's what paychex knows better than 403b.

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I agree with Carol Calhoun (of course!) and Mr. Bagwell.  403(b) Plans can be very difficult to terminate because of the distribution of assets in 12 months requirement.  Be sure to examine the annuity or other investment contracts in the 403(b) for termination rules or limits.  My understanding is that a failure to get this completed within the 12 months, "disqualifies" the termination.  So now (given a failure to distribute within 12 months) you may have assets improperly rolled over (payouts to some participants who then rolled over the distribution on the assumption that the plan termination was a distribution event) and if the sponsor has started the 401(k), the plan sponsor now would have two plans for 5500 filing etc.

Paychex does not have a 403(b) product.  So their "sale" to your client is an "If all you have is a hammer, everything is a nail" argument.  They are not selling your client a 401(k) because it is the best plan for your client; they are selling a 401(k) because that is all they have to sell.  A very significant advantage to a 403(b) is no testing requirement for the deferrals, as Mr. Bagwell notes.  You might run a sample ADP test on this client's statistics to help them see what happens.  This  change is also, in my opinion, a fiduciary decision to be made by your client.  They had better be prepared with investment and pricing comparisons to substantiate why this change is an improvement for the participants in this plan.  A decent article on this is "Your Payroll Provider and 401(k) Provider Should NOT be the Same!"  by Fiduciary Shield.  Also Ary Rosenbaum (an ERISA attorney) writes on this topic all the time.  I "Googled" and found one of his articles entitled "Why You Should Avoid Using Your Payroll Provider as your 401(k) Provider."

Good luck!


Patricia Neal Jensen, JD

Vice President and Nonprofit Practice Leader

|Future Plan, an Ascensus Company

21031 Ventura Blvd., 12th Floor

Woodland Hills, CA 91364

E patricia.jensen@futureplan.com

P 949-325-6727

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