Exchange Traded Funds in a 403(b)7 - is it doable?

[Guest scottyd]

I have come across a company that is launching an ETF 403(b)7 and I am not sure if this can be done - can it? ETF's technically are not stocks, they are mutual funds with daily liquidity and are registered with the SEC - I would love to hear if any of you know if they can be included in a 403(b)7 product and how I would go about identifying proof that they can be included.

ScottyD

[mbozek]

Any mutual fund under IRC 851 can be an investment in a 403(b) plan.

[ljr]

I'd be curious to learn if anyone knows if ETF's will work on traditional daily platforms? Somehow, I think not, but as someone else who posts says, then what do I know?!?

[Guest Joel Lee]

Scotty

I know it is doable in a 457(b).

[Ellie Lowder]

Scotty, as I said on the NTSAA bulletin board, I understand that Exchange Traded Funds are "baskets of securities" traded like a stock; thus, I don't believe they can be included in a 403(b)(7) custodial account. Everything that I have read discusses the fact that these are not actually mutual funds. It would be nice if they could be included in 403(b) investment choices, but many believe they cannot.

Obviously, based on what you have said, one provider believes they can be. I've been digging into this; however, haven't found anyone else who agrees as yet.

[Guest Joel Lee]

ScottyD,

As our friend mbozek says section 851 governs permissible investments under section 403(b)7. Unit Investment Trusts are included in the definition of a regulated investment company. ETF are Unit Investment Trusts. So a 403(b)7 participant may invest in ETF ie the Nasdaq 100 Index symbol QQQ. Below is section 851 of the IRC.

Peace,

Joel

-----------------------------------------------------------------------------------------------

Sec. 851. - Definition of regulated investment company

(a) General rule

For purposes of this subtitle, the term ''regulated investment company'' means any domestic corporation -

(1)

which, at all times during the taxable year -

(A)

is registered under the Investment Company Act of 1940, as amended (15 U.S.C. 80a-1 to 80b-2) as a management company or unit investment trust, or

(B)

has in effect an election under such Act to be treated as a business development company, or

(2)

which is a common trust fund or similar fund excluded by section 3©(3) of such Act (15 U.S.C. 80a-3©) from the definition of ''investment company'' and is not included in the definition of ''common trust fund'' by section 584(a).

[Guest danc4639]

The ETF instrument is attractive for (at least) diversification, liquidity and cost features. Certainly, the ETF is conceptually very much like a mutual fund.

Whether ETF's are or are not permissable in 403(b) it seems to me a more important consideration is how they would best be structured within a plan. Their price continuity makes them much like any individual security - and so I think they need to be relegated to individual brokerage accounts within plans.

Daily valuation recordkeeping systems developed around the traditional mutual fund instrument would not seem to be compatible with continuous priced assets, unless some artificial contraints are introduced.

For example suppose a plan participant wanted to move in an out of an ETF within a day. I can see how this could be handled within a brokerage account, but how would it work outside of a brokerage account. Could someone walk through the trading mechanics and explain this?

Of course, it does beg the question of why recordkeeping systems and brokerage sytems are separate animals.

Regards,

Dan

[mbozek]

ETFs are traded as closed end mutual funds listed on a stock exchange. Purchasers pay a commision. See www.amex.com for description of ETFs.

[mbozek]

danc: since the ETFs are closed end mutal funds they could be made available under a self directed brokerage account of a discount broker through the 403(b) plan which would not permit investments in individual stocks, bonds or other securities. This would permit the trading to be recorded through the brokerage account.