403(b) versus 401(k)

[blue]

I have a non-profit home health 501©3 organization that currently has a 401(k) plan and wants to terminate their 401(k) plan and establish a 403(b) plan. The reasoning behind the change is mainly because a salesperson told them they never should have been set up with a 401(k) plan and they could save o money by switching to a 403(b) plan.

It is my understanding the 403(b) plan would not be considered a successor plan so this could be accomplished in the same year. The plan has no HCE and is a deferral only plan which is currently invested in Nationwide product.

My knowledge about 403(b) plans is limited and more limited with regard to the differences of an ERSIA versus a Non-ERSIA 403(b) plan.

In light of the new final 403(b) regulations, could someone help explain to me why or why not this organization would be better off with either a Non-ERISA or an ERSIA 403(b) plan.

Any help would be very much appreciated.

[John Feldt ERPA CPC QPA]

Here's a few things to note:

Form 5500: A deferral-only 403(b) plan that is not subject to ERISA would not have to file a Form 5500. A 401(k) plan generally must file a Form 5500.

Accountant's Opinion: An ERISA 403(b) plan with (generally) over 100 partcipants is not required to obtain an accountant's opinion (auditor's report) to attach to their form 5500. A 401(k) plan (over 100 ppts) would be required to do so. These are kind of expensive and can be time consuming for you.

Discrimination Testing: If an HCE is ever in the plan, the 401(k) plan must run some tests, like ADP, coverage 410(b), top heavy, and so on, but a deferral-only 403(b) plan would not have to do these tests.

Coverage/Universal Availability: A 401(k) plan can have eligibility requirements such as 1 year of service and age 21 before the employee is eligible; and a 401(k) plan can choose to cover just certain employees as long as coverage passes (you always pass if you only cover NHCEs in a DC plan). Generally, a 403(b) plan must allow immediate deferrals to almost all employees (with some minor exceptions) under the "universal availability" rule - in a 403(b) plan you cannot have provisions that make employees wait for a period of time, like one year, or reach an age, like age 21, before they can defer.

Because of these things and depending on your goals, a 401(k) might suit you better than a 403(b), or vice-versa.

[TLGeer]

I have a non-profit home health 501©3 organization that currently has a 401(k) plan and wants to terminate their 401(k) plan and establish a 403(b) plan. The reasoning behind the change is mainly because a salesperson told them they never should have been set up with a 401(k) plan and they could save o money by switching to a 403(b) plan.

It is my understanding the 403(b) plan would not be considered a successor plan so this could be accomplished in the same year. The plan has no HCE and is a deferral only plan which is currently invested in Nationwide product.

My knowledge about 403(b) plans is limited and more limited with regard to the differences of an ERSIA versus a Non-ERSIA 403(b) plan.

In light of the new final 403(b) regulations, could someone help explain to me why or why not this organization would be better off with either a Non-ERISA or an ERSIA 403(b) plan.

Any help would be very much appreciated.

I had a similar situation earlier this year. The client had been moved from 403(b) to 401(k), and only then found out that the 403(b) money could not be merged into the 401(k). When the dust cleared, we recommended they have both. They wanted the capacity to use the special 403(b) catch-up rules and the flexibility to max out contributions for some employees who were approaching retirement with next to nothing, and we pointed out that the 415 limitation can be doubled with both plan types. Both plans have a "standby" employer contribution provision and "new comparability" or rate group allocation provisions, and the intention is to use the 401(k) for some employer contribution, then cross-test for the benefit of the older group without having the 415 limits constraining the plan. On the facts, this was preferable to a 457 because we could offer identical funds availability.

A 403(b) plan is, more or less, a 401(k) plan with looser regulation, as J4FKBC's response indicates. The only material disadvantage is the inability to make hardship distributions from non-salary reduction contributions held in a custodial account under a 403(b), which is not relevant on your facts. Of course, a 401(k) can make non-mutual fund investments, where a 403(b) is limited to annuities or mutual funds, but in the current state of plan design consensus this rarely matters.

Why did you say the new plan would not be a successor? It's pretty clear that the creation of the 403(b) would cause any termination of the 401(k) to be a termination-reestablishment and you can't directly transfer the assets, so the 401(k) is going to continue to exist. That means you have to have some positive reason to do this, because you're ging to end up paying for two plans. Also, the Nationwide contract may allow them to boot out the 401(k) and take all the back-end fees and discounts they have available because of a cesstion of future contributions. You are going to need somebody other than your salesperson to help you make this decision, if you want to be sure your decision is right.

As to ERISA vs. non-ERISA, the entire marketplace was tossed up in the air with the issuance of the final regulations and FAB 2007-2. I don't expect it to land in any intelligible pattern for some months.

Tom Geer

[John Feldt ERPA CPC QPA]

The 402(g) limit applies to the individual and it aggregates (combines) the 403(b) and 401(k) plans' deferrals together for this deferral limit. Thus, the 401(k) deferral plus the 403(b) deferral for 2007 (both combined) cannot exceed $15,500 for 2007 (ignoring the various catchup issues for sake of illustration).

and we pointed out that the 415 limitation can be doubled with both plan types.

Tom Geer

If the employee (not catch-up eligible) defers $15,500 into one of the plans, can you please provide a numerical example of this, just for fun (to show the $45,000 x 2 overall)?

[dmb]

I am also new to 403(b) plans. If they contain a new comparability employer contribution allocation, are the 403(b) deferrals required to be part of the average benefits test?? Thanks.

[Guest dbvail]

This has been a good thread so far. Now, for us that look for simple answers....

if a 403b has an employer contribution element, it is covered under ERISA.

For testing issues is there an ADP test? How about ABT?

If so, then 401k seems to be a viable alternative. If no testing, then no contest.

Thanks

[John Feldt ERPA CPC QPA]

Okay. First of all, Tom (TLGeer) is correct, an entity could have both a 403(b) and 401(k) and the 415 limit is not aggregated between the two.

"if a 403b has an employer contribution element, it is covered under ERISA."

Not if the employer is a church, assuming they do not volunteer to be covered by ERISA, and not if the employer is a government.

For testing issues is there an ADP test?

Nope. I think the "universal availability" requirement is the trade-off for that. If the plan is subject to ERISA and has match, then ACP testing is needed unless the plan satisifies the Safe Harbor requirements, giving either a Safe Harbor match, or a Safe Harbor nonelective. If you do ACP testing in a 403(b) plan, you cannot recharacterize deferrals like you could in a 401(k) plan.

How about ABT?

If the employer contributions do not use some deemed approved passing formula structure, like a uniform allocation, an integrated allocation, or otherwise, then 401(a)(4) testing would be required (ERISA plans only, so not for gov plans or church nonERISA plans).

I think the 5500 advantage goes away in 2009 - when the new regs appear to indicate a much more extensive version of the 5500 will be required for ERISA 403(b) plans and an independent accountant's opinion (audit requirement) would start (if over the 100/120 participant count).

[Guest mike webb]

According to Reg. 1.401(k)-1(d)(4) (see below-- boldface my emphasis) a 403(b) plan is NOT a successor plan to a 401(k). Thus, I beleive that a 401(k) plan can be terminated, and a 403(b) established in its place. Mr. Geer, am I incorrect?

A distribution may not be made under paragraph (d)(1)(iii) of this section if the employer establishes or maintains an alternative defined contribution plan. For purposes of the preceding sentence, the definition of the term "employer" contained in Section 1.401(k)-6 is applied as of the date of plan termination, and a plan is an alternative defined contribution plan only if it is a defined contribution plan that exists at any time during the period beginning on the date of plan termination and ending 12 months after distribution of all assets from the terminated plan. However, if at all times during the 24-month period beginning 12 months before the date of plan termination, fewer than 2% of the employees who were eligible under the defined contribution plan that includes the cash or deferred arrangement as of the date of plan termination are eligible under the other defined contribution plan, the other plan is not an alternative defined contribution plan. In addition, a defined contribution plan is not treated as an alternative defined contribution plan if it is an employee stock ownership plan as defined in section 4975(e)(7) or 409(a), a simplified employee pension as defined in section 408(k), a SIMPLE IRA plan as defined in section 408(p), a plan or contract that satisfies the requirements of section 403(b), or a plan that is described in section 457(b) or (f).

[MoShawn]

How about ABT?

If the employer contributions do not use some deemed approved passing formula structure, like a uniform allocation, an integrated allocation, or otherwise, then 401(a)(4) testing would be required (ERISA plans only, so not for gov plans or church nonERISA plans).

What do you mean, "not so for gov plans or church nonERISA plans"? Is 401(a)(4) testing not required or not available?

Currently reviewing a non-ERISA church 403(b), and trying to determine if they would be better off as a 401(k) plan. As I understand so far, church 403(b) plan would have no ADP test (assuming universal availability), no Form 5500, and could still use new comparability?

Kind of sounds like a no-brainer.

[Lori Friedman]

Kind of sounds like a no-brainer.

For whatever my 2 cents is worth (probably about 2 cents, literally, on the open market), I believe that the opportunity to offer 403(b) arrangements is a significant advantage of 501©(3) exempt status.

If an organization can't afford to fund a retirement plan, but wants to provide a vehicle for employee salary reduction contributions, 403(b) is a remarkably simple and efficient choice. If the organization decides to make employer contributions, it can easily adopt a money purchase pension plan to work alongside the 403(b) plan.

Okay, that'll be 2 cents, please.

[Kevin C]

Kind of sounds like a no-brainer.

For a non-electing Church plan, yes.

For some non-profits, a 401(k) may make more sense. Large 403(b)'s are proposed to be subject to the audit requirement for 2009. If they have a lot of turnover in the first year of employment, they could easily be in a situation where a 401(k) plan with 21 & 1yr eligibility has less than 100 participants, while a 403(b) could have well over 100. It's something to consider if they don't have an existing plan. Some of our clients are paying more for their audits than we charge for adminstration of the plan.

[Guest mjb]

Kind of sounds like a no-brainer.

For a non-electing Church plan, yes.

For some non-profits, a 401(k) may make more sense. Large 403(b)'s are proposed to be subject to the audit requirement for 2009. If they have a lot of turnover in the first year of employment, they could easily be in a situation where a 401(k) plan with 21 & 1yr eligibility has less than 100 participants, while a 403(b) could have well over 100. It's something to consider if they don't have an existing plan. Some of our clients are paying more for their audits than we charge for adminstration of the plan.

Why does a 401k plan make more sense for a NP? I thought under Dol regulations a 403b plan with no employer contributions is exempt from the audit requirements of ERISA and unlike a 401k plan all HCEs can contribute $15,500 plus catch up because there is no ADP testing.

[Kevin C]

Not all 403(b)'s are deferral only. Most of ours include employer contributions.

If you had a choice between adopting an ERISA covered 403(b) with 130 participants and a 401(k) plan with 80 participants, which would you choose? Starting in 2009 the difference in administration fees would be substantial because of the audit requirement.

Yes, there are other issues to consider, like ADP testing. All I am saying is that you shouldn't automatically assume a 403(b) is always a better choice.

[Lori Friedman]

All I am saying is that you shouldn't automatically assume a 403(b) is always a better choice.

Most of us would agree with you, Kevin. Except for certain message board participants who sell or promote 403(b) products, I don't think that anyone here would say that every 501©(3) organization should always choose 403(b). Personally, I steer organizations away from ERISA 403(b) plans; if the employer wants to provide a retirement contribution, my own opinion is that the best arrangement is a non-ERISA 403(b) plan (to receive employee salary reduction contributions) with a qualified plan (for the employer contributions).

Of course, each situation is unique, and there's no blanket approach that's universally preferable or disadvantageous.

[MoShawn]

Why would the 2 plan route be better? I'm looking at an organization with 15 employees here, with no possibility of an annual audit. If I can have a non-ERISA church plan and skip the ADP test and 5500 while providing crosstested employer discretionary contributions all in 1 plan, why would I go with 2 plans?

I apologize if I'm missing something obvious. This is my first foray into the 403(b) realm after 8+ years of 401(a) administration.