Primer on 403(b)s Cites Legislative Changes, Holding Pattern

Many 403(b) plans are sponsored by single employers, but that could change. A recent report by the Congressional Research Service (CRS) discusses legislation that has—and could—change the rules governing them.

In “403(b) Pension Plans: Overview and Legislative Developments,” the CRS provides a primer on the plans, as well as a discussion of measures enacted and under consideration and their effect on the plans. 

The Basics

While “there has been a move toward harmonizing” the rules governing 403(b)s and 401(k)s, the CRS says, the accounts have distinct origins. Following are highlights of the rules for 403(b)s. 

ERISA coverage. Whether a 403(b) plan is subject to ERISA depends on what employer sponsors it, as well as how involved the employer is with it. 
Plans whose sponsor is a private-sector tax-exempt 501(c)(3) are subject to ERISA, unless they meet a safe harbor exemption limiting the employer’s role. Plans whose sponsor is a public educational organization or a church are exempt from ERISA, although church plans may elect to be covered by ERISA.

Funding. There are three ways a 403(b) can be funded: 

1. annuity contracts provided by an insurance company; 
2. custodial accounts invested only in mutual funds registered with the Securities and Exchange Commission; or 
3. retirement income accounts for church employees under Internal Revenue Code (IRC) Section 403(b)(9).

Employer involvement. Employer involvement in a 403(b) ranges from minimal involvement—for instance, providing a list of insurance carriers to eligible employees—to greater involvement, such as choosing investment options and providing an employer match. 

Written document requirement. Since 2009, IRS regulations have required that 403(b) plans be maintained under a written plan document—with the exception of some church plans.

Enrollment. Employees can be automatically enrolled in an ERISA 403(b) plan, but not in a 403(b) that is not subject to ERISA.  

Contributions. Participants in 403(b) plans may make pre-tax contributions, designated Roth contributions, or after-tax contributions, if the plan allows it. Some 403(b) plans allow employees to make additional contributions upon reaching age 50 and/or having at least 15 years of service with the same eligible 403(b) employer.

Hardship distributions and loans. It is permissible for a 403(b) plan to offer hardship distributions and loans. 

Investments. Right now, 403(b) plans generally can only invest in annuities or mutual funds through custodial accounts—while there are few restrictions on the investments 401(k) plans can make. However, this could change if legislation now before the House of Representatives is enacted. 

Universal availability. Under the universal availability rule, if any employee is eligible to make 403(b) elective deferrals, then all employees must be eligible to make them. The CRS adds, however, that certain employees—such as those who work part-time or those who contribute to a different plan sponsored by the same employer—may be excluded.

Legislation

The SECURE 2.0 Act. Three provisions in the SECURE 2.0 Act affect 403(b)s: 

1. Section 106. This provision amended the IRC to formalize 403(b) multiple employer plans (MEPs) and authorize the creation of 403(b) pooled employer plans (PEPs). 
2. Section 128. This provision amended the IRC to permit 403(b) custodial accounts to invest in group trusts—such as collective investment trusts (CITs)—with other retirement plans and IRAs, though changes needed under the securities law did not make it into the final bill when it was enacted in December 2022 (discussed below).
3. Section 602. This provision expanded the types of 403(b) contributions that can be withdrawn as hardship distributions to include all types. This makes the rules for such distributions from 403(b)s consistent with those for 401(k) plans. This provision will go into effect in 2024. 

Pending legislation. On May 2, 2023, Rep. Frank Lucas (R-OK) introduced H.R. 3063, the Retirement Fairness for Charities and Educational Institutions Act of 2023. The bill would amend securities laws to permit ERISA 403(b) plan assets to be invested with certain other retirement plan assets in CITs and in non-registered variable annuities through insurance separate accounts. 

The House Financial Services Committee on May 24, 2023 held a mark-up session and ordered the bill to be reported. No further action has been taken since then. 

Says Andrew Remo, ARA’s Director of Federal & State Legislative Affairs, “ARA has been engaging with the Senate Banking Committee to continue pushing forward this legislation after it cleared the House Financial Services Committee in May. We are hopeful to continue the bipartisan momentum and include this fix in a future bipartisan banking bill.”