Three years after new regulations governing 403(b) plans went into effect, the plans are still in flux and experiencing some growing pains — actually, shrinking pains.
Fundamentals of retirement
The regulatory overhaul has pushed employers in some segments of the 403(b) market to limit the number of vendors servicing their plans. That, in turn, has caused plan participants in at least one segment of the 403(b) market to stop contributing to their plans.
403(b) plans 101
For the uninitiated, 403(b) plans are only available to 501(c)(3) organizations, or nonprofit organizations, and they were originally developed as a supplemental savings plan to traditional pensions, also known as defined benefit plans.
“You can break down the market to higher education, health care, the K-12 market, charitable organizations and churches as the big-bucket markets that 403(b)s serve,” says Alessandra Hobler, an analyst with Cerulli Associates, a financial services research firm.
Though they’re often lumped together with 401(k) plans, 403(b) plans can differ significantly from their for-profit counterparts — and from each other.
Industries that have moved away from defined benefit plans, such as health care industries, typically run 403(b) plans in a similar fashion to 401(k) plans. They give employees access to one plan provider that offers a selection of investment products. But in the K-12 public school system, the retirement plans are wildly different. Elementary and high school teachers who invest in a 403(b) have access to as many as two dozen different plan providers, and they’re pretty much left on their own to figure out with whom they should do business.
Before the new regulations were put into place, 403(b) plans in the K-12 market consisted of a jumble of individual annuity contracts negotiated between the participant and the provider of their choice.
The plan sponsors, or employers offering plans, were very hands-off and nearly extraneous to the transaction. For instance, a school might have simply opened its gym or teacher’s lounge to dozens of vendors, who would then market directly to teachers and faculty.
Participants could choose the provider they liked and then arrange contributions, loans and withdrawals directly with the investment provider.
Now participants must go through the plan sponsor to do things such as change the amount of money deferred or request loans and withdrawals.
“Everything now has to flow through the sponsor, so the entity sponsoring the plan can keep up with these (Internal Revenue Service) limitations. Participants can’t just go on their own and decide which provider they want to use,” says Rebecca Moore, senior editor at PlanSponsor.com and managing editor of PlanSponsor’s (b)lines newsletter.
The new regulations require that plan sponsors track and report participant contributions, loans and withdrawals to the IRS. For plans that include potentially dozens of providers, that amounts to an administrative nightmare.
“They have lots of vendors but are required to aggregate that data across the vendors. That is just becoming too much for them to do in some cases. So they have to slim down their offerings so that, from a compliance standpoint, they can say ‘this participant is contributing the allowed amount, and they are only taking out one loan — not 40,'” says Cerulli’s Hobler.
Daunting logistical issues aside, some of those providers are unable or unwilling to share information with plan sponsors.
As a result, some school districts are condensing provider options, from upward of 100 to mere handfuls, according to a recent study by the American Society of Pension Professionals and Actuaries’ Pension Education and Research Foundation.
But it’s not just the recent regulations that are affecting 403(b) participants’ choice of providers. State-specific legislation aimed at corralling costs and streamlining 403(b) plans are also a factor.
“In Southern California, 403(b) regulations caused the reduction in the number of choices. But in other places, legislation would reduce the number of choices in school districts. So it’s several factors that reduce the choices, not just regulations,” says Debra Davis, assistant general counsel and director of government affairs at ASPPA.
Fallout of fewer choices
The K-12 market is a bit of an anomaly in the 403(b) marketplace. They still have a defined benefit, or pension, plan and contributions to retirement accounts are supplements to the pension. Because of that and the high percentage of participant funds in individual annuities, it will be slow to transition to a structure that is more similar to a 401(k) plan. However, employee education may be the key to keeping participants engaged as the industry transitions.
ASPPA’s study examined the repercussions in school districts that deselected many of their 403(b) providers. It found that many participants dropped out of 403(b) plans when their provider was no longer an option.
“There was a decline by 19 percent in participation, and that could be for a variety of factors,” Davis says. “For participants whose providers that were deselected, participation decreased by three times as much, by 56 percent, so it was a very significant decline in participation when their providers were deselected.”
Davis says it’s not clear from the ASPPA study why participants dropped out of their plans after their providers were deselected.
“Other research shows that participants have varied preferences about how they want to receive assistance, and we hear anecdotally that participants have relationships with advisers that they trust. And when they are no longer available, some will seek out other advisers. But others may not or may take a longer time to do that, and that could account for the decline in participation,” she says.
Carl Steinhilber, national nonprofit practice leader for the nonprofit market at MassMutual, reports that in their work with 403(b) plan sponsors, participation often increases after consolidation — although they work with different types of plans.
“Our focus is ERISA 403(b) plans, and school districts are exempt from ERISA — and school districts are multi-multi vendors,” he says.
ERISA refers to the Employee Retirement Income Security Act of 1974, complicated federal regulations designed to set standards for retirement plans in private industry to protect individual workers.
Nonetheless, educating participants on the benefits of consolidating plan providers keeps workers contributing to their retirement plans through the transition process.
“It comes down to the communication program, and it could also come down to how many vendors you are consolidating from. If you are trying to go from 10 vendors to one, that can maybe complicate the communication process a little bit,” he says.
School districts may have many more than 10 vendors to try to consolidate and long histories of being very hands-off when it comes to their retirement plans.
“Obviously, the best case would be to try to avoid reducing investment providers unless it’s necessary,” says Davis. “The 403(b) regulations could result in situations where the school districts need to reduce the number of investment providers if they’re not willing to share information. In those situations, education is really critical in terms of disclosing to participants that they need to select a new provider and giving them information on what is available to them to let them pick the provider that’s right for them.”
In the future, 403(b) plans will likely continue to increasingly resemble 401(k) plans, with a trend toward offering less expensive institutional share classes of mutual funds, other products with lower fees and group annuities rather than individual annuity contracts.
ASPPA, in conjunction with the National Education Association and The National Tax Sheltered Accounts Association, has released a model disclosure form to make the process of selecting an investment provider easier for public school 403(b) plan participants.
The form provides “key information to the participants, the fees to be charged and what types of services are available. It’s designed to let participants make an apples-to-apples comparison of the investment products available to them,” Davis says.