(DOL) created a safe-harbor exclusion from ERISA coverage
for certain tax-sheltered annuities and individual retirement
accounts (IRAs), provided that employer involvement was
limited. The DOL emphasized the importance of participant
choice, as well as the responsibility of employers to offer participants a sufficient number of both investment options and
vendors to foster such choice and flexibility. In response to the
DOL rules, a myriad structural differences between 403(b) and
401(k) plans have developed and have been reinforced through
changes to the law and regulations over the years.
From 2007 through 2010, the Internal Revenue Service (IRS)
and DOL issued new 403(b) guidance and clarifications that have
opened the door to plan-level 403(b) administration, as opposed
to contract-by-contract-level administration. That led many
plan sponsors to consider the pros and cons of changing their
plan’s structure. The IRS acknowledged that these revisions had
blunted differences between some rules governing 403(b) plans
and those governing other employer-based retirement plans. But
it also affirmed that “significant differences” remain between
Section 403(b)s and other workplace plans, including 401(k)s.
The special tax and ERISA requirements create recordkeeping complexities for 403(b) plans and their vendors that far
exceed those typically associated with 401(k) plans. Moreover,
due to the limited involvement of employers as well as the
impact of the DOL’s safe-harbor guidance, 403(b) recordkeepers
have a long tradition of providing retirement services and assistance directly to the participants. The recordkeeping requirements for annuities are also more complex and rigorous as
compared with 401(k) plans. Although fiduciaries should take
costs associated with recordkeeping and administration into
consideration when evaluating investment options, cost is only
one factor in terms of the overall value of the services provided.
While the evolution of the 403(b) plan may continue to gradually converge with that of the 401(k) plan, numerous distinctions
persist. Consequently, it is simply erroneous to suggest that
403(b) and 401(k) plans are “a distinction without a difference.”
Since mid-2016, more than a dozen lawsuits have been filed against a number of prominent institutions of higher learn- ing, alleging these universities breached their fiduciary
duties to employees by offering 403(b) plans in a manner alleged
to be too expensive and complex. In general, the suits mistakenly assume that 403(b) retirement plans offered by universities
should follow the same blueprint as 401(k) plans. The following
describes the significant differences in the origins, goals and
legal treatment of 401(k) and 403(b) plans and why recent lawsuits have failed to appreciate these distinctions.
History and Purpose
The 403(b) plan was designed almost 100 years ago to provide
lifetime retirement security to employees of educational institutions. On the other hand, 401(k) plans first appeared in the
Internal Revenue Code (IRC) in 1978 and were established by
for-profit institutions; their purpose was to supplement traditional pension plans by allowing eligible employees to make
contributions on a pretax basis.
These two types of plans were designed to serve fundamentally different purposes. The chief aim of 403(b)s is to replace
income when an employee retires, while that of 401(k)s is wealth
accumulation. Nearly all 403(b) plans offer lifetime income
options known as annuities.
With such different histories and purposes, it is no coincidence that the law has treated these plan types quite differently. Section 403(b) was added to the IRC in 1958 and expressly
deals with annuities rather than plans—in contrast with Section
401(k), added 20 years later.
Rules Lead to Structural Differences
In 1974, Congress enacted the Employee Retirement Income
Security Act (ERISA). While this landmark legislation affected
all retirement savings vehicles established and maintained by
private employers, ERISA affirmed the distinct purpose and
design of 403(b) annuity contracts and included provisions
specific to them. Importantly, ERISA applies only to plans that
are “established or maintained by an employer” for its employees.
Application of this standard to “tax-sheltered annuities” that
were largely controlled by individuals and entirely funded by
them—not by employers at tax-exempt educational institutions—created some uncertainty.
To address this confusion, in 1979 the Department of Labor
Stephen Saxon is a partner with Groom Law Group,
Chartered, in Washington, D.C. George Sepsakos, an
associate with the firm, contributed to this article.
Lawsuits overlook differences between 401(k)s and 403(b)s