CFO.com
September 11, 2007

Non-profits will have to kick a 40-year-old habit of handing off responsibility for definedcontribution plans to vendors. That's because an Internal Revenue Service rule issued in late July revamps the existing tax code, forcing employers to take greater responsibility for developing and overseeing 403(b) retirement plans. When the new ruie goes into effect on January 1, 2009, it should bring the administration of 403(b) plans into line with rules governing 401(k)s, which are offered by some non-profits as well as by many profi-making companies.

The non-profit 403(b) plans were set up by the government in 1958 to encourage empioyees of schools, universities, hospitals, and other tax-exempt organizations to boister their pensions with retirement savings, notes 403bwlse.com, an educational website focused on the plans. As is the case in a 401(k), employees participating in a 403(b) direct parts of their salaries into tax-deferred accounts. That is, dividends, interest, and capital gains that accumulate in a 403 (b) grow tax-deferred until they're withdrawn.

For decades, many non-profits, hoping to avoid the arduous administrative duties of a 403(b), set up the plan's automatic payroll deduction process and then bowed out. Indeed, non-profit employers allowed insurance companies, mutual funds, and other third-party vendors that sold plan investment products to develop plan documents and deal directly with employees. Many 403(b) plans use annuities soid by insurance companies as their primary investment vehicles.

Starting in 2009, however, the rules will change. Similar to for-profit companies that sponsor 401(k) plans, non-profit 403(b) sponsors will have to prepare written plan documents and become the plan's chief administrators. That also means that the nonprofit employer will become the primary fiduciary of the plan and be responsible and liable for its proper administration. In the past, it was unclear which organization - the employer or vendor - was accountable.

The need for change was probably brought on by "a vacuum of responsibility," contends attorney Ralph Dejong, a law partner in the Chicago office of McDermott Will & Emery. "Historically, tax-exempt organizations that sponsored or made available 403(b) tax-sheltered annuities," he says, "took a hands-off approach."

One reason: There is still "widespread belief" that all non-profis are exempt from the strict fiduciary requirements of the Employee Retirement Income Security Act, says Jeff Robertson, an attorney with Bullivant Houser Bailey. That belief probably had its roots in the fact that most 403(b) plans sponsored by government entities or that don't include employer contributions are exempt from ERISA.

Currently, all but the most sophisticated non-profits run 403(b) plans in a "loose" way, requiring only a contract between employees and the vendor that "mayor may not comply" with the tax code, says Dejong. In addition, many "employers using multiple 403(b) plan vendors have done little or no monitoring of investment options and their performance," argues a new report released by Ginny Boggs, a senior compliance consultant at Milliman, a benefits advisory firm.

Boggs insists that the "existence of unmonitored excessive choice" among the annuities offered in 403(b) plans has hurt employees, "overwhelming them with choices and diluting the overall quality investments." That was also found to be true in the private sector, where plan sponsors, attempting to compiy with ERISA's rule to provide "a reasonable choice" of investment options, flooded participants with an excessive amount of alternatives.

The most notable change to the tax ruies is that employers will have to develop a plan document that identifies how the vendor and employer will work together to administer the 403(b) plan. The IRS is expected to release model language for the plan document sometime in 2008. But it's unclear how much guidance employers will need to complete the task that DeJong describes as, "very challenging"-especially for smaller businesses.