403(b) Pension Plans: Overview and Legislative Developments

403(b) Pension Plans: Overview and Legislative Developments

October 24, 2023
403(b) Pension Plans: Overview and Legislative Developments
Introduction
involvement in the plan. Plans sponsored by private sector,
A pension is a benefit employers may offer to assist
tax-exempt 501(c)(3) entities are subject to ERISA except
employees in preparing for retirement. Pension plans may
for those that meet a safe harbor exemption in which the
be sponsored by private sector (nonprofit and for-profit)
employer’s role is limited (see 29 C.F.R. §2510.3-2(f) and
employers or public (governmental) employers and may be
DOL’s Field Assistance Bulletin 2007-02). Among other
classified according to whether they are (1) defined benefit
provisions, the safe harbor specifies that employers may not
(DB) or defined contribution (DC) plans and (2) sponsored
contribute to the plan and employee participation must be
by one employer or more than one employer. In DB plans,
voluntary (i.e., no automatic enrollment features).
participants (or their beneficiaries) typically receive regular,
Plans sponsored by public educational organizations and
monthly benefit payments in retirement (which some refer
churches are exempt from ERISA. However, church plans
to as a “traditional” pension). In DC plans, participants
may elect ERISA coverage.
have individual accounts that can provide a source of
income in retirement.
ERISA 403(b) plans submit annual Form 5500 filings with
DOL, PBGC, and the Internal Revenue Service (IRS). Form
Two common type of DC plans are 401(k) plans and 403(b)
5500 includes data on the number of plan participants,
plans (named for the corresponding sections of the Internal
financial information about the plan, and details of
Revenue Code [IRC; Title 26 of the U.S. Code]). A 401(k)
companies providing services to the plan. In plan year 2020
plan is a type of DC plan available to private sector
(the most recent Form 5500 data available), DOL indicated
employers. A 403(b) plan (which may be called a tax-
that there were 20,732 private sector 403(b) plans with 9.6
sheltered annuity plan) is a type of DC plan sponsored by
million participants. The U.S. Government Accountability
public educational organizations (including public primary
Office estimated that in 2019, ERISA 403(b) plan assets
and secondary schools, state colleges and universities, and
comprised 57% of all 403(b) plan assets.
public junior colleges), 501(c)(3) tax-exempt entities, and
employers that provide retirement income accounts for
Structure of 403(b) Plans
ministers (e.g., churches). While many 403(b) plans are
Section 403(b) of the IRC permits three categories of
sponsored by single employers, recent legislative changes
funding arrangements: (1) annuity contracts provided by an
may increase the number of those sponsored by more than
insurance company, (2) custodial accounts invested only in
one employer.
Securities and Exchange Commission–registered mutual
Despite distinct legislative histories, there has been a move
funds, or (3) retirement income accounts for church
toward harmonizing rules for 401(k) and 403(b) plans. This
employees described in Section 403(b)(9) of the IRC
In Focus provides background on 403(b) plans, highlights
(which are treated as annuity contracts). Retirement income
areas in which they differ from 401(k) plans, and discusses
accounts do not have investment restrictions.
current legislative developments surrounding 403(b) plans.
Employers have varying degrees of involvement in their
403(b) Plans and Federal Pension Law
403(b) plans—ranging from minimal involvement, such as
providing a list of insurance carriers to eligible employees
Pension plans are generally tax qualified, which means that
(common in 403(b) plans sponsored by K-12 school
plan sponsors and participants receive certain tax
districts), to greater involvement, such as choosing
advantages provided they meet IRC requirements. Some
investment options and providing an employer match.
provisions of the IRC apply to both private and public
Starting in 2009, IRS regulations required that 403(b)
sector plans, while some apply to one or the other. Nearly
plans—both ERISA and non-ERISA—be maintained
all private sector pension plans are governed by the
pursuant to written plan documents (with some exceptions
Employee Retirement Income Security Act of 1974
for certain church plans).
(ERISA; P.L. 93-406), which is enforced by the
Department of the Treasury, the Department of Labor
Features of 403(b) Plans
(DOL), and the Pension Benefit Guaranty Corporation
The following summarizes information on 403(b) plans,
(PBGC). ERISA was enacted to protect the interests of
noting comparisons with 401(k) plans where relevant.
pension plan participants and beneficiaries. ERISA sets
standards that private sector pension plans must follow,
Enrollment. ERISA 403(b) plans may include automatic
including with regard to participation, funding, and
(“auto”) enrollment features, in which employees are, by
fiduciary responsibility (standards that govern how
default, enrolled in the plan but can opt out. As a condition
individuals with authority over pension plans must behave). of the safe harbor exemption, private sector 403(b) plans
that are not subject to ERISA are not permitted to auto
Whether a 403(b) plan is subject to ERISA depends on its
enroll participants. In addition, some states (via state law)
sponsoring employer and/or the degree of employer
do not permit non-ERISA 403(b) plans to auto enroll. A
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403(b) Pension Plans: Overview and Legislative Developments
provision in the SECURE 2.0 Act of 2022 (“SECURE 2.0,”
including individual retirement accounts [IRAs], for
enacted as Division T of P.L. 117-328) required that new
example). CITs are regulated by the Office of the
401(k) and 403(b) plans (with some exceptions) auto enroll
Comptroller of the Currency, an independent bureau of
newly eligible employees effective for plan years beginning
Treasury. CIT trustees must comply with ERISA fiduciary
after 2024. It is unclear how this provision will affect safe
duty if plan assets are invested in the CIT.
harbor 403(b) plans.
Recent Legislative Developments
Contributions. Like employees in 401(k) plans, employees
SECURE 2.0 (P.L. 117-328) included provisions affecting
in 403(b) plans may make pre-tax contributions, designated
403(b) plans:
Roth contributions, or after-tax (non-Roth) contributions (if
permitted by the plan). Pre-tax contributions lower an
• Section 106 amended the IRC to formalize 403(b)
individual’s taxable income, but withdrawals of savings
multiple employer plans (MEPs) and authorize 403(b)
(i.e., contributions and any investment earnings)
pooled employer plans (PEPs). PEPs are a type of MEP
attributable to them are included in taxable income.
in which unrelated employers join to offer a common
Designated Roth account contributions do not lower
retirement plan. Prior to the authorization of PEPs, each
taxable income, but qualified withdrawals are not included
employer participating in a 403(b) MEP (or
in taxable income. After-tax (non-Roth) contributions do
“aggregation arrangement”) had to demonstrate a
not lower taxable income. Withdrawals attributable to these
business or organizational connection and was treated as
contributions are not included in taxable income, but
sponsoring its own 403(b) plan under the IRC. Under
investment earnings attributable to them are included in
Section 106, 403(b) MEPs and PEPs may file a single
taxable income. Employers may match a fixed percentage
Form 5500 and both gain relief from the “one bad
of employee contributions (such as matching contributions
apple” rule, in which one participating employer that
up to, for example, 5% of a worker’s compensation).
failed to satisfy plan qualification requirements could
Employers may also make nonelective contributions (those
result in the entire plan failing them.
not based on an employee’s contributions).
• Section 602 expanded the types of 403(b) contributions
Some 403(b) plans permit employees to make additional
permitted to be withdrawn as hardship distributions to
contributions upon (1) reaching age 50 and/or (2) having at
include all types. (Previously, only employee
least 15 years of service with the same eligible 403(b)
contributions without earnings were permitted to be
employer (an educational organization, hospital, home
withdrawn.) These rules will be consistent with those for
health service agency, health and welfare service agency,
401(k) plans when the provision is effective in 2024.
church, or convention or association of churches). The latter
• Section 128 amended the IRC to permit 403(b) custodial
is known as the 15-year rule and is not available to 401(k)
accounts to invest in group trusts (as described in
plan participants. The amount permitted to be contributed
Revenue Ruling 81-100 and subsequent rulings) with
under the 15-year rule depends on an employee’s
other retirement plans and IRAs. A CIT is an example of
contribution history and years of service. All contribution
a group trust. Previously, assets of a 403(b) custodial
types are subject to annual limits.
account could not be commingled in a group trust with
The universal availability rule states that if any employee is
assets other than those of regulated investment
eligible to make 403(b) elective deferrals (i.e., employee
companies (i.e., mutual funds). However, without
contributions), all employees must be eligible to make
amending relevant securities laws (e.g., the Securities
them. Certain employees (e.g., certain part-time employees
Act of 1933, the Securities Exchange Act of 1934, and
and those making contributions to a different plan
the Investment Company Act of 1940), 403(b) plans are
sponsored by the same employer) may be excluded.
unable to invest in CITs.
Hardship distributions and loans. Like 401(k) plans,
In the 118th Congress, H.R. 3063, as reported out of the
403(b) plans may offer hardship distributions and loans,
House Financial Services Committee on May 24, 2023,
though specific details may vary. Hardship distributions are
would amend securities laws to permit ERISA 403(b) plan
pre-retirement distributions for employees who face
assets to be invested with certain other retirement plan
financial need. Hardship distributions are included in
assets in CITs and in non-registered variable annuities
taxable income and subject to a 10% penalty unless an
through insurance separate accounts. Insurance separate
exception in Title 26, Section 72(t), of the U.S. Code
accounts are accounts within annuity contracts typically
applies. Loans (which can be made from the plan, known as
used to hold variable annuities. Unlike general accounts,
a plan loan, or between the annuity contract issuer and the
assets in separate accounts are segregated from all other
participant, known as a policy loan) permit participants to
assets of the insurance company.
borrow from their account balances, though the mechanics
differ between 403(b) plan and policy loans.
Proponents contend that CITs and insurance separate
accounts have lower fees and would assist in diversifying
Investments. Under current law, 403(b) plans are generally
403(b) participants’ investment portfolios. However, some
limited to investing in annuities or mutual funds through
caution that CITs are less regulated than mutual funds and
custodial accounts (except for retirement income accounts
do not publicly disclose fee and expense information and
for church employees). In contrast, 401(k) plans have few
that assets in them are not able to be rolled over to IRAs or,
investment restrictions. Many 401(k) plans invest through
in many cases, to other qualified plans.
collective investment trusts (CITs), which are pooled
investment funds maintained by banks or trust companies
that are available only to certain retirement plans (not
Elizabeth A. Myers, Analyst in Income Security
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403(b) Pension Plans: Overview and Legislative Developments

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