04/16/02 - Fixing A Broken 403b Plan
By: Frank Armstrong, CFP, AIF
Is your 403(b) plan broke? Why not fix it? A little known, little used IRS Private Letter Ruling allows active participants of 403(b) plans to transfer their assets to another 403(b) of their choice. If you are not happy with your 403(b) plan's costs, investment choices or service, you can take control of your retirement plan using a 90-24 Transfer.
What is a 403(b) plan?
Special plans for employees of non-profit institutions are called 403(b) plans. They are a close relative of the better-known 401(k) plan but with a few interesting twists. These plans are available to public schools, hospitals, public and private universities, churches and other non-profit organizations qualified under §501(c)(3), employer-sponsored §403(b) plans are funded with both employer contributions and employee salary reduction contributions. Employer contributory plans (other than those maintained by governmental agencies) must meet the requirements of the Employee Retirement Income Security Act of 1974 (ERISA).
Most institutions contract with multiple providers to offer 403(b) benefits choices to their employees. The employee selects from the employer's providers and chooses from the investment options offered by that provider. The employer then makes contributions to the provider on behalf of the employee.
Quality retirement plans are not necessarily a high priority for non-profits
Some institutions have very fine plans. These employers have done their homework and selected very high quality providers that offer low cost funds, adequate investment choices to build a sophisticated asset allocation plan, superior service and meaningful education for their employees. Not all employees are so fortunate.
Far too many employees of America's non-profit institutions endure 403(b) retirement plans that are sub-standard and dirt poor. Too often, plan providers are selected without due consideration, or worse yet, as a political plum. Disinterested administrators leave participant education and enrollment to plan sponsors who promptly sell high cost inappropriate products to unsuspecting employees. The salesmen make out like bandits while the employees suffer dismal performance weighed down by exorbitant fees.
Where employers abdicate their responsibilities as fiduciaries and delegate education and enrollment to plan providers, results can be far from happy. Provider salesmen with severe conflicts of interest are turned loose on trusting employees with the implied endorsement of the employer. This is the functional equivalent of inviting the foxes to dine on the chickens.
Is your plan broken?
A broken plan has some or all of the following problems:
- High commission, high cost products. Many products commonly marketed to 403(b) plan participants have annual costs exceeding 3%. It is not at all unusual for employees to be told that only high commission annuities can fund their plans. Nothing could be farther from the truth. There is almost no rational justification for the use of so-called Tax Sheltered Annuities (TSAs) in a 403(b) plan. No-load mutual funds would far better serve the retirement needs of participants.
- Surrender fees and/or withdrawal restrictions that trap an employee who wishes to switch to lower cost, more effective provider plan.
- Investment choices may be so limited that it is impossible to properly diversify the portfolio or integrate it with the employee's other assets and financial planning.
- Information and education is inadequate to assist employees to make informed choices.
Your options to upgrade your 403(b)
Employees with substandard 403(b) plans have at least two options.
- Like employees in private industry, they can petition their employers to provide better options and suppliers. Depending on the employer, this may or may not be successful.
- However, unlike an employee trapped in a poor 401(k) plan, in most cases, the employee can simply open a self-directed 403(b) account with a friendly discount brokerage house and transfer his account balance. The employee is then free to choose almost the entire menu of investment options offered by the brokerage, and can even hire an investment advisor to assist if they so desire.
The second option, a 90-24 Transfer, is unique to the 403(b) participant. While the employer controls a 401(k) plan, a 403(b), on the other hand, is considered to be an individually controlled plan. This means that it is technically owned and controlled by each individual who participates. While an employer is permitted to limit the investment options they offer, they are technically not allowed to limit the participant's overall options. For this reason, the IRS issued a private letter ruling in 1990 to permit employees to transfer their money from one 403(b) plan to another without separating from service.
Additional considerations:
- If the investment is currently in annuities or back end loaded mutual funds, the employee may be charged surrender fees on all or part of them when he transfers them out. See the funds or annuity's prospectus for details.
- A 403(b) plan may not be rolled into an IRA while an employee continues in service. It may be, if the employee wishes, after the employee separates from service. However, the IRA may not enjoy all the protections against creditors that a 403(b) plan provides.
- The employee may transfer his assets to another 403(b) plan unless the current plan documents specifically prohibit it. Most plans do not.
- The employee should be careful not to close his present plan. In some cases, he may have to leave a token balance in the plan to keep it open. The employer will not make contributions directly to the transferred plan. He should use his existing plan to accumulate contributions until he makes any additional transfers to the new plan. Of course, any contributions temporarily held in the employer's plan should be directed to no-load, no surrender fee options until transferred out to avoid additional costs.
The bottom line:
Fixing a broken 403(b) plan can yield enormous benefits. You can take control of your investment account, lower costs, obtain access to the highest quality investment products, and/or work with an independent investment advisor to design and monitor a plan tailored to your exact needs.
For instance, assume an employee with a total $5000 annual contribution over 30 years. If the employee were able to increase his rate of return by 2% by simply cutting administrative costs, the increase would be staggering. At 7% compound return, the total after 30 years would be $505,365.21. However, at 9% the balance grows to $742,876.09, an increase of 47%.
Teachers, doctors, nurses, pastors, and other workers for America's non-profit enterprises deserve the best retirement plans. Fortunately, if their employers won't give it to them, they have a remedy. A 90-24 Transfer is a great way to fix a broken 403(b) plan.
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