Common Deficiencies Noted in 403(b) Plans

Common Deficiencies Noted in 403(b) Plans

For years, many school districts have been offering 403(b) plans that allow employees to save for their retirement. However, many districts have taken a hands off approach in managing the plan. With the number of teachers facing cuts increasing, there is more incentive to put away money in 403(b) plans. Also with pension cutbacks, 403(b) plans are becoming a greater part of assets necessary to fund retirement. Even though 403(b) plans sponsored by governmental employees, including public school districts, continue to be exempt from ERISA (Employee Retirement Income Security Act of 1974), including its fiduciary requirements and IRS Form 5500 reporting, it is important for the plans to be managed properly for the benefit of the district and its employees.

403(b) plans are subject to a “universal availability” requirement. Under the universal availability rules, if one employee is permitted to make contributions every year, virtually all employees must be permitted to do so. The 403(b) regulations also impose two additional requirements.

  • You must provide an annual notice of the right of your employees to participate in the plan, and
  • Employees must be given a meaningful opportunity to enroll or make changes to their contributions.

Violation of this requirement could cause your entire plan to be disqualified. While you can exclude certain employees, you can avoid possible violation of the universal availability requirement by permitting every common-law employee the right to participate in your plan. Some districts have considered automatic enrollment provisions, whereby eligible staff are automatically enrolled in the plan and they need to opt out of the plan should they decide not to contribute. This is something districts may wish to consider to help ensure their employees are retirement ready.

Public schools may also make matching discretionary employer contributions on behalf of their employees. Public schools may make post-employer contributions for up to five tax years after the year of separation on behalf of their employees who severed employment with them. Having employer contribution features do not make 403(b) plans sponsored by governmental employers, including public school districts, subject to ERISA. Public school districts are exempt from nondiscrimination rules for employer contributions to 403(b) plans. Governmental employers may make employer contributions for any employee or for any group of employees.

The 403(b) regulations require that 403(b) plans be maintained in accordance with plan provisions. This means you are responsible for ensuring that your plan documents comply with all regulations and that the operation of your plan satisfies those requirements.

Common plan violations to watch out for are:

  • No written plan – The written plan must cover all of the plan’s terms and conditions, including eligibility, benefits, contributions, approved investment providers, withdrawals, loans, rollovers, transfers, and distributions. The operation of your plan must be consistent with the terms of your plan.
  • Eligible employees have not been given the opportunity to participate in your plan – Because the exclusion of substitute teachers or any specific classification of employees (such as bus drivers who are common-law employees) is a common violation, it is important to permit substitute teachers and other classes of employees to participate if they so choose. To avoid the problem of payroll periods when a substitute may not have generated enough salary to support a flat-dollar contribution, you can permit these types of employees to make contributions based only on a percentage of compensation.
  • Employee contributions exceed eligible limits  You must monitor all employee contributions, regular and catch-up, to ensure that they do not exceed annual limits.
  • The plan has a minimum age requirement and/or a service requirement of more than 1,000 hours per year before employee salary deferral contributions are permitted  The universal availability requirement prohibits age restrictions on employee participation. Only employer contributions can be subject to a minimum age requirement.
  • Definition of compensation – The Plan document will outline what compensation base to use when calculating contributions. Using the incorrect base will either lead to excess or insufficient contributions. For example, the plan document might exclude certain wages from the definition of compensation such as leave payments or bonuses. It is not at the employer’s discretion to decide what to include and what to exclude from this calculation.
  • Timeliness of remittances – According to the Department, employee contributions should be remitted to the Plan when they can be reasonably segregated from general assets, but in no event can the deposit be later than the 15th business day of the following month. While there is a hard deadline, plan sponsors should not confuse this as being the deadline with which they will be judged. If it generally takes the sponsor three days to remit contributions to the plan, then three days may be determined to be the “reasonably segregated” date.

Many of the errors noted by the Department of Labor could be significantly mitigated if the plan’s sponsor (the employer) is aware of its role with relation to the plan and what that role really entails. Often times, those that are responsible for ensuring the safety and growth of retirement funds are complacent with the importance of their fiduciary role. As defined by the IRS “a fiduciary is a person who owes a duty of care and trust to another and must act primarily for the benefit of the other in a particular activity. For retirement plans, the law defines the actions that result in fiduciary duties and the extent of those duties.”

These responsibilities include:

  • Acting solely in the interest of the participants and their beneficiaries
  • Acting for the exclusive purpose of providing benefits to employees participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan
  • Following the plan documents
  • Diversifying plan investments
  • Carrying out duties with care, skill, prudence, and diligence of a prudent person familiar with the matters

While there must be at least one legal fiduciary as named in the plan document, the employer will generally hire other individuals to handle the daily operations of the plan. Because fiduciary status is determined based upon the functions performed by a person, and how many of those services are plan-related, there can, often times, be more than one fiduciary.

These individuals must first understand the purpose of their role, as defined above. The plan document is the criteria of judgment. Understanding the plan document and adhering to its provisions will alleviate many unnecessary issues that would otherwise be noted upon investigation. Wherever silent, the fiduciaries must act with prudence. Acting with prudence does not necessarily mean that plan investments won’t ever fail. Rather, it is taking the necessary steps to stem the loss. Changing the investment platform is a way to do this. Regularly monitoring the plan and documenting this process, is an extension of prudence.

While there are additional errors that can be found with relation to 403(b) plans, errors/deficiencies listed above appear to be the most common. Such errors will lead to non-compliance with the plan document. It is in the sponsor’s best interest to remedy such deficiencies when found rather than giving the DOL the opportunity to catch them on audit. The DOL plans to investigate even more pension plans in the coming years. Such investigations take significant staff energy, are costly, and can span multiple plan years. A plan sponsor’s understanding of the fiduciary role can significantly reduce, if not eliminate, these common pension errors and will increase participants’ confidence that their retirement funds, their future, is in adequate hands.

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This article was also featured in our newsletter Lesson Plan Vol. 14

Kenneth R. Cerini, CPA, CFP, FABFA

Kenneth R. Cerini, CPA, CFP, FABFA

Managing Partner

Ken is the Managing Partner of Cerini & Associates, LLP and is the executive responsible for the administration of our not-for-profit and educational provider practice groups. In addition to his extensive audit experience, Ken has been directly involved in providing consulting services for nonprofits and educational facilities of all sizes throughout New York State in such areas as cost reporting, financial analysis, Medicaid compliance, government audit representation, rate maximization, board training, budgeting and forecasting, and more.


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