ERISA Litigation in 403(b) Retirement Plans
By Mark Johnson, Ph.D., J.D.
Allegations of excessive administrative fees are behind a series of recent lawsuits brought against universities that sponsor 403(b) retirement plans. Claims involving fiduciary liability focus on the plan sponsor’s responsibility as a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA).
Similar to the wave of fee litigation that engulfed 401(k) sponsors, the 403(b) litigation is prompting university and non-profit plan sponsors to look more closely at investment fees and the performance of certain plan investments.
Background on 403(b) Retirement Plans
403(b) plans are a type of tax-sheltered annuity or mutual fund retirement plan offered to certain employees of some religious, 501(c)(3) tax-exempt, and government organizations including public schools and universities.Investments in 403(b) plans are restricted to annuity contracts and certain mutual fund accounts, although participants are able to self-direct their retirement funds among the plan choices offered.
The Employee Retirement Income Security Act (ERISA), the 1974 federal law that protects participants of private retirement plans, applies to 403(b) plans, except in limited instances when religious or 501(c)(3) tax-exempt employers met certain requirements or when the plan is offered by a government organizations.
For the employer, ERISA 403(b) plans offer numerous benefits, including exemption from state laws and regulations, more control over the plan, fewer compliance requirements, and limited liability for investment losses. Additionally, these plans generally have lower administrative costs for the employer than similar 401(k) plans. However, ERISA imposes strict reporting and disclosure requirements on the employer, including an annual Form 5500 which must be filed with the Department of Labor, summaries that must be provided to plan participants, fiduciary duties which may subject the employers to litigation if breached, and other applicable rules.
Employers are also subject to the universal availability rule that requires an employer to permit all non-excludable employees to defer salary to a 403(b) plan if that employer allows any employee to do so. An employer may exclude employees who work less than 20 hours each week, employees who will contribute $200 or less each year, employees who participate in a 401(k) or 457 plan, non-resident aliens, and students performing services defined by Section 3121(b)(10).
The universal availability rule also requires employers to notify employees that they may make elective deferrals to their 403(b) plans, when they may make an election, and when they can change their election.
For the employee, ERISA 403(b) plans offer substantial tax advantages, including pre-tax contributions and earnings which may be made by either the employer or the employee. These contributions are not taxed until the employee withdraws them from the plan.
Employees may elect to contribute money withheld from their salary by their employer in an amount not greater than 100% of includible compensation or $18,000. These types of contributions are known as elective deferrals. It is important to note that the maximum amount of elective deferrals an employee may contribute is reduced by the amount of contributions made to othercertain plans, including 401(k) plans.
There are also three other types of contributions to a 403(b) plan:
• Designated Roth contributions are elective deferrals which the employee includes as gross income in the year they were contributed by the employee.
• Non-elective employer contributions that are beyond the employee’s salary and are subject to income tax only when withdrawn.
• After-tax contributions, on the other hand, are employer contributions which an employee includes as gross income in the year they were contributed by the employer. Employers can continue to contribute to a former employee’s 403(b) plan for up to five years so long as the employee is not deceased and the contribution is not payable by other means.
Each year, the employer and employee may contribute a combined amount of $54,000 or the employee’s includible compensation, whichever is lesser. Additionally, if they meet certain criteria, employees may make additional catch-up contributions which are unavailable under similar 401(k) plans.
Employees may withdraw money from the plan once they either reach the age of 59 and a half, sever their employment with the plan provider, become disabled, or die. In some instances, employees may be allowed to take a loan or hardship distribution from their 403(b) plan early. However, early withdrawals are often subject to a 10% penalty and other tax consequences.
ABOUT THE AUTHOR: Mark Johnson, J.D., Ph.D. Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances.
ERISA Benefits Consulting, Inc. by Mark Johnson provides benefit consulting and advisory services and does not engage in the practice of law.
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