Where There Is Room for Improvement in 403(b)s

The Plan Sponsor Council of America’s (PSCA) 2014 403(b) Plan Survey found organizations that sponsor 403(b) plans are simplifying investment platforms by streamlining the options available for participants (see “403(b)s Simplifying Investment Menus”). However, Aaron Friedman, national tax-exempt practice leader at The Principal based in Shelton, Connecticut, tells PLANSPONSOR, while 403(b)s have made great strides in reducing the number of investments in their plans, there are still too many.

Friedman notes there has been an evolution away from retail, individual annuities or custodial accounts, to an institutional, mutual fund approach to plan investments, for which an adviser is used to do due diligence on the best investment lineup for the plan. Charities and general nonprofits started the trend about 20 years ago, and health care organizations jumped on the bandwagon 10 to 15 years ago, but the trend is emerging in the higher education segment of the 403(b) market, according to Friedman. He said the reduction in investments has been primarily due to this segment—from an average of 65 plan investment options for participant contributions in 2013 to 45 in 2014. “For the first time higher ed plan sponsors are realizing they need the help of financial professionals and are putting in place investment policy statements.”

Still, higher education institutions have approximately double the number of plan investments as other market segments, according to Friedman. This is an opportunity for retirement plan advisers to help 403(b)s adopt a responsible fiduciary governance structure, he adds.

A corollary to too much investment choice is the use of too many providers by 403(b)s and the complications of administration. This is another place 403(b)s can do better, Friedman says. He notes that 403(b) plan sponsors realize the complications of coordinating loans and hardship withdrawals, but they may not realize other complications of administration caused by having numerous plan vendors. For example, the plan may call for small balance cashouts that need to be coordinated across multiple vendor contracts. Qualified domestic relations orders (QDROs) also apply to the whole plan, not just one contract, and if beneficiary designation forms are filed with different vendors or contracts for the same participant, how do plan sponsors coordinate those?

Vendors may tell plan sponsors they don’t have to worry about it, Friedman says, but plan sponsors need to have processes and procedures in place to address these issues so they don’t have to worry about it. Advisers that have knowledge of the nuances of 403(b) plans can add value by helping plan sponsors establish appropriate procedures.

Another area in which 403(b)s could further improve is automatic enrollment. Only 16% of organizations participating in the PSCA survey offer automatic enrollment in their plans. Friedman notes this is up a little from 14.9% in 2012, but it is still about one-third of the number of 401(k) plans that offer auto enrollment.

According to Friedman, tax-exempt entities have always been slower to adopt new ideas than corporate firms, but in particular, 403(b) plan sponsors are concerned auto enrollment will cost them more in employer contributions and have a general concern about making decisions for participants. Again, he says, advisers can help. Certain plan design features can mitigate the cost of contributions—for example, a stretched match formula. “Advisers who can consult on plan design have a huge opportunity,” he says.

In addition, many plan sponsors do not understand the opt-out rule for automatic enrollment. If they present a very well-disclosed opt out procedure, letting participants know they can either opt out or contribute below the default contribution level, they will find it’s not something employees resent because employees still have control, Friedman contends. “Just providing that education for plan sponsors will help them improve their plans.”

One other point Friedman makes is about one-on-one participant education. The PSCA survey found 60.1% of 403(b) plans offer one-on-one education, and 403(b)s have traditionally offered one-on-one sessions with vendors because it is very important to nonprofits to hold participants’ hands and help them make decisions (see “What 401(k)s Can Learn from 403(b)s”), Friedman notes. However, he says, some plan sponsors that still allow vendors to sit in cafeterias or employee lounges trying to sell products could misinterpret that as one-on-one education, rather than what they need to do—have an education policy and have someone delivering education consistent with policy.

The Principal is a sponsor of the PSCA 403(b) Plan Survey.