The Seven “403(b) Administrative” Sins (Part 1)

Despite conventional wisdom that says one shouldn’t discuss religion or politics in social situations, I invariably find myself in conversations about one or both. Thankfully the discussions regarding religion have never touched on something as philosophical as the “Seven Deadly Sins” (I was definitely not a philosophy major!). But the concept got me thinking about the mistakes that 403(b) plan sponsors make—the “Seven Administrative Sins” if you will, that can put a non-profit plan in real jeopardy.

While the majority of “sins” are committed unknowingly, they have the potential to create some real administrative and compliance-related issues for plan sponsors—problems that could be avoided and rectified with the help of a financial professional. In the first installment of this series, I will go over the first two sins—the problems that surface as we at the Principal Financial Group® are assisting a plan sponsor.

Sin #1: Many plans have provisions to force out small amounts.

Let’s say a service provider has a $900 account balance for a participant who is leaving the company, and since many plan service providers have provisions to force out small amounts, that amount is distributed as an automatic cash payment. But the  total account balance held for the participant across all providers is $10,000. This becomes a problem with multiple providers involved because all plan assets count.

Thus a violation occurs the moment the first service provider automatically distributes the $900 balance upon the participant’s separation from service. It’s considered an impermissible distribution and puts the plan in jeopardy.

Sin #2: Most people are familiar with the retirement plan loan limitations of 50% of account balance, or $50,000 if less.  Yet not everybody knows that the $50,000 amount must be reduced by the highest outstanding loan balance in the prior 12 months.

This rule prevents a participant from keeping a perpetual $50,000 loan, and ensures some repayment. What’s one problem that can arise in some arrangements? A service provider may deal directly with plan participants and grant loans against balances held within a contract, without taking into account other retirement plan assets. In some cases, the service provider isn’t even aware there are other plan balances.

There are also many incidences of loan defaults that aren’t handled properly, that only a service provider may be aware of. In addition to this being a common violation, the Internal Revenue Service (IRS) proposed solution is strange. Under the new EPCRS program, the IRS says this can be corrected by the plan sponsor effectively paying the tax due to what is considered a distribution.

In other words, the employer may become responsible for the impact of a prohibited transaction caused by a participant and a another service provider contract that is outside their control.  I understand holding a plan sponsor responsible for compliance, but this logic ignores the realities of contract structures and relationships in the 403(b) world.

Get ahead of these common mistakes

Third party administrators (TPAs) are uniquely positioned to be able to handle both these problems, and could coordinate and monitor all plan assets to help ensure these “sins” don’t start—or continue.

Stay tuned for the next “sins” in the series: hardships and qualified domestic relations orders (QDROs).

Let’s chat in the comments.


Affiliation Disclosures

While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that none of the member companies of The Principal are rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

Insurance products and plan administrative services are provided by Principal Life Insurance Company, a member of the Principal Financial Group® (The Principal®), Des Moines, IA 50392.

© 2013 Principal Financial Services, Inc.

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  • Earl Sanders

    The real sins are:

    1) what’s an ACP test?
    2) what’s a compensation ratio test?
    3) what do you mean ‘rate of match’ testing?
    4) what do you mean when I have 2 years of eligibility i can’t change to the calendar year for the measurement period?

    and the #1 sin of 403b plans is…

    5) What do you mean ‘universal eligibility’?

    cue the band

    • Aaron Friedman, National Practice Leader – Tax-Exempt, the Principal Financial Group, Princor Registered Representative

      Thank you for your comment Earl. There are certainly a host of errors, and lack of understanding by many 403b plans.

      Stay tuned for the next two parts of this blog post for the rest of my top 7 list.