Recently, the Principal Financial Group and the Profit Sharing/401(k) Council of America (PSCA) released a new study indicating that 403(b) plan sponsors are coping well with the changing regulations and evolving markets. BenefitsPro spoke with Aaron Friedman, the national practice leader for nonprofit with the Principal Financial Group, about some of the key issues surrounding 403(b) plans. Friedman has been in the retirement plan business for 25 years.

BenefitsPro: There have been a lot of regulatory changes lately in regards to 403(b) plans. Can you outline these changes briefly?

The second new regulation came from the Department of Labor. It made significant changes in reporting for ERISA plans. Beginning with the 2009 plan year, ERISA 403(b) plans are now subject to the same requirements as 401(k) plans for Form 5500 reporting, including the need for an independent audit. Before this change, ERISA 403(b) plans only had to fill in a small number of items on Form 5500. They did not have to provide financial information and they were exempt from the audit requirement. 

In addition, ERISA 403(b) plans must also comply with the new fee disclosure rules.

AF: The rules are highly technical and require a level of expertise that rarely exists in-house at nonprofits. This is especially true at 501(c)(3) organizations that are focused on deploying all resources toward a charitable cause. For that reason, it's essential that 403(b) plan sponsors hire an advisor to help. 

The need for advisors is greatest among organizations that are operating non-ERISA 403(b) plans. These plans usually have a variety of compliance monitoring systems because they've been put in place by multiple vendors whose objective is to retain in-force business. 

Contrast this with the plans that either were already operating as ERISA plans or have converted to a true ERISA arrangement, where advisors help set up plan documents, robust governance and due diligence procedures. These plans have compliance covered.

AF: The penalties could impact both plan sponsors and their participants. Participants of a plan in violation could lose the tax deferred status of their 403(b) account. If the violation is found down the road, it could mean retroactive taxes and penalties. 

At plan sponsor level, failure to prepare and file a Form 5500 on time could result in penalties of up to $1,100 per day. 

Beyond those penalties, plan sponsors and participants pay another kind of price. A non-compliant plan is likely to be a less effective retirement savings vehicle. These plans are likely to be poorly structured, without governance procedures, and probably not part of an overall benefits strategy.   

An advisor can play an important role in helping plan sponsors analyze their objectives and incorporate their 403(b) plan into an effective benefit strategy.

BP: In the survey, you found that 12.3 percent of plans have an automatic enrollment feature. Is this comparable to 401(k) auto-enrollment usage? Why are larger plans using auto-enrollment more than smaller plans? How does auto-enrollment affect participation?

AF: 403(b) plans typically lag behind 401(k) plans when it comes to adopting new ideas, and auto enrollment is no exception. According to the PSCA's 53rd Annual Survey of Profit Sharing and 401(k) Plans, 38.4 percent of 401(k) plans have an auto-enrollment feature, more than three times the number of 403(b) plans.

The auto-enrollment take-up rate is greater among larger employers because bigger plans are more likely to use the services of advisors. Larger plans also tend to lead the market in adoption of new features.  

Auto-enrollment does impact savings behavior. A recent study of our block of business at the Principal Financial Group shows that automatic enrollment significantly boosted participation in retirement plans. The data reveals a 20 percent increase in participation in plans with an automatic enrollment feature compared to participation in plans without the feature.

However, the overall average deferral rate in plans with auto-enrollment is generally lower than in plans without auto-enrollment. This is largely because most auto-enrollment plans tend to set a relatively low initial deferral rate. Without auto-escalation, most participants tend to stay near that initial lower rate. 

The good news is that when plan sponsors set higher auto-enrollment default rates, participants tend not to opt out. Our study showed that raising the default percentage from 3 percent to 6 percent resulted in only a 4 percent increase in opt outs. This demonstrates that plan sponsors can boost default deferral percentages and improve savings rates without a significant drop off in participation. 

AF: There is an increasing emphasis in the overall marketplace on how well both 401(k) and 403(b) plans support retirement readiness.

Nonprofits with multi-provider and non-ERISA 403(b) plans will find that simply offering access to retail savings vehicles is not enough to effectively provide retirement readiness for the majority of their employees.

So there will continue to be an evolution toward converting to a responsible ERISA structure. This transition will facilitate both compliance as well as long-term financial health — retirement readiness — for a majority of their employees.

What it all points to is a significant opportunity for financial professionals as more and more 403(b) sponsors look for help. PSCA's 2011 403(b) Plan Survey shows that more than 45 percent of respondents are now using an independent investment advisor to help with fiduciary responsibilities compared to 41 percent in 2009. The survey also shows that 11.1 percent of all 403(b) sponsors are planning to issue a request for proposal in the next 12 months.