Nonprofits, School Districts and Hospitals, Beware: 403(b) Plans Targeted

Compliance.BLOGLate summer of 2016 brought a group of targeted class actions against 403(b) plans sponsored by nonprofits, school districts, and hospitals.

Inadequate fiduciary practices and little government regulation have locked some 403(b) plans into contracts, some with excessively high fees and surrender charges unknown to participants and employer sponsors. Historically, 403(b) plans operated a bit like the wild, wild West, with no regulatory oversight. In fact, the IRS, in announcing its 2016 priorities, said 403(b) plans have a “historical pattern of non-compliance.” The agency announced it will review 403(b) and 457(b) plans of tax-exempt organizations starting in 2016. Threatened since the latest 403(b) regulations became effective in 2010, this is the year that 403(b) plans have hit the IRS priority list for auditing and investigation.

Current 403(b) plan regulations require plans to have a written plan document and Summary Plan Description and to follow the additional reporting and disclosure requirements of the Employee Retirement Income Security Act. Legacy 403(b) plans had largely relied on contracts for annuities, often with fee arrangements that are difficult even for experts to explain. While the compliance deadline for 403(b) plans has long passed, some plans remain in the old frontier days, out of compliance with ERISA and Form 5500 filings and vulnerable to Department of Labor (DOL) and IRS fees and penalties. Some nonprofits have been targeted for audit based on a mention of a 403(b) plan in their 990 filing when no matching Form 5500 could be found when the DOL ran the comparison. Lesson? 990 disclosures should match Form 5500 filings for each year a 403(b) is mentioned. This also holds true for 457(b) Plans reported in 990s. They are matched against the DOL-required, one-time Top Hat filings.

There is a new sheriff in town in the form of aggressive plaintiffs’ firms targeting 403(b) plans for class-action suits. The initial wave hit some of our most prestigious universities over the last couple months. The claims are familiar: excessively high fees for investments and recordkeeping services. Historically, 403(b) plan fees have run significantly higher than 401(k) fees.


One lawsuit quoted Aon Hewitt’s 2016 survey, revealing that 403(b) plan mutual fund investments had a weighted average fee of 0.97 percent, whereas fees on annuities averaged 2.25 percent for variable and 1.15 percent for fixed. Yet, over 75 percent of all 403(b) assets are held in both annuities, more variable than fixed.

Associated with the excessive fees for recordkeeping are the surrender charges hidden in annuity investment options. When participants terminate and are ready to withdraw their funds, the balance can be reduced by “surrender fees” for investments that may not have remained in the annuity for the full “surrender period.” Some surrender periods are up to 12 years. Withdrawal before the surrender period results in these fees.

These lawsuits also claim that 403(b) plans offer too many investment options from which to choose, triggering “decision paralysis” among participants. Plans that offer too many investment options–perhaps in an effort to accommodate employee preferences and choices–end up confusing employees, who become overwhelmed, lose interest, or get frustrated. Johns Hopkins’ plan offers 440 different investment options from which to choose. For years, benefit experts have been suggesting reducing fund options to something manageable. Further, it is easy to dilute one asset class, such as aggressive equities, by offering five or more aggressive equity funds managed by differing providers. Recordkeeping fees are paid to each by participants, whereas putting all those assets into the same fund can reduce fees with efficiencies of scale.

What are the chances your 403(b) could be targeted in a lawsuit? Below are some actions that can reduce your risk:

  • Review the adequacy of your fiduciary liability insurance.
  • Confirm that you and the benefits committee are indemnified.
  • Make sure your 403(b) Plan Document exists and that it is compliant; ditto with the Summary Plan Description.
  • Confirm that you have retained copies of mandatory ERISA disclosures including the fee disclosures.
  • Follow the rules and procedures in your formal documents. Or, amend your plan documents.
  • Review investment performance and associated fees with providers. If unclear on fees, ask!
  • Document all benefit/board committee meetings, plan reviews and decision-making, as well as provider comparisons and benchmarking results.
  • Know your plan fiduciaries internally and, if applicable, externally. Confirm this is in writing.
  • Consider obtaining a confidential 403(b) compliance review from your benefits counsel or MSEC.