Typically, 403(b) plans are defined-contribution plans that allow participants to shelter money on a tax-deferred basis. Some nonprofits may be able to establish a Roth 403(b) plan or allow plan participants to make after-tax contributions.
In an effort to make it easier for American workers to save for retirement and for employers to set up and maintain workplace retirement plans, the House of Representatives has proposed the Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the SECURE Act.
This is big news because of the wide range of organizations that can offer 403(b) plans, including:
- Public school systems
- Cooperative hospital service organizations
- Uniformed Services University of the Health Sciences (USUHS)
- Public school systems organized by Native American tribal governments
- Any 501(c)(3) institution which might include a nonprofit university, religious organization or social service agency (consult Publication 571 for more details)
While the media has focused on the effects of the SECURE Act on 401(k) plans, this proposed legislation includes several changes that will also affect the way that 403(b) plans operate. Given that in 2016, there were over 1.56 million nonprofits employing over 12.2 million Americans, that’s a lot of changing 403(b) plans.
Increased Tax Credits for Setting Up a 403(b) Plan
To encourage more public schools, churches, and other eligible tax-exempt organizations to set up a 403(b) plan, the SECURE Act includes a provision to increase the current retirement plan startup cost tax credit from up to $500 per year to up to $5,000 per year.
This tax credit benefits small organizations with up to 100 employees, at least one plan participant who isn’t a highly compensated employee, and employees who weren’t receiving substantial retirement benefits through another plan sponsored by the same or another organization.
The proposed change increases the potential tax credit for setting up, managing, and educating employees of 403(b)-eligible organizations to up to $15,000 over a three-year period.
New Tax Credit for Automatic Enrollment in 403(b) Plan
To further encourage more nonprofits and other tax-exempt organizations to set up and maintain a 403(b), legislators also proposed a new tax credit of $500 per year to 403(b) plan sponsors that add an automatic enrollment feature.
The many benefits of automatic enrollment mean an increasing number of employers are opting for automatic enrollment for workplace plans. At the end of 2018, 48% of Vanguard retirement plans adopted automatic enrollment and 61% of new plan entrants were enrolled via automatic enrollment. Keep in mind that this stat from Vanguard is from a sample of 5 million participants across 1,900 retirement plans!
Learn more about how to claim these two tax credits for your 403(b) plan.
Portability of Lifetime Income Options of 403(b) Plans
403(b) plans limit investment options to annuity contracts or custodial accounts in mutual funds, which are forms of lifetime investment options. Some churches and religious organizations may have additional investment options, but the majority of 403(b) plans focus on lifetime income investments.
Previously, if a 403(b) plan were to be terminated or a lifetime income investment option under the plan were to be discontinued, a plan holder would have had to pay surrender charges and fees to transfer the lifetime income investment into another plan.
The SECURE Act allows 403(b) plans to make a direct trustee-to-trustee transfer to another employer-sponsored retirement plan or IRA of lifetime income investments or distributions of a lifetime income investment in the form of a qualified plan distribution annuity, should a lifetime income investment no longer be authorized as an investment option under the plan.
This change allows 403(b) plan holders to retain their lifetime income investments and avoid surrender charges and fees.
Treatment of Custodial Accounts on Termination of 403(b) Plans
Currently, when plan administrators terminate the 403(b), plan holders and/or their surviving beneficiaries may be hit with an unexpectedly large income tax bill, on top of surrender charges and fees. The SECURE Act takes special action to prevent a surprise tax bill by requiring the plan administrators to include an option for distribution of an individual custodial account in-kind to a participant or beneficiary in the event of a 403(b) plan termination.
This proposed change is a good one because it means a 403(b) individual custodial account would retain tax-deferred status until paid out. Additionally, the SECURE Act proposes that this change is effective no later than six months after the date of enactment and retroactive for all taxable years beginning December 31, 2018.
Permitted $5,000 Distribution In the Event of Birth or Adoption
Given the focus on tax-deferred contributions to 403(b) plans, there are very few under which participants can withdraw funds. Some 403(b) plans may allow for hardship distributions, but birth or adoption costs are usually not on the list of eligible reasons to take a hardship distribution.
The SECURE Act changes this by allowing a penalty-free withdrawal of up to $5,000 from a 403(b) plan for “qualified birth or adoption distributions.” Keep in mind that while the 10% early distribution penalty may be waived, applicable income taxes (including capital gains taxes) still apply in this case.
Are you interested in setting up a 403(b) plan for your non-profit organization or need to prepare to make the most of the upcoming changes with the SECURE Act?
Human Interest has helped several small businesses to set up, implement, and maintain a 403(b). We take care of creating participant accounts, processing contributions every pay period and syncing them with your payroll provider, as well as ensuring that all compliance testing and paperwork is completely taken care of.
If you would like to learn more about the process of setting up or improving a 403(b) or another plan that better suits your organization’s needs, please click here to contact us. We’d be happy to help!