(b)lines Ask the Experts – Why Offer Both a 401(a) and 403(b)?

Michael A. Webb, Vice President, Retirement Services, Cammack LaRhette Consulting, and David Powell, Groom Law Group, answered:    

There historically was a valid reason for maintaining a 401(a) and 403(b) plan with the same employer. Several years ago, the contribution limits were not as flexible as they are today. For example, the 415 limit on total contributions to a retirement plan (employer and employee), was once 25% of compensation, not 100% of pay as it is today. And the definition of compensation was more restrictive, excluding many types of pre-tax deductions.  

Thus, even employers with modest employer contribution amounts would find that their employees would often be restricted from deferring the maximum amount of employee voluntary salary reduction contributions to their 403(b) plan by the 415 limit. The solution was to set up a separate 401(a) plan for employer contributions. Though that plan would also have a 25% of compensation limit, it was a SEPARATE limit from the 403(b) plan, so employees (with some limited exceptions beyond the scope of this Q&A) could then defer the maximum into the 403(b) plan even if the total contribution amount exceeded 25% of compensation. In addition to the deferral limit issue, at one time the regulations regarding 403(b) plans were far less clear as to permissibility of certain types of employer contributions and designs in the 403(b) plan, so the 401(a) was viewed as a “safe” alternative to this uncertainty.  

However, with the passage of time, the rationale for such a plan structure has faded. The principal reason to establish such a plan structure today is if the employer contribution is SO large that it would impact the 415 dollar limit for highly compensated employees, necessitating a separate plan so that such employees could make voluntary salary deferrals up to the maximum permissible amount.  

However, though the 401(a) plan may be terminated, many plan sponsors have chosen to freeze their 401(a) “legacy” plans as opposed to terminating them, because the 401(a) plan cannot be merged into the 403(b) plan, and out of concern that employees, who would then have a right to receive a distribution of their 401(a) funds, would utilize the funds for non-retirement purposes rather than elect to roll them over to the 403(b). However, if the 401(a) plan is not terminated, significant ongoing administration is required, including all reporting and disclosure requirements (e.g. 5500s) for ERISA plan sponsors, and keeping plan documents current and administering benefit transactions for all plan sponsors.  

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.