How 403(b) Plans Became More Like 401(k) Plans

Regulatory changes are narrowing down the differences between the two largest kinds of defined contribution plans in the U.S. retirement market.

While 401(k) and 403(b) plans have historically offered significantly different experiences and investment options for both plan sponsors and participants, the dissimilarities between the two plans have been disappearing in recent years thanks to regulatory changes.

That trend began after the Pension Protection Act of 2006 required that 403(b) plans subject to the Employee Retirement Income Security Act would need to have a plan document and comply with qualified plan rules.

The 2024 PLANSPONSOR 403(b) Market Survey includes data from 27 recordkeepers reporting on their U.S. defined contribution recordkeeping business and focuses on recordkeeping of more than $1.3 trillion in single-employer 403(b) plan assets, including 70% in non-ERISA plans and 30% in ERISA plans. The same survey found roughly $7.3 trillion in single-employer 401(k) plans as the regulatory distance between the two types of retirement plans continues to narrow.

“It used to be that a plan sponsor could just sign up and get out of the way and let the plan vendor take care of everything, but that’s no longer the case,” says David Ashner, an attorney with Groom Law Group.

Recent changes have further increased the overlap between the 401(k) plans and the 25% of 403(b) plans subject to ERISA.

“[The Setting Every Community Up for Retirement Act] and SECURE 2.0 [Act of 2022] continued the trend of 401(k)-ifying the 403(b),” says Ashner. “Now a new employer has less reason to prefer a 403(b).”

Among the changes made by SECURE 2.0, 403(b) plans that are subject to ERISA:

• May participate in multi-employer plans (MEPs) and pooled employer plans (PEPs);
• Have new rules for hardship withdrawals that align with rules for 401(k) plans;
• Are now subject to the same rules requiring eligibility for long-term, part-time workers as 401(k) plans; and
• May now offer ‘de minimis’ (small-value) incentives to employees for participation or other engagement activities.

A Less Consequential Choice

The choice between plan types has become a less monumental one, given how comparable the plans have become.

“The modern version of the 403(b) plan is very similar to the modern version of the 401(k),” says Michael Gorman, an associate with Morgan Lewis. “There aren’t that many significant differences.”

SECURE 2.0 also included a provision that would allow 403(b) plans to expand the types of investments (currently only mutual funds and annuity contracts) they can offer to participants. However, while the law took care of the tax regulations that prevented 403(b) plans from offering collective investment trusts, which tend to be less expensive, it did not address the security regulations.

There is, however, pending legislation in Congress—widely expected to pass—that would finally permit 403(b) plans to offer these types of investments. CITs are generally less expensive than mutual funds, since they are not securities and do not need to be registered with the Securities and Exchange Commission.

Meanwhile, target-date funds have become more popular in ERISA 403(b) plans and are now available in 88% of plans, up from about 50% in 2009, according to data from the Investment Company Institute/Brightscope. Despite the restriction on asset types, investment costs in 403(b) plans are lower than those in 401(k) plans, averaging 0.51% of assets in 403(b) plans, compared with 0.83% in 401(k) plans.

Adding Automatic Provisions

SECURE and SECURE 2.0 also made both 401(k) and 403(b) plans eligible for many of the same optional provisions, including matching contributions based on student loan payments, Roth treatment of certain employer contributions, and an increase in the balance required to trigger a mandatory distribution when participants with small account balances separate from the plan. Plus, all newly created plans—401(k)s and 403(b)s—must include automatic enrollment and automatic escalation features, starting in 2025.

That is a significant change for 403(b) plans, nearly 70% of which still had not implemented auto-enrollment in 2022, although the share who did use such features is on the rise, according to the Plan Sponsor Council of America.

Meanwhile, the original SECURE Act cleared the way for more 401(k) plans to offer annuities or other lifetime-income products in their investment menus, although relatively few have been widely adopted in 401(k) plans.

“If you think your employee base might be interested in lifetime income, that could weigh in favor of a 403(b) plan,” Gorman says. “There’s a longer history of 403(b) plans permitting annuity options, so there might be value to running the plan through the 403(b) structure instead of as a 401(k).”

Still Some Distinctions

A few differences remain between 403(b) plans and 401(k) plans. These include an extra catch-up contribution for long-term 403(b) plan participants nearing retirement and the requirement for 401(k) plans to conduct—and pass—actual deferral percentage testing.

“On a granular, compliance level, the universal availability rule does make 403(b)s more attractive, relative to 401(k) plans, for employers that don’t want to deal with the [nondiscrimination] testing issue,” Gorman says. “But if you offer a safe harbor plan, you can mitigate some of that compliance risk.”

While plan sponsors can create their own plan design, 403(b) plans tend to offer more investment options (limited to annuities and mutual funds) than their 401(k) counterparts. Analyses by ICI/Brightscope found that large ERISA 403(b) plans offered an average of 42 investment options on their menu (with mutual funds the most common investment option), compared with an average of 28 investment options in 401(k) plans. That’s at least partly because, historically, 403(b) plans have featured multiple providers, each of whom offered their full range of investment options to participants.

While those and other differences remain, the SECURE and SECURE 2.0 laws have made 403(b)s more like 401(k)s.

—Beth Braverman