The SECURE 2.0 Act, signed into law in 2022, made several changes to qualified retirement plans, such as 401(k) plans. Although provisions applicable to 401(k) plans have been well-documented, how SECURE 2.0 impacts 403(b) plans — normally offered to employees of not-for-profit organizations — isn't as well understood. But if they haven't already, nonprofit employers may be required to update their plan documents. Here's what you need to know.
403(b) plans are commonly offered by charities, public schools, churches and other tax-exempt employers. Similar to 401(k) plans, 403(b) plans enable employees of qualified organizations to defer a portion of their salaries to individual accounts. The deferred salary and earnings on investments aren't taxable until participants make withdrawals (typically after they retire).
The rules governing 403(b) plans are also fairly comparable to those of 401(k) plans. For example, just as 401(k) plans can't discriminate against lower-paid workers, the "universal availability rule" for 403(b) plans requires nonprofits to offer the same basic participation opportunities to all eligible employees.
SECURE 2.0 includes four provisions that can significantly change 403(b) plans:
1. Hardship distributions. The law allows 403(b) plan participants to make in-service withdrawals to satisfy an "immediate and heavy financial need" that can't be satisfied through other financial sources. IRS regulations have established standards for approving financial hardship withdrawals, including a safe harbor option. SECURE 2.0 simplifies administrative matters by allowing 403(b) plan sponsors to self-certify that a vested withdrawal is made on account of an immediate and heavy financial need within the allowable limits. This change is effective as of the law's date of enactment.
Historically, the rules governing 403(b) plan hardship distributions were more stringent than those for 401(k) plans. Prior to SECURE 2.0, hardship withdrawals from a 403(b) plan could be funded only from the employee's elective deferrals, not from earnings. Effective for plan years beginning after 2023, 403(b) plans may allow hardship withdrawals of nonelective and matching contributions — including earnings on such contributions — as well as earnings attributable to elective deferrals.
2. Multiple employer plans (MEPs) and pooled employer plans (PEPs). Administering a 403(b) plan can be costly and burdensome, but SECURE 2.0 provides reasonable administration alternatives. Effective for plan years starting after 2022, most nonprofit employers offering 403(b) plans can participate in aggregated MEPs and PEPs without jeopardizing their tax-exempt status. Such options generally save participating employers time and money.
3. Part-time employees. Under the original SECURE Act of 2019, employers with 401(k) plans were required to allow part-time employees who complete at least 500 hours of service in three consecutive 12-month periods to make elective deferrals. For plan years beginning after 2024, SECURE 2.0 allows part-timers who complete at least 500 hours of service in two consecutive 12-month periods to make elective deferrals from 401(k) plans. SECURE 2.0 generally extends this rule to 403(b) plans.
That said, the actual impact of the part-time employee rule change may be negligible for 403(b) plans because employees of 403(b) plan sponsors generally are eligible for elective deferrals. But you should review the terms of your 403(b) plan to determine whether you need an amendment that enables it to satisfy the new rules for part-time workers.
4. Collective Investment Trusts (CITs). Generally, 403(b) plan investments are limited to mutual funds and annuity contracts. SECURE 2.0 expands the list of options to include CITs, which are tax-exempt pooled investment vehicles that hold assets attributable to certain employer-sponsored retirement plans. However, there's a major caveat: Currently, Securities and Exchange Commission regulations effectively prohibit investments in CITs through 403(b) plans. So, until this conflict is resolved, CITS are generally off-limits for 403(b) plans.
Note: Initially, SECURE 2.0 addressed CITs, but critical language was omitted from the final version of the law. If and when Congress revisits the issue, CITs could become a more significant factor in 403(b) investment decisions.
The four SECURE 2.0 provisions affecting 403(b) plans are complex in nature. If you haven't already, you may need to amend your plan documents to account for them. Be sure to seek help from experienced retirement plan and tax advisors.
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