A title like this one was bound to happen; and I was tempted to publish it on April Fool’s Day-except that its really not a joke.

Where it comes from is the simple fact that any DC Lifetime Income Program (ok, why not, lets use the acronym “DCLIP” while we’re at it) that guarantees lifetime income needs to have the ability to make an “in-kind” distribution of an annuity contract, whether that be a certificate under a group annuity contract or an actual individual annuity contract. This is because the transfer of any actual guaranteed income rights which may have been accumulated under a DCLIP must (currently) involve insurance somewhere in the chain of things, and an insurance company can only embody those rights in an insurance contract. The transfer of these insurance contract rights are accomplished by way of an “in-kind” distribution/transfer from the plan of the contractual rights under the DCLIP to an IRA of some sort, as a rollover; or by a distribution directly to the individual of those contractual rights in the form of an annuity.

These distributed annuities are generally referred to as the “Qualified Plan Distributed Annuity” (or the “QPDA”), though they may operate under various other names: Section 109 of SECURE 1.0 refers to them “qualified plan distribution annuity contracts”; 1.401(a)(31)-1 Q17 refers to them as “qualified plan distributed annuity contracts”; Rev. Run 2011-7, for 403(b) plans, refer to them as “fully paid annuity contracts.” The keys under the QPDA is that it is not a rollover to an IRA; the distributed contract retains the salient characteristics of the plan from which it was issued; and its distribution is not a taxable distribution from the plan.

Where the annuity contract had been previously purchased and (and held) by the plan as an investment, the subsequent distribution of the annuity as a QPDA is not a typical financial transaction on the books of the insurer. The ownership of the contract is merely transferred from the plan to the former plan particpant.

Therein lies the rub for the Independent Qualified Public Accountant (IQPA), which audits the books of the plan: there does not appear to be a well developed, standardized protocol in the auditing process under which the QPDA distribution can be verified as compliant with auditing standards. It is not that the insurer is not willing to certify that the distribution of the annuity contract has occurred, or that the distribution was appropriate and made in accordance with the plan’s governing documents. Instead, it becomes a point of “discussion” with the auditor as to what is an acceptable confirmation of the process. Especially as these distributions become more common, as I fully expect them to be, I would hope that the the auditing profession develops a sensible standard upon which we can all reasonably rely to document the validity of the distribution.

Many practitioners will point to the 2007 403(b) regs (the “new regs” as many of us often still call them, 16 years later…) as being a real seminal moment in the market, and probably rightfully so. However, an even more fundamental development occurred some 7 or 8 years earlier, which still has deep reverberations in the way these plans operate: the quirky 403(b) master custodial arrangement.

Prior to the development of the “master custodial account,” 403(b) plans were solely funded with group or individual annuity contracts issued by insurance carriers, or with individual custodial agreements entered into between the plan participant and the mutual fund company. Typically, these individual custodial contracts were funded solely with proprietary mutual funds of the “custodian, ” and under which retail priced retail mutual fund shares were widely used.

Back then, the “holy grail” of product manufacturers was to make 403(b) plans look and act like 401(k) plans. Many will recall that, at that time, there were even substantial legislative and policy efforts at creating a single, unified, all encompassing, type of defined contribution/elective deferral plan (the “RISA” anyone?). Well, the legislative efforts collapsed under their own weight, as the historical differences between the different types of tax-deferred savings plans made any sort of plausible transition to a “unified” approach virtually impossible. But that did not stop the continuing market efforts to make 403(b) and 401(k) plans look as much like each other as possible.

The route a handful of us chose to accomplish this was based on the notion that nothing in the 403(b) rules required that a custodial account be issued to an individual, as opposed to the plan sponsor. It occurred to us that, as long as the “custodial agreement” was able to be structured in such a way as to honor the SEC rules which demanded that the individual participants in that master account still be treated as the owners of the shares in that account, there was nothing in the Code or ERISA which prevented such an arrangement.

So we quietly went about our work, without there being widespread knowledge of what we were pulling off. Auditors were, and often still are, confused by these arrangements, treating them like 401(k) trusts, which they are not. In a technical ASPPA session with Bob Architect, I had mentioned to him the growing use of these vehicles, and his response was classic: he looked at me and said “and, yeah, I’ve seen Bigfoot!

It is this vehicle which has facilitated the ability of 403(b) plan sponsors to access the favorably priced classes of mutual fund shares which generally still have very limited availability in the individual custodial account market. It also gave fiduciaries broad authority over the selection and removal of mutual fund shares, as these “master” contracts were designed to give the plan the same authority over plan investments that was exercised by 401(k) plans; and really enabled the widespread use of 3(21) and 3(38) investment fiduciaries for those plans.

There is a distinct and legal difference between the 401(k) trust and the 403(b) master custodial agreement, and I invite you to compare the two documents should you have the chance. One of the key differences is that the custodial account is technically still not a “trust” in the traditional way used in the 401(a) market-for example, the 401(a) trust is a tax exempt entity under 501(a), where the 403(b) custodial account is not. That account is merely deemed to be an “annuity purchased by section 501(c)(3) organization or public school” (to quote the Code). Though ERISA will treat the custodial account as a trust for Title 1 purposes, it still is not legally a trust. The design of the master account vehicle was even a hot topic of conversation with the IRS when it was drafting the 403(b) termination distribution guidance, and whether or not a custodian could “spinoff” an individual contract from the master. The IRS ended up covering such (I believe, non-sensical) circumstances, under Ruling 2020-23.

You’ll find that these are not distinctions without differences and, when you get down to the nitty gritty of building the processes around these accounts, you’ll find the there is much with which to be sensitive.

One of the inevitable results of Congress’s failure to cobble together some sort of compromise on what the most suitable “Securities Fix” would be for the 403(b) CIT is a flurry of activity to find some way to craft a solution which would permit 403(b) plans’ investments in 81-100 trusts without a statutory fix. From a purely technical point of view, any of the three or four different possible legislative approaches being considered are not, in themselves, a heavy lift. Yet, any of the choices very much impacts different constituencies in different ways: from favoring one part of the financial services industry at the expense of another; to having to deal with newly “grandfathered” types of arrangements; to the risk of putting certain classes of consumers-like schoolteachers-at risk. Ultimately, I believe that there is a sound, well balanced compromise to be had.

In the meantime, we’ve seen a number of different proposals which would permit at least some 403(b) constituencies to utilize CITs (outside of churches, of course, who have long been able to use them). These efforts are all possible because of the incredible complexity of dealing with not only one, but three different, comprehensive securities law statutes. Each of the three applicable laws (the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Company Act of 1940) have their own (sort of) coordinated exemptions which the investment industry has utilized successfully over the years to be able to permit certain investments by certain parties to avoid the registration rules. So it is little surprise to see the intellectual exercises we are seeing, attempting to construct acceptable methods to make the 403(b) CIT work.

What we’ve not seen much discussion of is of the risks involved in adopting any of these seemingly esoteric approaches. There is a pointed lesson taught to me by my mentor and dear friend, the late Roger Siske (though I am still convinced he shared this with me to give me sleepless nights, which, of course, it did) as we were looking at a particular plan trying to ascertain its compliance with the Securities laws: the “12 month put.” Should an institution (here, think the trustee of the 403(b) CIT) offer its interests to be purchased by 403(b) plan custodians or the participants in a 403(b) plan without complying with the terms of the ’33 Act, that purchaser is granted the right to rescind that purchase under section 12 for 12 months following the discovery of the violation. Effectively, this grants to the wronged purchaser the ability to sit and wait for a year for the market to move in its “favor” before asserting its “put.”

As I had suggested in previous postings, consider the risks before moving forward; they are substantial if you don’t get it right.

There are only ten (or so) different provisions under SECURE 2.0 which seem to have any sort of direct relation to the provision of Lifetime Income through defined contribution plans (“LI”), and none of them seem to have the bold, systemic effects that we saw under the some of the terms under Secure 1.0. The 2.0 lifetime income terms have “headline grabbing” titles like “Remove RMD Barriers for Life Annuities;” and “Removing a Penalty on Partial Annuitization;” and the particularly catchy “Surviving Spouse Election To Be Treated As Employee.” Though there are a number of technical questions which need to be addressed under each of these sections, none of them seem to have any broad, meaningful impact on the LI market.

That is except with regard to a little noticed rule change in the handling of Qualified Longevity Annuity Contracts (QLAC) under divorce orders or separation agreements (which include both QDROs and DROs) under Section 202 of the Act. Though that Section’s increase in the QLAC limit to $200,000 (indexed) and the removal of the 25% account balance restriction have been widely reported, Section 202(b) is the term which is more likely to have widespread, institutional impact.

Sect. 202(b) actually does not make any statutory change to any of the Code’s or ERISA rules governing the distribution of a plan’s assets pursuant to divorce or separation orders, or other any such landmark modification. Instead, it instructs Treasury to amend its QLAC rules, which are obscurely found under Required Minimum Distribution applicable to DC plans which purchase annuities (Reg 1.401(a)(9)-6). The regs must be changed to reflect that if a QLAC is issued as a joint and survivor annuity (which it is required to be unless spousal consent is obtained, under plans to which such rules apply), and a divorce subsequently occurs prior to the date the annuity payments actually begin, the DRO “will not affect the permissibility of the joint and survivor annuity benefits” as long as that order:

• provides that the former spouse is entitled to the survivor benefits under the contract;
• provides that the former spouse is treated as a surviving spouse for purposes of the contract;
• does not modify the treatment of the former spouse as the beneficiary under the contract who is entitled to the survivor benefits; or
• does not modify the treatment of the former spouse as the measuring life for the survivor benefits under the contract.

There are a number of technical issues to work through in these instructions, not the least of which is discerning the meaning of the term “will not affect the permissibility of the joint and survivor annuity benefits.” Curiously enough, this change is retroactively effective to the initial effective date of the QLAC reg, July 2, 2014, which may create a few other challenges.

Technical analysis aside, however, is the potential “downstream” impact of this provision on a wide number of plan participants, legal and professionals who represent plan participants in divorce proceedings. Where there is a QLAC in a plan, this means that a wide swath of professionals of all sorts may need to be involved in sorting through this issue in resolving a domestic relations matter.

Handling QLACs in QDROs has may well force the whole idea of DC LI into the a significant number of professional “portfolios” as a matter of necessity. Particularly given the the adoption of the QLAC by the University of California Retirement Savings Program, with its 320,000 participants and $30 billion or so in assets (the second largest public sector DC in the US behind the federal government), its impact may begin to become widespread. At the very least, a significant number of non-ERISA attorneys and accountants may now need to have to some basic understanding of the QLAC, and at least a little familiarity with the manner in which DC annuities work.

Is DC Lifetime Income about to go mainstream?

One of the more curious circumstances under SECURE 2.0 arises from Act Section 128, which purports to permit 403(b) plan custodial accounts to invest in interests in Collective Investment Trusts (CITs), referred to as “81-100” group trusts in the Act. Prior to the Act, 403(b) custodial accounts could only invest mutual fund shares. The IRS had actually attempted earlier to open the door to group trusts in 2011 when it issued Rev Rul 2011-1, permitting 403(b) assets to be comingled with 401(a) assets in the 81-100 trusts, but that effort ran into problems because of the Code provisions which limit 403(b) plan investments.

Section 128 fixed that part of problem, as it amended the Code to permit the investment of 403(b) assets in group trusts, alongside mutual funds. But, as the Senate Finance Committee noted in its own Committee Report to the EARN Act, “In order to permit 403(b) plans to participate in a group trust, certain revisions to the securities laws will be required.” Those necessary revisions, however, never made it into SECURE 2.0

Mike Webb, 403(b) guru and senior financial adviser at CAPTRUST, astutely raised the question many are asking as to whether this even matters for certain plans-like government 403(b) plans- because of certain government plan exemptions under the Securities Laws. (He also raised the issue of church plans, some of which already can participate in CITs. The church plan securities issue is well beyond the scope of this article, as the rules for them are much different). Mike and I discussed the matter in some detail, and for those thinking about pursuing this route, you should first seek serious securities law counsel before doing so. The downside risk of getting it wrong is pretty substantial.

First some background on the problem. In a nutshell, 403(b) investments, just like 401(a) investments, are technically considered “securities” under federal Securities Laws (more specifically, the Securities Act of 1933; the Securities Exchange Law of 1934 and the Investment Company Act of 1940). Each one of these laws, however, generally (with very important exceptions) exempt the “purchase” by plan participants of “interests” in their 401(k) plans, without which each 401(k) plan would have to “register” as securities. 403(b) plans (with some church exceptions) do not enjoy these same exemptions.

One result of the workings of these various securities law exemptions is that most 401(k) plans can offer “non-registered” Collective Investment Trust (CIT) interests (which are “81-100” trusts) to their participants as part of their investment line-up without either the plan or the CIT having to register with the SEC (as is required, for example, of mutual funds), but 403(b) plans generally cannot. The same problem runs to IRAs investments, which also do not enjoy such exemptions (even though Rev Rul 2011-1 also permits, as a matter of tax law, IRA participation in a group trust).

In the end, Congress could not agree on just what the legislative securities law “fix” should be before the law was passed. Any fix would be complicated, nuanced, and involve a number of important competing trade-offs, in part because of the difference in the very nature of 403(b) and 401(k) plans. The Code still refers to 403(b) investments as individual arrangements. It calls for the “purchase for an employee by an employer” of an annuity contract. This is a fundamentally different approach than the “trusteed governed” rules which governs 401(k) plans, where 401(a) recognizes “a trust created …. forming part of a …. plan of an employer for the exclusive benefit of his employees.” Consistent with this differing language is the SEC’s historic treatment of 403(b) participant as a “shareholder,” where the trustee of a 401(k) plan is treated as the shareholder. Yes, we’ve made great strides in the past decade in order to make 403(b) and 401(k) arrangements available on very similar platforms, but there is still a significant portion of the market in which 403(b)s are still handled as individual investments.

Add to this the practical impact of granting a broad based securities law exemption to a 403(b) plan’s investment in CITs, the enabling language of which does not limit what investments in which the CIT may engage. Especially in the case of those individually based 403(b) product purchases which have no governing oversight (think most K-12 plans, for example): such an exemption may strip any sort of federal regulatory protection from many of these participants, without any serious “backup” protection at all.

So, getting back to whether certain 403(b) arrangements offered by governmental entities may be able to offer CITs because of potential securities law exemptions, extreme caution is the watchword. Those laws are complex, and the exemptions between the each of them can vary in very important ways. Consider instructive, however, that only the variable annuities which are registered have been able to be offered in this part of the 403(b) market, in spite of a wide variety of non-registered group annuities which are otherwise available to retirement plans. Similar rules will apply to the offering of CITs, as well. So, again, any decision to proceed will be complex, and will require advice of serious counsel.

Any discussion on any tax or securities law issue addressed in this blog (including any attachments or links) is NOT intended to provide legal advice, nor to create an attorney client relationship with any party.  

“Individual Annuities”-that is, annuity contracts which each cover a single person and their beneficiaries-are uncommon in 401(a) plans (403(b) plans are quite another story, to be discussed in a later writing).”Group annuities” -where a single annuity contract covers a group of participants-are, on the other hand, quite commonplace in retirement plans (yes, even 403(b) plans). The reason for this may well be both historical and technological: in a plan that, let’s say, covers 1000 employees, it has  in the past been a bit klutzy  to enter into (and administer) each one of those individual annuity contracts for each participant. Yet there are a number of elements of an individual annuity which makes them uniquely suited to address some of the more vexing logistical issues that arise in the implementation of a DC Lifetime Income program.

Enter technology, without which I don’t believe providing any sort of robust DC Lifetime Income program can really be possible. Each of the innovative programs we are seeing enter into the Lifetime Income market are heavily reliant on technology, often provided by what is commonly referred to as “middleware,” a term with which fiduciaries will become well aware. This middleware does a number of things, the most important of which is serving effectively as the “translator” between the sophisticated products providing lifetime income and the plan’s own participant records. That middleware is often used as the technological solution for the use of individual annuities where they haven’t been able to be used before.

There is an important cautionary note, however, in the use of individual annuities in plans. What has happened over time is that a large number of  insurance companies have developed two different sets of internal compliance and administrative processes, one which which applies to individual annuities (as they have been sold on a retail basis to individual consumers) and another, separate set of them which applies to group annuities (which have been largely sold to retirement plans).

Take group annuities. They can vary widely in design, from merely being a plan level investment of the plan, all the way  to the insurer establishing formal legal relationships with the participant through the issuance of a “certificate.”   There exists a very sophisticated industry established around the provisions of the group annuity in the retirement plan space, which is focused on ERISA’s fiduciary rules and matters of plan level compliance. Regardless of the particulars of any group annuity design, the one thing these contracts have in common is that they are designed to comply with the whole panoply of rules which apply when a retirement plan  purchases an insurance contract. There is, for example, an extensive set of ERISA rules which govern the use of annuities in retirement plans, from the ubiquitous PT exemption 84-24, to the Form 5500’s Schedule A, and many other requirements in between. The FINRA rules which apply to the sale  of annuities to plans are also different than those which apply to the sale of annuities to individuals, and the various anti-money laundering and OFAC rules apply in much different ways as well. Even the state laws governing the filing and approval of these contracts can be different. Insurers, though, are well skilled at these retirement plan practices.

Then there is, on the other hand, also a  very sophisticated industry established around the provisions of the individual annuity in the consumer driven  retirement income space, which is focused on ways to enhance and protect an individual’s financial well being-but outside of retirement plans. There are impressive mathematical models which continue to be developed (see, for example Wade Pfau’s and Alex Murguia’s new RISA being amongst the most prominent of them)which are designed to enable the design and implementation of personalized retirement income planning strategies aligned with individual preferences.  All of these kinds of services rely heavily upon the appropriate use of different types of guarantees provided by insurance companies, and matching them up with an individual’s own risk profile and preference. Like group annuities, individual annuities also have their own wide range of compliance requirements, which apply in different ways than to the sale of annuity products to retirement plans.  Insurers are also well skilled at these rules governing the individual annuities.

For the valuable, well established,  elements of the individual annuity retirement income space to successfully “crossover” into the DC Lifetime Income market, the group annuity “infrastructure” needs to be exported to the individual product side of things. This is where the “engineering” comes in, as aligning these products with new infrastructure is not necessarily a simple task.

Simply put, this means that most of the commonly available individual annuities sold to consumers are not suitable for the purchase by most 401(a) plans as part of their DC Lifetime Income program without changes being made to the design, administration and compensation (it is also worthwhile to note that the pricing and disclosure rules related to individual and retirement plan products can be vastly different). The differences can range from the types of disclosures being made, to the handling of money in and money out, to the manner in which it is all reported on required annual statements, along with a basketful of other sorts of requirements.

A number of insurers have made the investment necessary to accomplish this feat. It does, however, become a key fiduciary inquiry as to whether or not the annuity being purchased has been designed for use by retirement plans.  Recognize also that different products of the same insurer might be supported by different systems and processes, and the fiduciary will need to make sure it is getting to the right one.


Actuaries and mathematicians will tell us that the “actuarial cost” of any annuity you may purchase is effectively the same, no matter what sort of annuity you purchase. After all,  your life expectancy is what it is; the interest rates are what they are; and the insurance companies investments supporting the lifetime guarantees are what they are. The thinking then goes that all DC lifetime income decumulation guarantees have essentially the same value.

In reality, however, insurance companies “slice and dice” different annuity guarantees for retirement plans  in a variety of different ways, and there can be a bit of diversity  in the design and pricing of those guarantees.  For example, the promise of an enhanced future benefit which may provide increases in the payout over time (providing a measure of inflation protection) may  pay an initial monthly payout amount which may be less than what a comparable premium could purchase as a straight  life annuity; or the nature of certain so-called “high water mark” guarantees can differ vastly from product to product, and be balanced by the presence-or absence-of other features. Each insurer builds in these sorts of “favored” features into their products, and each of these choices may differ from insurer to insurer, and product to product.

Even more globally, an insurer may choose (yes,  insurers have some degree of  choice in such matters) to maintain the highest A.M. Best rating of “A++”, while  another may choose instead to maintain an “A” rating.  The higher rating can actually be more expensive to maintain because of certain financial requirements for those ratings, like the level of reserves, which also can be reflected in the cost of the annuity. As another example, some insurance companies are simply better than others at hedging investments because of the time and expense they may have put in (or not put in) developing and maintaining those particular skill sets. This can impact the design of equity-related guarantees which any insurer can offer (like the popular GLWB (“guaranteed lifetime withdrawal benefit”)).

Regardless of these choices,  common among all of the potential  guarantee variants is the simple fact that the longer an insurer holds your money (and with more certainty), the better the guarantee the insurer will typically be able provide to the plan -as guaranteeing risk is, one could say, a risky proposition. That risk becomes more manageable with longer tenured assets. This is one reason why the typical QLAC is relatively inexpensive: the QLAC payout is determinable at the date of purchase; it is set to begin payout at a specified date (perhaps as far out as age 85); there is extremely limited ability to surrender the contract once it is purchased; and there is very little ability for the benefit to grow.

This means that a plan purchasing longevity guarantees is typically accompanied with a number of restrictions which are needed by the insurer to manage the risks it has undertaken.   Given that DC investments have been focused almost solely on the simple asset accumulation models, the typical defined contribution plan fiduciary (or, much less, the participant) has little familiarity with this side of the decumulation of assets. It is, however, conceptually similar  to those old fixed account programs which placed restrictions on a participant’s ability to transfer to computing funds (or other similar restrictions) in return for their being credited with a higher rate of return; or with the typical design  of a “fixed index annuity,” where the insurer limits the ability of the participant to change indices through the year in order to guarantee a “floor” on the plan’s investment in the contract.

So it is with longevity guarantees: there will be what are effectively “time based” restrictions necessary for the insurer to manage its risks in providing those long-term guarantees. A classic example can be found in the design of the typical GLWB. Under the GLWB, the plan participant has the ability to invest their account balance in such a way that it can accumulate an “enhanced decumulation” benefit over time. How this is done is that such programs provide the plan participant with both an “account value” (often referred to as the accumulation value) and a value called the “benefit base.” The accumulation value is the dollar amount which is carried on the participant statement as part of the participants accrued benefit under the plan, and which reflects the cash value of the participant’s assets in the program.  This “benefit base,” on the other hand, is a calculated number which actually has no cash value. However,  it IS the number upon which the participant’s guaranteed monthly payout will be calculated at the time of retirement (instead of the account value). Each insurer calculates this “benefit base” differently, but it is effectively designed to “grow faster” (sometimes substantially so) than the actual account value. It reflects the larger lifetime guarantee that the insurer will be able to provide to the participant even after the participant’s accumulation value is exhausted through GLWB-permitted withdrawals (withdrawing amounts in excess of those permitted under the GLWB contract will reduce the monthly payment-but only before actual “annuitization”-but more on that in another blog). All or a portion of this accumulated “benefit base” can  be lost, however, to the extent the participant liquidates all or a portion of their plan account which is holding the guarantee.  Such a participant who then wants lifetime income  at retirement will then need to use their plan account value to purchase an annuity, sans the enhanced guarantees.

There are a few key takeaways. First, “accumulating decumulation” rights is very much different than merely accumulating investment assets under a plan. In order to benefit from the value of these enhancements, participants and fiduciaries must be comfortable with accepting some restrictions on accessing plan funds. This is so very opposite to the mutual fund, daily trading world to which participants have become accustomed. Secondly,  any such “decumulation accumulations” have  built in restrictions which are necessary for the insurer to be able to provide those guarantees. Thirdly, the specifics of these restrictions are  not universal from program to program, and should be reviewed and understood. Finally,  this blog only discusses the accumulation of guarantees over time within a plan. There is a whole host of valuable guarantees which can also be purchased at the time of retirement as well.

Properly investing a portion of a plan account in a Lifetime Income program really does  demand some appreciation-and acceptance- of time and the nature of insurance products.  A reset of the familiar mindset, if you will.


It sometimes helps to go back to the basics when assessing the impact of changes to the law, including some of the most seemingly obscure of them. One of the most obscure of 403(b) rules lies in the structural difference between 403(b) and 401(a) plans.  This has really only arisen in the past in matters related to 403(b) failures-which have been well addressed by the IRS in the 403(b) regulations.

Think about this: the tax favored status of the contributions to a 401(a) plan, and of the earnings on the fund held by the plan, are derived by the tax exempt status of the trust which receives and holds those funds under Code Section 501(a). Here is the actual languagefrom 501(a):

(a) Exemption from taxation An organization described in subsection (c) or (d) or section 401(a) shall be exempt from taxation under this subtitle unless such exemption is denied under section 502 or 503.(a) .

The 401(a) trust is an actual  tax exempt organization. As a tax exempt organization, it is subject to the same basic rules which apply to any other tax exempt entity, that is, it must have a not-for-profit-exempt purpose.  An example on how this comes into play is that a 401(a) plan’s investments can be subject to Unrelated Business Income Tax under Section 512 if it invests in partnership or other business interests in such a way that is deemed to be, under the tax regs, as engaging in business activities for a profit.

Compare this to the 403(b) plan. The favorable tax status granted to 403(b) plan participants does not derive from the tax exempt status of any particular organization or entity. Instead, the statutory language makes it clear that it is derived from the contributions being made to an annuity contract, a custodial account or retirement income account that meets the rules under 403(b).  There is no requirement under 403(b) that the custodian of these funds (whether it be an insurance company or any other qualified financial institution) be treated as a tax exempt entity under 501(a) as a condition of the tax favored status of those contributions or earnings thereon. Even where the 403(b) assets are held by a custodial account, by a trust account which is designed to be a 403(b) custodial account, or by a retirement income account at a financial institution that also “custodies” 401(a) funds, the “tax status” of that trust is generally meaningless. The tax status of the funds are determined under 403(b), not 501(a).  Functionally, you see this difference in the 403(b) regulations where 403(b) plans themselves do not suffer “tax qualification” failures: it is each contract which is governed by the failure which governs the actual tax effect.

To apply the 401(a) UBIT example, this means that a 403(b) plan’s investments is not subject to Unrelated Business Income Tax under Section 512. This has generally been a distinction without a difference because 403(b) plans (except, perhaps, church retirement income accounts) could not invest in partnerships or other business interests in such a way that is deemed to be engaging in business activities for a profit.  It could only be invested in mutual funds and annuity contracts.

So how, may you ask, is any of this relevant? Its relevance arises when we assess how to implement the tremendous changes that we see on the horizon, whether it be  implementing unique lifetime income vehicles,  PEPs, collective trusts, or any other of the sort of the innovative programs being developed which are designed to enhance retirement security. A number of these changes will require a close look at the manner in which the organizational “status” of the investment or the custodian will come into play. As importantly, this serves as a reminder that these dramatic changes all require close attention to this sort of detail. After all, once again, a 403(b) in not a 401(a)…..

I had just completed a fiduciary training session for a client’s Board in South Bend, IN,  when one of the more senior board members pulled me aside to tell me a story.  His father had been employed by Studebaker when it went under in 1963-and took its pension plan with it.  As the story goes, and which I had shared earlier with the Board,  the financially struggling automaker had borrowed money from its pension fund in order to keep the company afloat. The company did not steal the funds (it was fully obligated to repay the money back to the plan) but it was a transaction in which a “prudent fiduciary”  would not have engaged. Indeed, it was only the influence of the corporate officers on the pension board which enabled the transaction.

History tells the rest: the company went belly-up, not only causing the loss of 4,000 jobs, but also their pensions. That board member discussed the horrible consequences suffered by the former employees and the community at the time. It is that bankruptcy, and loss of the pensions, which served as the “policy trigger” which resulted in the passage of ERISA some ten years later. ERISA would have prevented that disastrous loan which lead to eventual collapse of the retirement plan. It also introduced those important tools which are now central to the operation of plans like enhanced fiduciary standards, tougher minimum required funding standards, the  prohibited transaction rules and-for DB plans-pension insurance.

As awful as the Studebaker collapse was,  it does evidence the stark reality that the market virtually demands that companies (think “plan sponsors”…) either radically change or go out of business over time. Think about the following:

  • No company on the original 1928 Dow Jones Industrial Average  is part of the current DJIA.
  • Of  the five hundred largest U.S, Companies in 1957, only 74 were still part of that select group, the Standard and Poor’s 500, forty years later. Only a few had disappeared in merger; the rest either shrank or went bust. (from the “The Black Swan,” by Nassim Nicholas Taleb, Random House, 2007,” p. 22).

This all  has incredible relevance in a  market under which the “decumulation” of retirement benefits has shifted from defined benefit plans to defined contribution plans. I had written in 2009 that the demise of the DB plan was inevitable because of the rise and fall of plan sponsors. It is noteworthy that it is one thing to rely upon an employer’s current funding of the accumulation of the lifetime income benefit through its employer sponsored retirement plan; it is quite another to expect that same employer sponsored plan to actually provide the guaranteed retirement payout over the retiree’s lifetime.

This really is where DC lifetime income programs have the opportunity to provide an important advantage over the traditional DB plan.  Unlike the DB benefit, the properly designed DC program does NOT require that the plan sponsor be around for the lifetime of the retiree-portability of the DC benefit is a critical differentiator. It also means that the retiree payouts are not dependent upon the employer’s design of the payout. The innovative programs being made available in the market today include features well beyond anything that could be offered in a traditional DB plan. This includes  (but is by no means limited to) things like the elective, periodic purchase of a pension guarantees over time; the ability to access cash balances which are also funding the retirement income benefit; and a sort of equity participation which can raise  lifetime income guarantees over time.

This “advantage” does, however, require that the design actually be able to protect these DC retirement accumulations which are to be paid out over the lifetime of the retiree. The protections need to be able to be provided even with the demise of the employers which had been used to fund  the retirement benefit. It’s obvious that true “portability’ is a fundamental element, especially where there is no PBGC backing the benefit.  There are a number of different ways in which these DC programs being offered in the market accomplish this, and there are some innovative methods being developed to address this issue as well. Not all of these methods are simple, and not all of them provide the same level of protection. Understanding how these protections work  (and understanding where they may or may not be needed)  is one key to the success of this process.


With so much change continuing to be in the air, it seems all too rare to be able take the opportunity to step back to broadly reflect on all of these moving pieces. The changes from CARES and SECURE, for example, are just working their way through the system, and now we expect to see SECURE 2.0 bring a number of further dramatic changes to the market. 2.0 is fascinating in many ways, especially given that right now it is really just a mashing together of three different legislative efforts- plus some.

That reflection always seems to circle back around to the impact of the finer details of these changes. Yes, there are substantive policy initiatives driving them, yet so much of their effectiveness and broader impact seem to be wrapped up in the-sometimes-maddening details of what is being passed.

A case in point is the anticipated changes in 2.0 which will open up pooled employer plans to 403(b) plans. Professionals in this area of the practice, we all know that the current PEP rules otherwise provided under Code Section 413(e) are unavailable to 403(b) plans,

Well, Congress is taking a well crafted, though pretty unusual, approach to the manner in which it has chosen to accomplish this feat. It seems to be a recognition of the impact of the details that associate to these sorts of dramatic changes. What is noteworthy is that 403(b) PEPs are going to be enabled through changes to 403(b), and not by simply including them in the definitional sections of 413(e), and through changes to ERISA’s PEP language under Sections 3(43) and 3(44). This is critically important because had Congress chosen to simply amend 413(e), it would have opened a Pandora’s box of details which would have demanded clumsy (and perhaps extensive) regulatory fixes.

Importantly, the statutory language does not just recognize the ability of 403(b) plans to be part of PEPs. It is part of a larger recognition of the vast array of “aggregation” arrangements in which 403(b) plans of “unrelated” sponsors have engaged over the years, which may driven by things like local statues, civic organizations or by a variety of plan designs. This includes the 403(b) MEP: though the Tax Code’s MEP rules have not applied to 403(b) plans, ERISA Section 210 DOES apply, and there is a  growing body of them in the market. What 2.0 language does do is that it confirms that the 403(b) status of those plans participating in the variety of aggregation arrangements is not jeopardized by participating in them.

In addition to all of this, that same section of the 2.0 also fixes an annoying 5500 filing problem related to those 403(b) MEPs; grants “one bad apple” relief to those 403(b) arrangements which satisfy rules similar to the PEP rules of Section 413(e)(2); and provides  a few other unique features will be important to “unpack.”

So much for reflection, I guess. An important takeaway for 2.0 is that there will be an awful lot of this sort of unpacking which will  need to be done for quite a few of the changes (like “403(b) eligible” CITs) which will be brought into play.