One of the most unfortunate and unintended consequences of the new 403(b) regulations is the freezing of hardship distributions and loans from contracts of "deselected" vendors, at a time when these funds are needed the most.
What at first seemed like an almost esoteric, academic discussion of what to do with contracts which were issued prior to 1/1/09 and to which all contributions ceased as of that date has now become one which is fraught with human tragedy. Participants in in 403(b) plans (and, it seems, mostly in non-ERISA plans like school districts) are now caught in a terrible cat-fight between employers and vendors which has resulted in employees not having access to those 403(b) funds to help them through this economic mess in which we find ourselves.
What is happening is all centered on the most fundamental change that the regs have introduced: the banning of the ability of a vendor or an employer to rely on a participant’s representation when taking a loan or hardship from their 403b contract. The old rule which permitted such reliance made much sense, particularly for employers where 403(b) plans were adopted and administered as the individual pensions they were intended to be. The wholesale "dumping" of that rule has now befuddled the marketplace, as vendors and employers try to sort out who has the responsibility for doing what employees used to be able to do.
The typical scenario goes something like this: An employer, in response to the new regs, has sorted through their plan and has limited the number of vendors available. The "deselected" vendors are not named in the plan document, and are not treated by the employer as part of the plan. Deselected vendors, by the same token, do not wish to be part of the plan and want no obligation for compliance from those old contracts. The employer has engaged in the "good faith" efforts under Rev. Proc. 2007-71, and has notified the deselected vendor of the contact information necessary to get compliance data.
A participant approaches a deselected vendor for a hardship distribution to prevent the foreclosure of their primary residence, and fills out the appropriate vendor form. The vendor, instead of being able to rely upon the employee’s representation as to the existence of a hardship, is now seeking assurances from the plan that: (1) that the plan allows for hardships, and that the safe harbor will be followed which suspends elective deferrals for 6 months; (2) that the employer make a determination of hardship; and (3) that the employer approve the distribution.
The employer is now in a quandary. They have excluded that old contract from their plan. They fear approving the hardship brings the vendor’s contract into the plan. It will cause them to try to enter into a servicing agreement with the deselected vendor to get the compliance the employer needs. Inclusion in the plan without referencing it in the plan document and without coordinating the terms of the contract with the terms of the plan can disqualify the plan. If it is a non-ERISA private employer, that sort of decision will trigger ERISA Title 1 obligations. So the employer tells the vendor to go away, and that its up to the vendor to make that determination.
The vendor, unwillingly to become the party responsible for complying with the new 403b regs, denies the hardship. The policyholder is left holding the bag.
What is happening on the loan side is also causing hardship. Deselected vendor loans are very difficult to get. Even with "selected" vendors, it is now very time consuming in the "multivendor" 403(b) environment to get a loan. It now typically takes a great deal of time to collect data from all the vendors in order to get loan approval, forcing incredible delays into the system that 401(k) plan participants do not suffer. Implementation of the SPARK standards, intended to help alleviate this, is spotty at best, and appears to be successfully implemented only in a small number of very large vendors.
It is within the IRS’s authority to partially address the most egregious of these problems: at least for deselected contracts issued prior to 1/1/09, and to which no contributions have been made after that date, allow vendors and employers to rely upon employee representations and the single vendor’s own records. Could there be some abuse? Absolutely. But will it help bring relief in a crisis where there is terrible human tragedy? Without a doubt.