There is an encouraging sign that Congressional staff and other legislative writers may finally be taking seriously the notion that that 403(b) plans really are fundamentally different than 401(k) plans. This “sign” takes the form of Section 112 of the SECURE Act, under which sponsors of “cash or deferred arrangements” must allow long-term employees working more than 500 but less than 1,000 hours per year to make elective deferrals to their plans.
At first glance, one may be under the mistaken impression that this is a rule which applies to all elective deferral plans, whether they be 401(k) plans, 403(b) plans or 457(b) governmental plans. But this impression is likely wrong: the statute, by its terms, clearly only applies to elective deferrals under 401(k) plans, not 403(b) plans.
The title of this section of the SECURE Act which imposes this new rule can be misleading (“QUALIFIED CASH OR DEFERRED ARRANGEMENTS MUST ALLOW LONG-TERM EMPLOYEES WORKING MORE THAN 500 BUT LESS THAN 1,000 HOURS PER YEAR TO PARTICIPATE”), because we have all been conditioned in recent years to treat 403(b) elective deferrals in the same manner as a “cash or deferred arrangement” under 401(k). But there is truly a legal difference between a deferral under a 401(k) “cash or deferred” arrangement” and one under 403(b).
Technically, here’s how it works. You’ll see that the legislative language could have been a bit clearer:
The new rule amends Section 401(k)(2)(D) of the Code, not 403(b). So we need to look at 403(b)and its regulations to see if 401(k)(2)(D) somehow applies to 403(b) elective deferrals.
1.403(b)-2(b)(7) defines a 403(b) elective deferral under 1.402(g)-1. 1.402(g)-1(b)(3) defines a 403(b) elective deferral as one made under a salary reduction agreement which is excluded from income by virtue of Code Section 403(b). Note the difference between this and the definition of elective deferral for 401(k) plans under 1.402(g)-1(b)(1), which defines a 401(k) elective deferral separately as being made under a “cash or deferred” arrangement under 401(k). This seems pretty clear, then, that the new rule would not apply to 403(b) plans.
But then it gets complicated. 1.403(b)(3)(a) excludes from income amounts “contributed by an eligible employer for the purchase of an annuity contract for an employee pursuant to a cash or deferred election (as defined at 1.401(k)–1(a)(3))”-which suggests that 401(k)(2)(D) (and the new rule) might apply. But when you go to 1.401(k)–1(a)(3), it merely defines the 403(b) contribution as an elective deferral, without any reference to any service requirement. Indeed, the service requirements under 401(k)(2) do not apply to 403(b) plans, as 403(b) plans instead have the universal availability rule-a rule which was NOT changed by SECURE. Thus the 500 hour rule will not apply to 403(b) plans.
I realize that this analysis may sound a bit convoluted, but that’s the way any legal analysis gets when you try to compare 403(b) and 401(k) rules. It sometimes is just like trying to compare apples and oranges.
Now, you may want to take the cynical view that this was merely a legislative drafting oversight, and that the regs which are eventually written will impose this rule on 403(b) plans. I don’t believe this will happen, for two reasons. First, there are no statutory grounds for doing so. Secondly, the ERISA minimum participation rules under Section 202 (which imposes the 1000 hours/2 year rule)- which would have made this new 500 hour rule apply to ERISA 403(b) plan if it were amended-was NOT changed.