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.