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.