403(b) Tax-Deferred Annuity Plan Investment Fund Options: Offer One Vendor or Multiple Vendors Issues to Consider in Evaluating Options

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1 403(b) Tax-Deferred Annuity Plan Investment Fund Options: Offer One Vendor or Multiple Vendors Issues to Consider in Evaluating Options Executive Summary Question: In order to comply with the final 403(b) regulations, should a school district offer only investment products provided by one vendor or investment products provided by multiple vendors under the district s 403(b) tax-deferred annuity plan? Response: The final 403(b) regulations do not discuss whether a school district should offer the products of one vendor or multiple vendors under the district s 403(b) plan. The only rules in the 403(b) regulations regarding investment products are that: (1) the only types of investments that a 403(b) plan may offer are annuity contracts or mutual funds held in a custodial account and (2) any annuity contract or mutual fund custodial account offered under a 403(b) plan must include certain required provisions in the annuity contract or custodial account agreement. Therefore, under the 403(b) regulations, the school district may make its own decision whether it will offer the investment products of one vendor or multiple vendors under the district s 403(b) plan. 1

2 Issues to Consider In making the decision as to whether the district should offer the investment products of one vendor or multiple vendors under the district s 403(b) plan, some issues that the school district should consider are as follows: (a) Potential Fiduciary Liability in Selecting Vendors A school district is not subject to fiduciary liability for its 403(b) plan under federal law (referred to as the Employee Retirement Income Security Act of 1974 ( ERISA )). However, each state has its own common trust laws that may cover school districts and other governmental entities. The state common trust laws have many of the same basic concepts as ERISA. Although generally not yet tested by plan participant lawsuits, it is possible for a plan participant to bring a potential fiduciary breach suit against the school district under state trust law if the plan participant believes that the school district did not exercise prudent fiduciary care in evaluating and selecting the vendors offered under the district s 403(b) plan. In order to protect itself against such potential fiduciary liability under state trust laws, the district may: (i) (ii) decide to review and evaluate the investment products of any limited number of vendors that it offers under the 403(b) plan in a prudent process, document the evaluation and decision making process that it used and conduct a re-evaluation process of investment products offered on a periodic basis (such as annually) or decide to establish a policy where multiple vendors are offered without a specific review and evaluation of the investment products, but with requirements of a minimum number of participant investors and an agreement that each vendor will satisfy all 403(b) requirements or 2

3 (iii) decide to establish another similar policy or a combination of a documented investment product review and established policy. Because 403(b) plans may only offer annuity contract and mutual fund account options, there is an additional potential fiduciary issue that a sufficiently diverse type of investment options is not made available if only the investments of one vendor are offered. Once again, this issue has not yet been tested, but because the investment options are already limited by the statutory rules of 403(b), there is a potential that a further limiting of the options to only the investments of one vendor would be found to not be sufficiently diverse for selection by a prudent plan fiduciary. (b) 403(b) Compliance Duties Will Apply to Funds Invested With Prior Multiple Vendors - If a school district has offered multiple vendors under its 403(b) plan in the past, the district will remain responsible in future years for ensuring that the funds invested with those multiple vendors satisfy the 403(b) rules, including rules on plan distributions, until all of the funds have been distributed. The school district may not force plan participants to transfer all of their funds currently held by vendors offered in the past to one or a limited number of vendors who will be offered in the future. Each plan participant must be permitted to hold the individual contracts that they entered into in the past. The district may require the participant to invest future contributions with only one or a limited number of vendors who will be offered in the future. The district may not force participants to take a distribution of funds currently held by vendors offered in the past. A distribution of plan funds is permitted only upon the participant s termination of employment (including retirement), attainment of age 59-1/2, death or disability. In addition, a distribution may occur if the district terminates its 403(b) plan and does not offer another 403(b) plan for at least one year 3

4 after the final distribution of all 403(b) plan funds. Even if a 403(b) plan is terminated, the district is responsible for ensuring that the funds invested with vendors offered in the past satisfy 403(b) rules until all such funds are distributed. The district is also responsible for ensuring that information about prior contributions to vendors offered in the past is made available to the service provider responsible for ensuring that the new 403(b) contribution rules are currently satisfied. For example, the special 403(b) catch-up contribution limit takes into account any special catch-up contribution made in prior years. (c) Determine if a Vendor Investment Review Includes a Compliance Review - In selecting one or more vendors to offer under its 403(b) plan, the school district needs to determine if the vendor investment review that it is receiving also includes a 403(b) compliance review. Typically, an investment review of a vendor only considers the investment performance of that vendor s products to those of its competitors. The consultants who conduct vendor investment performance reviews do not generally determine whether or not the vendor is satisfying the 403(b) statutory and regulatory rules and is providing the information to the district that the district needs to satisfy its responsibilities under the 403(b) rules. The 403(b) rules do not have any investment performance requirements that must be met by the investment products offered under the 403(b) plan. Thus, an investment performance review of the 403(b) investment products does not help the district determine if a vendor is satisfying the 403(b) contribution, distribution and other compliance rules. The investment performance review can be helpful to the district if the district has decided that it wants to conduct its own periodic review and selection of vendors that are offered under the district s 403(b) plan. Whether or not a district conducts an investment performance review of the vendors its offers under its 403(b) plan, the district should separately consider if it will conduct a 403(b) compliance 4

5 review of the vendors that are offered under the district s 403(b) plan. The 403(b) compliance review should review each vendor and evaluate whether the vendor satisfies the contribution, distribution, documentation, reporting and other compliance rules under 403(b). The compliance review should consider the vendor s compliance with the 403(b) rules for each of the vendor s investment products offered under the district s 403(b) plan and for a representative sample of years that the vendor has had products offered under the district s 403(b) plan. In determining whether a vendor will be offered under the district s 403(b) plan on a prospective basis, the district should consider the ability of the vendor to satisfy the 403(b) compliance rules. It is the district s determination, based on its consideration of some of the other issues noted above, whether the district will also consider the vendor s investment performance. (d) (e) Collective Bargaining Agreement Provisions - A school district should review its collective bargaining agreements to determine if agreements have been made previously to offer certain vendors and/or investment products under the district s 403(b) plan. If previous agreements have been made, the district will need to carefully evaluate if it will be possible to negotiate for one or more different vendors that the district determines it would like to offer. In the alternative, if the district decides to offer to all of its employees the one vendor or limited number of vendors negotiated in one of its collective bargaining agreements, the district needs to determine if offering that one vendor or limited number of vendors to all employees under the district s 403(b) plan is prudent from a fiduciary perspective under applicable state trust laws (as discussed in (a) above). Local Political Considerations A school district should consider any local political considerations to be taken into account in determining whether to offer one or multiple vendors under the district s 403(b) plan. For example, the district should not select one vendor based on the local political ties of that vendor for the reason that the selection of that one vendor may not be considered to be prudent from a fiduciary perspective under applicable state 5

6 trust laws (as discussed in (a) above). On the other hand, the district may not be able to offer only one vendor or even a very limited number of vendors under the district s 403(b) plan, because the local political climate is such that a number of vendors have close ties to the district and all will need to be considered for a slot as a prospective vendor under the district s 403(b) plan in order to be fair to all of these similarly situated vendors. The district will need to evaluate the approach that will work best for its particular situation, while keeping the best interests of the 403(b) plan participants in mind as its primary objective. (f) Certain States Restrict the Ability of School Districts to Limit the Number of Vendors Offered Under the District s 403(b) Plan - Certain states have adopted state statutes that require school districts to make all vendors that satisfy the state law requirements available under the district s 403(b) plan. These state laws are generally referred to as any willing provider laws. States that have these statutory restrictions include California, Iowa, Louisiana, Ohio, Oklahoma, Texas and Washington. In general, a school district in these states may only limit the number of vendors offered under the district s 403(b) plan if the manner in which the vendors are limited satisfy their state law requirements. The above summary lists a few of the issues that a school district should consider in deciding whether to offer the investment products of one vendor or multiple vendors under the district s 403(b) plan. Before a school district decides to limit the number of vendors that it offers, the district should carefully consider these issues and the specific circumstances of the district in order to decide the approach that best fits the facts and circumstances and employee benefit goals of the district. 6