When it comes to 403(b) plans of California school districts or charter schools, there is confusion about the ability of the sponsoring district or charter school to limit the participant’s ability to select a particular insurance provider for their tax-sheltered annuity (TSA). On the one hand, there is a provision of the California Insurance Code which provides that if a TSA “is to be placed or purchased for an employee, the employee shall have the right to pick the insurance agent, broker or company through whom… the… annuity [will be placed].” On the other hand, you have employers and plan fiduciaries who are trying to provide more competitive benefits, while controlling fiduciary liability and plan administrative burden. The bottom line is that many public school district and charter school employees in California mistakenly believe that they are entitled to select the TSA provider of their choice simply because they are allowed to direct the investment of their plan account.
So, how is this conundrum resolved? One way to analyze this issue is by understanding the differences between a “non-employer-sponsored 403(b) arrangement,” an NFA, and an “employer-sponsored 403(b) plan,” an EFP.
What’s an NFA and why does that matter? In an NFA, the employer is not taking an active role in either the design or administration of the program, and is simply facilitating the purchase of annuity contracts, or custodial account investments, by employees on a salary reduction basis. Since an employer is merely “facilitating” a purchase by employees of a TSA, it makes sense that employees should be able to decide from whom they will purchase their TSA. So, for the most part, section 770.3 should apply to NFAs. Although public sector 403(b)s generally are not subject to ERISA, the U.S. Department of Labor has issued useful guidance, which provide “safe harbor” rules for those employers who want to offer an NFA.
What’s an EFP and why does that matter? By contrast, an EFP is an employer-sponsored plan – one that the employer designs, administers, and accepts fiduciary responsibility for. One of the most obvious indicators of an EFP is the fact that the employer is making either matching or nonelective contributions to the plan. However, an employer can arguably maintain an EFP without making any employer contributions.
In recent years, 403(b) arrangements that are EFPs have become much more prevalent due to competitive pressures on employers to contribute to their 403(b) arrangements and due to increased worker familiarity with 401(k) plans, which are, by their nature, always employer-sponsored.
The distinction between NFAs and EFPs is important when it comes to participant choice within a 403(b) arrangement. The leading case on the application of Cal. Insurance Code section 770.3 involved University of California employees and the U.C. Regents. In McFee, U.C. employees sought to force the U.C. Regents to allow them to select the insurance agent, broker or company that their 403(b) contributions would be invested with or through. The California Court of Appeal ruled in favor of the Regents concluding that section 770.3 applies only to “third-party situations,” where employees are purchasing annuities or other permitted investments directly from providers without employer involvement. The Court concluded that section 770.3 does not apply to EFPs where the employer is administering the plan and has taken responsibility for the selection of annuity or custodial account investments. In other words, if the employer is acting as a fiduciary to select and monitor the plan’s investments, it apparently can allow participant-direction of investment without converting the plan to an NFA and making section 770.3 applicable.
In future posts, we will discuss the separate, but related, issue of California law governing the selection of 403(b) record-keepers.
Jeff Chang is a partner at Best Best & Krieger LLP. He has four decades of experience skillfully evaluating benefit and retirement plan compliance to achieve maximum outcomes for public agency clients throughout California. He can be reached at firstname.lastname@example.org or (916) 329-3685.