Opinion: Time To Clean Up School Employer Retirement Plan Compliance

Summary: Popular defined contribution programs for public school employees are not being run properly and may be out of compliance with IRS rules and regulations. This post explores who is charged with keeping 403(b) and 457(b) plans in compliance and where they are coming up short.

Compliance Third Party Administrators (CTPA) for public school 403(b) and 457(b) programs are charged with keeping public school employer's retirement plans in compliance with IRS regulations, but do they? It’s this author’s opinion that not all is well with these plans and Compliance TPAs may be at the heart of the problem.

I’ve written about what I term “CTPAs” many times over the years, but I am writing this post to discuss what I believe are major shortfalls in the companies that keep records for millions of public school teachers.

The term CTPA stands for Compliance Third Party Administrator, it’s an acronym I use for an entity that mostly exists to service public school 403(b) and 457(b) programs. A CTPA has many jobs, but the most basic is to keep the School Employer’s plan(s) in compliance with Internal Revenue Service rules and regulations.

The CTPA occupies the space between the employer and the employer’s plan providers. It’s not an easy task. Unlike most defined contribution programs, many 403(b) and 457(b) programs have multiple investment providers. A typical 401(k) plan has a single provider, but a 403(b) plan at a public school employer might have 40 or more. Coordinating between all the providers is the job of the CTPA.

A good CTPA will create and maintain a plan document, communicate generic information about the program, remit contributions from the employer to the various vendors, determine participant eligibility, process enrollments, monitor contribution limits, approve loans and distributions, coordinate some transactions across multiple employer plans and maintain confidential information in a private and secure manner. This work is normally accomplished without holding the plan’s assets (except for a short period where funds are received from the employer and forwarded to the vendor).

Why am I concerned?

It’s my opinion that there aren’t many competent CTPAs and many of the ones that are competent are severely conflicted. I believe a significant number of school employers are not in compliance with IRS regulations as they apply to 403(b) and 457(b), ironically, CTPAs may be to blame, at least partially.

Brief History

CTPAs are an outgrowth of the Final 403(b) Regulations issued by the IRS in 2007 and made final beginning in 2009. The regulations were meant to get these plans under control and into compliance with a new set of rules. These new rules were too complex for the average public school employer to implement on their own and CTPAs rose up to fill the need. Unfortunately, in the rush to find an entity to handle the compliance, many school employers chose companies that may not have been in their or their employee’s best interest. In the school employer’s defense, there were few firms to choose from and few CFO’s had the expertise to determine competency.

It’s been six years since the regulations went into affect and while it seems 403(b) plans are in better shape than they used to be, the operation of many of these plans is poor. Where 403(b) plans are paired with 457(b) plans the state of compliance is especially weak, if it even exists.

Poor compliance across the two plan types is where I’d like to focus the majority of this post.

403(b) and 457(b) Plans Are Related, Should Be Coordinated

Many employers and CTPAs don’t realize that 403(b) and 457(b) plans are not independent of one another. When both plans are offered by a single employer, they must coordinate the operation of them in order to stay compliant. There are several areas where information for one plan must be shared with the other. This rarely happens. This section focuses on the five pertinent coordination points.

1. Plan Loans

If one or both of an employer’s 403(b) or 457(b) programs offer plan loans, there must be coordination between the two plans to determine whether a participant is eligible to take a loan and what amount is available.

Most employers and many CTPAs are unaware that there is a single loan limit across all plans and that loans in one plan affect loans in the other. For example, a participant who defaults on a loan may become ineligible for another loan. If the defaulted loan is in the 403(b) and the participant also has a 457(b) that offers loans, a loan should not be granted. But if the administrator of the 457(b) has no access to information on loans in the 403(b), they have no basis for approval or denial of such a request. If the administrator approves the loan they risk being out of compliance.

Another problem area with loans that I see is that of “self-certification,” the idea that since it’s likely only the employee knows all the information about their accounts, they are in a position to provide the needed data to make loan decisions. Self-certification is specifically not allowed by the IRS. It’s the employer’s responsibility to monitor loans across all plans and all providers.

It’s also the employer’s responsibility (which can be delegated to the CTPA) to properly default loans. This is missed in many cases because the vendor maintains the data and neither the employer or CTPA see that a loan has been defaulted if the vendor does not share the information. The vendor (who is usually competing with other vendors) does not want to upset their client (the participant) by defaulting them and this creates a conflict of interest between the vendor and what is right for the plan.

The better CTPAs participate in data exchanges between CTPAs and vendors using a file format provided by the SPARK Institute. These “SPARK” files contain most or all of the data that a CTPA needs to approve plan transactions. For example, if all of the vendors in a particular plan supply outstanding loan data in SPARK files to the CTPA for the plan, the CTPA can search currently outstanding loans when a participant applies for a loan to see if the participant is eligible for the loan requested.

Another procedure used by some CTPAs is to require that all of the current 403(b) and 457(b) statements be submitted from a participant before granting a loan. Requiring this information is not usually considered “self certification” by IRS examiners. Reviewing these statements allows the CTPA to see if there are any other loans outstanding. This information, when used in conjunction with SPARK file data can provide even more assurance that no loan data is missed. In my experience though, many CTPAs don’t ask for statements.

Another example of loan rules that must be addressed is the issue of defaulted loans. According to 403(b) rules, if a participant has a loan on which he or she has defaulted, the plan cannot give the participant another loan and use the 403(b) account as collateral. Rather, the collateral for the loan must be an external asset. Since most employers do not want to be in the position of repossessing a participant’s car in the event of a 403(b) loan default, they may want to consider providing in the plan document and/or loan procedures that participants with defaulted loans are not eligible for future loans. This is just one of many issues that a good CTPA will help the employer review and decide how to handle.

Loans are really just the tip of a large iceberg.

2. Unforseeable Emergencies

In the 403(b) world participants have “hardship withdrawals” which have a fairly straight forward set of rules, but 457(b) plans instead offer the much tougher to qualify and quantify “unforseeable emergency.” The IRS says the following about unforeseeable emergencies:

“Under a 457(b) plan, a hardship distribution can only occur when the participant is faced with an unforeseeable emergency. (Code § 457(d)(1)(iii))
An unforeseeable emergency is a severe financial hardship resulting from an illness or accident, loss of property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the participant or beneficiary. Examples of events that may be considered unforeseeable emergencies include imminent foreclosure on, or eviction from, the employee's home, medical expenses, and funeral expenses. Generally, the purchase of a home and the payment of college tuition are not unforeseeable emergencies.(Reg. § 1.457-6(c)(2)(i))
Whether a participant or beneficiary is faced with an unforeseeable emergency depends on the facts and circumstances. However, a distribution is not on account of an unforeseeable emergency to the extent that the emergency can be relieved through reimbursement or compensation from insurance, liquidation of the participant's assets, or cessation of deferrals under the plan. (Reg. § 1.457-6(c)(2)(ii))
A distribution on account of an unforeseeable emergency must not exceed the amount reasonably necessary to satisfy the emergency need. (Reg. § 1.457-6(c)(2)(iii))”

As you can see, this provision is not simple to understand or administer and leaves a vendor in the uncomfortable situation of making a client unhappy just by following the regulations. This might not be an issue with a single vendor plan, but when there are multiple vendors in the plan it puts that vendor in a non-competitive position.

More importantly though, the ability to grant such a request requires information that may not be available to the 457(b) vendor. The 457(b) vendor, unless coordinating with the CTPA is unlikely to know whether the participant is contributing to a 403(b), whether a 403(b) loan or hardship withdrawal is available or if in fact the participant has already exhausted those avenues. Remember, the vendor can’t take the participants word for it, they need proof.

In addition, if the emergency request is granted, it’s possible that a plan provision suspending contributions will be triggered (granted, this is rare). Who will communicate this to the employer and ensure it is adhered to? The same goes for Hardship Distributions on the 403(b) side where participants are suspended (Safe Harbor plans) for a period of six months from contributing after taking a Hardship Withdrawal. This suspension applies to ALL plans of the employer, a mechanism must exist to notify the 457(b) plan administrator, it rarely exists.

3. Multiple Plan Documents

Another problem I see quite often is a public school employer who has multiple 457(b) vendors and multiple plan documents, all with conflicting provisions and no single person with authority. This situation usually occurs when school district personnel add a vendor and sign that vendor’s package of documents, trusting the vendor knows what they are doing. The process is repeated over and over as other vendors are added and suddenly there are multiple plan documents (each usually customized to the vendor). The presence of multiple plan documents represents a serious situation that could lead to real compliance issues. One plan document should govern all vendors.

4. Timing of Salary Deferrals

There is a strange rule that exists in 457(b) that doesn’t exist in other defined contribution plans and many school employers do not follow it, in fact much of the time even the vendors are unaware of the rule. The rule states that a salary reduction agreement must be in place in the month prior to the month contributions are taken from a paycheck. This is different than all other Defined Contribution plans. In a 403(b) you can make changes up to the date set by payroll and those changes can take affect in that month, this is not the case with 457(b) where a change must take place the month prior. Many CTPAs and vendors do not know this rule or if they do, don’t follow it. Some school districts don’t have systems in place to administer the rule. You can bet that this is an audit item for the IRS. It doesn’t seem like a big deal and in my opinion it’s a ridiculous rule (among many), but it’s still the rule and needs to be complied with.

5. Catch Up Rules

Another area that is difficult to administer and commonly done incorrectly is what’s referred to as the “Final Three Year” catch up provision. This catch up allows a participant to defer double the 457(b) contribution limit for a period of up to three years prior to retirement. The amount available to defer under this catch up provision can be difficult to calculate, but even when the calculation is straight forward, many CTPAs get wrong which years the participant is eligible to actually use it.

If a participant qualifies for this catch up they are allowed to use it in the three plan years prior to the year of the plan’s normal retirement age. Again, this seems straightforward, but it isn’t. Many employers and CTPAs get this wrong by not defining Normal Retirement Age in the plan document, having multiple Normal Retirement Ages (due to multiple plan docs) and by not understanding that the three years the participant is allowed to catch up are the three years prior to the Normal Retirement Age. This means that the increased contributions must stop before the year of Normal Retirement Age starts, this is a common area for mistakes.

It can be to the advantage of participants for the plan document to specify that the Normal Retirement Age for the 457(b) plan is the age at which the participant can elect an unreduced retirement under the state’s defined benefit plan in which the participant is a member or allow the participant to elect a normal retirement age from 55 through 70½. However, in order to use this all 457(b) plans of the employer must use the same definition of normal retirement age. Without a single CTPA overseeing the 457(b) plan(s) it is very difficult to coordinate the use of a single normal retirement age.

In addition, the election to use the three-year catch up can only be used once and can only be used for three successive years. Finally, this catch up is unlike the Age 50 Catch up which only requires one turn age 50 (or be 50 or older) during the calendar year to be eligible. For the three year catch up provision there must be years where the participant could have made a contribution, but didn’t. Without getting into the details, this can be a very difficult calculation and few employers or CTPA’s have the data to produce it.

A plan could choose to not offer loans, unforeseeable emergencies or the Final Three Year catch up, thereby simplifying the administration, but this eliminates many of the benefits of offering the plan in the first place.

While there are certainly other areas of compliance that employers and CTPAs miss, the above five points are the big ones when running two plans. There is more to hiring a CTPA than just compliance as this next section will explore.

CTPAs and “Education”

No analysis of CTPA’s ability to keep a public school employer’s defined contribution plans in compliance would be complete without talking about education. Education is an important component of any defined contribution plan, but the level of education is where many CTPA’s cross the line from complying with regulations to blatantly abusing their position as an administrator to sell products. Some CTPAs exist purely to sell expensive and complex financial products to unsophisticated and unsuspecting employees - not to provide competent compliance and education.

In a piece I penned for my blog in January of this year (Public School Employers Deceived By Shifty 403(b)/457(b) Providers) I explore one such “education” meeting that in reality was a salesperson using their status as the 457(b) administrator to sell financial products to unsuspecting teachers. More and more CTPAs these days finance their operations by selling financial products, most of which the compensation is never disclosed to the employer or the employee and the where no fiduciary duty exists. “Education” becomes a thinly veiled sales presentation designed to get rollover IRA business, life insurance sales or 403(b) exchanges, this was not the intent of the 457(b).

Employer Complacency?

Employers shouldn’t be let off the hook here. There tends to be very little involvement by most employers in the operation of the 457(b) in many school districts. This is completely understandable and there are simple solutions to relieve the employer of needing to be heavily involved, but the employers who decide to take on 403(b) and 457(b) programs and retain substantial management of them need to make sure they are following both Federal and State laws. Some state laws impose a fiduciary duty, others impose additional disclosure requirements and still others require almost nothing of the employer. Employers can help their plans stay in compliance by supplying good data on a regular basis, something I rarely see.

Employee Data, To Share or Not To Share?

Data these days is a big deal and employers are increasingly guarding that data out of concern for privacy. Securing participant (and employee) data is of the utmost concern and I fully understand employers who are wary of sharing any data with what amounts to a distributor of financial products. However, the data required to run a 403(b) and 457(b) program successfully and smoothly must originate with the employer and is vital to keeping the plan(s) running smoothly.

In addition, ensuring all contributions are remitted electronically along with list bill data that is accurate, detailed and timely will also go a long ways in ensuring participant money is invested as quickly as possible after being taken from a paycheck. It might sound counter intuitive, but sharing data with your compliance administrator or program vendor can actually work to protect your participants’ identity and privacy. This all assumes that the employer has chosen both vendors wisely.

If your administrator has the proper data it can better verify the participants identity and process transactions in a more secure manner than if that same data were communicated purely through the participant. I’m not advocating sharing all demographic data with all of your vendors, but I am advocating a thorough process for the hiring of your administrator that includes a detailed understanding of their security processes. If the vendor can demonstrate that the data can be kept secure and won’t be used to sell financial products, you should consider creating a process to share certain demographic data (name, address, SSN, DOB, employment status, length of service and a few other items depending on the plan type).

Conflicts of Interests with CTPAs

One thing I haven’t touched on is the conflicts of interest that exist with many CTPAs. I’ve noted that many CTPAs are simply financial product sales organizations in disguise while others claim to be “independent” when the reality is the majority of their income is derived from product vendors. This post is already longer then I want it to be, I will refer you to my post “Wild West in Government 403(b) Continues”. If that post doesn’t open your eyes to what is happening with CTPA compensation, nothing will.


In conclusion, while I believe there are several competent Compliance Third Party Administrators in operation today, I’m very concerned that a large swath of school employers are working with entities that are not actually doing compliance and are therefore jeopardizing their participants retirement and the tax qualification of the school employer’s defined contribution plans. I am also concerned that many school employers do not employ a CTPA when offering multiple plans or only employ the CTPA for one of the plans, ignoring the coordination that is required.


In the short term, the solution is to do a comprehensive evaluation of the plans offered and determine how best to manage them. Often times this means reducing providers, requiring more of surviving providers and hiring a competent CTPA. I believe most of the issues could be solved by eliminating the multiple vendor system itself. School employers who reduce vendors to one eliminate most of the issues that I discussed above, though they still may need to employ a CTPA. These plans need to be taken seriously as they may make the difference between a decent retirement and a great retirement for employees and mismanagement of the plans could lead to problems with IRS.

Scott Dauenhauer, CFP, MPAS, AIF