(How) Are 403(b) Plans Different from 401(k)s?

 The primary difference between 403(b) plans and 401(k) plans is the type of employer offering the plan, but a couple of new surveys from the Plan Sponsor Council of America (PSCA) highlight some interesting design differences as well.

Believe it or not, 403(b) plans have been around longer—since 1958. 401(k)s didn’t arrive until 1978 and really were not effective until 1981 (see Talking Points: An ‘Unintended’ Consequence). 

Like its 401(k) cousin, it was initially created under part of the Internal Revenue Code (Section 403(b)!)., and—like the 401(k)—it was designed to allow employees of certain tax-exempt organizations, such as public schools, hospitals, and religious institutions, to contribute to retirement savings on a tax-deferred basis. 

Over time, many of the things that differentiated the two (notably contribution limits) have been eliminated or at least narrowed. That said, their different histories and distinct employee populations mean that notable plan design differences remain.

What’s the Same (or Pretty Close)

According to PSCA’s 2024 403(b) Plan Survey, a quarter (24.4%) of 403(b) plan respondents now use auto-escalation, and another fifth (20.2%) permit voluntary escalation. That’s pretty consistent with findings from the (soon-to-be-published) 67th Annual Survey of Profit-Sharing and 401(k) plans, where 24.2% use automatic escalation for all participants, 8.9% do so for “under-contributing” participants, and 30.1% permit voluntary escalation.

One area in which 401(k) plan designs have traditionally lagged is periodic distribution options. However, perhaps due to the recent focus on retirement income, this gap has narrowed significantly. 

Among 401(k) plan respondents, two-thirds (68.8%) now offer a retirement periodic option (though 83.2% of the largest plans do), nearly identical to 403(b) plan respondents where 67.7% offer the periodic payment option, as do 91.2% of the larger plans.  

Another area of striking consistency is financial wellness programs. A quarter of responding 403(b) organizations provide financial wellness programs to employees—but that’s 44% of the largest plans (> 1000 workers) versus 10%-ish for plans with less than 200). Most (59%) deliver that online.  As for 401(k) employers, 27.1% provide those overall, versus 52.8% at the largest plans (and in the teens for those with 200 employees or less.

Most 403(b) plan organizations (78.4 percent) monitor at least one participant behavior. The most common behavior monitored by those plans was participant deferral rates (60.6 percent of plans), followed by loans (55.6%) and hardship withdrawals (51.4 percent of plans)—mirroring the tendency among 401(k) plan sponsors (78.3% deferral rates, 56.9% loan usage, and 50.9% hardship withdrawals).

What’s Different?

According to PSCA’s survey, while there has been movement in investment policy statements, only about half of 403(b) plan survey respondents (57%) have an IPS in place—though, in fairness, a full third (32.4%) didn’t know. Contrast that with the (soon-to-be published) 67th Annual Survey of Profit-Sharing and 401(k) Plans, which found those in place at 82.4% (here again, 12.5% weren’t sure, however).

Of course, there’s having the IPS to provide structure, and then there’s the frequency of review.  Among 403(b) plan respondents, annual was the most cited frequency (44.5%), with quarterly (34%) ranked second. Among 401(k) respondents, quarterly (64.8%) was the most common (even more so among larger plans), and annual was a distant second, cited by just 16.2%.

Automatic enrollment is (slowly) gaining traction in 403(b) plans; use increased yet again and is now available in 35.5 percent of plans — that’s up a third in just two years. Here, as with 401(k) plans (63.8% overall and 74.3% among the largest), more than half of large organizations employ automatic enrollment in contrast to just 21 percent of small plans, which is up from just eight percent of small plans a year ago.

Three percent of pay remains the most common default deferral rate among 403(b) plan respondents, used by 32.1 percent of plans, while 30.2 percent have a default rate greater than that.  Meanwhile, a default rate of more than 3% was already the default for two-thirds of 401(k) plan respondents to the 2023 survey.

Considering their history, it should be no surprise that 403(b) plans were much more likely to provide an annuity option; 56.7% overall and 70.6% of the larger plans do so for retirement.  That contrasts with 401(k) plans where the availability is half that—29% overall and 36.6% among the larger plans.

Another unsurprising difference can be found in the availability of ESG funds on the plan menu; just 6.4% of 401(k) plans did so in the 2023 401(k) survey, whereas those options were found at nearly four-in-10 403(b) plans, irrespective of plan size. 

Among 403(b) plan respondents, 42% offer a managed account option (29% of participants use it when offered) versus 50.4% of 401(k) plan survey respondents (68.5% among larger plans).

Oh – and one big difference not captured on these surveys – 403(b) plans (still) can’t invest in collective investment trusts (CITs). Apparently, some think that several decades of experience with 401(k)s isn’t enough for 403(b) adoption.

Of course, these similarities – and differences – are viewed from a macro lens.  We tend to talk about 401(k)s (and 403(b)s) as though these plans are designed and administered for the benefit of monolithic entities, but the industries and demographics for which these designs are applied are vastly different. 

Particularly in the 403(b) market, those differences often include whether a traditional defined benefit plan is part of the benefits equation—and that makes a huge difference in terms of positioning and ultimate benefits delivery—something that should always be considered in any kind of side-by-side comparison. 

Still, it’s good to know—and appreciate—not only the differences but the options and the rationale behind them as we work together to help support, expand, and enhance the nation’s private retirement system.

-          Nevin E. Adams, JD 

(Not-So) ‘Common’ — Wisdom

There is a “common wisdom” in our business that suggests that all plan sponsors are, more or less, alike; that large plans are the inevitable early adopters of trends that, sooner or later, trickle down to plans of all sizes.

Consequently, those who make their living trying to discern trends and patterns frequently focus on the behaviors in evidence at larger programs—figuring that, in three years or so, those same characteristics will emerge across the spectrum.

There’s some logic to that perspective—and at least anecdotal evidence to support it. Human beings—including plan fiduciaries—frequently draw comfort and solace from the experience of others, and smaller programs can hardly be faulted for adopting plan designs and approaches that have been “vetted” by programs with more copious resources.

Sure enough, there are areas in which larger programs once dominated—but over time those variances have disappeared. For example, according to the Plan Sponsor Council of America’s 66^th Annual Survey of Profit-Sharing and 401(k) plans, there is now essentially no difference in the availability of Roth options (more than 90% across the board do), and no longer any difference in permitting catch-up contributions (also about 90% for both the largest and smallest plans)—and just about the same percentage of workers took advantage of this feature. Nearly all plans of all sizes accept rollovers from other plans—while just under half of plans of all sizes encourage roll-ins. And while it’s hardly common, in-plan annuity options are to be found at about 1 in 10 plans, regardless of size.

That said, I have always found it dangerously simplistic to assume that small plans will, inevitably, follow along eventually in the footsteps of their larger cousins.

‘Less’ Likely

On the other hand, consider that—and this has long been the case—that the smallest employers (those with less than 50 employees) were significantly less likely to offer automatic enrollment than the largest programs—those with 5,000 or more workers (28.9% versus 71.8%), according to the Plan Sponsor Council of America’s 66^th Annual Survey of Profit-Sharing and 401(k) plans.[i] 

There’s also a big gap in opening the door to participation; more than three-quarters (77.9%) of those larger employers now offer immediate eligibility, versus just 30.4% of smaller employers, and 37% of those with 50-199 workers. Indeed, the most common for smaller employers remains a year. Similarly, to receive matching contributions, two-thirds (62.2%) of the largest plans allow them immediately, while just 28% of smaller employers do—and 45.7% overall. Therein lies some of the danger in relying solely on the aggregate responses in discerning trends—like averages in any assessment, they can obscure considerable variances in the underlying responses.

Note that the largest plans were also significantly more likely (93.1%) to report having an investment policy statement (IPS) than were the smallest plans (though more than two-thirds of those did). There’s some irony to be found in the reality that while just over a third of the smallest employers have 26 or more fund options available on the menu, only half as many (17.1%) of the largest have that many (roughly a third have 11-15). Smaller plans were also notably less likely to review those options; only half did so on a quarterly basis, compared to 81% of the largest programs.

Advisor Attributes

There were also differences in advisor compensation; the vast majority (81.1%) of the largest programs are using a fixed fee, while only about a quarter of the smallest are (60% of those are using a percentage of assets basis). Robo-advisors were much more typical (28%) at the largest plans than the smaller programs (7.8%). The smallest plans were notably more reliant on advisors[ii] for retirement committee plan education (75.9%), while the largest plans were more likely to lean on an ERISA attorney (68%) than an advisor (37%). 

The largest plans were notably more likely (6.4%) to be considering a change to provider or advisor in 2024 than the smallest (2.7%). On the other hand, 6% seemed to be a pretty solid response across the board.

Having worked for huge firms—and considerably smaller ones—I can tell you that, when people come together in groups, they are not as different as you might think (or hope, as the case may be). That said, resources and priorities differ and often diverge. Those who target specific niches—be they industry, geographic or plan size—are well advised to be alert to the potential divergence from the “common wisdom” of industry trends.

After all, we may all be alike—but that doesn’t mean we’re all the same.[iii]

- Nevin E. Adams, JD 

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[i] Though that’s likely at least partially attributable to the preponderance of safe-harbor plan designs—73.5% of smaller employers were safe harbor plans, compared with 36.7% of larger employers.

[ii] This actually was the case for all plan sizes other than 5.000+, with somewhere between three-quarters and two-thirds of responding employers noting that the advisor provided that education.

[iii] Of course, to see those plan size breakdowns, you need the full report—details on how to obtain it can be found at https://www.psca.org/research/401k/66thAR