History of 403(b) Plan

Although 403(b) retirement plans may be less well known than their 401(k) counterparts in the for-profit sector, they have been a major topic of discussion in the retirement industry in recent years due to major regulatory changes affecting them. 

Named after the section of the Internal Revenue Code that created them, 403(b) programs were officially established in 1958 to encourage employees of tax-exempt organizations to establish retirement savings programs. As far back as the 1940s, the income tax law recognized that schools could put money aside in annuity contracts for employees.

The annuity contracts operated as individual accounts in a retail environment. It wasn't until 1986 tax reform that such contracts began being referred to as plans rather than programs.  

But this relationship and the landscape for 403(b) plans have been changing dramatically in recent years. In 2009, the Internal Revenue Code sought to bring 403(b) plans closer to 401(k) plans in nature. "Now the objective is to make 403(b) operate like a cousin of 401(k)s and the IRS shifted responsibility to plan sponsors.

That shift is the result of audits of 403(b) plans that the IRS began in the late 1990s, which resulted in the discovery of widespread abuses with regard to loans and hardships. Providers weren't sharing information about employees, who could easily circumvent loan limits. 

Employers weren't paying much attention to the issues either. Now the two types of retirement plans are looking increasingly similar. 

The biggest differences remain eligibility and the fact that 401(k) plans benefits are based on contributions, not years of service, as under 403(b) plans. Additionally, 403(b) plans can only be funded with annuity contracts and mutual funds.

The 403(b) market has grown to represent more than $600 billion as of the end of 2008, according to a consulting firm. The tax-exempt organizations that can offer 403(b) tax-deferred plans include schools, colleges, hospitals, as well as governmental, charitable, church and other non-profit organizations.  

Typically in a 403(b) plan, an employee sets aside money for retirement on a pre-tax basis to a vendor plan offered by employers. 

Employees select a particular plan and grow their money tax free until retirement, at which point they are able to withdraw funds.

Some of the investment options for employees in a 403(b) plan are annuity and variable contracts offered by insurance companies, which dominate the market for providing tax deferred annuity plans, as well as mutual funds. 

Originally, there were supplemental plans. Some of them became ERISA plans as well, governed by the Employee Retirement Income Security Act of 1974. This Act requires information regarding the plan to be shared with the Department of Labor.

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