Robert J. Toth
There are substantial legal challenges related to offering to 403(b) plans the type of collective trust investments that are sold to 401(k) plans. You have to deal with Investment Company Act of 1940 rules; SEC registration requirements; and share accounting issues — all of which makes it virtually impossible to do.
The University of California made news recently when it announced that it has found a unique way to apply the collective trust rules in such a way as to make just such an offering to its 403(b) plan. They did not announce the method they used to “thread the needle” to make it work, but did mention that there is an IRS private letter ruling (PLR) which supported their position.
There is an obscure way for them to accomplish this, and there is an old PLR which describes the key tax issues. The downside to this possible approach is that it still does not “crack the nut” to make collective investment trusts (CITs) available on a bulk basis as 81-100 trusts for all unrelated employers. But for the large state university or K-12 arrangement, it may well work.
Here’s the technical structure. Internal Revenue Code Section 403(b)(7)(C) requires that a custodial account hold shares of a regulated investment company (RIC) as defined in Internal Revenue Code Section 851(a). Section 851(a) actually has three different types of RICS. Two of them are under Section 851(a)(1), which are your run-of-the-mill mutual fund and a unitized investment trust (for example, a 403(b) annuity contract uses the unitized investment trust version of a RIC). My earlier blog focused on these two types, because that is what is typically offered in the marketplace.
However, 851(a)(2) permits a third type of RIC. An 851(a)(2) RIC is a common trust fund “or similar fund” which is otherwise excluded from the definition of a RIC under 15 USC 80a-3(c)(3) (which is part of the Investment Company Act of 1940, which regulates investment companies). USC 80a-3(c)(3) excludes a common trust from the definition of RIC (for that section’s purposes, but not for 403(b)) as long as the trust interests are not (i) advertised; (ii) offered for sale to the general public; and (iii) “fees and expenses charged by such fund are not in contravention of fiduciary principles established under applicable Federal or State law.”
In order to qualify use this type of RIC as a 403(b) regulated investment company, the common trust also cannot be included in the definition of “common trust fund “under Internal Revenue Code Section 584(a) (per Code Section 851(a)(2)). Section 584(a) does NOT include state chartered trust companies, it only covers national banks and trusts.
What does this all mean? It means that as long as the CIT is offered by a state chartered trust company, and meets the USC 80a-3(c)(3) limitations (and the other limitations under Section 851) explained above, the interests in the trust can be purchased by a 403(b) custodian.
Add to this the fact that the UC plan is a governmental plan, the CIT interests would be exempt from registration under the Investment Company 40 Act — meaning no prospectuses, proxies or other such requirements the typical mutual fund or registered annuity contract must provide. The plan’s 403(b) custodial account could then hold the interests in that CIT.
The PLR related to it is PLR 8003155
Even if this is not the structured actually used at UC (and even if is, there are a number of details and legal issues which needed to be resolved in order to actually make this work), it could be something close to this. For sophisticated state universities with large plans, or even those large consolidated K-12 plans, this could be a very real option. We may be seeing more of the same.Robert J. Toth, Jr. is principal in the Law Office of Robert J. Toth, Jr., LLC and is a member of the NTSA Communications Committee.
Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA or its members.