Dr. Pinar Cebar, at the American Council on Capital Formation, put out a paper early in the year encouraging greater use of annuities in the payout phase of retirement plans. The paper is available at http://www.acff.org/reports/sr-annuities0406.html. Because a significant part of this blog bewailing high costs in annuities, this report provides an opportunity to point out positives of annuities.
In writing about defined contribution retirement plans (and non-plans), the author is almost compelled to focus on the employment-based accumulation phase of retirement planning. In part this is because that phase is where the fun is, and in part it is because so few plans allow or encourage employees to leave their money in the plan. Few and far between are the sponsors who did not want to minimize involvement with former employees, and even fewer are those who want to pay for the privilege. Reduction of costs and fear of lawsuits from employees who are now former employees seem to be the basic reasons, and they are both legitimate and substantial reasons.
In addition, because the plan is about the accumulation phase, the employer/administrator has to focus on the fees between the employee and the ultimate investments, and these tend to be much higher in annuities. A non-plan environment would appear to be neutral as between annuities and other investments, but in fact is highly biased in favor of annuities because it is much, much harder to get the money needed for tax compliance from a custodial account arrangement where everything is explicit than from an annuity. This results in over-usage of annuities in situations like school districts (even setting aside the endorsed product problem) in the accumulation phase.
What Dr. Cebi's study points out is the fundamentally different issues for the participant and in the payout phase. If one has to live off of the yield from a given pool of assets, the factors that are important are very different from those that affect an employer. Specifically, the individual should be concerned about investment risk on the downside, inflation and excess (?) longevity.
This means that the tradeoffs between cost, flexibility and annuity-specific investment characteristics is fundamentally different for the payout phase. It also means that the choices to use or not to use an annuity rather than mutual funds and which annuity to buy are highly individual. The choices are completely different, for example, if you come from a long-lived family and know you are in good health rather than come from a family with a history
of lung cancer and seem to be coughing a lot lately. As a result, people at retirement ought to look carefully at annuity alternatives, and particularly those that reduce inflation and investment risks.
This does not mean that employers should be involved. Running a mutual fund-based or annuity-based retirement plan does not make one an expert in individual annuities. It also does not make one expert in the personal details and attitudes that employees ought to consider in the payout phase. At the most, the employer may want to point the participants towards the possibilities and give them starting points for information to help them make their decisions. In a plan context, or in a non-plan context of done appropriately, the employer may want to consider having a collection of names of people interested in talking to participants now receiving money from the plan or or materials offered by investment advisors of all stripes who have that interest. But not many employers will want to, or should, go beyond that.
Saturday, December 30, 2006
Thursday, December 21, 2006
Written Plan Requirement for 403(b) (and 457)
A major service provider in retirement plans recently issued a new advisory on 403(b) plan document requirements. This post is to disagree with most of what that advisory says. (Most of these comments apply to 457 plans as well, but with less force because they tend to be in better shape with respect to compliance issues.)
First, they say that there is no written plan requirement in 403(b), which seems right after a cursory glance. 403(b) is essentially a laundry list of requirements imposed on the "annuity" or "contract" (including custodial accounts and retirement income accounts) to get tax-deferred status for contributions to it. However, 403(b)(5) says that if 403(b) applies to more than one annuity, "such contracts shall be treated as one contract."
The effects of 403(b)(5) is not simply with respect to operational compliance; it applies to 403(b) in its entirety. The effect of this is that two annuities each including the 402(g) deferral limits are treated as one contract with twice the limit. And two contracts allowing loans are treated as one contract with an impermissible loan limitation.
You could argue that this does not matter where only one annuity can receive contributions during a year, because 403(b) is simply an element of determining tax liability for the year. However, where the requirement of 403(b) applies after the contributions are made (again, as with loan limitations), this argument is weaker. And it certainly fails in the non-plan, multi-vendor environment where there are certainly at least two options available to each employee.
And, where there is a plan and it is subject to ERISA, all of this technical tax analysis is irrelevant. ERISA has a specific written plan document requirement.
Next, the advisory says not to worry because the final regulations are not out, and won't be effective before 2008. The problem with this statement is the advisory's assumption that a writing requirement is entirely a creation of the proposed regulations, which it is not. A 403(b) that is not in compliance for 2007 because of a failure to deal with the "one contract" language of 403(b)(5) simply is not in compliance and not a 403(b) annuity.
Last, the advisory says that the Department of Labor has never been interested in seeing 403(b) documents where ERISA applies and that the DOL has never said what has to be in an ERISA 403(b) document. 29 U.S.C. 1102(a) says: "Every employee benefit plan shall be established and maintained pursuant to a written instrument." That requirement is not conditional on DOL enforcement policy or the issuance of content regulations. The fact is that people have been writing qualified plan, 457 and 409A plan documents for a long time, and the adjustments in content to make those into compliant 403(b) documents are trivial (our 403(b) documents, marked up from approved prototype 401(k) documents, took about 20 hours to modify). This argument will hold no water if a DOL auditor or a court asks for you plan document.
There is another thread running through the advisory that needs to be addressed, references to amendment deadlines. These references are an echo of the remedial amendment period rules that apply to qualified plans under 401(b). These rules apply only to qualified plans. They have no application to 403(b) or 457. The timing requirement for all 403(b) rules is, in fact, the first day of the first plan year to which the requirement applies. To the extent that the final regulations provide greater detail or liberalize the rules, the IRS can certainly delay the effective date of the regulations. But the effective dates for requirement that are clear under existing law are unaffected.
What is left of the advisory? First, what I call the "I have always relied on the kindness of strangers" defense is asserted. This says, in effect, that IRS and DOL will continue to be nicer to 403(b) employers and participants than they have to be. Given the number of 403(b) plans and arrangements in force and the fact that regulators routinely go easier on governmental and charitable organizations and their employees, there is some truth to that assertion. However, it does not help with several things. First, a lawyer cannot properly opine that the attempted 403(b) meets the requirements of 403(b). Second, nobody can certify to anyone (e.g., trustees, custodians, payroll administrators, paying agents, Form 5500 and employee return preparers, auditors, etc.) that this is a good 403(b). Third, the courts are not bound at all by IRS or DOL enforcement policy, although they do, obviously, give effect to the remedial amendment period for qualified plans. Last, if an IRS or DOL agent decides, for whatever reason, to pursue the issue (say, the employer has done bad things otherwise or the 403(b) is an element of an excess compensation arrangement), prior non-enforcement will not be a defense.
All of that is not to say that everybody should panic and scramble to get a writing in place before 2007, which is obviously not going to happen. It is simply to say that there is a business risk in not getting a writing in place soon, and that employers should be making fully-informed decisions whether or not to do so.
All of that also indicates that 403(b) documents should be reviewed and/or amended annually. This can be a problem with the current market structure because annuity and custodial account forms of contract are not modified every year. At BPS, we structure the 403(b) document service on a maintenance model, reviewing every year, and amending if needed every year.
Last, Benefit Plan Solutions has, and has had for some years, 403(b) written plans and non-plans. They follow a prototype format and are very simple to use. Please feel free to call or fax to 888-277-1017 or e-mail to geertom@gmail.com or benefitplansolutions@gmail.com for more information.
First, they say that there is no written plan requirement in 403(b), which seems right after a cursory glance. 403(b) is essentially a laundry list of requirements imposed on the "annuity" or "contract" (including custodial accounts and retirement income accounts) to get tax-deferred status for contributions to it. However, 403(b)(5) says that if 403(b) applies to more than one annuity, "such contracts shall be treated as one contract."
The effects of 403(b)(5) is not simply with respect to operational compliance; it applies to 403(b) in its entirety. The effect of this is that two annuities each including the 402(g) deferral limits are treated as one contract with twice the limit. And two contracts allowing loans are treated as one contract with an impermissible loan limitation.
You could argue that this does not matter where only one annuity can receive contributions during a year, because 403(b) is simply an element of determining tax liability for the year. However, where the requirement of 403(b) applies after the contributions are made (again, as with loan limitations), this argument is weaker. And it certainly fails in the non-plan, multi-vendor environment where there are certainly at least two options available to each employee.
And, where there is a plan and it is subject to ERISA, all of this technical tax analysis is irrelevant. ERISA has a specific written plan document requirement.
Next, the advisory says not to worry because the final regulations are not out, and won't be effective before 2008. The problem with this statement is the advisory's assumption that a writing requirement is entirely a creation of the proposed regulations, which it is not. A 403(b) that is not in compliance for 2007 because of a failure to deal with the "one contract" language of 403(b)(5) simply is not in compliance and not a 403(b) annuity.
Last, the advisory says that the Department of Labor has never been interested in seeing 403(b) documents where ERISA applies and that the DOL has never said what has to be in an ERISA 403(b) document. 29 U.S.C. 1102(a) says: "Every employee benefit plan shall be established and maintained pursuant to a written instrument." That requirement is not conditional on DOL enforcement policy or the issuance of content regulations. The fact is that people have been writing qualified plan, 457 and 409A plan documents for a long time, and the adjustments in content to make those into compliant 403(b) documents are trivial (our 403(b) documents, marked up from approved prototype 401(k) documents, took about 20 hours to modify). This argument will hold no water if a DOL auditor or a court asks for you plan document.
There is another thread running through the advisory that needs to be addressed, references to amendment deadlines. These references are an echo of the remedial amendment period rules that apply to qualified plans under 401(b). These rules apply only to qualified plans. They have no application to 403(b) or 457. The timing requirement for all 403(b) rules is, in fact, the first day of the first plan year to which the requirement applies. To the extent that the final regulations provide greater detail or liberalize the rules, the IRS can certainly delay the effective date of the regulations. But the effective dates for requirement that are clear under existing law are unaffected.
What is left of the advisory? First, what I call the "I have always relied on the kindness of strangers" defense is asserted. This says, in effect, that IRS and DOL will continue to be nicer to 403(b) employers and participants than they have to be. Given the number of 403(b) plans and arrangements in force and the fact that regulators routinely go easier on governmental and charitable organizations and their employees, there is some truth to that assertion. However, it does not help with several things. First, a lawyer cannot properly opine that the attempted 403(b) meets the requirements of 403(b). Second, nobody can certify to anyone (e.g., trustees, custodians, payroll administrators, paying agents, Form 5500 and employee return preparers, auditors, etc.) that this is a good 403(b). Third, the courts are not bound at all by IRS or DOL enforcement policy, although they do, obviously, give effect to the remedial amendment period for qualified plans. Last, if an IRS or DOL agent decides, for whatever reason, to pursue the issue (say, the employer has done bad things otherwise or the 403(b) is an element of an excess compensation arrangement), prior non-enforcement will not be a defense.
All of that is not to say that everybody should panic and scramble to get a writing in place before 2007, which is obviously not going to happen. It is simply to say that there is a business risk in not getting a writing in place soon, and that employers should be making fully-informed decisions whether or not to do so.
All of that also indicates that 403(b) documents should be reviewed and/or amended annually. This can be a problem with the current market structure because annuity and custodial account forms of contract are not modified every year. At BPS, we structure the 403(b) document service on a maintenance model, reviewing every year, and amending if needed every year.
Last, Benefit Plan Solutions has, and has had for some years, 403(b) written plans and non-plans. They follow a prototype format and are very simple to use. Please feel free to call or fax to 888-277-1017 or e-mail to geertom@gmail.com or benefitplansolutions@gmail.com for more information.
Friday, December 1, 2006
More on Plan Drafting
On September 1, the ERISA and Disability Benefits Law Blog posted and excellent write-up of Ushakova v. AIG Life Ins. Co., 2006 WL 2473473 (W.D. Wash. 8/26/06). The District Court concluded that a claim for benefits was reviewable de novo because the plan documents contained no language specifically granting discretion to the plan administrator. Instead it required that the claimant provide "due written proof of the loss."
The case is certainly another instance of courts resisting the application of the Supreme Court's "arbitrary and capricious" standard of review. There are now so many of these cases that one has to assume that a court will always look far a way to apply some lower standard.
The case is also yet another reminder that plans need to be better written than is the norm today. It is very simple to include language that the plan (to paraphrase Firestone Tire and Rubber v. Bruch, 489 U.S. 101 (1989) that the plan gives the administrator discretionary authority to determine eligibility for benefits and to construe the terms of the plan. All plans, whether they are subject to ERISA or not, should do so loudly and clearly.
The case is certainly another instance of courts resisting the application of the Supreme Court's "arbitrary and capricious" standard of review. There are now so many of these cases that one has to assume that a court will always look far a way to apply some lower standard.
The case is also yet another reminder that plans need to be better written than is the norm today. It is very simple to include language that the plan (to paraphrase Firestone Tire and Rubber v. Bruch, 489 U.S. 101 (1989) that the plan gives the administrator discretionary authority to determine eligibility for benefits and to construe the terms of the plan. All plans, whether they are subject to ERISA or not, should do so loudly and clearly.
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