FAB 2010-01: Further Thoughts

The issuance of FAB 2010-01 by the Department of Labor has raised a very important problem with respect to 403(b) plans. The language of FAB 2010-01 creates a risk that employers seeking to avoid the application of ERISA to their 403(b) plans may fail in that effort. This post addresses that specific problem from two perspectives, whether and to what extent the ruling is deficient and how to adapt to it.

The Problem

The problem arises from the way in which the response to Question 15 is worded. The FAB says: “Q-15. Would an employer exceed the ERISA coverage safe harbor limitations on employer involvement in 29 CFR 2510.3-2(f) if the employer hires a third-party administrator (TPA) to make discretionary decisions? Yes. The employer's selection of a TPA would be inconsistent with the safe harbor in 29 CFR 2510.3-2(f). The Department's FAB 2007-02 addressed the safe harbor conditions for tax-sheltered annuity arrangements to fall outside of ERISA Title I coverage, and specifically noted that the documents governing the arrangement could identify parties other than the employer as "responsible for administrative functions, including those related to tax compliance." As FAB 2007-02 further noted, the documents should correctly describe the employer's limited role and allocate discretionary determinations to the annuity provider or other responsible third party selected by a person other than the employer. Moreover, an employer may limit the available providers it will make available in its safe harbor arrangement to those where the 403(b) contracts or accounts or other governing documents prepared by the provider state that the provider or another appropriate third party is responsible for discretionary decisions related to loans and hardship distributions.” (Emphasis added.)

The key point here is that the employer cannot appoint anyone to make discretionary determinations. FAB 2007-02 limited the employer’s ability to make discretionary determinations, resulting in a market trend towards hiring third party administrators to manage 403(b) plans, but this new constraint in FAB 2010-01 makes such a decision problematic.

The Context

The issue arises under DOL Regs. 2510.3-2(f), which provides an exemption from ERISA for salary reduction-only 403(b) plans that have minimal employer involvement. The requirements, broadly speaking, are that (1) participation be completely voluntary, (2) all rights under any investment vehicle be enforceable only by the employee or beneficiary, (3) the involvement of the employer be limited to certain optional specified activities, and (4) the employer receive no compensation. It is the third of these requirements that is at issue, the scope of the employer’s involvement in the plan.

Under the Regulation, which has been around for a long time, the permitted employer functions are: “(i) Permitting annuity contractors (which term shall include any agent or broker who offers annuity contracts or who makes available custodial accounts within the meaning of section 403(b)(7) of the Code) to publicize their products to employees, (ii) Requesting information concerning proposed funding media, products or annuity contractors; (iii) Summarizing or otherwise compiling the information provided with respect to the proposed funding media or products which are made available, or the annuity contractors whose services are provided, in order to facilitate review and analysis by the employees; (iv) Collecting annuity or custodial account considerations as required by salary reduction agreements or by agreements to forego salary increases, remitting such considerations to annuity contractors and maintaining records of such considerations; (v) Holding in the employer's name one or more group annuity contracts covering its employees...(vii) After February 6, 1978, limiting the funding media or products available to employees, or the annuity contractors who may approach employees, to a number and selection which is designed to afford employees a reasonable choice in light of all relevant circumstances. Relevant circumstances may include, but would not necessarily be limited to, the following types of factors: (A) The number of employees affected, (B) The number of contractors who have indicated interest in approaching employees, (C) The variety of available products, (D) The terms of the available arrangements, (E) The administrative burdens and costs to the employer, and (F) The possible interference with employee performance resulting from direct solicitation by contractors.” The reference to paragraph (f)(2) permits the employee to designate the employer as the employee’s authorized representative in dealing with the investment vendor.

Then, the IRS issued regulations under 403(b) intended to make 403(b) plans more like 401(k) plans in their operation. Prior to this issuance, enforcement had been, to say the least, relaxed, but the 403(b) regulations initiated a dramatic wave of regulatory vigor. One of the new requirements is for there to be a written plan, which raised concerns among employers about the continuing availability of the exemption in DOL Regs. 2510.3-2(f). This concern was based on a misunderstanding of the exemption. The exemption assumes there is a plan, but deems the plan not to be maintained by the employer, which is a basic jurisdictional requisite of ERISA. However, the confusion made the exemption a focus of attention, and reasonably so. The problem is not the written plan document requirement, but the tax treatment of the plan. Under the 403(b) regulations, the tax effects of compliance failures by the plan were made explicit. These effects were, if anything, limited by the 403(b) regulations, but their issuance caused people to notice them.

The core requirements under the 403(b) regulations for a plan to be a 403(b) plan are at Regs. 1.403(b)-3(a). The relevant requirements here are that (1) the plan meet the general minimum distribution rules, (2) the plan comply with the direct rollover rules of 402(c)(8)(B), and (c) the plan limit contributions under 415. In addition, Regs. 1.403(b)-3(b)(3) states that: “For this purpose, a plan is a written defined contribution plan, which, in both form and operation, satisfies the requirements of §1.403(b)-1, §1.403(b)-2, this section, and §§1.403(b)-4 through 1.403(b)-11. For purposes of §1.403(b)-1, §1.403(b)-2, this section, and §§1.403(b)-4 through 1.403(b)-11, the plan must contain all the material terms and conditions for eligibility, benefits, applicable limitations, the contracts available under the plan, and the time and form under which benefit distributions would be made. For purposes of §1.403(b)-1, §1.403(b)-2, this section, and §§1.403(b)-4 through 1.403(b)-11, a plan may contain certain optional features that are consistent with but not required under section 403(b), such as hardship withdrawal distributions, loans, plan-to-plan or annuity contract-to-annuity contract transfers, and acceptance of rollovers to the plan. However, if a plan contains any optional provisions, the optional provisions must meet, in both form and operation, the relevant requirements under section 403(b), this section and §§1.403(b)-4 through 1.403(b)-11.” This language in fact expands the requirements listed at Regs. 1.403(b)-3(a) so as to require that, in order for any tax rule sought by application of 403(b) to be available, the plan must fully comply with 403(b). And that compliance is not just that the plan document be worded properly, but that there be operational compliance. Otherwise, the plan is not eligible under 403(b) and, for example, salary reduction arrangements are invalid.

This history creates a fundamental tension, between the requirements of the IRS and the DOL. For the two most common concerns in this area, loans and hardship distributions, the IRS requires that there be correct administration and the DOL precludes the employer from making the sorts of determinations required to ensure correct compliance. (There are other issues with similar problems, but this analysis can be applied to any of them.)

Now we get a little good news. The 403(b) regulations use the term “contract” to mean the terms of the plan and funding vehicles as related to one specific participant, and generally limit the sanctions for operational failures to the contract, to the specific participant with respect to whom the failure has occurred. The exceptions to this rule are (1) nondiscrimination failures, which, in a salary reduction-only plan, means the universal availability rule, and (2) failure of the employer to be an eligible sponsor. Thus, for example, an incorrect hardship determination as to Employee A will not cause the plan to fail as to other employees. This language reduces the scope of risk as to tax sanctions on the employer and employee. They are not, however, eliminated; operational failure as to Employee A cause deferrals for Employee A to fail.

The Errors in FAB 2010-01

The rules enunciated in FAB 2010-01 result from two basic errors in analysis. First, the nature of discretion is misunderstood. Second, the DOL creates an infinite regression of causes.

The FAB assumes that determinations related to loans and hardship distributions are discretionary. As to a standard loan provision, which requires only mathematical calculations to determine permissibility of loans, this is obviously absurd. Some loan provisions may have language that is not fully automatic (e.g., adopt a loan policy, flexibility in the duration of the loan), but these are easily eliminated by a simplification of the terms of the plan to make loan eligibility a fully mathematical exercise.

Hardship eligibility is a more difficult case. Hardship standards can involve factual determinations that seem to involve discretion and judgment and plan documents typically give the plan administrator discretion as to hardship determinations. However, the existence or nonexistence of a hardship is a factual matter, albeit a more difficult one than the math involved in loan eligibility. This is certainly true where the hardship is safe harbor-safe harbor, and true, but less obviously so, where hardship distributions are not limited to the safe harbors. If, then, the plan removes its discretion language, the administrator is making a nondiscretionary factual determination, subject to de novo review by the courts.

The infinite regression error is the equivalent of asking what caused the Big Bang. Positing, logically, that each event has a cause, any voluntary act that is a necessary condition to a discretionary determination is a cause of that determination and, in the logic of the DOL, a forbidden discretionary determination. Thus, under this logic, the decision to create a 403(b) plan is a forbidden discretionary determination, as is the designation of a person or persons to undertake the hiring of a TPA. There must be a line drawn somewhere that cuts off this logical chain, and DOL has not proposed any such line. (Given the logic of the DOL’s role as an enforcement agency, this is hardly surprising since it would reduce the number of persons who are deemed to be fiduciaries and therefore amenable to DOL sanctions and liability to plans and participants.) A logical place to draw this line is that decisions under the plan are subject to causal regression analysis, but that decisions as to the terms of the plan are not.

Now What?

Employers need to have control of their own tax compliance, as both DOL and IRS concede. The question is how to do so without subjecting the plan to ERISA. The following are possible approaches.

Take the FAB literally. Under this approach, the TPA would make no actual determinations of any kind. Instead, the terms of the plan would state that all paperwork must flow through the TPA, that the TPA would send that paperwork on to affected investment providers and that the TA could advise investment providers as to its opinion on the permissibility of the proposed loan or hardship distribution under 403(b) and the terms of the plan.

This structure takes advantage of Q-17 of FAB 2010-01, which reads as follows:

“Q-17. Would an arrangement that otherwise meets the terms of the safe harbor stay within the safe harbor if the written plan document required by Treasury Regulations under Code section 403(b) provides that salary deferrals will be discontinued to a provider that is not complying with Code requirements? Yes. If the purpose of the provisions for discontinuing a provider from offering products to participants in the arrangement is necessary to maintain tax code compliance, then including such provisions in the arrangement will not take it outside the safe harbor.”

The fact that the TPA considers the specific loan or hardship distribution to be not in compliance with 403(b), under this structure, does not mean that the loan or hardship distribution is not made. But, by providing a factual basis for cutting of future deferrals to the investment provider, it gives the TPA de facto veto power.

The second option is to redo the terms of the plan to remove discretion. This has two components. The first is to remove the normal discretion/standard of review language from the plan document. The second is to eliminate the need for complex factual determinations. Logically, either one of these would be sufficient, but doing both probably makes sense given the added costs of ERISA compliance.

The third approach is to appoint the TPA in the plan document. Essentially, the position here is based on a close reading of DOL Regs. 2510.3-2(f). That regulation presupposes a “program” that meets the requirements of 403(b), which obviously has to be created by action of the employer. Only then does it limit the employer’s involvement. Since the adoption of the 403(b) plan is the action creating or continuing the “program” that action is not subject to the requirements of the DOL Regulation. This would also tie in to the logic the DOL uses to determine what functions (grantor functions) cannot be paid for by the plan, rather than the employer. These generally include design analysis and documentation, and this is therefore a familiar division point or line to the DOL. As stated above, the reading is close, so that an agency determination by the DOL that it is incorrect would be given deference by a court (particularly because the exemption is purely created by the DOL and is not contained in any statute).

The fourth approach is to combine two or all three of the above. Given that the approaches do not contain any inconsistencies, this is the preferred option. Thus, a conservative approach would (1) rewrite the plan document to (a) eliminate the ordinary discretion/standard of review language, (b) designate the TPA as the administrator of the plan for nondiscretionary matters and as the employer’s representative for tax compliance, and (c) reduce all determinations of fact to their simplest levels through the use of safe harbors and hard rules, and (2) eliminate all investment providers that do make distributions or loans over the objection of the TPA from receiving future deferrals or intra-plan transfers.

NOTE: Hardships and loans are not the only areas in which these issues arise. They are the focus here simply for convenience.

BP Solutions Announced

PRESS RELEASE
BENEFIT PLAN SOLUTIONS

Benefit Plan Solutions announces its newest service offering, DC Solutions. DC Solutions is a technical consulting, problem solving and plan design service available on either an ad hoc basis or by subscription.

DC Solutions clients can submit issues or problems, ranging from plan or ERISA interpretation to plan design and correction of plan administration issues. BPS will provide, in response, analysis of the technical issues involved and alternative courses of action taking into account the client’s role and situation. All subscribers will receive sanitized versions of all submissions and the responses and all comments from any client will be fully shared.

Pricing for the service, on a subscription basis, is $500 per year or $49 per month. This price allows subscribers full access to all resources and products of BPS. These include a blog, a newsletter and a manual on Section 457 plans. An additional manual on Section 403(b) plans is scheduled for completion in May 2010. Nonsubscription services are available for individually quoted prices.

Benefit Plan Solutions is an independent retirement plan consulting firm, focusing on defined contribution plans. Services include plan design analysis, including integration of Section 401(k), 403(b) and 457 plans, plan administration support for sponsors, plan administrators and third party administrators, general consulting and small plan administration.