401k-403b-457 Plans Blog

Can Participants Rely on Statements?

2010-06-09T14:29:00.000-04:00

Conveniently, the Sixth Circuit has issued another opinion illustrating this urge of the lower courts to find plaintiff remedies by creative applications of the law. The case, Bloemaker v. Laborers' Local 265 Pension Fund, No. 09-3536 (6th Circuit 2010), held that participants in defined benefit pension plans can assert benefit rights not created by the plan but reflected in written estimates of benefits based on an equitable estoppel theory.

The participant had asked for an estimate of benefits under a plan’s early retirement provisions. The estimate provided was incorrect, and obviously so to anyone who has experience with calculations of early retirement benefits. The participant then retired, in reliance on the estimate and received benefits for almost two years. At this point, the TPA noticed the error, and contacted the participant stating that (1) future benefits would be reduced, and (2) the participant had to repay the excess benefits actually received. The error was based on “a computer programming error.”

The opinion is poorly written, so much so that the operational test is stated in two similar but hardly identical formulations. In the first version, the Sixth Circuit said: “Under our precedent, the elements of an equitable estoppel claim are: 1) conduct or language amounting to a representation of material fact; 2) awareness of the true facts by the party to be estopped; 3) an intention on the part of the party to be estopped that the representation be acted on, or conduct toward the party asserting the estoppel such that the latter has a right to believe that the former’s conduct is so intended; 4) unawareness of the true facts by the party asserting the estoppel; and 5) detrimental and justifiable reliance by the party asserting estoppel on the representation.” The second version required “intended deception or such gross negligence as to amount to constructive fraud, plus (1) a written representation; (2) plan provisions which, although unambiguous, did not allow for individual calculation of benefits; and (3) extraordinary circumstances in which the balance of equities strongly favors the application of estoppel.” The Court treated these two formulations as being the same, and to maintain some semblance of order here the balance of this post will focus on the first because it is more detailed and less vague.

Under the first standard, the first and the last three items were pretty easily met by the participant’s complaint. The second, however, seems problematic. In fact, the complaint appears to have had only general allegations that the plan and the TPA knew the true facts. But what facts? Did the TPA know the benefit calculation was wrong? That is unlikely. Will the courts ultimately say that knowledge of the facts underlying the benefit determination is awareness of the true facts?

Also, the calculated early retirement benefit involved an actuarial reduction of the annual benefit of only 12.3%, a reduction that is pretty obviously too small. This raises a very real question as to whether there was actual reliance by the participant, whether any reliance was justifiable or whether the participant just decided to take advantage of the error. This fact question can be raised under either the fourth or fifth elements set out by the Sixth Circuit.

And, of course, it is still an open question whether the Supreme Court will, ultimately, allow an equitable estoppel claim. The Sixth Circuit makes all the right protestations to the effect that plans have to be in writing and that a determination that a participant has rights exceeding the terms of the plan may adversely affect other participants, but gives these considerations no effect.

Various Circuit Courts, but not all, allow some version of the equitable estoppel theory. Given that, the Supreme Court needs to step in again and shoot down this latest attempt to find remedies not provided in ERISA.

So how does this apply in a defined contribution context? Presumably, the theory could be applied based on (1) representations as to contribution rates, (2) representations as to the availability of various kinds of investments, (3) participant statements, and (4) whatever else is contained in a written communication.

Attorney’s Fees Awarded for Lawsuit Resulting in Remand to Plan Administrator

2010-06-09T14:27:00.000-04:00

The Supreme Court, in Hardt v. Reliance Standard Life Insurance Co., decided that attorney’s fees can be awarded to a participant where a case was remanded to the plan administrator and the claim was then granted. The attempt to prevent the award was based on the premises that (a) the person requesting an award of attorney’s fees must be a “prevailing party” in the lawsuit, and (b) “a fee claimant is a “prevailing party” only if he has obtained an “enforceable judgmen[t]on the merits ” or a “court-ordered consent decre[e]”.

The logic of the decision was that the specific language of ERISA does not require “prevailing party” status, but only that the person seeking fees show “some degree of success on the merits”.

This rule is to be applied not just in determining whether a court has authority to make an award of attorney’s fees but also in reviewing that court’s exercise of discretion in making the award. This, in effect, overturned the existing five factor analysis applied by the lower courts. Described by the Supreme Court as “(1) the degree of opposing parties’ culpability or bad faith; (2) ability of opposing parties to satisfy an award of attorneys’ fees; (3) whether an award of attorneys’ fees against the opposing parties would deter other persons acting under similar circumstances; (4) whether the parties requesting attorneys’ fees sought to benefit all participants and beneficiaries of an ERISA plan or to resolve a significant legal question regarding ERISA itself; and (5) the relative merits of the parties’ positions.” The only limitations on the capacity of a court to award attorney’s fees are that the result has to be more that “trivial success on the merits” or a “purely procedural victory.”

This case is primarily being written up as to the first issue, whether the participant/claimant has to be a “prevailing party.” However, the lack of meaningful standards for reviewing the exercise of discretion by the court making the award is actually more troubling. Until the courts begin to establish a track record of making and reviewing awards and denials of awards under this decision, plans and plan administrators will live with uncertainty. Logically, since most cases outside of disability benefits are rejected, this broad ability to make awards could be advantageous. However, in the real world it is unlikely that plans will be awarded attorney’s fees at anything like the rate of awards to participants, because that second rejected factor will be applied, explicitly or implicitly.

Another Attack on Administrator Discretion Turned Back

2010-06-09T14:24:00.000-04:00

There is a pattern in case law development under ERISA of lower courts giving pro-employee results, only to be overturned on appeal, particularly to the Supreme Court. This pattern certainly extends to case law on the appropriate standard of review of decisions by plan administrators. Yet another instance of this pattern is reflected in the recent Supreme Court case of Conkright v. Frommert, No. 08-810 (Apr. 21, 2010).

In Conkright, a participant’s claim was denied on one basis. The participant sued and eventually the basis for denying the claim was rejected by the Circuit Court, which returned the case to the plan administrator for consideration of other interpretations. The plan administrator again denied the claim, based on another interpretation, whereupon the participant went back to the courts. The participant argued that, since the plan administrator had been wrong the first time, there should be a de novo review, rather than a review for abuse of discretion, and the District Court and Circuit Court agreed. The Supreme Court disagreed, holding that the decision of the plan administrator on remand was still entitled to the deferential abuse of discretion review.

There are three lessons here. First, procedurally, plans should push for remand after adverse court decisions. Second, decisions by plan administrators should include language stating, broadly, that the initial denial is based on the issues considered as sufficient, and that other issues may warrant a denial. Third, nobody should get too worked up about lower court decisions on ERISA issues.

FAB 2010-01: Further Thoughts

2010-04-27T15:54:00.000-04:00

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

2010-04-27T15:52:00.000-04:00

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.

Why I hate FAB 2010-01

2010-03-29T14:52:00.000-04:00

The portions of FAB 2010-01 dealing with hiring a TPA are very poorly written and belie any knowledge of the real world.

The employer, in the plan document, is assumed to appoint a plan administrator of some sort. in the quoted language from FAB 2007-02. Reading the language narrowly, a problem arises only where the employer appoints a third party to make discretionary determinations. It is entirely possible, under the rubric of "administrative functions, including those related to tax compliance," to designate a TPA as plan administrator either in the plan document or otherwise. As to limitations on the TPA's authority:

1-As to loans, there are discretionary determinations only where there is discretion. If the eligibility and amount rules in the plan document are mechanical (i.e., amount, duration, etc. are formulaic), it is hard to see any discretion.

2-As to hardship, again there can be circumstances where no discretion is exercisable. E.g., the amount is deemed both an immediate and heavy financial need and necessary to satisfy financial need. However, there also can be circumstances under which there is discretion, as the DOL understands that term.

On the flip side, where a participant has more than one product vendor, it is possible for the participant to request loans/hardship distributions independently from each. This could easily result in excess loans or hardship amounts. Under the 403(b) regs. (i.e., the second sentence of Regs.1.403(b)-3(b)(3)(ii)), there must be someone performing those limitation functions.

The cautious approach would provide that the TPA simply collect and transmit information to the product vendors, giving the participant a single location for loan and hardship applications, coordinating so that maximum limits are not exceeded. and forwarding the results to the product vendors for discretionary determination. This much is not only permitted, but required.

In theory, there could be a less cautious approach that would attempt to draw a line, as to loans and hardship, between mechanistic determinations and discretionary ones. For example, a safe harbor/safe harbor hardship determination might be permitted, but others referred to the product vendors. Functionally, this runs into two problems. First, having ordinary TPA employees draw those sorts of lines will (not may) result in errors. Second, the product vendor has to make its own determination, under the terms of its own contract, as to whether or not the loan/hardship is permitted, and will not rely on the TPA unless the venodr has selected the TPA.

A third theoretical option is available. The plan document can designate a plan administrator (say, a corporate officer/nonparticpant) that can retain the services of a TPA. Unfortunately, this runs into the "what caused the big bang" problem. That is, appointing someone to appoint someone else to exercise discretion is, in the eyes of the DOL, a discretionary decision. So, probably a no-go here as well.

I am no philosopher or logician, but DOL seems to be unaware of two basic logical/linguistic fallacies.

First, they take the position that the kinds of factual determinations underlying loans and hardships are discretionary. Clearly, in the real world, this is not true all the time. And, even where there are factual issues, they are, in fact, factual. Thus, such determinations are inherently unlike decision such as whether or not to have a 403(b) plan. DOL appears to be confused by the routine language inserted in plans (broadest discretion, etc.) to get an abuse of discretion review of plan decisions into believing that all actions are discretionary. Is the determination as to whether an employer is of the sort that can offer the 403(b) catch-up any less discretionary than the determination that a person's house has burned down?

There is a pretty clear argument that this source of discretion can be eliminated simply by stating that the standard of decision for plan determinations other than as to tax compliance issues is nondiscretionary and the standard of review is de novo. And, in the kind of plan we are talking about (loosely connected products to which the employer makes no contribution), the kind of exposure to costs that motivates the seeking for an abuse of discretion standard of review is either reduced or absent. To the extent that the participant gets money, it is, after all, the employee's money. This is the fourth theoretical option.

The second fallacy is the illogic of infinite regression. Anything that is a necessary, or "but for," logical or sequential precondition to the determination of a discretionary determination can be caught under this fallacy. If the employer allows or requires a product vendor to make a determination, is that employer decision discretionary? Yes. If the plan permits or requires vendor determinations, is the employer's adoption discretionary? Yes. Once on this path, there is no place to stop.

Choosing between 401(k) and 403(b)

2009-06-15T14:55:00.000-04:00

BNA has published a brief article on choosing between 403(b) and 401(k) formats for retirement plans at http://www.bnatax.com/tm/insights_kenty.htm. The summary is well written and brief, both of which are real virtues. I have only two comment.

First, one of the stated reasons for choosing 403(b) is the availability of investments other than annuities and mutual funds. This is certainly true, but warrants a qualifier. Since an employer can have all three of a qualified plan, a 403(b) and a 457 plan, this is not an either/or choice. For example, to the extent the pressure for other types of investments comes from a short list of employees, a complementary 457 plan would provide a pressure release valve (in addition to allowing adding the 457 limitation to the applicable variant of 415 and 402(g) limitations). Also, all such issues are irrelevant if the 403(b) would be a church plan.

Second, the 403(b) version of the overall 415 limitation is systematically higher than the 401(k) version. The primary reason for this is the use, in defining compensation, of the most recent full-time equivalent year of service rather that a 12-month measurement period.

Defective Contract Exchanges

2009-06-15T14:52:00.000-04:00

The Segal Group issued a timely and well-written reminder of the June 30th deadline for defective contract exchanges from the 9/24/07 to 12/31/08 time period. It can be found at http://www.sibson.com/publications-and-resources/compliance-alert/archives/?id=1279.

Church Plan Effective Dates

2008-09-05T18:46:00.000-04:00

The Pension Protection Act Blog has a concise, clear explanation of the effective dates of the final regulations for church 403(b) plans.

The post is at http://qualifiedpensionconsulting.com/ppablog/2008/08/21/final-403b-regulation-date-tricky-for-church-plans/

New Teacher Pay Rule from IRS

2008-09-05T14:00:00.000-04:00

On July 21, 2008, in Notice 2008-62, the IRS created a new rule on public school teacher compensation. In a nutshell, the rule says that “recurring part year compensation” will not be treated as deferred compensation under Section 457(f) as long as “(1) the arrangement does not defer payment of any of the recurring part-year compensation beyond the last day of the 13th month following the beginning of the service period and (2) does not defer from one taxable year to the next taxable year the payment of more than the applicable dollar amount under 402(g)(1)(B) in effect for the calendar year in which the service period begins ($15,500 for 2008).” “Recurring part year compensation” is defined at Regs. 1.409A-2(a)(14) as follows:

“the term recurring part-year compensation means compensation paid for services rendered in a position that the service recipient and service provider reasonably anticipate will continue on similar terms and conditions in subsequent years, and will require services to be provided during successive service periods each of which comprises less than 12 months (for example, a teacher providing services during a school year comprised of 10 consecutive months), and each of which periods begins in one taxable year of the service provider and ends in the next such taxable year. The rules of this paragraph (a)(14) apply to a particular amount of compensation only once, so that an amount deferred under this rule may not again be treated as recurring part-year compensation for purposes of this paragraph and subject to a second deferral election under this paragraph (a)(14).”

The reason for creating this rule is to allow teachers and other eligible public school employees to annualize their compensation. Typically, this allows a teacher to receive pay in equal amounts from the beginning of a school year (say, September) to the beginning of the next school year (say, the following August). The unwillingness of the IRS to extend the rule to non-teachers, incidentally, serves as an example of the clout of K-12 teachers and otherwise has absolutely no justification. So far, so good.

There are two problems with this rule.

First, the very notion of regulating deferral of compensation within a year is bizarre. Note the limitation that the rule does not allow deferral to a new taxable year of the teacher. However, the rule not only limits how much may be deferred between the two years but how those amounts must be paid within the second year. The rule certainly could have been written more clearly in terms of the inter-year deferral, and in ways that do not regulate the payment structure in the second year. For example, the rule could have allowed deferrals of recurring part year compensation up to a limit of the lesser of the 402(g) limitation or the inter-year deferral amount, and then defined that second amount as the compensation that would have been paid in the first year minus the amounts actually paid. This would more clearly define the amounts limit the regulatory impact to inter-year deferrals and make the rule more easily applied.

Second, how does the Section 402(g) limitation get involved here? At no point does either 457(f) or 409A refer to 402(g) and neither of them contains the detailed language necessary to address an issue as narrow as annualized compensation elections. There is certainly no support in the statute for this add-on and, given the real-world reasons for and ubiquity of teacher annualization, I can think of no legitimate regulatory purpose for it. This is simply another example of the IRS making up the rules on the fly and of a disregard for the difference between interpretive regulations (in which the IRS is supposed to flesh out the rules in the statute) and legislative regulations (where the IRS is authorized to make up new rules).

At the least, the fact of application of the 402(g) limitation shows what deferral is being regulated, the inter-year deferral. The absurdity of regulating intra-year deferral supports this premise.

Of course, one of the problems in dealing with the entire non-401(a) compensation area is collateral implications. Absent the specific language of proposed regulations, it is difficult to resolve these issues, so the following comment are just tentative. What effect does this rule have on 457(b) and 403(b)? Or, for that matter, on 401(k)? The major possible issues are:

1. Section 401(a).

(a) The annualized compensation structure may affect plan operations. Assume the qualified plan has a compensation measurement year and a limitation year of 8/1-7/31. In that case, an annualization election will have the effect of shifting some compensation accrued during on compensation/limitation year back one year. This affects both the application of 415 and the compensation base for determining or allocating contributions. Setting aside the potential for a 415 violation as minor, the deferral could certainly affect a contribution of, say, 6% of compensation or a matching contribution of, say, 100% of the first 6% of compensation, particularly if the contribution rate varies between years. (And fixing that differential would involve individually designed plan-type features, the calculation of compensation separately for allocations and testing and the running of a general nondiscrimination test.)

(b) The annualization can reduce the ability of TPAs to catch unreported severances. Many TPAs rely on the cessation of compensation as a backup for employer reporting of severances. To the extent the amounts not yet paid on severance of an annualized teacher are not paid in a balloon payment, this backup will not work until the annualization period is completed.

(c) The annualization structure creates the potential for some of the compensation to be paid more than 2-1/2 months after severance, particularly if the “annualization” uses a 13-month period. Since the 415 regulations only allow the plan to take into account compensation paid before the later of 2-1/2 months from severance or the end of the limitation year, this could have a meaningful effect on severance. Using the same plan and assuming a 13-month annualization from 9/1 of the first year and termination on 6/1 of the second year, the 2-1/2 months expires on 8/15, while compensation continues to be paid through 9/30. Since the limitation year ends on 7/31, compensation paid after 8/15 is not taken into account under 415. The 9/1 and 6/1 dates are admittedly artificial, and the more likely scenario is 8/15 and 6/15, in which a 12-month annualization coincides with the end of the 2-1/2 months, more or less, so that the issue is minor, It can, nonetheless, cause violations.

(d) At no point does the rule say that the annualized amounts can or cannot be the subject of cash or deferred elections. Because of the 2-1/2 month limitation under the 415 regulations, it is possible that annualized amounts will not be eligible for deferral because the amounts would not be included in 415 compensation. Given that the employer and TPA may not have properly classified the employee as terminated, this is a specific risk of the annualized compensation structure that does not get fixed easily, with a higher risk of error when the fact pattern occurs than, say, a matching or employer contribution determination made after the end of the plan year.

(e) If the qualified plan has an active service requirement (say, employed on the last day of the plan year), the employee could lose a match or employer contribution as to the amount pushed into the plan year of termination. In addition, the last day rule may not be applied properly in the year of severance because of the continuation of compensation after the date of severance.

(f) The deferral limits are personal, and based on the taxable year of the employee. Thus, shifting within that year has no effect on how they are determined or applied. There is, of course, the possibility that changing elections will change deferrals (For example, increasing deferrals for the summer because of other compensation from summer employment is a possibility.); this simply afford more flexibility. The higher risk of administrative errors is a constant.

2. Section 403(b). The issues are essentially the same, except that the 415 limitation is not really relevant because the 403(b) rules are based on the employee's taxable year. As a result, the limitation that the annualization not defer to subsequent years of the employee prevents any non-technical 415 significance. In addition, most 403(b) plans will use a calendar year for all purposes to avoid the need to calculate the 415 limitation and other compensation-related items on separate bases.

3. Section 457. Ditto for 457. The limitations in 457 are based on taxable years of service providers and most are calendar year plans.

Broker Fiduciary Liability

2007-08-20T15:51:00.000-04:00

The 401khelpcenter.com has written up a new Federal District Court case at:

http://www.401khelpcenter.com/401k/meehan_perils.html

The case involved and Edward Jones broker who helped the plan create asset allocation models. The Court found that he and Edward Jones were fiduciaries. The employer had borrowed money from the plan, booked them as "employer receivables" and then filed for bankruptcy. The broker was charged with the responsibility to question the increasing employer receivables number.

Common Remitter Functions under the Final 403(b) Regs. and FAB 2007-02

2007-07-26T00:43:00.000-04:00

We finally have what we need to determine employer responsibilities under §403(b) and how those responsibilities have to be allocated to maintain ERISA exemption in the absence on governmental or church plan status. And it looks like all employer trying to use the special 403(b) exemption are going to have to hire somebody to provide compliance services, including payroll processing in a common remitter function.

Let’s start with the language of the exemption at DOL Regs. §2510.3-2(f):

“(f) Tax sheltered annuities. For the purpose of title I of the Act and this chapter, a program for the purchase of an annuity contract or the establishment of a custodial account described in section 403(b) of the Internal Revenue Code of 1954 (the Code), pursuant to salary reduction agreements or agreements to forego an increase in salary, which meets the requirements of 26 CFR 1.403(b)-1(b)(3) shall not be ``established or maintained by an employer'' as that phrase is used in the definition of the terms ``employee pension benefit plan'' and ``pension plan'' if

(1) Participation is completely voluntary for employees;

(2) All rights under the annuity contract or custodial account are enforceable solely by the employee, by a beneficiary of such employee, or by any authorized representative of such employee or beneficiary;

(3) The sole involvement of the employer, other than pursuant to paragraph (f)(2) of this section, is limited to any of the following:

(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;

(vi) Before February 7, 1978, to have limited the funding media or products available to employees, or the annuity contractors who could approach employees, to those which, in the judgment of the employer, afforded employees appropriate investment opportunities; or

(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,

(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; and

(4) The employer receives no direct or indirect consideration or compensation in cash or otherwise other than reasonable compensation to cover expenses properly and actually incurred by such employer in the performance of the employer's duties pursuant to the salary reduction agreements or agreements to forego salary increases described in this paragraph (f) of this section.”

The current concerns of many seem to focus on whether the existence of the plan document required under §403(b) is going to cause loss of the exemption, The answer to that is simple-NO. The quoted exemption is often called a non-plan exemption, but in fact it says that the “program” will not be treated as established or maintained by an employer.

The more interesting question is whether the operational requirement under §403(b), which are more explicit since the final regulations, are inconsistent with the exemption. Here the answer is also clear-YES.

FAB 2007-2 says, inter alia:

“The Code’s qualification requirements impose obligations directly on employers in connection with the employees’ annuity contracts and custodial accounts. If individual contracts or accounts fail to satisfy the tax qualification requirements, even if due to actions or errors of an employee or annuity contractor, the employer can be liable to the IRS for potentially substantial penalty taxes, correction fees, and employment taxes on employee salary deferrals. Accordingly, in the Department’s view, the safe harbor at section 2510.3-2(f) subsumes certain employer activities designed to ensure that a TSA program continues to be tax compliant under section 403(b) of the Code.

The Department of Labor has issued advisory opinions and other guidance on whether specific employer functions are compatible with the safe harbor. The Department believes that the safe harbor allows an employer to conduct administrative reviews of the program structure and operation for tax compliance defects. Such reviews may include discrimination testing and compliance with maximum contribution limitations under the Treasury regulations. As noted in previous guidance issued by the Department, the employer may also fashion and propose corrections; develop improvements to the plan's administrative processes that will obviate the recurrence of tax defects; obtain the cooperation of independent entities involved in the program needed to correct tax defects; and keep records of its activities.

A program could fit within the section 2510.3-2(f) safe harbor and include terms that require employers to certify to an annuity provider a state of facts within the employer's knowledge as employer, such as employee addresses, attendance records or compensation levels. The employer may also transmit to the annuity provider another party's certification as to other facts, such as a doctor's certification of the employee's physical condition. The employer could not, however, consistent with the safe harbor, have responsibility for, or make, discretionary determinations in administering the program. Examples of such discretionary determinations are authorizing plan-to-plan transfers, processing distributions, satisfying applicable qualified joint and survivor annuity requirements, and making determinations regarding hardship distributions, qualified domestic relations orders (QDROs), and eligibility for or enforcement of loans.”

The last quoted sentence puts the bunny into the hat. Clearly these functions are required to maintain §403(b) status, and clearly the employer is not allowed to do them. Implicit in this listing are multi-contract functions such as limiting aggregate loans and hardship distributions, ensuring minimum required distributions compliance and determining what investments will be allocated under QDROs. Also implicit is some amount of payroll compliance outsourcing, if only to administer loan repayments.

This need for outside assistance is reinforced by provisions of the §403(b) regulations. Regs. §1.403(b)-3(b)(3) reads as follows:

“(3) Plan in form and operation. (i) A contract does not satisfy paragraph (a) of this section unless it is maintained pursuant to a plan. 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.

(ii) The plan may allocate responsibility for performing administrative functions, including functions to comply with the requirements of section 403(b) and other tax requirements. Any such allocation must identify responsibility for compliance with the requirements of the Internal Revenue Code that apply on the basis of the aggregated contracts issued to a participant under a plan, including loans under section 72(p) and the conditions for obtaining a hardship withdrawal under §1.403(b)-6. A plan is permitted to assign such responsibilities to parties other than the eligible employer, but not to participants (other than employees of the employer a substantial portion of whose duties are administration of the plan), and may incorporate by reference other documents, including the insurance policy or custodial account, which thereupon become part of the plan.

(iii) This paragraph (b)(3) applies to contributions to an annuity contract by a church only if the annuity is part of a retirement income account, as defined in §1.403(b)-9.”

This requires a plan document that contains all of the technical requirements of §403(b) as well as eligibility and the contracts available under the plan. The other possible subjects for coverage are not really relevant since the 403(b) exemption doesn’t permit much flexibility in design. Eligibility can of course take into account the part-time and other permitted exclusions at Regs. §1.403(b)-5(b)(4), but the plan document must reflect any exclusions the employer wants to apply.

But Regs. §1.403(b)-3(b)(1) requires that all contracts be taken into account in determining compliance with §403(b), a simple restatement of the rule at §403(b)(5). However, this reiteration makes it absolutely clear that there needs to be either (1) only one investment option, or (2) some sort of master document to set forth aggregate rules. Since the first situation is hardly normal, and in any event cannot be maintained without violating the requirements for ERISA exemption, by default the master document approach is mandated. Fortunately, the regulations permit incorporation by reference of the specific investment vehicle.

The problem that raises is how to deal with conflicting terms. This is not addressed directly in either the regulations or the FAB, but the answer is suggested in both the FAB and the preamble to the regulations. The preamble says:

“As a result, a plan may include a wide variety of documents, but it is important for the employer that adopts the plan to ensure that there is no conflict with other documents that are incorporated by reference. If a plan does incorporate other documents by reference, then, in the event of a conflict with another document, except in rare and unusual cases, the plan would govern. In the case of a plan that is funded through multiple issuers, it is expected that an employer would adopt a single plan document to coordinate administration among the issuers, rather than having a separate document for each issuer.”

And the FAB says:

“The Department of Labor expects that the written plan for a TSA program that complies with the safe harbor would consist largely of the separate contracts and related documents supplied by the annuity providers and account trustees or custodians. An employer’s development and adoption of a single document to coordinate administration among different issuers, and to address tax matters that apply, such as the universal availability requirement in Code section 403(b)(12)(A)(ii), without reference to a particular contract or account, would not put the TSA program out of compliance with the safe harbor."

From these quotes, it seems clear that both DOL and IRS expect the “normal” plan seeking the §403(b) ERISA exemption to be a wraparound document, incorporating but also limiting the terms of the underlying annuities, custodial accounts and/or retirement income accounts. This document will also have to specify what functions will be performed and by whom. Employers have essentially no capacity to prepare a compliant plan document, or to understand what they must do, what they can do and what can or must be done that they cannot do.

How exactly the coordination functions on plan language and administration will work is likely to be somewhat fluid over the next few years. For example, the employer has the responsibility for dealing with document conflicts, but the FAB makes it clear that the employer cannot negotiate with investment providers. One way to handle this is by retaining third parties to review existing and proposed investment vehicles and to communicate how the vendor is expected to fit into overall plan operations, then rejecting vendors that will not cooperate, but there may be other approaches developed over time and industry standards may evolve to effectively moot the issue. However, even with uncertainties, it is unlikely the ultimate structure will vary much from what we have been advising for some time now.

Final 403(B0 Regs.-A Ramble Through the Preamble

2007-07-23T17:34:00.000-04:00

Well, we finally have the final regulations under §403(b). Assuming no changes are made before the projected publication date of July 26th and based on a review of the Preamble, here are what appear to be the highlights, with a focus on elements that will affect employers and the marketplace most directly.

· The final regulations are not effective until 2009. This is surprising to anyone who contemplated the chaos that would result from a 2008 effective date. There are also transitional rules for collectively bargained plans (the earlier of the termination of existing CBAs or three years from publication of the final regulations) and plans of church-related organizations (2010). Plans that rely now on Rev. Rul. 90-83 can continue to do so until 2010.

· The written plan requirement has been left in the final regulations. Again, this is not surprising, but it is likely to continue the consternation felt by sponsors who have essentially treated their employees and payroll systems as marketplaces for annuity vendors. It should not, because the simple fact of creating a plan document has absolutely no effect on whether a plan is subject to ERISA or on the responsibilities of employers with §403(b) plans or arrangements.

· The final regulations help somewhat with the process of creating a written plan by allowing incorporation by reference of things like annuities. This makes clear that the employer can create a wraparound document that lists and incorporates by reference the terms of the investment vehicles available under the plan. They also explicitly authorize the employer, in the plan, to allocate responsibilities for administration and compliance matters to others. However, there is also a requirement that documents incorporated by reference not conflict and that the plan control over the incorporated documents; this should make it routine for the employer to request copies of all §403(b)-related documents and to instruct vendors that they must subordinate their documents to the terms of the plan.

· The final regulations continue the requirement that the §403(b) plan comply “in both form and operation” with §403(b). This emphasizes further the need for employers to get a better grip on their plans, and in particular the limitations on distributions that can cause a §403(b) plan to fail even though the employer has done nothing. It is precisely “nothing” that employers can no longer do.

· The emphasis on the §403(b)(5) rule continues in place, and is actually emphasized. This rule treats all contracts as a single contract, with the result that limitations like the annual deferral and annual contribution limits and the limitations on time of distribution, loans and hardships have to be set out in the wraparound document and have to be complied with on an aggregate, plan-wide basis. This is emphasized by the new requirement for like kind exchanges out of the plan that the plan and the recipient investment vehicle exchange data to coordinate distributions. The preamble also explicitly states that investment issuers will have to look to the employer for employment-related information, in effect subordinating the issuers to the employer in compliance matters.

· The anomaly for hardship distributions from custodial accounts has been finalized. This says that although employer contributions to annuities and retirement income accounts can be distributed on hardship, employer contributions to custodial accounts cannot.

Conceptual Issues in 403(b) Documentation

2007-03-20T17:25:00.000-04:00

With the upcoming final regulations due under 403(b), there is a definite need to re-think how 403(b) documentation is structured. For a variety of reasons, mostly historical and marketplace driven, there is no generally agreed set of practices for how to get documents in place that actually meet the requirements of 403(b) and are consistent with the complex of plan structures that has evolved over time.

The marketplace is likely to evolve in these directions over time, so this post is something of a roadmap for the future. At least, it should provide a template of issues you can raise with your provider when the final regulations come out. (And, of course, how we will be working with our clients.)

THE THREE PLAN TYPES

There are three distinct program types in the 403(b) world, as opposed to just two in the 401(k) environment. Each of these types has different documentation needs, so let's look at each separately.

ERISA Plan

A 403(b) that seeks to be or admits it is a plan subject to ERISA is, in many ways, the simplest type to figure out. These plans almost always limit investments to a single array, within the setting of a single group annuity contract or a single TPA administration structure. This means that, like an ERISA 401(k) plan, they need (1) a plan document, and (2) a funding vehicle. Group annuity contracts regularly provide both where they are the selected investment medium (subject to my concerns about whether they are amended on a timely basis). Otherwise, the plan needs a plan document and a pooled custodial account agreement that comply with 403(b)(7) (all in mutual funds, plan document controls over custodial account agreement, etc.). Given the possibility that there will be prior annuities in place with distribution restrictions, and the possibility that an employer would allow an opener to individual annuities, the plan document probably ought to permit the plan administrator to designate more than one investment vehicle or at least to grandfather existing funding arrangements.

Non-ERISA Plan

There are also 403(b) programs that are plans, but not subject to ERISA, because the employer itself is not an ERISA employer (technically, the exemption is for governmental and church plans under a bizarre and complex set of definitions). These are going to require either (1) a separate plan document that excludes ERISA rules, or (2) a master document that has provisions for ERISA and non-ERISA plans. There is no particular technical reason to pick one of these over the other. The single document is easier to draft and to draft from, but has provisions that do not apply to non-ERISA plans, while the two-document choice has less extraneous materials for non-ERISA plans. Given the implications of not having a remedial amendment period, and the better quality control inherent in a single document, we have opted for a single, combined master plan.

Oh, and don't forget church plan retirement income accounts as a third investment medium.

Non-Plan Programs

Mostly for cultural reasons, there is a genuine fear of plan status in 403(b) culture. There is good reason to attribute this mostly to fear-mongering in a marketplace where a lot of small insurance agencies make money from individual 403(b) annuities, but it is real. Setting aside all the negative effects on employees of not having any assistance from employers with, hopefully, better expertise, there it is an there it will remain for some time.

This creates an entirely new type of 403(b) program, the non-plan program or arrangement. Even ERISA-exempt employers try to maintain this status, and one of the central marketplaces, school districts, normally have to do so by state law. Otherwise, the structure tends to be fixed by the requirement of the DOL's definition of "pension plan".

Normally folks want to see these programs as simpler. For starters, they are all salary reduction-only, so there is no need to cover things like matching contributions or vesting. For another, there is no need to comply with ERISA requirements, except to the extent that analogous rules are placed in the final 403(b) regulations. However, the investment side, and the effects of the market structure, create offsetting complexities.

In this marketplace, and program type, there are multiple, unrelated investment providers, most of whom are offering single annuities. Each of these single annuities purports to comply with 403(b), although they are rarely amended on a timely basis to reflect changes in the law. However, none of them provides any of the aggregate limitations resulting from the fact that 403(b)(5) says, and has always said, that multiple contracts are treated as a single contract. Nor do they have to have common provisions about such essentially employer issues as withholding and timing of contributions.

After some hemming and hawing, we came to the conclusion that this program type needs a separate document type. Essentially, the need is for a program document that (1) says it is not a plan (ours calls itself a personnel policy), (2) includes overall limitations to be applied under all funding vehicles, in the aggregate, on contributions, loans and distributions, (3) contemplates the addition and removal of specific annuities, custodial account arrangements and retirement income accounts as funding vehicles, and (4) includes the definition of a non-plan under the DOL regulations, where applicable. Procedures under such a program would also be required, along with cooperation from investment providers, to ensure compliance with the aggregate limitations, but that should become a standard part of the "common remitter" function, as we are prepared to do.

So there we are. Reasonable minds can differ, but it is clear that the decisions we have made will keep our clients in compliance.

This is going to be an important subject, but it is unlikely that anybody will write much about it when the final regulations come out. Accordingly, I am going to pst this on my blog (403b-457plansblog.blogspot.com) for regular readers and at the 403bWise and BenefitsLink bulletin boards. My hope is that the bulletin board postings will generate discussion, and point out the flaws in this posting. At least, they will create forums where I can clarify the underlying reasons and how our system will work.

Tom Geer

A Summary of Fees from The Standard

2007-03-19T14:37:00.000-04:00

Courtesy of the BenefitsLink Newsletter, here is a good summary of fee types and effects from The Standard.

http://www.standard.com/pensions/publications/rp-13438_fees_guide.pdf

And a reminder. If you are interested in technical issues for retirement plans, subscribe to BenefitsLink. Their newsletter is definitive.

Then, when you see a BenefitsLink source with consistent quality coverage in your area, see if you can subscribe to it.

I am particularly looking forward to the deluge of coverage when the final 403(b) regulations come out. The best way to come to an understanding of them will be (1) download and read the regulations front to back, including the preamble, before you read anything else, (2) read everything you can get, remembering that everybody has an axe to grind, (2) keep doing that for two to four weeks, (3) keep notes of open issues or ones you don't understand yet (e.g., Dewey, Cheatham & Howe law firm says you can do this, but doesn't say how), and (4) resolve your open issues by looking back and formulating your best answer. Last, feel free to send me your questions at any time, to geertom@gmail.com.

2007 Task Deadlines

2007-01-23T00:23:00.000-05:00

Plan Sponsor has a listing of tax and ERISA deadlines for 2007 at:

http://www.plansponsor.com/magazine_type1/?RECORD_ID=36118

McKay Hochman, the PPA and 403(b)

2007-01-22T15:14:00.000-05:00

McKay Hochman issued in October a well-done summary of the PPA provisions affecting 403(b). You can find it at:

http://www.mhco.com/Commentary/2006/PPA_403b_091406.htm

They also issued a nice summary of PPA particpant notice requirements at:

http://www.mhco.com/Commentary/2006/PPA_Disclose_Notice_083106.htm

And a terrific chart on rollovers between plan types at:

http://www.mhco.com/Charts/Rollover_011206.htm

More on Top-Hat Plans

2007-01-22T14:04:00.000-05:00

There aren't many days when three things appear that need a comment here, but this is the day.

There is an excellent article at the Plan Sponsor web site on top-hat plan status. This is a reversal of a decision discussed here earlier (not because of its dramatic content but because there are so few cases on the issue).

The article is located at:

http://www.plansponsor.com/pi_type10/?RECORD_ID=36259

The decision reflects pretty much the traditional understanding that top-hat plans should be limited to those who have actual bargaining power. In that sense, the new result is unsurprising.

The lesson from the decision is that one bad coverage decision loses top-hat plan status, so employers and their advisers should be careful.

Settlor Function Case at Supreme Court

2007-01-22T13:30:00.000-05:00

The Supreme Court has decided to review a case decided on the issue of what constitute settlor functions. The ERISA fiduciary duties do not apply to actions taken by the plan sponsor in its capacity as employer/sponsor, which raises the question of where the line gets drawn.

In Beck v. PACE International Union, the court will look at the dividing line in the context of of plan terminations. The Bankruptcy Court, District Court and 9th Circuit held that the employer's decision to terminate was a settlor function, but that all steps in implementing that decision were made under the fiduciary duty rules. The employer had decided to terminate the plans by buying annuities to fund the entire accrued benefit and distributing the surplus resulting from that purchase to the participants, ignoring a suggestion by the union that the plans be merged into a multiemployer plan. The holding was that the ERISA fiduciary duties required that the employer review the merger alternative and that it had failed to do so adequately.

Arguing that fiduciary duties do not apply to the implementation of settlor decisions is not for the faint of heart. However, the facts here are much more complex, and it seems pretty clear that the employer and the fiduciaries fully met their obligations, and then some. A decision from the Supreme Court may tell us more about how to do a plan termination than it does about fiduciary duties.

Since the case is going to generate a decision by the Supreme Court, a full analysis is premature. If you want more detail, you can find it at:

http://www.lawmemo.com/sct/05/Beck/

Reviewing Annuities: Don't Try This at Home

2007-01-04T14:14:00.000-05:00

I have seen several pieces lately on what to review in a group annuity contract, and read them hoping for additional insight. There were some, but the pieces did not cover the full range of issues. This post is another contribution to those items in the 403(b) context. The same concerns, by and large, apply in the 457 and 401(k) contexts but usually in simpler forms because they usually have one insurer (if they have one at all). The focus here is on economics, and in particular unpleasant economic surprises in the form of surrender-type charges and restrictions on moving money around.

* Preliminarily, remember that annuities are not written with ease of reading in mind. My experience is that the "exciting" provisions can show up almost anywhere and that they are written in broad principals rather than in terms of "If this happens, then this happens." One way to view legal training is as a graduate course in being paranoid and suspicious. This is as useful a skill in reading annuity contracts as in any other area. And if you find yourself saying "What?" or "Hunh?" slow down and think it through.

* In a perfect world, everybody would get their annuity contracts reviewed at the beginning, before signing them. This does not happen very often, because by the time a plan gets big enough to carry the review costs at the beginning, even though there may not be problems later, it is likely to be invested in something other than annuities. However, with the increasing focus on finding and disclosing costs, there will, eventually, be increasing focus on potential costs. (In the general form of "Bad fiduciary! You should have read that annuity contract more carefully.") But at this point in the development of the retirement plan industry, the problem normally comes up only when bad things start to happen, and the review ends up being part of a scramble to find some way out.

* When you think about these issues or review an annuity contract, bear in mind two salient facts about annuities. First, the insurer is promising funds based on underlying investments that do not exactly match the promises. This is clearest when the insurer takes money into a fixed income stable value fund that annuitants can treat like a money market fund and buys long term bonds with greater price variation based in interest rate fluctuations in the fund. But it is also true when the insurer takes the annuitant's relatively small investment and makes huge asset purchases or when the contract contains any form of guarantee. The insurer then may have a legitimate need to protect itself against the possibility that annuity holder behavior will cost them more money than they expected in structuring their investments. (Although, there is a pretty good counter-argument that the insurer should hedge the risks up front rather than pass the risks through to the annuity holder. The insurer is almost by definition in a better position to assume and hedge against those risks.) Second, setting up and running an annuity account costs the insurer money that the insurer assumes initially will be recovered over time in fees within the contract, so the insurer has a legitimate interest in recovering some of these costs if the contract is terminated earlier than expected. If you keep these two issues in mind, it will help you sort through what the contract is doing because you will know what the contract is getting at. NOTE: Even when surprises have a legitimate reason, they are still no fun.

* Back-end loads. Sometimes called contingent deferred sales charges or surrender charges, these are charges for getting your money back. They come in two basic varieties. Decreasing surrender charges have a percentage rate that declines as the policy gets older; an example would be 7% one year, 6% the next, etc. Rolling surrender charges are like decreasing surrender charges except that the schedule applies separately to each deposit of new money, so that even after a long period of time there are charges on the newer money.

* You have to determine the extent to which the contract is "benefits sensitive"; that is, if the withdrawal is not simply to change investments as permitted under the plan or to pay benefits under the plan, do the surrender charges still apply? Careful review of benefits sensitivity would also look at whether, in a multi-vendor environment, the contract says that it will be first, last or pro rata vis a vis other sources of funds in payment of benefits.

* Now my favorite, market value adjustments. If you buy long-term bonds to fund a short-term investment, you get a higher yield. But the long-term bonds change value with changes in interest rates, so the underlying investments are always worth more or less than the nominal balance of the product. This is true in most short-term and GIC-type investments under annuities. The insurer, therefore, wants to avoid losses when the investments are down (and, of course, keep the gains when they are up). Thus, the market value discount or adjustment. These can come in two types. The first says the insurer will calculate its losses and apply them. The second sets up a hypothetical bond each year with some fairly long maturity (e.g., 20 years) and interest at the rate credited under the annuity, then discounts the projected cash flows back at the rate being used for new money in new, similar products. In the alternative, the insurer could use some external rate (Fed funds, LIBOR, etc.) as the basis for calculation. Market value discounts cannot be ignored--I had a client once with a 56% market value discount.

* So you look at the contract, and at the surrender charges and market value discounts, and say "Well, we'll wait them out, we'll phase them out over time." So you make all new deposits to other investments, if the contract allows a, say, 20% withdrawal per year without tripping any costs you'll take out the 20% each year, you'll make all benefits payments from this annuity, and you'll wait until the costs are phased out or all the money has trickled out. Some contracts say that the insurer can, under certain circumstances, treat the annuity contract as terminated and pay out the entire proceeds, net of surrender charges and market value discounts. The circumstances vary from contract to contract, but normal triggers are cessation of future deposits or introduction of an investment alternative that competes with one or more inside the annuity. Or, of course, the contract could say that if you want cash the insurer can force installments. This kind of clause prevents the sort of "cute" planning so loved by lawyers and consultants like me, and is extremely bad to have lying about unnoticed.

* Coordination with other investment vehicles is an important issue. It has always been true that some piece of paper with the basics of the 403(b) rules had to be in place, but the written plan document requirement in the proposed 403(b regulations has highlighted this. In a "plan" environment with one investment provider, this problem arises when the rules change and the contract doesn't or where something other than a single group annuity contract holds funds. But in a multi-vendor environment, you may have ten or twenty alternatives, each of which pretends the others don't exist. So look for language that says that contributions, loans, hardship distributions and minimum distributions will be determined taking into account such items already done under other contracts unless you have a wraparound plan document.

* The next issue is the ordering of withdrawals. (To some extent, this portion is theoretical because I have seen some but not all of these alternatives; all are at least theoretically possible.) Let me posit an example. An employee has $30,000 in each of two different annuities. In each annuity, 1/3 of the money is in a fixed income fund, 1/3 in a growth fund and 1/3 in a small cap equity fund. The participant wants to borrow or take a hardship distribution of $10,000. The previous paragraph talks about the issues that come up between the two contracts. But we still have an issue about which fund inside a contract is going to pay out the money. If the entire $10,000 comes out of one annuity, we still need to know if we can freely pick the funds. Suppose interest rates are up; will the insurer let us take the money from the fixed fund with a below-market yield? This could be barred by specific language in the contract, including any terms that give the insurer discretion. It could also be impracticable in fact because taking the full $10,000 out of one fund might trip a penalty of some sort, like the market value discount in the fixed fund or cause the insurer to use its power (if any) to wind up the contract. And, even if it does not, there is the possibility that it moves the annuity (if it's a group annuity contract) closer to the point where a market value discount or surrender charge is triggered, and therefore prejudices the next participant who needs money. And, to make it even messier, the terms of the benefits sensitivity language may, or may not, cover the specific event and may, or may not, cause the payout to be treated as a zero when the next distribution is analyzed.

* And we're not done with ordering yet. If the annuity has a rolling surrender charge, that applies anew to each deposit, which deposits are treated as withdrawn? Take the same example, and add that the equity funds have a 5 year 5% rolling surrender charge that decreases by 1% each of the five years. Can the contract holder say "I'll take the oldest $5000 from each?" Does the contract specify first-in-first-out or last-in-first-out or pro rata? Generally, the timing ordering rules will be parallel as between the fixed fund and the equity funds, so that a FIFO rule would increase potential market value discount but decrease potential surrender charges and vice versa, but they could differ (FIFO on the fixed fund and LIFO on the others being the worst potential structure).

* Last, once you figure the contract out, as well as can be done, it's a good idea to ask the insurer "What if?" The best protection against surprises is a letter, or fax, or e-mail message, or phone notes, saying nothing bad will happen. That may sound like a good enough idea to make it so you don't have to read the darn thing, but it's not, because the insurance company is not going to point out every workaround or exception for you. Remember, insurance companies make money just like everybody else, by collecting money and investing, and paying benefits is a cost more or less like any other cost.

There may well be other issues lurking out there, because you can be sure that insurance companies have lawyers and accountants and actuaries who are at least as smart as you or I thinking about this stuff. That means that annuities should be read with care and suspicion, and that the reader should always be ready to stop and say "What does that mean?" Thus the title: "Don't Try This at Home."

DISCLAIMER: This post is specifically not intended to give enough information to allow readers to fully review annuity contracts. Given the complexity of annuity contracts, any review should be done by a competent professional, preferably with experience in doing such reviews.

A Good Reason to Look at Annuities

2006-12-30T15:09:00.000-05:00

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.

Written Plan Requirement for 403(b) (and 457)

2006-12-21T16:15:00.000-05:00

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.

More on Plan Drafting

2006-12-01T17:16:00.000-05:00

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.

What's a Plan? Gray v. Prudential

2006-11-27T17:11:00.000-05:00

An interesting decision was made by the Eastern District of Arkansas in August. The case, Gray v. Prudential Ins. Co. of Am. (E.D. Ark. 2006) was decided under a provision in the DOL Regulations that is the counterpart of the non-plan regulations that apply to 403(b). The case is interesting for (1) how it uses a very technical analysis to find the arrangement is a plan and (2) the way it illustrates the importance of specific provisions in the DOL Regs. for 403(b) non-plans.

The insurer wanted to get the deferential review available to plans, and the employee wanted the de novo review standard that applies in insurance policy disputes. The employee argued that the plan met the requirements of DOL Regs. 1.2510.3-1(j).

DOL Regs. 1.2510.3-1(j) are met if (1) the employer does not contribute, (2) participation is completely voluntary, (3) all the employer does is permit the insurer to publicize the program to employees and collect and pay premiums over to the insurer and (4) the employer receives nothing other than reasonable compensation, without profit, for payroll administration services.

In claiming the exemption does not apply, the insurer pointed to the following: the employer's logo was on the cover page of the plan and the SPD; the formal contract holder was the employer; the employer was designated in the documents as plan administrator and agent for service of legal process; and the employer determined whether an employee was eligible. The court found that the employer's involvement with respect to the plan was more than ministerial, putting the plan outside of the exemption.

The first interesting thing to do with this case is to compare the terms of DOL Regs. 1.2510.3-2(f), which is the regulation for 403(b) non-plans. The core difference is that DOL Regs. 1.2510.3-2(f) has much more detail. The standards for welfare benefits require that “(3) The sole functions of the employer or employee organization with respect to the program are, without endorsing the program, to permit the insurer to publicize the program to employees or members, to collect premiums through payroll deductions or dues checkoffs and to remit them to the insurer; and (4) The employer or employee organization receives no consideration in the form of cash or otherwise in connection with the program, other than reasonable compensation, excluding any profit, for administrative services actually rendered in connection with payroll deductions or dues checkoffs.” The regulation for 403(b) says:

“(2) All rights under the annuity contract or custodial account are enforceable solely by the employee, by a beneficiary of such employee, or by any authorized representative of such employee or beneficiary;

(3) The sole involvement of the employer, other than pursuant to paragraph (f)(2) of this section, is limited to any of the following:

(ii) Requesting information concerning proposed funding media, products or annuity contractors;

(v) Holding in the employer's name one or more group annuity contracts covering its employees;

(A) The number of employees affected,

(B) The number of contractors who have indicated interest in approaching employees,

(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; and

Obviously, this more detailed set of rules constitutes a better, clearer road map for non-plan 403(b) arrangements. As a result, Gray v. Prudential Ins. Co. of Am. is only strictly relevant to 403(b) determinations where a parallel requirement exists. The use of employer logos is not specifically permitted or barred under either regulation, so permitting its use may violate the “sole involvement” standard in DOL Regs. 1.2510.3-2(f)(3) even though there is no explicit non-endorsement rule. Under DOL Regs. 1.2510.3-2(f)(3)(v) the fact that the employer is the contract holder is not dispositive; however, policy holders typically have some rights under policies, which could lead to a violation of the requirement in DOL Regs. 1.2510.3-2(f)(2) that the employees hold all enforcement rights. The designation of the employer as plan administrator and agent for service of process and the preparation of a document designated as a Summary Plan Description must have been the result of using documents intended for ERISA plans and is an egregious error, but certainly possible with respect to a 403(b) arrangement and equally outside of what DOL Regs. 1.2510.3-2(f) specifically permits. As to the last item, that the employer determines eligibility, there are two issues. First, since the employer has to run contributions through its payroll system it is hard to see how the employer can be uninvolved in eligibility determinations. Second, this is not likely to be an issue for 403(b) since they typically permit any employee to sign up.

There is a pretty good argument to be made that the greater specificity of DOL Regs. 1.2510.3-2(f) can be a problem as well as an opportunity. It was by no means automatic that policy holder status of the employer was a problem for welfare plans as long as the substantive rights were vested in the employee, but the solely enforceable requirement of DOL Regs. 1.2510.3-2(f) clearly precludes any minor rights being held by the employer. The requirements of DOL Regs. 1.2510.3-2(f)(3)(ii), (iii) and (vii) have no counterparts in DOL Regs. 1.2510.3-1(j), and they are in fact a more specific, and therefore less flexible in interpretation, elaboration of the sole involvement provision of DOL Regs. 1.2510.3-1(j). Given this greater specificity of DOL Regs. 1.2510.3-2(f), it is incumbent on employers to comply literally with its terms, which certainly involves more attention to detail than was paid in Gray, and to document the reasons for denying any provider access under DOL Regs. 1.2510.3-2(f)(3)(vii).

In doing so, employers need to be careful about the specific wording of DOL Regs. 1.2510.3-2(f). In particular, note the following:

(f)(3)(i) states that the employer may permit providers to publicize their products. It does not allow any assistance from the employer of any kind.
(f)(3)(iii) allows the employer to summarize and compile information "to facilitate review and analysis by the employees." Unless any summary or compilation is prepared by the employer (rather than an investment provider), is prepared solely at the behest of the employer or employees, covers all material issues (including fees and costs) and is written very blandly, clever lawyers will be able to find ways to attack non-plan status.
In turning down any investment provider under (f)(3)(vii), an employer should document each of the listed factors.
Compensation permitted under (f)(4) only covers the costs of payroll compliance, not of any other services (internal distribution, use of facilities, and the like).
Compensation may not be paid of costs "other than reasonable compensation to cover expenses properly and actually incurred by such employer." This should cover related payroll costs and allocable overhead (rent, depreciation, etc.) but all expenses should be carefully documented.

Last, the differences between the two sets of regulations are clearly intended to permit the 403(b) market to operate as it always has operated. Given the statement by the IRS when it delayed final 403(b) regulations that the subject of plans not subject to ERISA was under review, it is by no means safe to assume that DOL Regs. 1.2510.3-2(f) will not be amended at the same time. And, given that the IRS and the DOL now have their sights fixed firmly on fees, changes to DOL Regs. 1.2510.3-2(f) would be a perfect place to create an obligation to discover and disclose fees in 403(b) non-plans.

Mutual Fund Fees-Some Good News

2006-11-26T18:26:00.000-05:00

In the United States, there has been a strong, unremitting focus on mutual fund fees for decades. This focus is now being turned to retirement plan and annuity fees, and even there, the focus in 403(b) and 457 markets is more recent and much more intense. A recent study of mutual fund fees by country has some interesting implications for that focus.

The study was conducted by Ajay Khorana of the Georgia Institute of Technology, Henri Servacs of the London School of Economics, and Peter Tufano of the Harvard Business School. The result? The United States has a relatively low fee level (and, oddly, Canada has a high level). This low fee level results from several factors, including economies of scale for larger funds and fund families, better courts, higher per capita GDP, higher education levels, separation of banking and fund management industries, higher investor protection in both general stock markets and mutual fund markets and mutual fund industry maturity.

Managing a mutual fund is different from managing a retirement plan or account. Most important is that certain fees (e.g., prospectus vs. SPD or other communications) are borne once by each fund but once by each plan or account. This is the core cause of a tension between the need to pay for the work that has to be done to get tax deferral for the investments and the human desire to get that done for free. The compliance costs are real, and somebody has to pay them. This urge is the basic reason why there are separate markets for annuities and mutual funds, with annuities having a higher expense structure that is generally advantageous for smaller accounts and smaller asset totals, and mutual funds being used more often with larger plans and larger account balances.

Of course, there are other factors operating in 403(b) and 457 markets. Employers who want to say they don't have a plan leave their employees in the position of individual investors, and they tend to hear more often from annuity providers than from mutual fund providers because of the superior profitability of annuitiew at smaller scales. The fact that mutual fund providers are fairly new to the markets is another cause, because of the dominant market position of a short list of providers offering annuities that have technical competence and an interest in the market. But the underlying economics that result from having mutual funds with relatively low fee structures reinforces these market anomalies.

All in all. though, investors in the United States are fortunate. Move north to Canada, and the fees increase by something like 175%. The fact that these fees can't carry the compliance costs for tax deferral are a lot less important than this fundamental advantage.

2007 Limitations

2006-11-20T14:28:00.000-05:00

A reminder of the 403(b) and 457 limitations for 2007.

Overall Limit--$45,000
403(b) Deferrals--$15,500
Age 50 Catch-Up--$5,000

Primary 457 Limit--$15,000
Age 50 Catch-Up--$5,000

I Says What I Means...

2006-11-06T23:16:00.000-05:00

The Eighth Circuit allowed a reduction in disability benefits for earnings while receiving benefits in Riddell v. Unum Life Ins. Co. of America (8th Cir. 8/10/2006), and the case contains a useful lesson for any 403(b) or 457 employer.

The policy based benefits on a monthly earnings definition that excluded bonus payments. The policy also head residual/partial disability benefit provisions, under which benefits could be reduced based on "disability earnings" that were defined to take into account bonus payments. The physician receiving benefits under the policy argued that a category of payments he received was in the nature of a bonus, and that those payments should not be used to reduce disability benefits because the two definitions were internally inconsistent. Rather than just calling the argument hogwash, the court more politely pointed out that the reduction provisions always used the "disability earnings" definition and never used the first, and more generally applicable, definition of monthly earnings.

This case may seem unglamorous, but it should remind all concerned of the need to use plan documents that are decently written. In the 403(b) and 457 markets, and retirement plan markets generally, this is not always the case because the focus of drafting is on technical compliance. Try reading your plan documents; if you don't know what they mean, you should ask for an explanation or a rewrite, because the participants won't understand it either.

In 403(b) and 457 environments, there is one particularly important issue to cover, and cover clearly - ERISA/fiduciary status. As long as the funding vehicle is not a trust and the employer or plan are not subject to ERISA (church and governmental, non-plan 403(b) and top-hat 457), the non-ERISA, non-fiduciary status should be crystal clear in the plan document. If the issue might ever come up, it will help a great deal to have a document that clearly states employer/plan status and the ramifications of that status.

McKay Hochman PPA Effective Dates

2006-10-16T16:42:00.000-04:00

McKay Hochman has an excellent list of effective dates for PPA. You can find it at:

http://www.mhco.com/Commentary/2006/PPA_Effective_Date_083106.htm

PPA Part 2-Qualified Default Investment Alternatives

2006-10-16T16:16:00.000-04:00

If you are concerned only about non-ERISA plans and arrangements, you can stop reading here if you want. Otherwise, you have to learn another acronym, QDIA, for Qualified Default Investment Alternatives.

Once again, the Department of Labor has chosen to make a directed investments rule too complex. This time, it is the QDIA.

Section 624 of the Pension Protection Act amended ERISA 404(c) to create the QDIA concept and required that the Department of Labor issue regulations defining a QDIA by 2/1/2007. The DOL has now issued proposed regulations.

The function of a QDIA is to solve a problem created in the overly complex existing ERISA 404(c) regulations. The protection from fiduciary duties under ERISA 404(c) applies only "if a participant or beneficiary exercises control over the assets in his account (as determined under regulations of the Secretary)". It seems clear that the parenthetical clause would have allowed a decision not to exercise after notice to be treated as an exercise, but the DOL did not do so. This meant that all the participants who got notice and did nothing were not subject to ERISA 404(c) and left the question of what to do with their accounts.

The answer seemed pretty clear, invest it how you would invest the plan that did not have a directed investments provision-de facto meaning invest it in a balanced portfolio. However, many plan sponsors decided that putting the money in a stable value or money market investment would reduce their actual risk because the participants' accounts would never show losses. And, given how people normally behave, it may have been the safest answer.

Theoretically, there were three ways to resolve this issue. The first alternative, and the cleanest, easiest one, would have been for the DOL to issue Regulations modifying the 404(c) regulations to treat inactivity after notice as an exercise of control. The second alternative was for the DOL to say that the funds had to be invested in an investment that would be appropriate for the plan as a whole, which would have in effect mandated a balanced fund in each plan. The third, and worst, option was the creation of the QDIA, because its enactment and definition have been an occasion to increase the administrative burdens on plans.

The QDIA rules have two parts. One defines the sort of investments that can be a QDIA. This part is not too complex for a 403(b) plan or arrangement. Essentially, the investment has to (1) be a mutual fund or managed by an investment manager under ERISA 3(38), and (2) be (a) a target retirement date or lifestyle fund, (b) a balanced fund, or (c) a fund managed by an investment manager taking into account, individually, the participant's age, target retirement date and life expectancy. The choice between the first and second types of mutual funds is easy, based on what funds are available and how many funds the plan wants to offer (a general balanced fund being one fund and an array of lifestyle funds being more than one). The managed fund option is a viable option only if you can find an investment manager willing to look at all the small (since those with large accounts will likely make their own decisions) accounts in the plan and take responsibility for them. My opinion has always been that every plan should have a sound, well-managed balanced fund, so my general recommendation would likely be to use that as the default investment before or after the QDIA rules become effective.

The second part of the QDIA rules is procedural, and more complex and burdensome than it needs to be. First, and pretty obvious, is that there should not be too many barriers to moving out of the QDIA; specifically, transfers out must be allowed at least quarterly and must not cost the participant more money. Second, the participant must be given an opportunity to direct investments-this will never be an issue because the QDIA rules only apply where a participant with the right to direct investments doesn't. Third, the participant has to be given a notice at least 30 days before amounts are invested in the QDIA and 30 days before each plan year; this is duplicative of the normal notices given in plans with directed investments and plans using a 401(k) safe harbor and the requirements can be met by extending the coverage of existing notices.

Fourth, the plan document must require that the plan, and the plan must in fact, send to the participant all material received by the plan relating to the QDIA or a participant's investment in the QDIA, presumably within a reasonable time. This one is potentially a problem, because of the vagueness of the word "material." All we know is that it includes account statements, any prospectus and voting proxy materials; we do not know if it includes e-mails from brokers, periodic reports by TPAs, Morningstar or other similar items, or even the contents of phone calls (unless we assume that the received "material" has to be material). You can safely bet that lawyers will be asking, sooner or later, for everything anybody involved with the plan receives from anybody any time. This requirement is not contained in the PPA, and so the ambiguity is a gratuitous part of a gratuitous requirement. In addition, since the IRS takes the position that failure to administer a plan in compliance with its terms is a qualification issue, it has the effect of adding the IRS as an enforcer of fiduciary duties in this context.

The last requirement is that the plan offer investments, including the QDIA, which meet the requirements of ERISA 404(c). Since QDIA status only matters as a fix to a hole in the 404(c) regulations, this is wholly unnecessary.

PPA Changes Affecting 403(b) and 457

2006-09-14T15:18:00.000-04:00

The PPA made too many changes affecting 403(b) and 457 to cover in one post. This blog will, instead, cover them essentially one at a time, to allow for context and comments. This is the first such post.

The most important thing the Pension Protection Act did was to make permanent the changes in the law passed by EGTRRA. Just as a reminder, these are (as described in the PPA Blue Book and as having relevance to 403(b) or 457):

Individual retirement arrangements (“IRAs”)

• Increases in the IRA contribution limits, including the ability to make catch-up contributions (secs. 219, 408, and 408A of the Code and sec. 601 of EGTRRA); and

• Rules relating to deemed IRAs under employer plans (sec. 408(q) of the Code and sec. 602 of EGTRRA).

Expanding coverage

• Increases in the limits on contributions, benefits, and compensation under qualified retirement plans, tax-sheltered annuities, and eligible deferred compensation plans (secs. 401(a)(17), 402(g), 408(p), 414(v), 415, and 457 of the Code and sec. 611 of EGTRRA);

• Modification of the top-heavy rules (sec. 416 of the Code and sec. 613 of EGTRRA);

• Repeal of coordination requirements for deferred compensation plans of state and local governments and tax-exempt organizations (sec. 457 of the Code and sec. 615of EGTRRA);

• Option to treat elective deferrals as after-tax Roth contributions (sec. 402A of the Code and sec. 617 of EGTRRA);

and

• Certain nonresident aliens excluded in applying minimum coverage requirements (secs. 410(b)(3) and 861(a)(3) of the Code).

Enhancing fairness

• Catch-up contributions for individuals age 50 and older (sec. 414 of the Code and sec. 631 of EGTRRA);

• Equitable treatment for contributions of employees to defined contribution plans (secs. 403(b), 415, and 457 of the Code and sec. 632 of EGTRRA);

• Faster vesting of employer matching contributions (sec. 411 of the Code and sec. 633 of EGTRRA);

• Modifications to minimum distribution rules (sec. 401(a)(9) of the Code and sec. 634 of EGTRRA);

• Clarification of tax treatment of division of section 457 plan benefits upon divorce (secs. 414(p) and 457 of the Code and sec. 635 of EGTRRA);

• Provisions relating to hardship withdrawals (secs. 401(k) and 402 of the Code and sec. 636 of EGTRRA); and

Increasing portability

• Rollovers of retirement plan and IRA distributions (secs. 401, 402, 403(b), 408, 457, and 3405 of the Code and secs. 641-644 of EGTRRA);

• Treatment of forms of distribution (sec. 411(d)(6) of the Code and sec. 645 of EGTRRA);

• Rationalization of restrictions on distributions (secs. 401(k), 403(b), and 457 of the Code and sec. 646 of EGTRRA):

• Purchase of service credit under governmental pension plans (secs. 403(b) and 457 of the Code and sec. 647 of EGTRRA):

• Employers may disregard rollovers for purposes of cash-out rules (sec. 411(a)(11) of the Code and sec. 648 of EGTRRA); and

• Minimum distribution and inclusion requirements for section 457 plans (sec. 457 of the Code and sec. 649 of EGTRRA).

Strengthening pension security and enforcement

• Automatic rollovers of certain mandatory distributions (secs. 401(a)(31) and 402(f)(1) of the Code and sec. 657 of EGTRRA);

Reducing regulatory burdens

• Repeal transition rule relating to certain highly compensated employees (sec. 663 of EGTRRA);

• Treatment of employees of tax-exempt entities for purposes of nondiscrimination rules (secs. 410, 401(k), and 401(m) of the Code and sec. 664 of EGTRRA);

• Treatment of employer-provided retirement advice (sec. 132 of the Code and sec. 665 of EGTRRA).

Lest we forget, the failure to repeal these changes would have set back progress in 403(b) service markets dramatically. The effect of the changes was to make 403(b) more like 401(k), but with some nice special rules. Before, simple tasks like determining maximum contributions, was a nightmare and very few providers could handle them, which caused most TPAs to avoid 403(b) like the plague. Now, in essence, you can run a 403(b) like a 401(k), and only look at the differences if there is a problem (e.g., ADP test, annual limits, 402(g) deferral limits). This is opening up new providers to 403(b) employers and should serve to increase quality and service levels while decreasing price for all 403(b) plans or arrangements. At Benefit Plan Solutions, we are seeing a steady increase in activity helping 401(k) providers move into a new market with very soft competition.

Delay in Effective Date for Regulations Under Section 403(b)

2006-08-29T15:23:00.000-04:00

From the IRS:

WASHINGTON —The Internal Revenue Service announced today that the general effective date for the regulations regarding section 403(b) arrangements that were proposed in 2004 (including the related controlled group regulations under section 414(c)) will be extended.

In order to provide employers, employees, insurance carriers, and mutual funds involved in section 403(b) arrangements a reasonable advance period before the regulations go into effect, the final regulations generally will not be effective earlier than January 1, 2008.

Effects of Expense Subsidies

2006-08-29T14:52:00.000-04:00

Jeb Graham CEBS, CIMAÃÂ® of CapTrust Financial Advisors has written an excellent article at 401khelpcenter.com on plan fees. The article can be read at:

http://www.401khelpcenter.com/401k/graham_stable_value.html

Preliminarily, he focuses on stable value fund economics. Stable value fund is such a loose term that different stable value funds may be invested in different asset types and may have different expense structures. Expenses may not even be fixed in amount or by a formula.

The more essential point made by Mr. Graham is that fees that are not disclosed, but are instead applied to reduce the expenses of plan administration through, e.g., sub-TA fees, are inevitably allocated unfairly.

For example, suppose two employees invest the same amounts in different funds, and one has an expense total of $100 while the other has an expense total of $200. Because the extra expense of $100 reduces the second participant's income, the plan and that participant are bearing that cost, which may or may not be reasonable. If the extra $100 is, instead, paid to the plan’s TPA, then (a) the extra is clearly not needed by the investment provider to operate the investment, (b) the use of the extra money to reduce plan administration is needed to restore fairness to the plan, and (c) the second participant, by selecting the more expensive investment, is subsidizing the operations of the plan.

If the plan’s sponsor would otherwise pay the extra $100, because the sponsor pays the plan administration fees, then there is an indirect benefit to the sponsor of $100. This may constitute a prohibited transaction under §4975 of ERISA §406, although since the effect is to pay for plan administration, and plans are allowed to defray administration expenses, it should not be a prohibited transaction, or at least not a violation of the exclusive benefit rule.

If the plan receives a subsidy from the investment provider and uses it to reduce total plan administration expenses paid by the plan, then the plan as a whole is treated fairly but there is, in effect, a subsidy of the first participant who invested in the lower-expense investment by the second participant who bore higher expenses that now reduce everyone else’s costs.

To eliminate the subsidy from one set of participants to another, the plan would have to apply the subsidy it receives to reduce the expenses only of those participants who invested in the higher-expense investment.

But look at the result of doing so. If the participant bears the higher expense through reduced investment yield, then gets it back through an expense reduction, the whole exercise is pointless. That is, the investment provide’s setting up of the arrangement only makes sense if it is not returned to the participant who bears the expense.

The only reason to jump through the hoops needed to create the arrangement is to use the money to influence the behavior of the plan or its advisers in the fund selection process. (To encourage use of the investment by participants, the best approach would be to eliminate the extra fee and have a higher product yield.) If the subsidy is created to encourage sales outside of employee benefit plans, and a full rebate is made, the arrangement may be defensible, although the plan needs to know about the subsidy to decide if it should be specially allocated. Otherwise, defending such an arrangement cannot be much fun.

What's Not a Top-Hat Plan

2006-08-17T15:48:00.000-04:00

A thank you to PlanSponsor for finding Guiragoss v. Khoury, E.D. Va., No. 1:06vy187, 8/10/06, a case determining that a plan was not a top-hat plan exempt from ERISA. Unfortunately, the case is not all that useful, as is true of most cases on top-hat plan status. At least it makes clear one way to screw up top-hat status.

The plaintiff and sole participant was a clerk for the employer jewelry store, so the result is hardly surprising. Some of the language is troubling, saying "Guiragoss had no influence on the terms of the agreement and never consulted with an attorney prior to signing the agreement." Both of these statements are true of most top-hat plan participants, which is why the language is troubling. With any luck, and because this is a District Court decision, future courts will ignore that language and focus instead on the participants'' bargaining power, or lack thereof, rather than whether there was any actual bargaining.

A Reminder About Moral Hazard

2006-08-01T15:33:00.000-04:00

There is an interesting post at http://www.bostonerisalaw.com/, the blog of Steven D. Rosenberg of the McCormack Firm in Boston relevant to reviews of claims decisions by benefit plan administrators. Those of us who do not subscribe should thank Mr. Rosenberg.

The post refers to a New York Times article that says, essentially, that some people who receive disability benefits don't go back to work when they could. No professional who has worked with plans that offer disability benefits, including LTD, STD, subsididized disability benefits under defined benefit plans or vesting up defined contribution account balances on disability, is surprised by this statement. Nor is any worker's compensation lawyer on either side. All one really has to do is notice (1) that the word "lie" exists and is frequently used, and (2) the statement that "Money is the root of all evil."

A disproportionate number of cases on reveiw standards under ERISA relate to subjective, non-verifiable symptoms, and particularly reported pain. Insurance companies are used to people who lie, but many of the cases appear to we cynics to, in essence, find some reason to reduce the deference given to the plan administrator, ignore the possibility that the, e.g., reviewing physician simply thought the claimant was lying, and take the claimant's word.

The response to this is (1) to be explicit when credibility affects a decision, and (2) to use experts and/or research to remind the court that the concept of moral hazard has always been a core component of insurance economics, not a novel way of arguing for deference to plan administrators under ERISA.

Exclusion Under §§401(k) and (m) for §403(b) Participants

2006-07-24T12:38:00.000-04:00

The IRS on Friday issued regulations on the relationship between §§403(b) and 401(k)/(m). The regulations change was to the §410(b) definition of excludible employees, and although it technically affects only the related §401(k)/(m) plans, it clearly affects both the design and the operation of §403(b) plans and arrangements.

The change was originated by §664 of EGTRRA, which says the following:

“SEC. 664. EMPLOYEES OF TAX-EXEMPT ENTITIES.

(a) In General.--The Secretary of the Treasury shall modify Treasury Regulations section 1.410(b)-6(g) to provide that employees of an organization described in section 403(b)(1)(A)(i) of the Internal Revenue Code of 1986 who are eligible to make contributions under section 403(b) of such Code pursuant to a salary reduction agreement may be treated as excludable with respect to a plan under section 401(k) or (m) of such Code that is provided under the same general arrangement as a plan under such section 401(k), if (1) no employee of an organization described in section 403(b)(1)(A)(i) of such Code is eligible to participate in such section 401(k) plan or section 401(m) plan; and (2) 95 percent of the employees who are not employees of an organization described in section 403(b)(1)(A)(i) of such Code are eligible to participate in such plan under such section 401(k) or (m).

(b) Effective Date.--The modification required by subsection (a) shall apply as of the same date set forth in section 1426(b) of the Small Business Job Protection Act of 1996.”

A few key points here before looking at the regulation. First, it applies only to employees of §403(b)()(A)(i) organizations, not to public education employees described in §403(N)(1)(A)(ii). Second, it excludes them from §401(m) testing under the qualified plan (“the same general arrangement” acts to differentiate the qualified plan form the §403(b) arrangement, including any component subject to §401(m) testing). Second, the employees include all eligible to make deferrals into the §403(b), not just those making them. Third, there cannot be any employees of any §501(c)(3) organizations in the qualified plan. Last, 95% of the employees who are not employed by §501(c)(3) organizations have to be eligible to make deferrals into the qualified plan; the statue simply does not address whether statutory exclusions or the excludible employee definitions apply under the 95% requirement.

Now to the Final Regulations:

“Sec. 1.410(b)-6 Excludable employees.

(g) Employees of certain governmental or tax-exempt entities (1) Plans covered. For purposes of testing either a section 401(k) plan, or a section 401(m) plan that is provided under the same general arrangement as a section 401(k) plan, an employer may treat as excludable those employees described in paragraphs (g)(2) and (3) of this section.

(2) Employees of governmental entities. Employees of governmental entities who are precluded from being eligible employees under a section 401(k) plan by reason of section 401(k)(4)(B)(ii) may be treated as excludable employees if more than 95 percent of the employees of the employer who are not precluded from being eligible employees by reason of section 401(k)(4)(B)(ii) benefit under the plan for the year.

(3) Employees of tax-exempt entities. Employees of an organization described in section 403(b)(1)(A)(i) who are eligible to make salary reduction contributions under section 403(b) may be treated as excludable with respect to a section 401(k) plan, or a section 401(m) plan that is provided under the same general arrangement as a section 401(k) plan, if (i) No employee of an organization described in section 403(b)(1)(A)(i) is eligible to participate in such section 401(k) plan or section 401(m) plan; and (ii) At least 95 percent of the employees who are neither employees of an organization described in section 403(b)(1)(A)(i) nor employees of a governmental entity who are precluded from being eligible employees under a section 401(k) plan by reason of section 401(k)(4)(B)(ii) are eligible to participate in such section 401(k) plan or section 401(m) plan.”

The most obvious change is the addition of an exclusion for employees of governmental employers that cannot offer §401(k) plans. While not mandated by EGTRRA §664, this is a reasonable measure. I would argue that given the absolute inability of the §401(k)(4)(B)(ii) employer to participate maintain a §401(k) plan, the 95% coverage requirement is not appropriate here. In addition, note that subsection (2) does not explicitly exclude employees of §501(c)(3) employers at all.

Subsection (3) is, at first glance, simply parallel to subsection (2). However, note that in applying the 95% test under subsection (3), employees of governmental employers that cannot maintain §401(k) plans at all are excluded. This means that, in a very rare occurrence, the rules for nongovernmental employers are more liberal than those for governmental employers because subsection (2) does not allow exclusion of employees of charities excluded under subsection (3).

Last, there is a very problematic paragraph in the preamble, as follows: “Commentators asked whether employees of a tax-exempt organization described in section 501(c)(3) who would be eligible to make salary reduction contributions under a section 403(b) plan but for the exclusions permitted under section 403(b)(12), such as nonresident aliens and employees who normally work less than 20 hours per week, are taken into account as employees who are eligible to make salary reduction contributions for purposes of these regulations. These regulations provide that such employees are not taken into account unless they are actually eligible to make salary reduction contributions to the section 403(b) plan.” (Let’s set aside for the moment how regulation by legislative history, special provision not reflected in the Code and preambles makes for the sort of sloppiness evident here and makes the job of running plan too exciting.) This makes it that much harder for these employees to be excluded in testing the qualified plan; although at the least the §401(k) plan does not need to rewrite its entire set of exclusions to reflect both §§401(k) and 403(b) exclusions, it may mean that the calculations have to be done manually to apply §401(k) exclusions to the entire employee population minus the number of persons actually eligible within that non-excludible population.

More broadly, the paragraph in the preamble gives no hint on the application of statutory exclusions generally under the two 95% rules. Do the pre-ERISA rules apply to employees of governmental employers ineligible to maintain plans? Do the §410(b) rules for excludible employees, aggregation or disaggregation apply? And, if they do, under which plans? Governmental? ERISA? Section 403(b)? One analysis would say that these issues should be handled in parallel to the treatment of §403(b) exclusions (i.e., ignored). The second analysis would be that the IRS could have said that, so that in applying qualified plan exclusions §410(b) applies in all its glorious complexity, and by analogy to governmental plans with appropriate modifications. I, for one, have no idea which approach to use, and am hoping others will have some ideas.

Delay in 403(b) Regulations

2006-07-06T17:51:00.000-04:00

The final 403(b) regulations are being postponed, probably until the Fall of this year. This means that they simply cannot be effective for 2007, which is a good thing. Employers can now take some time to absorb their implications and to adopt a more intelligent approach than simply calling their providers for advice.

With the increasing emphasis on fees (DOL refers to them as Enroning plans, which is not a good analogy, but is a good indicator of attitude ) and behind-the-scenes payments (see the article dated June 20th), there is likely to be a real shakeout in a market based in large part on high fees being used to make payments for endorsements.

I'm not sure I would want to handle that issue and the final regulations all at once, but may will end up doing exactly that. In any event, employers are going to have to start asking questions about fee levels and hidden payments, and this column will focus on how to do that over the next few posts. And, any employer needs to start asking now about how providers will handle issues like:

-How will the written plan document requirement be handled?
-Does a written plan always make the employer a fiduciary? If not, how not?
-How will the provided handle overall limitations when there are multiple products in place or being phased out?
-What are all of the fees and costs between employees and the ultimate investments?
-Are there funds moving around behind the scenes? If so, who is paying, who is receiving, how much are the payments and what are they for?

This is, in fact, a harder issue for plans and arrangements not subject to ERISA, for various reasons. The next entry here will cover them in more detail, but the essence is that ERISA preempts a whole host of state laws that can be applied to money moving around from place to place. Just ask the Enron and MCI/WorldCom executives, and imagine 50 state attorneys general jumping on the bandwagon with Elliott Spitzer.

Whoops! MarshMac Bites Again

2006-06-20T20:44:00.000-04:00

This is self-explanatory. It's almost incredible to people who deal with 401(k) plans that anyobody would get a 2.85% wrap fee, and even more astounding that the NYSUT got $3,000,000 for endorsing it. It will be interesting to see the results of the class action suit that should follow.

The lesson here is that the Marsh & McClennan case sets a paradigm for dealing with all the sub-TA fees, incentives, referral fees and all other non-disclosed fees. They will, from here on out, be characterized as kickbacks and bribes paid directly with money from the pockets of participants. It is hard to imagine how a payor or payee can avoid liability, or how an employer or a fiduciary can say they have met their burden all unless of this is disclosed. And, worst of all, this is not limited to ERISA plans, since the claim can be framed as state-law fraud.

More later on this topic.

"NYSUT’S MEMBERS BENEFITS UNIT SETTLES PROBE

Settlement is Part of Ongoing Investigation of Retirement Products

Attorney General Eliot Spitzer today announced an agreement to resolve an investigation of the marketing of retirement products to members of the state’s largest teachers’ union.

Under the agreement, an arm of the New York State United Teachers (NYSUT) will adopt a series of reforms and pay $100,000 to the state to cover costs of the investigation.

The agreement follows a lengthy probe revealing that NYSUT’s Member Benefits unit accepted payments from an insurance company to promote the company’s retirement products to NYSUT members. The unit did not disclose this arrangement and, instead, took steps to conceal it.

"A simple rule that my office has enforced time and time again is that fiduciaries must place the interests of their clients first," Spitzer said. "Accordingly, an office set up to counsel union members on retirement alternatives should always provide objective advice and full disclosure of relevant facts. That did not happen in this instance. But as result of this agreement, reforms have been adopted to ensure that this standard will be met in the future."

The investigation revealed that a retirement product endorsed by the unit – a so-called 403(b) plan offered by the Dutch insurance giant ING and its predecessor, Aetna Life Insurance and Annuity Company– charged investors fees and expenses as high as 2.85 percent per year while delivering only limited benefits. The unit endorsed the plan (even though cheaper alternatives were available) in return for undisclosed payments of as much as $3 million per year.

The unit took pains to hide this "silent partnership" with ING/Aetna. The unit would urge union members to attend financial planning seminars, claiming that: "There’s no sales pitch - they [the seminars] do not promote specific products or services." But contrary to this claim, the seminars were used as a "foot in the door" to promote ING/Aetna retirement products.

In addition, the unit redirected calls it received arising from the retirement seminars to ING/Aetna employees, who answered the phones with their first names only. Callers thought they were talking to NYSUT benefits unit personnel when in fact they were talking to the insurance company’s marketing representatives.

In late 2004, after it became aware of the Attorney General’s investigation of insurance and retirement products, the unit drafted a new disclosure policy, which was described by officials in an internal e-mail as moving from a "try to hid[e] it" approach to a more open approach that included disclosing all payments from ING.

Under today’s agreement, the unit agrees to the following:

* Conduct open bidding for future retirement plan endorsements;

* Provide full disclosure of any and all payments from insurance companies;

* Allow members an opportunity to roll over savings to a new endorsed plan at no cost;

* Provide free and objective investment advice to members; and

* Hire an independent consultant to oversee reforms and report to the Attorney General’s office.

More than 50,000 New York teachers and other school district employees bought into the retirement plan without having been told by the unit of the payments it received from ING/Aetna.

The investigation underlying today’s settlement was conducted by Assistant Attorneys General Peter Dean and Harriet Rosen, under the direction of David D. Brown IV, Chief of the Attorney General’s Investment Protection Bureau.

A broad investigation of the marketing of retirement products continues."

For more detail, see the following:
http://www.oag.state.ny.us/press/2006/jun/NYSUT%20AOD.pdf
http://www.oag.state.ny.us/press/2006/jun/NYSUT%20Member%20Benefits_Exhibits.pdf

A Tale of Two Funds

2006-06-14T21:19:00.000-04:00

Before reading the actual decision in Jenkins v. Yager & Mid America Motorworks, Inc., No. 04-4258 (7th Cir. April 16, 2006), I thought it was an unmixed positive case. Write-ups came to the conclusion like "the Seventh Circuit affirmed the decision in favor of the plan trustee." On actually reading the case, it turns out that this is not quite true. In a nutshell, the plan, which looks like a National Auto Dealers Association plan, had a profit sharing feature without directed investments and a 401(k) feature with directed investments. The decision affirmed dismissal with respect to the directed investment portion of the plan and remanded for trial on the undirected profit sharing portion.

As to the directed investment portion, the court found that ERISA 404(c) was not the only route to avoiding fiduciary claims where participants can control their own accounts. To do this, the court felt it had to find an "implied exception", which certainly doesn't jump off the page, in ERISA 403(a). However, the fundamental logic, which is that (1) if ERISA 404(c) is a safe harbor, there should be other ways that aren't as safe, and (2) the DOL Regulations specifically contemplate other routes to compliance. (See DOL Regs. 2550.404c-1(a)(2): "The standards set forth in this section are applicable solely for the purpose of determining whether a plan is an ERISA section 404(c) plan and whether a particular transaction engaged in by a participant or beneficiary of such plan is afforded relief by 404(c). Such standards, therefore, are not intended to be applied in determining whether, or to what extent, a plan which does not meet the requirements for an ERISA Section 404(c) plan or a fiduciary with respect to such a plan satisfies the fiduciary responsibility or other provisions of Title I of the Act." The real meat of the decision on this point, however, is in the recitation of how conservative the funds were, the extensive conversation with a Raymond James RIA, the ready availability to employees of investment-related materials, and the fact that the sponsor had annual meetings with employees at which the RIA made a presentation. Given that record of attention and thoroughness, the court reasonably concluded that there was no breach of duties.

So far, so good. At this point, it looks like the case is an example of what I have always called the "I have always relied on the kindness of strangers" defense. It certainly stands for the notion that if you are intelligent and attentive, and hire the right advisers, you can forget about some of the ticky-tacky stuff in the DOL regulations (e.g., statement that the plan is intended to qualify under ERISA 404(c), name address and phone number of plan fiduciary, arguably the prospectus for the investments where ordinary investors don't read it (which is pretty much every prospectus for every investment a plan would even think about making available), voting rights materials (again, where real folks don't look at them), minimum quarterly investment direction), and the standards for the array of investments and their relationships). It also makes no distinction between participants who have acted on their choices and those who have not. If there are employer securities involved, it is probably a good idea to jump through all the hoops for ERISA 404(c) compliance, because employer securities make courts justifiably nervous.

The profit sharing portion of the plan presented a very different picture. The court started citing the employer's deposition, which contained a lot of I dunno answers. The same funds were used as investments, but the employer couldn't answer questions about the mix initially set up, changes to the mix or rebalancing. The Seventh Circuit remanded for further proceedings as to the profit sharing fund.

This means two things. First, I am going to have to start distinguishing between defenses that permit or require real reliance ("I have always relied..."), such as penalty cases under the Code, and fiduciary reliance on advisers, which should be described as "I have always listened to the advice of strangers and made my own informed decisions." (Since the second one is not very snappy, I'll probably have to come up with two brand new names.) Second, always get your advisers to cover all the bases for you.

If, because the exciting issues were under the directed investment part of the plan, both parties' lawyers paid less attention to the profit sharing fund, Defendant's lawyers will probably try to get better answers from the Raymond James RIA. Then, whether they can get those better results will likely determine the outcome of the case.

One last note. Somehow or other, the DOL has decided it disagrees with the decision. It's hard to reconcile that with the language for DOL Regs. 2550.404c-1(a)(2) cited above I have no idea. Given the content of the regulations cited and the fact that thus decision is now on the books, it would seem to be too late for DOL to close this particular barn door.

Final 403(b) Regulations for 2007?

2006-06-12T17:27:00.000-04:00

The IRS announced last week that final 403(b) regulations will be issued this month and that they will be effective for 2006.

I am willing to take the IRS at its word as to issuance, although they could be delayed a month or two. The second element, making them effective for 2007, is more problematic. For starters, the 403(b) industry is not exactly designed for efficiency. Second, both charities and governments have more cumbersome processes for taking "corporate" action. Third, lots of employers (e.g., school districts) have an array of 403(b) products from different vendors and will be getting different advice from each. Fourth, six months isn't much time anyway. Last, effective dates seem to be pushed back infinitely for governmental employers. Employers should move as quickly as possible, but the regulations will probably not go into effect until 2007.

Reports say that some providers are charging on the order of $3000 to help meet the written plan document requirement. We are hoping that our solution, which is quick, efficient, written to avoid fiduciary status and a lot less money will become popular. Employers need to be very careful about not volunteering for a fiduciary status that they do not have to assume.

I am looking forward to the 414 part of the final regulations. The IRS operates under way too many different standards for nonprofit/governmental employers. These included 414 (which appears to require an 80% board control), 415 (50% board control by the employee), the church plan and governmental plan standards in 414 and ERISA, the requirements for getting a group determination letter of tax-exempt status and the operated, supervised or controlled by or in connection with standard for determining private foundation status. It would be far preferable if one set of standards were used, even if that requires legislation. Wherever the line is drawn, a lot of analysis and hard decisions will need to be made, as multiple 415 limitations disappear or appear, as plan become or cease being multiple employer plans, among other possible effects. Any line is better than no line, so that at least people know what to do, but one line would be preferable.

Should be exciting, at least. And maybe this will help trigger the professionalism and efficiency improvements that 403(b) markets need so much.

What's a Top-Hat Plan?

2006-06-10T16:50:00.000-04:00

There are two basic ways a court can end up deciding whther a plan is a top-hat plan or not. The first is to decide under ERISA exemption provisions, and the second is in a claim for benefits where the sponsor is bankrupt. In In re IT Group, Inc., 2006 WL 1421016 (3rd Cir. 2006), the Third Ciruit got one of the latter. The case not only looks at top-hat status, but also clearly pijnts out the downside of being "unfunded".

The claimants were participants who alleged that the plan required the establishment of rabbi trust, with all the customary disclaimers in the plan and the trust agreement. The decision also assumed that the plan was for a select group of management and highly compensated employees. so that funding was the only real issue.

The court decided that this was a case of first impression. Footnote 3 says "In previous cases involving deferred compensation plans offered to management and highly compensated employees, we have always assumed, without further examination, that ERISA’s “top hat” exemption applies. See, e.g., Goldstein v. Johnson & Johnson, 251 F.3d 433, 435 (3d Cir. 2001) (considering the proper scope of judicial review of an administrator’s decision to deny benefits owed under a top hat plan); Senior Executive Benefit Plan Participants v. New Valley Corp. (In re New Valley Corp.), 89 F.3d 143, 148 (3d Cir. 1996) (“Both plans at issue are top hat plans . . . .”); Kemmerer v. ICI Americas Inc., 70 F.3d 281, 284 (3d Cir. 1995) (“The dispute on appeal centers around [an] executive deferred compensation plan, which like all such plans is commonly referred to as a ‘top hat’ plan.”)."

However , they still manage to cite other decisions on unfunded welfare plan status, as follows: The Eighth Circuit Court of Appeals has examined this issue from both sides. In considering whether a death benefit plan supported by a life insurance policy was subject to ERISA’s substantive requirements, it stated that “[f]unding implies the existence of a res separate from the ordinary assets of the corporation.” Dependahl v. Falstaff Brewing Corp., 653 F.2d 1208, 1214 (8th Cir. 1981). The plan was “funded” because the insurance policy provided “a res separate from the corporation” to which beneficiaries could look for payment of benefits under the plan. Id. On the other hand, an excess benefit plan that specified that the rights of the beneficiary under the plan would “be solely those of an unsecured creditor” was unfunded, even though the employer had purchased an insurance policy to help it finance the plan, because the policy in that case “simply became a general, unpledged, unrestricted asset of the [employer] and those . . . assets in turn would be used to fund [the] plan.” Belsky v. First Nat’l Life Ins. Co., 818 F.2d 661, 663-64 (8th Cir. 1987). Similarly, the Second Circuit Court of Appeals has observed that a plan under which benefits were to be paid “‘solely from the general assets of the employer’” is unfunded. Demery v. Extebank Deferred Compensation Plan, 216 F.3d 283, 287 (2d Cir. 2000) (quoting Gallione v. 17 Flaherty, 70 F.3d 724, 725 (2d Cir. 1995)). More recently, it adopted a standard first articulated in Miller v. Heller, 915 F. Supp. 651 (S.D.N.Y. 1996):
the question a court must ask in determining whether a plan is unfunded is: can the beneficiary establish, through the plan documents, a legal right any greater than that of an unsecured creditor to a specific set of funds from which the employer is, under the terms of the plan, obligated to pay the deferred compensation?” Demery, 216 F.3d at 287 (quoting Miller, 915 F. Supp. at 660). Applying this test, the court found that a deferred compensation plan that was financed using life insurance contracts, the proceeds of which were kept in a separate account, was unfunded. According to the court, the plan’s terms did not “give plaintiffs a greater legal right to the funds in the Deferred Compensation Liability Account than that possessed by an unsecured creditor.” Id. Although the account was separate, it was part of the “general assets” of the corporation, and the plan was therefore “unfunded as a matter of law.” Id. The Fifth Circuit Court of Appeals employed a similar analysis, but also considered the tax treatment of the plan. In Reliable Home Health Care, Inc. v. Union Central Insurance Co., 295 F.3d 505 (5th Cir. 2002), it surveyed the decisions of the other courts of appeals, and noted that the Department of Labor had provided the following guidance: “‘[A]ny determination of the ‘unfunded’ status of an ‘excess benefit’ or ‘top hat’ plan of deferred compensation requires an
examination of the facts and circumstances, including the status of the plan under non-ERISA law.’” Id. at 513 (quoting Dep’t of Labor, Pension & Welfare Benefit Programs, Op. Ltr. 92-13A, 1992 ERISA LEXIS 14, at *7 (May 19, 1992)). More specifically, the court emphasized DOL’s advice that the tax consequences of the plan should be considered in the analysis, id. (citing DOL Op. Ltr. 92-13A, 1992 ERISA LEXIS 14, at *7), and noted a district court’s holding that “a ‘plan is more likely than not to be regarded as unfunded if the beneficiaries under the plan do not incur tax liability during the year that the contributions to the plan are made,’” id. at 514 (quoting Miller, 915 F. Supp. at 659). Combining all of this information, the court devised the following test: in determining whether a plan is “funded” or “unfunded” under ERISA, a court must first look to the surrounding facts and circumstances, including the status of the plan under non-ERISA law. Second, a court should identify whether a [plan] is funded by a res separate from the general assets of the company. Id. 4As noted above, a plan under which the beneficiaries do not incur tax liability during the year that the contributions to the plan are made is “more likely than not” an “unfunded” plan. Miller v. Heller, 915 F. Supp. 651, 659 (S.D.N.Y. 1996). This is so because the tests for taxation of deferred compensation and for funding status ovelap–deferred compensation is not taxable as current income only where the future payment of the compensation is somehow uncertain, i.e., where the assets used The Reliable court concluded, under this test, that a death benefit plan was unfunded. Like the plans at issue in Demery and Belsky, the plan was financed through the purchase of life insurance contracts on behalf of participating employees. However, those contracts belonged to the company, not the participating employees. Plan participants were prohibited from contributing to the plan, and did not treat the company’s contributions to the plan on their behalf as taxable income. Thus, the plan was unfunded and exempt from ERISA’s substantive provisions. Id. at 514-15. We agree with our fellow courts of appeals that the keys to the determination of whether a plan is “funded” or “unfunded” under ERISA are (1) whether beneficiaries of the plan can look to a res separate from the general assets of the corporation to satisfy their claims; (2) whether beneficiaries of the plan have a legal right greater than that of general, unsecured creditors to the assets of the corporation or to some specific subset of corporate assets. We may also consider the plan’s intended and actual tax treatment. We will analyze the to pay participants’ claims are also subject to other creditors’ claims. Thus, the fact that a plan qualifies for deferred taxtreatment strongly supports the conclusion that it was unfunded.
See Dep’t of Labor, Pension & Welfare Benefit Programs, Op. Ltr. 92-13A, 1992 ERISA LEXIS 14, at *7 (May 19, 1992) (noting that “the tax consequences to trust beneficiaries should be accorded significant weight” in determining whether a plan is “funded” or “unfunded”)."

Th Court then determined (1) that the plan was a top-hat plan, (2) that the employees were not entitled to a priority claim in the bakruptcy, and (3) that no one involved with the plan had breached any fiduciary duties.

This decision is not overwhelmingly important for Sections 403(b) and 457, certainly not as important as an effort to determine what constitutes a select group. Nonetheless, it points out the fact that some legalese has a purpose, and shows what language needs to be included in nongovernmental Section 457 plans.