Business of Benefits : Employee Benefits Lawyer & Attorney : Law Office of Robert J. Toth, Jr. : 403(b) Plans, Annuity & Insurance Law : Business of Benefits Blog

A number of years ago, I was in-house ERISA counsel for Kellogg Company (yes, the home of Tony the Tiger). The company’s CEO was in charge of the food manufacturer’s trade group at the time, and he sent me to DC to review and help “fix” the retirement plan for its employees. This was a time prior to even the IRS’s Administrative Policy on Self Correction (“APRSC”-I am showing my age). As I explained to the group’s Executive Committee the issues and the list of horribles which could result, the V.P. for Taxes of Kellogg stopped me in the middle of my presentation and blurted out: “Toth, this s**t’s hard!”

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Be prepared to work hard when you need to take a 403(b) plan through the new EPCRS process under Rev Proc 2013-12-as many of you will need to do soon- especially if you have to use the VCP process, or are defending an audit under CAP. It is going to be complicated. Quite frankly, a separate 403(b) guide to the VCP program will need to be utilized.

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I am pleased, again, that Linda has provided us with the following guest post. I am a big fan of her writing style: making things simple is an extraordinarily difficult task, but one that Linda does so well.

In this posting, Linda provides some practical guidance on what to do to prepare for an IRS 403(b) audit-particualrly given that the Service has announced that it will be increasing the number of 403(b) audits this fiscal year. 

Bob

Keeping Your 403(b) Plan in Control

by Linda Segal Blinn, J.D.*

Vice President, Technical Services, ING U.S. Retirement

 If you have seen the November 14th edition of the IRS’ Employee Plans News (click to link to the newsletter), you already know that “internal controls” is the latest catchphrase.  And, as the IRS ramps up its audit activity with 403(b) plans, chances are that more IRS auditors will be asking 403(b) sponsors about internal controls for their plans.   

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One of the more difficult questions that has arisen under the 404a-5 participant disclosure rules is related to those pesky "old" 403(b) contracts. In the multiple vendor ERISA world, where a number of vendors have been in and out of the plan over decades, the question becomes whether-and to what extent-the 404a-5 disclosures have to be made under those contracts into which deposits could no longer be made.  I had heard of a number of practitioners and consultants who had hoped that these disclosures would not have to be made for such contracts.

The DOL's FAB 2012-2 answered this question in two parts. The first is in Q2, where the DOL exempted from coverage those "old" contracts which are also excluded from 408b-2 and Form 5500 treatment (that is, those contracts issued before Jan 1 2009,and into which no deposits were made after 12/31/2008; the rights under the contracts run solely to the participant without any involvement by the employer; and the amounts in the contract are fully vested).

The second part is in Q15. Here's what Q15 says:

"Q-15: Must a plan administrator furnish the disclosures required under paragraph (d) for a designated investment alternative that is closed to new investments, but that allows participants and beneficiaries to maintain prior investments in the alternative and to transfer their interests to other plan investment alternatives?

A-15: Yes. A plan administrator must furnish the disclosures required by paragraph (d) of this regulation to participants and beneficiaries for each designated investment alternative on the plan’s investment platform even if the alternative is closed to new money. In the Department’s view, the required disclosures are as important for deciding whether to transfer out of a designated investment alternative as they are for deciding whether to invest in a designated investment alternative. Consequently, participants and beneficiaries are entitled to, and have the same need for, information about a designated investment alternative that is closed to the inflow of new money as a designated investment alternative that is accepting new money. The plan administrator is not required, but may choose, to provide the disclosures required by paragraph (d) about the closed alternative as part of a comparative document furnished only to those participants or beneficiaries that remain invested in that alternative."

This means that, for those "old" 403(b) contracts not excluded under Q2, the 404a-5 disclosures will still need to be made, even though the only act participants can take is to move money from those contracts. This Q15 also makes it clear that the disclosure only needs to be made to those who hold those contracts, if the plan administrator so elects to do so.

What really comes into play here is 408(b)(2). 403(b) plan sponsors have all, by now, been told by vendors which of these "old" contracts are not excluded from the plan for these purposes. This means that, unless the plan sponsor disagrees with the vendor, they now have a list of contracts for which 404a-5 disclosures will need to be made. Often times the employer will not have the contact information for former employees holding these contracts, but these former employees are still considered plan participants. Sponsors will need to work with their old vendors to get the data they need in order to make the participant disclosure, which those old vendors seem to be required to give.

And there really isn't an easy answer for these sorts of circumstances, given Q21:

"Q-21: Must a plan administrator furnish a single, unified comparative chart or may multiple charts, supplied by the plan’s various service providers or investment issuers, be furnished to participants and beneficiaries?

A-21: Plan administrators may furnish multiple comparative charts or documents that are supplied by the plan’s various service providers or investment issuers, provided all of the comparative charts or documents are furnished to participants and beneficiaries at the same time in a single mailing or transmission and the comparative charts or documents are designed to facilitate a comparison among designated investment alternatives available under the plan. However, as stated in the preamble, permitting individual investment issuers, or others, to separately distribute comparative documents reflecting their particular investment alternatives would not facilitate a comparison of the core investment information and therefore would not satisfy the plan administrator’s obligations under paragraph (d)(2)."

For all the noise which arose under 408(b)(2), these kinds of issues demonstrate that the more difficult challenge for 403(b) plan sponsors swill be 404a-5.

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The DOL, in its final 408(b)-2 regulation, issued relief for 403(b) plans, under which information related to  certain contracts would not be subject to the the new fee disclosure rules. Though this was very helpful, it did not specifically address the 404a-5 participant disclosure regulations for the same type of contracts. This raised a degree of uncertainty with regard to whether or not that relief would be extended to the participant disclosures--causing a good  friend to comment in his inimitable NY manner, "what are the participant regs anyway, chopped liver?!?"

The DOL has saved those regs from chopped liver status, today making it clear in Question 2 to FAB 2012-2 that the 408b-2 relief for 403(b) plans also is extended to the 404a-5 requirements for said plans, on the same terms and conditions.

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NOTE: I STRONGLY CAUTION READERS THAT THE FOLLOWING IS MERELY A SUGGESTED APPROACH WHICH COULD BE SENSIBLY USED BY THE IRS IF IT WERE TO CHOOSE TO RECOGNIZE THE DSTRIBUTION OF INDIVIDUAL CUSTODIAL ACCOUNTS FROM 403(b)(7) PLANS, AND TO LEAD TO FURTHER DISCUSSION. IT IS NOT REFLECTIVE OF THE IRS’S (NOR, AS FAR AS I KNOW, THE DOL’S) CURRENT POSITION, OR EVEN ONE IT IS CONSIDERING. THE FOLLOWING IS NOT INTENDED TO PROVDE LEGAL OR TAX ADVICE, AND SHOULD NOT BE USED AS A BASIS TO JUSTFY A DISTRIBUTION OF A 403(b)(7) CUSTODIAL ACCOUNT.

I, like many others, struggle with the notion of advocating for the ability to terminate a 403(b) retirement plan.  However, any retirement plan needs to be able to be sanely unwound -often for a number of critical, exigent reasons unrelated to the plan itself.  We now find ourselves in a growing number of difficult circumstances where the right solution is to terminate a 403(b) plan, but find ourselves unable to do so.

The IRS’s ongoing position is that an individual 403(b)(7) custodial account cannot be distributed from a 403(b) plan upon its termination, while a “fully paid” annuity contract is permitted to be distributed- as it will not deem the custodial account to be an annuity for these purposes.  This has the practical effect of preventing termination of any 403(b) plan which is funded with individual custodial accounts. As time wears on, and this position begins to get long in the tooth, its “unworkableness” becomes more and more apparent as it causes difficulties beyond the actual plan itself. 

I have never fully understood the legal concerns that the IRS has with treating the custodial account as a deemed annuity and thus a distributable asset from the plan, but will fully admit that this arises from my perspectives on these contracts bred by my particular experience with them.

Could it be that the IRS is uncomfortable with the notion of treating the custodial account as an annuity means treating the custodian contract of a plan as being, itself, a plan asset?  If so, this concern is eminently understandable. It seems counterintuitive, at best, that a part of the fundamental structure of a plan be considered a plan asset.  It makes much better sense that the underlying securities (or the cash generated from their sales) held by the custodian is the asset that can be distributed; and that its not really possible to distribute a portion of the structure of the plan. An individual custodial account cannot possibly be a financial instrument that can be recognized as an “in-kind” plan asset: its part of the plan itself.

Like many things 403(b), however, these sorts of issues are novel and of first impression when applied to such plans, requiring that we return to some very basic concepts.

I would hope that the following analysis would be useful.

Lets start with the distribution of an annuity contract from a 401(a) plan.  The tax regulations have long recognized that an annuity contract is a financial instrument (as opposed to cash) which can be distributed from a 401(a) plan (see 1.401(a)-20, Q&A 2); that it can have an account balance or a cash value (see 1.401(a)31, Q&A 17 which requires a qualified plan distributed annuity to allow a direct rollover of funds from the annuity contract to another plan or IRA); and the IRS has issued a number PLRs to that effect (see, for example PLR 200951039, which describes a variable annuity contract issued from a plan).

So it becomes a relatively straightforward proposition to permit the distribution of an individual annuity contract from a terminating 403(b) plan (putting aside for now the issue of what is a “fully paid” annuity contract). Even though it can be seen as constituting a part of the actual structure of a plan, its distribution is accorded no different legal or tax effect than is granted to annuity contracts distributed from a 401(a) plan.  And just as a qualified plan distributed annuity continues to be subject to 401(a) (as administered by the insurance company, see for example 1.401(a)-20 Q&A 17), the distributed annuity 403(b) contract continues to be subject to the terms of 403(b) (see Rev. Rul. 2011-7). 

But what of individually owned 403(b) custodial accounts which, like the annuity contracts they are deemed to be by the Code, seem to be an integral part of the plan’s structure?  Could it also be comfortably considered a financial instrument capable of being distributed by a 403(b) plan on termination in the same manner as an annuity?  

I invite consideration of the following: 

-The individually owned custodial account is a financial instrument, a legally binding contract which is signed by the participant (not the plan) and the custodian, like the individual annuity contract. It has specific terms and conditions on the exercise of the rights by the participant/owner over the underlying securities it holds. For example, the custodial accounts limit the distribution of its assets to those distributions permitted under 403(b)-11, and needed No-Act approval from the SEC to do so-as had the annuity contract. The legal right and title to those contracts under state law run to the participant (though also being subject to ERISA standards for ERISA plans), as does the rights under an individual annuity contract. It would be hard to argue that these are not ”bundle of rights” which constitutes property rights under traditional state property law analysis, as with an annuity contract. 

-The individual custodial account is fundamentally different than the traditional 401(a) custodial account, here with rights to the underlying assets themselves not only running directly to the participant, but the rights of participants can vary greatly within the same plan. 

-Given the state law property rights granted to the individual owner of the custodial accounts, and that the DOL uses ordinary notions of property law to determine whether or not something is a plan asset (see, for example AO 94-31-though the DOL has yet to take a position on this in the 403(b) custodial account context), and that annuity contracts are generally considered plan assets, it becomes hard to argue that the individually owned custodial account is not also a plan asset. And just because it is a plan asset which holds other plan assets (like annuity contracts with separate accounts), this does not disqualify its own plan asset "status."  I suspect that, if the custodial account were abused by a participant or vendor in some sort of way, the DOL would be the first to acknowledge that it is a plan asset.

-The custodial account can, and has historically has been able to, legally exist and operate independently from the existence of a plan and a plan sponsor, with the custodian acting in the same manner as an insurer under a 403(b)  annuity contract which is not related to a plan. 

-This financial instrument is recognized as a security by the SEC. The SEC’s own position recognizes the interests embodied in the 403(b) custodial account as a security owned by the participant, which further lends weight to the argument that it is an asset which can be distributed.  In Release 33-6188, it stated these interests are securities, though “as a matter of administrative practice...the staff does not require such interests to be registered."  This is not a reference to the underlying securities held by the custodial account, as those interests are specifically required to be registered. 

Admittedly, this presents a one sided view, but it is one which is both legitimate and could form the basis of permitting the distribution of the individual custodial account upon plan termination. Supporting this from a logistical view of things is that there are already a significant number of such custodial accounts described above in the marketplace which exist outside a plan. These came to be by virtue of 90-24 transfers occurring before 9/24/2007. Note that I do not address-nor advocate-the application of this approach to distributions from ongoing plans. There are a number of other complications which arise from that circumstance. Note, too, that I suggest that this analysis is only possible under 403(b) (and not under 401(a)) because of the specific language of 403(b)(7).

I would hope that this approach, recognizing the individual custodial account as the financial instrument it is, would make some sense to our regulators in deciding upon its termination distribution. 

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 I have written often of the large impact of the small, the concept of  "minimum necessary change" to accomplish what needs to be done, and have noted a number of regulatory instances where this has been-and not-accomplished.

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I have expressed several times my sense that the 2007 403(b) regulations were unfortunate in a number of different ways. Though they sought to address some very real compliance issues, they did so in a heavy handed and often complicated way which virtually ignored the difficulties inherent in transitioning from a statutory and commercial system that had been operating for 3 or 4 generations under the prior set of rules.

We are very fortunate, however, that the IRS staff responsible for implementing and enforcing those regulations recognized this failing early on, and has often sought to administratively address some of the more difficult concerns that have cropped up through this transition period.

Most recently, Monika Templeman (Director of Employee Plans Examinations for the IRS's TE/GE Division) announced in February an interim program to address an audit problem related to the IRS's delay in updating the EPCRS program to reflect 403(b) document rule changes, and the stalled 403(b) prototype program.

This program, according to IRS staff, will not be provided in formal, published guidance, but will be implemented by the field staff during audit until such time as EPCRS and the prototype program are finalized. It will helpful to the practitioner to be familiar with how this works, because it is relief that operates within limitations of the IRS's formal audit closing structure.

If an employer is found not to have adopted formal 403(b) plan document in a timely manner, the IRS may choose (presumably under non-abusive circumstances) to enter into a type of agreement where sanctions more resembling those available under the “Voluntary Corrections Program” (VCP) will apply, rather than those under the more expensive “Closing Agreement Program” (CAP). This should help encourage employers who still have not adopted a formal program to act as quickly as possible to adopt a formal written plan document, albiet late.

If a "document error" (as that term is used under EPCRS) has been found,  the employer may be given the option of amending the plan prospectively and fixing the past error as an operational error (either as a self correction, where applicable, or using the VCP structure); or to instead commit to adopting a prototype program (when issued) and follow the rules for the remedial amendment period under that program. It is important to note that the IRS will follow up with the employer should the "prototype choice" be selected, and one should give it serious thought before making this particular choice.

What the IRS CAN'T do under favorable terms because of the legal structure of the audit program (though some practitioners apparently insist on doing so) is to permit the retroactive amendment of the plan on audit. Insisting on this fix will cause the higher CAP sanctions to be applied.

On another note, it has come to my attention that my prior blog related to the "mis-marketing" of the 403(b) SPARK standards by some parties could have been read to imply that SPARK itself has been involved in this practice.  SPARK has not represented or suggested that its best practices are intended to serve as a DOL disclosure solution.  It was never my intent to lead any one to this conclusion, as SPARK is not engaged in such a practice. I do apologize for any misunderstanding that this may have caused.

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The 403(b) regulations replaced the "contract exchange" rules under Revenue Ruling 90-24 (which allowed the tax free transfer of 403(b) contracts between different vendors, including that of different plans, as long as certain, minimal conditions were met) with a new scheme of exchanges and transfers. After September 24, 2007, the former "90-24 transfers" between unrelated plans could only be accomplished through a formal "transfer agreement" between plans, much in the same manner as 401(a) plans.  

The IRS also imposed new rules for exchanging contracts between vendors in the same plan. These new rules include the infamous "Information Sharing Agreement" (or "ISA") requirement, that conditions the exchange on the employer entering into an agreement with the issuer of the contract into which the funds will be exchanged. Under the ISA, the employer and the new issuer agree to, "from time to time in the future," provide each other Information necessary for the new contract, or any other contract to which contributions have been made by the employer, to satisfy section 403(b). This includes information concerning the participant’s  employment  status, eligibility for a hardship, and ability take a loan (and in what amount),  as well as Information necessary to satisfy other tax requirements.

In response to these new data exchange requirements, a number of friends and colleagues from a variety of 403(b) vendors joined together and  worked diligently and effectively over several years following the publication of the regulations to establish information standards for the exchange of this data. They are known as the SPARK 403(b) Information Sharing Data Elements Best Practices. 

Now, however, there appears to be a number of parties that are touting these ISA standards as the solution to 408(b)2 and 404a-5-compliance; that the SPARK standards will provide a solution to these new DOL disclosure rules; or that adopting the SPARK Standard suggests capability to successfully implement the disclosure rules.

Don't be misled; nothing can be further from the truth. The SPARK standards address the basic contract information which is necessary for compliance with the ISA requirements. There is no fee data; there is no investment data; there is no description of services. Reference to the "SPARK Standard" as a solution to the DOL rules does present a very catchy marketing and sales hook, but one which is also very wrong.

As an aside, the ISA standards were well developed by dedicated professionals, many of whom are passionate about this business. They have been, in effect, a tremendously successful  "Skunk Works."   Much of the standards' current value derives from volunteers who have moved on to other positions within and without the original organizations which were committed to the process.  So sustainability now becomes an issue. The standards were also developed under the auspices of a small organization with very limited professional and administrative staff which-in addition to attempting to establish annuity data standards along side the 403(b) standards-is very much focused on establishing its own new "brand." Sustainability, structure and support  are necessary elements for the maintenance and further development of these standards as they mature. 

Ultimately, as I've suggested in the past, the answer may well lie in the formation of a consortium funded in large part by user fees; supported by a well established center such as a public university; and governed by a wide variety of stakeholders-not just vendors. This is not just a pipe dream, this is how a number of standard setting organizations and consortia are run with a degree of permanence. I admit here to a bias, as a number off us had proposed and developed just such a structure in the early days of the new regs, and a number of critical parties were interested.

It will be interesting to see what happens over time.

  __________________

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The DOL continues with its sensitivity to the challenges created for 403(b) plan sponsors in the transition to an employer accountable world. In today's release of the final 408(b)(2) regs, the DOL provided tremendously needed relief for 403(b)plans. The language from the preamble speaks for itself:

The Department was persuaded by commenters on the interim final rule to exclude all or that part of a Code section 403(b) plan (hereafter “403(b) plan”) that consists exclusively of “frozen” contracts or accounts, as described in the Department’s Field Assistance Bulletins addressing the limited application of the annual reporting requirements to such contracts or accounts.  Plan sponsors and fiduciaries likely would be unable to comply with this rule because they often have no dealings with the relevant plan service providers and are unable to obtain information about these contracts and accounts.  Accordingly, paragraph (c)(1)(ii) of the final rule now provides that, in the case of a Code section 403(b) plan subject to Title I of ERISA, the “covered plan” would not include annuity contracts and custodial accounts described in section 403(b) of the Code with respect to which the plan sponsor ceased to have any obligation to make contributions (including employee salary reduction contributions) and in fact ceased making contributions to such contracts or accounts for periods before January 1, 2009.  Further, the contract or account has to have been issued to a current or former employee before January 1, 2009; all the rights and benefits under the contract or account have to be legally enforceable against the insurer or custodian by the individual owner of the contract or account without any involvement by the employer; and such individual owner has to be fully vested in the contract or account. 

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I am, by some serious training and long experience, a corporate lawyer, having been put through the paces by two incredible general counsels: Jack Hunter of Lincoln Financial Group and Scott Campbell of Kellogg Company. Each of these gentleman made quite a study of their attendant Boards and the rules (both formal and informal)  related to their rarefied status. The expectation was that lawyers  dealing with Board matters clearly understood the proper role and culture of "their" Boards.

Every year end I tend to be reminded of this seemingly mundane work (though it is really anything but!) in private practice, as this tends to be the "busy" season when it comes to corporate actions related to plan amendments and other plan activity. Though it may be too late in the year to be useful this year, there are a few thoughts that come to mind which you may hopefully find relevant the next time a plan amendment crosses your desk:

1.  Boards do not manage companies. It is fundamental corporate law that corporate officers run companies, not the Board. Board members have the fiduciary obligation to the shareholders to oversee management; but they do not step into the role of management.  This means that whatever you are looking for the Board to do, it should be generally "big picture,"  such as adopting or terminating the retirement plan. When adopting the plan, try to make sure that a corporate officer has the ability to amend the plan. In larger corporations, this authority will often be subject to certain limits, such as where the benefit is increased.  

2.  Check the minutes.  If you are unsure of who has the authority to amend the plan, check the past Board minutes (if you can find them) to see who has that authority to amend.

3. Rely upon general authority.  If it is not clear who has the authority to amend, you may find guidance in the general authority granted to officers in the bylaws or enabling resolutions as to who may have the authority to amend a plan, absent a specific grant. If you find yourself needing to go in for a Board resolution, take that opportunity to delegate future amendment authority to an officer.

4. Keep details minimal. I recently saw a board resolution that not only adopted a QACA, but also directed the officers to provide required notices. This is patently unacceptable drafting. The officers should be directed, instead,  to take all necessary actions to execute the decision of the board.

5. That fiduciary thing. Make sure that whatever you are asking the Board to do does not constitute a fiduciary action unless you intend it to. One of the worst things you can do to Board members is to inadvertently cause them to have unwanted fiduciary status. Make sure that the authority to act on behalf of the plan is properly delegated to appropriate officers: in the absence of a clear delegation, one would not generally like the DOL or courts to make a de facto finding of inadvertent ERISA fiduciary status of a Bord member.

Related to this are a number of RMD amendments I have been seeing for 403(b) plans, which purport to amend 403(b) plans for the WRERA rule that allowed RMD waivers in 2009.  Some vendors are presenting these amendments to plan sponsors for their signature by year end, as the vendor may have taken it upon itself to generally waive these requirements for those 403(b) customers with individual contracts.

First, it is not clear that such an amendment is needed because, at least for now, you can still incorporate a lot of things by reference-and the inclusion of 401(a)(9) in a 403(b) document should suffice.

Secondly, though, is the bigger problem.  These these carrier provided amendments purport to amend the entire plan. If there are other vendors in the plan  which did NOT offer the RMD waiver, you actually have a plan document problem on your hands if you adopt this broad amendment.

So, be careful; and may your New Year be fruitful, fulfilling and meaningful. 

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Keeping it simple and sensible is never an easy task. As a matter of fact, it is extremely difficult to do, particularly when dealing with something as complex as 403(b) regulations. This is why the IRS's recent release of its 8955 FAQ's is so striking: in merely two FAQs,  IRS and Treasury provided answers that not only make regulatory sense and further tax administration, but did it in a way which makes sense for 403(b) plan sponsors. And it surprisingly well co-ordinates with positions the DOL has taken.

TE/GE has spent considerable effort in 403(b) outreach over the past decade, even in face of much cynicism about the enhanced regulatory approach to these plans-developing an unusual amount of knowledge about the marketplace in the process. It clearly tapped into this expertise in developing the FAQs. They could not have been written without a number of highly knowledgeable regulators and auditors recognizing a challenge, and being committed to coming up with a workable solution. I have not, in the past, been shy at commenting on a number of different unfortunate choices staff has made when writing and implementing the 403(b) regulations. This time, however, staff impressed.

The following are the 403(b) questions from the FAQ. Even the most difficult part of them-the part about contracts which cease payments in 2008-arises from the requirements of the 8955 itself, but the IRS found a way to integrate it well. 

Does the Form 8955-SSA filed for 2009 by a 403(b) plan sponsor have to report participants who separated from service prior to 2008 with a deferred vested benefit under the plan?

Generally, no. Form 8955-SSA filed for 2009 generally only has to report participants who separated from service in 2008. Thus, participants with a 403(b) contract or account who separated from service prior to 2008 are not required to be reported on the Form 8955-SSA filed for 2009 (or for any subsequent year).However, a participant should be reported on the Form 8955-SSA filed for 2009 if that participant separated from service in a year before 2008 and began receiving payments under the contract or account, but the payments stopped in 2008 before all of the participant’s benefits were paid. See the Instructions for 2009 Form 8955-SSA. See also Question and Answer 2 for an exception that applies even in the case where payments stopped in 2008. 

Does a 403(b) plan sponsor have to report all participants who separated from service after 2007 with a deferred vested benefit under the plan?  

No. A plan sponsor is not required to report a separated participant if the participant’s deferred vested benefits are attributable to an annuity contract or custodial account that is not required to be treated as part of the section 403(b) plan assets for purposes of the reporting requirements of ERISA Title I, as set forth in DOL Field Assistance Bulletin (FAB) 2009-02. 

For this exception  to apply, (1) the contract or account would have to have been issued to a current or former employee before January 1, 2009, (2) the employer would have ceased having any obligation to make contributions (including employee salary reduction contributions), and in fact ceased making contributions to the contract or account before January 1, 2009, (3) all of the rights and benefits under the contract or account would be legally enforceable against the issuer or custodian by the participant without any involvement by the employer, and (4) the participant would have to be fully vested in the contract or account. For further information, please see DOL FAB 2009-02, www.dol.gov/ebsa.

There are a couple of important nuances in the application of these rules. I invite you to read Conni's analysis in the Thompson quarterly 403(b)/457newsletter, coming out shortly, where she explains them.

Once again, there are several choices TE/GE could have made when developing its position. It used its knowledge and experience to make some pretty good ones here.

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Guest Blog:  Linda Segal Blinn on 403(b)

Writing a blog on technical/legal/regulatory issues can be daunting. You want the information to be right, but you also want it to be understandable (and in as few words as possible) to the professional who wants to be able to use the information you are trying to provide.  This is why the writings of Linda Segal Blinn caught my attention. A well known professional in the 403(b) world, her technical writings are straightforward, accurate, understandable and make the point well. There are few technical writers who have this skill set.

Linda has graciously accepted my invitation to write something of importance for this blog,  even getting corporate approval to do so. Her following piece on 403(b) plan documents is very timely particularly given that the IRS is now auditing for compliance with the new plan document rules.

 Thank you Linda.  

“Planning to Amend”

by Linda Segal Blinn, JD

Vice President of Technical Services, ING

“Just do it” may work as an athletic slogan, but it doesn’t always work so well with plan documents.

 Certainly, “just do it” was the reminder to 403(b) sponsors in 2009.  In that year, the IRS’ 403(b) regulations became effective and, with it, the written plan requirement, regardless of an employer’s ERISA status.  As a result, with the limited exception of certain church plans, 501(c)(3) organizations and public schools were reminded – whether through IRS outreach efforts, industry associations, service providers and/or their own counsel – of the importance of adopting a 403(b) plan that folded in these IRS requirements no later than December 31, 2009.

 And so, by and large, sponsors have done what the IRS has asked of them by adopting a written 403(b) plan that reflects the IRS regulations.  In doing so, these employers also had choices to make – did they want to offer a Roth 403(b) feature?  What about loans, hardships, rollovers in, and the like?   Decisions were made, and employers were able to check off that they had timely adopted their 403(b) plan by the IRS’ regulatory due date.

 But a 403(b) plan document is not a “set it and forget it” kind of document.  Yes, it will need to be updated periodically to reflect new tax laws.  To that end, the IRS, industry associations, service providers and tax advisors will again reach out to these employers to remind them of new deadlines to do so.  However, lost in the flurry of paper as employers rushed to adopt their 403(b) plan documents is this important reminder: if an employer wants to tweak plan design, rather than regulatory provisions, the plan document must be amended for that as well.  

 I was reminded of this recently when reviewing a 403(b) plan document.  While the plan document stated that an IRS safe harbor definition would be used, it turned out that, in fact, the plan had just switched over to using a homegrown definition that was perfectly acceptable, given the employer’s objectives. 

 “Is that a problem?” was the predictable question when the discrepancy between plan in form and plan in operation was pointed out.  Well, yes and no.  Both the Internal Revenue Code and ERISA provide that an employer must operate its plan in accordance with the terms of that plan.  Yes, deviating from plan terms is technically not allowed and would make the plan defective.  But adopting a simple amendment to the plan would resolve the matter.  So, perhaps this is not so much a problem as a need for a minor repair.

 And this is where the word needs to get out to 403(b) sponsors. Choice is good and choosing the design features that best fit your plan’s needs is important.  But just as important is not losing sight that if you decide to revisit those choices, you will also need to make sure that you fold those changes into the 403(b) plan document to remain compliant with IRS and ERISA rules.  While “just do it” should create a healthy environment, “just renew it” may be an even better motto for avoiding a plan document defect.

          ***************************

 (This material was created to provide accurate information on the subjects covered.  It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation.  These materials are not intended to be used to avoid tax penalties, and were prepared to support the promotion or marketing of the matters addressed in this document.  The taxpayer should seek advice from an independent tax advisor.)

__________________________________________

Linda Segal Blinn is Vice President of ING's Technical Services. In this capacity, Blinn supervises the provision of legislative, regulatory, and compliance information to assist employers in operating their retirement plans.  Linda's expertise includes administering and designing defined contribution plans in conformance with the Internal Revenue Code and ERISA.

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 Important Update to last blog posting. On June 21, IRS announced the extension of the 8955-SSA deadline to January 17, 2011, for which no Form 58 extension will need to be filed. The announcement is here.

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Important Update. On June 21, IRS announced the extension of the 8955-SSA deadline to January 17, 2011, for which no Form 58 extension will need to be filed. The announcement is here

The challenges continue for 403(b) plans, as the IRS and DOL continue to implement their plan level rules in the 403(b) space. The most recent: the IRS's Form 8955-SSA  and instructions for the 2009 plan year, released on June 18th. You will need Adobe X to open them.  It is due to be filed by August 1, with a 2 1/2 month extension permitted if you file a separate Form 5558.

The Form 8955-SSA replaces the old Schedule SSA to the Form 5500, where former employees with vested account balances remaining in the plan are reported.

Prior to 2009, ERISA 403(b) plans (the only 403(b) plans required to file a Form 5500) never had to file a Schedule SSA because the Form 5500 instructions never required them to do so. Curiously enough, it appears that the DOL may never really have had the authority under ERISA Section 110 to waive its filing in prior years because it is required under Code Section 6057(a), not under ERISA. Here's the language, by the way, from the 2008 5500 instructions:

"403(b) Arrangements: A pension plan or arrangement using a tax deferred annuity arrangement under Code section 403(b)(1) and/or a custodial account for regulated investment company stock under Code section 403(b)(7) as the sole funding vehicle for providing pension benefits need complete only Form 5500, Part I and Part II, lines 1 through 5, and 8 (enter pension feature code 2L, 2M, or both). Note: The administrator of an arrangement described above is not required to engage an independent qualified public accountant, attach an accountant’s opinion to the Form 5500, or attach any schedules to the Form 5500."

Now to the tough part.  For ERISA 403(b) plans for which no SSA has ever been filed, how far back does a 403(b) plan sponsor need to go in reporting past participants? Conni did quite a piece on this for our Thompson Publishing newsletter. She strongly makes the case, with which I concur (but, please, check with your own counsel), that Rev Proc 2007-71 is actually determinative here. Oversimplifyng it, under 2007-71, 403(b) contracts which were issued prior to 1/1/2005, and to which no contributions have been made after 12/31/2004 (but loans, 90-24 transfers and other such things may also come into play), are not considered part of the 403(b) plan.

If you use this as a starting point, it would appear that the plan sponsor may need to go back to the 2005, 2006, 2007, 2008 and 2009 plan years, list all terminating participants from those years, and provide that to their current and deselected vendors. Then they will need to find which of those former employees have a current account balance (as of plan year end 2009)-but only if they had made a deposit to those contracts after 2004. And only for those years in which the plan was an ERISA plan. There is a bit more to it as well, as you are really trying to see who you can exclude for 2007-71 purposes.

A caution: the IRS has not taken this positiion on this. What really would be helpful is if the IRS issued relief telling us we only need to report those who left employment after January 1, 2009. 

408(b)(2) also comes into play here.  I had blogged on the "Flushing Effect" of 408(b)(2), where deselected ERISA 403(b) vendors will be required to make disclosures to plan sponsors in order to keep the comp on these contracts. I suspect that a number of employers will be surprised by these disclosures, and be receiving notices on contracts they may not realize exist.  This, in turn, is likely to cause consternation about the data on the 5500 filings in the past-and the new 8955- which then may need to be amended.

Its not getting any easier.  

__________________

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There are three key employer groups which utilize 403(b) plans: K-12; colleges and universities; and non-profit healthcare systems.  Of the three, its is healthcare that seems to be most impacted by the new aggregation rules introduced with the 2007 403(b) regulations.

Not-for-profit hospital systems are typically corporations organized under the non-profit corporation rules of the states in which they are domiciled. There is an important feature of these incorporation rules at which the 403(b) changes were aimed: these nonprofit healthcare organizations typically have no stock. Instead of stock ownership, the corporations are generally organized around "membership," or like concepts.

The practical effect of this lack of stock ownership is is that the controlled group rules under Code Sections 414(b),(c),(m) and (o) and 1563 would often not apply (Notice 89-23 only being a safe harbor), meaning the discrimination and coverage rules under 403(b)(12)(A)(i) for 403(b) employer contributions were often tested on an organization by organization (as opposed to controlled group) basis.

Treasury changed this all with the introduction of 1.414(c)-5. In effect, an "80%" control test was introduced, with certain permissive aggregation rules permitted, and with church controlled orgs being able to permissively disaggregate under certain circumstances. 

More than in any other 403(b) plan sponsor community, those in the healthcare system have undergone tremendous consolidation activity over the past 15 years, with hospitals (and other sorts of related entities) seeking to survive and be successful through acquisition and merger.  This activity has often resulted in healthcare systems owning quite an assortment of separate nonprofit and for-profit organizations-with the related odd collection of legacy 403(b) and 401(k) plans.

This merger activity, when combined with the new aggregation rules, has resulted in a very difficult hangover for a number of unsuspecting healthcare systems. First, the traditional rules governing discrimination and coverage apply in ways they didn't prior to 2009, and many of these legacy programs have never been tested under the new aggregation rules (its that inertia thing). Secondly, there are very specific rules which apply to coverage testing when you have 403(b)  plans and 401(k) plans within these new controlled groups, the application of which may make it difficult (and sometimes impossible) to maintain both kinds of plans-particularly when its a 501(c)(3) maintaining a 401(k) plan.

Even those orgs which have taken the lead in moving to consolidate platforms in order to deal with the new 403(b) regs are finding themselves now in some difficulty, where there is a dawning on just how the new aggregation rules apply.  

Of all the 403(b) hangovers we have experienced in the past few years, my guess is that this is the most unanticipated of them.

 __________________

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The IRS's Employer Plans Compliance Unit  is in the process of issuing a 21 question questionnaire, Form 866a, to a sampling of colleges and universities, aimed at  testing  whether or not there is compliance with 403(b)'s "universal eligibility rule."

This inquiry is different than the 401(k) questionnaire that EPCU issued a while back, and is more like the "soft audit" it conducted of K-12 school districts a couple of years ago.  Where the IRS committed that the answers to the questions in the 401(k) questionnaire would not, by themselves, trigger any follow-up enforcement activity, the IRS intends to follow-up with the plan sponsor should the 403(b) questionnaire reveal any problems with either universal eligibility or plan documents. It expects employers to use the EPCRS programs to correct eligibility problems it uncovers.

The "Universal Eligibility" rule is the discrimination test for elective deferrals under 403(b), standing in the stead of ADP testing. It requires that all employees (except for small classes of excludable employees) be given an "effective" opportunity to make elective deferrals into the sponsor's 403(b) plan, which includes giving employees regular notice of their right to defer.  The most difficult part of this rule is that it is vastly different than the 401(k) eligibility rule, where full time employees can be required to wait a year or two before becoming eligible to defer; where substantial classes of employees can be carved out of participation; and where there is no special requirement to regularly (and currently) advise them as to their right to defer.

This can be a very expensive proposition. EPCRS requires employers who improperly exclude classes of employees to contribute to the plan on behalf of those employees 50% of the average deferral amount that others have made to the plan for all years for which they were improperly excluded, as well as lost earnings on those amounts.

Anyone who has been through the corrections process knows how expensive this can get, as it also includes making a match on those monies where a match was otherwise also made under the plan. Further adding to to the scare on this one is that it is not a new rule that became into play with the 2007 regulations: "Universal Eligibility" has been a requirement for a very long time. It will be interesting to see how the IRS will approach any "long-failing" plans.

The plan document failures, on the other hand, are a recent phenomena-and one in which we will need the EPCRS changes (which are expected to have "non-adopters" corrections) to be published to provide relief under this new "review."

Like the 401(k) questionnaire, the IRS has promised to follow-up on those who fail to answer the questionnaire-as they are now following up on non-responders to the 401(k) questionnaire with formal investigations. 

 ______________________

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I would think that it is a basic law of physics that, whenever you attempt to apply a number of different and complicated principles to a single object, that the consequences on that object will be hard to predict, or even readily ascertained.

So it is with a potential impact 408(b)(2) may have on many 501(c)(3) sponsors of ERISA 403(b) plans. It shows up when you take an 403(b) ERISA plan, impose a fundamentally new set of basic principles (by way of the 2007 403(b) tax regulations); revoke its exemptive relief  from reporting requirements (the Form 5500); while nearly simultaneously superimposing a tremendous new disclosure scheme (participant and service provider disclosures);  there are inevitably going to be some unusual results.

Take a typical example. A hospital sponsors an ERISA 403(b) plan with 10,000 current employees. Over time, it has merged with a number of different hospitals, each which had separately maintained its own 403(b) arrangements in the past with a wide number of vendors. The hospital, in anticipation of the problems with the 2007 tax regulations, consolidated all the affiliates plans into a single platform on 1/1/2009.

Over its history, though, it and its affiliated hospitals had selected and deselected a number of other vendors (no one is quite sure how many) many with whom they have long lost contact.

All of these contracts over the history of the plans have been owned by the individual participants. Though the employer did have an audit done, it did not report many of those "lost" deselected vendor contracts, as it didn't know much about them or the vendors. They reported those old plans as merging with the 2009 Form 5500.

The deselected vendors all still have some old contracts that participants have hung onto,  even after those participants have left the employee of the hospital. The records of the vendor shows that these were ERISA contracts, and that they earn a "mortality and expense", or some other contract charge, and they are indeed "recordkeepers" for the investments in those contracts as defined by 408(b)(2). In order to prevent that compensation from being prohibited, and from the need to be prudent, the vendor decides to make the required disclosures to the hospital's "responsible plan fiduciary-" with whom they have not had contact for many years.

Imagine that fiduciary's surprise when it receives these "blasts from the past," the ghosts of decisions made long ago, often by folks with which they were never affiliated with at the time decisions were made. 

The hospital never knew about these contracts for which they are receiving disclosures, but can't ignore them.  They have just completed all of their work with regard to participant fee disclosures, but now someone is telling them that there may be a dozen more companies' investment products upon which they have to report. They also just filed their 2010 Form 5500, and didn't report many of these contracts as assets of the plan.  

Now what? This is just one scenario, they are others which may be likely once vendors seek to comply with 408(b)(2) on their books of old ERISA contracts. Though the regulator view may be that this flushing of old contracts is a good thing, it can actually be quite a mess to sort through-including whether or not you still have relief and can exclude them from compliance responsibility under Rev Proc.2007-71, and just at a time when the IRS is beginning their 403(b) 2009 audits. I suspect that the management of the problems can only resolved by closely looking at all of the particular facts which will apply to the plan.

I leave it to your imagination as to the myriad of difficulties this may cause; as there are potentially many. I also may be wrong, and this may never happen.......

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It has been a while since I jumped on the blogging trail, but the question "What comes first, the Written Plan or the Implementation Date?"  seems more and more like...  "the Chicken and the egg." 

Taking this one step at a time, there are a significant number of employer/plan sponsors, administrators and others tackling this question.  I have had a number of conversations with individuals and groups that began pulling together the "Written Plan" for their 403(b) plan(s) and were simply stumped when posed with defining the original start date of the plan.  I have found this question alone can be the primary reason a "written plan" was not finalized for some 403(b) plans.  

Once we get past the "chicken and egg" conversation, the conversation progresses to somewhat of a dart board effect.  Well, a reasonable guess would be to date the plan as of 01-01-2009, but your investments would possibly age prior to that date.  Another reasonable guess is the oldest date on the first investment contract or account holding current assets.  There is a solid argument for this approach, but it can result in a bit of an art, rather than a science. 

Sometimes the right answer is very much tied to your facts and circumstances, within reason.  If you can identify the date of the first contribution or funding to your 403(b) plan, begin there and work forward.  Read on for additional challenges that have surfaced while capturing the "written plan"...

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 The IRS issued its long awaited guidance on the termination of 403(b) plans, with Revenue Ruling 2011-7. TEGE was well attuned to the challenges of terminating 403(b) plans, and its staff moved quickly to address some of the basic issues related to this "newly found" ability, provided by the 403(b) regulations, to treat the 403(b) plan termination as a distributable event. The delay in the final issuance of this guidance was due to factors well beyond the control of the TEGE, which had pressed to have it approved much earlier.

A number of practitioners are likely to be disappointed by the limited scope of this ruling. However, it establishes a fundamental structure within which to work, and clarified things at which we could only guess in the past.  A number of issues are left unresolved, which I hope will be addressed over time by the IRS. But this provides us with an important starting point.

In dealing with anything as complex and new as a 403(b) termination, guidance will be a mixed bag. Here, there are Clarifications and things that still leave us In the Fog. 

Clarifications

1. We now know the process to be followed under which the IRS will recognize a plan as being terminated and as a distributable event occurring: a binding resolution; notification to participants and beneficiaries of the termination; 402(f) notice of rollover rights; cessation of all 403(b) contributions to other 403(b) plans within the controlled group (or at least, per the regs, 98% of the group); and distributions are made within 12 months, including distributions of  "a fully paid individual insurance annuity contract."
2. Certificates under a group annuity contract will be considered as the distribution of  a "fully paid individual insurance annuity contract" as long as all of the other rules are met.
3. The distributed annuity contract will still be considered a 403(b) contract.
4. Amounts from this distributed contract can still be rolled over.
5. The IRS formally recognized the legitimacy of the group custodial arrangement

In the Fog

1. The revenue ruling is silent on whether or not, or under what conditions, the distribution of a custodial account can be treated as a "fully paid individual insurance annuity contract." I would hesitate to treat this silence as meaning it can't be done, as the ruling doesn't change the legal basis used by those who distribute custodial accounts. it may exist. But the custodian must agree to the "distribution"  treatment if that is what you choose-and, in any event, the revenue ruling doesn't provide support for this position.
2. It cites "Situation #3," where a participant elects payments from a custodial account upon termination of the plan, either cash or in kind. It is silent on what happens when no election is made. I assume the termination then fails, but this is unclear. 
3. There is no guidance on what constitutes delivery of a "fully paid" contract. Hopefully, in the case of an individual contract, it merely means notifying the individual that the contract is no longer part of the plan. 
4. It creates some confusion on vesting in non-ERISA governmental plans: the tax regs don't seem require full vesting of non-vested amounts on termination, as they are treated as 403(c) monies. It only requires that 403(b) amounts be non-forfeitable. I THINK all this ruling says is that the 403(c) amounts can never become 403(b) upon termination if they do not vest-but that is unclear.
5. The ruling is silent on what happens to the distributed (and rolled) amounts if all of the assets cannot be distributed by the end 12 month period-which can be a real problem for 403(b) plans which generally doesn't exist for 401(k) plans.

AND, perhaps the Grandest Fog:

How does a distributed contract, with no employer being responsible for it, maintain its status as a 403(b) contract? A colleague has pointed out that it appears to require a permanent grandfather of the rules as of the date of  distribution-which is incredibly unworkable from a vendor view given the amount of change that occurs in this area. Or, as my good friend and mineral collector Evan Giller colorfully puts it, it preserves each year's then current rules "like bugs in Amber..." (though, as Evan also points out, Amber is not really a mineral).

There are other questions along the same lines.  Can you roll funds into it, as permitted under 403(b)? Can you process loans, and can the vendor rely upon participant representations? What of transfers and exchanges?

This Revenue Ruling also raises a related question, for future guidance, that is, the question on whether or not there will be a determination letter process for 403(b) terminations.

This is a nice start. But there is still a lot of work to be done.

___________________________

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This was modified 12/28 at 6:18 a.m.  

The IRS issued Revenue Ruling 2011-1, under which it will allow the combining of 403(b) assets with 401(a) assets in the 81-100 trusts.

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 I have finally been putting together the pieces on how all of these new DOL transparency rules will affect 403(b) plans. It is, in many ways, surprising. I'm not quite sure its even possible for many 403(b) plans to actually comply with key elements of the new rules, but at east we have some time to work on it.

I will be doing a free  webinar/overview of the 403(b) impact  of the 408b2 and the participant disclosure  on Tuesday, November 23 at noon ET, as part of  The Standard's "Building Your Business" series for advisors (click "webinar/overview" for instructions). If you miss it, you should be able to listen to it at a later date as well. 

Hope you have a chance to listen in.

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 As we continue to dig into the weeds in the 403(b) world, particularly through this difficult audit season, we continue to find more and more of those "unintended consequences" of the application of the 403(b) rules.

The latest in this line lies the manner in which the regs apply the universal eligibility rule to the collectively bargained group. Attempting to comply with this rule could cause an an employer to engage in an unfair labor practice where a recalcitrant union is involved.

You see, unlike the 401(a) rules which allow for the exclusion of collectively bargained groups from many of the key testing rules, 403(b) itself does not.  IRS Notice 89-23 was written to address one of the key impacts of that problem, and had permitted employers to exclude employees from the universal eligibility rule whose retirement plans were subject to collective bargaining.

The new 403(b)  regulations, however, generally revoked  89-23 and that exclusion, and required 403(b) plan sponsors to cover collectively bargained employees as part of the universal eligibility rule.  The reg writers recognized some of the transition problems this would cause, and permitted the exclusion through:

"the later of (i) the first day of the first taxable year that begins after December 31, 2008, or (ii) the earlier of (I) the date that such agreement terminates (determined without regard to any extension thereof after July 26, 2007) or (II) July 26, 2010."

The reg, however, ignored a reality in union relations with companies: those relations are often not very smooth.  What happens if the union has not agreed to a 403(b) plan? This can (and does!) happen for a number of reasons. These include things like  poor employer/union relations; it could be seen an interfering with an important priority of the union or the employer; and  questions could arise over control over or design of the program; and the like.  An employer, I've been told by a number of labor lawyers, has no right to unilaterally impose a 403(b) program on a unionized group even where it is already being offered to the non-unionized workforce.

So July 26, 2010 has now come and gone, which means that employees covered by a collectively bargained agreement who are employed by an employer who sponsors a 403(b) plan now must be covered by the plan-even if the union has not agreed to this arrangement.This really leaves the employer with limited options, particularly if the union relations are sour: seek to impose the plan on the union, though it may result in an unfair labor practice charge; or terminate the existing plan covering non-unionized employees.  Neither of these options are very attractive.

I would hope that the IRS, an audit, would recognize this problem where there has been an impasse in negotiating these plans.

403(b)plans have a very long history and were well ingrained into a host of different state and federal laws which have over time accommodated those programs. We will likely continue to have to work with the fallout from the failure to recognize those long-established "accommodate practices" for a number of years to come. I really think that the takeaway is that, when crafting rules to address specific compliance concerns, care be taken to draft rules to address those concerns, rather imposing rules in a new and broad brush.

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As 403(b) plan sponsors continue to understand and apply new regulations, meet expectations in their roles as fiduciaries and seek assistance with some very tough decisions, the comparison between 403(b) and 401(k) plans generally takes place.  Spending time pondering this question is not a waste of time.  However, there is NO blanket statement declaring either plan type is better than the other for every plan sponsor.  Facts and circumstances must be identified and considered before starting up a new plan or terminating a plan possibly with the intent to set up a different type of plan.

Expenses related to plan documentation, investment products and administrative services are usually the first items to hit the list for consideration on what plan is best suited for the plan sponsor. Weighing the cost is certainly an appropriate approach.  But don't end up paying the piper because you failed to consider potential limitations with your new plan design... 

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It had to happen if we kept at this long enough. We have written often over the past few years on the minutiae of 403(b), particularly where they demonstrate the often goofy differences between 401(k) plans and 403(b) plans. We have also written some on the finer technical rules which apply to plan distributed annuities, which tend to apply in some pretty unusual ways.

Now there is the rare opportunity to discuss the "crossing" of these two worlds, hopefully without the cataclysmic effect of the crossing of the "proton ray gun" beams in the original Ghostbusters movie. These two areas find a common theme in the handling of mandatory cash outs to terminated employees, of all things.

I make light of this point, but minutiae like this is not without important effect: the "form and operation" plan document rules require us to get it right, or risk serious tax consequences.

It goes something like this: Code Section 401(a)(31) contains the direct rollover rules and applies to both 401(a) and 403(b) plans. Oddly enough, this section also contains the mandatory cash out rules which applies to account balances of less than $5,000 (I say "oddly" because 411(a)(11) actually has the old rule, which still exists, which permits the distribution without consent of amounts less than $5,000 from a tax qualified plan) for terminated participants.

Now suppose you have a 403(b) plan funded with individual annuity contracts, and you diligently drafted 401(a)(31) language containing a mandatory cash-out clause. This rule, buy the way, requires cash-outs to be  made for all participants, and into an IRA, if the plan chooses to have cash outs..

It appears to me as if you may have a problem on your hands.  If the Plan Administrator cannot access those funds in the individual annuity contract, how is it to "mandatorily" cash out sums less than $5,000 and roll it into an IRA when it has no control over those assets? Sounds like a serious "form and operation" challenge.

The real answer probably lies in the  oft-overlooked section 401(a)(31)(C), which only requires a mandatory rollover if the force-out would otherwise be subject to immediate taxation. Forcing a 403(b) annuity contract out of a plan as an in-kind distribution does not appear to have to comply with 401(a)(31), because that force out would not be a taxable event. This means you can turn to ERISA Section 203(e) (Code Section 411(a)11 does not apply to 403(b) plans) which permits the distribution, without consent, of the vested "present value of the nonforfeitable benefit. " It does not require an IRA, or a rollover, or even a cash distribution. The in-kind annuity account distribution seems to work.

A handy tool, by the way, to help manage the Form 5500 "100 participant" rule for audit purposes.

This is where those "beams cross" into the Plan Distributed Annuity (PDA) world.  A 401(a) plan could, instead of following the 401(a)(31) rules,  merely purchase a PDA in the name of the participant without that being a taxable distribution, either. Code Section 411(a)11 DOES apply here (as well as ERISA Section 203(e), in most cases. It uses the term "nonforfeitable accrued benefit," not cash lump sum).  Perhaps a handy tool  clean out certain kinds of plans.

By the way, this further demonstrates the caution one should use: ERISA 203(e) will not apply to governmental and church 403(b)plans-which raises the possibility of forcing out larger amounts. You do not save on the Form 5500 and audit fees (there are none), but it offers some interesting planning opportunities.

__________________________

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.   

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Growing up, I often listened to Paul Harvey with great fascination. His stories were most interesting in topic alone. However, I grew to understand that capturing even the smallest of details could shift the entire meaning of a story. I must confess my intrigue with details is probably deeply rooted with years of listening to Mr. Harvey, a broadcasting legend.

The significance of details has once again been confirmed. Just last week, I read an article titled “Recession No Hindrance to 403(b) Transformation” on planadviser.com.

Several colleagues and I found we were skeptical with the results because the survey indicates that plan sponsors are adjusting well to the final 403(b) regulations. These results are simply not consistent with the perception in the market.

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Roger Siske, dear friend, mentor and traveling companion had taught me much about the art of travel, about enjoying myself well while on the road for what seems at times like far too many hours. One of the places to which we had traveled several times together was San Francisco, home of the two labyrinths of Grace Cathedral.

The Cathedral's Labyrinths are part of an impressive church meditative tradition.  It is a walking maze,  with many interconnecting paths,  offer blind alleys and cul-de-sacs as part of the design, often deliberately disrupting the sensibilities of the human mind. 

It is with pleasure I think of visiting those mazes, not of the one's created by the 403(b) rules regarding church plans.

It truly is an odd maze, one where differences in the manner in which a church approaches its missions reflects in a different way in which the rules will apply. This short piece will hopefully help wend through the maze.

"Church" is really used in three different ways in governing 403(b) plans, to different effect:

1.  Definition of Church Plan for ERISA purposes. This definition determines whether or not a 403(b) plan (or 401(a) plan, for that matter) will be subject to ERISA or not. it is the definition under 414(e) of the Code (ERISA, itself, doesn't define church):

A plan established and maintained for its employees (or their beneficiaries) by a church or by a convention or association of churches includes a plan maintained by an organization, whether a civil law corporation or otherwise, the principal purpose or function of which is the administration or funding of a plan or program for the provision of retirement benefits or welfare benefits, or both, for the employees of a church or a convention or association of churches, if such organization is controlled by or associated with a church or a convention or association of churches. 

An organization, whether a civil law corporation or otherwise, is associated with a church or a convention or association of churches if it shares common religious bonds and convictions with that church or convention or association of churches

This is a broad definition of church, effectively meaning the church itself and any other org which shares its common religious bonds.  This would include the likes of church hospitals and church affiliated universities.

2.  Definition of "Church related organization."  The 403(b) regs uses the term 414(e) definition of church, and calls it a "church related organizations" (note the emphasized language in the 414(e) definition above) when it addresses most issues which the typical practitioner sees as a "church."  It is used for identifying what organization can have a retirement income account; defining a minister under 403(b) (you don't need to be a minister of a "steeple church, below, to be a minister) and church employees; qualified organization for the 15 year long service catch-up; permissive disaggregation; and the extended effective dates or specific 403(b) reg purposes. 

The only special treatments attendant to this designation are those listed in the prior sentence.  The other 403(b) rules which apply to other 501(c)(3) orgs apply to "church related organizations" which are not "churches," as defined below.

3. Definition of "Church."   "Church," under the 403(b) regs, is a very limited term. It only refers to "steeple churches," (as defined under 3121(w)) and determines what kind of church organization gets extraordinary treatment under the 403(b) regulations. The plans offered by these churches are still 414(e) church plans for the rest of the regulation's purposes, and not ERISA covered (unless they elect otherwise). The special treatment is that they do not need plan documents; nor are they required to perform discrimination testing. "Church," for these purposes, is defined as follows:

 “Church” means a church, a convention or association of churches, or an elementary or secondary school which is controlled, operated, or principally supported by a church or by a convention or association of churches, and includes a “qualified church-controlled organization.”  This means any church-controlled tax-exempt organization described in section 501(c)(3), other than an organization which—

 

(i) offers goods, services, or facilities for sale, other than on an incidental basis, to the general public, other than goods, services, or facilities which are sold at a nominal charge which is substantially less than the cost of providing such goods, services, or facilities; and

(ii) normally receives more than 25 percent of its support from either (I) governmental sources, or (II) receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities, in activities which are not unrelated trades or businesses, or both.

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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Sheri Fitts, marketing Guru of The Standard, and I put on a webcast which detailed the steps an advisor can take in assisting their clients in winding their way through the maze of ERISA issues that 403(b) plans need to deal with. This webcast includes some thoughts on moving a plan from non-ERISA status to ERISA status.  The webcast is just over 45 minutes long, and can be accessed for free by following this link. There is an accompanying, detailed checklist, which you can download by this link. 

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Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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The independent auditor is really at the heart of the growing storm in the 403(b) world. For all the problems and challenges caused by the tax regulations, they really pale when compared to what has to happen on the ERISA Title 1 side of things as employers and the market attempt to transform to an accountability to which they have never been held in the past.

To those of us who are the "non-initiates" when it comes to accounting and auditing standards, we have suspected for the past year that there may be massive problems when it comes to compiling the 403(b) audited financial statement. The problem: you need prior year data to do the current year financials.

The AICPA released a FAQ on 403(b) plan audits.  Here's what they said on the "prior data" issue. Though it is lengthy, these are words that every professional dealing with 403(b) plans needs to be familiar with. It fully explains the conundrum faced by the auditor-and the costs that will need to be incurred by plans:

5.   Generally, what initial audit procedures would the auditor perform on the beginning of year (e.g. – January 1, 2009) contract and accounts?

Audit procedures include testing the accuracy and completeness of the beginning balances of reported contracts and accounts. The nature, timing, and extent of auditing procedures applied by the auditor are a matter of judgment and will vary with such factors as the length of time the plan has been in existence, adequacy of past records, the significance of beginning balances and the complexity of the plan's operations (such as the number and consistency of vendors). In accordance with Chapter 5 of the AICPA Audit and Accounting Guide, Employee Benefit Plans, areas of special consideration are the completeness of participant data and records of the prior years, especially as they relate to participant eligibility, the amounts and types of benefits, the eligibility for benefits, and account balances.

The auditor should also make inquires of the plan administrator and outside service providers, as applicable, regarding the plan’s operations during those earlier years. The auditor also may wish to obtain relevant information (for example, trust statements, recordkeeping reports, reconciliations, minutes of meetings, and reports prepared in accordance with Statement on Auditing Standards (SAS) No. 70, Service Organizations [AICPA, Professional Standards, vol. 1, (AU sec. 324)] for earlier years, as applicable, to determine whether there appear to be any errors during those years that could have a material effect on current year balances. Further, the auditor should gain an understanding of the accounting practices that were followed in prior years to determine that they have been consistently applied in the current year. Based on the results of the auditor’s inquiries, review of relevant information, and evidence gathered during the current year audit, the auditor would determine the necessity of performing additional substantive procedures (including detailed testing or substantive analytics) on earlier years’ balances. (See AICPA TIS 6933.01 Initial Audit of a Plan (AICPA Technical Practice Aids, vol.1) for additional discussion of initial audits.)

The inability of the auditor to obtain sufficient appropriate audit evidence supporting the accuracy and completeness of beginning balances of reported contracts and accounts is considered a restriction on the scope of the audit and may require the auditor to modify his or her opinion.

6. What procedures does the auditor need to apply to the comparative statements of net assets available for benefits?

ERISA requires that audited plan financial statements present comparative statements of net assets available for benefits (for example, December 31, 2009 plan year would present a comparative December 31, 2008 statement of net assets available for benefits.) The prior year comparative statements of net assets available for benefits may be compiled, reviewed, or audited. Practically speaking, however, although a compilation or review of the prior year is acceptable, the auditor would need to apply sufficient auditing procedures on the beginning balance of net assets available for benefits in the current year to obtain reasonable assurance that there are no material misstatements that may affect the current year’s statement of changes in net assets available for benefits. (See AICPA TIS 6933.01 Initial Audit of a Plan (AICPA Technical Practice Aids, vol.1)

7. What if historical records do not exist or are not available for reported contracts and accounts?

The DOL has indicated that they expect the plan administrator to use “good faith efforts” to locate and provide all of the necessary records in accordance with its fiduciary responsibilities under ERISA. If historical records (such as payroll records and participant data) do not exist or are not available for the reported contracts and accounts, and the amounts of reported contracts and accounts are material, the auditor may need to modify the report because of a restriction on the scope of the audit.

This would actually be funny if it weren't such scary stuff. We know that this past data (in a useful form) will be virtually impossible to collect and compile in GAAS acceptable formats, even in the case of a single vendor plan. But the plan will need to still hire the CPA to establish the good faith effort at collecting the data necessary, and then wrestle with the financial services company to try to get something which may not even exist-or at least not at prices that won't bankrupt the charity. The good news is that if good data that can't be found, it can then be excluded from the financial statement and the audit.

But that just begs the question: if you exclude an opening balance, can you really even have a financial statement? Ever? THEN what? Without relief from the CPA's standards setting body, we will have our own, permanently recurring, expensive conundrum. 

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Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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The DOL issued its highly anticipated 403(b) Frequently Asked Questions as part of a Field Assistance Bulletin, FAB 2010-01.  The seriousness in which the DOL is taking these 403(b) issues is reflected in the fact that it was issued as a FAB, and not merely the sort of informal guidance offered by a simple FAQ.  As one DOL staffer mentioned to me, though a FAB nay not have a whole lot more legal weight than an FAQ, it does speak to the weight the DOL is giving to the matters at hand.

There are now three DOL 403(b) FABs: 2007-2; 2009-2 and 2010-1.  The three of these should be read together when seeking answers, as they constitute substantial regulatory guidance.

This new FAQ was really designed to give plans and accountants some reporting and disclosure guidance as they attempt to put together their first, full fledged 403(b) Form 5500s, though it does also touch upon important ERISA coverage issues. It does not directly speak to some of the more pressing substantive 403(b) Title 1 issues (such as , what the heck is a 403(b) plan asset?), but it does say some interesting things. Hidden in the mundane, though, are quirks, gems and quirky gems-with a touch of the controversial. Lets sample a few:

GEMS

• Q12.  Yes, I am listing this one out of order because this is a High Quality Gem (according to Mr.Giller, there is no specific rating system for gems outside of diamonds, or I would use it here). The DOL extended its discussion of "good faith efforts" in applying the FAB 2009-2 exemptions. It specifically here recognizes that some "non 2009-2 exempted" contracts may not be able to be found. As long as the plan can demonstrate and document a good faith effort to find those contracts, and as long as "the guiding principle must be to ensure that appropriate efforts are made to act reasonably, prudently, and in the interest of the plan’s participants and beneficiaries"  (this is language from 2009-2),  the exclusion of these "non-findable/non-exemptable" contracts will not cause the 5500 to be rejected. Now, to convince your auditor to do cooperate will be something else-its that GAAP thing.
• Q3.  Knowing where the contract is, and who issued it, does not disqualify it from being excludable under 2009-2.
• Q11.  The DOL verified that 2009-2 extends beyond the 2009 reporting year.
• Q13. Cool. The DOL recognized the problem with the last payroll we have always had in 403(b) plans (and, to some extent 401(k) plans), particularly in with regard to testing 402(g) limits and, in the past, running MEAs:   making a deposit in 2009 from the last payroll in 2008 will not take the contract out of 2009-2.

 QUIRKS

• Q2. In a question designed to answer the question of whether loan repayments forwarded to a vendor by an employer on a contract that otherwise qualifies under 2009-2 for reporting relief takes the contract out of 2009-2 (the answer is yes), an interesting question is raised. Many 403(b) loans are "self-billed", that is, they are paid directly by the plan participant to the vendor.  In a contract that is NOT exempted by 2009-2, do these payments need to be reported on the 5500? If so, what line would you use on Schedules H or I?
• Q6.  Okay guys, quit teasing us. You used that term again, "plan asset," but just in the context of what a "plan asset" isn't for the 2009-2 reporting purposes. We really need to know how the plan asset rules  apply in the individual contract context  for other minor  purposes, like fiduciary obligations. Please?
• Q14. There are two alternative conditions to allowing the applicability of 2009-2,where the employer decides to allow or not allow an optional plan feature (like loans):  a cost basis, that is, including or excluding would serve to increase plan costs; or where including the option could require the use of employer discretion in its execution. 
• Q15.  The DOL reiterated and affirmed its public stance that an employer hiring a TPA to make discretionary decisions is the same thing as exercising discretion, and cause the plan to fall out of the ERISA 403(b) safe harbor. The employer may, however, allow the purchase of a product where the product vendor exercises discretion without violating the safe harbor. This has the odd effect of allowing the vendor to subcontract out discretion to the same TPA that an employer could not.  In spite of its quirkiness, I believe (and there those who I respect which disagree) the reasoning for this is soundly based.

QUIRKY GEMS

• Q7. The DOL giveth, and the DOL taketh away.  It affirms that the right to determine whether any contract is exempted under 2009-2 is reserved to the Plan Administrator. BUT, it also introduces a new "ratting clause" (which is the term I also use to describe the obligation on Schedules A and C to report non-cooperative vendors): If the plan auditor doesn't agree with the employer, the auditor must note it in the audit report. I have had far too many disagreements with poorly trained, junior auditors on the 401(a) side to even remotely take a shining to this condition. 
• Q12.  Yes, I listed this as a High Quality Gem. But what makes this one also quirky is the odd reference to personal liability for those who were required to keep records but failed to do so.  In a world where employers and plans mostly kept no such records, and where this recordkeeping obligation was never really formally assigned, and much of it never really required because of the minimal 5500 requirement, it is truly a quirky reference.
• Q16.  My guess some readers were wondering where I would put this one.  It is truly interesting, and a Quirky Gem.  This is the question of whether the ERISA safe harbor requires a certain number of vendors, or whether a single vendor with a reasonable choice of investment options (whether it be in an annuity contract or in an open architecture program) will suffice. The DOL refrained from affirming some public statements on how many vendors are required to avoid losing the safe harbor;   it did reaffirm that the safe harbor refers to both "contractors" as well "investment products" separately; and it focused heavily on facts and circumstances.  It allows employers (or, more precisely, imposes the burden on the employer) to establish that the costs and administrative burdens on that employer justify a use of a single open architecture program or annuity contract.

In any event, attempting to claim protection of the safe harbor will require hard work and diligence and, ultimately, the cooperation of the vendor. 

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Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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In a lunch conversation with Kathy Elliott , (a CPA specializing in 403(b) audits) at the annual meeting of the TE/GE Councils in Baltimore (which, by the way was pulled off fantastically by Warren Widmayer (and a few others), in the face of a snowstorm of historic dimensions), we went into more detail on my blog on 403(b) plan disqualification.

In talking about what now seems to be the obvious, Kathy pointed out the absurdity of "disqualifying" an entire 403(b) plan: the employer suffers little direct tax sanction, and the burden of the employer's errors are borne by the employees. There is no "stick" to the "carrot and stick" combination that makes 401k plans work, according to Kathy.

Think about it. In a 401(a) disqualification, the employer will lose its tax deduction and suffer potentially significant tax penalties when disqualifying the plan.  There is no such penalty for the 501(c)(3) employer (except where there is UBTI) or school district.  So, should the plan fail eligible employer status, be discriminatory or have a failed plan document, what really is the impact on the employer? Well, it seems, it is only the feeble link upon which audits were based prior to the regulations: W-2 reporting failure, with its  current max penalty of $30 per W-2.  The real "sanction" is the threat to report as taxable all amounts contributed to employee accounts. Again, as is so often the case with the impact of these regulations (see, for example an earlier blog), it is the employees of these tax exempt organizations which are to suffer the brunt-and, this time, for things outside of their control.

The IRS will soon publish a new set of EPCRS rules, which are generally intended to update the program for the new 403(b) regs.It will be interesting to see whether these new rules will recognize this factor in the determination of the appropriate Audit CAP sanction, where the largest tax liability to the employer is really only W-2 based. Under the prior audits, any sanctions paid by the employer were really only part of a settlement agreement with the IRS, where it agreed not assess tax penalties against employees in return for the payment of a sanction. To its credit by the way, the IRS was not aggressive in imposing these penalties upon audit, and were extraordinarily reasonable where there was good faith attempts at compliance by the employer.

Please do not read this as any criticism of the IRS TEGE staffs, as they have the duties of interpreting and imposing an awful set of regs. Application of these regs are settling in nicely due to the thoughtful efforts of the dedicated staffs. There are really only a handful of difficult issues (from the tax side) which are yet open, and these are mostly  being worked on. But application of these regs are repeatedly demonstrating some really unusual effects-all related to the point that he basis of the 403(b) plan is the idea of an individual pension.

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 Co-authored by Richard Turner

One of my personal highlights of the just finished NTSAA Annual meeting in Palm Springs (the first under the joint auspices of ASPPA and NTSAA, which has all the looks of a marvelous arrangement for the 403(b) market), was a conversation with Richard Turner, my old friend and VALIC's top 403(b) lawyer.

Richard and I have been engaged in an odd sort of range war over the past two years on the level of liability a public school district has in relation to the manner in which it handles its 403(b) program. Early on (in late 2007, methinks), I gave a few speeches discussing the potential "fiduciary like" exposures school districts may have from mismanagement of their 403(b) programs. Richard responded with a lengthy paper differentiating 403(b) compliance duties from an employer’s decisions about how involved they choose to become in selecting individual investments. I responded in kind with a part of a paper for the National Association of School Boards (with Jack Lance, Fred Reish, Bruce Ashton, Dave Kolhoff and others) on the whole host of liabilities I see a school district bumping into. Of course, Richard replied with a few more things.  

Richard and I finally caught up with each other in Palm Springs. Richard grabbed my arm, saying "Bob, we have to talk. You're not serious about this broad school district fiduciary liability thing, are you?" My response was, of course, "and you're not seriously saying that school districts can never be held liable if they seriously mismanage their 403(b) programs, are you?"

Richard and I have been arguing about various tax and retirement questions for nigh on 20 years, so-as he put it-a singularity has occurred that may jeopardize the continued existence of the universe as we know it: we came to a general consensus on this issue. Here's where we ended up; we were never very far from each other's point:

Throughout this process, two primary areas of contention have been: (a) In those states that provide broad statutory protections for public school 403(b) plan sponsors, is there some type, or level, of employer activity that might weaken or forfeit those protections?  And, (b) To what extent, if at all, might certain uniform acts (such as prudent investor acts) that primarily govern the investment of state and local pension funds and certain trusts and estates, also apply to public school districts overseeing their 403(b) plans?

We've agreed that school districts which limit their plan involvement to coordinating plan compliance, either with central compliance oversight or by making sure vendors are talking to each either, and adopting a plan document, will  likely have little liability to participants for the investment selections the participants are permitted to make under the program. In these sorts of instances, many states have laws which protect districts from this "hands off" approach.

We've also agreed to the other end of the spectrum: where a school district (lets say in an effort to control compliance costs and to get a better priced product for its employees ) selects and negotiates a single investment platform (either open or closed architecture) and oversees the selection of investment options on that platform, it could be forfeiting some of those state law protections by voluntarily taking on the additional investment selection responsibilities (outside of the scope of 403(b) compliance duties), and in doing so could be exposing itself to "fiduciary-like" (or even, in some cases, state fiduciary law ) liability.   (It should be noted that in some states a public school is not permitted to take such actions.)  As another example, such liability concerns might arise if a district hd authrotiy, under the plan and the underlying investment products, to map existing dollars to new investments and elected to do so.

Where there needs to be much more discussion is where the  liability line is crossed in the "continuum" between these two points, though the answer could be different under the different laws in each state.

But where would we be if Richard and I agreed on everything?

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Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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 "Plan disqualification" is a well understood and managed feature of the 401(a) landscape, complete with great history, a long line of guidance and rulings, and a well developed set of correction programs. We all know what happens when a 401(a) rule is violated, its affect on plan qualification, and (ususally) what to do about it.

We would be badly mistaken if we were, though, to apply those same concepts, experiences and rules to managing problems arising from the violation of a 403(b) rule. 403(b) "plan disqualification" isn't what you might otherwise think. It is truly a curious matter.

403(b) itself only has 2 things that will cause all participant accounts to lose their 403(b) status(something I guess you could loosely call "plan disqualification"):  the plan being sponsored by an ineligible employer and the plan's contributions being discriminatory (which includes violating the universal availability rule).  Period. Nothing else does it.

The new regulations have levied a third "disqualification" rule in that, in order to qualify for 403(b) treatment, a contract must be part of a written plan which conforms in form with all of the 403(b) and other operational rules.  Thus, for example, if a plan does not limit contributions to the 415 limit, no contract under the plan will qualify for 403(b) tax treatment even if the 415 limit was never exceeded. (I have always had a problem with this part of the reg, by the way, because of the lack of statutory authority for it -but it is truly not an argument worth making).

OK, so you ask, what happens if the plan document is proper, you have an eligible employer and you have non-discriminatory contributions? Will a plan's operational error (such as a loan violation) potentially "disqualify" the plan, like it would for a 401(k) plan?

No.

Only the accounts or contracts which are affected by the operational error are affected. Thus, for example, only the contract or account from which the excess loan is made will be at issue, not the entire plan. And the regs treat all of the contracts of the participant as a single contract, for these purposes.

So the next question is whether or not the entire contract's 403(b) status is affected by the operational error, or is it just the portion of the account in violation?  The regs make it clear that vesting, 415 and 402(g) operational errors only affects  those amounts within the contract related to the error, not the 403(b) status of the contract itself.  The IRS, in making these choices, appears to have closely followed the statutory language (unlike what it did when imposing the "form" rule for plan disqualification!). So what if you failed to correct a 402(g) or 415 excess? The 403(b) contract still will not lose its favored status under 403(b), but the uncorrected excess will continue to suffer tax penalties, presumably under the individual tax rules. 

And then there's the notion of the 403(b) "plan disqualification" itself. Even should the sponsor be an ineligible employer,  even if the contributions were discriminatory, and even if the plan document violated the "form" rules, if the contract also qualifies as an annuity contract under other sections of the Code, it appears that the earnings on those (now taxable) deposits to the contract may still well enjoy deferred taxation until they are distributed-in accordance with the rules governing "non-qualified" annuities.

It IS interesting the more we keep peeling this onion.....

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Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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 I had posted in an earlier blog some of the technical  differences between 401(k) plans and 403(b) plans. One of the more striking differences I did NOT mention was that of the Prohibited Transaction.

Assume a successful insurance agent sits on the Board of a mid-sized tax exempt organization with 250 employees, a Board which also serves as the Plan Administrator of its ERISA 403(b) plan. The Board has just conducted a review and chosen a new vendor to handle all of the new tax rules while also complying with its fiduciary obligations. The Board selected a 403(b) vendor which is an insurance company that the agent/board member has been appointed to do business with. That agent/board member took all the (often excruciating) steps necessary to make sure that no commissions are paid to her on the purchase of those annuities by the charity's plan.

The agent opens her quarterly bonus statement from the insurance company and finds, to her great dismay, that the insurance company has paid a retention bonus on the charity's 403(b) plan annuities. She immediately calls a fellow Board member, who also happens to be the CPA which will be auditing the charity's plan. She wants to know whether this is a problem, and how should she fix this. The CPA is now concerned, because the audit may need to address this circumstance.

Assuming that the payment of the retention bonus is a prohibited transaction  (there are circumstances in which it may not be), and setting aside the issue of how to correct something like this (that's why people hire lawyers like me), how does the CPA approach this?

The first, and most important, point is a 403(b) plan is NOT a plan defined under IRC Section 4975(e)-which means that 4975 and its related excise taxes does NOT apply to 403(b) plans. There is no "disqualified person;" there is no "non-exempt transaction" that is reportable under Schedule G, Part III of the Form 5500; and no Form 5330 needs to be filed.

This also means that, by virtue of not being covered by 4975, that it is subject to ERISA's Civil Penalties under ERISA Section 502(i), which relate to the Title 1 Prohibited Transactions under ERISA Section 406. The 403(b) plan is NOT exempt from this section. But there is currently no way to report this transaction to the DOL, which "may" asses the civil penalties thereunder.

This may put the CPA in a bit of a quandary, particularly if the potential prohibited transaction penalty is substantial because of the size of the transaction or because of the number of years it went uncorrected. Until the matter is resolved with the DOL, and a decision made whether to asses the penalty, this may be carried as a sort of open liability on the audit report. ... yet another 403(b) regulatory issue to be resolved.

Preview

For a heads up, I thought I'd preview with you a few of the matters I expect to address in the early part of the new year:

• Part 3 of the Annuity "Fiduciary Concerns." Yes, there is a "Part 3" on the boards. This will cover "Invisibility", which is really a discussion of sales charges, and "Immobility,"which is a discussion on Portability.
• Annuity Transparency.  How to make disclosures relevant.
• Complex Prohibited Transactions. There will be a few blogs on how the prohibited transaction rules apply in large, complex financial organizations.
• A Schedule H and C "walkthrough" for the 403(b) plan. 
• ERISA Section 502(a)(9), the Plan Distributed Annuity and 403(b).

And a few other interesting tidbits.  Keep watching.....

A Final Reflection

The year's end always brings the opportunity to reflect again on important matters. I would like to share with you a quote from Learned Hand, eminent jurist of the federal bench in the early 20th century. I came across this quote some 30 years ago, as I was deciding to go to law school, and have carried it with me since. In a corporate world where the staff "common denominator" often seems to be fear, where ideas are much at risk, this takes on particular relevance:

 Our dangers, it seems to me, are not from the outrageous but from the conforming; not from those who rarely and under the lurid glare of obloquy upset our moral complaisance, or shock us with unaccustomed conduct, but from those, the mass of us, who take their virtues and their tastes, like their shirts and their furniture, from the limited patterns which the market offers.

Learned Hand June  2, 1927, commencement address at Brym Mawr College. Bryn Mawr Alumnae Bulletin, Oct, 1927.

To all, wishing a healthy and fulfilling new year.

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 Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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403(b) devotees often speak of the continuing, and significant, number of technical differences between 403(b) and 401(k) plans. The following lists a few of the differences not given a lot of attention, a sort of holiday stocking stuffer:

Handling 403(b) cash.   Handling cash is much more challenging under a 403(b) plan than under the 401(k) plan as pointed out to me a little while back by David Walters of Bodman LLP. A 401(k) deposit can sit in some sort of cash account (sometimes for lengthy periods of time) in the trust while a variety of administrative issues related to the handling of that cash can be resolved. Not so with 403(b) plans. First,  403(b) cash needs to put in a "custodian account  held"  registered investment company share or into an annuity contract to maintain its 403(b) status. It can't just sit around in some sort of custodian owned cash account for more than a very short time.  Secondly, 403(b) investments are registered products which are subject to strict SEC rules on timing of deposits and the return of funds received "Not In Good Order." 403(b) custodians beware!

Notice of restrictions on distributions.  In an example of the quirkiness of the 403(b) rules, the SEC issued a No-Act letter in 1988 to the ACLI regarding the distribution restrictions on 403(b) annuity contracts. It appears that the 403(b)(11) distribution restrictions could have run afoul of the distribution requirements under the Investment Company Act of 1940 (403(b) investments being registered securities subject to these rules) but for this issuance of this No Act. 

The 403(b) SAR.  ERISA 403(b) plans have always had to file an SAR. They were very silly, not looking at all like a 401(k) SAR, with very little information on them because of the minimal 5500 reporting requirements. Now, those 403(b) SARs will be substantial. Those who have "standard" 403(b) forms will need to modify them to look like the 401(k) standard.

Non-merger.  It was conventional wisdom in the past, as Kurt Lawson  of Hogan and Hartson notes, that 403(b) plans and 401(a) plans could not be merged, though this surely would be a handy planning tool to have today to manage all of these 403(b) issues. The 403(b) regs confirmed this "conventional wisdom" in 1.403(b)-10(b)(1)(i).

Employer Approval.  I find it fascinating that, with all the back and forth going on between employers and vendors on "approving" hardships and loans and the like that, unlike 401(k) plans, the 403(b) regs do not actually require employers to approve such things. The 403(b) "Plan Administrator" is really a much different animal than the 401 (k) Plan Administrator. It really is more like a compliance coordinator.  

A Personal Thought

My friends and colleagues likely do not think of me of being particularly religious or spiritual, even given my 12 years of Catholic schooling and reading more than my fair share of the likes of Lao Tzu, William Stringfellow (lawyer and theologian),  Kahil Gibran,  Eckhart Tolle and others. But this holiday season causes us all to reflect, regardless of one's religious tradition, on the magnitude of personal tragedy we are witnessing today. NPR reported the other day that 1 in 7 U.S. families are struggling putting food on their tables. 

So let us be thankful for what we do have and for those incredible folks who give their hearts-mostly without thanks or recognition- to righting the indignities and inequities of this time. And let us  humbly remember those who are much less fortunate than us, as all of the traditions teach us that-yes-we are all our brother's keeper.

 ______________

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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The DOL issued FAB 2009-2 back in July, in response to the concerns of employers and investment providers that in many cases they would not be able to obtain the information necessary related  to a number of "old" 403(b) contracts and accounts for the expanded Form 5500 required for 403(b) plans beginning with the 2009 plan year. Moreover, even in cases where some annual reporting with respect to the contracts would be possible, the DOL recognized that compliance efforts involved in including these contracts in the financial statements would be substantial and expensive.

The FAB  was not uniformly well received initially, many expressing the thought that the relief was illusory at best.  Now that we have had some time for the FAB to settle in, and now that parts of the market are beginning to try to identify past contracts and "classify" what to do with them, the usefulness of the FAB becomes more clear. 

The FAB allowed contracts to be excluded from an audit if they met the following 4 conditions:

1. were issued prior to 1/1/09,
2. all contributions ceased prior to 1/1/09,
3. all rights under the contract are"legally enforceable" against the insurer or custodian by the individual owner "without any involvement of the employer," and
4. the mounts in the contract were fully vested and non-forfeitable.

The real key to making the FAB work for the employer in keeping auditing costs down is in the sensible application of the FAB's 3rd condition.  I would suggest that applying it consists of two parts. First, use a reasonable effort to determine and find contracts that were related to the plan at some time in the past and, secondly, making a reasonable effort to determine whether or not the rights under those contracts are "legally enforceable" by the individual.

Finding contracts

Establish a reasonable (meaning not "perfect") method to use to find what contracts might possibly be part of your plan. Review the employer records to determine (to the best of your ability) which employees made contributions to which vendors over a reasonable period of time (perhaps the ERISA 6 year recordkeping requirement?).  Do the best you can, document it, and convince your CPA that a reasonable effort should do. 

Legally Enforceable 

From a purely legal viewpoint, this should be "easy." Heck, just get a copy of all those contracts issued over the past (6 years?) and read them. Right? Two problems, of course:

• Go ahead. Try finding them. You won't find them. This is in part because insurance companies don't typically keep actual copies of contracts. Instead, they keep records of the application, plus the "form number" they issued to the individual. Which means when you try to ask for a copy, you'll just get an assembled form-assuming the company would give the employer (who doesn't own the contract) a copy anyway.
• Then try reading it. I dare you.  Have you ever tried to read an annuity contract?Trying to determine whether or not rights are solely enforceable by the individual will be a difficult task, and one which an answer to this question may never be readily findable.

There may be a way a reasonable method or two to try to divine this answer.  For current vendors, for example, the task is a simple one (of course, nothing is turning out to be simple nowadays in this world): have your vendors give you a list of all the contracts to which they seek your approval for something like loans or distributions.

For past vendors, this is where the gold mine should be. See if you have heard from any of those past vendors for which you have compiled a list (see "Finding Vendors"). It may well be reasonable to assume that, had you not heard from them on your former or current employees, that those employees rights are being enforced without your involvement.

Tougher questions arise when, under 2007-71, you have excluded contracts from your plan.  Can these contracts be excluded for Title 1 reporting purposes? Vendors have taken a hard line on these contracts, and are submitting all sorts of decisions to employers for approval, even where the employer has advised them those contracts are not part of the plan-and many times these approvals are demanded in spite of contract language NOT requiring employer approval.  

A number of employers have decided that they were subject to ERISA just this year, because of the press of the tax regulations. One needs to consider (after consulting a lawyer or accountant) whether any of the old, past contracts under such circumstances would need to be counted.

Finally, this business really is only the tip of one of those melting Antarctica icebergs. Ultimately, the lawyer, accountant and employer need to sit down and review the employer's situation, and make a case amongst themselves for the most reasonable approach. Remember, the DOL's approach right now is accommodative. It is not trying to bankrupt charities through the crushing cost of unreasonable audit requirements.

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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The DOL continues what is actually a pretty extraordinary effort with regard to 403(b) plans.  It had struggled early with the new 403(b) changes brought on by the IRS rule changes. It had not really taken a good look at these plans since 1978 when it issued its "safe harbor" which exempted many 403(b) plans from  Title 1 coverage, and I do not recall ever actually dealing with a DOL investigation of a 403(b) plan prior to this year.

DOL staff has kept talking to the accounting, legal and consulting professions, as well as employers and vendors, as they try to sort out  some of the unusual difficulties presented by 403(b) plans. Indeed, the biggest challenge in this market is not related to the tax code, it is in addressing  the mystery of how to define and manage fiduciary issues arising from 403(b) plans funded with individually owned annuity contracts.

The DOL is about to take the next step, and is considering issuing a 403(b) "Frequently Asked Questions" as they have done twice for the Schedule C. The FAQ is to address critical year end 403(b) issues related to reporting and Title 1 status.

While applauding the DOL in its continuing efforts, there is a danger related to one particular issue it may be addressing: the question of how few vendors can be offered by a 403(b) plan (which otherwise qualifies under the safe harbor) without triggering Title 1 coverage.

Putting aside the the very real practical problem of whether a 403(b) plan of a non-church, non-public educational organization can even qualify under the safe harbor because of problems created by the new tax regs, there is a significant issue related to "open architecture" platforms and certain annuity contracts which offer a large number of unrelated investment managers and mutual funds under the programs.

DOL Reg 2510.3-2 (click for a download of the reg) permits the employer to limit the number of vendors which are offered under the plan as long as employees are offered a "reasonable choice." The reg does not specify whether the choice of  "vendor" or "investment" needs to be reasonable.  

The regulations were written 25 years before the first "open architecture" 403(b) programs began showing up, where these large number of mutual funds are made available, and before the advent of a significant number of variable investment alternatives were available under certain annuity contracts. It would not be unreasonable for an employer to take the position that limiting the investments  to a single platform with a large ("reasonable choice") of investment options available would not jeopardize a plan's "non-Title 1" status.

DOL staff has been discussing publicly for the past year or so the position that any less than 3 vendors would not be considered offering a "reasonable choice," even if the one platform offered a large number of mutual funds unrelated to the "platform vendor."  Should this position be published now, at year's end, in the FAQ , without any hint of relief for all those plans which had interpreted the "reasonable choice" rule in a good faith manner, the effect can be severely disruptive. There are a significant number of (some very significant) plans which have taken the position that a single platform offering many choices kept them from Title 1 status.

Taking this position now in a FAQ has the same practical effect of issuing a final regulation: employers would take it as THE RULE, immediately effective. There would be no room for a comment period, or proposed corrections or transition periods. In short, this could cause a great deal of problems for a large number of employers.

One other thing. We have seen estimated that there may be some 35,000 or so 403(b) plans, and perhaps less than 20,000 that will be filing Form 5500s.  This number is likely to be sorely underestimated: There are a million or so private charities in this country and at least 14,550 public, k-12 school districts as well. If only 10% of the charities have 403(b) plans, and if almost all school districts have them, we are at least triple the government estimates. As mentioned, the impact of any of these rules will be significant, so their effect needs to be well considered.

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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There are still a number of critical tax issues related to the 2007 403(b) regulations that need to be resolved.  For example, the iRS needs to clean up the horrible mess created by the ambiguities of Revenue Procedure 2007-71, and it needs to come to terms with the fact that mutual fund custodial accounts should be able to be distributed upon plan termination. For the most part, however, answers to the remaining tax  issues are  being wrought through a transition processs -albeit sometimes painfully.

What is really turning out to be the gravaman of the 403(b) marketplace, the one laden with the most liability for plan sponsors and the one with the most intractable problems are those related to the application of ERISA Title I.

For many years, a large number of 403(b) plans assumed that they fell well within the ERISA safe harbor,  which permits such plans to operate without regard to ERISA.  Others, because of the individual nature of the annuity selections, never considered that they were covered by Tile I, but would have realized that they have always been covered if they took a serious look.

The new regs have complicated the ERISA matters by forcing more accountability upon 403b plan sponsors, which has resulted in some serious catfights between employers and vendors about who has responsibility for what. This has ultimately resulted in a large number of even safe harbor plans finding themselves in the throes of Title 1.

Title 1 ‘s most obvious problem is the 5500, because, concurrent with the rest of this mess, is the new requirement that 403(b) plans are now subject to the full 5500 rules which have always covered 401(a) plans.

But the story does not end with 5500. Here are some thoughts (by no means exhaustive, by the way) of the true difficulty of what a non-ERISA plan has to go through when it bites the bullet and accepts  ERISA responsibilities:

-Corporate Action. Recognize, by formal corporate action, the “establishment of a plan” under ERISA Title 1.

-Vendor cooperation.  The vendor needs to transition its relationship with its vendors, and resolve compliance responsibilities

-Spousal consent/beneficiary designations. Perhaps the most significant issue, is working through and now applying these rules properly.

-ERISA-ify the Document and Summary Plan Description.

-Investment classes. Many investment classes under non-ERISA custodial accounts aren’t available under ERISA.

-ERISA Compliance Co-ordination.

-Establishing Plan Governance Structure including:

-ERISA Committee

-Claims and Appeals process.  

-Investment Policy, geared toward the unique aspects of 403(b). 

-Insurance.  ERISA bondng and fiduciary insurance. 

-Audit and Annual Report. 

-Participant Notifications, statements and disclosures.

Its going to be a difficult and time consuming process.

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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 BNA reported on August 20th the concerns of the AICPA's  403(b) Plan Audit Task Force about practitioners "misunderstanding" of the impact of the recently issued DOL FAB 2009-2, where the DOL took steps to alleviate some of the more draconian impacts of the new Form 5500 reporting rules for certain 403(b) plans.

Task force members are reported to say that the relief does not change their duties, as it does not change the DOL regualtions. With this statement, I must strongly but respectfully disagree with my CPA colleagues. For some plans, 2009-2 will make a significant difference in the work that needs to be done.

It is very true that 2009-2 is no panacea. The transition from treating 403(b)s as essentially individual pensions to treating them as fully employer sponsored plans is proving to be more difficult than even the most cynical of us could have imagined.  2009-2 does not change that. There are many unresolved administrative and fiduciary challenges facing 403(b) plan sponsors, and the task force's concern that some employers may read 2009-2 as bringing more than transitional reporting relief is well founded.

I do empathize with the auditors, as they are the focus of much of the new 403(b) rules. They are learning a new "art", as the profession (with a few very notable exceptions) has so little experience in this field. The applicability of both GAAP and auditing standards will be difficult in an environment where the fiduciary does not control many of the assets or contracts, a circumstance which may even cause a need to review how those standards should work in this environment. It is not, after all, the same control environment as a 401(k) plan.

But 2009-2 does truly change what the auditors need to do for a number of plans, and employers need to be aware of this.

Employers need to spend time with their auditors and explore where the auditors should be spending their time, and where 2009-2 may (or may not) be of some use to the plan.  It means that (for some employers) auditors will not need to spend a lot of employer resources chasing down data which cannot be retrieved (for a large number of reasons, ranging from system limitations to privacy laws). Indeed , the FAB requires auditors to advise plan sponsors of any issue which may materially raise the auditing costs to the plan.  Employers should pay attention to this requirement closely, as active involvement in the 403(b) audit may result in significant cost savings.  Because the DOL has said it will accept a "qualified" opinion on a 403(b) plan if it is based on 2009-2, the limited auditing resources of some plan sponsors could be better spent establishing "good faith" rather than tilting at the data "windmill."

One also cannot overlook the 2009-2 value for many smaller employers of not counting many of those old contracts toward the 100 participant audit trigger.  

There are severe limitations on 2009-2, to be sure. But those dealing with auditors do need to understand that it will, in at least some instances, change the extent of the work auditors will need to do.

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 The DOL's release of FAB 2009-2 may well more significant than I took at first glance. Soon after blogging on the release of the FAB and how it sets us up to develop a more permanent solution, Ellie Lowder and my colleagues Evan and Monica let me know of a different view: they believe that the relief only make sense if it applies to all years-as the data collection requirements in future years for those old contracts will only get worse, not better. The NTSAA has taken this position in a notice to their members.

The FAB itself is silent on the specifics of its application to future years, and it is clear that the DOL was focusing on the immediate problems posed by the 2009 Form 5500. But I'm now convinced after to talking to a number of colleagues that there is little reason to believe that this same reasoning will not apply to future years.  Should this position hold sway, and I believe it will, this is a pretty incredible move on the part of the DOL . It  addresses the most troubling of the new generation of 403(b) Title 1 issues.

The DOL's Lisa Alexander and I will be talking about those other pressing 403(b) Title 1 issues at ASPPA's  "DOL Speaks" in Washington on September 14 and 15. Come join us!

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The DOL released to Field Assistance Bulletin 2009-2 on July 20th, which provides much needed Title 1 reporting relief for 403(b) plans. 

So, first of all, our hats off to Ass't Sec'y Borzi, for what looks to be one of her first public acts, and to the Good Bob Doyle, for showing true leadership in assisting a critical sector of our society which has been unduly burdened at a time their scarce resources are most needed elsewhere.   

Here's what the relief does:

 The 2009 Plan Year for 403(b) Plans has been recognized as a "Transitional Year."  This means that if an annuity contract or custodial account  to EITHER a former employee or current employee:

1. was issued before January 1, 2009;
2. had all contributions, or rights to contributions,  to it cease prior to 1/1/09;
3. has all of the rights enforceable against the insurer without involvement by the employer; and
4. holds only fully vested amounts,

assets in that contract will be excludible from the 2009 Form 5500 and 5500-SF.  Even better, those former employees owning those contracts will not need to be counted as participants toward that 100 participant threshold for large plans. (As an aside, there is a technical question about current employees: though they may be excludable by virtue of a pre-2009 contract, they may then be includable because of operation of the universal coverage rule, even if not owning a post 2008 contract).

Pretty incredible. Simple, clear and adminsterable.  Just for kicks, you may want to try to re-read Rev. Proc. 2007-71 again, just to appreciate how valuable the DOL's guidance really is.

It is not Nirvana by any stretch of the imagination. First of all it is all only transitional, but granted when it is needed the most and in a very timely fashion. We now have time to discuss the nature of permanent relief. Secondly, it is only for reporting purposes, not other Title 1 purposes such as spousal consent and others.

Next, though is a practical problem.  The third requirement mandates that all rights are enforceable without involvement of the employer. In the current environment, with vendors demanding employers' approval of all distributions from all contracts- even of those deselected vendors with no contributions after 12/31/2008 which employers have otherwise excluded from their plans- employer approval may make those contracts ineligible for exclusion from the 5500 and participant counts.

This is a bit sad, as often employers will sign these vendor imposed forms as a matter of convenience just as a way to help employees who need the money- lending truth to the axiom that no good deed will go unpunished.

Who knows. Perhaps Andy Zuckerman's fine staff (and they truly are a good bunch) is penning tax relief right now which would mirror that granted by the DOL......

I have updated this with a further blog with the following:

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Some of the dust is settling, in an odd sort of way, on the IRS issues related to 403(b) plans. For sure, there are many unresolved and contentious issues that remain open or poorly addressed (such as terminations and dealing with historical contracts) which will continue to to cause vendors, employers and employees all shared amounts of anguish.  There is enough of a framework in place however, to now get down to the nitty gritty of running 403(b) plans.

So what are we finding as we get down to this nitty gritty of things? Most striking is the unique ways in which ERISA's fiduciary rules will need to be used in their application to ERISA 403(b) plans.  It is not that the rules were never there in the past, it is just that the new rules have forced the industry and employers to more closely define their relationships and the duties for which vendors and employers will each be responsible. This process of defining roles has caused us all to look more closely at how the rules apply, in ways we have never done in the past.

All 403(b) practitioners are painfully aware of the controversies surrounding the threshold question of whether any particular plan is governed by ERISA Title 1. Once you get past that point and attempt to, for example, draft a proper investment policy, you will see that we will not be able to apply many of the ERISA rules in the same manner in which we are used to applying them in the 401(k) context. This is particularly true where individual annuity contracts or individual custodial contracts are involved. We are all likely to find some challenging surprises as we work through the details.

Let me give you an example. Individually owned variable annuity contracts are a "staple" in the 403(b) industry. They continue to be regularly offered in 403(b) plans, even with the advent of "401(k)-like" group custodial arrangements.  These variable annuity contracts offer investment accounts, called "separate accounts" or sub accounts which are treated by security laws as a type of mutual fund.  Annuity contracts (for technical tax reasons) cannot offer publicly available mutual funds in their separate accounts, so these funds are often designed as "clones" to those publicly available mutual funds offered to 401(k) plans.

These separate accounts often offer large numbers of different investment sub-accounts managed by a wide variety of managers with varying styles.  The management of these investment accounts are all monitored and benchmarked by the annuity companies.  Occasionally, the annuity company will find it necessary to completely replace a fund (a "fund substitution") because of either performance or investment style considerations.

The fund substitution process is a lengthy one,  governed by the Investment Company Act of 1940, requiring notice and proxies going to the individual participant in a 403(b) plan-not, typically, the plan sponsor.

What are the ERISA implications of a fund substitution under individual annuities for the 403(b) plan fiduciary? It is clear that the choice of an annuity carrier for an ERISA 403(b) plan is a fiduciary act, which also carries with it the ongoing obligation to periodically review the appropriateness of that choice.  In a 401(k) plan, changing the investment fund made available to the participant is a fiduciary choice. Likewise, some duty will also apply to changing the investment choice by way of a substitution of an investment fund in an ERISA  403(b) annuity. 

So the question becomes what is the fiduciary obligation of a 403(b) plan sponsor who has no right to vote on such a substitution, or otherwise have any authority with regard to the contract? I think its pretty clear that the plan fiduciary has an obligation to review the fund substitution, and make an independent determination as to whether the new fund is  appropriate for its plan. The review is going to be quite different than the typical 401(k) review as the fiduciary really will have no control over whether or not the substitution will occur.

If the fund substitution is appropriate, the fiduciary need to take no further action other than to document its review. If the substitution is not appropriate, some very real fiduciary issues arise.  It seems that the fiduciary would need to approach the carrier and ask that their employees be blocked from being able to make new deposits to the inappropriate fund. If the annuity company does not have that ability, there may be a fiduciary obligation to cease making contributions to that entire contract. With regard to the existing funds which will be substituted, where the fiduciary has no authority over the contract, little can be done. But it seems that the fiduciary is unlikely to be found in breach where it has no authority, but may have some sort of duty to inform participants of its finding.  

This problem is by no means limited to annuity contracts. If an ERISA 403(b) plan funded with individual custodial accounts permits the participant to invest in any of that mutual fund family's funds, the availability of all of those funds would be subject to fiduciary review, as well as any material changes made to the management of any of those funds.

This is all so different than the process to which we have become accustomed in the 401(a) world. What does all this mean? It means that 403(b) plan sponsors of plans funded with individual contracts  will need to pay close attention to matters to which they have likely paid little attention in the past, and monitor changes in their annuity contract and custodial account offerings over which they have little control.

In a broader context,  it really seems to me that a whole new line of ERISA will develop, much as it had to when 401(k) plans became popular, and how it will need to further develop as annuitization grows. The circumstances of 403(b) administration will demand unique approaches to the law.

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One of the natural byproducts of doing a lot of 403(b) work is a necessary familiarity with many of the security law rules which apply to retirement  plans. This familiarity is recently becoming handy on the 401(a) side of our business as well, with the SEC showing an increasing interest in all retirement plans. The DOL, FINRA and the SEC have a growing "commonality of interests" in things like disclosure and advice.

It is striking, though, how separate the securities compliance world is from the ERISA compliance world-though it is a "separation" which will eventually die a natural death. Security practitioners and ERISA practitioners will be getting to know each other well, and probably sooner than later.

So this is my contribution to that effort. The link below brings you an article which describes ERISA compliance for the security law compliance officer. To many of you, this will be very basic, and pretty boring stuff. The securities folks, however, have expressed amazement of some of the basic things I have written about, things which we take for granted.

My article is entitled "SEC's and DOL's Cross Agency Waltz: The ERISA Connection to Disclosure, Advice, Compensation and Conflict of Interest ", in the May-June 2009 Issue of the Practical Compliance & Risk Management For the Securities Industry."  It really is impressive how closely correlated these rules of the various "compliance" industries really are.

POST NOTE:

I've been told by a number of readers that the above link is not working well, coming up "garbage." If so, try this link for another PDF version , or write me at rtoth@gillercalhoun.com and I'll get you a copy.

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Our blog of May 26 on "Distributed Custodial Accounts" generated a number of comments, which require a bit of a "follow-on."  Ellie Lowder, one of the grand dames  of the 403(b) world, agreed with my assessment.  She mentioned  that she had discussions with the IRS on this point. Staff  just couldn't see how distributions of custodial accounts from a terminated 403(b) plan could work under Section 72 (dealing with the taxability of distributions from plans and annuities). The IRS mentioned that Section 72 is clear on the distribution of annuities, but there is nothing about the distribution of custodial accounts.

Though I can empathize with the IRS's concerns, it actually points out the difficulty with the path it has chosen to foster greater 403(b) compliance: for over 50 years, these arrangements have been treated as individual pensions. Trying  to force them into an employer plan scheme gives rise to these kinds of  difficulties.

For the past 20 years,  custodial accounts have existed outside of a plan, with Section 72 being applied well-and being administered properly under the Code, to boot. There are a few examples  which are telling:

• Example 1:  A tax-exempt employer goes out of business in 1998, after having  sponsored an ERISA 403(b) plan funded with individual custodial accounts from a single mutual fund complex.  The plan would have terminated (for ERISA purposes) upon the employer going out of business and ceasing contributions. A former employee, age 71,  begins withdrawing his RMDs.  There is no employer to approve the distributions, or to certify to the participants age, and the investment company relies upon the employee representations.  The employee has to take distributions, or suffer penalties. What happens? The mutual fund begins the payments, and continues even today, should he still be living. The custodial account exists without a plan, and is effectively distributed. Though the plan termination was not a distributable event, the severance from employment was. But the tax effect is the same.
• Example 2:  A similarly situated employer employer goes out of business in 2010. Now what? Will the investment company ever approve payments out, bcause there is no employer? Does the IRS now view the custodial accounts of the plan participants as being immediately taxable because it is no longer associated with an employer? And why should the tax treatment be any different between the 1998 bankrupt employer and the 2010 bankrupt employer? Will the participant be penalized by a 50% tax on the failure to take an RMD when he was required to, but there was no way to do it?
• Example 3:  The plan of the employer in Example 2 was funded solely by annuity contracts of a single vendor. Two months prior to going out of business, the employer terminates its plan and distributes the annuity contracts.  We know the IRS permits this, so the contract maintains its 403(b) status. But we don't know what rules apply to the contract when an employer no longer exists. Will the annuity company permit the RMDs without employer approval? When the IRS eventually promulgates rules on how such contracts such be administered, is there any legal reason those rules should not apply to the custodial account in Example 2?

This really all points out to the unworkability of the IRS's position. The impact of forcing individual pensions into an employer mode is tough enough without having to make it more difficult on vendors, employers and employees than need be. 

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What Happened

One of the biggest disappointments arising from the issuance of the 403(b) regs has been the inability of employers to effectively terminate their plans.  At first, the IRS caused quite a favorable stir when it announced that the regs would specifically classify the termination of a 403(b) plan as a distributable event, and would  further permit the distribution of a "fully paid individual insurance annuity contract" as a terminating distribution. This seemed almost too good to be true as employers (who were willing to pay the cost of termination, including the full vesting of employer contributions) and consultants now had another tool with which to manage the complicated changes coming out of the new 403(b) scheme. Those of us familiar with the intricacies of individual 403(b) contracts were also well familiar with the administrative methods under which an employer could actually distribute an individually owned 403(b) contract without violating the individual's contractual rights.  Life, for a moment, seemed wonkishly swell.

Reality then hit. IRS officials soon started making public statements that individually owned custodial accounts would not be honored as annuity contracts for purposes of terminating plan distributions. Some unusual comments were even made that distributing certificates under group annuity contracts (a standard method of dstribtuing annuities under terminated defined benefit plans) also would not be honored as valid terminating distributions.

These positions had the practical effect of making most 403(b) plan terminations impractical. Because all of the assets of a terminated 403(b) plan need to be distributed within 12 months of the date of termination, and because employers cannot typically force the distributions out of an individual custodial account (and often not from the certificate of a group annuity contract), any attempt at termination would have a high likelihood of failure. If an employer could not convince all of the plan's custodial account owners to take a cash distribution from their accounts, the termination would fail.  If the termination fails, then the funds of all of those who had rolled funds into an IRA from the supposedly terminating 403(b) plan or had taken a "fully paid insurance annuity contract" all becomes taxable.

 This is an absurd result. It completely eviscerates  the IRS's own termination provision and takes away a valuable planning tool from the marketplace.  

Solutions

The draconian position taken by the IRS in drawing a distinction between an individually owned annuity and a custodial account is hard to understand. From a strictly statutory view, it seems to have little support. The language of 403(b)(7) is unambiguous:

"for purposes of this tilte, amounts paid by an employer described in paragrph (1)(A) to a custodial account which satisfies the provisions of 401(f) shall be treated as amounts contributed by him for an annuity contract for his employee...."

The only 403(b) distinctions between a custodial account and an annuity contract (related to the ability to withdraw employer contributions without a "distributable event") are in 403(b)(7) itself. There seems to be little statutory authority for allowing terminating annuity distributions and not allowing custodial account distributions. For 403(b) purposes, a custodial account IS an annuity contract.  What is really interesting about the 403(b) regualtions, is that a fair reading of it doesn't seem to prevent the distribution of a custodial account as an annuity contract.

As a practical matter, the IRS's public position makes even less sense.  If you start with the proposition that 403(b) contracts have been administered for years as individual pensions and that- to many custodial account administration systems- it mattered little whether or not the account was associated with an employer. Many non-ERISA, individually owned 403(b) custodial accounts have actually been administered by mutual fund companies on the same systems that administers their IRA accounts.

It is truly hard to understand the basis for the IRS's odd position in this matter. There is no longer any potential for employer abuse, as any relationship with the employer has been terminated, and the terms of the contracts continue to regulate participant's activity.

So, now what? The Investment Company Institute has recently suggested a complex solution to the IRS to solve the IRS's "problem".  It involves waiting periods, switching the taxability of the account, issuuing deemed distribution notices and the like. All of this seems terribly complex and unnecessary, creating even more tax horror for paritcipants and administrative nightmares for vendors.

Isn't the answer really much simpler than all that?Is there any reason why a "distributed custodial account" couldn't be administered in the way non-ERISA contracts had been administered in the past, or in the manner IRAs are currently administered?  

Perhaps if there is a distaste for that past, allow the distribution of a custodial account from a terminated 403(b) plan, and treat it under the same tax rules as distributed annuity contracts. After all, those distributed annuity contracts often hold mutual funds in their variable accounts. Outline a simple set of rules for both of those types of contracts, based upon the former 403(b) rules but infused with a dose of any anti-abuse the IRS see as a risk. Require simple annual reporting as a line on the existing IRA reporting form, Form  5498.  Perhaps even allow it to be treated in the same manner as plan distributed annuities.

Does the IRS fear so much that relying upon the representations of terminated 403(b) plan participants without employer oversight will so undermine the system as to be destructive, in a system where those funds could also be transferred to a relatively unregulated IRA,  where such a vast amounts of assets are held?

I just don't get it.

Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.  

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The Green Book, published May 11 by the Treasury Department, contains further details on Obama's workplace pensions first described in his budget proposals (on which we blogged  in March). See pages 7-9 of the Treasury report for details.

It really does create a new scheme of individual pensions, much akin to the 403(b) arrangements of the past. I strongly suspect that there will be many similarities to the manner in which private industry approaches these to the way industry had approached "non-ERISA" 403(b)s.

It will cover employers who had been in business for  two or more years and who have 10 or more employees. Eligibility will be a lot like the "universal eligibility" rules under 403(b), in that those employees who are eligible (or who are excluded under a statutory exclusion) under a plan of the employer (even if not participating) can be excluded from this automatic program. If an employer excludes a class of employees for reasons other than the statutory exclusions, they must be covered by the IRA program.

The default rate of deferral is proposed to be 3%, which the employee could lower or raise (but who cannot "opt out"). 

It would be by payroll deduction, mostly with direct deposit to the IRA. There would be default IRA investments set by statute, for employers who did not wish to be involved in vendor selection. Employers would have the option of designating a private sector custodian, or permit employees to choose their private vendor.

Like the 403(b) plans of old, employers would have no responsibility for compliance with "qualified plan-like" requirements, nor have any responsibility for monitoring IRA eligibility or contribution limitations. The individuals, not the employers, would bear ultimate responsibility for compliance. A national website would be maintained with information and investment educational material.

Like 403(b) plans of old, the variable investments among these products these will be registered  which need to be sold by registered reps. They will be individual arrangements, typically with higher costs and fees, and in different asset classes than employer products. Inevitably, group arrangements will be offered by vendors to attempt to garner more assets from larger employers or groups of employers in order to offer more competitively priced products. Eventually, there will be RFPs and competition at the employer level for access to payroll slots. This all can create some ERISA tensions.

This proposal really means something for 403(b)plans down the road. But even now, given the Administration's position that it is OK to rely upon participant representations under circumstances such as these, perhaps the IRS should take a closer look at allowing such representations under its current 403(b) regulatory attempts as a way in which to resolve many of the tough transition rules which we are now facing.

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Just when I thought I was going to get a chance to talk a bit about annuities again, the IRS drops a bomb: it has proposed the design of its long awaited 403(b) prototype program and List of Required Modifications.  Announcement 2009-34 is the description of the prototype program; and the LRMs can be linked here. 

Combined, it is 92 pages of pretty serious reading. Pay close attention to the detail as you read it, as some very small statements seem to reflect some pretty large decisions.

There is a lot in that announcement and the LRM, and you'll find us blogging on a number of issues we have already noticed. First, however, let's tip our hats to the IRS. The documents are clearly written and well considered. There a number of things to take issue with, but this is  a vast improvement over the ambiguities introduced by the difficult language under Rev. Proc 2007-71. I have read a large number of documents in the past year, and this is really among the best written I have seen. The Announcement itself also shows that the IRS has been listening to (though not necessarily agreeing with) the comments of the 403(b) community.  Angelique Carrington and James Flannery should be complimented on their efforts, as well as the drafters of the LRMs.

So, now that I'm done gushing about the IRS staff, lets take a quick look at a few key points about the structure:

• Comments are due by June 1. The IRS also wants to hear from potential volume submitters and prototype sponsors. They want to know who will be sponsoring these plans, and how many plans do they intend to sponsor.
• There will be a Standardized and Non-Standardized program, both based upon using a basic document.
• There will be an individual determination letter program, but it is still in the making.
• In a thoughtful move, there will be the ability to retroactively correct defects in currently drafted plans, by a date to be determined-but it will be no earlier than March 15, 2010.
• There is not yet any auto-enrollment language, that is still being written.
• No changes will be required for any school district which has adopted the sample language in Rev. Proc. 2007-71. There will still be reliance to the extent the 2007-71 language is used, but sponsors will not have the benefits of a prototype program.  
• It limits Notice 2007-3 to 2009 only; that Notice will not be extended.

Some initial thoughts on a few substantive points:

• The IRS wants to cover what they consider to be "most eligible employers," a decision which seems to have driven most of their substantive choices. Several of its choices, however, severely limit the use of the prototype:
  • Users of the prototype can only have one beneficiary per contract. Virtually all annuity contracts support multiple beneficiaries.
  • The prototype MUST have language under which the specific plan language will override any inconsistent provision in any annuity contract or custodial account. This will force employers to take a serious look at each of their contracts (assuming they can figure out which contracts are part of the plan) before they can adopt a prototype. On the positive side, does this imply that a Plan Administrator for an individually designed plan has the authority to determine if the contract language or the plan language applies?
  • The prototype language requires that the participant can change investments at will. This is a particular problem for a lot of annuity contracts, many of which have transfer restrictions on their "guaranteed" funds. 
  • All employer contributions must be fully vested-even under the Non-Standardized contracts. This means that most plans with employer contributions will not qualify for the prototype program.
• The IRS recognizes that many plans will not be able to be covered by the prototype program. I suspect there will be a lot more not eligible than they think.
• The administrative duties language in the LRM is smartly written: it obligates the sponsor to monitor and make sure things are being done, instead of commanding them to do specific acts for which they may not have the authority. Well done. 
• The LRM and the proposed Rev. Proc. have taken a huge step in identifying the 415 limit as an Employer based limit, not an individual limit. IRS staff in the past had suggested publicly that the 415 limit was to be applied against all 403(b) contributions from unrelated employers.

There is much more to come.

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Evan and I spoke at the ALI-ABA's Advance Law of Pensions this past week in San Francisco, probably the leading seminar for experienced employee benefit lawyers in the country. Our topic was "Getting Over The Hump," a 403(b) guide for the non-403(b) practitioner. We're checking with ALI-ABA for permission to publish our paper and PowerPoint here.

One of the most difficult questions we received from the audience had to do with the counting of former employees for purposes of the 2009 Form 5500 (those "Lost Souls of 403(b)"), which 403(b) plans will need to file in toto for the first time. Follow this link to the DOL's 2009 Form 5500 regs.

The question went something like this (with editorial license taken): a private tax-exempt employer has maintained a 403(b) plan for 25 years, under which 75 employees are currently eligible to participate (remember, here, the universal eligibility rules will really goose this number).  The employer also has had, over its 25 years of maintaining the plan, 100 former employees who had left its employ owning individual 403(b) contracts (either custodial accounts or annuity contracts). The employer has never tracked these contracts, and now needs to know whether or not to include these former employees in their counts for the Form 5500.

This is a huge question, because the answer will determine whether or not an expensive audit will be needed for the plan year: if contracts for those "lost souls" need to be included, the participant count will cross the audit threshold of (generally) 100 participants; if the plan doesn't need to count them, the audit will not need to be done. Its an important issue even for those for whom the threshold will not be crossed, as the totals will still be needed for inclusion in the shortened Form 5500 schedules, and the Form itself.

Regrettably, there are a whole host of other Title 1 questions which are also implicated.

One would hope that we could look to the IRS's Rev. Proc. 2007-71 for guidance, to glean some sort of sensible ERISA answer which would be consistent with the Code: perhaps if you don't need to track the participant's contract or account for tax compliance purposes, you wouldn't need to include it in plan counts for ERISA purposes.  This, though, has its odd results: the inactive contracts issued prior to 2005 would all be excluded, and inclusion of those in the 2005-2009 "transition" period would depend upon whether they were for active or former employees and whether a good faith effort has failed. Given the difficulties and ambiguities surrounding the implementation of 2007-71, this Rev. Proc. will not provide a testable, objective standard which would pass an auditor's scrutiny.

A clearer answer is likely to be found in using the DOL's traditional analysis of what constitutes a "plan asset" for its regulatory purposes. The DOL has consistently ruled in the past that "in situations outside of the scope of the plan assets-investments regulation, the assets of a plan are to be identified on the basis of ordinary notions of property rights," Advisory opinion 92-22A. See also 2005-08A, and 2003-05A.

So, it would seem that you would need to look to the terms of the annuity contracts and custodial accounts of these former employees and make a determination if the particular contract fell within the "ordinary notions" concept. To me, this is particularly attractive because it uses an existing "structure" to address the tough issues for employers like the one in my example, who may have no idea if any particular contract even exists any more. It also may provide a method by which to sanely determine whether an individual annuity contract, a certificate under a group annuity contract, an individual custodial contract or an interest in a group custodial arrangement should be covered: that is, look at their terms and the legal rights they convey, not merely at the "type" of arrangement it is.

There is no doubt a bit of tweaking will need to be done to make this work in the 403(b) context-including developing protections to avoid excluding active contracts, and how to deal with plan terminations. But the DOL has addressed odd issues before, noting in footnote 2 to Advisory Opinion 94-31A that they can be informed by their ability to further develop the "common law" of ERISA when dealing with the definition of "plan assets."

Important participant rights can be protected in the same manner as under terminal funding annuities or under plan distributed annuities (about which we have blogged). It would be also helpful if whatever the DOL comes up with was recognized by the IRS as representing the same "pool of lost souls" against which the tax compliance rules would apply. 

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One of the most unfortunate and unintended consequences of the new 403(b) regulations is the freezing of hardship distributions and loans from contracts of "deselected" vendors, at a time when these funds are needed the most.

What at first seemed like an almost esoteric, academic discussion of what to do with contracts which were issued prior to 1/1/09 and to which all contributions ceased as of that date has now become one which is fraught with human tragedy. Participants in in 403(b) plans (and, it seems, mostly in non-ERISA plans like school districts) are now caught in a terrible cat-fight between employers and vendors which has resulted in employees not having access to those 403(b) funds to help them through this economic mess in which we find ourselves.

What is happening is all centered on the most fundamental change that the regs have introduced: the banning of the ability of a vendor or an employer to rely on a participant's representation when taking a loan or hardship from their 403b contract. The old rule which permitted such reliance made much sense, particularly for employers where 403(b) plans were adopted and administered as the individual pensions they were intended to be.  The wholesale "dumping" of that rule has now befuddled the marketplace, as vendors and employers try to sort out who has the responsibility for doing what employees used to be able to do.

The typical scenario goes something like this: An employer, in response to the new regs, has sorted through their plan and has limited the number of vendors available. The "deselected" vendors are not named in the plan document, and are not treated by the employer as part of the plan. Deselected vendors, by the same token, do not wish to be part of the plan and want no obligation for compliance from those old contracts. The employer has engaged in the "good faith" efforts under Rev. Proc. 2007-71, and has notified the deselected vendor of the contact information necessary to get compliance data.

A participant approaches a deselected vendor for a hardship distribution to prevent the foreclosure of their primary residence, and fills out the appropriate vendor form. The vendor, instead of being able to rely upon the employee's representation as to the existence of a hardship, is now seeking assurances from the plan that: (1) that the plan allows for hardships, and that the safe harbor will be followed which suspends elective deferrals for 6 months; (2) that the employer make a determination of hardship; and (3) that the employer approve the distribution.

The employer is now in a quandary.  They have excluded that old contract from their plan.  They fear approving the hardship brings the vendor's contract into the plan. It will cause them to try to enter into a servicing agreement with the deselected vendor to get the compliance the employer needs.  Inclusion in the plan without referencing it in the plan document and without coordinating the terms of the contract with the terms of the plan can disqualify the plan. If it is a non-ERISA private employer, that sort of decision will trigger ERISA Title 1 obligations. So the employer tells the vendor to go away, and that its up to the vendor to make that determination.

The vendor, unwillingly to become the party responsible for complying with the new 403b regs, denies the hardship.  The policyholder is left holding the bag.

What is happening on the loan side is also causing hardship. Deselected vendor loans are very difficult to get.  Even with "selected" vendors, it is now very time consuming in the "multivendor" 403(b) environment to get a loan. It now typically takes a great deal of time to collect data from all the vendors in order to get loan approval, forcing incredible delays into the system that 401(k) plan participants do not suffer. Implementation of the SPARK standards, intended to help alleviate this, is spotty at best, and appears  to be successfully implemented only in a small number of very large vendors.

It is within the IRS's authority to partially address the most egregious of these problems: at least for deselected contracts issued prior to 1/1/09, and to which no contributions have been made after that date, allow vendors and employers to rely upon employee representations and the single vendor's own records. Could there be some abuse? Absolutely. But will it help bring relief in a crisis where there is terrible human tragedy? Without a doubt.

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We recently blogged on the similarities between the Automatic Workplace Pension being proposed in President Obama’s budget proposal and the original concept of the retirement programs under IRC section 403(b). We noted that while 403(b) programs were initially set up as individual pension plans, it has been the policy of the IRS for over 15 years to treat 403(b) programs as employer plans. The IRS’ approach to 403(b) plans, most recently manifested in the new regulations under 403(b), is particularly problematic for the continued viability of the so-called non-ERISA 403(b) arrangements. These are 403(b) programs that are intended to fit under a safe harbor from ERISA coverage ( DOL regulations §2510-3.2) that exempts a 403(b) program from Title I of ERISA if the employer is minimally involved in its administration and does not exercise any discretionary authority over the program. The increased compliance responsibility imposed by the new IRS regulations can easily cause an employer to run afoul of the DOL rules, and have caused practitioners to question the continued viability of non-ERISA 403(b) arrangements.

Despite some helpful efforts by the DOL to provide guidance (e.g., Field Assistance Bulletin 2007-02), there are still significant obstacles for the employer that wants to maintain a non-ERISA 403(b) arrangement. Under the 403(b) regulations, the employer is responsible to make certain that the program remains in compliance with the tax rules, but its efforts to meet this responsibility can then cause it to fall out of the DOL safe harbor.   For example, a program that allows loans or hardship withdrawals will fail to meet the IRS’ rules unless someone, other that the employee, determines that a request for a loan or hardship withdrawal complies with the applicable tax rules. If the employer makes that determination, it has gone beyond what is permitted under the DOL rules. While the determination can be made by the investment provider, many are unwilling to take on that responsibility. And the employer apparently cannot simply hire a TPA to fulfill this function; the decisions of the TPA will be attributed to the employer. This problem is exacerbated when the plan is funded by multiple investment providers and the records of each provider need to be coordinated to ensure compliance with the tax rules.   As the DOL has said that in order to fall within the safe harbor a 403(b) plan must (at least in most cases) have more than one investment provider, most non-ERISA 403(b) arrangements will need to coordinate between providers.

The similarities of the Automatic Workplace Pension proposal to 403(b) plans and its apparent (early) support from both sides of the political spectrum demonstrate that there is still a continuing need for the non-ERISA 403(b). This is a simple and relatively inexpensive retirement savings arrangement that works much like the new proposal: the employer’s major responsibility is to send salary reduction contributions to investment providers. It avoids some of the costly obligations that apply to ERISA covered plans, such as the need to have an independent audit if the plan has over 100 employees.   Moreover, the non-discrimination rules that apply to the salary reduction provisions of 403(b) plans – universal availability – are easy to apply and consistent with the policy goals of encouraging widespread participation. Arrangements under section 403(b) have a long and successful track record of promoting retirement savings among employees in the tax-exempt community, and should continue to be encouraged.

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There has been a discussion circulating around Washington for a number of years about the value of establishing a simplified Defined Contribution retirement system commonly referred to as "401(x)".  This program would create a single defined contribution program with a single set of rules to replace the "alphabet soup" of DC plans currently in existence.

Many product vendors have championed this cause, particularly through organizations like the Investment Company Institute, the mutual fund companies' trade group. Even the U.S. Chamber of Commerce's chimed in with support in a policy report in 2007. It is an attractive notion. The claim is that the system is far too complex for employers, and that going to a single, simplified program would work to everyone's benefit.

I have always viewed this as a dubious claim.  "401(x)" seems to be a program that is more centered on the self-interests of a handful of vendors for which such a program would save much expense; it is not one which is designed to benefit employers. While it is true that  ASPPA and Metlife count no less than 17 types of DC plans (see the Metlife's excellent chart , which was also published by ASPPA in its latest Journal), and I could probably add a few more, it is also true that these programs did not arise in a vacuum. We have a complex, sophisticated employer base in the United States.  It stands to reason that an effective retirement program cannot be based on a "one size fits all" concept. Does it make sense that a small, 5 employee charity has the same design as a publicly traded company with 150,000 employees? I think not. Does it make sense that a start-up sole proprietorship has the same program as a large international company that is over 100 years old? I think not.

These 17 plans are there for a reason: both the marketplace and valid policy concerns have insisted that they be there. Each of the plans have a particular purpose, a particular market whose purposes they serve. Trying to force it otherwise will be disruptive to those same forces which enabled those program in the first place. I do not doubt that these programs may need a bit of tweaking, but the fundamental concept remains: they were each created in response to a (at least perceived) specific policy concern  and need of the marketplace.

The classic example of the potential disruption which can be caused by a "401(x)" approach is found in the implementation of the new set of 403(b) regs. 403(b) plans were designed as individual pensions for employers that could ill-afford highly complex retirement plans. They have worked well for over 50 years. But since the IRS has taken upon itself the view that these should be treated like 401(k) plans, it wrote a set of regs which actually acts as a sort of "backdoor 401(x)."  While I understand and support the notion that the serious non-compliance the IRS found needed to be addressed,  the chosen approach to enforcing compliance is creating awful results. The transition costs have been unexpectedly high for the retirement industry (including many vendors which had originally supported 401(x)) and has created a growing anger and frustration in the bar and in the 403(b) plan sponsor community.  The new rules attempt to force a well designed individual pension program into an employer program that large parts of the market are ill-equipped to handle.  We will likely see, as the year progresses, a regulatory and enforcement nightmare.

It is this nightmare, I believe, that exposes the serious shortcomings of the concept of "401(x)." It doesn't serve marketplace needs; there is no significant  policy it serves; and it has large, hidden transition costs.  The New York Times noted the lack of political will to do a single simplified program in its recent  article discussing  Workplace Pensions.  The Workplace Pension program sits on top of the current system, addresses a serious policy need and marketplace need, and does not attempt to replace the current system with thoughtless uniformity. It is a lesson which I hope policymakers remember as they discuss the revamping of the current system, one which should dissipate any notion of a "401(x)."

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I was intending to leave this issue alone for a few weeks, and wait until the Workplace Pension proposal (upon which we blogged a few days ago) had a chance to percolate within the retirement industry. But I had the chance to spend a few minutes with David John (David is a senior scholar at the Heritage Foundation and is one of the Principals of the Retirement Security Project) in DC this week, and he spoke of this program-one on which he and Mark Iwry have spent years developing. The conversation set me to thinking.

Those of us who have spent serious time within a large organization, whether it be a financial services company, a manufacturing company or a governmental agency,  all have many war stories on these organizations'  capacity to ignore lessons from their own pasts-even their recent pasts. I would argue (digressing for a moment) that many of our current economic problems arise from us ignoring our history-not remembering that the anti-trust rules were there in part to prevent a handful of companies and individuals from amassing so much economic strength as to be able to wrack havoc on the entire economy.

So what does this have to do with the President's proposals for Workplace Pensions? The retirement markets have a long and rich experience in dealing with salary deferral programs which can well inform the structure of this new program. We know what things work, and what things have been a disaster. 

This proposal is  unique in that it DOES recognize our experience. It has the support of both ends of the political policy spectrum (scholars from both Brookings and Heritage have lent their weight), which is likely because it uses well learned lessons of our past.

Some thoughts of what this thing may look like:

• Yes, the proposal really does look a lot like the simple, old 403(b) programs. Though the legislative proposal is not yet written, the idea is designed to rely upon marketplace products. The twist is that vendors will be listed in a program designed on the successful parts of Medicare Part D. And simplicity is a key.
• It will recognize the need for safe, "stable value" like investments for a while, until the employee can weigh in on where the money will be invested.
• There will be "COBRA -like" rules for small employers, and there will "403(b) like" rules for part-time and short term employees.

Fee transparency will be important, and there is even some discussion of the making available the purchase of lifetime income guarantees.

There will be a number of technical issues that will come up as this thing progresses. Some may have been addressed, but they are worth noting:

• We need to avoid the 403(b) disaster, which has arisen from trying to force an individual pension program into an employer program mold.
• The tensions with Title 1 of ERISA will need to be addressed. A way needs to be found to balance employee protection (for example, on the deposit of the funds) with limits on employer responsibility.
• There are a number of technical security law rules which need to be addressed, as most of these products will be registered investment products. Touchy issues such as suitability, prospectus delivery, and whether, practically,  an employer can force the purchase of a registered product.
• Data, we have learned over time, is ugly. Privacy of data is critical. So the lesser the data requirements, likely the better.

I expect that there is much discussion and negotiation yet to be had. Of course, there is likely to be a grand policy debate on whether this sort of program will ultimately lessen the use of traditional 401(k)  and profit sharing plans, undermining incentives for employers to contribute to their employees' retirement.

But the thoughtfulness and bipartisan manner in which the proposal has been developed leads me to believe that these sorts of issues (and others) will be well addressed. It is  a welcome breather from the often frantic approach to policy we have seen emerge in the past few years.

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President Obama's new budget proposes the establishment of a new "Automatic Workplace Pension" (see pages 84 and 85 of the OMB's budget description and David John's description at the Heritage Foundation's site). It is based upon proposals from the Retirement Security Project run by Mark Iwry, David John and William Gale.

There is little doubt that the proposal will catch a lot of heat, as the logistics of establishing this type of program seems, at first glance, to be almost overwhelming. A number of trade groups are already discussing the issue of what kind of financial products and services can and should be used to implement this proposal, and there doesn't seem to be an easy answer at first glance.

But there really may be an answer. The good Mr. Iwry and I have been talking about his proposal for a few years now, and it strikes me how similar this proposal is to the original 403(b) programs of the past.  Nearly 50 years ago, 403(b) programs were designed as individual pensions.  The employer's sole responsibility was to make sure the employee's deferrals were sent to the company of the employee's choosing. The design was very similar (and actually still is today) to the IRAs which were adopted some 20 years or so later, more so than the qualified plans that the IRS is now trying to make them out to be.

Think about the delivery system which was successfully established by the marketplace for those early 403(b) programs. The tax-exempt employers agreed to which vendors they would permit deferrals, and the vendors came in and did the rest. They were (and still are) registered products (to the extent they provide equity based investment accounts) which are required to be sold by registered representatives. The employees owned the products, or had individual certificates under group annuities, which were completely portable. Revenue Ruling 90-24 gave employees the right to transfer their money tax free to another 403(b) investment product, making them REALLY portable.

In short: the marketplace has proven its ability to make this kind of program work, using the old 403(b) model.  Is there any reason why this shouldn't serve as the basis for this new proposal?

There is a curious side bar to all of this, though. The IRS has spent the last 15 years trying to force the individually based 403(b) program into an "employer" based model. The IRS may face a new challenge, as the Automatic Workplace Pension proposal may well be 403(b) on steroids. It would seem to offer an alternative to all those non-ERISA 403(b) plans who find themselves being "ERISAfied" by the new 403(b) regulations.

THIS is going to be interesting.....

For a blog discussion thread on the Automatic Workplace Pension, check out the Bogleheads blog.

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When the IRS extended the deadline for meeting the written plan requirement for 403(b) arrangements from January 1 to December 31, 2009 in Notice 2009-3, it did so with some conditions attached. In particular, the IRS is requiring sponsors to operate their plans during 2009 in accordance with a reasonable interpretation of 403(b) and the final regulations.    The Notice also requires 403(b) plans to make its best efforts to correct any operational failure that occurs in 2009 by the end of the year. Therefore, while the Notice was very welcome, relieving some of the pressure caused by the original deadline, it is hardly a one year’s free pass from compliance with the final regulations.

Under the final regulations, one of the biggest challenges for plans with multiple investment providers is to establish procedures so that the venders can effectively share information with the employer and with each other.   Historically, each investment provider in 403(b) plans has operated largely independently, typically with little or no communication between them. Changing this structure to facilitate compliance across investment providers is a significant task that will not happen overnight.   

A number of investment providers, individually and together (most notably, through the SPARK Institute data sharing standards) have made efforts to provide services that try to tackle this issue. (The various information sharing services that are emerging will be discussed in a subsequent post.) But many plans have yet to implement any form of process for exchanging plan information. Even more critical, many plans have also not yet resolved the question of who is ultimately signing off on plan transactions such as loans or hardship withdrawals: the plan administrator, the vendor, or a third party.

Despite the Notice 2009-3 delay and encouraging statements from IRS officials about how the IRS is not “expecting perfection”, plan sponsors should not lapse into complacency in 2009. Now is the time to establish effective compliance programs that integrate information from all the investment providers.

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 One of the biggest challenges for the benefits professional is trying to weed through all of these new 403(b) rules, and explain them in a meaningful way to their clients. Monica and I wrote this checklist designed specifically for that purpose-to give advisors a tool to use when they need to work with employers on their 403(b) issues.

This list is not intended to  replace the employer's need to do a compliance review. This is designed help advisors educate employers about the challenges they face, and in an organized way. 

You are welcome to use the checklist for personal use. If you intend to reproduce it for any other use, please contact us for permission.

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