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

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. 

______________

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.  

• Comments
• Trackbacks
• Print This
• Email This

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. 

_____________________

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.  

• Comments
• Trackbacks
• Print This
• Email This

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.

• Comments
• Trackbacks
• Print This
• Email This

 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?

______________

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.  

• Comments
• Trackbacks
• Print This
• Email This

 "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.....

______________

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.  

• Comments
• Trackbacks
• Print This
• Email This

 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.

_________________

 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.  

• Comments
• Trackbacks
• Print This
• Email This

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.  

• Comments
• Trackbacks
• Print This
• Email This

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.  

• Comments
• Trackbacks
• Print This
• Email This

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.  

• Comments
• Trackbacks
• Print This
• Email This

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.  

• Comments
• Trackbacks
• Print This
• Email This

 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.

• Comments
• Trackbacks
• Print This
• Email This

 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!

• Comments
• Trackbacks
• Print This
• Email This

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:

• Comments (1)
• Trackbacks
• Print This
• Email This

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.

• Comments
• Trackbacks
• Print This
• Email This

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.

• Comments
• Trackbacks
• Print This
• Email This

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. 

• Comments
• Trackbacks
• Print This
• Email This

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.  

• Comments
• Trackbacks
• Print This
• Email This

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.

• Comments
• Trackbacks
• Print This
• Email This

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.

• Comments
• Trackbacks
• Print This
• Email This

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. 

• Comments
• Trackbacks
• Print This
• Email This

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.

• Comments
• Trackbacks
• Print This
• Email This

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.

• Comments
• Trackbacks
• Print This
• Email This

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)."

• Comments
• Trackbacks
• Print This
• Email This

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.

• Comments
• Trackbacks
• Print This
• Email This

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.

• Comments (1)
• Trackbacks
• Print This
• Email This

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.

• Comments
• Trackbacks
• Print This
• Email This

 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.

• Comments
• Trackbacks
• Print This
• Email This