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

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

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Freedom and liberty are not merely themes sounded by politicians in political campaigns, or in rousing marches by military bands (though I am personally  particularly fond of them!), nor are they ideas which you will typically see being discussed in a piece about retirement issues. But they are themes woven into the fabric of our our everyday life, without our often even even being aware of them. They form not only the basis of our own civil society, but (believe it or not) are deeply embedded in the holy texts of the major religions. 

But there is a risk nowadays in even referencing these two grand ideas in today's political environment: instead of being viewed as the firm basis of how the vast majority of us quietly operate, they seem to have been outrageously hijacked by political extremists (such as of the libertarian/Ron Paul/ Tea Party sort-of which I am not so inclined) for some specific end.

In spite of all that, there is something well worth mentioning along these lines about the striking impact of the work we do, something we are not prone to see while working the fine minutiae of our chosen profession.

If we step back for a minute, we can see the extraordinary policy underlying 408(b)(2), the prohibited transaction rules and the exclusive benefit rules (which apply even to non-ERISA plans).  These rules seek to set aside and protect from others the individual wealth of those who accumulate benefits under these plans. It became pretty plain to me while reading Absolute Monarchs, by John Norwich (a history of the Catholic Popes, which really is a brief history of the absolute power of royalty as well as the church over individuals), where, historically, an individual's financial well being was wholly dependent on the whims of powers that be.

We now have something very odd in man's modern history. The value of the funds which are now protected for participants in retirement plans by the Code, ERISA or both approximates 85% of the value of publicly traded securities in the United States.  Though this seemingly huge amount is not yet adequate to establish broad retirement security, it is material enough to take note: these pooled funds are outside of the legal reach of the unaccountable "whims" of those who have something other than the best interests of the participants at heart.  Imagine that. A significant and growing portion of society's wealth is institutionally dedicated in funded pools to the individual's well being, which are difficult to access by an abusive use of power which has so often corrupted society-and jeopardized freedom and liberty-in the past. 

The only way this really works, however, is by things like 408(b)(2); by enforcement of the prohibited transaction rules; and by giving serious attention to the exclusive benefit rules. And all of this is dependent on what appears to be non-sensical minutiae upon which we daily work.

There is a reason I like doing what I do......

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 A while back, I did a piece on the manner in which the 408(b)(2) regs applied to the variable investment accounts under a group annuity contract held by a retirement plan, in particular, 401(k)plans; and a "light" piece on its application to general account products. In that I hear more and more rumblings  about the "fixed investment" portion of these accounts under 408(b)(2), it may be helpful to take another, more detailed look at how that reg applies to such accounts.

The first thing that comes to mind when looking at the regs for these purposes is the thing I noted in that previous blog: regardless of what you may think about 408b2 and the requirements now imposed by the rules, this reg has been craftfully drafted. The pieces fit together nicely, and complex issues with regard to investment products have been meaningfully addressed in as simple and direct manner as possible.There may be a few interpretaive issues that need to be resolved (which is to be expected), and 403(b) issues continue to be a serious challenge, but this is a fine piece of technical writing.

So it is with the "guaranteed account," "stable value fund" or "fixed account" within these group annuity contracts.  The 408(b)(2) pieces fit well together.

First, it may be helpful to read my piece on general accounts, and how they work. This can go a long way in understanding why 408b2 applies in the way it does. It is one of my favorites, because it includes a Dick Van Dyke clip from "Mary Poppins." That blog only generally addressed the 408b2 issue.

Next, the fiduciary needs to know whether or not the investment account is a contractual obligation of the insurer,  backed by the "general assets" of the insurer, or if it is part of a "separate account" (see my above noted blog on this). Confusion may arise from the variety of marketing names these funds may be called: the general account product will sometimes be called a "stable value fund" (typically because the crediting rate is set by use of an unrelated, third party index), which may be confused by a "stable value" mutual fund or collective trust interest which is offered under the annuity contract's variable investment separate accounts.

Once you know that fund is a fixed obligation of the insurer from its general account, you need to see what kind of Covered Service Provider (CSP) is the insurer.  It will not be considered an "A" type with regard to the fixed account, because it is not a fiduciary with regard to the management of the assets of the general account backing its contractual promise (a book could be written on this point, alone).  It may be a "B" type of CSP if, under the contract, the insurer is a "recordkeeper."  It will not typically be a "C"  type of CSP because, even though it is insurance, the insurer will not usually receive indirect compensation (as that term is defined by 408b2) related to that account (but keep in mind that these contracts may be part of an annuity where separate accounts are used-and thus indirect comp typically received-for which "C" status may occur). 

What needs to be disclosed?

-If the plan will only buy a group annuity contract with a fixed fund from the insurer, and the insurer will not provide any participant level recordkeeping services, then the insurer may not even be a CSP that will need to report under the new 408(b)(2) regs. The only complication will be the reporting of commissions. 

-If the insurer is a "B" CSP, then two things will need to be reported:  (i) a description of any compensation that will be charged directly against the account balance in connection with the acquisition, sale, transfer of, or withdrawal from the product, like surrender charges; and (ii)  description of any ongoing expenses such as mortality and expense charges or contract charges.

What will NOT need to be reported, however, is any "spread" between the crediting rate under the contract and the investment return on the insurers' general account, as the regs specifically exempt "operating expenses" from needing to be reported from a fixed account.

Didn't say it would be easy, but it all does fit together nicely.....

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

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

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

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

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

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

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

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

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

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

Its not getting any easier.  

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

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

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

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

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

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

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

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

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

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

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 I have had the pleasure recently of making a presentation to the National Society of Compliance Professionals Midwest Compliance Meeting with Chris Guanciale of PlanMember Services. The NSPC is a nonprofit membership organization dedicated to serving and supporting compliance officials in the securities industry. What we had to say to them was not particularly good news for these overworked professionals. 

There has been a distant relationship in the past between the application of securities law and the application of ERISA. See, for example SEC Release 33-6188 (among other releases) where the SEC describes its essentially "hands off " position with regard to retirement plans.

Over the past few years, with the new found activism of the DOL and the growing impact of retirement plans in the securties market (as of 3rd quarter last year, retirement plans-both ERISA and non-ERISA- had a value equal to about $16 trillion, which was some 88% of the value of publicly traded securities in the Unitied States. Individual account plans like most 401(k) and 403(b) plans, are a "mere" $4 trillion dollars of that total, or some 23% of the value of publicly traded securities), this distance has been "shortening". I have blogged a number of times on this point. 

So now we have the new 408(b)(2) regs, which I often term as potential "business busters" because they speak to the fundamental basis of doing business in this very large retirement plan marketplace: getting paid for the services provided. If you are in this business, compliance with 408(b)(2) is a fundamental issue, because it is a prohibited transaction exemption. Without compliance with 408(b)(2), the business often cannot receive some of their compensation for services related to ERISA retirement plans.

The sorts of things 408(b)(2) covers are at the heart of the Security Compliance Professionals' practice: disclosure, particularly with regard to fees generated off of investments. It seems that "Compliance" is really the only institutional structure many financial firms have under which they can implement, manage and control their 408(b)(2) practices.  And any new "fiduciary" rules only further complicates this task.

Attached is the outline provided for this presentation. Hopefully, you'll find it helpful. 

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Working through the technical terms of 408(b)(2) is not much different than putting together a picture puzzle. There are a lot of pieces which fit together in some very precise ways. But, in the end, the disclosures which are required are pretty straightforward and-even given the work needed to describe certain ”wrapped” services and estimating their costs- can be made very simply. Keep in mind Asimov’s concept of “Minimum Necessary Change," upon which I blogged a while back.

Long pages of disclosure are not necessary or warranted. 

There are certain keys to making it work, and making the disclosure simple. Keep a few things in mind:

•  Are you really a “Covered Service Provider” (CSP) that has to make a disclosure (see, for example, my piece on annuity investment accounts)? Remember, a CSP has a direct contract or arrangement with the plan, and that is the party that has to disclose-and only certain service providers are subject to disclosure rules. So, for example, a TPA which doesn't maintain the financial records (such as where a 401(k) plan is funded with allocated group annuity contracts; or for most 403(b) plans which are funded with individual annuity and custodial contracts);  whose fees are paid directly by the employer or the plan; and for which the TPA doesn't receive 12b-1 fees, commissions, or other indirect compensation are not CSPs and need not disclose under the new reg.

• Are you an affiliate or a subcontractor? If so, you don’t need to disclose, but the CSP needs to disclose what they pay you. This generally may include insurance agents who sell annuity contracts to 401(k) or 403(b) plans, and who are likely to be "subcontractors" because of their servicing the contract with things like enrollment services.The caution to those folks: make sure you understand what the actual CSP is saying about you.

• Make sure you are a “recordkeeper” before you commit to making financial disclosures. Many TPA’s are not 408(b)(2) recordkeepers on much of their business.

• Keep the disclosures simple, short and sensible. Check existing documents first, as most of the required disclosures may already be in the existing service agreement, policy or other existing agreement.

• For those who will receive indirect comp from a number of sources, try to standardize what you say about them, and create a short disclosure statement. Only send to those plans which generate that comp.

•  Over-disclosure is as bad as under-disclosure. Review and edit the description of indirect comp programs that others give you, to make sure it actually applies to you and properly describes your role in it all.

• Tweak your contract form to accommodate what you say in the disclosure, if necessary. Many existing contracts will not need to be changed to meet the rules.  Even then, however, consider incorporating some helpful changes when renewing the contract.

It does get a bit messier where data on the underlying investment needs to be disclosed, but even this is straightforward and can be simply made from existing data from accessible sources, and can be made in a standardized format.

Follow these guidelines, and you may be surprised with how simple the 408b2 disclosures may really be.

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The DOL's newly delayed 408(b)(2) regs are particularly striking in that they demonstrate a growing sophistication, and efficiency, on the part of the EBSA staff in its approach to retirement plan financial products and services. The regs are short, by almost any measure of federal regulations, yet they are packed with meaningful rules which will apply in different ways to different product and services.  

The marketplace is a fast moving one, with complex instruments and services being used in new and unusual ways. Keeping up with this whirlwind is a challenge for the industry and employers, let alone a government regulatory agency which must somehow craft rules which have broad application to ever-shifting, complex and unanticipated circumstances.  Though not always successful, the DOL is approaching its learning curves impressively-including the way in which continues to seek to know and understand what it does not.

A prime example of this is the manner in which the 408b2 rules apply to variable investment accounts within the annuity contracts used to fund 403(b), 401(k) and other 401(a) plans. What is fascinating is that the word "annuity" only shows up with regard to IRAs;  the words "individual," "group," "variable," "fixed," "registered," or "non-registered"-all of which are descriptors of a variety of different sorts of annuity contracts- never show up; and the word "insurance" only appears once. Yet, it provides clear guidance on how these investment products are to be regulated. 

Lets take a quick look at the way the rules apply differently to registered variable annuity separate accounts (lets call these "Type 1" for purposes of this blog) typically used in the 403(b) market, and the way they apply to non-registered variable annuity separate accounts (which I'll call "Type 2") typically used in 401(k) plans.

This, by the way, is important for plan sponsors to know because they have to sort out whether they are receiving the disclosures they need, and report it to the DOL if they are not.

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