I think that most practitioners would agree that untimely adopted plan documents continues to be one of the more persistent problem for 403(b) plan sponsors, in large part because it is now a historical problem: plan sponsors which missed the original plan document adoption date of 12/31/2008 have to jump through several hoops for their plan to qualify as a 403(b) plan, even if they have since adopted a plan. 
 
Prior to the new EPCRS, Rev Proc 2013-12, the IRS took several approaches to non-adopters.  First, it issued a formal extension until 12/31/2009 in Announcement 2009-03, if certain rules were met.  For those plans that failed to meet that deadline, it informally took the position that as long as the 2009-3 rules were met, it would generally grant relief on audit. Finally, in certain circumstances it would recognize what Conni calls the “big paper clip” approach to plan documents, permitting a collection of documents, employee communications and evidence of corporate actions to be cobbled together and recognized as the plan document.
 
2013-12 institutionalizes part of that approach. For VCP “late adopter” filings, the submission is conditioned upon adoption of a plan document which is intended to comply with 403(b); the plan, in operation, must have acted in accordance with a reasonable interpretation of 403(b) during the period of time for which relief is requested; and, for that period, the plan sponsor must have engaged in a compliance review, under which it used its best efforts to find operational problems and to correct them in accordance with the principles under EPCRS.   For Audit CAP, this also appears to be the required correction.
 
This is a tough requirement, but it reflects the IRS’s intent to compel 403(b) plan sponsors to finally do the hard work necessary to comply with the 2007 regulations.  The IRS has been accommodating over the past several years, recognizing the problems and challenges related to the transition to those new regulations (some of which are yet to be resolved).  But now, it is taking this opportunity to cause “best efforts” compliance and correction activity for a significant number of plans. 
 
“Best efforts” is really a standard we have rarely, if ever, seen from the IRS in the retirement plan space. It means more than just a “reasonable” effort, or some sort of cursory documentation of some sort of activity. Be prepared to be able to evidence a serious review of the plan’s activities since the effective date of the regulations for that plan. 
 
And remember, this applies to anyone who missed the deadline, even if they have since adopted the plan.
 
………………………………..
 
The world, we are finding, is a very small place. Conni and I are in India, where she is conducting Penserv retirement plan training for certain financial service company IT professionals who are responsible for some pretty impressive software programs which many plan sponsors here in the U.S. use. We have been welcomed graciously, and the staff’s passion and interest in the ERISA and Code technical rules are impressive-and so much akin to that we are used to encountering among our colleagues in the States.
 
Now, if I could only develop a taste for curry….
 
 ________________
 

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.   

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

This is not necessarily the fault of the drafters of the Rev Proc. They were stuck with a very difficult task: to try to make something which is fundamentally different from a 401(a) plan still fit uniformly into the 401(a) correction scheme. It is clear that a great deal of effort went into this task, but it is still, in many respects, trying to fit round pegs into square holes.  To do so requires a number of tortured acts. 
 
This will come out when we actually try to apply the details of the corrections programs in practice. Sometimes it will work and, well, sometimes it is not going to.  But in all events, you will need to think it through thoroughly, and outside of the 401(a) box to which one is normally accustomed.  
 
Hopefully, a few tips will be useful to this effort:
 
Late/non-adopters.  The IRS put together a sound program for dealing with “late adopters” and “non-adopters” of 403(b) plan documents.  The 2007 regulations imposed a plan document requirement on 403(b) plans, requiring at first that they be adopted by 12/31/2008. The IRS granted an extension until 12/31/2009, as long as certain requirements were met.
 
Sponsors who adopted a plan document after 12/31/2009 (or failed to meet the requirements for the extension until that date), or who still haven’t gotten around to adopting a document, can now protect themselves from the penalties arising from the lack of a timely plan document adoption through a  “late adopter” VCP submission. The IRS sought to encourage these filings by reducing the VCP fee by 50% if the filing is made by 12/31/2013. But it is still a VCP fee, which can be substantial.
 
The details, however, can make it difficult. The Rev Proc requires a statement that  “the plan sponsor has contacted all other entities involved with the plan and has been assured of cooperation to the extent necessary to implement the applicable correction.”  This means contacting all of the vendors under the plan, including deselected vendors, to obtain this statement. This, again, raises the ugly issue that the plan sponsor will need to resolve:  what contracts are under the plan under Rev Proc 2007-71(assuming it applies to EPCRS, which is not entirely clear), and which are not?
 
There are a number of technical twists to the VCP filing to deal with 403(b) (such as, for example, dealing with the fact that 403(b) plans do not have the required "Favorable Letter"). The compliance letter which will be issued will recognize the plan as being adopted timely, but will not opine on the qualified status of the plan document. Which leads to the next point:
 
Plan document failures (other than late adopters).    This one is really messy. A plan document failure is one under which a plan term itself, or the lack of a plan term, will cause the plan to fail 403(b) status. In reality, there are precious few terms that need to be in a 403(b) plan document, and of those that need to be in, there is little guidance as to what they should say.  The IRS also recognizes that it generally has a problem because of the lack of a 403(b) determination letter program.  
 
To the extent that a plan document error is found on CAP, the plan sponsor will be let off the hook as long as it agrees to adopt correcting amendments in accordance with, within the time permitted, and to the extent required by, the remedial amendment period which will be adopted by the yet to be developed determination letter programs. (I suppose there may be certain, egregious errors which won’t be covered by remedial amendments, but one can only guess).
 
With regard to VCP, I really have a hard time figuring out the circumstances where good faith terms would ever need to be submitted under VCP as a plan document failure until the 403(b) determination letter programs are developed.  This is because those plans can always be corrected under the yet to be developed remedial amendment period. Now this will change over time, of course, to the extent a newly required document term is required by a change in the law, and it is not timely adopted.
 
Operational errors.  The new EPCRS states that the 403(b) corrections will be applied in the same manner as the 401(a) corrections. My first response to this overly broad statement can be best described by the old Trix cereal commercial (“Silly Rabbit…..”). 403(b) plans still are not 401(a) plans, and the corrections-and the ability to correct-are often quite different. So exercise caution when putting the VCP submission together.
 
Lets use the example of the required minimum distribution. Here’s what EPCRS says: “In a defined contribution plan, the permitted correction method is to distribute the required minimum distributions (with Earnings from the date of the failure to the date of the distribution). The amount required to be distributed for each year in which the initial failure occurred should be determined by dividing the adjusted account balance on the applicable valuation date by the applicable distribution period. For this purpose, adjusted account balance means the actual account balance, determined in accordance with § 1.401(a)(9)-5, Q&A-3, reduced by the amount of the total missed minimum distributions for prior years.”  
 
Well, the problems with applying this to the 403(b) minimum distribution are many: because it is an individual, not plan, requirement, the amount of the RMD is based upon all of the 403(b) contracts of the employee with any employer in that participants lifetime; the employee has the right to elect which contract to take the RMD from; and most individual contracts do not permit the employer to force out a distribution from the contract.  To do so, by the way, may well violate certain securities laws under certain circumstances. This really means that EPCRS likely cannot be used to correct many 403(b) plans with RMD failures.
 
So, be careful.
 
Vendor cooperation statement.  Finally, any 403(b) VCP submission requires that above noted  statement that “the plan sponsor has contacted all other entities involved with the plan and has been assured of cooperation to the extent necessary to implement the applicable correction.” This means sponsors need to affirmatively contact each vendor, including deselected ones, for VCP to succeed. In addition to the problems in identifying which vendors are part of the plan, vendors themselves may have a problem. They may need to caveat that statement with “to the extent permitted by law.”  State insurance law, state contract law, and certain securities laws may otherwise prevent this “cooperation.” 
 
This actually reflects an attitude of certain treasury staff which I find troubling: the belief that vendors have the unilateral right to change their contracts with individuals to give employers certain rights over the individual’s contract. My experience is that state law is still valid. State insurance commissioners, in particular, take a dim view of insurers and employers acting in such a fashion without the policyholder’s consent. 
 
*******
It will take a bit of work to implement this program, and we are likely to find everyone struggling a bit in its implementation. VCP may become unavailable in many instances to the 403(b) plan.  Where this happens, I would hope that this would be a factor to be taken into account when determining sanctions for such plans should they become subject to Audit CAP. 
 
 ________________
 

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.   


 

With the passing of another year, I first must express my heartfelt appreciation for the support that you have given this blog over the years.  Nick Curabba and I first set it up in 2008, following the lead and advice of Jerry Kalish. There never seems to be a shortage of interesting things about which to write. Thank you.

One of the things which has been keeping us very busy lately is  something very unusual: we have been doing substantial research into the allocation of fiduciary obligations. 

The growing complication of the ERISA regulatory scheme is causing many retirement plan sponsors to seek some measure of relief.  As important as the rules are, they are making it a more difficult task to properly maintain what used to be very simple defined contribution plans. Between growing fiduciary obligations, increased disclosure and reporting rules, a growing panoply of different retirement plan products, its not easy to maintain a 401(k) or 403(b) plan anymore.This, in turn, really forms the basis for the popularity of MEPs and PEOs, as a number of service providers seek to fulfill a pressing  market demand for a new kind of professional fiduciary which address these employer concerns.
 
As we deep dive into how the fiduciary rules actually work, I am struck by the manner in which fiduciary allocations were initially structured under ERISA, and how they have evolved since then. Looking closely at the original statutory language, it is clear that plans were established with a single fiduciary, a "trustee," in mind: in the days before daily valuations; mutual fund investment accounts in defined contribution plans; before employee contributions were the predominant feature of these plans; before the differences between 3(16), 3(21) and 3(28) were parsed and analyzed; an employer establishing a profit sharing plan would usually seek to hire a centralized fiduciary to run the plan.
 
This fiduciary would manage the assets of plan, provide the trust account, custody the assets and often provide all of the recordkeeping and compliance services required by the plan. Often, these were provided by institutions like bank trust departments, where the trust department was clearly the fiduciary for all activities under the plan; or held in annuity contracts, were the insurance company was, likewise, regularly seen as centralizing and controlling plan activities.
 
The market has moved dramatically over a generation, away from a centralized independent authority which took full responsibility for operating a plan. Lawyers, such as myself, would regularly counsel service provider clients to do anything but accept fiduciary status.  That status, we advised, should be left to the employer. Then we proceeded to slice and dice up those services, always making sure that the employer/plan sponsor would bear the brunt of responsibility.
 
However, it is the centralized, professional fiduciary model (well beyond the professional investment fiduciary) to which employers again are returning, as the sophistication of maintaining the plan is well beyond the ken of the typical employer. Especially since the DOL’s MEP advisory Opinion in 2012-4,where a single plan model was turned down by the DOL, we find ourselves now to turning to ERISA Sections 402 and 405 to explore ways to cost effectively aggregate these centralized services which the market is again demanding. It is back to the future, in many ways.
 
Most professionals I know pay scant attention to these allocation rules, which dictate how fiduciary allocations are effected. Even more telling are the regulations under these sections, which go into detail of the process related to these allocations.  As we re-think fiduciary allocations, this old, dusty portion of the ERISA now becomes critical.
 
The statutory language is actually quite simple, but it talks of things little discussed. I encourage you to click here to read the rules.  It will become a basic part of the repertoire of the type of service provider who is now seeking to provide what used to be the traditional level of fiduciary responsibility.
 
___
 
A New Years treat, of sort.
 
I have come up with a couple of interesting historical pieces, which are relevant to what we do today.
 
First, I went through my Mom’s old vinyl records, and discovered an album of John F. Kennedy’s old speeches. I was particularly taken by JFK’s "New Frontier" speech, a 2 1/2 minute clip from it to which I am linking, below. I invite you to listen to it, and think some about a point I have made from time to time on this blog: what we do with retirement plans makes a difference. This is important public policy which affects large numbers of folks.  Though the rules are small, this is big stuff, and stuff which is undergoing dramatic change. The choices related to retirement plans which are soon to be made in tax reform will be setting important policy which will affect our lives for years to come. And, as Kennedy points out, the task is not easy.
 
Next, I stumbled across in my files a counterpoint, the now infamous "Ownership Society" political memo coming from the Bush White House in 2005. The privatization of social security was seriously promoted in it.  Though both pieces (the New Frontier and the ownership memo) speak to personal responsibility, the Ownership Society advocates it in a way which suggests that  we are all better off, instead, at going it alone.
 
Take a look:
 
White House Ownership Society can be found by clicking here. 
An MP3 clip of JFK’s New Frontier can be found by clicking here.
 
___
 
Wishing you all a New Year full of those things which bring you peace. I look forward to seeing and keeping in touch with many of you during the year.
 
Bob Toth

 

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

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

Bob

 

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Keeping Your 403(b) Plan in Control

by Linda Segal Blinn, J.D.*

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

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

So, what are some of the internal controls the IRS might have in mind? 
 
• Human Resources procedures:  
 
• Certainly, having your 403(b) “written plan” in place is important, but that may only be the first step.  An IRS auditor also may request the most recent version of your employee handbook to compare against the terms of your 403(b) plan.  Take the time now – before an IRS audit – to resolve discrepancies between the plan document and the employee handbook.  Keep in mind that the 403(b) plan should reflect both your operating procedures and the IRS rules.  
 
• Be prepared to provide samples of the annual “universal availability” notice sent each year, plus documentation of the distribution list of eligible employees, regardless of whether they were currently participating in the 403(b) plan.  
 
• Payroll procedures:    Establish payroll procedures to monitor employee deferrals against the annual IRS deferral limit.  If employees are making catch-up contributions, maintain catch-up calculation worksheets to assess whether those catch-ups conform to the IRS-permitted limits.
 
• Procedures to coordinate with your service providers:  
 
• Confirm that employees’ contributions are transferred to the authorized investment providers in accordance with the timeframes permitted under the IRS regulations.  Amounts are only considered to be under the plan when received by the investment –provides.  If the plan uses a common remitter service, determine how quickly the remitter sends contributions to its investment providers.  
 
• Demonstrate that your investment providers are sharing information with you (or your TPA, if you have delegated this function) to confirm that the participant is eligible for the disbursement before processing a participant’s request for a loan, hardship, or distribution due to severance of employment.  Be prepared to show your internal procedures and information sharing agreements with the plan’s investment providers. 
 
Anticipating the lines of inquiry in advance of an IRS audit is the best preparation you can take.  Make your own list of internal controls and check it twice to determine if you are able to produce documentation for each of the above internal controls.  Any disconnects between the plan document and your internal procedures could highlight either document or operational defects to an IRS auditor.  Even if your 403(b) plan is not under examination, this serves as a good reminder to review your plan so that you can identify and fix any outstanding issues in the event of a potential audit in the future.  The IRS has indicated that a 403(b) plan with the proper internal controls will be perceived as having greater credibility for operating in an IRS-compliant environment. 
 

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——————————–

 

Linda Segal Blinn, J.D.*, is vice president of Technical Services for ING U.S. Retirement.  In this capacity, Blinn supervises the provision of legislative, regulatory, and compliance information to assist employers in operating their retirement plans.  A contributing author to several publications, Blinn also speaks frequently at industry associations meetings on retirement plan issues facing K-12 schools, higher educational institutions, and non-profit entities.  Contact Linda at (860) 580-1643 or LindaSegal.Blinn@us.ing.com

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

* Linda is not a practicing attorney.

 

 

 
David Kolhoff, friend and former colleague at Lincoln Financial Group, has graciously agreed to become a contributing author to this blog.  Dave is one of the best benefits lawyers I know, and is more than willing to take me to task when he believes it is necessary to do so-and I am more than willing to return the favor, as appropriate. For well over a decade, we have jointly presented something called the "Bob and Dave Show," where we have  entertained benefits professionals in this region by actively discussing the benefits issues of the day. I look forward to reading his posts and continuing our long-standing dialogue,  and think you will enjoy them as well.
 
Dave’s first post is on the Affordable Care Act. Though most of us retirement law types would prefer to turn the other way when it comes to the new healthcare law, we really cannot. The following is his initial take on the Act’s impact.–Bob Toth
 
 
The Patient Protection and Affordable Care Act (the “Act” or “Affordable Care Act”) was signed into law early in 2010 and was the subject of much controversy and media attention for much of the two years before it was enacted.  Yet today there remains an amazing lack of understanding about even the basic requirements and concepts found in this seminal legislation.
 
For example, at a panel discussion at a local university less than two weeks ago billed as “Obamacare and You: What Obamacare Means for Business and Healthcare in Fort Wayne,” a very successful business owner described how some of her fellow business owners were considering increasing their number of part-time employees and, thereby, reducing their number of full-time employees below 50 in order to avoid being an “applicable large employer” subject to the Affordable Care Act.  The panel included a CEO of a large regional health insurer, chief physician of a large regional hospital system, professor/MD from a medical college and the successful large business owner and one of her staff.  The moderator was a professor from the university who apparently had spent a great deal of time understanding the Act. He had a slide that described the “Patient Portability and Affordable Care Act.”  Of course, the requirements of the Act cannot be avoided by turning full-time employees into part-time employees and the name of the Act doesn’t include the word “portability.”  
 
While this lack of basic understanding in these two instances might be the exception rather than the rule, that does not appear to be the case to me.  And while it is true that the “individual mandate” and state exchange requirements do not come into effect until 2014, there are many other requirements already in effect and even employers with grandfathered plans should have already been paying close attention and planning for implementation of current, near future and farther-off 2014 requirements.
 
The Affordable Care Act is singular in my experience for acceptance of a wait-and-see attitude.  While I understand that the Supreme Court decision less than five months ago may have caused many to adopt such a wait-and-see attitude and even as I write this article two days before the presidential election, I understand some may still have that attitude.  That I think has been and is a mistake.  No matter what the outcome of the court decision in June might have been or the presidential election in two days may be, the Affordable Care Act is here to stay in many very significant respects.  Employers may, for example, find themselves with increased tax liabilities under the Act because a state in which they operate chooses not to expand its Medicaid coverage despite the federal government paying for almost all of that expansion.  If the employer has low wage employees who would have been covered under the Act’s Medicaid expansion, but now cannot afford to participate in the employer’s plan, all as described in the Act, the employer may incur tax liability.  Such an employer may look with disfavor on providers and others who advised that they wait before working on issues and problems that might arise under the Act.
 
While we all have to work issues in a priority order that makes sense given all of the surrounding circumstances, it appears to me that most employers and their providers have not paid sufficient attention to the requirements of the Affordable Care Act.  While I don’t think that doing so post-election will be too late since it’s always better “to work” a problem, I do think that the ability of employers to influence what the final product looks like has been degraded by the lack of greater effort over the last couple of years. 
 
Revenue sharing related to retirement plan investments plays a central role in the financing of plan administrative services and sales compensation in the retirement industry. The bulk of this revenue sharing arises from mutual fund payments of 12b-1 fees and other service fees (such as sub-transfer agent fees) either paid directly by the mutual fund company to the plan and its service providers, or indirectly through vehicles like separate accounts in group annuity contracts.
 
All sorts of revenue sharing issues arise well beyond the disclosure of these arrangements which has been required by the new 408(b)(2) regulations. For example, one of the focuses of the ASPPA annual conference being held here in DC in the middle of hurricane Sandy is related to ERISA accounts and forfeitures, much of which arise because of these 12b-1 based revenue sharing programs; and revenue sharing continues to garner the attention of the DOL through its investigative activities.
 
I have noticed a curious perception with regard to all of this activity related to 12b-1 arrangements, which gives me some pause.  There seems to be a growing sense of entitlement, that somehow plans are entitled to revenue sharing, that there is some sort of innate (and perhaps legal) right plans have to the 12b-1 and service fee payments generated under these programs. It seems that a plan’s "right" to revenue sharing is too often where the conversations begin, and even seems to be creeping into some of the DOL’s own approach to it. 
 
I think it may be helpful to keep in mind the source and purposes of mutual fund 12b-1 and service fee programs, as it will help keep a healthy perspective when winding one’s way through these revenue sharing issues.
 
12b-1 is actually Rule 12b-1 to the Investment Company act of 1940, which establishes the manner in which the Board of a mutual fund company can establish and administer marketing programs which support the sales of mutual funds. The language of 12b-1 is telling. The rule applies:
 
“if it (the investment company) engages directly or indirectly in financing any activity which is primarily intended to result in the sale of shares issued by such company, including, but not necessarily limited to, advertising, compensation of underwriters, dealers, and sales personnel, the printing and mailing of prospectuses to other than current shareholders, and the printing and mailing of sales literature.”
 
Note the absence of any language related to paying retirement plans for administrative services. Indeed, mutual fund companies have often taken the position that these 12b-1 fees can only be paid to broker dealers for their marketing activities, and often have issues with their shareholders (such as retirement plans) actually receiving these funds. This fear arises in part from the “discrimination” issues that ’40 Act companies face: mutual fund companies are prohibited from discriminating between its shareholders. They really cannot pay 12b-1 fees to some shareholders (plans) and not to others (individual shareholders).
 
The industry has devised all manner of machinations to address the problems raised by the actual structure of 12b-1 fees as marketing fees, and to address the discrimination issue. But they are, after all,  machinations: 12b-1 fees are, in reality, fees paid to promote the marketing of mutual fund shares. How this then somehow worked to eventually serve as the basis of a crucial part of retirement industry is quite a story.  
 
The basic notion remains, and is helpful to keep in mind when analyzing revenue sharing. 12b-1 fees are marketing fees payable to distributors and marketers of mutual fund shares. It is these marketers and distributors to whom revenue sharing rights arise; any plan rights to such payments are only derivative. These are not funds to which mutual fund shareholders (like 401(k) plans) are entitled.  No plan has the right to demand the payment of these fees and, in actuality, their eventual payment to plans requires implementing some very interesting fictions.  
 
________________
 

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.   

 

Now with EPCRS, we are told, being on the verge of release, and with 403(b) audits beginning to enter a new, what I would call “normalized,” stage, the 2007 regs will truly be put to the test. I have long been critical of those regs as being far more complex than necessary, and as being based-in part-on a basic misconception that 401(a) plans and 403(b) plans are similar in too many respects.  This second point has been implicitly recognized by the good work of  both the DOL and the IRS in their efforts subsequent to the issuance of the regs to address some of the more glaring problems which the regs brought into play.
 
At the heart of the problem is the statute itself: Code Section 403(b) is still more like an IRA in many ways than a qualified plan. The tax impact and benefits are fully directed at the individual not the employer. 
 
Where this will have its impact is when you have to drill down and attempt to apply the regs in detail to any particular fact circumstance, as we are now attempting to do. Take, for example, any attempted application of the plan document “form and operation” rule (which is, at is heart, a 401(a) rule). Assume  a case where either the employer or the IRS discovers that elective  deferrals to an individual contract violated the manner in which the 15 year catch-up and the age 50 catch should have been coordinated for the past 3 years, and that $9,000 needs to be disgorged from the plan. If the individual contract gives the employer no right to order a corrective distribution from the contract, and the participant refuses to take a distribution, the plan has clearly violated the plan document “form and operation” rule  (and VCP has failed because  a corrective distribution was not made), and the plan would not qualify for 403(b) treatment.  What is the sanction then, where, legally, the employer has no tax liability for a failed 403(b) plan? Is the employer assessed for the tax on the $9,000;  or is the base for the sanction the tax on all amounts in the 403(b) plan-but what is the legal basis for either of these actions?  At least under the VCP portion of EPCRS, it could be imposed as a condition for the favorable treatment under the program, but what happens under audit/audit CAP? 
 
There is actually a whole host of issues like this. As a practical matter, IRS 403(b) audits have been,  well, practical, up to now. But as “institutionalization” seeps in, with more 403(b) agents, with EPCRS finalizing, formality will begin to impose itself. And I would expect technical application of the questionable portions of the regs to begin to run into rough sailing.
 

 

 The GAO issued its long awaited study on Multiple Employer Plans. It is nicely written, and for those who with an interest in such matters, it’s a good read. 

It pretty well summarizes the current state of affairs related to MEPs. The report, along with our own recent review of MEPs, really demonstrates a few key points:
 
1.  MEPS, under current rules, operate best in a controlled environment.  The report makes it clear that there remains a great deal of uncertainty, ambiguity and risk in a MEP unless it is a controlled environment. For example, the problems associated with recognizing service of a participant with all participating employers can be a serious challenge (particularly in those PEOs with thousands of employers); the “one bad apple” rule can be expensive for the sponsor of a MEP to fix, especially when spinning off the plan doesn’t work as a cure; there is a potential co-fiduciary liability issue no one discusses; and there is that insistence by the DOL that both commonality and control be met. What this all adds up to is that, unless you are working with a small, identifiable group-such as franchisees or other closely related firms; with a group of companies with close working relationships (such as in a “non-controlled” group with common ownership); or in a traditional association, its going to be tough to adequately address these sort of risks under the current MEP rules. 
 
2. There are better arrangements.  When you look closely at it all, the alternatives to MEP arrangements can be pretty favorable, with a lot less risk for both the participating employers and the MEP sponsor. There are legitimate ways to create fiduciary and investing relationships which accomplish the similar end result of a MEP (the good Mr. Pozek coined the term “APA”, or ”Aggregated Plan Arrangement”) which uses existing DOL and IRS rules to accomplish virtually the same thing as a MEP-the exception being dealing with the audit costs. However, there are even suitable ways to deal with that under certain circumstances.
 
3.  A MEP fix is a way off.  The GAO encouraged the IRS and the DOL to move “sooner than later” in resolving what it found to be the lack of coordination between the regulatory agencies, and the agencies all agreed. Given their current workload and the delays in, for example, one of the agencies issuing something as relatively straightforward as the new EPCRS program, one can only imagine the priority an interagency coordinated regulatory effort would receive-and how soon it would come to be.  And even then, the simplest coordination is to declare that the DOL current rules on MEPs are a precondition to application of 413(c).  I suspect legislative changes would occur much before we see the agencies acting. 
 
And legislation? The priority for the retirement industry this coming year will be preserving the 401(k) system, and I would expect MEP solutions to be given low priority.
 
In short, risk, particularly in non-traditional MEP markets, is likely to be a regular companion. 
 
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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.   

 

 
Both Treasury and Labor continue to engage in efforts to accommodate the availability of defined contribution plans to provide participants the ability to choose to use a portion of their account balances to choose some level of guarantee lifetime income.  The Treasury’s efforts have been especially notable, as Rev Ruling 2012-3 (which defined the spousal consent rules for plan annuities) and the proposed Qualified Longevity Annuity Contract regulation (which grants RMD relief for certain annuities) have established some very basic groundwork to enable DC annuitization to be broadly made available. 
 
Both of these agencies continue to attempt to support this process, using their existing regulatory authority. Though there are a number of things which probably need legislative action in order to really make guaranteed lifetime income readily available, there are still a few things regulators may want to consider doing to help it all along:
 
1.  Clarify the QPDA.  Both the QLAC at 2012-3 rely on a fundamental premise, that the annuity contract, or “qualified plan distributed annuity” (the “QPDA”) can be distributed from the plan. Distributing annuities from plans has been around for generations, and the concept is well imbedded in various parts of the Code. However, it would be helpful to consolidate those rules into a single piece of guidance discussing the rules which will apply to these distributed annuities.
 
2. Title 1 Clarification. While the DOL is focusing on important issues such as education and disclosure of lifetime income amounts, there is actually an important structural issue it can also address. We all assume that a distribution of a QPDA is also considered a distribution for Title 1 purposes as well, mostly because of the "ordinary notions" of property law upon which ERISA’s plan asset rules are based. It s a fiduciary decision to purchase the right kind of an annuity, and any sort of post distribution protections which are needed can be built into such an annuity (such as not being used as an end-around the spousal consent rules). But there appears to be little reason not to treat annuities, even if they have a cash surrender value, or otherwise have an account balance, as a distribution from the plan under ERISA Title 1. This is particularly so where the participant has the right, instead, to take that same amount in cash rather than purchasing an annuity.
 
3.  Rollover Guidance. 1.401(a)31 Q&A 17 makes it clear that you can roll money over from a distributed annuity. The language is quite striking:
 
“Q-17. Must a direct rollover option be provided for an eligible rollover distribution from a qualified plan distributed annuity contract?
 
A-17. Yes. If any amount to be distributed under a qualified plan distributed annuity contract is an eligible rollover distribution (in accordance with Section 1.402(c)-2), Q & A-10 the annuity contract must satisfy section 401(a)(31) in the same manner as a qualified plan under section 401(a). Section 1.402(c)-2, Q & A-10 defines a qualified plan distributed annuity contract as an annuity contract purchased for a participant, and distributed to the participant, by a qualified plan. In the case of a qualified plan distributed annuity contract, the payor under the contract is treated as the plan administrator. See Section 31.3405(c)-1, Q & A-13 of this chapter concerning the application of mandatory 20-percent withholding requirements to distributions from a qualified plan distributed annuity contract.”
 
However, it is has never been entirely clear that you can roll funds into a QPDA.  Making this clear would increase the ability to consolidate and “port” these benefits, and to switch out of a contract that becomes unfavorable or from an insurer that becomes financially weak.  The complications for this, however, lie in the securities laws, and whether or not this annuity would need to be a registered product.  
 
In any event, there are a number of interesting steps the agencies can take within existing authority-even though I probably shouldn’t be thinking about this stuff while we’re surrounded by peak color season up in mountains….  

Designing a product or platform for the retirement plan market is an incredibly complex task, involving a large number of integrated relationships and coordinated protocols between unrelated parties which all must work seamlessly. “Looking under the hood” (its that Detroit thing, y’know. I do wear my “Imported From Detroit” shirt with pride) of even the simplest of 401(k) arrangements will reveal surprisingly sophisticated sets of arrangements.  

It is almost mind boggling to think of what is behind, for example,  executing even the simplest 401(k) transaction: an electronic trade between two unrelated mutual funds on a trust platform.  With my apologies to James Joyce and my English teachers from the Sisters of the Holy Family of Nazareth, the let me provide the following run-on sentence, listing a number of the logistical tasks involved in pulling off of this “simple” transaction:

Protocols and software to make sure the website or smartphone data is handled and stored securely; testing the parties to the transaction under the OFAC regulations (yes, even some of your 40(k) trades are subject to testing for terrorist transactions); the matching of the trade to the right plan to the right participant; the testing under SEC Rule 22(c)2 at both the omnibus and plan level for market timing and restrictions on the trade if it is in violation; testing the trade against plan document terms and, ultimately, the Investment Policy; imposing equity wash restrictions on trades, if applicable; documenting the processes to meet the accounting and auditing standards under SSAE16 (formerly SAS70); the balancing of the plan and participant accounts both before and after the trade, and the accurate timely execution of this balancing in a very tight time frame; transmitting the information between fund companies or platforms using NSCC protocols; obtaining and applying the correct NAV, and dealing with breakdowns related to the untimely setting of a funds’ NAV; the actual execution of a trade, often in a block trade, which may include the use of certain offsetting of trades; the generation and monitoring of soft dollars from the trade; the recording of the trade for the generation of 12b-1 and subtransfer fee purposes; the T-1 settlement of the trade, and the process related to its failure; the management of cash and cash flow arising from high volumes of liquidating trades; handling the mismatching of data and dollars; and the proper posting and balancing of the trade to the plans after it is done.
 
This is only a partial listing of all of the discrete tasks required to perform this simple 401(k) transaction.  It does not even take into account the plethora of agreements and regulations which apply at every stage of this arrangement to legally enable them;  the procedures related to the marketing and distribution of these products and the design of the compensation related to them; or the massive amount of tax and ERISA compliance services integrated at every stage.  These pieces are governed by a fascinating combination of state and federal law, including securities laws, banking laws, tax, insurance and others.
 
These steps become geometrically more complicated when you have other services or platforms involved. Think about what happens when an annuity contract or a self-directed brokerage account is added to the equation. Take a look at the flow charts at at the beginning  of that link, which outlines a process than Dan Herr and I put together on annuitizing from a mutual fund based 401(k). There are a lot of moving pieces. 
 
In short, a retirement plan product is really a package of financial and administrative services.  This knowledge is especially important when one is tasked with understanding the reasonableness of fees related to retirement products and services.  Purchasing investments through a defined contribution plan is so different than an individual making purchases for their own personal account, and it is horribly misleading to suggest otherwise.
 
Layering on top of all of this the 408(b) 2 and 404a-5 disclosure regulations, and you can begin to understand the challenge that the new ERISA disclosure requirements can create. 408b-2 is especially crucial, as it is a prohibited transaction rule which can through a monkey wrench into the entire Rube Goldberg-type structures which are necessary to make these programs look simple.
 
I am not an apologist for those who will use this complexity to hide unreasonable fees, something I will discuss in a future post, and this is something upon which advisors must be diligent. Transparency is critical to the fair operation of the retirement plans. But one of the benefits of transparency will be a better understanding on just how complex the system is, and just what it is that these fees support.
 
The marketplace has worked hard to make the 401(k) plan look deceivingly simple. But it is anything but.