A number of friends, and other commentators, had suggested to me that I was perhaps “overstating” the position I had discussed on my last blog regarding the delivery of 404a-5 notices to non-electing participants in an elective deferral plan. It was a very kind way of saying that I was wrong. After looking at the way I wrote the blog, I’d have to agree. I have retracted the posting. This is the first time I have had to do this in nearly five years of postings, but I strongly suspect it will not be the last. As one of my early mentors once exclaimed to me: “Toth, this stuff’s hard!” -though he did NOT use the word “stuff….” 

And I do apologize for not getting this “errata” piece out sooner than this.
 
In that blog, I stated that “the mere eligibility to make a deferral into an individual account plan doesn’t trigger the right to the 404a-5 disclosures.” That is the error. The “mere eligibility” does trigger the right to the 404(a)-5 disclosure, without question. The real question I was badly attempting to get at is “when.” Or, more precisely, a question that a number of professionals are asking: did the August 30 deadline for initial disclosure apply to those participants in an elective deferral plan who had not elected to participate? 
 
This is a real question.  We know that someone need not be given the notice immediately upon  becoming eligible for the plan (though, as a practical matter, I would recommend giving participants that disclosure when required to be given the SPD).  The regs in § 2550.404a–5(c)(2)(i)(A) state that the administrative expenses must be given to participants “on or before the date on which a participant or beneficiary can first direct his or her investments and at least annually thereafter.”  (c)3(i)(A) states the same for the individual expenses; while (d)(1) contains the exact same language for investment related information. 
 
So, we know there is time, beyond the date first being hired (or otherwise first becoming eligible) to provide the relevant information to any eligible employee, which is to be no later than the date that that person enrolls in the plan.  (A related question is how far can you push this out before you actually undermine the rule that all participants are required to be given a notice?  It appears that it DOL suggests that this be no later than the annual notice you would otherwise provide to all participants, as the preamble, again, gives a clue, when the DOL states that “The Department believes that, with regard to employees that have not enrolled in their plan, the annual notice will serve as an important reminder of their eligibility to participate in the plan.”).
 
But what about that initial August 30 notice requirement? The reg at 2550.404-a5(j)(3) states that “the initial disclosures required on or before the date on which a participant or beneficiary can first direct his or her investment must be furnished no later than 60 days after such applicability date to participants or beneficiaries who had the right to direct the investment of assets held in, or contributed to, their individual account on the applicability date.”
 
Does this suggest that the term “participants and beneficiaries” may be conditioned on whether there is an account under which assets could be directed?  Indeed, the Department has made it clear that beneficiaries do not have the right to such a notice unless they can exercise investment control over an account.
 
This position would be consistent with the well established concept that a claim for a fiduciary breach requires the showing of actual harm (see, for example, CIGNA v. Amara, 131 S.Ct. 1866, 1878-80 (2011). In a regulation which is geared to fee and expense activity (as opposed to general, non-monetary ERISA rights), if there is no account against which to assess fees and expenses, can non-disclosure be a fiduciary breach? If the breach is the lack of knowledge that the deferrals can be made, isn’t this is well covered-at least in the 403(b) space-where the responsibility (which is actually under the Tax Code, not Title 1) to notify participants of the availability to make elective deferrals is covered by the annual notification of universal eligibility; and by the rule of current availability for 401(k) plans?
  
 A conversation worth having…..
 
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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.   

The DOL has long treated the revenues sharing programs (such as 12b-1 and sub-transfer agent fees) related to investment funds in the same manner as the SEC:  as an integral part of the funds’ operating expenses. This choice, however, has the side effect of the actual amount of the revenue sharing not ever having to be disclosed under ERISA’s various disclosure schemes. So, for example, the actual amount of revenue sharing generated by the vast majority of plan investments is exempt from disclosure under Schedule C as long as the prospectus describing the revenue sharing formula is delivered to the trustee; 404a-5 exempts disclosure of these amounts from the other disclosures required on participant statements as long as the revenue sharing is part of the fund operating expenses under the model disclosure chart; and the 408b-2 regulations and PTE 84-24 only require disclosure of the formula used upon which the compensation will be based.

One court’s decision, however, may throw a monkey wrench into this disclosure scheme. 
 
The case in point is the Tussey vs ABB. Tussey, in case you are not familiar with it, is a U.S. District Court matter in which the employer used the revenue sharing generated by the employer’s 401(k) plan investments to help subsidize the administration of other employee benefit programs. The plan’s Investment Policy Statement actually required that the fiduciary track the revenue sharing generated by the plan’s investments, something the fiduciaries never did. The court held the fiduciaries liable for a fiduciary breach with regard to, in part, their failure to monitor revenue sharing and assessed approximately $35 million in penalties.
 
The first commentary coming from practitioners was relatively narrow, that the holding really stood for the proposition that the plan had better follow what is in the plan’s governing documents like the IPS. But a growing number of respected practitioners and advisors have been taking the position that the Tussey case stands for something much broader than that: that it stands for the notion that-beyond just following the plan documents-fiduciaries should affirmatively seek information regarding how much revenue sharing will actually be be generated by their plan.  After all, this approach is consistent with the manner in which the DOL treats other sorts of sales related compensation. Schedule A to the Form 5500 has always required insurance companies to disclose the actual amount of sales related payments generated by assets paid for the past year, related to an annuity contract, and Schedule C also requires the disclosure of such payments, if made from something other an insurance contract, as long as those payments are not generated as part of the funds operating expenses.
 
In practice, many investment vendors are moving in this direction, and an estimate of the revenue generated by the investments is becoming more and more part of the sales process. It is an especially critical number where ERISA Accounts (upon which I commented a few times) are involved.
 
Yet, should this position evolve and develop into a basic fiduciary obligation, it will not be without a bit of difficulty in application. Small employers, in particular those with little or no bargaining power, would be put in a pretty unfair spot: having an obligation to review a number that no one is required to report to them. 
 
 

Pension funds and insurance companies share a little discussed attribute, one which I have mentioned from time to time on this blog: they are both great drivers of capital formation.  One of the unique aspects of capital formation through these entities is the function of time: it takes time, to quote the bankers from the movie Mary Poppins in the infamous "Fidleity Fiduciary Bank"  scene, to “build railways through Africa” (or even California, for that matter). Pension funds and insurance general accounts are of a nature uniquely suited to such investment, the commitment to which often may span decades.

Annuity contracts purchased by 401(k) plans, and other retirement plans, often offer the ability for the plan or the participant to invest in these insurer’s “general accounts” as an investment fund. They are now often marketed as “stable value funds” which, in return for time, provide guarantees of principal, some measure of guaranteed returns, and enhanced crediting rates. Though they are called "stable value funds," they are really nothing like the stable value mutual funds. They are backed (in part) by real "things" like investments in bridges, roads, equipment, factories, apartments and shopping malls.
 
Many of these general account investments offered under annuity contracts, however, have the hated “contingent deferred sales charges” (otherwise known as surrender charges), or “market value adjustments (MVA) ” to the stable fund investments, should these contracts be terminated or substantial amounts withdrawn before a stated time. Surrender charges are generally related to sales costs, but the MVA, as unpopular as they may be, are often necessary because of the long term capital investments backing the guarantees which may be provided. Many products today, by the way, are offered without surrender charges or MVAs, but also generally offer reduced crediting rates in return.

Which really brings us to an obscure problem the DOL has struggled with in the past under ERISA’s plan asset rules (in attempting to define a “transition guaranteed benefit policy”), and now is an issue which may well come to the forefront because of the termination rules under Reg. 1.408b-2(c)(3). 1.408b-2(c)(3)  states that a contract will not be considered reasonable if it does not permit termination “on reasonably short notice under the circumstances“ of the contract by the plan without penalty to the plan. Fortunately, the DOL noted that this should not be read to prevent long term contracts, nor contracts which “reasonably compensates the service provider” for their loss upon early termination of the contract. This exception will not apply if that recoupment is “in excess of actual loss or if it fails to require mitigation of damages.”

So the question becomes what does “without penalty” mean, under 408b-2, when you are terminating an annuity contract.  As noted, the DOL had addressed this issue in the past in an odd, and very specialized, regulation under ERISA 401(c)(1) – which may now have renewed meaning under 408b-2. Under 2550.401c–1, the DOL outlined what it meant to terminate an annuity contract "without penalty" for purposes of that reg.  It established a standard to be applied to both the surrender charge and the MVA:   ”the term penalty does not include a market value adjustment (as defined in paragraph (h)(7) of this section) or the recovery of costs actually incurred which would have been recovered by the insurer but for the termination or discontinuance of the policy, including any unliquidated acquisition expenses, to the extent not previously recovered by the insurer."
 
This seems consistent with the language used in 408b-2.
 
The challenge for regulators, insurers and the responsible plan fiduciary will be figuring out when annuity contract termination charges cross this line.  Though annuities designed for the retirement market typically are designed to meet these rules, there may be some questions related to retail annuities placed into plans.
 

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Continue Reading Annuity Termination Charges under 408b-2: What is “Without Penalty?”

I have a statue of an elephant on my office credenza. It is actually an exotic little contraption, a bank, where a coin placed on its spring-loaded trunk will be deposited in the elephant.  It was a gift to me from a consultant friend of mine, after I told him about my experience with a number of major financial software conversions. Dealing with the fallout from system conversions, I explained, is like cleaning up after elephants (after recalling an incident I had witnessed involving some poor photographer at the Brookfield Zoo…). Next time, I promised, I was going to get in FRONT of the elephant. 

The Wall Street Journal today reports the slogan “One Line Of Code” in its description of the massive software failure at Knight Capital Group, which resulted in nearly a half billion dollars worth of losses and the collapse of a central player in the equities market.  This could well be the mantra, however, for any major system change involving retirement plan systems as well.  
 
Think about it. Retirement plans, and all of their moving pieces (from CRM, to compliance, to trading, to financial transactions and everything in between) likely create some of the most complex of transactional requirements that exist in the financial marketplace. Hedge fund and other trading platforms have complex formulas, for sure. But if you take a retirement plan from soup to nuts, with all of its different iterations, you’ll likely not find a set of processes in the financial marketplace that has more massive and demanding systems requirements.
 
The problem Knight had is really one that has (usually quietly) been encountered by most major financial service firms in the retirement market, and has been outrageously expensive for those firms. The challenge is what I call the “overpromise of technology.” The IT executive or consultant of an organization makes grand promises to the business side of the house based upon grand conceptual notions, all of which-by the way-make great sense on paper. These notions can be made to sound so very enticing. But the problem is that the executives generally underplay one very basic tenant of software development painfully driven into to me by some very talented developers: software and computers are dumb.   They will only do what you tell them to do, and at a very granular level. 
 
The “grand notion” may be great on paper, but-particularly in the retirement world-the very close details, the minutiae of which I have often spoken of in this blog, is what will make or break any such effort.  The “80%” rule won’t work; you have to worry the details.  It is the smallest of choices which will trip up the viability of any system development effort. What makes this so counterintuitive to the executive is that properly managing this risk means putting some very high level and valuable corporate assets into the “grunge pit,” grinding through the thousands of small decisions that must be made in the development of software which are really reflective of corporate decisions about how you will run the business. It is painful. It is time consuming. It is ugly. It is exhausting. But it is the ONLY way a system can be properly developed in a way that serves the business, and delivers on the promise. But this is a lesson far too often lost in the C-Suite.
 
 

Well I have to admit I was wrong. About 15 months ago in this Business of Benefits blog I predicted that "Time Had Come Today" for in-plan retirement income solutions to gain traction in DC plans. After all, it seemed like all the stars had aligned for the big turn around in the way retirement plans were perceived.  DOL and IRS had tag-teamed on a RFI designed to find ways to facilitate the offering and selection of guaranteed lifetime income (both in-plan and out-of-plan), DOL’s ERISA Advisory Council had issued a report containing recommendations for viable regulatory changes to enhance the environment for plan sponsors to offer GLI, the first baby boomers were reaching retirement age and approaching the decumulation phase of their retirement planning, new and innovative guaranteed lifetime income products were now available that addressed the challenges and shortcomings associated with traditional GLI products and more and more recognition and appreciation had emerged for the need to address the risks associated with outliving one’s assets. 

Unfortunately, it turns out that the status quo persists as plan sponsors continue to be leery/reluctant to offer GLI as an investment alternative or distribution option.  My prophetic blunder was aided and abetted by an ever-expanding and burdensome regulatory environment, a continuing weak economy making plan sponsors less inclined to consider enhancements and low interest rates which increases the cost to purchase GLI products. Couple the foregoing with costly compliance concerns and the dreaded "F" word that plan sponsors can avoid by steering clear, it’s not at all surprising that what seemed to me like a reasonable time horizon prognostication for widespread acceptance and use of in-plan guaranteed lifetime income strategies. now doesn’t seem anywhere in sight. 
 
That said, the critical need for the certainty and security that guaranteed lifetime provides cannot be overstated. That is something that everyone – short of those who have a contra interest in keeping control of funds – can agree on. See for example.  The NY Times  “Wealth Matters” (July 27 2012) article written by Paul Sullivan in which he discusses research conducted by the noted behavioral economist Shlomo Benzarti  Sullivan says “Shlomo Benartzi, a business professor at the University of California, Los Angeles and the chief behavioral economist at Allianz Global Investors’ Center for Behavioral Finance, said research had shown that most people were incapable of managing a lump sum of money well and that at least half of them got worse at it by the time they turned 80 and their mental faculties declined.”  The article provides a well balanced discussion of the pros and cons relating to GLI choices and if you haven’t read it I recommend it highly.  Of course the article was written in the context of a defined benefit plan but for the vast majority who need GLI the conclusions are the same (if not even more dire) in the case of most defined contribution plans where GLI isn’t even a choice.  
 
 So, let’s consider another way to address this issue. Like the overall basis for DC plans in the first place, let’s put the responsibility for selecting GLI on participants who bear the risks and ask plan sponsors to merely help participants recognize the need. How? Comprehensive financial education made available to employees by plan sponsors. Retirement planning represents only one of the many critical components that comprise individuals’ overall financial plans. And, in this area as we all know, people need help with a lot more than saving for retirement. This includes,  but is not limited to, matters as basic as strategies for coping with everyday financial pressures, debt management, buying a home, saving for college, estate planning and, of course retirement savings and investment issues and the important role protection products can offer to address longevity risks, retiree health and long term care needs. 
 
So, after 15 months of pondering, I’ve now reached the conclusion that the focus must shift from trying to engage plan sponsors about the need for GLI to the need to help participants understand and manage their finances in an increasingly complex investment and financial world. If we take care of providing quality financial education to American workers, thereby helping people make better financial decisions, then it stands to reason that the obvious need for GLI will take care of itself.  
 

A couple of decades ago, I attended an ERISA litigation conference where one of the topics of discussion was the potential for lawsuits from participants who were placed in stable value (then known as "fixed funds") investment funds in a 401(k) plan, who would claim somehow that it was a fiduciary obligation to optimize gains in such plans. I scoffed at those comments then, as I do now.

I bought my first shares of stock when I was 16, using $300 of savings from my Detroit News paper route collections to buy into Continental Telephone, American Airlines and Georgia Pacific.  I had studied these (and other) companies under the tutelage of my stepfather, a civil servant in Wayne County, whose passion was the stock market. At that time, Merrill Lynch had a broker in its Downtown Detroit office which specialized in small, odd lot sales. And yes, I ordered delivery of the stock certificates, and enrolled in those companies’ dividend reinvestment programs.  Ahh, the days of Lou Rukeyser and Wall Street Week.

It is this long familiarity with the equity market which had caused me to challenge the wisdom of the QDIA regs when they were first proposed. Though I very much understand those who are concerned about the importance of smart investing in retirement plans, I remember more than one conversation with Ann Combs about the concerns I had about a default fund being equity based. Markets do go down, and employees tend to trade investments in defined contribution plans at inopportune moments. As I’ve noted in a past blog, ERISA Section 404 demands that the funds be invested in such a way to minimize the risk of large losses, not to optimize gains for adequate retirement. Optimization may be a laudable public policy position, but a fiduciary standard it is not.

Even today, I advise clients about the downside of choosing an equity based investment as a default.  I actually don’t  think the QDIA, as currently designed, is necessarily prudent.   But for the QDIA reg granting relief, choosing a default investment fund based on equities could cause fiduciaries some exposure. And even though an employer may have a legal defense to the participant losing money on a default fund because of the QDIA rules, it is the employer, not the regulators, who have to deal with the bitter employee who has lost funds under such an election. It may be legally defensible, but it isn’t necessarily right-or the right thing for participants.

So finally we have the Bidwell case, involving a platform I helped design.  An employer changed its default fund from a insurance guaranteed account type of fund to an equity based QDIA just as the market was entering into the Great Recession’s downturn.  Those participants who’s funds were moved lost substantial value. They sued, but the employer prevailed. In that the employer had complied with all of the particulars of the QDIA rules, there was no fiduciary breach, and the employer was not held liable for those losses.

Though we legally applaud the ruling, and the affirming status it gives to the QDIA regs, there really are a couple of "darker side" takeaways from this case: if you are doing a QDIA, make sure you are doing it right. Otherwise, there may be exposure, as there is nothing inherently prudent about target date or lifecycle funds as a default investment fund. The second is to not discount the thought that  "prudence" as a standard still applies to other default investments, and that the QDIA may actually be putting participants at a disadvantage.

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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.   

 

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

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

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

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

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

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

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

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

 

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

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

 

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

 

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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.   

  

 

 

 

The disclosures related to 408()(2) are really just a precursor to the next step: the imposition of the prohibited transaction taxes and penalties related to compensation which fails to meet those standards.  It looks like the regs have the effect of shifting the application of the rules related to the "amount involved" in the transaction a bit. The "amount involved" in the transaction is the amount upon which the prohibited transaction taxes and penalties will be assessed.

Well prior to the new 408(b)(2) regulation, the DOL had developed guidance on the application of the prohibited transaction penalties. Compensation would be subject to penalty to the extentt that it was not reasonable. This meant that the penalties and taxes (the two are coordinated by the IRS and the DOL) only applied to the amounts above what would be a reasonable amount. (By the way, if you are looking for the manner in which to compute the correction and penalty amounts, you will need to reference the Tax Code-including the  tax rules governing foundations under 53.4941(e)).

What the new disclosure rules have done is establish the principal that ANY compensation for which proper disclosure has not  been made will not be considered reasonable. This means the "amount involved in the transaction" will be the entire amount of the improperly (or non) disclosed compensation.  The "to the extent" rule will then only apply to that compensation which has been properly disclosed but is unreasonable.

The application of the PT rules like these tend toward the  arcane, but will now become a central part of the service provider’s life.

 

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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.   

  

 

 

Now that the initial 408(b)(2) disclosures are out, the challenge becomes understanding them. Beyond just understanding whether or not the fees disclosed are reasonable (a challenge in itself), the disclosures do something arguably more important: they take us behind the looking glass, opening a window to a world with which most are not familiar, but which is critical to the operation of 401(k) and 403(b) plans. The disclosures provides hints to, and sometimes disclose, the complex series of relationships and financial arrangements which make possible the daily trading and investing of the assets in individual account plans, on both NAV and insurance platforms, and the manner in which those parties involved in those relationships are paid for those services.

 What this new view reminds us of is that 408(b)2 is but one (albeit important) part of the entire scheme of prohibited transaction rules.  There are a myriad of other prohibited transaction exemptions that are necessary to make the system work. Everything does not begin and end with the “covered service provider”: though all CSPs will be “parties-in-interest” and “disqualified persons” (under the Tax Code’s version of the prohibited transaction rules), not all “parties-in-interest” and “disqualified persons” are CSPs. And many of these non-CSPs will pop up during the 408b-2 disclosure process.
The “simple” payment of 12b-1 fees to a broker dealer is a prime example.  Assume a 401(k) trust has purchased a mutual fund share which pays 12b-1 fees, and assume a registered rep made the sale.  The trust will be a CSP to the plan, but the investment company, through the purchase of the mutual fund share, is not. The mutual fund share is merely an investment asset of the plan, under which no services are provided under ERISA 408(b)(2). Further, there is no “look thru” to the dealings of the underlying assets of the mutual fund.
The mutual fund itself is an interesting creature. It is an investment company which typically has no employees.  In order for it to pay the 12b-1 fees which are generated by the 401(k) plans’ purchase of a share, it usually has an arrangement with a fund distributor or a transfer agent (or both), to which it will pay the 12b-1 fee. These fees are authorized to be used for the specific purposes outlined by the mutual fund’s board in its adoption of its 12b-1 program, and it is for servicing the mutual fund, not the 401(k) plan which purchased the share.
That fund distributor is not a CSP, as it provides no services to the plan, and is not a 408(b)(2) subcontractor because the mutual fund to which it provides services is not a CSP (and there is a specific exception in the regs for those which provide the sorts of services fund distributors provide to investment companies).
The fund distributor will then have a selling agreement with the broker-dealer which sells the mutual fund shares, under which the 12b-1 fees are paid to that broker dealer.  That broker dealer then has a registered representative agreement with the selling broker, under which it agrees to pay to that rep a certain percentage of the 12b-1 fees it receives.
Though the fund distributor, the broker dealer and the registered rep are all receiving indirect compensation from the plan, absent any thing else, they are not CSPs or subcontractors to CSPs. They are paid under a contract for 12b-1 services to the mutual fund, not the 401(k) plan.  Therefore, no 408b-2 disclosure would need to be made of this compensation under this set of facts.
Arguably, once a rep and a broker dealer receive the 12b-1 fee, they may become a party in interest to the plan, even though they may not otherwise be a CSP. In that event, the payment of future commissions (being indirect compensation) would become a prohibited transaction unless there is a prohibited transaction exemption, which there is. PTE 84-24 permits a rep to receive a mutual fund commission if it is disclosed (much like 408(b)(2)) beforehand.
I provide this example only as an illustration, as it is very often not as simple as this. In this type of arrangement, there is often an affiliated party which IS providing services to the plan, whether as a plan trustee, a TPA or an advisor, which then changes the entire formula. And some may take issue with the thought that the b/d and rep are not CSPs, and others may take issue with the payment of a commission as creating party-in-interest status. All are legitimate points. On top of everything else, these determinations are notoriously fact-specific.
But the point is that these complex relationships now become a much more open part of the fiduciary mix.
For your reading pleasure, by the way, is the Investment Company Institute’s description of how intermediaries work in this chain described above. It is useful reading. Note that it is a 2009 document, and technology (and the market) continues to shift many of these relationships and arrangements. Note, also, that an analysis involving the purchase of variable annuity contracts by plans is substantially different than the one described above.
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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.   

 

 

It has been quite a time the past few weeks, with working through the details of MEP transitions to the 408(b) 2 July 1st effective date. With a little break to come up for air, I’d like to comment on something for post July 1 consideration, the variable non-registered group annuity contract.

This type of contract remains one of my favorite products in the 401k space. It can, if so designed, serve merely as an efficient investment platform, or serve as a complete package of financial and administrative services, with flexible pricing and compensation. Most of these contracts have within them the fixed account, which typically has enhanced guaranteed returns of the sort never available out of money market funds or the non-insurance “stable value” funds. Wirehouses and their reps typically have a great deal of disdain for these products, which I could never quite understand. Biases, though, often do get in the way of sound businesses judgments.

These contracts, however, are not simple investments. They have a number of moving pieces , which can make them a challenge to review for 408b2 purposes. And many of the insurance company disclosures I’ve seen are far more complicated than need be.

So I offer the following list for these who need to look at the disclosure related to these products under 408(b)-2:

-Trust or not. These contracts do not need to be held by a trustee, but sometimes they are. You need to know if they are so held, because the trustee will be a CSP, and their fees will need to be disclosed and understood.

-Fixed account or not. Most of the contracts have a fixed account into which variable account assets can be transferred. The fixed account, if one which is based on the insurer’s general account, will have no separate 408b2 disclosure. So don’t look for one.

-Variable separate accounts. The assets in these accounts are plan assets. If they hold mutual funds, you typically will not find an investment management fee, but you may find a sort of account fee. Take a look at it. If the funds in the account are actively managed outside of a mutual fund, look for a separate investment management fee.

-Fiduciary status. Depending on the structure of the separate accounts, the insurer may be a fiduciary of the separate account (they’ll never be one with regard to the fixed account). Look for whether or not, and to what extent, they have fiduciary status.

–Allocation models. Many insurers are offering asset allocation and management programs to plans and participants, for managing the separate account investments. Look to see if there is fiduciary status involved in these programs, and the fees related to them.

-Contract charges. Most of these contracts have separate contract or administrative charges. These are related to the fact that they really are providing a package of financial services (such as free trading between a wide range of mutual funds, and in active monitoring those funds). In assessing this fee, make sure you understand the sorts of services you are getting for that fee.

-Termination provisions. Look for surrender charges and market value adjustments. Sometimes, they are worth it given the rate of return being paid under the general account, and for payment of services from your insurance agent. But understand them.

-Commissions. Look to the amount of commissions being paid, and whether you are getting the support you need. Commissions are not bad things; as a matter of fact, they are necessary for many plan sponsors to get the kind of information and support they need in order to adopt and maintain the plan. Just make sure they are reasonable.

-Annuity disclosure. Virtually all of these contracts offer the right to annuitize at a certain prce. You will likely receive this disclosure, but they rarely have a significant  impact on the fees charged on the investment portion of the contract. Unless you are cnsidering offering anutization, don’t spend a lot of tme on this.

By the way, the issues related to a registered group annuity contract, which are typically offered in the 403(b) space, can be different. I will handle those in a separate posting. 

 

 

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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.