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

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

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

GEMS

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

 QUIRKS

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

QUIRKY GEMS

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

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

 

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


 

 

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

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

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

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

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

 

 

 Co-authored by Richard Turner

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

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

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

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

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

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

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

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

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

 

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


 

 EBSA and the IRS issued their long promised Request For Information on annuities-or, should I say, as promised by the EBSA. We had not expected this particular piece to be a joint effort. It shows that Phyllis’s and Mark’s agenda is getting policy effectively done, not engaging in damning bureaucratic turf warfare. Hmm. With this and the recent DOL/ SEC activities, we may be seeing a trend here somewhere….

The RFI is extensive and well thought out (though they do reference  the GAO report I criticized in an earlier blog). There looks to be a lot of work put into the effort already, as it well identifies the key issues facing the idea of providing lifetime income streams.

Importantly, it does not make the mistake of focusing on "annuities." Instead, it focuses on how an adequate retirement policy addresses three key risks: longevity, Investment and Inflation (OK. So at least on THIS point the GAO report got it right).  I believe the recent attacks by the Investment Company Institute, as well as Jack Brennan, on "annuities" misses the point: there are solutions needed to each one of these risks, solutions which can have a critical role for mutual funds, investment managers and the insurance industry. This is NOT an industry specific effort, as one industry alone cannot address all three of these risks without the others.

As promised, the RFI focuses strongly on transparency (yes, yes, my Annuity Transparency blog is coming), relevancy for the average participant, portability and cost. But I was intrigued by the questions related to 404(c) and IB 96-1 (on participant education).  I am particularly interested in the insurer solvency issue, which to me is the key fiduciary risk (next to transparency), but you need to look closely in the RFI to find that issue.

The substance aside, one must be impressed by the process. We always thought the Borzi/Iwry combination would be an extraordinarily effective one, and this is proving to be true. Seeing these two longtime compatriots openly cooperate with the goal of effective public policy is something for which we have long waited.

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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.  

 

 

 

 

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

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

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

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

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

No.

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

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

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

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

 

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

 

 

 

  

My everlasting thanks to Andrea-Ben Yousef of BNA. We were exploring annuities, and some confusion from my blog of January 6th, 2009.  We discovered that I posted the incorrect PLR number and link on that blog, where I discussed the importance of a new PLR to DC annuitization.  The link I had incorrectly provided was to a PLR on longevity insurance

The correct link and reference is PLR 200951039.   …. My apologies! It is now reading properly.

Some professional news. II have taken the exciting plunge, and have established my own firm. I now can be found at the Law Office of Robert J. Toth, Jr., rjt@rtothlaw.com.  The address and telephone numbers remain the same.I have been told that I am creating a challenge for those who still maintain a Rolodex!

 

Bob Toth

Annuitization from DC plans suffers from the lack of clarity on a number of key technical rules, which need to be resolved before such annuities can be widely implemented. The IRS has taken a major step in its issuance of PLR200951039, a complex PLR which- for the first time-defines what an annuity really is for purposes of DC annuitization, and when the annuity election election occurs. This is critical for determining which RMD rule  applies, and when spousal consents will be required. It also, very importantly, recognizes the Plan Distributed Annuity (see my prior blogs)  and the qualification rules which will apply to them.

Even the informed reader is likely to get lost in trying to parse through this particular PLR.  Suffice it to say that there is a highly involved set of facts related to an insurance company’s specific group and individual annuity products. The relevant features are:

  • It is an annuity purchased by a DC plan for distribution to participants-either from the group annuity contract held by the plan (and not being a "plan asset", by the way) or as an individual annuity contract purchased by the plan and distributed to a participant-the classic Plan Distributed Annuity.
  • The contracts have account balances within them which are invested in variable separate accounts. The retirement distributions from these contracts are actually treated by the contracts as withdrawals from the account balance. Every dollar taken out reduces the account balance by the same amount.
  • At the time the participant starts taking payments, the participant elects how the amount of the withdrawals will be calculated. The  choice is that the payment will be equal that which would be paid under either a single life annuity or a joint and survivor annuity. This particular product gives the participant the right to actually choose the interest rate at which the annuity will be determined. 
  • The amount of the withdrawal is adjusted every year to reflect investment performance relative to the interest rate selected. It is also adjusted for any "extra" withdrawals taken by the participant during the year. 
  • At a certain age (typically age 85, but the plan can elect the age, within a range), the account balance actually disappears. All payments now come directly from the insurance company, not from the participant’s account, and that payment is guaranteed for a lifetime. This particular product has an interesting twist, called "variable annuitization." This feature actually allows the participant to elect to have their annual payment adjusted in accordance with investment performance using a sort of "phantom" set of accounts.

Here’s what the IRS has importantly said:

  • Payment as an annuity/not as an annuity. Payments made from the contract after the account balance is "shutdown" IS annuitization. All payments before then are NOT considered annuitization, but systematic or periodic  withdrawals (let’s call it the "access period"). Those "access period payments"  are also considered RMDs, but only up to up to the calculated RMD amount. (This, by the way, means that the amounts up to the RMD cannot be rolled over, but the amounts in excess of that can be). 
  • Application /Timing of  spousal consent rules. Spousal consent is required at the time the participants elects distribution from the annuity- even though the payments during the access period are "non-annuity" payments. Electing the form of computing the payment at the time withdrawals begin is necessary under this product to make the systematic withdrawal "match up" with the actual annuity payments, to make it resemble a guaranteed income stream that is set for life. This then makes the election the same thing as currently electing an annuity payout at age 85 (or whatever age is elected), even if the intervening periodic payments are not paid as an annuity. This means that the spousal consent must be received  if the basis for computing the payment (and ultimate annuity payment at a later age) is other than (at least) 50% Joint and Survivor. Though one may quibble whether this is the right decision, we finally have  a rule we can use. As a practical matter, this may cause some problems if there is an intervening divorce and remarriage during the access period.
  • Spousal beneficiary. The account balance during the access period will still be subject to the spousal consent rules on the naming of the beneficiary.
  • RMD.  In determining the RMD, the RMD for the for payments during the access period will be determined using the account balance  under the standard DC rules. AFTER the account balance disappears, the DB method of computing the RMD will apply.

Finally, it is the overall message of the PLR which bears importance: the IRS further affirms the tax treatment of an annuity that was distributed from the plan, for an annuity that meets the requirements of 404(a)(2).

 

 

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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.  

 


 

 

 Its going to be a demanding year for fiduciaries of retirement plans, particularly of those in the small and mid-market which are not particularly accustomed to paying close attention to them. I have blogged earlier on the increased fiduciary demands related to the new data provided to fiduciaries under the 2008 Form 5500 Schedule C and Schedule A. But there is another unusually dicey issue that is soon to land on their laps: voting proxies on stocks and mutual funds following an economic collapse.

On October 17, 2008, the DOL issued a new Interpretive Bulletin, 2509.8-2, on the manner in which a fiduciary needs to deal with the voting of proxies on stocks and mutual funds held as assets of plans. It was generally seen as a reaffirmation of the EBSA’s long held views on shareholder activism, and the need for a plan to make proxy decisions based solely on the plan’s own economic interests.  

But the I.B. is especially rich in describing the fiduciary processes that is required of a plan in dealing with proxies.  It notes that the fiduciary responsible for voting the proxies must

  1.  vote the proxy, or
  2. monitor those who are voting proxies and review the basis for their votes, or
  3. if proxies are not voted, make an affirmative decision that the burden of doing a proper review is too high given the benefit to the plan; and
  4. of course, document all of this.

None of this is really news to any one who has advised fiduciaries. But the problem of "paying attention" to these rules is a very real one given the financial collapse of the past year.

The anger at the leaders of financial institutions of the collapsed titans is very real, and well documented; there is great outrage at the amazing recovery (and related executive compensation quickly paid) within those organizations while the massive  "collateral damage" and personal trauma throughout the world continues;  and the continued befuddlement is palatable at the lack accountability of corporate board members, where it seems to be quickly becoming "business as usual."

The IB strongly warns us that, from the fiduciary’s view, any attempt to use proxy voting to apply any sort of sense of "economic justice" would be mislaid and be a fiduciary breach.  But the IB ALSO strongly warns us that that same fiduciary must  follow a process and take proxy voting (which has typically been seen as a "throwaway" sort of "bother") seriously and, particularly this year, consider whether their vote is in the best economic interests of the plan.

I would suggest that this likely means, that when voting for Board members (for example) or on other proxy issues, a fiduciary needs to address whether the current Board candidates and compensation schemes serves the plans best interests: that is, the continued financial strength of the stock held by the plan.  For mutual fund boards, the question would be more of a process question: how active where the mutual fund boards in overseeing the voting the proxies on the shares owned by the mutual fund.

This sounds like an awful lot of work, particularly if the fiduciaries themselves are struggling to keep their own businesses going. So, what’s a fiduciary to do? Perhaps the following:

  1. Find out who has the duty to vote proxies under the plan. The I.B. does a good job of helping a plan sponsor work through this.  
  2. Make whatever decision is made on the proxy voting process part of the  Investment Policy statement.
  3. Research (or get someone to research), within reason, the the proxy issues-noting, particularly that voting on Board members is not a simple "throwaway."
  4. If there will be no vote, establish that it is too burdensome for the plan to do all those things needed to make an informed vote.
  5. Of course, document all of this.

 

 

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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.  

 


 

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

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

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

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

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

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

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

Preview

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

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

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

A Final Reflection

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

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

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

To all, wishing a healthy and fulfilling new year.

 

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

 

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

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

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

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

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

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

A Personal Thought

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

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

 

 

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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.