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.

______________

 

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…..

 

______________

 

 

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).

 

 

_________________

 

 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.

 

 

_________________

 

 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.

 

_________________

 

 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.

 

 

 ______________

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 blogged a couple of weeks ago on the DB demise because of what I was seeing my current work on DC annuities, triggered by an interesting e-mail discussion string between fellows of the American College of Employee Benefits Counsel. 

But then the PBGC held a 35th anniversary forum shortly thereafter, extolling the idea of revitalizing the current DB system.  I thought this made it an opportune time to further the discussion.

The December 7 Forum on DB plans seem to hit it mostly right  in its calling the attention to the fundamental value of employers providing "guaranteed income for life" to employees. The National Institute on Retirement Security also reported on the meeting, noting the  critical role of Defined Benefit Plans, calling them the "Real Deal." The NIRS has also published its vision with which one can hardly argue. Under a high quality retirement system retirement system: 

  • employers can offer affordable, high quality retirement benefits that help them achieve their human resources goals;
  • employees can count on a secure source of retirement income that enables them to maintain a decent living standard after a lifetime of work;
  • the public interest is well-served by retirement systems that are managed in ways that promote fiscal responsibility, economic growth, and responsible stewardship of retirement assets

But here’s where the problem lies. Juxtapose those statements with the following quote from "The Black Swan," by Nassim Nicholas Taleb, Random House, 2007:

"Consider the following sobering statistic.Of the five hundred largest U.S, Companies in 1957, only 74 were still part of that select group, the Standard and Poors 500, forty years later. Only a few had disappeared in merger; the rest either shrank or went bust." p.22

This where the PBGC, the NIRS and Pension Rights Center (which also presented at the conference) have it all wrong: the traditional DB plan does not, and will not, meet these laudable goals if you rely upon the private employer for the financial wherewithal to insure that the funding and fund management will be adequate. Plan sponsors can be terribly conflicted, with their own corporate financial needs creating economic pressure to engage in some sort  dangerous "creative accounting" in the management of these plans- which we have all too often seen in the past.  I am tempted to argue that public plans do not have this problem, and that they should get a "bye" on this concern. But think again. Many state and local governments are in serous trouble because of a disturbing lack of financial discipline, as they have not really had to "pay as you go" when promising very expensive benefits. Are not these promises really of the most cruel kind, when we find the money to pay for them really is not, nor ever can be, there?

The current DB system is premised on the notion that a private employer can more cost effectively provide this benefit. Logically, this cannot be true because of the lack of sensible pooling even in the largest employers. Some employers will be able to do so today because of their current demographics, but many cannot-and even those who can may find themselves in a bind in a decade or two. The only potential cost savings is in the profit charge on this guarantee issued by an insurer.

In effect, the system believes that it can do a better job at longevity risk management than regulated insurance companies, and to get that insurance for, in effect, free. When all is said and done, it is likely far from free. We are seeing the effect of the fallacy today, with only 19,000 DB plans now being covered by the PBGC.

So if the system REALLY needs a guaranteed lifetime benefit based upon employer sponsorship, one under which employers have the ability to choose the benefits (and thereby control the cost),  but one under which the employees should not be exposed to the vagaries of foolish business decisions of their  employers’ senior management, what IS the answer?

I truly believe the answer lies in a private insurance system which provides Annuity Transparency, in annuities purchased through the employer sponsored system.  I’ll talk about this on my next blog. For now, though, its back to the ski slopes of Quebec…. 

A footnote, added 12/21: Gretchen Morgenson reports in the Sunday NY Times  on a multi-billion dollar failure in the Alaska pension system, caused in large part by the alleged error of Mercer.  Again, my point: non-regulated institutions are ill-equipped to manage DB plans, particularly large ones. Had Alaska purchased insurance, the risk of error would have be borne by a well capitalized, highly regulated expert organization.

 

 

 

 

 

The DOL issued FAB 2009-2 back in July, in response to the concerns of employers and investment providers that in many cases they would not be able to obtain the information necessary related  to a number of "old" 403(b) contracts and accounts for the expanded Form 5500 required for 403(b) plans beginning with the 2009 plan year. Moreover, even in cases where some annual reporting with respect to the contracts would be possible, the DOL recognized that compliance efforts involved in including these contracts in the financial statements would be substantial and expensive.

The FAB  was not uniformly well received initially, many expressing the thought that the relief was illusory at best.  Now that we have had some time for the FAB to settle in, and now that parts of the market are beginning to try to identify past contracts and "classify" what to do with them, the usefulness of the FAB becomes more clear. 

The FAB allowed contracts to be excluded from an audit if they met the following 4 conditions:

  1. were issued prior to 1/1/09,
  2. all contributions ceased prior to 1/1/09,
  3. all rights under the contract are"legally enforceable" against the insurer or custodian by the individual owner "without any involvement of the employer," and
  4. the mounts in the contract were fully vested and non-forfeitable.

The real key to making the FAB work for the employer in keeping auditing costs down is in the sensible application of the FAB’s 3rd condition.  I would suggest that applying it consists of two parts. First, use a reasonable effort to determine and find contracts that were related to the plan at some time in the past and, secondly, making a reasonable effort to determine whether or not the rights under those contracts are "legally enforceable" by the individual.

Finding contracts

Establish a reasonable (meaning not "perfect") method to use to find what contracts might possibly be part of your plan. Review the employer records to determine (to the best of your ability) which employees made contributions to which vendors over a reasonable period of time (perhaps the ERISA 6 year recordkeping requirement?).  Do the best you can, document it, and convince your CPA that a reasonable effort should do. 

Legally Enforceable 

From a purely legal viewpoint, this should be "easy." Heck, just get a copy of all those contracts issued over the past (6 years?) and read them. Right? Two problems, of course:

  • Go ahead. Try finding them. You won’t find them. This is in part because insurance companies don’t typically keep actual copies of contracts. Instead, they keep records of the application, plus the "form number" they issued to the individual. Which means when you try to ask for a copy, you’ll just get an assembled form-assuming the company would give the employer (who doesn’t own the contract) a copy anyway.
  • Then try reading it. I dare you.  Have you ever tried to read an annuity contract?Trying to determine whether or not rights are solely enforceable by the individual will be a difficult task, and one which an answer to this question may never be readily findable.

There may be a way a reasonable method or two to try to divine this answer.  For current vendors, for example, the task is a simple one (of course, nothing is turning out to be simple nowadays in this world): have your vendors give you a list of all the contracts to which they seek your approval for something like loans or distributions.

For past vendors, this is where the gold mine should be. See if you have heard from any of those past vendors for which you have compiled a list (see "Finding Vendors"). It may well be reasonable to assume that, had you not heard from them on your former or current employees, that those employees rights are being enforced without your involvement.

Tougher questions arise when, under 2007-71, you have excluded contracts from your plan.  Can these contracts be excluded for Title 1 reporting purposes? Vendors have taken a hard line on these contracts, and are submitting all sorts of decisions to employers for approval, even where the employer has advised them those contracts are not part of the plan-and many times these approvals are demanded in spite of contract language NOT requiring employer approval.  

A number of employers have decided that they were subject to ERISA just this year, because of the press of the tax regulations. One needs to consider (after consulting a lawyer or accountant) whether any of the old, past contracts under such circumstances would need to be counted.

Finally, this business really is only the tip of one of those melting Antarctica icebergs. Ultimately, the lawyer, accountant and employer need to sit down and review the employer’s situation, and make a case amongst themselves for the most reasonable approach. Remember, the DOL’s approach right now is accommodative. It is not trying to bankrupt charities through the crushing cost of unreasonable audit requirements.

 

 

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

 

 

                  

 

The DOL continues what is actually a pretty extraordinary effort with regard to 403(b) plans.  It had struggled early with the new 403(b) changes brought on by the IRS rule changes. It had not really taken a good look at these plans since 1978 when it issued its "safe harbor" which exempted many 403(b) plans from  Title 1 coverage, and I do not recall ever actually dealing with a DOL investigation of a 403(b) plan prior to this year.

DOL staff has kept talking to the accounting, legal and consulting professions, as well as employers and vendors, as they try to sort out  some of the unusual difficulties presented by 403(b) plans. Indeed, the biggest challenge in this market is not related to the tax code, it is in addressing  the mystery of how to define and manage fiduciary issues arising from 403(b) plans funded with individually owned annuity contracts.

The DOL is about to take the next step, and is considering issuing a 403(b) "Frequently Asked Questions" as they have done twice for the Schedule C. The FAQ is to address critical year end 403(b) issues related to reporting and Title 1 status.

While applauding the DOL in its continuing efforts, there is a danger related to one particular issue it may be addressing: the question of how few vendors can be offered by a 403(b) plan (which otherwise qualifies under the safe harbor) without triggering Title 1 coverage.

Putting aside the the very real practical problem of whether a 403(b) plan of a non-church, non-public educational organization can even qualify under the safe harbor because of problems created by the new tax regs, there is a significant issue related to "open architecture" platforms and certain annuity contracts which offer a large number of unrelated investment managers and mutual funds under the programs.

DOL Reg 2510.3-2 (click for a download of the reg) permits the employer to limit the number of vendors which are offered under the plan as long as employees are offered a "reasonable choice." The reg does not specify whether the choice of  "vendor" or "investment" needs to be reasonable.  

The regulations were written 25 years before the first "open architecture" 403(b) programs began showing up, where these large number of mutual funds are made available, and before the advent of a significant number of variable investment alternatives were available under certain annuity contracts. It would not be unreasonable for an employer to take the position that limiting the investments  to a single platform with a large ("reasonable choice") of investment options available would not jeopardize a plan’s "non-Title 1" status.

DOL staff has been discussing publicly for the past year or so the position that any less than 3 vendors would not be considered offering a "reasonable choice," even if the one platform offered a large number of mutual funds unrelated to the "platform vendor."  Should this position be published now, at year’s end, in the FAQ , without any hint of relief for all those plans which had interpreted the "reasonable choice" rule in a good faith manner, the effect can be severely disruptive. There are a significant number of (some very significant) plans which have taken the position that a single platform offering many choices kept them from Title 1 status.

Taking this position now in a FAQ has the same practical effect of issuing a final regulation: employers would take it as THE RULE, immediately effective. There would be no room for a comment period, or proposed corrections or transition periods. In short, this could cause a great deal of problems for a large number of employers.

One other thing. We have seen estimated that there may be some 35,000 or so 403(b) plans, and perhaps less than 20,000 that will be filing Form 5500s.  This number is likely to be sorely underestimated: There are a million or so private charities in this country and at least 14,550 public, k-12 school districts as well. If only 10% of the charities have 403(b) plans, and if almost all school districts have them, we are at least triple the government estimates. As mentioned, the impact of any of these rules will be significant, so their effect needs to be well considered.

 

 

 

 

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