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How do the IRS and DOL determine whether a closed MEP exists?

“What criteria do the Internal Revenue Service (IRS) and Department of Labor (DOL) consider when determining whether a single multiple employer plan (MEP) exists for an association of employers?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Oregon is representative of a common inquiry involving multiple employer plans.

Highlights of discussion

  • A single MEP, otherwise known as a “closed MEP,” is a single employee benefit plan maintained by two or more employers that meets the requirements of Internal Revenue Code Section (IRC §) 413(c), where the employers are not related under IRC §414(b) (regarding a controlled group of employers), IRC §414(c) (regarding trades or businesses under common control), or IRC §414(m) (regarding affiliated service groups).
  • The IRS has put together a chart that indicates how specific IRC provisions apply to closed MEPs (Internal Revenue Manual, Part 7, Chapter 11, Section 7 Multiple Employer Plans).
  • The failure of one participating employer or the failure of the plan itself to satisfy an applicable qualification requirement will result in disqualification of the multiple employer plan for all participating employers [Treasury Regulation 1.413-2(a)(3)(iv)]. For example, the failure of any participating employer to satisfy the top-heavy rules disqualifies the entire multiple employer plan for all of the employers maintaining the plan (Treasury Regulation 1.416-1, Q&A G-2).
  • The DOL categorizes plans covering more than one employer as either a single employee pension benefit plan, or a combination of separate, individual plans. If the MEP is a single plan under ERISA (i.e., a closed MEP), then the plan administrator files a single Form 5500, which requires only one independent audit for the group. Similarly, the ERISA §412 fidelity bonding requirements for a closed MEP apply as if to a single plan, rather than independently as to a series of individual plans.
  • Pursuant to § ERISA §3(5) , the DOL requires that the employers in a closed MEP must be part of a bona fide group or association that has something in common besides cosponsoring one or more plans. It is the DOL’s view that where several unrelated employers merely execute identically worded trust agreements or similar documents as a means to fund or provide benefits, in the absence of any genuine organizational relationship between the employers, no employer group or association exists for purposes of ERISA §3(5).
  • In DOL Advisory Opinion 2012-04A , the DOL opined that determining whether a bona fide employer group or association exists for purposes of maintaining a closed MEP depends on all of the facts and circumstances involved. Relevant factors in judging whether a plan sponsor is a bona fide group or association of employers include the following:
  1. How members are solicited;
  2. Who is entitled to participate and who actually participates in the association;
  3. The process by which the association was formed,
  4. The purposes for which it was formed, and what, if any, were the preexisting relationships of its members;
  5. The powers, rights, and privileges of employer members that exist by reason of their status as employers; and
  6. Who actually controls and directs the activities and operations of the benefit program.
  • The employers that participate in a closed MEP must, either directly or indirectly, exercise control over the program, both in form and in substance, in order to act as a bona fide employer group or association with respect to the program.
  • Courts have ruled that the entity or group maintaining a closed MEP must be tied to the employees or the contributing employers by genuine economic or representational interests unrelated to the provision of benefits [MDPhysicians & Associates, Inc. v. State Bd. Ins., 957 F.2d 178,185 (5th Cir.), cert. denied, 506 U.S. 861 (1992) and Wisconsin Educ. Assoc. Ins. Trust v. Iowa State Bd., 804 F.2d 1059, 1063 (8th Cir. 1986)].
  • In DOL Advisory Opinion 94-07A the DOL emphasized it is the commonality of interest among the individuals that benefit from the plan and the party that sponsors the plan that forms the basis for sponsorship of a closed MEP.
  • As a rule of thumb, examples of employer associations that are likely to qualify to maintain closed MEPs include
  1. Well-established associations whose members are very similar (e.g., members of a particular trade possibly within a specific geographic region);
  2. Employers related by common ownership (but where ownership does not reach the level to require aggregation under the controlled group rules);
  3. Employers who regularly and closely cooperate in serving a particular group of clients (but do not aggregate under the affiliated service group rules); and
  4. Certain Professional Employer Organizations (PEOs).

Conclusion

Under the current regulatory framework, whether several independent employers represent a bona fide employer group or association that is eligible to maintain a closed MEP depends on the facts and circumstances of the particular situation, taking into consideration a number of factors as identified by the DOL in several of its advisory opinions on the topic.

 

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What Constitutes a Partial Plan Termination?

My client is in the process of acquiring another company, which has a 401(k) plan. I’m concerned about a partial plan termination situation because of a reduction in force. What constitutes a partial plan termination and how might it affect the plan?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of discussion

  • When a significant number or percentage of employees who are participating in a business’s qualified plan are terminated and/or are no longer eligible to participate in the plan, a partial termination may have occurred in the eyes of the IRS.
  • Similar to a situation involving a complete plan termination, the IRS requires that all participants covered under the portion of the plan deemed terminated become 100% vested in matching contributions and other employer contributions [IRC 411(d)(3)]. Failure to fully vest participants could result in underpayments from the plan upon distribution of former participants’ account balances. These underpayments could, potentially, cause the IRS to disqualify the plan if the error is not corrected.
  • The IRS makes it clear that the determination of a partial plan termination is based on the facts and circumstances of the particular scenario [Treasury Regulation § 1.411(d)-2(b)]. However, within Revenue Ruling 2017-43 the IRS provides the following guidance in helping to determine if a partial plan termination has occurred.
  • A partial termination may be deemed to occur when an employer reduces its workforce (and plan participation) by 20%.
  • The turnover rate is calculated by dividing employees terminated from employment (vested or unvested) by all participating employees during the applicable period.
  • The applicable period is generally the plan year, but can be deem longer based on facts and circumstances. An example would be if there are a series of related severances of employment the applicable period could be longer than the plan year.
  • The only severance from employment that is not factored in determining the 20% are those that are out of the employer control such as death, disability or retirement.
  • Partial plan termination can also occur when a plan is amended to exclude a group of employees that were previously covered by the plan or vesting is adversely affected.
  • In a defined benefit plan partial plan termination can occur when future benefits are reduced or ceased.
  • The IRS adopted the 20% guideline in Rev. Proc. 2007-43 from a 2004 court case Matz v. Household International Tax Reduction Investment Plan, 388 F. 3d 577 (7th Cir. 2004), which, ironically, was dismissed in 2014 after its fifth appeal [Matz v. Household Int’l Tax Reduction Inv. Plan, No. 14-2507 (7th Cir. 2014)]. The 20% threshold still stands under the IRS’s revenue procedure.
  • If a partial termination may be an issue, a plan sponsor may seek an opinion from the IRS as to whether the facts and circumstances amount to a partial termination. The plan sponsor can file, IRS Form 5300, Application for Determination for Employee Benefit Plan with the IRS to request a determination of partial plan termination.

Conclusion

Based on facts and circumstances, a company could be deemed to have a partial plan termination. The participants affected by the partial plan termination must become 100% vested upon termination. Plan sponsors should monitor their companies’ turnover rates to ensure they are not experiencing a partial plan termination and, if they are, ensure affected former participants receive proper distributions from the plan.

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Non Statutory Stock Options and 401(k) Deferrals

“My client has participants in his company’s 401(k) plan who are receiving cash as a result of exercising their stock options. The client is going to report the income on the participants’ IRS Form W-2 for the year. Is this eligible/included as compensation for purposes of withholding salary deferrals? ”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans.

Highlights of discussion

  • Whether income from the exercise of stock options is includable as W-2 income as defined in 1.415(c)-2(d)(4) income for purposes of making salary deferrals to a 401(k) plan depends on whether the stock options are statutory or nonstatutory.
  • W-2 income includes income from the exercise of nonstatutory stock options for the year the options are exercised.
  • In contrast, income from the exercise of statutory stock options is excludable from W-2 income.
  • Therefore, when a participant exercises nonstatutory stock options, he or she will have additional taxable income, reported on IRS Form W-2, which can increase the amount of money the individual has available for making 401(k) employee salary deferrals.
  • The IRS has several publications with helpful information regarding the taxation of stock options: Topic 27, Publication 525, IRS CPE Compensation, Instructions Form W-2.

Conclusion

  • Income from the exercise of nonstatutory stock options is included in W-2 income, and is eligible for deferral into a 401(k) plan up to the maximum annual limit.

 

© 2017 Retirement Learning Center, LLC, a subsidiary of Retirement Literacy Center

 

 

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401(k) Plan Comparative Fee Chart

“My client, who has a 401(k) plan, timely distributed the plan’s annual fee disclosure in the comparative chart format. The next month, an expense ratio changed for one of the designated investments under the plan.  Must my client provide a new comparative chart to show the change?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of discussion

  • Pursuant to Department of Labor Regulation Section (DOL Reg. §)2550.404a-5 , plan sponsors must initially, and at least annually thereafter, disclose plan information and investment-related fee information to participants of 401(k) plans.
  • The investment-related fee information can be provided in a comparative chart format.
  • Plan sponsors need only provide one comparative chart to participants and beneficiaries per year. If there is a change to a designated investment alternative’s fee and expense information after the plan administrator has furnished the annual disclosure (“comparative chart”) to participants and beneficiaries, the plan sponsor is not required to issue a second disclosure (Field Assistance Bulletin 2012-02R, Q&A 22).
  • However, fee and expense information must be made available on a Web site (Field Assistance Bulletin 2012-02R, Q&As 17 through 19). Information made available on the Web site must be accurate and updated as soon as reasonably possible following a change (Field Assistance Bulletin 2012-02R, Q&A 19). The Web site also should reflect the date on which it was most recently updated.
  • Additionally, under extraordinary circumstances, the duties of prudence and loyalty under ERISA § 404 may require the plan sponsor to inform participants and beneficiaries of important changes to investment- related information before the next comparative chart is required under the regulation (please see 75 FR 64922, footnote 17 of the preamble to the final regulation).
  • Note that a description of changes to plan-related information must be distributed at least 30 days, but not more than 90 days, in advance of the effective date of any change, unless the inability to provide such advance notice is due to events that were unforeseeable or circumstances beyond the control of the plan administrator, in which case notice of such change must be furnished as soon as reasonably practicable (Section (DOL Reg. §)2550.404a-5 ).

Conclusion

  • A plan sponsor need only provide the annual comparative chart that reflects its 401(k) plan’s fee and expense information once per year, regardless of whether the information changes during the year. However, the coordinating Web site must reflect the most up-to-date fee information available.

 

 

© 2017 Retirement Learning Center, LLC

 

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Change in Plan Blackout Ending Date

 

“My client is changing his 401(k) plan to a new record keeper and is under a blackout. We anticipate the blackout may go longer than what he initially disclosed to the participants. What are the participant notification requirements when the end of a blackout period is extended?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans.

Highlights of discussion

  • Pursuant to DOL Reg. Sec. 2520.101(b)(4), if a plan’s blackout period will run for a longer period than was initially disclosed to the participants, the plan sponsor must furnish a new notice to indicate the change.
  • The updated notice must
    • 1. Explain the reasons for the change; and
    • 2. Identify all material changes in the information contained in the prior notice.
  • The plan sponsor must furnish the updated notice to all affected participants and beneficiaries as soon as reasonably possible, unless such notice in advance of the termination of the blackout period is impracticable.
  • The DOL also expects that where a plan administrator has the ability to provide notice to some participants earlier than others, the administrator should provide the notice even if notice to other participants would not be practicable.

Conclusion

If a 401(k) plan’s blackout period will run past the previously disclosed end date, the plan sponsor has the obligation to issue a second updated notice to affected participants and beneficiaries.

 

 

 

 

 

 

 

 

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Cyber Security and Retirement Plans

“With so many examples of data hacking in the news, I’m curious about what cybersecurity standards apply for qualified retirement plans?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • Great question! There is an understanding under Department of Labor (DOL) Regulation Section 2520.104b-1(c) and other pronouncements related to the electronic delivery of plan information that a plan sponsor must ensure the electronic system it uses keeps participants’ personal information relating to their accounts and benefits confidential. However, presently, there is no comprehensive federal regulatory regime covering cybersecurity for retirement plans.
  • Each state has different laws governing cybersecurity concerns that may come into play. Unfortunately, many retirement plans cover multiple states or retirees who have moved out of state.
  • At the end of 2016, the ERISA Advisory Council issued a report entitled, Cybersecurity Considerations for Benefit Plans. “The Report” puts forth considerations for the industry for navigating cybersecurity risks. The considerations relate to the following three key areas. Please refer to the report for more details.

1. Establish a strategy

  • Identify the data (e.g., how it is accessed, shared, stored, controlled, transmitted, secured and maintained).
  • Consider following existing security frameworks available through organizations such as the Nation Institute of Standards and Technology (NIST), Health Information Trust Alliance (HITRUST), the SAFETY Act, and industry-based initiatives.
  • Establish process considerations (e.g., protocols and policies covering testing, updating, reporting, training, data retention, third party risks, etc.).
  • Customize a strategy taking into account resources, integration, cost, cyber insurance, etc.
  • Strike the right balance based on size, complexity and overall risk exposure.
  • Consider applicable state and federal laws.

2. Contracts with service providers

  • Define security obligations.
  • Identify reporting and monitoring responsibilities.
  • Conduct periodic risk assessments.
  • Establish due diligence standards for vetting and tiering providers based on the sensitivity of data being shared.
  • Consider whether the service provider has a cyber security program, how data is encrypted, liability for breaches, etc.

3. Insurance

  • Understand overall insurance programs covering plans and service providers.
  • Evaluate whether cyber insurance has a role in a cyber risk management strategy.
  • Consider the need for first party coverage.
  • The ERISA Advisory Council has suggested that the DOL raise awareness about cybersecurity risks and provide information for developing a cybersecurity strategy specifically focused on benefit plans.
  • The Report concludes with an appendix entitled, Employee Benefit Plans: Considerations for Managing Cybersecurity Risks (A Resource for Plan Sponsors and Service Providers).  At this time, no comprehensive cybersecurity protocol for retirement plan administration exists at the federal level. The ERISA Advisory Council has provided suggested materials for plan sponsors, fiduciaries and service providers to utilize when developing a cybersecurity strategy and program.

Conclusion 

At this time, no comprehensive cybersecurity protocol for retirement plan administration exists at the federal level. The ERISA Advisory Council has provided suggested materials for plan sponsors, fiduciaries and service providers to utilize when developing a cybersecurity strategy and program.

 

 

 

 

 

 

 

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Federal Withholding on an In-Plan Roth Conversion

“How do the federal withholding rules apply to an in-plan Roth conversion in a 401(k) plan?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • The federal withholding rules for in-plan conversions to a designated Roth account in a 401(k) plan are similar to the rules that generally apply for eligible rollover distributions that are rolled over directly to another eligible plan versus rolled over indirectly (i.e., within 60 days) (Internal Revenue Code Section 3405). The IRS has provided specific guidance for in-plan Roth conversions in Notice 2013-74 Q&A 4.
  • If the conversion of assets in-plan is done as a direct rollover to the designated Roth account, and the participant does not receive any of the assets, the plan sponsor should not withhold taxes. Neither can a participant request voluntary withholding under IRC Sec. 3402(p). Since a conversion is generally a taxable event, a plan participant making a direct in-plan Roth conversion may need to increase his or her withholding or make estimated tax payments to avoid an underpayment penalty from the IRS.
  • In contrast, if a plan participant receives a distribution in cash from the plan, the plan sponsor must withhold 20 percent federal income tax even if the participant later rolls over the distribution to a designated Roth account within 60 days. Because plan sponsors do not apply federal income tax withholding to a direct in-plan Roth conversion, a plan participant may need to increase his or her withholding or make estimated tax payments to avoid an underpayment penalty from the IRS.

Conclusion

Because plan sponsors do not apply federal income tax withholding to a direct in-plan Roth conversion, a plan participant may need to increase his or her withholding or make estimated tax payments to avoid an underpayment penalty from the IRS.

 

 

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What does it take to be a QACA?

“Does the IRS have specific requirements that apply to an automatic escalation feature in a qualified automatic contribution arrangement (QACA) 401(k)?

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of discussion

  • Yes, in addition to other requirements for a QACA, the auto-enrollment and escalation features in a QACA must satisfy a minimum and maximum amount related to the percentage of compensation (“default percentage”) that, in the absence of an affirmative election, is automatically deducted from employees’ wages and contributed to the plan as elective contributions [Internal Revenue Code Section (IRC §) 401(k)(13)(C)(iii)].
  • Under Treasury Regulation 1.401(k)-3(j)(2), in general, a default contribution percentage is a qualified percentage only if it is “uniform” for all eligible employees, does not exceed 10%, and satisfies certain minimum percentage requirements. The default percentage must be at least
  • 3% during the “initial period;”
  • 4% during the first plan year following the initial period;
  • 5% during the second plan year following the initial period;
  • 6% during the third and subsequent plan years following the initial period.
  • The initial period is the date an employee is first covered by the QACA through the end of the following plan year. For example, if an employee is eligible under the QACA on 02/01/17, the initial period may run through 12/31/18
  • A uniform percentage, generally, means that the default percentage must be the same for every employee with the same number of years or portions of years since the beginning of the employee’s initial period. The percentage can vary to accommodate certain statutory restrictions, however. For example, the default election is not applied during the period an employee is not permitted to make elective contributions because of a six-month suspension following a hardship withdrawal under Treas. Reg. 1.401(k)-3(c)(6)(v)(B). (Please see Part 4 Examining Process Section 4.72.2.14.3 of the IRS’ Manual for further details and exceptions.)
  • A plan could avoid these automatic increases in the default percentage, often referred to as an “escalator,” by having just one default percentage of between 6 and 10% of compensation.
  • The IRS provides further clarification of QACAs in Revenue Rulings 2009-30.  Plan sponsors must be aware that the auto-enrollment and escalation features in a QACA must satisfy minimum and maximum contribution percentage requirements.

Conclusion

Plan sponsors must be aware that the auto-enrollment and escalation features in a QACA must satisfy minimum and maximum contribution percentage requirements.

 

 

 

 

 

 

 

 

 

 

 

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Decrease in Employer Stock Value

“I’m familiar with employer stock and the special tax treatment for net unrealized appreciation (NUA), but what happens if the employer’s stock decreases in value?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of discussion

  • When distributed from the plan, if the value of the employer’s stock has decreased in value to an amount that is less than the plan participant’s cost basis (attributable to the participant’s after-tax contributions) in the shares, he or she may be able to claim a loss under Internal Revenue Code 165—but not until the year the stock is sold. For additional information, please see IRS Revenue Ruling 72-305. In order to claim the loss, the recipient would need to itemized deductions on his or her tax return.

 

  • There is an exception to the above rule in cases where the stock becomes worthless as a result of the employer’s bankruptcy.  A participant who receives a distribution of worthless stock of a bankrupt employer is entitled to an ordinary loss deduction in the year of the distribution for the total amount of his or her after-tax contributions used to purchase the stock.  For additional information, please see IRS Revenue Ruling 72-328.

Conclusion

Investing in employer stock within a qualified plan can subject the investor to losses, and so should be carefully considered before undertaking.  There are limited circumstances under which a plan participant may claim a loss in value to employer stocks distributed from a qualified retirement plan.

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Fiduciary Rule Transition

What New Disclosure is Required during the Fiduciary Rule Transition Period?

“Our firm will be following the Best Interest Contract Exemption (BICE) under the new investment advice fiduciary rules.  Our compliance department has provided a written notice of fiduciary status for us to use with our clients during the transition period that runs through December 31, 2017. Is this notice required?  

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • No, the written statement of fiduciary status is no longer required during the transition period. This is a recent change that was included in the regulation that delayed the applicability date of the new fiduciary rules to June 9, 2017 (DOL Reg. 2510.3-21).
  • The DOL changed the BICE and Principal Transaction Exemption transition period requirements, making adherence to the Impartial Conduct Standards1 during the transition period (June 9, 2017 through December 31, 2017) the only condition of compliance (removing the need to provide a written statement of fiduciary status as well as other requirements).
  • However, service providers to qualified plans may still be required to provide an updated service and fee disclosure under ERISA §408(b)(2) to reflect a change in fiduciary status as of June 9, 2017.
  • Pursuant to DOL Reg. § 2550.408b-2(c)(1)(iv), covered service providers to qualified retirement plans (e.g., 401(k) plans) who expect to receive at least $1,000 in direct or indirect compensation must provide plan fiduciaries with service and fee disclosures.  As part of the “408b-2” disclosure, service providers must include a statement of fiduciary status, if applicable [DOL Reg. § 2550.408b-2(c)(1)(iv)(B)].
  • Therefore, if a financial advisor’s status as a fiduciary to the plan changes as of the applicability date (June 9, 2017) of the investment advice fiduciary regulations, then he or she is required to provide an updated disclosure to the plan fiduciary reflecting the change in his or her fiduciary status.
  • The updated 408b-2 disclosure must be provided “as soon as practicable, but not later than 60 days from the date on which the covered service provider is informed of such change”  [DOL Reg. § 2550.408b-2(c)(1)(v)(B)]. Consequently, financial advisors should provide the notice by June 9, 2017 and no later than August 8, 2017.

 

Conclusion

Financial advisors should be aware that they may need to issue updated 408b-2 disclosures during the BICE and Principal Transaction Exemption transition period.

 

 

© 2017 Retirement Learning Center, LLC

 

 

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