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Economically targeted investing—ERISA considerations

“A number of my clients have asked about economically targeted investing (ETI). Are there any special considerations of which I need to be aware?”

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, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from New Jersey is representative of a common inquiry related to selecting plan investments.

Highlights of the Discussion

Plan fiduciaries under the Employee Retirement Income Security Act of 1974 (ERISA) should be aware of the Department of Labor’s (DOL’s) stance and guidance on ETI. First, let’s wrap our heads around what ETI is, and the many names by which it is known.

ETI is a type of investment behavior where an individual or plan committee considers the economic, social and/or corporate governance benefits of an investment, in addition to its propensity for favorable returns, when making investing decisions. Other common names for this behavior include socially responsible investing, sustainable and responsible investing, environmental, social and governance (ESG) investing, green investing and impact investing.

ESG criteria are many and varied. The Forum for Sustainable and Responsible Investment offers the following common examples of ESG criteria, but there are surely others:

Environmental Social Corporate Governance
Water Use & Conservation Workplace Safety Corporate Political Contributions
Sustainable Natural Resources Labor Relations Executive Compensation
Pollution/Toxins Workplace Benefits Board Diversity
Clean Technology Diversity & Anti-Bias Issues Anti-Corruption Policies
Climate change/Carbon Community Development Board Independence
Green Building/Smart Growth Avoidance of Tobacco or Other Harmful Products  
Agriculture Human Rights  

Over the past 35 years, various members of the financial industry have asked the DOL to opine on the use of ESG investments within qualified retirement plans given the constraints of ERISA. ERISA requires plan fiduciaries to make decisions with respect to their plans that are in the best interests of the participants and beneficiaries, with their decisions being held to an expert standard. Selecting and monitoring plan investments is well within this purview.

Through several DOL interpretive bulletins (IBs), culminating with IB 2015-01, the DOL has confirmed its longstanding view that, “… plan fiduciaries may invest in ETIs based, in part, on their collateral benefits so long as the investment is appropriate for the plan and economically and financially equivalent with respect to the plan’s investment objectives, return, risk, and other financial attributes as competing investment choices.” Some have referred to this standard as the “all things being equal” test. Put another way, “Would the investment make the cut as a plan investment using ERISA standards if it were not ESG conscious?”

What about a plan’s investment policy statement (IPS), the written document that provides fiduciaries with general instructions for making investment management decisions? If ESG investing is an objective of the plan, then the DOL deems it appropriate for a plan’s IPS to reference the process and criteria for inclusion of such investments. Moreover, prudence dictates plan fiduciaries maintain records sufficient to demonstrate compliance with ERISA’s evaluation requirements and IPS guidelines.

Conclusion

All things being equal, plan fiduciaries can consider an investment’s ESG criteria as part of an ETI objective as long as the investment otherwise meets ERISA’s best interest and prudent expert standards.

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Deferral limit, multiple plans and excess deferrals

“What is a plan participant’s deferral limit if he or she participates in more than one 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, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Connecticut is representative of a common inquiry related to contribution limits.

Highlights of the Discussion

The IRC § 402(g) annual limit on employee salary deferrals is an individual taxpayer limit—not a per plan limit. Consequently, an individual under age 50 for 2018 was limited to deferring 100 percent of compensation up to a maximum of $18,500 (or $24,500 if age 50 or more)—regardless of the number of plans in which he or she participated during the year. For 2019, the respective limits are $19,000 and $25,000.

This annual limit is inclusive of employee salary deferrals (pre-tax and designated Roth) an individual makes to all of the following plan types:

  • 401(k),
  • 403(b),
  • Savings incentive match plans for employees (SIMPLE) plans [both SIMPLE IRAs and SIMPLE 401(k) plans[1]] and
  • Salary reduction simplified employee pension (SARSEP) plans.[2]

(Note: A person who participates in a 457(b) plan has a separate deferral limit that includes both employee and employer contributions.)

If a taxpayer exceeds the annual limit—the result is an excess deferral that must be timely corrected. The IRS could disqualify a plan for violating the elective deferral limitation, resulting in adverse tax consequences to the employer and employees under the plan. But there are ways to correct the error. It is important to follow the correction procedures contained in the governing plan document.

Generally, if a participant has excess deferrals based on the elective deferrals made to a single 401(k) plan or plans maintained by the same employer, then the plan must return the excess deferrals and their earnings to the participant no later than April 15th of the year following the year the excess was created [Treas. Reg. § 1.402(g)-1(e)(1)].

In the case of an employee who participates in more than one salary deferral-type plan of unrelated employers, it may be difficult for the plan sponsor to recognize there is an excess deferral. Therefore, the onus is on the participant to notify the plan administrator of the amount of excess deferrals allocated to the plan prior to the April 15th correction deadline (usually a notification date is specified in the plan).

[1] The 2018 limit for deferrals to a SIMPLE IRA or 401(k) plan is $12,500 ($15,500 if age 50 or more).

[2] The 2018 limit for deferrals to a SARSEP plan is 25% of compensation up to $18,500 ($24,500 if age 50 or more).

document). The plan is then required to distribute the excess and earnings to the participant no later than the April 15th correction deadline [Treas. Reg. § 1.402(g)-1(e)(2)].

If the excess deferrals are timely withdrawn by the April 15th correction deadline, then

  • The excess deferrals are taxed in the calendar year deferred;
  • The associated earnings are taxed in the year distributed;
  • There is no 10% early distribution penalty tax; and
  • There is no 20% withholding (since the amounts are ineligible for rollover).

If the excess deferrals are withdrawn after the April 15th correction deadline, then

  • Each affected plan of the employer is subject to disqualification and would need to go through the IRS’s Employee Plans Compliance Resolution System (EPCRS) to properly correct the error;
  • The excess deferrals are subject to double taxation—taxed in the year contributed and in the year distributed;
  • The associated earnings are taxed in the year distributed; and
  • The excess deferrals could also be subject to the 10% early distribution penalty tax if no exception applies.

EXAMPLE 1

Joe, a 45-year old worker, made his full salary deferral contribution of $18,500 to Company A’s 401(k) plan by October 2018. He then left Company A to go to work for Company B, an unaffiliated company, on November 1, 2018, and was immediately allowed to participate in the 401(k) plan. Not understanding how the 402(g) limit works, he begins making salary deferral contributions to Company B’s 401(k) plan. In December his financial advisor informed him that may have over contributed for 2018.

The onus is on Joe to report the excess salary deferrals to Company B. Company B is then required to distribute the excess deferrals and earnings by April 15, 2019.  The plan document also requires forfeiture of any matching contributions associated with the excess deferral.

Conclusion

Although the annual IRC §402(g) employee salary deferral limit is an individual employee limit, exceeding it can have consequences for both the employee and the plan sponsor. Timely correction of the excess is key to minimizing possible negative effects.  Plan sponsors should review the correction procedures outlined in their plan documents, and follow them carefully should they detect or be informed of an excess deferral. Also rely on the IRS’s EPCRS corrections program.

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401(k) Record Retention Rules

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401(k) After-Tax Contributions May Be Testy–But Worth It

“What are the limitations, if any, on making after-tax contributions to a 401(k) plan?” Read more

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