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Plan Termination and Successor Plans

A financial advisor recently asked:  “What is the successor plan rule and to which plans does it apply?”

ERISA consultants at the Retirement Learning Center (RLC) 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 an advisor in Ohio is representative of a common question on plan termination and successor plans.

Highlights of the Discussion

  • The successor plan rule of IRC 401(k)(10)(A) and Treasury Regulation Section (Treas. Reg. § 1.401(k)-1(d)(4)(i)] provides that a 401(k) plan which is terminated cannot distribute participants’ elective deferrals if the employer maintains or establishes a “successor plan” (a.k.a., an alternative defined contribution plan) within a certain period of time following the termination.
  • A similar rule exists for 403(b) plans in Treas. Reg. §1. 403(b)-10(a)(1).
  • When a 401(k) or a 403(b) plan is terminated, a successor plan would be one that exists at any time during the period beginning on the date of plan termination and ending 12 months after all the assets from the terminated plan are distributed.
  • The successor plan rule was created to prevent employers from circumventing the age 59 ½ early distribution restriction that applies to salary deferrals by simply terminating a 401(k) [or 403(b)] plan to allow for withdrawals and immediately establishing a new successor plan.
  • Consequently, a terminated 401(k) plan could not be replaced by another 401(k) plan within the waiting period. Similarly, a terminated 403(b) plan could not be replaced by another 403(b) plan within the waiting period. (But if an employer terminates its 403(b) plan, it may set up a 401(k) plan with no waiting period if it is otherwise eligible to do so, and vice versa.)
  • For a 401(k) plan, treasury regulations state that the following defined contribution plans are not considered as successor plans: a(n)
    1. Employee stock ownership plan (ESOP),
    2. Simplified employee pension (SEP) plan,
    3. Savings incentive match plan for employees (SIMPLE) IRA plan,
    4. 403(b) plan, or
    5. 457(b) or (f) plan (Treasury Regulation 1.401(k)-1(d)(4)(i)].
  • There is one more exception. Plans that otherwise would be considered a successor plan are not if at all times during the 24-month period beginning 12 months before the date of plan termination, fewer than two percent of the employees eligible to participate in the 401(k) [or 403(b)] plan at the time of its termination are eligible to participate in the new defined contribution plan.

Conclusion

The successor plan rules prevent 401(k) plans and 403(b) plans that are terminated from distributing employee salary deferrals as a result of the termination if the employer maintains or establishes a successor plan within the allotted timeframe. The definition of successor plan is important.

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When Are Retirement Assets Protected from Creditors?

An advisor asked: “Can you give me a refresher on the creditor protection rules for retirement plan assets at the federal and state levels?”

ERISA consultants at the Retirement Learning Center (RLC) 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 an advisor in Minnesota is representative of a common question on creditor protection for retirement plan assets.

Highlights of the Discussion
• The level of creditor protection for retirement plan assets depends on

1) the type of plan assets, and

2) whether the owner of the assets has filed for bankruptcy and, if not, the governing laws of the state with jurisdiction over the assets.

• The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), effective October 17, 2005, clarified the level of creditor protection for retirement plan assets when the owner has filed for bankruptcy.

Bankruptcy
• BAPCPA amended Section 522 of the Bankruptcy Code to exempt from a debtor’s bankruptcy estate retirement assets that are held in

– IRC Sec. 401(a) plans (e.g., 401(k), defined contribution and defined benefit plans);
– 403(b) plans,
– Traditional IRAs (up to $1 million of contributory assets, indexed periodically),
– Roth IRAs (up to $1 million of contributory assets, indexed periodically),
– Simplified employee pension (SEP) plans,
– Savings Incentive Match Plans for Employees (SIMPLE) plans,
– Church plans,
– Governmental plans,
– Multiemployer plans,
– Eligible 457(b) plans of state and local governments and IRC Sec. 501(c)(3) tax-exempt organizations and
– IRC Sec. 501(a) plans of tax-exempt organizations.

• Eligible rollover distributions under IRC Sec. 402(c) retain the unlimited bankruptcy protection given to them while held in the exempt retirement plan if they are contributed to another eligible retirement plan within 60 days of distribution. Earnings on the rollover assets are protected as well.

Nonbankruptcy
• In nonbankruptcy situations, assets held in ERISA plans are fully protected under the anti-alienation provision of the law [see Section 541(c)(2) of the Bankruptcy Code pursuant to Patterson vs. Shumate, 504 U.S. 753 (1992) and Section 206(d)(1) of ERISA].
• The protection of IRA assets (including rollover amounts) from general creditors of the IRA owner in nonbankruptcy situations falls under applicable state law, with many states—but not all—providing some level of exemption. (Link to State Government Websites for more information)
• Keep in mind that any qualified retirement plan or IRA (including traditional, Roth, rollover, SIMPLE or SEP plan IRAs) may be subject to an IRS tax levy.

Conclusion
The amount of creditor protection for retirement assets depends on whether the investor has filed for bankruptcy or not, and the type of retirement savings arrangements involved. For specific situations, individuals should consult legal counsel.

 

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Cybersecurity and Retirement Plans—What’s the Latest?

Can you bring me up to speed on what cybersecurity standards apply to qualified retirement plans?”

ERISA consultants at the Retirement Learning Center (RLC) 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 an advisor in Massachusetts is representative of a common question on what the Department of Labor (DOL) has to say about cybersecurity and retirement plans.

Highlights of the Discussion

Cybersecurity has been a growing topic of importance in the retirement services industry for years. The Bartnett v Abbott Labs et al  court case in 2020 (although later dismissed), along with other cases, have heightened the concern for fiduciary liability related to such breeches. From a historical perspective, there is an understanding under DOL    Regulation Section 2520.104b-1(c)(i)(B)   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.

Most recently, the DOL on April 14, 2021, issued three cybersecurity directives for retirement plans: one for plan sponsors, one for plan recordkeepers and one for plan participants:

  • Tips for Hiring a Service Provider: This piece helps plan sponsors and fiduciaries prudently select a service provider with strong cybersecurity practices and monitor their activities, as required by ERISA
  • Cybersecurity Program Best Practices: This piece assists plan fiduciaries and record-keepers in their responsibilities to manage cybersecurity risks by following these steps.
  1. Have a formal, well documented cybersecurity program.
  2. Conduct prudent annual risk assessments.
  3. Have a reliable annual third-party audit of security controls.
  4. Clearly define and assign information security roles and responsibilities.
  5. Have strong access control procedures.
  6. Ensure that any assets or data stored in a cloud or managed by a third-party service provider are subject to appropriate security reviews and independent security assessments.
  7. Conduct periodic cybersecurity awareness training.
  8. Implement and manage a secure system development life cycle (SDLC) program.
  9. Have an effective business resiliency program addressing business continuity, disaster recovery, and incident response.
  10. Encrypt sensitive data, stored and in transit.
  11. Implement strong technical controls in accordance with best security practices.
  12. Appropriately respond to any past cybersecurity incidents.
  • Online Security Tips: This piece offers plan participants and beneficiaries who check their accounts online basic rules to reduce the risk of fraud or loss.

This trifecta of DOL guidance comes on the heels of two recommendations to the DOL from a February 2021 Government Accountability Office (GAO) report to: 1) formally state whether it is a fiduciary’s responsibility to mitigate cybersecurity risks in defined contribution plans and to 2) establish minimum expectations for addressing cybersecurity risks in defined contribution plans. But despite the release of these three directives, presently, there is no comprehensive federal regulatory regime covering cybersecurity for retirement plans.

Other Sources of Guidance to Consider

The American Institute of CPAs (AICIPA) has developed and maintains a cybersecurity risk management program for use by plan auditors, which includes a Systems and Organizations Controls (SOC) protocol intended to help plan sponsors in creating a strong cybersecurity framework .  This Q&A, “Cybersecurity and employee benefit plans: Questions and answers,” provides an overview of the resources.

The ERISA Advisory Council issued a report in 2016 entitled, “Cybersecurity Considerations for Benefit Plans.” The ERISA Advisory Council suggested the DOL raise awareness about cybersecurity risks and provide information for developing a cybersecurity strategy specifically focused on benefit plans. “The Report” put 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.
  1. 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.
  1. 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 Report concludes with an appendix entitled, Employee Benefit Plans:  Considerations for Managing Cybersecurity Risks (A Resource for Plan Sponsors and Service Providers).

State laws are another consideration. 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.

Conclusion

As fiduciaries of their retirement plans, the DOL requires plan sponsors to ensure the electronic systems they authorize for use in the administration of their plans keeps participants’ personal information relating to their accounts and benefits confidential. While currently no comprehensive cybersecurity protocol for retirement plan administration exists at the federal level—we do have a series of guidelines, suggestions and best practices.

 

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Are Governmental Plans Exempt from ERISA?

“I have a colleague that says governmental retirement plans are exempt from ERISA and one that says they are not. Can you settle the argument? Are retirement plans maintained by governmental entities exempt from ERISA?”

ERISA consultants at the Retirement Learning Center (RLC) 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 an advisor in Wisconsin is representative of a common question on the Employee Retirement Income Security Act of 1974 (ERISA) and retirement plans maintained by governmental entities.

Highlights of the Discussion

  • Yes and no; both answers are partially correct. ERISA consists of five sections or “Titles:”
    • Title I: Protection of Employee Benefit Rights
    • Title II: Amendments to the Internal Revenue Code Relating to Retirement Plans
    • Title III: Jurisdiction, Administration, Enforcement; Joint Pension Task Force, Etc. and
    • Title IV: Plan Termination Insurance
  • Generally, governmental retirement plans are fully exempt from Titles I and IV of ERISA. Those titles cover fiduciary duties, reporting and disclosure requirements, and termination insurance from the Pension Benefit Guaranty Corporation [ERISA Secs. 4(b)(1) and 4021(b)(2)].
  • A few of the provisions of Title II of ERISA apply to governmental plans. Title II relates to the portion of ERISA that amended the Internal Revenue Code and includes certain plan qualification requirements like limits on plan contributions.
  • Governmental plans are subject to Title III of ERISA, which contains procedures for co-coordinating enforcement efforts between the Department of Labor and Treasury Department.
  • While governmental plans are exempt from the federal fiduciary requirements of Title I of ERISA, they are subject to any fiduciary requirements imposed by applicable state laws. For example, California Government Code Section 53213.5 applies fiduciary standards and responsibilities to plans of governmental entities that essentially mirror those fiduciary standards and responsibilities in Title I of ERISA. Similarly, Florida imposes a federal-like fiduciary standard on plan officials under Florida Statute 112.656.
  • Other state statutes have fiduciary provisions that may be different than federal fiduciary rules. A sponsor of a governmental plan must be familiar with the fiduciary standards of its state, as well as other state laws that may affect the operation of its plan.

Conclusion

As a rule, retirement plans of governmental employers are exempt from the federal fiduciary requirements imposed under Title I of ERISA, as well as the plan termination insurance requirements under Title IV.  However, it is important for plan sponsors and others who may have discretionary authority over governmental plans to consider any fiduciary requirements and other legal requirements under applicable state law.

 

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Five-Part Test Involves Reasonable Understanding

“Can you give me real-world insight into the five-part test the Department of Labor (DOL) will apply for determining whether an advisor or firm is giving fiduciary investment “advice?”

ERISA consultants at the Retirement Learning Center (RLC) 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 an advisor in North Carolina is representative of a common question on what constitutes investment advice.

Highlights of the Discussion

To determine whether investment guidance rises to the fiduciary level of investment advice, the DOL and IRS will apply the following five-part test (see PTE 2020-02  and IRS FAQs on PTE 2020-02. If the answer is “yes” to all five of the following test questions, and the advisor receives payment for the advice, he or she is an investment advice fiduciary, and would have to follow a prohibited transaction exemption (PTE) (e.g., PTE 2020-02) to receive payment for the advice.

Five-Part Test Questions

Consideration:  Authorities will consider written statements disclaiming any element of the five-part test but the disclaimers will not in and of themselves be determinative of fiduciary status. Firms and investment professionals cannot use written disclaimers to undermine reasonable investor understandings.

Yes No
1.    Will the advisor render advice to the plan, plan fiduciary, or IRA owner as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property? 

 

Consideration:  Advice could include a recommendation to an investor to conduct a rollover. A recommendation to roll assets out of a retirement plan is advice with respect to moneys or other property of the plan and, if provided by a person who satisfies all of the requirements of the five-part test, constitutes fiduciary investment advice.

2. Will the advice be given on a regular basis?

Considerations:  Whether advice to rollover assets from a workplace retirement plan to an IRA constitutes advice “on a regular basis” depends on whether the advice

·         Is a single, discrete instance;

·         Occurs as part of an ongoing relationship; or

·         Occurs at the beginning of an intended future ongoing relationship that an individual has with an investment advice provider.

3. Is the advice given pursuant to a mutual agreement, arrangement, or understanding with the plan, plan fiduciary or IRA owner?

Consideration:  When making a determination on this question, the DOL intends to consider the reasonable understandings of the parties based on the totality of the circumstances.

4.  Will the advice serve as a primary basis for investment decisions with respect to plan or IRA assets? 

Consideration:  The recommendation need only be “a” primary basis for investment decisions—not necessarily “the” primary basis for investment decisions—before it would deem to satisfy this prong of the five-part test.  If the parties reasonably understand that the advice is important to the investor and could affect the investor’s decision, that is enough to satisfy the primary basis requirement.

5.  Will the advice be individualized based on the particular needs of the plan or IRA?

Consideration: Put another way, is the advisor making an individualized recommendation to an investor upon which he or she will rely on to make an investment decision? Here again, the DOL will look at the reasonable understandings of the parties based on the totality of the circumstances.

 

Conclusion

Although the DOL’s five-part test for fiduciary investment advice may seem straightforward, there are important subtleties that come into play.  The DOL will consider the reasonable understandings of the parties based on the totality of the circumstances.

 

 

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