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What is a 10b5-1 plan?

“Is a 10b5-1 plan a type of qualified retirement plan?”

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 a financial advisor from Kansas is representative of a common inquiry related to trading securities.

Highlights of the Discussion

No, it is not a “qualified plan” in the sense of a 401(k) or profit sharing plan, which meets requirements for favorable tax treatment under Internal Revenue Code 401(a). A 10b5-1 plan is a buy/sell agreement for securities that meets the requirements of the Securities Exchange Commission’s Rule 10b5-1 related to “insider trading.”

Legal insider trading occurs when corporate insiders—officers, directors, and employees—buy and sell stock in their own companies and report their trades to the SEC. Illegal insider trading refers to an insider using material, nonpublic information to buy or sell securities to his or her  advantage.  A 10b5-1 plan is a written contract between an insider and his or her broker to buy or sell company stock at a time when the insider is not in possession of any restricted information related to the stock. A 10b5-1 plan is a way for insiders to trade company securities and minimize legal exposure by giving them an affirmative legal defense. An affirmative defense is not a safe harbor nor will it protect a person from allegations of wrongdoing. It allows a person to refute allegations of wrongdoing.

In order for a 10b5-1 plan to serve as a defense against charges of insider trading, it must meet the following criteria:

  1. Entered into in good faith without intent to abuse Rule 10b5-1;
  2. Adopted when the individual trading the security was not aware of any material, nonpublic information;
  3. The terms of the plan contains a pre-set formula for determining the amount, price and date of transactions;
  4. The individual subsequently cannot affect criterion #3 once it is in place;
  5. The purchase or sale of the security was made according to the plan.

Anyone can adopt a 10b5-1 plan, although it is generally used by large stock holders, directors and officers of the company. A company’s internal trading policies should address 10b5-1 plans, if they are offered.

EXAMPLE

Erin, an executive at Enrun Corporation, executes a written, one-year contract between herself and her broker that instructs the broker to sell 10,000 shares of Enrun on the first trading day of each month and twice as many shares (20,000) if the price has increased by 5% since the prior sale date. On the surface, this contract, generally, would meet the requirements to be a 10b5-1 plan.

Conclusion

A properly executed 10b5-1 plan can stand as an affirmative defense against allegations of insider trading for someone who is in a position to have material, nonpublic information. Extreme care should be used when establishing and using such plans as they are not infallible, however. Consult a legal expert.

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Financial Wellness

“I’ve heard the broad term ‘financial wellness or wellbeing’ more and more frequently in relation to retirement plan participants. What is financial wellness?” 

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 a financial advisor from Colorado is representative of a common inquiry related to plan participant education.

Highlights of the Discussion

The phrase likely started with the Consumer Financial Protection Bureau (CFPB). It seems the CFPB had concluded employee financial education has not been successful in encouraging plan participants to save more for retirement. The CFPB suggests the way to fix the problem of faulty employee education is by redefining 1) what the goal of financial education is, and 2) how employees can get there, within the context of behavioral economics/finance.

In 2015, the CFPB defined the goal of financial education as “financial wellbeing,” in its report Financial Well-being: The Goal of Finance Education. Financial well-being is a state of being wherein a person can fully meet current and ongoing financial obligations, can feel secure in his or her financial future, and is able to make choices that allow enjoyment of life. The CFPB has concluded overall financial wellness consists of four elements as illustrated below.

In the last four years, the percentage of plans that offer a comprehensive financial wellness program has grown from 16% to 23%, according to the Plan Sponsor Council of America. What are the most common employee concerns addressed by financial wellness programs?

  • Getting overall spending under control (41%),
  • Preparing for retirement (39%),
  • Paying off debt (31%),
  • Saving more for major goals (e.g., purchases, home, education) (27%),
  • Better management of my investments/asset allocation (23%), and
  • Better manage of healthcare expenses/saving for future healthcare expenses (12%).

The Employee Benefits Research Institute (EBRI) found an overwhelming majority of workers thought the following financial wellness programs would be either very or somewhat helpful:

  • Help calculating how much to save for a secure retirement (75%);
  • Help calculating how much to anticipate spending each month in retirement (72%);
  • Planning for health care expenses in retirement (72%); and
  • Help with comprehensive financial planning (68%).

The CFPB conducted a five-year study on consumer financial education, which culminated in a 2017 report in which it identified five principles of financial education that make the biggest difference between financial success and failure.

Principle 1: Tailor information to the specific circumstances, challenges, goals, and situational factors of the individuals served. Avoid a one-size-fits-all approach.

Principle 2: Provide timely information that is relevant and actionable to a specific situation or goal, so that information and skills are more likely to be retained.

Principle 3: Improve key financial skills.

Principle 4: Help people build qualities that strengthen and reinforce their determination to take specific steps to achieve their financial goals.

Principle 5: Help create habits and systems so that it’s easy to follow through on decisions.

The CFPB has a resource guide available on how to launch a workplace financial wellness program by following eight basic steps:

  1. Focus on your human resources (HR) strategy;
  2. Identify possible internal challenges;
  3. Understand your workforce’s unique needs;
  4. Decide which financial topics to highlight;
  5. Leverage existing employee benefits;
  6. Expand your employee offerings with more financial education resources;
  7. Use existing or new channels and opportunities to deliver resources; and
  8. Establish metrics for success for your financial wellness program.

Conclusion

Financial wellness is more than educating plan participants. It is taking financial education to the next level to help plan participants fully meet current and ongoing financial obligations, feel secure in their financial future, and be able to make choices that allow enjoyment of life.

 

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What is a stretch IRA?

“What is a stretch IRA?”

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 a financial advisor from Arkansas is representative of a common inquiry related to beneficiary payout timelines.

Highlights of the Discussion

Contrary to popular belief, a stretch IRA is not a unique type of IRA. It is simply a type of distribution strategy that allows beneficiaries, and beneficiaries of beneficiaries, to base IRA payouts on the longest life expectancy permitted under the circumstances. Any regular IRA, simplified employee pension (SEP) IRA, saving incentive match plan for employees (SIMPLE) IRA or Roth IRA can be a stretch IRA. The stretching feature is achieved by applying standard distribution rules that allow beneficiaries to prolong payouts over an applicable life expectancy.

According to Treasury regulations, following the death of an IRA owner or plan participant, typically, the beneficiary has the option to take life expectancy payments. Moreover, if the beneficiary has not exhausted the payments upon his or her death, a subsequent beneficiary may continue the payments over the course of the remaining schedule. Note that some IRA beneficiary forms allow a beneficiary to name a beneficiary, whiles others do not. Most qualified retirement plan beneficiary forms do not permit a beneficiary to name a beneficiary.

EXAMPLE

Herb, age 75, has an IRA valued at $2 million. His wife, Judith, who is 20 years his junior, is his beneficiary. The couple has a special-needs child, Richard, who is 30 years old. Herb has been taking RMDs based on the joint life expectancy of Judith and himself (because she is more than 10 years younger than he). As a result of failing health, Herb passes away. Rather than treat the IRA as her own, which would subject her to the early distribution penalty tax for any amounts taken before she reaches age 59 1/2, Judith begins life expectancy payments as a beneficiary. Because the IRA forms permitted it, Judith named Richard as the beneficiary of her inherited IRA. At age 58, Judith dies. Richard may continue distributions from the IRA over Judith’s remaining life expectancy, nonrecalculated.

The ability to do a stretch IRA may come to an end if HR 1994 Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) is enacted into law. Section 401 of the bill would modify the required minimum distribution rules with respect to defined contribution plans and IRAs upon the death of the account owner. Under the legislation, depletion of the account would be required by the end of the 10th calendar year following the year of the employee or IRA owner’s death. A few exceptions would apply.

Conclusion

A stretch IRA is not a specific type of IRA but, rather, is a distribution strategy that allows beneficiaries, and beneficiaries of beneficiaries, to continue IRA payouts on the longest life expectancy permitted pursuant to the given circumstances. A stretch IRA is only permitted if the underlying beneficiary forms can accommodate a beneficiary naming a beneficiary. Legislative changes have been proposed that would, if enacted, eliminate stretch IRAs.

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What is 412(e) plan?

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 a financial advisor from New York is representative of a common inquiry related to a type of retirement plan.

Highlights of the Discussion

An IRC Sec. 412(e)(3) plan is a unique type of defined benefit plan that is funded exclusively by the purchase of life insurance contracts, fixed annuity contracts or a combination of the two. Because of this design, 412(e) plans do not require the services of an enrolled actuary to calculate the annual contributions. A fully insured 412(e)(3) defined benefit plan may be a plan solution for the owner of a small business or professional enterprise who desires a large current tax deduction for contributions and secure guaranteed retirement income. The most likely candidates for a 412(e) plan are small, professional businesses that want to maximize contributions for their owners. They work best for business that are small (five or fewer employees), well established, highly-profitable and have an older owner and younger employees.

IRC Sec. 412(e) plans are subject to the same qualification requirements that apply to traditional defined benefit plans, with two exceptions. First, if the insurance contracts meet the requirements of IRC Sec. 412(e)(3) and Treasury Regulation 1.412(i)-1(b)(2) as outlined below, the plan is exempt from the normal minimum funding requirements of IRC §412.

  1. The plan must be funded exclusively by the purchase of individual annuity or individual insurance contracts, or a combination thereof from a U.S. insurance company or companies. The purchase may be made either directly by the employer or through the use of a custodial account or trust.
  2. The individual annuity or individual insurance contracts issued under the plan must provide for level annual, or more frequent, premium payments to be paid under the plan for the period commencing with the date each individual participating in the plan became a participant, and ending not later than the normal retirement age for that individual or, if earlier, the date the individual ceases participation in the plan.
  3. The benefits provided by the plan for each individual participant must be equal to the benefits provided under his or her individual contracts at normal retirement age under the plan provisions.
  4. The benefits provided by the plan for each individual participant must be guaranteed by the life insurance company.
  5. All premiums payable for the plan year, and for all prior plan years, under the insurance or annuity contracts must have been paid before lapse.
  6. No rights under the individual contracts may have been subject to a security interest at any time during the plan year. This subdivision shall not apply to contracts which have been distributed to participants if the security interest is created after the date of distribution.
  7. No policy loans, including loans to individual participants, on any of the individual contracts may be outstanding at any time during the plan year. This subdivision shall not apply to contracts which have been distributed to participants if the loan is made after the date of distribution.

Second, a 412(e) plan will automatically satisfy the accrued benefit test if the plan satisfies items 1 through 4 above, plus provides that an employee’s accrued benefit at any time is not less than what the cash surrender value of his/her insurance contracts would be if all premiums due are paid, no rights under the contracts have been subject to a security interest at any time, and no policy loans are outstanding at any time during the year.

Note that the IRS has identified certain abusive sales practices involving 412(e)(3) plans funded only with life insurance rather than a combination of life insurance and annuities. Therefore, such plans will invite greater scrutiny by the IRS. (See EP Abusive Tax Transactions – Deductions for Excess Life Insurance in a Section 412(i)[1] or Other Defined Benefit Plan for specific guidance.)

Conclusion

A 412(e)(3) plan is a niche defined benefit retirement plan that allows for higher than usual tax deductible contributions. It is most suitable for businesses that are owner-only, or have fewer than five employees where the owner is materially older than the employees. Business owners should consult with a tax professional or attorney to determine whether a 412(e)(3) plan is the right choice for their firms.

[1] 412(e) plans were formerly know as 412(i) plans. The Pension Protection Act of 2006 renumbered the code section.

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IRS exams and Form 872

“My client is going through an IRS examination of his company’s retirement plan, and he has been asked to sign a Form 872. What is the purpose of this form?”

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 a financial advisor from California is representative of a common inquiry related to an IRS examination.

Highlights of the Discussion

To ensure timely examination of tax returns, the law prescribes a deadline, or statute of limitations, for assessing taxes, making refunds or crediting taxes related to a particular tax return. By law, the IRS has the authority to extend the period of time for which it may assess a tax on a taxpayer [IRC Sec. 6501(c)(4)]. However, a taxpayer must consent to the extension in order for it to be valid; that’s where IRS Form 872, Consent to Extend the Time to Assess Tax comes in.

The assessment statute of limitations generally limits the time the IRS has to make tax assessments to within three years after a return is due or filed, whichever is later. In certain limited circumstances, the IRS examiner may identify tax returns under examination for which the statutory period for assessment is about to expire and may request that the taxpayer (in this case, the plan sponsor) extend the assessment statute of limitations.

It is the policy of the IRS to secure consents to extend the period of time to assess tax only in cases involving unusual circumstances (see Revenue Procedure 57-6 text reprinted below). Two common reasons are 1) the limitation period for a taxable year under examination will expire within 180 days and there is insufficient time to complete the examination and the administrative processing of the case; or 2) the statute of limitations for the taxable year under examination requires extension so the case can go through an appeals process. For a broader list of potential reasons for an extension see the IRS examination manual at 25.6.22.2.1.

How can a plan sponsor respond to an assessment extension request? There are four options:

  1. Consent to an extension;
  2. Refuse to extend the period of time for assessment;
  3. Request that the extension be limited to particular issues; or
  4. Request that the period for assessment be limited to a particular period of time, for example, to a specific date.

For additional information and guidance, see IRS Publication 1035, Extending the Tax Assessment Period.

What benefit could the plan sponsor receive from an assessment extension? The statute of limitations also limits the time a taxpayer has to file a claim for credit or refund. The IRS is legally prohibited from making a refund or credit for a claim if it is filed after the time for filing has expired under the statute of limitations. Also, if a taxpayer were to disagree with the IRS’s examination findings, the IRS cannot provide the taxpayer with an administrative appeal unless sufficient time remains on the statute of limitations.

Conclusion

Some plan sponsors facing a plan examination from the IRS may be asked to sign a Form 872, but that should only be in situations with unusual circumstances.

Rev. Proc. 57-6 (reprinted)

It is the policy of the Internal Revenue Service to secure a consent, extending the statutory period of limitation upon assessment of income and profits tax, only in a case involving unusual circum­stances. It is the purpose of the Service to keep to an absolute minimum the number of consents obtained from taxpayers.

The Internal Revenue Service has been asked to state its policy and issue a guide for taxpayers and practitioners regarding the circum­stances under which the securing of a waiver or consent provided for by. section 6501 (c) (4) of the Internal Revenue Code of 1954, to extend the period of limitation upon assessment of income and profits tax, is appropriate.

It has been the long-established policy of the Service to secure a consent, extending the statutory period of limitation, only in a case involving unusual circumstances. An examining officer must have the approval of his group supervisor prior to requesting a consent. Approval will not be granted in any case where previous contact with the taxpayer has not been made, except where compelling reasons exist.

It is the policy and purpose of the Service to keep to an absolute minimum the number of consents obtained from taxpayers. The audit program of the Service is set up to obtain the completion of the examination of returns within the present statutory period of limi­tation wherever possible. Nevertheless, situations arise which make it impossible for the examining officers to complete some of their examinations within the statutory period. As an example, an issue involved in a particular taxpayer’s case may be similar to an issue in litigation in the case of another taxpayer or the same issue may be pending decision by the courts with reference to some other year of the same taxpayer. Obviously, in an instance of this nature, the examination cannot be satisfactorily completed until such time as the court’s decision has been rendered and the issue resolved.

Similarly, where disagreement exists regarding some complex or intricate question of fact or doubtful issues of law and sufficient time does not remain within the statutory period to permit the taxpayer to gather the necessary data to support his contentions and to avail himself of his conference and appellate rights, there is no alternative, in the interest of a practical administration of the tax laws, but to request a consent from the taxpayer, extending the statutory period of limitation, in order to arrive at an equitable solution to the problem involved.

Also, where a net operating loss is to be applied as a carry back, sufficient time may not remain to complete the necessary audit action within the regular period and, accordingly, an extension of the period of limitation is obtained, an action of mutual benefit to the taxpayer and the Government. In these examples, and in other instances, the possibility exists that an additional or renewal consent may be found necessary. However, it is the policy of the Service to restrict addi­tional consents to such cases as were the circumstances are, ordinarily, beyond the control of the Service and a further extension is fully justified in the opinion of the supervisory officials concerned, after a thor­ough review of all the facts present in the case.

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CalSavers Sign Up Begins

“The CalSavers program has been in the news. What is it?”

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 a financial advisor from California is representative of a common inquiry related to types of retirement plans.

Highlights of the Discussion

The CalSavers Retirement Savings Program (CalSavers) is a mandatory retirement savings program run by the state of California for private sector workers of California. California state law requires employers to either offer their own retirement plan[1] or register to facilitate CalSavers. On threat of penalty,[2] the employer is required to register with the state for CalSavers if the business

  • Has at least five California-based employees, at least one of whom is age 18, and
  • Does not sponsor a qualified retirement plan.

July 1, 2019, marked the opening for registration. There are staggered compliance deadlines depending on the size of employer. For eligible employers with

  • More than 100 employees, the deadline to participate is June 30, 2020;
  • More than 50 employees, the deadline to participate is June 30, 2021; and
  • With five or more employees, the deadline to participate is June 30, 2022.

Employer Involvement

An eligible employer is responsible for registering for the program, providing basic employee roster information to the state for eligible employees (i.e., name, date of birth, Social Security Number or ITIN, and contact information), and facilitating by payroll deduction the appropriate contributions each pay cycle.

Employee Involvement

Covered employees are automatically enrolled in CalSavers, and the state will contact employees directly to make them aware of the program and inform them of their ability to opt-out or customize their contributions. The default contribution is five percent of an employee’s gross salary, with an automatic one percent increase each year up to a maximum of eight percent. Currently, the CalSavers Program uses after-tax Roth IRAs, but is working on adding a Traditional IRA choice in late 2019 or early 2020. For 2019, the contribution limit is $6,000 for those under age 50 and $7,000 for those ages 50 and over. Note that this limit applies to all of an individual’s IRAs in aggregate—including a CalSavers account. Standard Roth IRA distribution rules apply. Unless an employee selects another investment option, the first $1,000 in contributions will be invested in the CalSavers Money Market Fund and subsequent contributions will be invested in a target retirement date fund based on the individual’s age. Employees can decide at any time whether to keep their investments in these funds or choose from a menu of other investment options. That’s just the top of the waves. The CalSavers website contains a wealth of information for employers and savers.

Conclusion

Registration is now officially open for the California-run CalSavers Retirement Savings Program—a automatic Roth IRA program for California workers who do not have access to a workplace retirement plan.

[1] Qualified retirement plans include pension plans; 401(k) plans; 403(a) plans; 403(b) plans; Simplified Employee Pension (SEP) plans; Savings Incentive Match Plan for Employees (SIMPLE) plans; or Payroll deduction IRAs with automatic enrollment.

[2] A penalty of $250 per eligible employee applies if noncompliance extends 90 days or more after notice, and if found to be in noncompliance 180 days or more after notice, an additional penalty of $500 per eligible employee will apply.

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De-villainizing Backdoor Roth IRAs

“Backdoor Roth IRAs sound bad. Are they?”  

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 a financial advisor from California is representative of a common inquiry related to Roth IRA conversions.

Highlights of the Discussion

You won’t find the phrase backdoor Roth IRA in the Internal Revenue Code or Treasury regulations. Nor is it a specific product, but the industry has known about the phenomena for years.  A backdoor Roth IRA is merely a series of transactions or steps an individual can take to have a Roth IRA—regardless of income level.

The ability to make a 2019 Roth IRA contribution is phased out and eliminated for single tax filers with income between $122,000-$137,000; and for joint tax filers with income between $193,000-$203,000. Consequently, if a person earns too much, he or she cannot make a Roth IRA contribution directly (i.e., through the front door). But, many can still take another route—through a traditional IRA.

For traditional IRA contributions, there are modified adjusted gross income (MAGI) thresholds that apply above which individuals are prevented from making deductible contributions.[1] However, anyone under the age of 70½ with earned income can make a nondeductible contribution to a traditional IRA, regardless of income level.  Anyone with a traditional IRA can convert it to a Roth IRA regardless of income level. The traditional-IRA-to-Roth-IRA conversion is another route to having a Roth IRA—what has become known as the backdoor Roth.

IRA technicians through the years have raised the specter of the Step Transaction Doctrine to cast a shadow over the efficacy of the backdoor Roth IRA. The Step Transaction Doctrine is a broad application tax law policy in which the IRS may view a series of separate but related transactions as a single transaction and apply any tax liability based on that transaction rather than the individual transactions in the series.

A traditional-IRA-to-Roth-IRA conversion is a taxable event to the extent a person converts pre-tax dollars. There are ways to maximize the tax efficiency of the transaction, for example, by rolling over IRA pre-tax dollars first to a qualified retirement plan. Those strategies are beyond the scope of this writing, but the consultants at RLC’s Resource Desk would be happy to have those discussions.

Informal guidance from the IRS and Congress from a year ago seems to have put to rest the concerns about backdoor Roth IRAs and the Step Transaction Doctrine. First, Congress made reference to the legitimacy of the traditional-IRA-to-Roth-IRA conversion in its conference report for the Tax Cut and Jobs Act (see page 289).

Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA.

Second, in a July 10, 2018, Tax Talk Today, Donald Kieffer Jr., a tax law specialist in employee plans rulings and agreements with the IRS Tax-Exempt and Government Entities Division, said the backdoor Roth is allowed under the law. Mr. Kieffer stated: “I think the IRS’s only caution would be whenever we see words like ‘backdoor’ or ‘workaround’ or other step transactions that are putatively enabling a way to get around limits – especially statutory contribution limits – you generally find the IRS is not happy and prepared to challenge those. But in this one that we’re talking about, it’s allowed under the law.”

Conclusion

According to IRS and Congressional guidance, “backdoor” is no longer a cue for a potentially illicit tax activity when linked to Roth IRA. Therefore, it’s time to de-villainize the transaction.

[1] If filing a joint return and covered by a workplace retirement plan $103,000,-$123,000; Single or head of household $64,000-$74,000; and Joint return with spouse not covered by a workplace plan $193,000-$203,000

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What is a “flexible” ERISA 3(38)

“Is there such a thing as a ‘flexible’ ERISA 3(38) fiduciary?”  

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 Hampshire is representative of a common inquiry related to ERISA fiduciary services.

Highlights of the Discussion

According to a strict reading of ERISA and its regulations under 29 U.S.C. Title 29 §3(38)—no; there is no such legally defined entity. However, in practice, there are ERISA 3(38) fiduciary services that are advertised as “flexible.” Let’s start with the definition of an ERISA §3(38) plan fiduciary. An ERISA 3(38) fiduciary is an investment manager that is a registered investment advisor (e.g., RIA, bank or insurance company), appointed by the plan sponsor to fully manage the assets of the plan. Such individual or entity has the power to manage, acquire, or dispose of any asset of a plan; is responsible for selecting, monitoring and replacing plan investment options; and has full discretion regarding a plan’s investment management process. When the 3(38) fiduciary is appointed, a written agreement must be executed acknowledging the 3(38)’s fiduciary responsibility for managing the assets of the plan. ERISA 3(38) relieves the plan sponsor of fiduciary liability with respect to the selection, performance, monitoring and replacement of the investments for a plan when the sponsor has prudently selected the 3(38) investment manager; and the sponsor continues to monitor the 3(38)’s services. As one can see, the strict definition of an ERISA 3(38) does not seem to leave room for too much, if any, flexibility.

A few firms that offer 3(38) services have added the “flexible” moniker or adjective to describe situations where the plan sponsor can provide the 3(38) investment manager with “suggestions” regarding the investment line up. These plan sponsor suggestions could range widely from encouraging the 3(38) to take over and assume responsibility for an existing investment line up; providing input on investments the plan sponsors would like the 3(38) to add to the 3(38)’s available options; or having the ability to select from a broad universe of investments that are within the 3(38)’s fiduciary coverage universe to create the investment line up. The gnawing question becomes has the plan sponsor exerted discretion over the investment decisions and, thereby, clawed back some of the fiduciary responsibility it sought to relinquish? There is no clear answer. It is another one of those “facts and circumstances” situations the DOL and courts would evaluate on a case by case basis. But it is important to be aware of and take into consideration when making a decision that flexibility can muddy the fiduciary liability and relief waters.

Conclusion

Some firms advertise a flexible 3(38) investment management solution. Plan sponsors and their advisors should be sure they 1) understand what precisely the flexibility is; 2) evaluate if it could potentially affect liability; 3) make a prudent, educated decision based on the information; and 3) record the decision making process for their fiduciary process records.

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Qualified Separate Line of Business

“How are the qualified separate line of business (QSLOB) rules helpful for a defined contribution 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 Massachusetts is representative of a common inquiry related to plan testing.

Highlights of the Discussion

The QSLOB rules can help a plan satisfy minimum coverage rules. Among other requirements, a defined contribution plan must cover or “benefit” a minimum number of a firm’s employees in order to remain qualified and receive favorable tax treatment from the IRS [Treasury Regulation Section (Treas. Reg. §) 1.410(b)-1]. Generally, all employees of a single employer are considered when applying the minimum coverage requirements. One exception to applying this test on a firm-wide basis exists by following the QSLOB rules of Treas. Reg. §1.414(r)-8. If an employer operates QSLOBs, then it may apply the minimum coverage requirement separately with respect to the employees of each QSLOB. That could make it easier for the employer to pass testing.

Treas. Reg. §1.414(r)-1

The above flow chart from the IRS is a helpful guide and is explained as follows. A line of business (LOB) is a portion of an employer that is identified by the property or services it provides to customers of the employer. For this purpose, the employer is permitted to determine the LOBs it operates by designating the property and services that each of its LOBs provides to customers of the employer.

A separate LOB (SLOB) is a line of business that is organized and operated separately from the remainder of the employer. In order to be a SLOB, the LOB must satisfy four statutory requirements 1) separate organizational unit; 2) separate financial accountability; 3) separate employee workforce; and 4) separate management [Treas. Reg. §1.414(r)-3].

In order to be a qualified SLOB (QSLOB), the SLOB must meet three additional requirements: 1) it must have 50 dedicated employees at all times during the testing year; 2) the employer must notify the Secretary of the Treasury that it intends to treat a SLOB as a QSLOB (by filing IRS Form 5310-A, Notice of Plan Merger or Consolidation, Spinoff, or Transfer of Plan Assets or Liabilities; Notice of Qualified Separate Lines of Business; and 3) the SLOB must satisfy the administrative scrutiny test—for which there are seven safe harbor options (see Treas. Reg. §1.414(r)-5 and Treas. Reg. §1.414(r)-6).

Finally, if all the property and services of the business are provided by the QSLOBs, then the employer may test the QSLOBs separately in order to satisfy the minimum coverage rules. A couple additional notes:

  • The QSLOB testing exception can be used in controlled group situations but not with affiliated service groups [see IRC §414(r)(8)].
  • Defined benefit plans may use the exception for minimum coverage testing, and for minimum participation testing pursuant to IRC §401(a)(26) with IRS approval.

A complete analysis of the QSLOB rules are beyond the scope of this writing.

Conclusion

The QSLOB testing exception for minimum coverage can be beneficial, but, as one can see, is complicated. Employers considering its application should consult with tax attorneys or advisors who are well-versed in the subject.

 

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401(k) Plan Committee Charter

“If a 401(k) plan has an investment or administrative committee, is the committee required to have a charter?”

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 Ohio is representative of a common inquiry related to 401(k) plan committees.

Highlights of the Discussion

Neither the Department of Labor (DOL) nor the IRS, both of which regulate qualified retirement plans, specifically require that a 401(k) plan committee have a charter. However, more and more firms with plan committees are adopting committee charters as a fiduciary best practice. Practically speaking, a committee charter can help committee members understand their roles and responsibilities.

Retirement plan committee charters are distinct from an investment policy statement. (Please see Investment Policy Statement Checklist and an Education Policy Statement.)

A plan committee charter should be approved by the board of directors of the company and answer the following questions:

  • What authority does the committee have?
  • What is the committee’s purpose?
  • How is the committee structured?
  • Who may serve on the committee?
  • How are committee members replaced?
  • How will the committee delegate authority?
  • How will the committee assign responsibilities and duties?
  • How frequently will the committee meet?
  • What procedures will the committee follow?
  • What are the standing agenda items and how are new topics introduced?
  • What is the process for selecting and managing plan service providers?
  • What reporting will the committee do and to whom?
  • What are the procedures for protecting committee members financially?

Retirement plan committees that do have charters should be sure to follow them, and review them regularly to determine if adjustments are needed.

Here is a sample format:

  • Introduction
  • Purpose of the Plan Committee
  • Committee Membership
  • Schedule and Organization of Meetings
  • Authority and Responsibilities
  • Procedures for Decision Making
  • Meeting Minutes and Reports
  • Fiduciary Liability and Protection

Conclusion

For retirement plans that have investment or administrative committees, having a committee charter in place could be a good fiduciary liability mitigation tactic—as long as it is followed.

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