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Updating the Plan Administrator

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“In an M&A situation, where the acquiring organization does not assume the seller’s retirement plan, what is something that the selling company often overlooks with respect to its 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 an advisor in Minnesota is representative of a common inquiry related to company acquisitions and mergers (M&As).

Highlights of Discussion

M&A scenarios are notorious for treating retirement plans as an after-thought. Because little thought is given to plans in these situations, a great deal of confusion, many missteps and fiduciary risk arise. That said, failing to update the Plan Administrator—the person or entity that is authorized with plan service providers to make decisions related to the retirement plan—is a common oversight.

RLC consulted on a case where Company A purchased Company B in an asset sale and Company A did not take on Company B’s 401(k) plan. The person who had been identified as Company B’s Plan Administrator and signed the Forms 5500 no longer held that role after the acquisition. Months went by and the Plan Administrator role was not filled. That meant that the plan was in limbo, and the level of participant frustration was escalating, along with risk of Department of Labor involvement.

Until a new Plan Administrator was formally appointed and the proper documentation provided, the plan recordkeeper would not/could not make any decisions or take any actions with respect to the plan (for fear of fiduciary liability). The owners of Company B should have anticipated that after the sale, a new Plan Administrator would need to be appointed. Once the new Plan Administrator was officially installed, the plan was put on a course for payout and termination.

Conclusion

Little thought—if any—is given to retirement plans in M&A scenarios. Something as simple and common as failing to update the plan decision-maker (Plan Administrator) with service providers can render a plan dead-in-the-water.

© Copyright 2024 Retirement Learning Center, all rights reserved
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ESOP Rebalancing

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“One of my clients with an Employee Stock Ownership Plan (ESOP) asked about a true up provision in his plan. What is an ESOP true up provision?”

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 Illinois is representative of a common inquiry related to an ESOP.

Highlights of Discussion

I believe what your client is referred to is a “rebalancing” provision in the ESOP. Rebalancing is the periodic mandatory transfer of employer securities among participant accounts, resulting in all participants having the same proportion of employer stock to other investments as in the ESOP trust as a whole (see this 2010 IRS Memorandum for more details). For example, if the ESOP was invested 70 percent in employer stock and 30 percent in other investments, after rebalancing, each participant’s ESOP account would be invested 70 percent in stock and 30 percent in other investments.

Rebalancing usually happens at the end of the plan year and does not affect the face value of an ESOP participant’s account balance. According to the IRS’s, Listing of Required Modifications for ESOPs, “rebalancing, which treats all participant accounts the same, will not raise issues of current or effective availability and is generally acceptable.” Rebalancing is different than “reshuffling,” which will be covered in a future Case of the Week.

For an ESOP to be able to perform rebalancing it

  • Must hold cash and
  • The plan document must include an annual rebalancing provision.

An example of where rebalancing may come into play might be in a mature ESOP that has allocated all of its shares to its employees and begun contributing cash into the accounts of new employees. Without rebalancing, the new ESOP participants would not be shareholders in the ESOP.

Conclusion

Rebalancing is the mandatory transfer of employer securities into and out of the accounts of ESOP participants, usually on an annual basis, designed to result in all participant accounts having the same proportion of employer securities. In order to rebalance, the plan document must have specific language permitting rebalancing.

© Copyright 2024 Retirement Learning Center, all rights reserved
Governance
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Plan Termination and the Principle of Permanency

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“I have a client who set up a cash balance plan a few years ago and now wants to terminate the plan. Is that OK? Or does the IRS require a sponsor to maintain its qualified plan for a certain number of years?”

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 Illinois is representative of a common inquiry related to plan termination and the principle of permanency.

Highlights of Discussion

It depends on the reason your client is ending the plan. The IRS has an expectation of plan permanency. “The term ‘plan’ implies a permanent, as distinguished from a temporary, program,” Treasury Regulation 1.401-1(b)(2). However, a plan sponsor reserves the right to change or terminate the plan, and discontinue contributions, but if this happens within a few years after plan establishment, the plan sponsor must document as evidence a valid business reason for terminating the plan. Without documentation of the business necessity, upon examination the IRS will presume the plan was not intended to be a permanent program from its inception. A potential consequence could be the IRS would deem the plan was never qualified and revoke its tax-favored status—making the plan’s assets immediately taxable to participants, and any tax deductions taken by the employer null and void.

What is “a few years?” The IRS gave more insight into the time requirement for plan permanency in Revenue Ruling 72-239, stating a plan that has been in existence for over 10 years can be terminated without a business necessity.

In Revenue Ruling 69-25 the IRS elaborated on what constitutes a “business necessity.” Business necessity, in this context, means adverse business conditions, not within the control of the employer, under which it is not possible to continue the plan, including bankruptcy or insolvency, and discontinuance of the business, along with merger or acquisition of the plan sponsor, provided the merger or acquisition was not foreseeable at the time the plan was created.

IRS examiners are instructed to look for evidence of plan permanency. The IRS’s Employee Plans Guidelines for Plan Terminations at 7.12.1.3 outline the steps examiners must take to evaluate plan permanency, including checking Forms 5310, Application for Determination Upon Termination to determine how long the plan has been in existence, the reason for termination and, if terminated due to adverse business reasons, an explanation detailing the conditions that require the sponsor to end the plan. The examination steps in the Internal Revenue Manual also list the valid business reasons that demonstrate “necessity” for plan termination purposes.

As a fiduciary liability mitigation strategy, a plan sponsor should thoroughly document any decision to terminate its retirement plan, and the reasons for terminating, being mindful of the need for documentation of a valid business reason if termination occurs within a few years after the plan’s initial adoption.

Conclusion

Business owners who have established or who may be contemplating establishing a qualified retirement plan must be aware that the IRS expects the arrangement will be a permanent one. And, although plan sponsors reserve the right to terminate their qualified retirement plans, the IRS views “business necessity” as the only legitimate reason for plan abandonment within the first few years of establishment.

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Fixing Fixed-Rate Cash Balance Plans

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“Why are we being told we have to contribute much higher amounts to our cash balance plans than ever before?”

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.

Recently, we have received calls from advisors with a repeating concern related to cash balance plans.

Highlights of the Discussion

This is a common concern among certain cash balance plans, and often comes with no warning or creative fixes from their current consultants. Our response is to ask about the plan’s rate of return in 2022 and explain why that is relevant to their required contributions. We start here because most cash balance plan sponsors have what we call a “fixed-rate” plan design, which is a design that promises a positive return (sometimes as high as 5%) every single year. When assets post double-digit investment losses, like many did in 2022, this design will result in unwelcome news of much higher required cash outlay to keep their plans funded.

We then explain there is a better approach to consider that can keep contributions (and deductions) more predictable.  Enter the “market return cash balance” (MRCB) plan. Instead of designing a cash balance plan with a fixed interest rate, MRCB plans are designed to credit accounts with the actual investment return in the plan’s trust. This can make a huge difference in funding stability as illustrated next.

In the following example, a sponsor has committed to a $100,000 annual contribution, and the plan has a design promising a 4% fixed interest rate of return.  See the investment returns from 2016 to 2022 below, under Actual Return.

The fix-rate design created a mismatch between the promised benefits and the assets backing them. To keep the plan funded, the contribution had to fluctuate year-to-year, as shown in the column second from the right.

As a fixed-rate plan matures, one bad investment return year can have drastic consequences to the required funding levels. This often comes at an inopportune time. In this case, the -15% return in 2022 turned a $100,000 contribution into $226,000.

By contrast, look at the column on the far right. MRCBs, when designed correctly, can mitigate this problem and result in a smooth experience for plan sponsors.

Making the Switch

Advisors have asked us, how hard is it to switch from a fixed-rate design to MRCB design? It’s much simpler than one might expect. Plans often can either be amended or restated without the need to terminate the program. This affords sponsors minimal disruption.

While sponsors cannot reverse the 2022 underfunding problem they may be facing, they can move to an MRCB design prospectively. There are ways to smooth out the “make-up” contributions over time while the plan recovers.

Conclusion

Most plan sponsors of fixed-rate cash balance plans are facing a challenging funding result after negative 2022 returns. In some cases, this news has already been delivered, but others may not realize the problem for several months. Specifically, plans that are valued at the beginning of the year were measured on January 1, 2022, which is before the market loss. This means their 2022 contributions may be funding an outdated result, and this won’t be addressed until after a 2023 valuation is completed. For more information, please see the article, “Advantages to a Market Return Cash Balance Plan Design.”

 

 

 

 

 

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Education on Education Policy Statements

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“I just attended a training meeting where the speaker mentioned an Education Policy Statement (EPS). Is a plan required to have an EPS?”

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 Maryland involved a question on participant education.

Highlights of Discussion

While the DOL does not require qualified retirement plans to have an Education Policy Statement (EPS), it can be a helpful fiduciary liability reduction tool for plan sponsors who offer plan participants the ability to self-direct their account balances. It is often viewed as an extension of a plan’s Investment Policy Statement. The EPS is the blueprint for how the fiduciaries of the plan will implement, monitor and evaluate an employee education program with respect to the plan.

ERISA 404(c) provides a mechanism for plan sponsors to shift investment responsibility to participants, provided the plan meets certain requirements. Generally, to meet the requirements of ERISA 404(c), participants must have the opportunity to 1) exercise control over their individual account; and 2) choose from a broad range of investment alternatives (DOL Reg. 2550.404c-1). As part of the ability to exercise control participants must have “…the opportunity to obtain sufficient information to make informed investment decisions.” The EPS can be the means by which plan fiduciaries document how this requirement is met.

Today, the EPS can be part of a broader Financial Wellness Program for employees.

While there is no prescribed format for an EPS, answering the following questions may be helpful in designing the document:

  • What is the purpose of the EPS?
  • What are the objectives of the EPS?
  • What are the educational goals for the plan participants?
  • Who are the responsible parties and what are their duties?
  • How will the education be delivered?
  • How will results be measured?

Conclusion

An EPS is a blueprint for how plan fiduciaries will implement, monitor and evaluate an employee education program with respect to a retirement plan. Although not required, an EPS could be a prudent addition to a plan sponsor’s fiduciary fulfillment file.

 

 

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401(k) Catch-Up Contributions

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“When does a 401(k) deferral become a catch-up contribution?”

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 Virginia involved a question on 401(k) catch-up contributions.

Highlights of Discussion

An employee salary deferral becomes a catch-up contribution when it exceeds the lowest of the following three limits (See Treasury Regulation § 1.414(v)-1 ):

  • A statutory or legal limit (as explained below),
  • A plan-imposed limit stated in the plan document and
  • The plan’s actual deferral percentage (ADP) limit on salary deferrals.

Salary deferrals above the lowest of these three limits will be considered catch-up contributions up to the annual catch-up maximum amount for a 401(k) plan (i.e., $7,500 for 2023).

Examples of a statutory or legal limit include the IRC § 402(g) limit (i.e., 22,500 for 2023) or the IRC § 415(c) annual additions limit (i.e., 100 percent of a participant’s compensation up to $66,000 for 2023)]. An example of a plan limit would be if the plan document were to specify that employee salary deferrals are limited to 10 percent of a participant’s annual compensation. Finally, a plan’s ADP limit on employee salary deferrals is determined by comparing the salary deferrals of the highly compensated employees (HCEs) to those of the nonhighly compensated employees (NHCEs) and limiting deferrals for HCEs to a level that allows the plan to satisfy the ADP nondiscrimination test.

Example:  Rowan is a 55-year-old HCE who participates in a 401(k) plan he established for his firm. His compensation for the year is $100,000. The maximum IRC Sec. 402(g) limit for the year is $22,500. The terms of the 401(k) plan limit employee salary deferrals to 10% of compensation or, in Rowan’s case, $10,000. The plan administrator determines the salary deferral ADP limit for the year is $8,000.  The lessor of $22,500, $10,000 or $8,000 is $8,000. Therefore, any salary deferral Rowan would make above $8,000 (up to a maximum catch-up limit of $7,500) would be considered a catch-up contribution.

Conclusion

There may be more to catch-up contributions than the average person realizes. An employee salary deferral becomes a catch-up contribution when it exceeds the lowest of a legal limit, a plan-imposed limit or the ADP limit.

 

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Retirement Proposals in the 2024 U.S. Budget

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“I heard the 2024 Budget for the U.S. contains some restrictions on retirement savings and Roth conversions. Can you explain the provisions and when they take effect?”

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 California involved a question on President Biden’s 2024 Budget.

Highlights of Discussion

Let’s start with the second half of your question first—when do the provisions take effect? The federal budget contains estimates of federal government income and spending for the upcoming fiscal year (October 1 through September 30) and includes suggestions or proposals—not laws—on how to achieve income and spending goals. Consequently, while there are recommended effective dates tied to the provisions of the budget, nothing has been enacted. The provisions are merely suggestions. The president’s release of the budget to Congress is an early step in the entire budget process.

That said, the budget does reflect what is on the Administration’s mind, and the retirement proposals are ones that are recurring themes (e.g., included in the 2021 “Build Back Better” bill). The related General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals includes a description of “modifications to rules relating to retirement plans.”

Among other items, the budget suggests imposing $10 million and $20 million caps on savings in tax-favored retirement accounts for “high income taxpayers,” and requiring distributions of a portion of the excess based on the applicable cap.

A high-income taxpayer would be someone with gross income over

  • $450,000, if the taxpayer is married and filing jointly (or is filing as a surviving spouse); or
  • $425,000, if the taxpayer is a head-of-household; or
  • $400,000, in other cases.

High-income taxpayers with accumulations of more than $10 million would be required to distribute 50 percent of the excess amount, and if accumulations exceeded $20 million, then the required distribution would be the lessor of the excess or all Roth accumulations.

Second, plan administrators of a tax-favored retirement arrangements would be required to report to the Treasury Secretary any vested account balance of a plan participant or beneficiary that exceeds $2.5 million.

Third, certain Roth conversions would be eliminated for high-income taxpayers (as described above).

While action on these initiatives is not expected this year, targeting large retirement account balances has some populist appeal, and has had the support of Democrat policymakers for some time. The idea of capping retirement accumulations is likely to persist beyond the next election.

Conclusion

The president’s budget proposal, containing suggestions on how to achieve income and spending goals, is an early step in the budget process. None of the budget’s provisions are law at this point. But several themes targeting excessive retirement savings in the budget reflect the current focus of the Administration and are likely to be points of discussion and debate in Congress.

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What Are PS 58 Costs?

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“My client has life insurance in her 401(k) plan. Her accountant told her that the “PS 58 costs” are taxable to her.  Can you explain?”

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 Illinois involved a case related to life insurance.

Highlights of Discussion

Your client’s accountant is correct. If the plan uses deductible employer contributions to purchase life insurance for her, then the cost of the protection (the premium paid) is included in her gross income [Treas. Reg. § 1.72-16(b)(2)].  The cost of this coverage is called the “PS 58 cost,” and is includible in income for the taxable year during which the plan pays the premium.

The plan administrator reports the taxable cost of life insurance (the PS 58 cost) annually on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., even when there has been no physical distribution from the plan. Since these amounts have already been taxed, they create a basis in the plan. That means your client will not be taxed again on the cumulative PS 58 costs when the insurance contract is distributed to her or when the life insurance proceeds are distributed to her beneficiaries.

Conclusion

If the plan uses deductible employer contributions to purchase life insurance for a participant, then the cost of the protection (PS 58 cost) is reported on Form 1099-R. The participant must include the amount in taxable income for the year the premium is paid.

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Partial Plan Termination and the Applicable Period

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“My client suffered an accident and cannot keep employees on at his business. He was wondering if he could lay off employees over time to avoid triggering full vesting for a partial plan termination?”

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 involved a case related to a partial plan termination.

Highlights of Discussion

  • The IRS will determine whether a partial plan termination has occurred based on the facts and circumstances of a particular scenario [Treasury Regulation § 1.411(d)-2(b)]. According to Revenue Ruling 2007-43, one of the circumstances considered is the employee turnover rate during “the applicable period.”
  • The applicable period is a plan year (or, in the case of a plan year that is less than 12 months, the plan year plus the immediately preceding plan year) or a longer period if there are a series of related severances from employment. Consequently, in your client’s situation, because the layoffs would all occur as a result of a single event—the IRS would consider them related severances.
  • There are other guidelines in Revenue Ruling 2007-43 that are helpful in determining 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 percent.
  • 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 deemed 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 severances from employment that plan sponsors DO NOT factor in when determining the 20 percent ratio are those that are out of the employer’s control (e.g., an employee death, disability, retirement or depressed economic conditions).
  • Partial plan terminations 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 percent guideline in Rev. Rul. 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 percent threshold still stands under the IRS’s revenue ruling.
  • Keep in mind that employee turnover is not the only reason for a partial termination. A partial termination can also happen if a sponsor adopts amendments that adversely affect the rights of employees to vest in benefits under the plan, excludes a group of employees that previously had been included, or reduces or ceases future benefit accruals that can result in a reversion to the employer (in the case of a defined benefit plan), the IRS may find that a partial termination occurred, even if the turnover rate is under 20 percent (Issue Snapshot-Partial Plan Termination).
  • 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 Instructions for 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 over the applicable period, a company could be deemed to have a partial plan termination. The participants affected by the partial plan termination must become 100 percent vested in their account balances upon termination. Plan sponsors should monitor their companies’ turnover rates and amendment activities to be aware of potential partial plan terminations.

 

 

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401(k)s, 403(b)s and MEPs

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“One of my clients is a health care association, the members of which offer both 401(k) plans and 403(b) plans to employees. The association is considering offering a multiple employer plan (MEP). Would there be any issues in creating one MEP that would include both the 401(k) plans and the ERISA 403(b) 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 Illinois involved a case related to multiple employer plans (MEPs).

Highlights of Discussion

  • Under Section 106 of SECURE Act 2.0 of 2022 (SECURE 2.0), we now have certainty that 403(b) plans have access to MEPs and Pooled Employer Plans (PEPs) on par with 401(k) plans. A MEP is a single plan that covers two or more associated employers that are not part of the same controlled group of employers. A PEP covers two or more unrelated employers under a single plan.
  • However, existing treasury regulations do not allow mergers or transfers of assets between 403(b) and 401(k) plans [Treasury Regulation 1.403(b)-10(b)(1)(i)]. Further, the IRS has stated in at least one private letter ruling (PLR) (e.g., PLR 200317022) that if a 403(b) plan is merged with a plan that is qualified under IRC Sec. 401(a), the assets of the 403(b) plan will be taxable to the employees. Combining 401(k) and 403(b) assets in one trust could also jeopardize the tax-qualified status of the 401(k) plan.
  • Therefore, it would not be possible to maintain one MEP that covers both 403(b) and 401(k) plans. The association could use one 401(k) MEP to cover the 401(k) plans and a separate MEP for 403(b) plans.

 

Conclusion

While the law permits both 403(b) MEPs and 401(k) MEPs, it is not possible to have one MEP that covers both types of plans. The IRS treats 403(b)s and 401(k)s as unlike plans and, therefore, incompatible, for the purpose of plan-to-plan transfers or mergers.

 

 

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