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Archive for the ‘Defined contribution’ Category

Picturing potential IRS penalties on audit, NDCP sponsors should seek selfies

November 13th, 2014 No comments

Pizzano-DominickAfter taking a selfie, the photographer/subject can examine the resulting image before deciding to share it. If the image is not satisfactory, appropriate adjustments can be made before others have the chance to view it. This same principle applies to nonqualified deferred compensation plans (NDCPs) with all the complex rules governing them and the costly consequences of noncompliance. Why risk the executive or sponsor being subjected to the paparazzi-like blitz of an Internal Revenue Service (IRS) audit, which could capture an unflattering candid shot of the plan’s operation? Wouldn’t it make more sense to take a selfie of the plan (i.e., conduct a self-audit) so that any operational blemishes may be fixed before seen through the unforgiving lens of an IRS audit? Encouraging such selfies, the NDCP operational correction procedures issued by the IRS generally provide that the quicker any errors are caught and corrected, the better the chances are of minimizing or even eliminating negative tax results for the affected participants.

While the sponsor may incur some cost in conducting a self-audit of its NDCPs, failing to find and promptly correct operational errors could potentially be even more expensive. IRC Section 409A violations can result in substantial tax penalties for the affected participants. The nonqualified deferred compensation (NDC) in question becomes fully taxable as soon as the participant has a vested (nonforfeitable) right to receive it. Furthermore, a 20% additional tax penalty on the value of the NDC will be imposed at the same time and, under certain circumstances, an interest charge will be imposed. Beyond the 409A ramifications, there may be other tax penalties for under-withholding if, for example, the applicable Federal Insurance Contributions Act (FICA) tax is not paid when due.

Maintaining operational compliance and correct reporting of amounts deferred to and distributed from their NDCPs poses a significant challenge for many sponsors who, while well-versed in qualified plan administration, do not have the same level of expertise available internally when it comes to the various and sometimes subtle differences presented by NDCPs. Just three of the plethora of potential pitfalls:

(1) Timely distributions: Most distributions from qualified plans do not occur until a participant elects to commence the benefit. The sponsor typically starts the process by sending an election package requesting the participant to make an election on the timing and form of the distribution. If no such election is made, it’s not uncommon for the benefit to be deferred in the plan. In contrast, there’s considerably less flexibility regarding the participant’s ability to choose the timing and form of distribution in NDCPs. Once the distribution triggering event occurs, the 409A compliance clock begins ticking and failure to transfer the applicable funds to the participant on a timely basis produces a 409A failure. It’s essential for sponsors to accurately track these distribution dates and stress to participants the importance of making sure the sponsor always has up-to-date instructions on where to send payments (especially in cases where participants terminate employment long before payment is due). A self-audit can determine if the current procedures are ensuring that all distributions are commencing in accordance with the plan’s terms.

(2) FICA calculation: While federal and most state income tax rules typically permit participants in a 409A-compliant NDCP to defer taxation until distribution, FICA taxation timing rules may require earlier inclusion in income. One of the most common omissions occurs in defined contribution style NDCPs that feature both executive deferrals and employer allocations. FICA rules require amounts deferred under these plans to be taxed when vested. Employee deferrals are 100% immediately vested and thus generally processed correctly (i.e., they are run through payroll and FICA tax procedures at that time). However, because employer allocations are treated separately and often subject to a vesting schedule, they can be overlooked and not properly FICA taxed once vesting occurs. A self-audit ascertains whether or not deferred amounts are being FICA taxed when due.

(3) W-2 reporting and withholding: There are separate, specific instructions and guidance that apply to which boxes need to be completed and what amounts should be entered on W-2 forms in order to properly report NDCP deferrals and distributions. NDCP sponsors must be extremely careful to not only accurately communicate the terms of their NDCPs to their payroll providers but also to review a provider’s initial withholding/report setup for the plan. Failure to address this during the initial stages can result in a wide range of negative tax consequences for participants. In addition to possibly triggering 409A violations, if amounts are not accurately reported, the participant may be overtaxed, under-taxed, and/or have their Social Security benefits adversely affected. A self-audit can compare the amounts currently being reported on W-2 with the supporting plan materials (e.g., election forms, benefit statements, salary information) to assure proper agreement.

NDCP sponsors would need a photographic memory to retain every nuance of the 409A rules, the FICA tax implications, and the reporting/withholding requirements. The preceding information represents just a very small snapshot of some of the issues that illustrate the need to self-audit. However, it is important to note that if the sponsors do not have the internal expertise in these areas, they should strongly consider seeking consulting advice to identify any and all imperfections so as to make sure that their selfies produce a pretty plan picture.

Nondiscrimination testing: Minimum allocation gateway

November 11th, 2014 No comments

Peatrowsky-MikeA defined contribution (DC) plan can test on a benefits basis if it meets any of the following criteria:

• Provides broadly available allocation rates
• Provides age-based allocations
• Provides a minimum allocation gateway to non-highly compensated employees (NHCE)

A plan satisfies the minimum allocation gateway test if each NHCE has an allocation rate, which is determined using Internal Revenue Code (IRC) Section 414(s) compensation, that is at least one-third of the highest allocation rate of any highly compensated employee (HCE) participating in the plan.

Alternatively, a plan is deemed to satisfy the gateway test if each NHCE receives an allocation of at least 5% of the employee’s IRC Section 415 compensation. Therefore, a DC plan designed to provide a minimum allocation of at least 5% to NHCEs will always be eligible to be cross-tested for nondiscrimination testing.

Aggregated DB/DC plans
To satisfy the minimum gateway for an aggregated defined benefit (DB)/DC plan, each NHCE must have an aggregate normal allocation rate (ANAR) that meets the following requirements:

Nondiscrimination testing graph

Instead of using each NHCE’s equivalent allocation rate under a DB plan in calculating the aggregate allocation rate, it is permissible to use the average of the equivalent allocation rates of all NHCEs benefiting under the DB plan.

Who must receive the minimum allocation gateway?
Employees who receive a safe harbor nonelective contribution, a top-heavy minimum contribution, or a qualified nonelective contribution (QNEC) must receive a minimum allocation gateway contribution, unless they are separately tested under 401(a) as part of a disaggregated group.

If you have questions regarding the minimum allocation gateway, please contact your Milliman consultant.

The Supreme Court, Tibble, fees, and the statute of limitations

October 24th, 2014 No comments

Smith-SuzanneEarlier this month, the U. S. Supreme Court decided that it will review a case relating to retirement plan fees. Although it is a case about fees, the issue before the Supreme Court is really about ERISA’s six-year statute of limitations.

Background about the case. Plan participant Glenn Tibble brought a lawsuit against his employer, Edison International, and the company’s benefits and investment committees as fiduciaries and administrators of his defined contribution (DC) plan. Tibble claims the plan fiduciaries managed the plan imprudently by selecting retail mutual funds as retirement plan investments when institutional shares were available at a much lower cost to participants.

The lower courts found that the fiduciaries were imprudent in selecting retail-class shares and failing to investigate alternative institutional-class mutual funds.

The problem for Tibble is that some of the retail-class funds were added to the retirement plan more than six years before Tibble filed the lawsuit.

The courts have held that although the fiduciaries were imprudent with the selection of the retail-class shares, Tibble’s claim with respect to funds selected more than six years before the lawsuit is barred by ERISA’s six-year statute of limitations.

Current issue for the Supreme Court review. Now the Supreme Court has agreed to review the statute of limitations issue.

Tibble’s argument, which is supported by the U.S. Department of Labor, is that there is a continuing duty to monitor the plan investments. As a result, Tibble thinks his claim should not be time-barred under the theory that there is a restart of the six-year period with the ongoing failure to monitor the plan’s investments. This is a frightening thought for employers!

Prior court decisions have sided with the fiduciaries and found that the six-year period runs from the initial selection of the investment. While there is a duty to monitor the plan’s investments, the courts have been reluctant to permit a new limitations period for a continuing violation. The Ninth Circuit said it would lead to an “unworkable result” where present fiduciaries could be liable for decisions made by their predecessors decades before.

So what are the takeaways for plan fiduciaries? On the fee issues, if you are selecting retail type mutual funds, you need to consider alternative institutional-class mutual funds and document your decision.

With respect to the statute of limitations, we should have the Supreme Court decision by the end of June 2015. For plan fiduciaries, the decision will be an important ruling on the meaning of ERISA’s six-year statute of limitations and the future liability for plan sponsors.

Tibble vs. Edison: What will it mean for plan sponsors and fiduciaries?

October 16th, 2014 No comments

Conkel-DouglasThe U.S. Supreme Court has agreed to rule on the Tibble vs. Edison case, the first case in front of the Supreme Court dealing with excess fees within a qualified defined contribution (DC) plan, e.g., a 401(k) plan. In this case the plaintiff contends there was a fiduciary breach of duty by Edison because the plan continued to use retail share class funds when lower-cost share classes became available to the plan as it grew. However, the focus of the ruling may not focus on the excess fee component but more on the six-year statute of limitations under ERISA (the U.S. law that regulates qualified retirement plans and fiduciary responsibilities). The statute of limitation under ERISA is designed to prevent fiduciaries from never-ending risks arising from historical decisions. Congress specifically added this limitation to try to minimize the burden of a 401(k) plan to plan sponsors. For this reason, the scope of the ruling may be limited to the statute of limitations rather than specifics on the fee issue. However, this ruling will be significant in light of the $4.2 trillion in 401(k) plan retirement assets.

Ultimately, the Supreme Court’s ruling and comments could have a large impact on future litigation concerning participant grievance against plan sponsors—we will have to wait and see. Regardless of the ruling, this increased attention will hopefully promote more education and development of best practices when it comes to plan sponsors truly understanding their fee arrangements within their qualified plans. As an active relationship manager ensuring that my clients completely understand their “total” fee structure, there has been a focused effort on my part toward that end the last several years. I have written a couple of white papers discussing elements of qualified plan fees, which often are overlooked or not discussed in detail at the fiduciary/advisor/provider level:

Fees: What everyone is NOT talking about!

Fees: What no one is talking about, round 2

One of the fee elements I discuss in detail is the administrative fees (revenue sharing) embedded in the plan’s investment options. It often feels as if sponsors focus on implicit administration fees when usually 70% or more of the plan’s total cost comes from the expense ratios of the plan’s investment options. One important best practice is to ensure that any revenue sharing embedded in a fund’s expense ratio is used to benefit the participants invested in that fund (not at the plan level but to benefit the participants who actually pay that revenue-sharing amount via the expense ratio). This is referred to as “fee-leveling” and while it is becoming a best practice there are still a large number of sponsors who don’t understand the issue and simply don’t know the solutions.

Assuming that a plan levels fees by giving the participants in a fund the benefit of that fund’s revenue sharing, then once an investment option is chosen for a plan’s fund lineup selecting the share class of that fund becomes an easy choice. The sponsor simply needs to select the share class that provides the lowest net cost to the participant. In the example below, assume that a plan sponsor levels fees by taking any revenue sharing paid by an investment option and crediting that back to the participants in that fund as a revenue-sharing expense reimbursement (a credit).

Figure 1: Fund A, Various Share Classes

Expense Ratio Revenue Sharing Net Cost to Participant
Share Class A 0.75% 0.30% 0.45%
Share Class I 0.50% 0% 0.50%

In the example above, for this plan at its current provider, the lowest net cost to participants (once the revenue sharing is allocated back to participants in this fund) would be the Share Class A. This is not always the result, depending on the fund family and share classes. Sometimes, there is no difference in net cost so the conclusion would be to go with the zero revenue-sharing class so the plan doesn’t have to do a revenue-sharing credit allocation.

As this case progresses we will post more comments and updates, but, for now, I encourage sponsors to study up on their plan’s fee arrangements, fee-leveling, and other best practices within the industry. Sponsors should not rely too much on their current providers or advisors if some of the topics discussed above have never been mentioned in a retirement committee meeting, as they might lack the insight required to do a complete evaluation.

Facts sponsors need to know about reducing pension risk

October 8th, 2014 No comments

Many companies are looking for ways to reduce the risk and volatility associated with defined benefit (DB) pension plans. Factors such as low interest rates, increases in Pension Benefit Guaranty Corporation (PBGC) premiums, and new mortality tables have sponsors considering de-risking measures.

In a recent Institutional Investor webcast (registration required) Milliman’s John Ehrhardt hosts a panel discussion with Prudential consultants Scott Kaplan and Rohit Mathur addressing five common misconceptions that may deter sponsors from reducing their pension risks.

This webcast was sponsored by Prudential Retirement.

For more Milliman perspective on de-risking DB plans, click here.

Retirement plan leakage and retirement readiness

September 10th, 2014 No comments

Tedesco-KaraThe title alone proves opposites don’t always attract. “Leakage” means outflow and outflows in retirement plans are not easily controlled. Worse yet, the impact on a participant’s retirement readiness is a big problem. Where money goes once it leaves a retirement plan is a question with many answers, some of which lead to plan sponsors feeling concerned about plan design and the choices available to participants.

In defined contribution (DC) plans such as the 401(k), participants defer money from their paychecks into the plan. The employer may make matching or other employer contributions. Most 401(k) plans are designed to allow participants to access these deferrals, as well as their other vested monies, while actively working. This access occurs through loans, hardship withdrawals, and other in-service distributions. When participants take a loan, they pay themselves back over time. In some instances, however, a participant defaults on the loan, which automatically reduces the account balance. In the case of in-service distributions, once the money is paid to the participant, it does not come back into the plan, similarly reducing the participant account balance.

Of greater concern may be the preretirement withdrawal of an account balance upon termination of employment. Participants terminate employment for a myriad of reasons, such as to start a new career path. In a defined benefit (DB) plan, it is not uncommon to see a lump-sum window option offered to participants. Plan sponsors benefit from participants choosing the lump-sum window option just as they do when terminated participants take their money from 401(k) plans. The plan sponsor’s administrative costs associated with either type of plan are reduced.

The problem? Participant account balances that are cashed out and not rolled over to an IRA or another qualified retirement plan are subject to immediate income tax and potentially burdensome tax penalties, depending upon their age. But many participants don’t know what to do with the money and will often use it right away to satisfy an immediate financial need rather than save it for retirement. An even greater, more glaring problem is that the participant’s total projected retirement savings has been compromised. Does this mean that a participant will not achieve the suggested 70% to 80% income replacement rate? Most likely, the answer is yes, especially if the participant has no other savings outside the former retirement plan.

There is no clear answer to the leakage problem in plans. A good retirement plan design can greatly influence the behavior of its participants. It has to include and encourage regular employer and employee contributions to help build retirement accounts. Withdrawal provisions and loans in plans don’t signify poor plan design, but tighter administrative controls around the plan provisions, such as allowing only one in-service withdrawal per year, helps keep money in the plan. In addition, increased participant education has to remain a focus for employers, with a special emphasis on the benefits of taking a rollover instead of a lump-sum cash distribution.

Thrift Savings Plan for all Americans?

August 19th, 2014 No comments

Moen-AlexRecently, members of Congress reintroduced the idea of opening the government-employees-only Thrift Savings Plan (TSP) to all Americans not currently covered by an employer-sponsored plan. Right now, that number is estimated at 78 million U.S. workers. According to the Bureau of Labor Statistics, as of early 2013, 68% of all workers had access to a defined benefit (DB) or defined contribution (DC) plan and 54% were enrolled. The vast majority of workers not covered are part-time or seasonal employees. The government recognizes that help is needed, and the TSP proposal is the latest attempt.

In place since 1986, the Thrift Savings Plan (TSP) has provided federal employees and military service members with retirement savings. It is a defined contribution plan, similar to 401(k) plans offered by corporations. A governing board, consisting of six people who are presidentially appointed, administers the plan. A variety of issues should be considered with this proposal, but there are a few important advantages and disadvantages.

Positives:
• The most important aspect of this proposal is that it would provide payroll-based savings to millions of American workers—people who do not now have access to employer-sponsored retirement savings accounts.
• The Thrift Savings Plan is a simple plan with an auto-enrollment feature, six investment choices, and low fees.
• Because it is run by government agencies, taxpayers are technically funding the costs of the plan, so opening it to all Americans is a fair proposal.
• Increasing the TSP population this significantly would have a profound impact on the retirement savings industry that is hard to predict. Both private and government providers may benefit from increased competition.

Challenges:
• Administration of the TSP would require a major upgrade at a minimum, and possibly an entirely new system.
• With TSP membership this massive, government agencies would have a greatly increased, more powerful role in the retirement savings industry, and selection of investment fund options might take on a political element (at least the perception of such). This is the biggest concern that has been voiced.
• Potential compliance issues would be introduced as the TSP is exempt from ERISA and Internal Revenue Service regulations that govern the private sector. Independent review/oversight of the TSP would have to be in place. The TSP is required to adhere to regulations under the Federal Employees’ Retirement System Act (FERSA). These regulations are more lax.
• The conservative investment options offered by the TSP deliver the security and returns associated with long-term Treasuries, which are not protected against inflation.

All employees deserve the availability of a retirement savings plan. The difficulty lies in determining the best option to accomplish that goal. Inviting American workers not covered by an employer-sponsored plan to the TSP may not represent the best solution. The administration-sponsored “myRA” is already taking a step in that direction. This starter retirement account offered by the Department of the Treasury gives workers access to the most conservative of the six TSP funds, the G fund. MyRA will serve as an important first attempt, on a manageable scale, and will provide important input to the comprehensive solution. The time may be right for Congress to undertake a complete review of this area. Hopefully, employers will be included in these discussions.

It’s PPA restatement time! … wait, what’s PPA restatement?

August 13th, 2014 No comments

Cross,-Brandy_mugShotLet’s start from the beginning.

If your qualified defined contribution (DC) retirement plan uses a base plan document with most of the basic features of the plan and an adoption agreement that allows you to select some specific plan features (as opposed to having an individually drafted plan document where there is just one document written specifically for the provisions of your plan), then you have a preapproved plan document.

Almost a decade ago, the Internal Revenue Service (IRS) determined that all preapproved plans would have to be restated periodically — every six years to be exact. This would allow them to pull in all of the law changes in the previous six years and hopefully make the plans easier to read, administer, and review.

The first cycle was referred to as the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) restatement, which was to be completed no later than April 30, 2010.

In early 2014, the IRS released the approval letters to sponsors of preapproved plans for the second cycle, referred to as the Pension Protection Act of 2006 (PPA) restatement. The PPA restatement brings in required changes from that legislation, as well as all subsequent regulatory changes — including Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART) and Worker, Retiree and Employer Recovery Act of 2008 (WRERA).

All plans that use a preapproved plan document must be restated before April 30, 2016. Failure to amend by this date will require the plan to submit an application to the IRS, through its Voluntary Compliance Program (VCP), to correct this error. IRS VCP fees as well as preparation fees will apply, and could be hefty depending on the size of the plan.

Milliman is in the process of working with plan sponsors utilizing our preapproved DC plan document services to complete the restatement prior to the above deadline.

Now is an excellent time for every plan sponsor to review the plan provisions to ensure they are in line with actual plan operations, as well as to ensure that the plan is meeting the goals and needs of the plan sponsor and plan participants.

Reviewing the plan provisions with your Milliman consultant at the time of restatement is both beneficial and cost-effective.

Some items that the plan sponsor should be reviewing include:

Eligibility: Are participants entering the plan when they should? Once eligible, is there anything that can be done to encourage participation in the plan? Should auto enrollment or other provisions be considered to get participants into the plan faster?

Plan design/contributions: Do the plan design and contributions elected and allowed under the plan meet the needs and goals of plan sponsors and participants? Each plan, plan sponsor, and participant population is unique. Visit with your consultants and advisors to see if there is anything you could be doing differently.

New provisions: Are there new provisions added in recent years, such as in-plan Roth conversions, or changes to base document language, such as the use of forfeitures and ERISA recapture accounts, that might make sense to review against the way your plan is operating?

Compensation: Is the correct compensation being provided to your plan’s recordkeeper or administrator? Plans should take this time to review the compensation definition in the plan document to make sure that it matches the compensation used by the payroll systems to determine contributions and benefits. The IRS finds compensation errors one of the most frequent errors made in qualified retirement plans.

When the restatement process is complete, you should receive a new signature-ready adoption agreement, a copy of the base plan document, and the IRS approval letter of the preapproved plan document, as well as an updated Summary Plan Description. You will want to make sure to maintain copies of all plan documents, including superseded versions for the life of the plan, plus six years.

Remember, changes to the plan document are fiduciary decisions, and should be reviewed carefully with your consultant and plan’s legal counsel.

Happy PPA restatement!

Plan language and administration can clarify beneficiary designation issues

July 31st, 2014 No comments

Determining the beneficiary of a qualified retirement plan after a participant’s death has legal ramifications. Plan sponsors should ensure that a plan’s benefit distribution language and plan administration meet federal requirements.

In this article, Milliman’s Dawilla Madsen and Dominick Pizzano examine key issues that sponsors should consider when reviewing and updating plan documents and administrative procedures to ensure compliance with current beneficiary designation rules.

Here is an excerpt:

Staying true to form
While clear and proactive plan and form designs are a great head start, the path toward deterring beneficiary disputes does not stop there. Plan sponsors also must efficiently and effectively:

• Communicate to participants the importance of completing and updating their beneficiary designation forms;
• Deliver to and retrieve the forms from the participants;
• Review the completed forms to ensure that they are accurate; and
• Maintain and manage the forms.

In addition, a best practice is for plan sponsors to periodically remind participants to review their beneficiary designations in the event of a change in family status.

Technology-based solutions can improve the above processes. For example, an electronic system for designating beneficiaries could ensure that all items are complete on a form before it can be submitted. Electronic storage makes retaining and reproducing (even on demand) designations easy. In addition, current electronic (e-signature) technology might help reduce claims of forgery. Unfortunately, current statutory and regulatory requirements for qualified plans make having a totally paperless process impossible. This is true even though:

• Under the spousal consent requirements, the spouse’s signature can be an electronic one in accordance with E-SIGN or state law, and
• Regulations permit a notary or plan representative to electronically acknowledge witnessing the spouse’s signature.

Despite these helpful rules, the spouse is still required to be in the physical presence of the plan representative or notary witnessing the signing of the consent form.

Target date funds: A fiduciary review process is crucial

July 2nd, 2014 No comments

Jeff_MarzinskyRetirement plan participants are often told that target date funds (TDFs) are a “set it and forget it” investment. Many sponsors have similar feelings when selecting a TDF series. Still, it is important for them to constantly monitor the fund series subsequent to its initial review. Sponsors need to focus on fees, asset allocation along the glide path, performance, and expenses. Looking at a combination of indexes and peer groups can offers sponsors better perspective on a suitable investment philosophy.

Plan Sponsor recently published an article focusing on four areas to revaluating TDFs. In the following excerpt from the article I discussed the importance of reviewing a fund’s investment strategy.

That sort of analysis is especially important because some target-date funds have made significant changes in recent years. Look for issues such as alterations to the glide path, a move from active management to enhanced index or indexing strategies, or switches in the underlying funds, suggests Jeff Marzinsky, a principal at consultant Milliman Inc. in Albany, New York. He has seen sponsors actually replace their target-date funds, mainly in cases of investment underperformance or changes in the funds’ underlying philosophy.

I also provided perspective regarding an increased interest in custom target date funds, which offer sponsors control over investment options and asset allocation changes.

…It may be less about many having an employee base different enough to warrant a custom glide path than sponsors seeing it as “a better way to pick the investments,” because sponsors have more control than with off-the-shelf funds.

In a prior article, “Considerations in choosing a target date fund,” I explored some key aspects of TDFs and issues plan sponsors should bear in mind when selecting and the ongoing monitoring of a TDF series.