Category Archives: Defined contribution

Basic fiduciary duties: Loyalty, prudence, diversification, follow the plan document

Woodman-PaulineWhile the basic duties sound easy enough, a plethora of recent cases demonstrates the prudence of constant review of the retirement plan decision-making process. The recent U.S. Department of Labor (DOL) rule on fiduciary conflicts of interest expands the duty of a fiduciary detailed in ERISA 401(a)(1) to act solely in the interests of participants and beneficiaries. Similarly, rulings on the fiduciary duty of prudence centered on breaches that were due to failure to monitor.

In Tibble v. Edison, the lower courts found that the trustees offered no credible explanation for offering high-price mutual funds. While this was a breach of fiduciary duty, part of the case was dismissed because of a six-year statute of limitations. The Supreme Court found that the fiduciary duty to select a prudent investment does not end once that decision is made: “ERISA’s fiduciary duty is derived from the common law of trusts. As such, a trustee has a continuing duty … to monitor, and remove imprudent, trust investments.” Therefore, the six-year statute was only a starting point for the ongoing duty to monitor any fiduciary decision. This case was remanded back to the lower courts for review.

Enact procedural prudence. In each of the ERISA fiduciary cases, courts focused on “how” a decision was made. Did the fiduciaries document their decision and how they arrived at it? Deciding not to act is a decision. Document both decisions and the progression to an eventual decision. Did the fiduciaries seek expert advice when warranted? The courts are not looking for the right answer using the benefit of hindsight. They are looking for an answer that a prudent person familiar with the situation could have arrived at. When fiduciaries document a prudent decision-making process, unfavorable legal decisions should not become an issue.

Honor thy 409A grandfather

Pizzano-DominickThis blog is part of a 12-part series entitled “The nonqualified deferred compensation plan (NDCP) dirty dozen: An administrative guide to avoiding 12 traps.” To read the introduction to the series, click here.

Section 409A certainly has set forth more than its fair share of commandments; however, “Honor thy 409A grandfather” has to rank very close to the top of the “most need to follow” list. While Section 409A’s regulatory reach has been described as overwhelmingly widespread, there is still one 409A-free safe haven for NDCP sponsors and participants—the past. Because the 409A rules generally are effective only for amounts deferred after December 31, 2004, benefits attributable to the period prior to January 1, 2005, can avoid 409A coverage provided that they are correctly calculated under and maintained in accordance with the grandfather rules. This blog will review these rules in an effort to provide NDCP sponsors with a reminder of the importance of preserving their grandfathers and a guide to assisting them with such maintenance.

Correct creation and identification of the grandfather
As briefly indicated above, this topic only affects those NDCPs that were in effect prior to January 1, 2005 (i.e., the date that 409A officially became effective). Furthermore, even if an NDCP was in effect prior to that date, the grandfather treatment is only available if the NDCP sponsor made a timely decision to elect grandfathering and met the required documentation and administrative conditions to effect such treatment. To meet the documentation requirement, the sponsor would have had to adopt an amendment to the plan clearly stating that the applicable amounts would be grandfathered and that only the benefits accrued on and after January 1, 2005, would be subject to the 409A rules. The administrative requirement is a bit trickier. First, the plan sponsor had to correctly identify and calculate the permissible amount to be grandfathered. The general rule is that grandfathered treatment is available for any amounts that were both earned and vested as of December 31, 2005. The specific calculation of the applicable amounts depends on whether the NDCP under consideration is a defined contribution (DC) or defined benefit (DB) style plan:

DC style
The permissible grandfather amount equals the sum of (1) the vested portion of the participant’s account balance as of December 31, 2004, plus (2) any future contributions to the account, the right to which was earned and vested as of December 31, 2004, to the extent such contributions were actually made, plus (3) any future earnings (whether actual or notional) on such amounts.

DB style
As one might imagine, the calculation of the permissible grandfathered amount under DB style is considerably more complex. It equals the present value of the amount to which the participant would have been entitled under the plan if such participant (1) voluntarily terminated services without cause on December 31, 2004, (2) received a payment of the benefits available from the plan on the earliest possible date allowed under the plan to receive a payment of benefits following the termination of services, and (3) received the benefits in the form with the maximum value. There are various ways that this amount may increase over time without violating the grandfather rules; however, an increase in the potential benefits under a DB NDCP that is due to, for example, an application of an increase in compensation after December 31, 2004, to a final average pay plan, or to subsequent eligibility for an early retirement subsidy, would not constitute earnings on the amounts deferred under the plan before January 1, 2005, and thus are not permissible reasons to increase the grandfathered amount. A complete description of how such increases can occur without violating the grandfather rules is beyond the scope of this blog. The calculation of any such increases should be made by the sponsor only after consultation with its actuary and legal counsel to ensure that they are completed in a permissible manner. The 409A rules indicate that when performing such calculations, “reasonable” actuarial assumptions and methods must be used. While no exact definition of “reasonable” is offered, the rules do provide two pieces of guidance to assist with this process:

(1) Whether assumptions and methods are reasonable for this purpose is determined as of each date the benefit is valued for purposes of determining the grandfathered benefit, provided that any reasonable actuarial assumptions and methods that were used by the plan sponsor with respect to such benefit as of December 31, 2004, will continue to be treated as reasonable assumptions and methods for purposes of calculating the grandfathered benefit.

(2) Actuarial assumptions and methods will be presumed reasonable if they are the same as those used to value benefits under the qualified plan maintained by the NDCP, provided that such qualified plan’s benefits are part of the benefit formula, or otherwise affect the amount of benefits, under the NDCP.

Accordingly, sponsors need to have not only correctly calculated their plan’s original grandfathered amounts, but also to have established and continue to maintain administrative systems that accurately track such amounts (along with any applicable future earnings attributable to such amounts) separately from any non-grandfathered amounts that may exist under their plans.

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Top hat plans are not one size fits all

Pizzano-DominickThis blog is part of a 12-part series entitled “The nonqualified deferred compensation plan (NDCP) dirty dozen: An administrative guide to avoiding 12 traps.” To read the introduction to the series, click here.

“Nonqualified deferred compensation plan” (NDCP) is a widely used term and has even been set in statutory stone by its inclusion as a definition in the final 409A regulations.  However, while 409A defines what constitutes such a plan and creates numerous rules governing these arrangements, one area it does not address is which employees of the plan sponsor are permitted to participate in an NDCP.  Nevertheless, accurately capturing the correct covered group is an essential first step and ongoing process for NDCP sponsors.  So who exactly can be included in an NDCP? Well, due to the lack of any specific, official government guidance on this topic, the process of determining the answer to that question is really more of an art than a science.  In order to attempt to paint a proper picture of permissible NDCP participation, we must first look to the Employee Retirement Income Security Act (ERISA).

Sizing NDCPs for an ERISA’s “top hat”
ERISA imposes a number of substantive and procedural requirements on qualified plans.  Similarly, the Internal Revenue Code (IRC) creates additional restrictions through its various limitations on compensation and benefit amounts. However, ERISA includes an exemption for plans that are unfunded and “maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.”  Plans that fit this standard are exempt from many ERISA and IRC requirements and are commonly referred to as “top hat” plans.  However, given that to date the only official ERISA definition of which employees can be included in such plans consists solely of the above general description, the identification process, like art, is very much subject to interpretation.

While the IRC has its own definition of “highly compensated employee,” this definition is not the standard for “top hat plan” purposes. The U.S. Department of Labor (DOL) has the authority to impose ERISA penalties and thus it is the DOL definition that must be met. Generally, the IRC definition is much less restrictive than the DOL definition. In fact, the DOL has indicated that the IRC definition of highly compensated employee (generally earning at least $120,000 for 2016 limit as indexed) is not appropriate for this purpose. The DOL would presumably focus on a more restrictive group of employees as it issued a past ERISA advisory opinion that warned employers to restrict eligibility for top hat plans to only those individuals who, by virtue of their position in the company, have the ability to negotiate the terms of their employment and thus influence the design and operation of the plan. This rule would be very limiting and, as several commentators have noted, would exclude some people who in the past clearly have been considered “top hat” individuals. The DOL, however, has never issued regulations formalizing its position on this matter. 

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Goodbye rollovers, hello “stay-overs”

Moen-AlexNo surprise here—Baby Boomers are retiring. But as they retire, there is a new trend in town, the “stay-over.” The stay-over approach represents a shift in thinking about how employees will handle their retirement savings investments. Instead of rolling money out of employer plans into IRAs, the stay-over approach encourages retirees to keep their money in their current company-sponsored plans.

Plan sponsors, and their plan advisors, are now competing to keep retirees’ money in employer plans. The reason? As that extremely large workforce exits, sponsors are worried about their ability to negotiate fees with their outside fund managers and maintain lower overall fees for plan participants. Plan sponsors are now forced to weigh traditional concerns related to administration and compliance costs against fee negotiations. A recent Wall Street Journal article says, “Workers pay about 0.45% of assets in fees to outside money managers when they remain in the firm’s 401(k) plan; by comparison, experts estimate they would pay fees of more than 1.5% in IRAs.” Increased plan assets create economies of scale, which in turn reduces the level of fees for all participants in the plan. This movement is also in line with the overarching goal of encouraging retirees’ savings, focusing on keeping money in the plan, and educating employees about their options. Baby Boomer assets in defined contribution/401(k) plans currently total $4 trillion dollars, according to the same Wall Street Journal article, and 2013 was the first year that plan level withdrawals exceeded contributions. This rollover versus stay-over debate is just beginning to launch.

Employees benefit by keeping their balances in the plan as well. Fees paid by participants have a huge impact on the growth of investments over time, thus participants can benefit from the lower fees. Retirees face pressure from outside financial advisors who will try to convince them that keeping money in employer plans adds a layer of difficulty to investment changes and accessing funds. On the contrary, though, investing can be easier for ex-employees to manage because they are more familiar with the fund offerings and fewer choices are less overwhelming. Usually plan investment options are selected and monitored by independent investment advisors who work with the plan fiduciaries—this translates into professional unbiased advisory services, which benefits all participants. A plan feature to consider, which will aid and encourage workers to keep money in the plan, is ad hoc withdrawals for retirees, allowing participants to access their accounts the same way they would in an IRA, and take money as needed. This is a balancing act, however, as the retiree still needs to be aware of the risks of removing money and should have a financial plan in place for retirement.

Employers and plan sponsors should think big. Rather than designing retirement savings plans for the length of time the employee is with the company, plans should represent a tool for lifetime retirement savings for all workers.

409A’s documentation decree: Put it in writing

Pizzano-DominickThis blog is part of a 12-part series entitled “The nonqualified deferred compensation plan (NDCP) dirty dozen: An administrative guide to avoiding 12 traps.” To read the introduction to the series, click here.

In the first part of this series, we examined the need to inventory and examine all compensation arrangements in order to ascertain which ones are nonqualified deferred compensation plans (NDCPs) and thus subject to 409A. One of the main reasons that such proactive analysis is strongly recommended is that, chances are, if the employer does not know an arrangement is subject to 409A, the arrangement most likely is not supported by a “409A-compliant document.” So just what constitutes a 409A-compliant document? Well, the 409A rules make it clear that each NDCP must include the following material terms in writing:

• Individuals or group to be covered
• The amount to which the participant has a right to be paid (or in the case of an amount determinable under an objective, nondiscretionary formula, the terms of such formula)
• Time of payment
• Form of payment

If the plan permits a deferral election, such election also must be “documented”―either in the actual plan document or by reference in the plan document to forms that are completed and executed by participants on a timely basis.

Also, the six-month delay rule for any payment triggered by a separation from service of a key employee of a publicly traded company must be stated in the NDCP by the later of either the plan sponsor’s stock becoming publicly traded or the participant becoming a “specified employee” (i.e., generally a “key employee” as determined under the qualified plan top-heavy rules). Accordingly, plan sponsors may wish to include this provision even if their companies are privately held currently so as to avoid a violation in the event that they go public in the future and then neglect to add this information to the document.

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Celebrating National 401(k) Day can generate enthusiasm for retirement plan

Many employers hold benefits fairs during open enrollment, providing employees an opportunity to review all benefits offered to them. Focusing on the 401(k) plan only during open enrollment events can give employees the false impression that they must make their 401(k) decisions only during the open enrollment period. This article explains how Milliman helped one employer highlight its 401(k) benefits by engaging employees in the process more effectively.

The NDCP dirty dozen: 409A plan recognition

Pizzano-DominickThis blog is part of a 12-part series entitled “The nonqualified deferred compensation plan (NDCP) dirty dozen: An administrative guide to avoiding 12 traps.” To read the introduction to the series, click here.

To quote Section 409A: An NDCP by any other name is still an NDCP
When the topic of nonqualified deferred compensation plans (NDCPs) is raised, there are certain arrangements that immediately come to mind. Supplemental executive retirement plans (SERPs) in the style of defined benefit plans, straight deferral-only plans, “401(k) mirror plans,” and excess plans are among the vehicles that clearly must be parked in the 409A compliance lot. Employers who offer such arrangements for their select group of top management and/or highly compensated employees have been inundated with information on this topic and most likely have already taken measures to address this requirement with a 409A-compliant plan document and operational procedures. However, it is crucial to note that the Internal Revenue Code Section 409A rules cast a very wide net when it comes to the definition of what constitutes a NDCP. Accordingly, employers need to regularly inventory and review their various compensation/benefits agreements in order to determine if any existing and/or new arrangements are structured in a manner that creates a 409A NDCP. This blog will highlight points to consider when conducting this 409A “to be or not to be” determination process.

The get out of 409A free exemptions
Before beginning the inventory and review process, plan sponsors may be able to immediately wean out some arrangements from consideration if they qualify for a 409A exemption. The 409A rules specifically exempt some from coverage; these include but are not limited to the following:

• Qualified retirement plans under Code Sections 401(a) or 401(k)
• Qualified annuity plans under Code Section 403(a)
• Tax-sheltered annuity arrangements under Code Section 403(b)
• Eligible deferred compensation plans under Code Section 457(b)
• Qualified governmental excess benefit arrangements under Code Section 415(m)
• Simplified Employee Pension (SEP), Salary Reduction SEP (SARSEP), and Savings Incentive Match Plan for Employees (SIMPLE) plans under Code Section 408
• Plans involving deductible contributions to a Code Section 501(c)(18) trust
• Certain foreign plans as described in 409A
• Certain welfare benefits (e.g., any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan)
• Any Archer Medical Savings Account as described in Section 220
• Any health savings account (HSA) as described in Section 223
• Any other medical reimbursement arrangement, including a health reimbursement arrangement (HRA), that satisfies the requirements of Section 105 and Section 106, such that the benefits or reimbursements provided are not includible in income

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Evaluating retirement readiness formulas

Retirement plan sponsors should evaluate the assumptions used by providers in their retirement readiness calculator formulas. This can result in more accurate projections that help participants make better long-term savings decisions. A recent PlanSponsor article quoted Milliman consultant Kevin Skow discussing some assumptions that sponsors need to assess to improve retirement readiness projections.

Here is an excerpt from the article:

To calculate these projections, providers have to make numerous assumptions about key variables. Some, such as future inflation rates, do not relate to individuals specifically. But many variables do, and the default assumptions a provider uses may or may not reflect reality for a plan’s participants. “In our mind, the assumptions made are critical,” says Kevin Skow, principal and consultant at Milliman Inc. in Minneapolis.

In order to evaluate readiness formulas, plan sponsors should start by looking at three key areas where assumptions are made:

Salary, retirement date and savings. Understand what salary-increase rate a provider’s model assumes, Skow recommends. “How does that equate to what’s happened historically at your company, or what is anticipated in the future?” he says. And these models assume an average retirement age in doing the calculations, he says, so in evaluating a provider’s model, it helps to know whether that number reasonably lines up with a work force’s actual retirement patterns.

The models also hypothesize about a work force’s retirement-savings rates, going forward. In its retirement readiness calculator for participants, Milliman actually asks each to input any deferral increase he plans. When it does plan-level reports on retirement readiness, the company typically takes a “snapshot” approach and does not assume a deferral-rate increase by participants, Skow says. “But if a plan has automatic increases, a model could assume that everybody who was auto-enrolled at a 5% deferral with a 1% increase, for example, will stay with it,” he says. “Most people who are auto-enrolled stay, and very few tend to opt out….”

Additionally, retirement readiness models have to make assumptions about how long people will live… The suppositions about how long people will live have a big influence on these calculations, Skow says. “In our tools, we tend to project that an individual will need income until age 95 if that person is male, or 97 if that person is female,” he says. “Many models use the normal mortality rate in the U.S. today, which is in the late 80s.” A model assuming a shorter lifespan will improve someone’s monthly retirement-income projection, but also may create false security for some who then end up outliving their savings.

The NDCP dirty dozen: An administrative guide to avoiding 12 traps

Pizzano-DominickEven with the economic downturns, heightened Internal Revenue Service (IRS) scrutiny, and ever-increasing compliance complexity that have marked the last decade, nonqualified deferred compensation plans (NDCPs) remain popular and highly effective executive benefit plans. In addition to providing executives with tax-deferred benefits in excess of their qualified plan benefits, these plans also can be structured to serve a wide range of corporate agendas (e.g., golden handcuffs, recruitment, performance incentives, etc.).

However, what could and should be a “win-win” proposition for employers and executives alike can quickly degenerate into a “lose-lose” bet if the players cannot keep track of the compliance cards that cover their plan’s hand. Whether plan sponsors are opening with the initial draw of the design, drafting and communication of NDCPs, or dealing with the ongoing administration of their existing plans, they must ensure that these compliance cards do not get lost in the shuffle. The compliance stakes are very high for both the employers and executives.

For example, employers need to be concerned about violations of Section 409A because the penalties for such violations are significant, and are imposed directly on the executive who receives the deferred compensation. While employers are not directly subject to penalties for these violations, they may decide or have agreed to pay any 409A tax penalties incurred by their employees. Furthermore, employers may face associated tax reporting and withholding penalties.

Based on our experience with these plans, we have identified the following 12 traps as the areas to which plan sponsors need to pay particular attention:

1. 409A plan recognition
2. Plan document requirement
3. “Top-Hat” group determination
4. 409A grandfathering
5. Application of FICA taxation
6. Timing of deferral elections
7. 401(k) contingent benefit rule
8. Timing of distributions
9. Forms of distributions
10. NDCP/defined benefit (DB) plan funding connection
11. Plan termination rules
12. Separate rules for tax-exempt organizations

Throughout 2016, we will be examining one of these issues each month. Whether you deal with NDCPs from the human resources or administrative perspective, these posts will alert you to some of the most common, most problematic, and potentially costliest errors that plan sponsors and/or participants make in these plans. Rather than delve into a highly technical review of the intricacies of the applicable regulations, the above listed 12 traps will be explored, intending to provide guidance regarding not only what to watch out for but also what proactive steps should be taken to avoid these traps.

The year in DC plans: Confidence up, savings to follow?

Regli-JinnieFrom a regulatory perspective, 2015 has been a good year for defined contribution (DC) retirement plans. The Employee Benefit Research Institute (EBRI) 2015 Retirement Confidence Survey reported that 22% of workers are now very confident about their retirement savings, up 4% from 2014 and 9% from 2013 survey results. Despite the rising confidence, only 67% percent of workers have reported they or their spouses have saved for retirement, which is statistically equivalent to the findings from 2014.

As we roll into 2016, we’ll begin to see the effects of most of 2015’s legislative updates. We hope to see a continued rise in retirement confidence among American workers. Here are the regulatory updates from 2015 that will affect defined contribution plans:

Announcement 2015-19 (January): Changed the determination letter program for qualified plans. Effective January 1, 2017, the regular five-year determination letter cycle for individually designed plans will be terminated. Determination letters will only be required upon initial plan qualification and plan termination. Effective July 21, 2015, off-cycle determination letter applications will no longer be accepted.
Form 5500 SUP (effective January 2015): Offers a paper-only form to supplement the Form 5500 for 2015 and later plan years. Only plans that are exempt from mandatory Internal Revenue Service (IRS) electronic filing may use this form.
Rev Proc 2015-28 (April): Updated the corrections procedures under the Employee Plans Compliance Resolution System (EPCRS) to provide some relief for missed deferral penalties.
Rev Proc 2015-32 (June): Granted late filer penalty relief for Form 5500-EZ filers. The new payment per submission is $500 for each delinquent return for each plan up to a maximum penalty of $1,500 per plan.
• H.R. 3236, Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 aka “The Highway Funding Bill” (July): Extended the Form 5500 deadline for taxable years beginning after December 31, 2015. For calendar-year plans, the deadline extends from October 15 to November 15 of the following year.

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