Category Archives: Defined contribution

Observing the 409A speed limit on payment accelerations after an NDCP termination

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 plans (NDCPs) are designed to run their course at the usual payment pace with the only designated distribution pit stops made along the way being those specifically prescribed by the plan’s provisions. Internal Revenue Code Section 409A (409A) serves as an ever waving yellow caution flag warning NDCP sponsors of the consequences of accelerating distributions (see the “Timing is Everything” blog entry from this series for description). So the question arises, what is an NDCP sponsor to do when it concludes that its vehicle for high performance executives is now no longer running smoothly and/or too costly to maintain on a per participant basis?

Prior to 409A going into effect, many NDCPs contained provisions permitting the sponsor to terminate the plan at its discretion and distribute benefits as soon as possible after such termination. This unlimited distribution discretion upon termination created the potential for the following two suspect scenarios under which sponsors and participants could violate the spirit (if not technically the rules in effect at that time) of how the IRS intended NDCPs to be administered:

Pre-409A suspect scenario #1: Until distributed, NDCPs’ benefits are required to remain subject to the creditors of the sponsor in the event of the sponsor’s insolvency in which case the participants have no greater rights than such creditors. There were cases where, because the plan sponsor was on shaky financial ground with the prospect of insolvency looming, the decision was made to terminate the NDCP so that the participants could “take their money and run” before the sponsor’s insolvency became official and the fate of any NDCP assets were left to the judgment of a bankruptcy court.

Pre-409A suspect scenario #2: Even before 409A, NDCPs were governed by the general tax principle of “constructive receipt,” which generally provides that participants should be taxed on benefits if they could potentially have access to such benefits even if they did not actually access them. Consequently, NDCPs could not contain provisions that would allow participants to withdraw funds while still employed. However, prior to 409A, there were no statutory restrictions preventing sponsors from terminating plans, distributing benefits to the participants, and then immediately creating new programs to provide future benefits, thereby in effect creating a loophole around the prohibition against “no withdrawals while employed” rule.

Recognizing there may still be legitimate reasons for an NDCP sponsor to want or need to terminate its plan(s) and distribute benefits, 409A does allow for an exception to its general prohibition against accelerations of payments. However, in an effort to prevent future occurrences of the past abuses described in scenarios #1 and #2, the 409A rules mandate that such payments will only be permissible upon certain specified circumstances. The remainder of this blog entry will review those cases where 409A raises the green flag for such early payments upon a plan’s termination.

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Final fiduciary rules: Frustrations and the unknown

Tedesco-KaraOn June 8, 2016, the U.S. Department of Labor (DOL) final fiduciary rules became effective, but these new rules are not actually applicable until April 10, 2017. The final rules outline what advisers, financial institutions, and employers need to do to adhere to them. Daunting? Yes. Impossible? Maybe, but some believe the fiduciary rules have been a long time coming. The new rules require advisers and financial institutions to comply with and uphold the fiduciary standards surrounding ERISA when advising clients for a fee. This is significant, as it has the potential to impact how some advisers help their clients with retirement planning. Some advisers may decide to stop helping.

As participants become more and more responsible for their own retirement savings, employers are finding they need to turn to their retirement plan experts for help. A plan adviser who gives fiduciary advice receives compensation for the recommendation he or she makes, and usually the recommendation is based on the specific needs of the participant. The advice is given so that an action will be taken. The final rules clearly state this expert is a fiduciary and the recommendation made has to be in the best interest of the participant and not the pocketbook of the employer and or adviser.

Why is this so important? Because millions of participant dollars have been rolled into IRAs that have high fees and expenses associated with them. Participants don’t understand the fees, they don’t understand their investments, and often they lack the proper tools to help them make educated decisions. It bears asking the question, should an adviser make a recommendation to roll or transfer account balances to another plan or IRA, when a participant might be better off staying put? The answer could be yes, and employers may find that terminated employees are staying with them because it is a better financial decision.

How do advisers and employers feel about this? Many advisers are frustrated they will have to comply with the best interest contract exemption. It has several requirements, but it means advisers may need to modify or fine tune their current practices to satisfy the rules. Plan sponsors will have to take another look at their advisers and service providers and understand their fiduciary responsibilities. It’s important they confirm that any rollover assistance is administrative in nature and cannot be perceived as advice from non-fiduciary human resources (HR) staff or service providers. However, plan sponsors can now feel good knowing that the general education they offer to participants about plans and investments is acceptable; it does not mean they are providing investment advice or taking on additional fiduciary responsibility.

With all of this said, could the election results change, delay, or repeal the final fiduciary rules? There is speculation this could happen, which makes the financial services industry happy, but for those pushing for reform, very unhappy.

Administering a 401(k) plan termination

There are certain circumstances that can result in a company terminating its 401(k) plan. Milliman’s Ginny Boggs was quoted in a recent Employee Benefit Adviser article discussing the steps involved with a 401(k) plan termination during the American Society of Pension Professionals & Actuaries (ASPPA) annual conference.

Here’s an excerpt from the article:

Until all assets within the plan are finally distributed the plan still remains in effect and cannot be terminated. During this time, Boggs recommends that advisers work with their clients on:

• Testing
• Distribution requests due to many participants wanting their money immediately and to assist with loan repayments
• Governmental forms and filings
• QDROs

Advisers should remind their clients to use up their forfeiture accounts through expenses, allocating to participants or offsetting final contributions

“You can’t have any unallocated assets going into plan termination and you do have to liquidate,” Boggs said. “You want to make sure the plan termination amendment encompasses everything that the plan document doesn’t already provide.”

Nondiscrimination (Part 4): Time for employers to brush up again on nondiscrimination testing?

Many employers have modified their traditional defined benefit (DB) plans by moving to a “soft frozen” plan (or “closed” plan), where the existing participants continue to accrue benefits, but plan participation is closed to new employees. One common design is to maintain the DB plan for a closed group of employees and to establish or enhance a defined contribution (DC) plan for newer (and future) employees. In Part 2 of our earlier series on nondiscrimination testing, we explored the issues faced by a typical plan sponsor electing this route.

As an example of how circumstances change, many years ago Employer F permitted a “grandfathered” group of longer-service employees to continue accruals under its DB plan, and established a profit-sharing plan for all of the remaining employees. New employees joined the profit-sharing plan when eligible. At the time of the program change, the plans met the three main nondiscrimination tests, which are:

• Participation (only applicable to the DB plan)
• Coverage
• Benefits

A number of years have passed since the change, and the DB plan population has now declined and become more heavily weighted toward highly compensated employees (HCEs). The DB plan is no longer passing the 70% ratio percentage test, and is currently meeting the coverage requirement via the more complex average benefits test. Employer F is concerned that the average benefits test is in danger of failing in the near future, and is now looking for alternative ways to ensure that the DB plan continues to meet the coverage requirements.

In many circumstances, the nondiscrimination rules will currently allow plan sponsors to consider two or more plans to be a single combined (or “aggregated”) plan for purposes of meeting the coverage and benefit requirements (but not the participation requirements). If this is done for a DB plan and a DC plan, the combined plan is known as a “DB/DC” plan.

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IRS adds flexibility to rollover timing

Moen-AlexOn August 24, 2016, the Internal Revenue Service (IRS) released Rev. Proc. 2016-47, allowing quicker and easier relief of the existing 60-day rollover rule for retirement plans, including 403(b) and governmental 457 plans and IRAs. In the past, under Rev. Proc. 2003-16, an individual had to submit for a private letter ruling requesting a waiver of the 60-day rule and await a response before proceeding with the rollover. The request for waiver via private letter ruling from the IRS is not free; in 2016, an individual may be required to pay up to $10,000 for the waiver. Under Rev. Proc. 2016-47, an individual can proceed with the rollover, at no cost, as long as he or she self-certifies the reason for the delay.

The revenue procedure provides a sample letter that can be supplied to the plan administrator or financial institution, and allows an individual to submit a request for waiver as long as the IRS has not already issued a denial. There are 11 acceptable reasons for waiver of the 60-day rule, including:

• The financial institution made mistakes or did not supply needed information when requested
• A lost check or postal service errors
• An IRS levy
• The check was deposited into an account incorrectly believed to be a retirement plan or IRA
• Personal reasons: family death or illness/disability, natural disaster, incarceration, or foreign country restrictions

If none of the above situations apply, a person can still use the old private letter ruling process to request relief.

As expected, there are timing conditions associated with the self-certification. An individual must complete the rollover contribution “as soon as practicable” after the reasons that caused the delay in the first place are no longer present. The revenue procedure refers to this as the 30-day safe harbor.

What happens if it is discovered during an IRS audit that the waiver is not accepted? The individual would receive additional income and be required to pay the taxes and, potentially, penalties.

This new rule reduces the burden on plan administrators, trustees, and custodians to verify the legality of the rollover. In addition, the ruling simplifies procedures for the individual because the rollover can be processed efficiently, without having to wait for an IRS review of the situation and response letter.

Plan sponsors, you may be wondering if there is any action you need to take, or if this is even relevant to you. The answer is no. This is simply for your reference in case a participant asks whether the 60-day rollover rule has any exceptions. I’ve found that with some of our smaller clients, plan sponsors receive a variety of questions and become more involved in assisting participants with the distribution process. You may get a question about this new Rev. Proc. from a participant and after reading this, hopefully, you are more equipped to assist them.

Sponsors and participants must follow 409A true to form

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.

While last month’s blog explored the permissible times NDCP distributions may occur under section 409A of the tax code, this month’s entry examines the rules surrounding the forms of payment that may be offered under these plans. Accelerations and deferrals can just as easily be effected with a choice of form (e.g., lump sum versus installment payments) as they can with timing elections. These two sets of rules are connected because they share a common purpose: proving some degree of flexibility while preventing the type of excessive control that 409A was enacted to eliminate. The following will examine how sponsors can ensure that their NDCP forms follow 409A function.

First step: Grounding form flights of fancy
NDCP participants are used to the free-flowing flexibility of the qualified plan world in which they can typically wait right up until their benefit commencement date (BCD) before having to commit to the form of payment under which they wish to have their plan benefits distributed. A further false sense of flexibility may arise from pre-409A provisions, which permitted the linking of the form of payment from the NDCP to the form of payment elected by the participant under the qualified plan that the NDCP was intended to supplement. These were most prevalent in defined benefit (DB) style NDCPs but occasionally also appeared in some defined contribution (DC) ones. The 409A rules do allow grandfathering of prior amounts (see the “Honor thy 409A grandfather” entry of this series for details); however, such linking is prohibited for benefits attributable to post-December 31, 2004, accruals or contributions.

Because the rules governing NDCP form elections for such amounts are much more rigid, NDCP sponsors must make sure they clearly communicate these differences to participants, develop the appropriate 409A-compliant plan designs for their executive groups, and vigilantly administer their NDCPs in accordance with such designs. The rules for 409A generally require that a participant’s form of payment under a NDCP be designated much earlier than would be the case under a qualified plan. For most NDCPs, the rule requires participants to elect their form of payments when they first become eligible for the NDCP. Accordingly, sponsors need to provide participants with sufficient notice and means to make this election prior to the expiration of their initial eligibility periods (i.e., generally 30 days from the date they are first designated as eligible).

Exceptions to the rule
There are two exceptions to this rule requiring participants to make form elections to be made when first eligible:

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