A former employee attains age 65 and applies for a retirement pension. That’s normally a routine situation for any plan administrator. But what if the employee stopped rendering covered service 24 years ago and the plan administrator has no records of the employee or his employment because he worked for a separate company that was acquired 14 years ago? Can the plan deny the benefit claim because it has no records relating to either the prior employer’s plan participation or the employee? Or, does the employee have a valid claim because he has W-2s and paystubs showing that he was employed by the separate company for at least a portion of his claimed tenure?
When both parties have insufficient records, who loses because they have the burden of proof?
At least one court has considered this situation and concluded that the employee does not have the burden of proof for “matters within the defendant’s control.” So, if the employee asserts a prima facie case that he is owed a benefit, the burden of proof shifts to the plan. This is especially the case where it would be “unreasonable” for the employee to prove his actual hours worked over each of his 20 years of employment during the 60s, 70s, and 80s. The matter was remanded to the trial court for disposition in accordance with these principles by the 9th Circuit Court of Appeals in Estate of Barton v. ADT Security Services Pension Plan (2016).
It is worth noting that ERISA imposes specific record retention requirements on retirement plans and their administrators. As set out in proposed Department of Labor regulations, participant benefit records must be retained
"…as long as a possibility exists that they might be relevant to a determination of the benefit entitlements of a participant or beneficiary."
As the IRS explains: “You should keep retirement plan records until the trust…has paid all benefits and enough time has passed that the plan won’t be audited.” In plan terms, that means forever – actually forever plus the audit period!
Less restrictive rules apply to retirement plan records that do not relate to the determination of benefit entitlements such as records used to prepare annual reports on IRS Form 5500, which must be retained for six years after the date of filing.
Retirement plan retention requirements are pretty clear. The retention lapses that do occur both in the Estate of Barton case and in our experience usually result from business acquisitions where the acquiring business either does not receive or fails to retain the “forever” records of the acquired entity. So, any due diligence checklist in a business acquisition should contain a detailed inquiry about the target’s “forever” records. And yes, you can retain your own forever records electronically in accordance with applicable Department of Labor regulations.
Recent legislation passed by both the House and the Senate with substantial bipartisan majorities (the SECURE Act and RESA) is aimed at promoting retirement savings in Section 401(k) plans.
Legislative concerns about 401(k) participants who are financially unprepared for retirement has resulted in a number of specific provisions intended to encourage participants to save more. Those provisions include tax credits for small businesses that include automatic enrollment provisions in their 401(k) plans, expanded availability of multiple employer plans, 401(k) eligibility for tenured part-time employees, postponed start date for required minimum distributions from age 70½ to 72, and penalty free participant withdraws of up to $5,000.00 upon the birth or adoption of a child.
The legislation also includes provisions that afford some liability protection for 401(k) fiduciaries who choose to include annuities in the investment options offered to plan participants.
Annuity investments (or “lifetime income” options) are intended to encourage participants to save more for retirement and provide an income stream in retirement that they (and their beneficiaries) cannot outlive. But even though you cannot outlive an annuity, this protection comes at a cost. There are annuity sales commissions as well as annual maintenance fees, mortality charges, and the risk of forfeiture if you (or your beneficiary) die sooner than expected. There also is a tradeoff from the significant equity investments that many investment advisors suggest as a hedge against your outliving average life expectancies.
In-plan annuities also offer the prospect of providing a “variable” annuity product which combines a fixed annuity component with investment funds that are intended to provide additional retirement income. But no load mutual funds will be more flexible and definitely less expensive than annuity investment funds in today’s market.
So, Plan Fiduciary, do you want to add annuity contracts to your investment mix?
Consider the cost and complication of an annuity product. You, as a fiduciary, need to be able to understand the annuity product before offering it to plan participants. But your participants also need to make an informed choice. Also ask yourself, is your workforce likely to save more for retirement because they can choose to invest in an annuity? Would other measures (such as auto enrollment) work better? And, will annuities appeal to the typical 401(k) participant? You may find that annuities appeal primarily to those sober and sophisticated participants who are best equipped to plan their financial affairs with traditional investment funds.
Annuities can appeal to participants particularly when they are assessing their financial situation at or near retirement age. But adding variable annuities as an investment option for younger participants seems unduly complicated for both plan fiduciaries who have to evaluate them and participants who have to select them.
Fiduciaries of 401(k) plans should not select an annuity investment for their plans without first thoroughly investigating the product and the financial institution behind it. Also document this investigation.
Consider limiting any offered annuity to a fixed annuity and not offer any annuity that is bundled with investment products that are not currently cost competitive with traditional mutual funds. And if you do want to offer fixed annuities, consider providing that option only for participants at or near retirement age when they are in a better position to evaluate their income needs in retirement.
What happens when you go to an in-network facility (hospital or emergency room) and are treated by a doctor who is not in your insurance company’s PPO network? You get a bill from a specialist like a radiologist or anesthesiologist that exceeds your insurer’s normal reimbursement – and you’re stuck with the balance. Surprise! Or, as the insurers like to say, you’ve been subject to “balance billing.”
Roughly one in six emergency room or hospital visits results in surprise billing, although the odds vary significantly depending on where you live. Such charges can be significant as the out-of-network doctor typically charges a full “list price” for services. Consumer bankruptcies have resulted because in some cases surprise billing has amounted to tens of thousands of dollars.
What can you do about surprise billing where your insurer initially refuses to cover charges incurred at an in-network facility?
The good news: depending on state law, you may have rights that limit your responsibility for surprise billing. In Illinois, the Network Adequacy and Transparency Act protects consumers from balance billing both for services at an in-network facility and for treatment at an out-of-network facility in the event of an emergency. But consumers have to follow the specified claim procedure (see here for details).
The bad news: state law does not govern the “self-insured” group medical plans typically maintained by larger employers. So, until protective legislation pending in Congress becomes law, there will be no formal restrictions on surprise billing by self-insured medical plans.
Always appeal any surprise billing by your insurance company. Even those insurance companies that are processing claims for self-funded medical plans may have a uniform surprise billing policy responsive to state law. Also, follow up any surprise billing claim appeal that is denied with your offer to pay only a reasonable fee for the services rendered – you may be able to negotiate a better deal.
The Department of Labor issued guidance in mid-2018 which allowed employer associations to adopt a single multiple employer health plan to cover a greater number of employers and their employees. These Association Health Plans (or “AHPs”) were intended to allow more smaller employers and self-employed individuals to band together in order to secure simpler health plan arrangements and cheaper coverage in the marketplace (our February Benefits Bulletin provides some of the details here).
The U.S. District Court for the District of Columbia recently vacated significant portions of the Department of Labor AHP rule that expanded access to affordable healthcare options for small businesses. Although the Department of Labor disagrees with the Court holding and has filed a notice of appeal, there are still many businesses that have elected AHP healthcare coverage in reliance on the Department of Labor rule in effect prior to this holding. So, what does an employer that has recently signed onto an AHP that now has a questionable legal foundation do to protect itself – and its employees – from the consequences of possible non-compliance?
The Department of Labor recently issued a statement addressed to these employers advising them that they do not have to terminate or switch their current healthcare coverage until the end of the current plan year or, if later, the expiration of the current contract term (the “transition period”). So for now, employees can rest assured that their AHP coverage will stay in force.
In accordance with the above policy, the Department of Labor statement provides that it will not during the transition period pursue enforcement actions against parties for violations stemming from actions taken before the recent Court ruling – so long as the actions were taken in good faith and the AHP pays health benefit claims as promised.
Small employers and sole proprietors with AHP coverage should stay the course – for now. If they instead drop AHP coverage, those employers may have to wait for an open enrollment period to obtain replacement coverage, which could create a gap in coverage. In the meantime, the Department of Labor appeal of the Court holding could reverse its holding and reinstate the prior Department of Labor AHP rule.
The Illinois Secure Choice Savings Program requires employers with at least 25 Illinois employees to set up a state-sponsored IRA based retirement program if they do not already have a retirement plan. Although the program is funded solely by payroll contributions from employees, subject employers must go through an online registration and enrollment process, forward payroll contributions to the program custodian and provide program information to employees (click here for more details).
A similar program was adopted in California and was challenged in court. Although the U.S. Department of Labor had issued favorable guidance as to the impact on these state programs of ERISA, the federal pension law, Congress rescinded this guidance with the change of administration in 2017. This presented the issue of whether or not ERISA would “pre-exempt” these state programs and impose burdensome federal compliance responsibilities on employers.
A U.S. District Court in California held in Howard Jarvis Taxpayers Ass’n v. California Secure Choice Ret. Savings Program on March 29, 2019 that the California program was not subject to federal law and could be implemented on its terms. Because the California program is very similar to the Secure Choice Program in Illinois, the California case may remove the Secure Choice Program from legal limbo. Although the California decision is not binding in Illinois (and it could be reversed on appeal), this makes it less likely that ERISA-related litigation will impede the Secure Choice Program.
Employers that do not currently sponsor a retirement program for their Illinois employees need to consider retirement plan options to the Secure Choice Program such as a 401(k) plan. For employers with 100-499 Illinois employees, the Secure Choice compliance deadline is July 1, 2019 (employers with 25-99 employees have until November 1, 2019 to enroll in the Secure Choice Program – or set up an alternative arrangement). Employers with 500 or more Illinois employees who have no retirement plan need to scramble – their Secure Choice compliance deadline, November 1, 2018, has already passed.
Department of Labor proposed regulations would allow certain employers (including employer groups or associations) and business owners with no employees to share a single 401(k) plan. This arrangement would transfer administrative and compliance responsibility to the sponsor of the retirement plan under a multiple employer plan, or “MEP.”
Under the proposed regulations, the MEP sponsor would be responsible for ERISA reporting and disclosure requirements for all of the participating employers. So, there would only be one ERISA bond and one annual report no matter how many employers participate in the MEP plan. MEP sponsors would also be responsible for general fiduciary duties although each participating employer would continue to be responsible for choosing the MEP plan, reviewing its performance, and arranging for employer and employee contributions to the plan.
MEPs can also be offered through qualifying professional employer organizations (“PEOs”), which are businesses that perform certain employment-related functions for its employer clients, such as hiring, payroll, employee benefits and HR functions.
So, the proposed regulations are intended to expand availability of 401(k)-type plans to smaller employers with the prospect of making such plans available at a lower cost. But bear in mind that the availability of MEP retirement plans is subject to a number of requirements, principally:
MEP sponsors must have a business purpose other than just providing retirement plan benefits to its member employers.
MEP members must have a “commonality of interests” such as (1) being in the same trade, business or profession, or (2) having a principal place of business in the same state or city as the other MEP members.
So, MEPs might work to expand the availability of 401(k)-type plans at a cheaper price for smaller employers. They could also protect member employers from responsibility for much of the plan’s administrative compliance. But bear in mind that the above is just a brief summary of the requirements for MEP members and MEP sponsors. Any specific MEP arrangement should be carefully reviewed before entering into a MEP participation agreement.
Smaller employers who find that candidates in a competitive labor market need to have 401(k) benefits may find a MEP plan to be a simpler, cheaper alternative to adopting their own plan. Also, employers with 25 or more Illinois employees who do not currently have a retirement plan will be required to adopt an Illinois “Secure Choice” plan by no later than November 1 of this year (click here for details on the Secure Choice program). Adopting an available MEP plan might prove to be an attractive alternative.
We have an award winner for 2018: Florida eye doctor Samuel Poppell.
In McLain v. Poppell, it was alleged that Dr. Poppell, owner of the Emerald Coast Eye Clinic and trustee of its 401(k) plan with total investment discretion, invested plan assets primarily in VirnetX, a publicly traded company whose principal business was acting as a “patent troll” (a company that acquires patents and uses them primarily to sue other businesses for alleged patent infringement).
Dr. Poppell’s investment decisions were based on his personal review of internet message boards. His investment acumen resulted in a loss of more than one-half of the plan’s asset value in a single year as the VirnetX stock cratered.
In response to participant complaints about these investment losses, Dr. Poppell allegedly threatened to terminate the plan as its VirnetX investment continued to lose money. Dr. Poppell’s next response, as participants continued to complain, was to terminate their employment!
Dr. Poppell was able to settle the suit filed by participants against him for about 25 percent of the plan’s total investment losses. However, the Department of Labor subsequently intervened and required Dr. Poppell to compensate participants for the balance of their aggregate losses.
So, for his complete disregard for his fiduciary duties to his employees and his related retaliation against participants who had the temerity to complain, Dr. Poppell is our 2018 ERISA Hall of Shame “honoree.”
Fiduciaries of 401(k) plans need to engage and rely on their professional advisors – you can’t just wing it when it comes to plan investment decisions.
Whether you are an accountant, lawyer, banker, business consultant or investment advisor, many of your business clients will have a 401(k) or other qualified retirement plan. You may not specialize in retirement plans, but consider the following as the kinds of things you might do to assist your clients and prospects with their retirement plans:
- Introduce your client to responsible third party administrators (TPAs), investment advisors, record keepers and, if necessary, ERISA counsel
- Make sure your client has an investment policy statement and uses it as a basis for investment decisions
- Your client should meet at least twice a year with an investment advisor to discuss the plan’s investment funds – and document those discussions
- Encourage your client to maintain fiduciary liability insurance (not to be confused with the plan’s required ERISA fidelity bond!)
- See that your client has participants sign a release when they receive benefit distributions (see Howell v. Motorola, Inc.)
- Suggest that your client include low cost index funds as 401(k) investment selections to provide a defense to claims of excessive costs or poor performance on other fund selections (see Divane v. Northwestern University)
- Encourage your client to use independent ERISA counsel to assure confidentiality of sensitive information (the company’s lawyer has a confidential attorney-client relationship only with the company, not the plan or its fiduciaries)
No fee mutual funds are here!
Fidelity recently announced domestic and international “index” funds that would charge no management fees – and no transaction fees when purchased directly from Fidelity.
The no fee structure appears to be more than a come on, and industry sources report that Fidelity intends to subsidize fund costs in order to provide no fee funds indefinitely. Fidelity’s expectation is that the no fee funds will generate business for Fidelity’s other mutual funds. So, should retirement plan investment fiduciaries rejoice at the potential cost savings and flock to these new mutual funds?
Well, a word of caution is in order.
As part of the cost savings for the new funds, Fidelity will not license an index such as the S&P 500 for the new funds. Instead, Fidelity will create its own index. Neither the new funds nor the index will have a track record, so plan investment fiduciaries need to do their homework on both the no cost funds and the new Fidelity index. Then these fiduciaries need to determine if the investment prospects of the new funds outweigh the likely returns of existing index funds which charge management fees as low as three or four basis points.
The no cost mutual funds will attract a lot of attention and likely some new business for Fidelity. Retirement plan investment fiduciaries need to carefully consider the funds’ investment prospects – and, as ever, document their decision making. From an administrative standpoint, plan fiduciaries should also bear in mind that in order to avoid transaction charges on the “no cost” funds, they have to invest directly with Fidelity.
We’ve all read about the lawsuits questioning an employer’s 401(k) investment fund selections and related claims of excessive fund costs. And typically a plan’s professional investment advisor (yes – you should have one unless you have an investment professional on staff) meets with company representatives periodically to discuss a detailed report on fund investment performance and any recommended changes in the plan’s investment fund selections. So, your 401(k) plan files bulge with investment-related materials (and they should!). But what about the rest of an employer’s 401(k) responsibilities?
As posed by the moderator of the 401(k) panel at the Illinois CPA Society’s recent annual Summit that I had the pleasure of appearing on, what should plan sponsors be paying attention to in addition to monitoring plan investment results?
Good question – so what can you do to get a leg up on the rest of the 401(k) universe?
Consider online IRS compliance guides like “A Plan Sponsor’s Responsibilities”. This material covers plan documentation, monitoring plan service providers, internal controls, law changes, payroll data you need to share with plan providers, hardship distributions, participant loans, ERISA fiduciary bonds, as well as eligibility, vesting and benefit payment matters. It also provides links to other IRS compliance resources and is a good starting point to find more detailed information on specific plan administrative requirements such as government filings, participant notices and fiduciary requirements. Also consider articles such as “Your Fiduciary Duty – And What to Do About It”.
There’s more to an employer’s 401(k) responsibilities than selecting and reviewing plan investment funds. Remember, as the “Plan Administrator,” the buck stops with the employer when it comes to all compliance matters. So, consider IRS guidance as a starting point, but do not hesitate to address any resulting concerns with your plan’s investment advisor, third party administrator, accountant or ERISA lawyer.
Employers with 25 or more employees in Illinois will be subject to the Secure Choice Savings Program Act (the “Act”) if they do not already have an employer sponsored retirement arrangement like a 401(k) plan. For such employers with 500 or more Illinois employees that have been in business for at least two years, the compliance deadline is November 1, 2018. By that date, these employers must register at the Secure Choice website here and enroll their employees. Subject employers with fewer than 500 Illinois employees have compliance dates deferred until July 1, 2019 (100-499 employees) and November 1, 2019 (25-99 employees).
Here are some of the details:
The required retirement arrangement includes a separate Roth IRA account for each employee that is set up by the employer. Employees are automatically enrolled at a five percent contribution rate but they can elect out of the plan at any time. There are no employer fees to participate in the program and no employer retirement contributions are required or permitted.
The program is administered through the Illinois State Treasurer’s Office by a private contractor that will act as the Roth IRA “trustee,” process contributions, manage account records and maintain the website. Program costs are funded through an annual administrative charge not to exceed .75 percent of employee account balances. The Treasurer’s Office also charges employees a fee of .05 percent to cover its costs.
Employees may choose between several diversified mutual funds for the investment of their accounts and, if they make no investment direction, their accounts will default into a target date fund. Employee accounts are portable and may be transferred to other Illinois employers.
The employer’s role as “facilitator” includes registering as a participating employer, establishing an online “employer portal,” setting up a payroll deduction process, and remitting employee contributions.
The program is established with the intent to avoid complication for employers under ERISA, the federal pension law, and it is anticipated that employers will be subject to none of the ERISA responsibilities that apply to sponsors of 401(k) plans.
Non-compliant employers are subject to a fine of $250.00 per employee per year.
The Fine Print:
Official guidance available at this time provides the following specifics:
For purposes of determining program applicability, employers need to count all employees 18 years of age or older who receive wages taxable in Illinois (this includes part-time employees, but some seasonal employees can be excluded).
Illinois employers, including not-for-profit organizations, are subject to the Act if: (1) at no time during the prior calendar year they employed fewer than 25 Illinois employees, (2) they have been in business at least two years, and (3) they have not offered an employer sponsored retirement plan in the preceding two years.
Employers are required to log on to the Treasurer’s website to create a payroll list and then to input the following information in the employer portal by the applicable deadline: each employee’s address, phone number, email address, legal name, date of birth and social security number or individual tax identification number (undocumented workers are not permitted to participate in the program).
For employers with 500 or more Illinois employees, the November 1, 2018 deadline is fast approaching. Employer electronic enrollment of each of its employees may take some time unless data is submitted in bulk form. More important, subject employers may want to give serious consideration to a private retirement plan alternative like a 401(k) plan that also can provide enhanced benefits for management-level employees.
If your company is not among the eighty-eight percent (88%) or so of large Illinois employers that already sponsor a retirement plan under Sections 401(a), 403(b), 408(k), 408(p) or 457(b) of the Internal Revenue Code, then you need to take the steps outlined above to comply with the Illinois Secure Choice Act by November 1, 2018. Also consider the 401(k) and 403(b) options that may work better for you and your work force. Retirement professionals can analyze a census of your current employees to provide specific retirement plan options that might make more sense for you than a Secure Choice arrangement.
Fiduciaries who handle investments for 401(k) and other self-directed retirement plans (such as 403(b) plans for not-for-profit organizations) are increasingly exposed to liability for their investment decisions. Those fiduciaries, including employers and any individuals charged with investment decision making, are being second guessed for the investment funds they select. Plan fiduciaries have been sued for a variety of allegations ranging from excessive fees, self-dealing, lack of transparency and poor investment performance. Some of these actions are filed as class actions, and like other fiduciary claims, they assert personal liability against plan fiduciaries.
A recent decision of the Federal District Court in Chicago, Divane v. Northwestern University, suggests a way to help insulate plan fiduciaries from such claims.
In Divane, Northwestern University and a number of individuals involved with two of its self-directed 403(b) plans were alleged to have breached their fiduciary duty to plan participants by providing too many investment options, providing mutual fund selections with excessive “retail” expense ratios, charging participants too much for record-keeping services funded through “revenue sharing,” and including a fund that had not performed well.
The Court granted the defendants’ Motion to Dismiss because plan participants could select among investment funds that included index funds with expense ratios ranging from .05 percent to .1 percent. The Court held that, as a “matter of law,” these expense ratios were “low.” Because participants had the option of selecting these funds, they were in a position to avoid more expensive funds, a poorly performing fund, and a fund which made revenue sharing payments to the record keepers that were alleged to be “excessive.” Further, the Court added that record-keeping fees were “reasonable as a matter of law.” Based on these conclusions, the Court went on to dismiss the Complaint with prejudice thereby resolving this case in the defendants favor, subject to any possible appeal.
The decision in Divane suggests that any self-directed retirement plan should include low cost funds (usually index funds) in its investment array. This obviously makes available to participants the desirable features of such funds but it also helps insulate plan fiduciaries from claims that they have not properly performed their duties with respect to the plan’s other investment funds – funds which may not be low cost and may not offer investment results that match the results of index funds. With this in mind, you will want to include a selection of low cost index funds in your 401(k) or 403(b) investment array. These funds may turn out to be profitable investments for plan participants but, based on the Divane opinion, they will also provide a good defense if plan fiduciaries are ever second guessed by a plaintiff’s lawyer – or a government auditor.
There are judicial decisions holding that a business owner can be personally responsible when the owner has control over company finances and exercises such authority by paying company creditors instead of making required payments to a welfare benefit plan. But a recent decision of the U.S. Court of Appeals for the Ninth Circuit holds that an employer does not become an ERISA fiduciary merely because it breaks its contractual obligations to make welfare plan contributions (see Glazing Health & Welfare Fund v. Lamek).
In the Lamek decision, the Court considered whether or not unpaid contributions could be considered “plan assets” so that parties in control of those assets would be deemed fiduciaries to the plan. The Court found that:
…even an ERISA plan that treats unpaid contributions as plan assets does not make an employer a fiduciary with respect to those owed funds.
This is good news to plan sponsors, especially those who contribute to union sponsored health and welfare funds. Under Lamek, parties to an ERISA plan cannot by contract designate unpaid contributions as “plan assets” in order to make employers plan fiduciaries. However, not all circuit courts agree with the Ninth Circuit and employers in the Second Circuit (New York, Connecticut and Vermont) and the Eleventh Circuit (Alabama, Georgia and Florida) should be wary of collective bargaining agreements that define unpaid employer contributions as plan assets. Other circuit courts such as the Court of Appeals for the Seventh Circuit in Chicago have not yet ruled on this issue. It may eventually take a Supreme Court decision to resolve the conflict among the circuit courts. Until then, there will be no nationwide judicial resolution of this matter.
The Ninth Circuit decision is a favorable development for employers in California and the other West Coast states included in the Ninth Circuit. For the rest of the country, it’s wait-and-see what happens in the circuit courts – or the U.S. Supreme Court.
All transactions involving the purchase or redemption of employer stock by an Employee Stock Ownership Plan (“ESOP”) must be conducted at fair market value. This assures that the statutory prohibited transaction exceptions available to compliant ESOPs will apply. Fair market value for private companies must be determined by an independent appraisal. This would include annual valuations and, more important, the valuation of the ESOP’s critical acquisition of the employer stock that it is required to maintain as its “principal investment.”
ESOP appraisals can be influenced by misleading information provided by company management. Appraisers can even give their approval to ESOP transactions that leave the employer-sponsor insolvent as in the case of the Chicago Tribune ESOP. The resulting litigation was concluded by a settlement agreement with the Department of Labor that charges ESOP fiduciaries with the responsibility of performing their own due diligence investigation of any ESOP appraisal report.
A recent Department of Labor settlement agreement with First Banker Trust Services (“FBTS”) resolves three separate cases and outlines additional valuation guidelines that ESOP fiduciaries (including the employer-sponsor of an ESOP) should consider any time they deal with a valuation report issued by the ESOP appraiser, or “Valuation Advisor.”
Each of the three cases alleged that FBTS approved ESOP transactions without undertaking a thorough investigation of the value of the company stock involved. Because the stock valuations were based on unrealistic projections of future company earnings, they overstated the value of the stock of each sponsor. As a result, the three subject ESOPs allegedly overpaid for the stock purchased by each of them. As part of the settlement agreement, FBTS also agreed to pay $15.75 million to the three ESOPs.
The FBTS settlement agreement sets out the following requirements and, although they technically apply only to FBTS, ESOP trustees and administrative committees should consider them as generally applicable compliance guidelines (these are just highlights of the new requirements):
The selection process for any Valuation Advisor must include at least three references and review of any regulatory proceedings involving the Advisor. The Valuation Advisor cannot have previously worked for either the ESOP sponsor or a committee of its employees.
Any valuation report must comment on, among other things, the financial impact of a proposed ESOP transaction and related securities acquisition debt on the ESOP sponsor (remember the Tribune ESOP!).
Valuation reports should be based on audited financial statements of the sponsor for the prior five year period. If unaudited or qualified financial statements are used, any selling shareholders who are officers, managers or directors of the ESOP sponsor must agree to compensate the ESOP for any losses attributable to inaccuracies in the sponsor’s financial statements.
If the ESOP pays a control premium for company stock, ESOP fiduciaries must document that the ESOP is obtaining voting control in fact. Any limitations on such voting control must be identified and valued in terms of amounts paid to the ESOP as “consideration” for those limitations.
Valuation reports must consider whether a proposed ESOP loan is at least as favorable to the ESOP as any loan between the ESOP sponsor and any of its executives in the prior two years.
The ESOP trustee must provide the Valuation Advisor certain specific information about the sponsor, including offers to purchase or sell its stock in the prior two year period as well as any sponsor defaults under a loan agreement, any management letters from the sponsor’s accountant and information relating to any sponsor valuations provided to the IRS during the prior five years.
The ESOP trustee must consider whether or not it is appropriate to include a purchase price adjustment or claw-back provision in any share purchase agreement in order to take into account a future corporate event or other event that might adversely affect the value of the sponsor’s stock.
The ESOP trustee must meet certain documentary requirements, including a certification by its employees who participated in decision making with respect to an ESOP transaction that they have read the valuation report and considered the reasonableness of its underlying assumptions and value conclusion.
ESOP sponsors and financial institutions involved in ESOP transactions should consider the new territory staked out in the FBTS settlement agreement. First of all, note the requirement that company insiders agree to compensate the ESOP for errors in company financial statements if those statements are not audited financial statements. Second, the normal practice of assigning a control premium in the valuation of majority stock interests purchased by ESOPs must now be questioned by ESOP fiduciaries. This means that typical arrangements that leave incumbent management in control of the voting of ESOP stock must not only be investigated by ESOP fiduciaries but also may require the fiduciaries to determine a value for any such limitations on control – and to provide that the ESOP be “compensated” accordingly.
Nick Saban is the highest paid college football coach in the country. In 2017, he was reportedly paid $11 million by the University of Alabama. If he is paid that amount in 2018, the recently passed Tax Cuts and Jobs Act (the “Act”) will impose an excise tax on Alabama, his employer, of over $2 million!
Why is Congress picking on Alabama?
Well, the Act applies not only to Alabama but also to other tax-exempt organizations. In order to level the playing field between tax-exempt and for-profit entities, the Act imposes a 21 percent excise tax on compensation in excess of $1 million paid to “covered employees” (the organization’s top five earners for the current and any preceding tax year). This excise tax also applies to excess “parachute payments” made to covered employees upon separation from employment. In the for-profit realm, such payments are penalized with a loss of the employer’s corresponding income tax deduction.
So, who are the likely targets of the new tax? In addition to football coaches, college presidents and highly paid executives of public charities come to mind. However, there is an exception for compensation paid to doctors, nurses, veterinarians and other licensed professionals for providing medical services. So, superstar physicians may not subject their tax-exempt employers to the new excise tax.
Tax-exempt employers may want to consider deferred compensation arrangements for executives in order to reduce current compensation. Medical service providers like public hospitals that pay compensation primarily for medical services may want to revise physician employment agreements to separate compensation paid for administrative and teaching services from compensation paid directly for medical services. In any event, there is no grandfather provision so the excise tax will apply to existing compensation arrangements for taxable years beginning after December 31, 2017 (that’s January 1, 2018 for employers with calendar tax years).
Your retirement plan may have an outside third party administrator (TPA) to assist with plan administration. However, a TPA typically is not a fiduciary to the plan and does not act as “plan administrator” (that’s usually the employer itself as provided in a typical TPA services agreement). This leaves the employer ultimately responsible for the plan’s compliance with all applicable legal requirements. So, even if your TPA makes a mistake, the employer is likely on the hook for any resulting liability because the TPA’s services agreement usually imposes damage limits and employer indemnities that protect the TPA.
An independent service provider (maybe your current TPA) can be engaged to act as the “plan administrator” pursuant to Section 3(16) of ERISA. As a 3(16) fiduciary, the service provider assumes fiduciary responsibilities in administering the plan. The 3(16) fiduciary is responsible for all compliance activities, including the following:
- Determining employee eligibility
- Retaining plan service providers
- Preparing and filing annual reports
- Maintaining fidelity bond coverage for employees who handle plan assets
- Interpreting and applying plan provisions
- Distributing summary plan descriptions and supplements on a timely basis
- Preparing an investment policy statement
- Administration of participant loans, hardship withdrawals, as well as benefit computations and distributions
- Distributing participant notes such as summary annual reports and, as applicable, annual qualified default investment alternative (QDIA) notices, safe harbor notices and investment fee disclosures
- Reviewing and acting on reports of plan investment advisors and any private auditor
- Reviewing and implementing qualified domestic relations orders (QDROs)
Are your bases covered on all of the above? If your TPA is not involved in these compliance functions, are they adequately performed by your own employees? If not, your plan may need help from an outside service provider or even a 3(16) fiduciary.
Engaging a competent 3(16) fiduciary should provide any retirement plan the maximum compliance protection available. Just bear in mind that the employer still retains a legal obligation to prudently select the 3(16) fiduciary and to monitor the fiduciary’s ongoing performance of its duties.
Many of us have believed that every ERISA plan must have both a plan document and a summary plan description (“SPD”). An SPD is required for all ERISA plans in order to explain them in plain English. ERISA also requires subject plans to have a “written instrument” and it is the usual practice, for retirement plans in particular, to have both a plan document and an SPD.
In the absence of a separate plan document, can a plan’s SPD itself also satisfy the ERISA “written instrument” requirement? A recent decision of the Firth Circuit Court of Appeals (Rhea v. Alan Ritchey, Inc. Welfare Benefit Plan) says yes.
Because many insured group health plans have no documentation other than an SPD, this decision may provide a defense to employers who are sued because their group health and other welfare plans are documented only by an SPD and, therefore, are alleged to fail to meet ERISA’s so-called “plan document” requirement.
In reaching its decision in Rhea, the Fifth Circuit rejected arguments that the defendant’s SPD was deficient because it referenced a separate, non-existent “plan document.” The Court also found that the SPD’s short hand description of procedures for amending the plan and its funding arrangement satisfied applicable ERISA requirements.
Although the decision in Rhea recognizes the reality that most sponsors of insured group health plans do not have a separate plan document, note that many of those plans do not even have an SPD. This is because their insurance company has provided only an insurance company “certificate of coverage.” That type of documentation as well as SPDs that lack all the required provisions are not covered by the decision of the Court in Rhea.
Sponsors of insured group health plans with only an SPD and not a separate plan document can relax – but only if their SPD’s satisfy the applicable ERISA “written instrument” requirements. Also bear in mind that there are other reasons to have a separate plan document. SPDs are prepared by insurance companies and may not include optional provisions that plan sponsors frequently include in separate plan documents. Also, more employers are adopting “wrap plan” documents that consolidate all of their welfare benefits such as group health, group life and group disability plans into a single plan to allow ERISA annual reporting on just one Form 5500.
It's a Familiar Story
You or your retirement plan’s third party administrator (TPA) need to make a benefit distribution to an ex-employee. But the employer’s records are out of date and the former employee cannot be located. Worse yet, the missing participant has attained age 70½ so the plan is required to make minimum distributions (RMDs) but cannot do so.
Can you sit back and wait for the missing ex-employee to come forward and claim their benefits? If they never show up, can you forfeit their benefits?
The U.S. Department of Labor (DOL) is reported to be targeting retirement plans with missing participants for audit. By examining Form 5500 annual reports, the DOL discovered that some plans were reporting a larger number of terminated vested participants who were not receiving benefits. Worse yet, the DOL was able to contact a significant number of these “missing” participants by simply sending a certified letter to their last known address. As a result, the DOL has reportedly initiated a national audit campaign targeting plans with missing participants with a view towards treating lackadaisical efforts to locate them as a breach of fiduciary duty. And, the IRS can weigh in with additional penalties for failure to make RMDs to those ex-employees who have attained age 70½.
What to do? Well, the IRS has recently provided a get out of jail card that works if you follow the mandated procedure for finding missing participants. So, what is the secret sauce?
If the plan has taken all of the following steps, the IRS will not challenge your plan for failure to make RMDs:
- Searched plan and related plan, sponsor, and publicly-available records or directories for alternative contact information.
- Used any of the search methods below:
- A commercial locator service;
- A credit reporting agency; or
- A proprietary internet search tool for locating individuals.
- Attempted contact via United States Postal Service certified mail to the last known mailing address and through appropriate means for any address or contact information (including email addresses and telephone numbers).
Also bear in mind that the DOL expects employees to be proactive and take steps to locate missing participants before their benefit start dates.
Takeaway: You or your plan’s TPA need to take appropriate steps to locate missing participants before their plan benefits are payable. This is likely to be successful with a significant number of ex-employees. However, for those who stay missing, you will want to follow the IRS drill set out above before those participants reach age 70½.
Most larger group health plans are self-funded, which means the employer, not an insurer, is primarily responsible for paying benefits. These plans also are likely to require employee contributions towards the cost of benefits, and those contributions typically are paid to the employer (not a trust) on a pre-tax basis through a cafeteria (Section 125) plan.
Is a self-funded group health plan with more than 100 participants required to have an annual audit? There seems to be a difference of opinion among professionals on this question. But let’s look at the rules on group health plans and other “welfare plans.”
The applicable Department of Labor regulations provide certain welfare plans “relief” from the annual audit requirement. The instructions for the annual report (Form 5500) refer to DOL Technical Release 1992-01 for clarification of the exemption. That release bases the availability of relief from the audit requirement for welfare plans with more than 100 participants on whether or not the contributory plan provides benefits “solely from the general assets of the employer.” If employee contributions are used for any purpose other than paying group health or HMO premiums, then benefits are not deemed to be paid solely from the employer’s general assets – and the audit requirement would apply. This is set out in the following extract from the DOL release:
In accordance with the terms of the regulations, the relief afforded by [the regulations] is not available to any welfare plan with respect to which benefits or premiums are paid from a trust. Moreover, even in the absence of a trust…the exemptive relief would, in the absence of additional relief, be available only to those contributory welfare plans which apply participant contributions toward the payment of premiums in accordance with the terms of the regulations. For example, a welfare plan that applies participant contributions directly to the payment of benefits (or indirectly by way of reimbursement to the employer) would not qualify for exemptive relief because the benefits under such a plan could not be considered as paid solely from the general assets of the employer.
Despite the above authority, the accounting community has focused on whether or not the subject welfare plan funds benefits through a trust. Of course, if there is a trust, the audit requirement clearly applies as stated in the first sentence of the above extract. However, the above text goes on to deal with the applicability of the exemption to contributory welfare plans that do not use a trust. So it seems clear that the audit requirement does not turn entirely on the question of whether or not the plan is funded through a trust. But note Q&A 18 published by the American Institute of Certified Public Accountants which states that relief from the audit requirement for contributory self-funded welfare plans with more than 100 participants is based on whether or not the plan is funded through a trust:
Assume a partially insured H&W plan where the employer pays claims to a certain level and then reinsurance assumes the liability. There are over 100 participants, and the employer and employees each pay a portion of the premiums. The employee share is paid on a pretax basis through a section 125 plan. There is no trust established, but at year end there may be a minimal payable to the third party administrator for regular monthly charges and a small reinsurance receivable, depending on timing. Does this plan require an audit?
No, the plan does not require an audit. According to the fact pattern described, no separate trust exists to hold the assets of this plan, and therefore it is not a funded plan for ERISA purposes. ERISA exempts unfunded plans from the requirement to perform an annual audit. Participant contributions made through a section 125 cafeteria plan are not required to be held in trust per DOL Technical Release 92-1, and as long as no trust is being utilized, no audit requirement exists. (Source: AICPA Audit and Accounting Guide, Employee Benefit Plans, March 2004, Appendix A paragraphs A.25 and A.28.)
So, are the accountants right in saying that self-funded group health plans with more than 100 participants – and no trust – are always exempt from the annual audit requirement? Can that conclusion be sustained by the technical release quoted above? For sponsors of larger self-funded group health plans, the answer spells the difference between ERISA compliance and non-compliance. Remember, any plan annual report that is filed without a required plan audit is not complete and triggers a Department of Labor non-filing penalty of up to $2,063 per day.
Takeaway: Well, should you trust the accountants on this one? We are open minded, but we’re betting that the larger self-funded group health plans with employee contributions are required to have annual plan audits.
Consider a typical retirement plan sponsored by a private employer. The employer is a fiduciary to the plan along with employees who individually serve as trustees or members of the plan’s investment or retirement committee.
The employer may (should!) have concerns about the liability associated with its fiduciary status. Let’s say you are the person asked by the employer to look into this matter.
There are a number of steps you might take to protect plan fiduciaries from liability. One thing you might consider is engaging an investment advisor to act as a co-fiduciary along with the in-house staff responsible for the plan. But let’s say you take another step and engage an “investment manager” to take on “all” responsibility for plan investments. In this case, the hired investment manager actually makes all decisions about plan investment and, as a “discretionary” advisor, only notifies the employer afterwards as to specific investment transactions.
At this point, in-house fiduciaries are exempt from liability for the specific investment decisions made by the investment manager. But are the in-house fiduciaries completely off the hook?
A recent federal district court decision, Perez v. WPN Corp, et al., elaborates on what in-house fiduciaries are required to do in exactly this situation. The court holds that the plan fiduciaries who appoint the investment manager are still responsible for “monitoring” the investment manager’s performance. This duty includes adopting routine monitoring procedures, following those procedures, reviewing the results of the monitoring procedures and, most important, taking any action required to correct any performance deficiencies of the investment manager. So, whether you pick an investment advisor to act as a co-fiduciary or an investment manager to make all the decisions on plan investments, in-house fiduciaries still need to review the conduct of these professionals and take action when necessary.
- There’s no risk-free way to put your retirement plan on autopilot. Having quality service providers is a good idea but they cannot relieve you, your company or your other in-house fiduciaries from all responsibility for investment and administrative decisions.
- Some financial advisory firms charge extra to act as “investment managers.” You may find that the “extra protection” afforded by this arrangement is not really worth the additional expense.
- Consider other alternatives to mitigate fiduciary liability. This may include steps like adopting a suitable investment policy statement or obtaining fiduciary insurance. Other possibilities are outlined in “Your Fiduciary Duty – And What to Do About It” that can be viewed here.
You’re a successful business owner and you’d like to plan ahead. Professionals are urging you to prepare a “succession plan” – but you look at it as a retirement plan. Getting out of the daily grind might be nice, but giving up your life’s work and your legacy business? Maybe not so nice. No matter how they sugar coat it, “succession planning” looks like you’re calling it quits.
Whether they call it a succession plan, an exit plan or a retirement plan, it usually amounts to a transaction where you cash in your chips and your legacy business goes away. And, as soon as you sign that transaction document, you may no longer have any input in the conduct of your own business.
Is there another way? Can you cash your chips, continue your legacy business and still have a hands-on role? Can you have your cake and eat it too? The answer for you very well may be “yes!”
An employee stock ownership plan (“ESOP”) may allow you to sell your business to your employees in a non-adversarial, tax-advantaged transaction and continue to manage operations by electing directors of your choosing. You can participate in the business as much or as little as you would like. Want to taper off over the next ten years or so? No problem!
In this way, ESOPs can treat the two major non-financial issues facing business owners “in transition”: the end of the business involvement of a lifetime, and the likely loss of the legacy business itself.
The Takeaway: If a business transition is in your future, make sure an ESOP purchase is on your short list.
If your organization sponsors a 401(k) or other retirement plan, you or someone in your organization is a fiduciary to that plan. You may have hired a service provider to administer the plan (a third party administrator, or “TPA”), but the buck stops with your organization. This is because the fine print in your TPA’s service agreement says the official “Plan Administrator” is the employer, not the TPA. This means the employer has the ultimate responsibility for the plan’s ERISA compliance.
On the investment side, the plan’s trustee or investment committee will be a responsible plan fiduciary. The investment fiduciary must act with the care, skill, prudence and diligence of a prudent person “familiar with such matters.”
This is a prudent expert standard. So ask yourself, do the people making investment decisions for your plan have a financial or investment background? If not, you need to consider engaging a professional investment advisor to assist with investment decisions.
What does all this mean to you?
Plan fiduciaries do not have to make perfect decisions but they do need to exercise diligence in their deliberation on both administrative and investment matters. It is always advisable to document fiduciary deliberations as the best defense to a claim of fiduciary misconduct. Remember, good intentions never justify fiduciary misconduct including any inattention to fiduciary duties. As one federal judge put it: “A pure heart and an empty head are not an acceptable substitute for proper analysis.”
There are other steps that plan sponsors take to help their plan fiduciaries:
- Hire an investment advisor, adopt an investment policy statement – and follow it!
- Meet with your investment advisor at least annually to review plan investments – and document these discussions.
- Perform self-help compliance checkups for your plans using IRS and Department of Labor websites.
- Consider fiduciary insurance (that’s not the plan’s ERISA fidelity bond).
- Get professional help when you need it, and consider using independent legal counsel to assure the confidentiality of sensitive plan-related information.
The Takeaway: Take another look at the bullet points immediately above. Is there any good reason not to follow each of those protective steps?
Many 401(k) plan sponsors have wisely selected investment professionals to assist in selecting the plan’s investment menu, typically a listing of various mutual funds. Other plan sponsors may allocate this duty to company officers and other key employees. In either case, the resident plan fiduciaries (the company officers and key employees who act on behalf of the sponsor as plan administrator or trustee) have a legal duty to “select and monitor” plan investments and, in the case of sponsors who have hired investment professionals – to monitor not only investment performance but also the performance of the investment professionals.
So, how do you “select and monitor?”
There’s only one hard and fast rule: Document what your investment-related decisions are and how you made them. But here are some guidelines on how to proceed:
- Investigate available investment providers. This may include banks, insurance companies, stockbrokers and mutual fund companies and their broad array of investment options. Then solicit specific information on several investment programs. This could be done in a standard format such as a request for proposal (RFP).
- Analyze costs and investment characteristics of available investments and select the investment menu that offers diversified investment options at competitive prices. Remember, your plan is not “free” if your participants pay administrative costs through reduced returns on their plan investments. So, get a handle on this kind of indirect compensation (“revenue sharing”) and make sure you take it into account.
- The general requirement is endorsed by the Supreme Court in the Tibble opinion as a “separate” duty of a trustee to “monitor trust investments and remove imprudent ones.” You should review investment results on a periodic basis with a view towards replacing laggards in your plan’s investment array.
- Compare investment results with criteria set out in your plan’s investment policy statement, or IPS (yes, having an IPS is a good idea). Also, document your decision-making process to prove that in-house plan fiduciaries have performed this duty.
The Takeaway: Process, process, process! Just going through the procedure suggested above – and providing documentary proof – could satisfy an IRS or Department of Labor inquiry even if your plan has mediocre investment results.
The Affordable Care Act (ACA) has tied the hands of employers who would like to reimburse employees for the cost of their individual health insurance coverage. Under the ACA, tax-free reimbursement of employee health insurance costs was not permitted through a health reimbursement arrangement (HRA) unless it was “integrated” with an employer-provided group health plan. Stand-alone HRAs were prohibited even for small employers that were not subject to the ACA mandate to offer group health coverage.
However, in the waning days of the Obama administration, the President signed the 21st Century Cures Act which allows “small employers” to adopt Qualified Small Employer HRAs (QSEHRAs) to reimburse covered employees for their own health insurance premiums as well as other qualified medical expenses.
Small employer means an employer that does not employ at least 50 full-time plus “full-time equivalent” employees. In other words, employers that are not required to offer ACA coverage to their employees. Full-time employees for this purpose are those working 30 or more hours per week. If a small employer does maintain a group health plan, it cannot provide QSEHRA reimbursement benefits.
QSEHRA benefits must be offered to all eligible employees. Some employees can be excluded (those under age 25, those who have been employed fewer than 90 days, part-time and seasonal employees). Annual reimbursement benefits are limited to $4,950.00 (individual) and $10,000.00 (family) with a proration of these limits for partial plan years. No employee contributions are permitted. Also, employees must personally maintain ACA minimum essential coverage to avoid taxable income on reimbursement benefits. There are additional employee notice and tax reporting requirements.
The Takeaways: For small employers with employees covered by individual ACA policies, a QSEHRA can provide tax advantaged benefits at whatever benefit level the employer selects up to the permitted maximum. Qualifying employers with a young work force may find this benefit particularly attractive as it is young workers who are paying significantly increased premiums for individual ACA coverage.
For shareholders of S corporations, their QSEHRA eligibility needs to be reviewed because of existing limits under the Internal Revenue Code on those who may have “other coverage” available through a spouse or otherwise. S corporation shareholders need to consult a tax professional if they intend to participate in their corporation’s QSEHRA. Additional guidance from the IRS on QSEHRA’s is expected, and such guidance could affect the current understanding of QSEHRA requirements.
Entrepreneurs who work hard and build a business over decades realize that, at some point, they need to think about slowing down and stepping back. Frequently, planning and specific decisions about transition are put off. Entrepreneurs worry about two things that can make delay an attractive option. Number one is a concern about their standard of living if they sell their business. Number two is facing the prospect of disposing of the entrepreneur’s legacy business that may represent a lifetime of work and achievement.
Both of these concerns are very real. First, after payment of transaction costs and taxes, the possible investment of the net proceeds of the sale of the business very well may result in a reduced cash flow to the entrepreneur and family. And, unless there’s a family member who is capable – and interested – in taking over the business, the entrepreneur justifiably feels that the legacy business may have to be surrendered. Both of these factors make it hard to let go - or even to think about letting go.
Here’s something for the reluctant entrepreneur to consider: there is a way to defer or even avoid taxes on the sale of your business, to undertake a transaction without the aggravation and delay of dealing with pesky buyers, to sell your business in installments or a lump sum - and still not give up control!
These results can be attained if the business is sold to its current employees through an employee stock ownership plan, or ESOP.
Maybe the entrepreneur you know would be more willing to plan for a business transition if he or she were aware of these ESOP possibilities.
The Takeaway: ESOPs can be more than just retirement plans and for many entrepreneurs, they offer the best succession solution.