Business of Benefits

The Rubber Finally Hits the Road: The AICPA 403(b) FAQ Confirms Our Fears

Robert Toth — Mon, 08 Mar 2010 11:12:16 -0500

The independent auditor is really at the heart of the growing storm in the 403(b) world. For all the problems and challenges caused by the tax regulations, they really pale when compared to what has to happen on the ERISA Title 1 side of things as employers and the market attempt to transform to an accountability to which they have never been held in the past.

To those of us who are the "non-initiates" when it comes to accounting and auditing standards, we have suspected for the past year that there may be massive problems when it comes to compiling the 403(b) audited financial statement. The problem: you need prior year data to do the current year financials.

The AICPA released a FAQ on 403(b) plan audits. Here's what they said on the "prior data" issue. Though it is lengthy, these are words that every professional dealing with 403(b) plans needs to be familiar with. It fully explains the conundrum faced by the auditor-and the costs that will need to be incurred by plans:

5. Generally, what initial audit procedures would the auditor perform on the beginning of year (e.g. – January 1, 2009) contract and accounts?

Audit procedures include testing the accuracy and completeness of the beginning balances of reported contracts and accounts. The nature, timing, and extent of auditing procedures applied by the auditor are a matter of judgment and will vary with such factors as the length of time the plan has been in existence, adequacy of past records, the significance of beginning balances and the complexity of the plan's operations (such as the number and consistency of vendors). In accordance with Chapter 5 of the AICPA Audit and Accounting Guide, Employee Benefit Plans, areas of special consideration are the completeness of participant data and records of the prior years, especially as they relate to participant eligibility, the amounts and types of benefits, the eligibility for benefits, and account balances.

The auditor should also make inquires of the plan administrator and outside service providers, as applicable, regarding the plan’s operations during those earlier years. The auditor also may wish to obtain relevant information (for example, trust statements, recordkeeping reports, reconciliations, minutes of meetings, and reports prepared in accordance with Statement on Auditing Standards (SAS) No. 70, Service Organizations [AICPA, Professional Standards, vol. 1, (AU sec. 324)] for earlier years, as applicable, to determine whether there appear to be any errors during those years that could have a material effect on current year balances. Further, the auditor should gain an understanding of the accounting practices that were followed in prior years to determine that they have been consistently applied in the current year. Based on the results of the auditor’s inquiries, review of relevant information, and evidence gathered during the current year audit, the auditor would determine the necessity of performing additional substantive procedures (including detailed testing or substantive analytics) on earlier years’ balances. (See AICPA TIS 6933.01 Initial Audit of a Plan (AICPA Technical Practice Aids, vol.1) for additional discussion of initial audits.)

The inability of the auditor to obtain sufficient appropriate audit evidence supporting the accuracy and completeness of beginning balances of reported contracts and accounts is considered a restriction on the scope of the audit and may require the auditor to modify his or her opinion.

6. What procedures does the auditor need to apply to the comparative statements of net assets available for benefits?

ERISA requires that audited plan financial statements present comparative statements of net assets available for benefits (for example, December 31, 2009 plan year would present a comparative December 31, 2008 statement of net assets available for benefits.) The prior year comparative statements of net assets available for benefits may be compiled, reviewed, or audited. Practically speaking, however, although a compilation or review of the prior year is acceptable, the auditor would need to apply sufficient auditing procedures on the beginning balance of net assets available for benefits in the current year to obtain reasonable assurance that there are no material misstatements that may affect the current year’s statement of changes in net assets available for benefits. (See AICPA TIS 6933.01 Initial Audit of a Plan (AICPA Technical Practice Aids, vol.1)

7. What if historical records do not exist or are not available for reported contracts and accounts?

The DOL has indicated that they expect the plan administrator to use “good faith efforts” to locate and provide all of the necessary records in accordance with its fiduciary responsibilities under ERISA. If historical records (such as payroll records and participant data) do not exist or are not available for the reported contracts and accounts, and the amounts of reported contracts and accounts are material, the auditor may need to modify the report because of a restriction on the scope of the audit.

This would actually be funny if it weren't such scary stuff. We know that this past data (in a useful form) will be virtually impossible to collect and compile in GAAS acceptable formats, even in the case of a single vendor plan. But the plan will need to still hire the CPA to establish the good faith effort at collecting the data necessary, and then wrestle with the financial services company to try to get something which may not even exist-or at least not at prices that won't bankrupt the charity. The good news is that if good data that can't be found, it can then be excluded from the financial statement and the audit.

But that just begs the question: if you exclude an opening balance, can you really even have a financial statement? Ever? THEN what? Without relief from the CPA's standards setting body, we will have our own, permanently recurring, expensive conundrum.

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Any discussion on any tax issue addressed in this blog (including any attachments or links) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any transaction or tax-related position addressed therein. Further, nothing contained herein is intended to provide legal advice, nor to create an attorney client relationship with any party.

Gems, Quirks, and Quirky Gems in the DOL's Third 403(b) FAB

Robert Toth — Sat, 20 Feb 2010 10:58:49 -0500

The DOL issued its highly anticipated 403(b) Frequently Asked Questions as part of a Field Assistance Bulletin, FAB 2010-01. The seriousness in which the DOL is taking these 403(b) issues is reflected in the fact that it was issued as a FAB, and not merely the sort of informal guidance offered by a simple FAQ. As one DOL staffer mentioned to me, though a FAB nay not have a whole lot more legal weight than an FAQ, it does speak to the weight the DOL is giving to the matters at hand.

There are now three DOL 403(b) FABs: 2007-2; 2009-2 and 2010-1. The three of these should be read together when seeking answers, as they constitute substantial regulatory guidance.

This new FAQ was really designed to give plans and accountants some reporting and disclosure guidance as they attempt to put together their first, full fledged 403(b) Form 5500s, though it does also touch upon important ERISA coverage issues. It does not directly speak to some of the more pressing substantive 403(b) Title 1 issues (such as , what the heck is a 403(b) plan asset?), but it does say some interesting things. Hidden in the mundane, though, are quirks, gems and quirky gems-with a touch of the controversial. Lets sample a few:

GEMS

Q12. Yes, I am listing this one out of order because this is a High Quality Gem (according to Mr.Giller, there is no specific rating system for gems outside of diamonds, or I would use it here). The DOL extended its discussion of "good faith efforts" in applying the FAB 2009-2 exemptions. It specifically here recognizes that some "non 2009-2 exempted" contracts may not be able to be found. As long as the plan can demonstrate and document a good faith effort to find those contracts, and as long as "the guiding principle must be to ensure that appropriate efforts are made to act reasonably, prudently, and in the interest of the plan’s participants and beneficiaries" (this is language from 2009-2), the exclusion of these "non-findable/non-exemptable" contracts will not cause the 5500 to be rejected. Now, to convince your auditor to do cooperate will be something else-its that GAAP thing.
Q3. Knowing where the contract is, and who issued it, does not disqualify it from being excludable under 2009-2.
Q11. The DOL verified that 2009-2 extends beyond the 2009 reporting year.
Q13. Cool. The DOL recognized the problem with the last payroll we have always had in 403(b) plans (and, to some extent 401(k) plans), particularly in with regard to testing 402(g) limits and, in the past, running MEAs: making a deposit in 2009 from the last payroll in 2008 will not take the contract out of 2009-2.

QUIRKS

Q2. In a question designed to answer the question of whether loan repayments forwarded to a vendor by an employer on a contract that otherwise qualifies under 2009-2 for reporting relief takes the contract out of 2009-2 (the answer is yes), an interesting question is raised. Many 403(b) loans are "self-billed", that is, they are paid directly by the plan participant to the vendor. In a contract that is NOT exempted by 2009-2, do these payments need to be reported on the 5500? If so, what line would you use on Schedules H or I?
Q6. Okay guys, quit teasing us. You used that term again, "plan asset," but just in the context of what a "plan asset" isn't for the 2009-2 reporting purposes. We really need to know how the plan asset rules apply in the individual contract context for other minor purposes, like fiduciary obligations. Please?
Q14. There are two alternative conditions to allowing the applicability of 2009-2,where the employer decides to allow or not allow an optional plan feature (like loans): a cost basis, that is, including or excluding would serve to increase plan costs; or where including the option could require the use of employer discretion in its execution.
Q15. The DOL reiterated and affirmed its public stance that an employer hiring a TPA to make discretionary decisions is the same thing as exercising discretion, and cause the plan to fall out of the ERISA 403(b) safe harbor. The employer may, however, allow the purchase of a product where the product vendor exercises discretion without violating the safe harbor. This has the odd effect of allowing the vendor to subcontract out discretion to the same TPA that an employer could not. In spite of its quirkiness, I believe (and there those who I respect which disagree) the reasoning for this is soundly based.

QUIRKY GEMS

Q7. The DOL giveth, and the DOL taketh away. It affirms that the right to determine whether any contract is exempted under 2009-2 is reserved to the Plan Administrator. BUT, it also introduces a new "ratting clause" (which is the term I also use to describe the obligation on Schedules A and C to report non-cooperative vendors): If the plan auditor doesn't agree with the employer, the auditor must note it in the audit report. I have had far too many disagreements with poorly trained, junior auditors on the 401(a) side to even remotely take a shining to this condition.
Q12. Yes, I listed this as a High Quality Gem. But what makes this one also quirky is the odd reference to personal liability for those who were required to keep records but failed to do so. In a world where employers and plans mostly kept no such records, and where this recordkeeping obligation was never really formally assigned, and much of it never really required because of the minimal 5500 requirement, it is truly a quirky reference.
Q16. My guess some readers were wondering where I would put this one. It is truly interesting, and a Quirky Gem. This is the question of whether the ERISA safe harbor requires a certain number of vendors, or whether a single vendor with a reasonable choice of investment options (whether it be in an annuity contract or in an open architecture program) will suffice. The DOL refrained from affirming some public statements on how many vendors are required to avoid losing the safe harbor; it did reaffirm that the safe harbor refers to both "contractors" as well "investment products" separately; and it focused heavily on facts and circumstances. It allows employers (or, more precisely, imposes the burden on the employer) to establish that the costs and administrative burdens on that employer justify a use of a single open architecture program or annuity contract.

In any event, attempting to claim protection of the safe harbor will require hard work and diligence and, ultimately, the cooperation of the vendor.

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EPCRS Issues Arising from 403(b) "Disqualification"

Robert Toth — Sat, 06 Feb 2010 15:24:54 -0500

In a lunch conversation with Kathy Elliott , (a CPA specializing in 403(b) audits) at the annual meeting of the TE/GE Councils in Baltimore (which, by the way was pulled off fantastically by Warren Widmayer (and a few others), in the face of a snowstorm of historic dimensions), we went into more detail on my blog on 403(b) plan disqualification.

In talking about what now seems to be the obvious, Kathy pointed out the absurdity of "disqualifying" an entire 403(b) plan: the employer suffers little direct tax sanction, and the burden of the employer's errors are borne by the employees. There is no "stick" to the "carrot and stick" combination that makes 401k plans work, according to Kathy.

Think about it. In a 401(a) disqualification, the employer will lose its tax deduction and suffer potentially significant tax penalties when disqualifying the plan. There is no such penalty for the 501(c)(3) employer (except where there is UBTI) or school district. So, should the plan fail eligible employer status, be discriminatory or have a failed plan document, what really is the impact on the employer? Well, it seems, it is only the feeble link upon which audits were based prior to the regulations: W-2 reporting failure, with its current max penalty of $30 per W-2. The real "sanction" is the threat to report as taxable all amounts contributed to employee accounts. Again, as is so often the case with the impact of these regulations (see, for example an earlier blog), it is the employees of these tax exempt organizations which are to suffer the brunt-and, this time, for things outside of their control.

The IRS will soon publish a new set of EPCRS rules, which are generally intended to update the program for the new 403(b) regs.It will be interesting to see whether these new rules will recognize this factor in the determination of the appropriate Audit CAP sanction, where the largest tax liability to the employer is really only W-2 based. Under the prior audits, any sanctions paid by the employer were really only part of a settlement agreement with the IRS, where it agreed not assess tax penalties against employees in return for the payment of a sanction. To its credit by the way, the IRS was not aggressive in imposing these penalties upon audit, and were extraordinarily reasonable where there was good faith attempts at compliance by the employer.

Please do not read this as any criticism of the IRS TEGE staffs, as they have the duties of interpreting and imposing an awful set of regs. Application of these regs are settling in nicely due to the thoughtful efforts of the dedicated staffs. There are really only a handful of difficult issues (from the tax side) which are yet open, and these are mostly being worked on. But application of these regs are repeatedly demonstrating some really unusual effects-all related to the point that he basis of the 403(b) plan is the idea of an individual pension.

The K-12 403(b) Non-ERISA Fiduciary Question: The Growing Turner/Toth Consensus

Robert Toth — Mon, 01 Feb 2010 16:57:54 -0500

Co-authored by Richard Turner

One of my personal highlights of the just finished NTSAA Annual meeting in Palm Springs (the first under the joint auspices of ASPPA and NTSAA, which has all the looks of a marvelous arrangement for the 403(b) market), was a conversation with Richard Turner, my old friend and VALIC's top 403(b) lawyer.

Richard and I have been engaged in an odd sort of range war over the past two years on the level of liability a public school district has in relation to the manner in which it handles its 403(b) program. Early on (in late 2007, methinks), I gave a few speeches discussing the potential "fiduciary like" exposures school districts may have from mismanagement of their 403(b) programs. Richard responded with a lengthy paper differentiating 403(b) compliance duties from an employer’s decisions about how involved they choose to become in selecting individual investments. I responded in kind with a part of a paper for the National Association of School Boards (with Jack Lance, Fred Reish, Bruce Ashton, Dave Kolhoff and others) on the whole host of liabilities I see a school district bumping into. Of course, Richard replied with a few more things.

Richard and I finally caught up with each other in Palm Springs. Richard grabbed my arm, saying "Bob, we have to talk. You're not serious about this broad school district fiduciary liability thing, are you?" My response was, of course, "and you're not seriously saying that school districts can never be held liable if they seriously mismanage their 403(b) programs, are you?"

Richard and I have been arguing about various tax and retirement questions for nigh on 20 years, so-as he put it-a singularity has occurred that may jeopardize the continued existence of the universe as we know it: we came to a general consensus on this issue. Here's where we ended up; we were never very far from each other's point:

Throughout this process, two primary areas of contention have been: (a) In those states that provide broad statutory protections for public school 403(b) plan sponsors, is there some type, or level, of employer activity that might weaken or forfeit those protections? And, (b) To what extent, if at all, might certain uniform acts (such as prudent investor acts) that primarily govern the investment of state and local pension funds and certain trusts and estates, also apply to public school districts overseeing their 403(b) plans?

We've agreed that school districts which limit their plan involvement to coordinating plan compliance, either with central compliance oversight or by making sure vendors are talking to each either, and adopting a plan document, will likely have little liability to participants for the investment selections the participants are permitted to make under the program. In these sorts of instances, many states have laws which protect districts from this "hands off" approach.

We've also agreed to the other end of the spectrum: where a school district (lets say in an effort to control compliance costs and to get a better priced product for its employees ) selects and negotiates a single investment platform (either open or closed architecture) and oversees the selection of investment options on that platform, it could be forfeiting some of those state law protections by voluntarily taking on the additional investment selection responsibilities (outside of the scope of 403(b) compliance duties), and in doing so could be exposing itself to "fiduciary-like" (or even, in some cases, state fiduciary law ) liability. (It should be noted that in some states a public school is not permitted to take such actions.) As another example, such liability concerns might arise if a district hd authrotiy, under the plan and the underlying investment products, to map existing dollars to new investments and elected to do so.

Where there needs to be much more discussion is where the liability line is crossed in the "continuum" between these two points, though the answer could be different under the different laws in each state.

But where would we be if Richard and I agreed on everything?

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The Annuity RFI: A Rare, Inter-Agency Treat

Robert Toth — Mon, 01 Feb 2010 12:07:21 -0500

EBSA and the IRS issued their long promised Request For Information on annuities-or, should I say, as promised by the EBSA. We had not expected this particular piece to be a joint effort. It shows that Phyllis's and Mark's agenda is getting policy effectively done, not engaging in damning bureaucratic turf warfare. Hmm. With this and the recent DOL/ SEC activities, we may be seeing a trend here somewhere....

The RFI is extensive and well thought out (though they do reference the GAO report I criticized in an earlier blog). There looks to be a lot of work put into the effort already, as it well identifies the key issues facing the idea of providing lifetime income streams.

Importantly, it does not make the mistake of focusing on "annuities." Instead, it focuses on how an adequate retirement policy addresses three key risks: longevity, Investment and Inflation (OK. So at least on THIS point the GAO report got it right). I believe the recent attacks by the Investment Company Institute, as well as Jack Brennan, on "annuities" misses the point: there are solutions needed to each one of these risks, solutions which can have a critical role for mutual funds, investment managers and the insurance industry. This is NOT an industry specific effort, as one industry alone cannot address all three of these risks without the others.

As promised, the RFI focuses strongly on transparency (yes, yes, my Annuity Transparency blog is coming), relevancy for the average participant, portability and cost. But I was intrigued by the questions related to 404(c) and IB 96-1 (on participant education). I am particularly interested in the insurer solvency issue, which to me is the key fiduciary risk (next to transparency), but you need to look closely in the RFI to find that issue.

The substance aside, one must be impressed by the process. We always thought the Borzi/Iwry combination would be an extraordinarily effective one, and this is proving to be true. Seeing these two longtime compatriots openly cooperate with the goal of effective public policy is something for which we have long waited.

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The Curious Matter of 403(b) Plan Disqualifiction

Robert Toth — Wed, 20 Jan 2010 09:43:24 -0500

"Plan disqualification" is a well understood and managed feature of the 401(a) landscape, complete with great history, a long line of guidance and rulings, and a well developed set of correction programs. We all know what happens when a 401(a) rule is violated, its affect on plan qualification, and (ususally) what to do about it.

We would be badly mistaken if we were, though, to apply those same concepts, experiences and rules to managing problems arising from the violation of a 403(b) rule. 403(b) "plan disqualification" isn't what you might otherwise think. It is truly a curious matter.

403(b) itself only has 2 things that will cause all participant accounts to lose their 403(b) status(something I guess you could loosely call "plan disqualification"): the plan being sponsored by an ineligible employer and the plan's contributions being discriminatory (which includes violating the universal availability rule). Period. Nothing else does it.

The new regulations have levied a third "disqualification" rule in that, in order to qualify for 403(b) treatment, a contract must be part of a written plan which conforms in form with all of the 403(b) and other operational rules. Thus, for example, if a plan does not limit contributions to the 415 limit, no contract under the plan will qualify for 403(b) tax treatment even if the 415 limit was never exceeded. (I have always had a problem with this part of the reg, by the way, because of the lack of statutory authority for it -but it is truly not an argument worth making).

OK, so you ask, what happens if the plan document is proper, you have an eligible employer and you have non-discriminatory contributions? Will a plan's operational error (such as a loan violation) potentially "disqualify" the plan, like it would for a 401(k) plan?

No.

Only the accounts or contracts which are affected by the operational error are affected. Thus, for example, only the contract or account from which the excess loan is made will be at issue, not the entire plan. And the regs treat all of the contracts of the participant as a single contract, for these purposes.

So the next question is whether or not the entire contract's 403(b) status is affected by the operational error, or is it just the portion of the account in violation? The regs make it clear that vesting, 415 and 402(g) operational errors only affects those amounts within the contract related to the error, not the 403(b) status of the contract itself. The IRS, in making these choices, appears to have closely followed the statutory language (unlike what it did when imposing the "form" rule for plan disqualification!). So what if you failed to correct a 402(g) or 415 excess? The 403(b) contract still will not lose its favored status under 403(b), but the uncorrected excess will continue to suffer tax penalties, presumably under the individual tax rules.

And then there's the notion of the 403(b) "plan disqualification" itself. Even should the sponsor be an ineligible employer, even if the contributions were discriminatory, and even if the plan document violated the "form" rules, if the contract also qualifies as an annuity contract under other sections of the Code, it appears that the earnings on those (now taxable) deposits to the contract may still well enjoy deferred taxation until they are distributed-in accordance with the rules governing "non-qualified" annuities.

It IS interesting the more we keep peeling this onion.....

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CORRECTION BLOG: Annuity PLR Reference Incorrect!

Robert Toth — Thu, 14 Jan 2010 10:44:20 -0500

My everlasting thanks to Andrea-Ben Yousef of BNA. We were exploring annuities, and some confusion from my blog of January 6th, 2009. We discovered that I posted the incorrect PLR number and link on that blog, where I discussed the importance of a new PLR to DC annuitization. The link I had incorrectly provided was to a PLR on longevity insurance

The correct link and reference is PLR 200951039. .... My apologies! It is now reading properly.

Some professional news. II have taken the exciting plunge, and have established my own firm. I now can be found at the Law Office of Robert J. Toth, Jr., rjt@rtothlaw.com. The address and telephone numbers remain the same.I have been told that I am creating a challenge for those who still maintain a Rolodex!

Bob Toth

IRS PLR Helps Pave the Way for DC Annuities

Robert Toth — Wed, 06 Jan 2010 11:40:31 -0500

Annuitization from DC plans suffers from the lack of clarity on a number of key technical rules, which need to be resolved before such annuities can be widely implemented. The IRS has taken a major step in its issuance of PLR200951039, a complex PLR which- for the first time-defines what an annuity really is for purposes of DC annuitization, and when the annuity election election occurs. This is critical for determining which RMD rule applies, and when spousal consents will be required. It also, very importantly, recognizes the Plan Distributed Annuity (see my prior blogs) and the qualification rules which will apply to them.

Even the informed reader is likely to get lost in trying to parse through this particular PLR. Suffice it to say that there is a highly involved set of facts related to an insurance company's specific group and individual annuity products. The relevant features are:

It is an annuity purchased by a DC plan for distribution to participants-either from the group annuity contract held by the plan (and not being a "plan asset", by the way) or as an individual annuity contract purchased by the plan and distributed to a participant-the classic Plan Distributed Annuity.
The contracts have account balances within them which are invested in variable separate accounts. The retirement distributions from these contracts are actually treated by the contracts as withdrawals from the account balance. Every dollar taken out reduces the account balance by the same amount.
At the time the participant starts taking payments, the participant elects how the amount of the withdrawals will be calculated. The choice is that the payment will be equal that which would be paid under either a single life annuity or a joint and survivor annuity. This particular product gives the participant the right to actually choose the interest rate at which the annuity will be determined.
The amount of the withdrawal is adjusted every year to reflect investment performance relative to the interest rate selected. It is also adjusted for any "extra" withdrawals taken by the participant during the year.
At a certain age (typically age 85, but the plan can elect the age, within a range), the account balance actually disappears. All payments now come directly from the insurance company, not from the participant's account, and that payment is guaranteed for a lifetime. This particular product has an interesting twist, called "variable annuitization." This feature actually allows the participant to elect to have their annual payment adjusted in accordance with investment performance using a sort of "phantom" set of accounts.

Here's what the IRS has importantly said:

Payment as an annuity/not as an annuity. Payments made from the contract after the account balance is "shutdown" IS annuitization. All payments before then are NOT considered annuitization, but systematic or periodic withdrawals (let's call it the "access period"). Those "access period payments" are also considered RMDs, but only up to up to the calculated RMD amount. (This, by the way, means that the amounts up to the RMD cannot be rolled over, but the amounts in excess of that can be).
Application /Timing of spousal consent rules. Spousal consent is required at the time the participants elects distribution from the annuity- even though the payments during the access period are "non-annuity" payments. Electing the form of computing the payment at the time withdrawals begin is necessary under this product to make the systematic withdrawal "match up" with the actual annuity payments, to make it resemble a guaranteed income stream that is set for life. This then makes the election the same thing as currently electing an annuity payout at age 85 (or whatever age is elected), even if the intervening periodic payments are not paid as an annuity. This means that the spousal consent must be received if the basis for computing the payment (and ultimate annuity payment at a later age) is other than (at least) 50% Joint and Survivor. Though one may quibble whether this is the right decision, we finally have a rule we can use. As a practical matter, this may cause some problems if there is an intervening divorce and remarriage during the access period.
Spousal beneficiary. The account balance during the access period will still be subject to the spousal consent rules on the naming of the beneficiary.
RMD. In determining the RMD, the RMD for the for payments during the access period will be determined using the account balance under the standard DC rules. AFTER the account balance disappears, the DB method of computing the RMD will apply.

Finally, it is the overall message of the PLR which bears importance: the IRS further affirms the tax treatment of an annuity that was distributed from the plan, for an annuity that meets the requirements of 404(a)(2).

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DOL's Fiduciary Proxy Voting Rules Makes Upcoming Proxy Season "Dicey" for Plan Fiduciaries

Robert Toth — Mon, 04 Jan 2010 08:20:53 -0500

Its going to be a demanding year for fiduciaries of retirement plans, particularly of those in the small and mid-market which are not particularly accustomed to paying close attention to them. I have blogged earlier on the increased fiduciary demands related to the new data provided to fiduciaries under the 2008 Form 5500 Schedule C and Schedule A. But there is another unusually dicey issue that is soon to land on their laps: voting proxies on stocks and mutual funds following an economic collapse.

On October 17, 2008, the DOL issued a new Interpretive Bulletin, 2509.8-2, on the manner in which a fiduciary needs to deal with the voting of proxies on stocks and mutual funds held as assets of plans. It was generally seen as a reaffirmation of the EBSA's long held views on shareholder activism, and the need for a plan to make proxy decisions based solely on the plan's own economic interests.

But the I.B. is especially rich in describing the fiduciary processes that is required of a plan in dealing with proxies. It notes that the fiduciary responsible for voting the proxies must

vote the proxy, or
monitor those who are voting proxies and review the basis for their votes, or
if proxies are not voted, make an affirmative decision that the burden of doing a proper review is too high given the benefit to the plan; and
of course, document all of this.

None of this is really news to any one who has advised fiduciaries. But the problem of "paying attention" to these rules is a very real one given the financial collapse of the past year.

The anger at the leaders of financial institutions of the collapsed titans is very real, and well documented; there is great outrage at the amazing recovery (and related executive compensation quickly paid) within those organizations while the massive "collateral damage" and personal trauma throughout the world continues; and the continued befuddlement is palatable at the lack accountability of corporate board members, where it seems to be quickly becoming "business as usual."

The IB strongly warns us that, from the fiduciary's view, any attempt to use proxy voting to apply any sort of sense of "economic justice" would be mislaid and be a fiduciary breach. But the IB ALSO strongly warns us that that same fiduciary must follow a process and take proxy voting (which has typically been seen as a "throwaway" sort of "bother") seriously and, particularly this year, consider whether their vote is in the best economic interests of the plan.

I would suggest that this likely means, that when voting for Board members (for example) or on other proxy issues, a fiduciary needs to address whether the current Board candidates and compensation schemes serves the plans best interests: that is, the continued financial strength of the stock held by the plan. For mutual fund boards, the question would be more of a process question: how active where the mutual fund boards in overseeing the voting the proxies on the shares owned by the mutual fund.

This sounds like an awful lot of work, particularly if the fiduciaries themselves are struggling to keep their own businesses going. So, what's a fiduciary to do? Perhaps the following:

Find out who has the duty to vote proxies under the plan. The I.B. does a good job of helping a plan sponsor work through this.
Make whatever decision is made on the proxy voting process part of the Investment Policy statement.
Research (or get someone to research), within reason, the the proxy issues-noting, particularly that voting on Board members is not a simple "throwaway."
If there will be no vote, establish that it is too burdensome for the plan to do all those things needed to make an informed vote.
Of course, document all of this.

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The 403(b) Prohibited Transaction

Robert Toth — Wed, 30 Dec 2009 07:56:16 -0500

I had posted in an earlier blog some of the technical differences between 401(k) plans and 403(b) plans. One of the more striking differences I did NOT mention was that of the Prohibited Transaction.

Assume a successful insurance agent sits on the Board of a mid-sized tax exempt organization with 250 employees, a Board which also serves as the Plan Administrator of its ERISA 403(b) plan. The Board has just conducted a review and chosen a new vendor to handle all of the new tax rules while also complying with its fiduciary obligations. The Board selected a 403(b) vendor which is an insurance company that the agent/board member has been appointed to do business with. That agent/board member took all the (often excruciating) steps necessary to make sure that no commissions are paid to her on the purchase of those annuities by the charity's plan.

The agent opens her quarterly bonus statement from the insurance company and finds, to her great dismay, that the insurance company has paid a retention bonus on the charity's 403(b) plan annuities. She immediately calls a fellow Board member, who also happens to be the CPA which will be auditing the charity's plan. She wants to know whether this is a problem, and how should she fix this. The CPA is now concerned, because the audit may need to address this circumstance.

Assuming that the payment of the retention bonus is a prohibited transaction (there are circumstances in which it may not be), and setting aside the issue of how to correct something like this (that's why people hire lawyers like me), how does the CPA approach this?

The first, and most important, point is a 403(b) plan is NOT a plan defined under IRC Section 4975(e)-which means that 4975 and its related excise taxes does NOT apply to 403(b) plans. There is no "disqualified person;" there is no "non-exempt transaction" that is reportable under Schedule G, Part III of the Form 5500; and no Form 5330 needs to be filed.

This also means that, by virtue of not being covered by 4975, that it is subject to ERISA's Civil Penalties under ERISA Section 502(i), which relate to the Title 1 Prohibited Transactions under ERISA Section 406. The 403(b) plan is NOT exempt from this section. But there is currently no way to report this transaction to the DOL, which "may" asses the civil penalties thereunder.

This may put the CPA in a bit of a quandary, particularly if the potential prohibited transaction penalty is substantial because of the size of the transaction or because of the number of years it went uncorrected. Until the matter is resolved with the DOL, and a decision made whether to asses the penalty, this may be carried as a sort of open liability on the audit report. ... yet another 403(b) regulatory issue to be resolved.

Preview

For a heads up, I thought I'd preview with you a few of the matters I expect to address in the early part of the new year:

Part 3 of the Annuity "Fiduciary Concerns." Yes, there is a "Part 3" on the boards. This will cover "Invisibility", which is really a discussion of sales charges, and "Immobility,"which is a discussion on Portability.
Annuity Transparency. How to make disclosures relevant.
Complex Prohibited Transactions. There will be a few blogs on how the prohibited transaction rules apply in large, complex financial organizations.
A Schedule H and C "walkthrough" for the 403(b) plan.
ERISA Section 502(a)(9), the Plan Distributed Annuity and 403(b).

And a few other interesting tidbits. Keep watching.....

A Final Reflection

The year's end always brings the opportunity to reflect again on important matters. I would like to share with you a quote from Learned Hand, eminent jurist of the federal bench in the early 20th century. I came across this quote some 30 years ago, as I was deciding to go to law school, and have carried it with me since. In a corporate world where the staff "common denominator" often seems to be fear, where ideas are much at risk, this takes on particular relevance:

Our dangers, it seems to me, are not from the outrageous but from the conforming; not from those who rarely and under the lurid glare of obloquy upset our moral complaisance, or shock us with unaccustomed conduct, but from those, the mass of us, who take their virtues and their tastes, like their shirts and their furniture, from the limited patterns which the market offers.

Learned Hand June 2, 1927, commencement address at Brym Mawr College. Bryn Mawr Alumnae Bulletin, Oct, 1927.

To all, wishing a healthy and fulfilling new year.

_________________

The Trouble with 403(b) Cash; the 403(b) SAR; and Other 403(b) Stocking Stuffers

Robert Toth — Wed, 23 Dec 2009 06:26:26 -0500

403(b) devotees often speak of the continuing, and significant, number of technical differences between 403(b) and 401(k) plans. The following lists a few of the differences not given a lot of attention, a sort of holiday stocking stuffer:

Handling 403(b) cash. Handling cash is much more challenging under a 403(b) plan than under the 401(k) plan as pointed out to me a little while back by David Walters of Bodman LLP. A 401(k) deposit can sit in some sort of cash account (sometimes for lengthy periods of time) in the trust while a variety of administrative issues related to the handling of that cash can be resolved. Not so with 403(b) plans. First, 403(b) cash needs to put in a "custodian account held" registered investment company share or into an annuity contract to maintain its 403(b) status. It can't just sit around in some sort of custodian owned cash account for more than a very short time. Secondly, 403(b) investments are registered products which are subject to strict SEC rules on timing of deposits and the return of funds received "Not In Good Order." 403(b) custodians beware!

Notice of restrictions on distributions. In an example of the quirkiness of the 403(b) rules, the SEC issued a No-Act letter in 1988 to the ACLI regarding the distribution restrictions on 403(b) annuity contracts. It appears that the 403(b)(11) distribution restrictions could have run afoul of the distribution requirements under the Investment Company Act of 1940 (403(b) investments being registered securities subject to these rules) but for this issuance of this No Act.

The 403(b) SAR. ERISA 403(b) plans have always had to file an SAR. They were very silly, not looking at all like a 401(k) SAR, with very little information on them because of the minimal 5500 reporting requirements. Now, those 403(b) SARs will be substantial. Those who have "standard" 403(b) forms will need to modify them to look like the 401(k) standard.

Non-merger. It was conventional wisdom in the past, as Kurt Lawson of Hogan and Hartson notes, that 403(b) plans and 401(a) plans could not be merged, though this surely would be a handy planning tool to have today to manage all of these 403(b) issues. The 403(b) regs confirmed this "conventional wisdom" in 1.403(b)-10(b)(1)(i).

Employer Approval. I find it fascinating that, with all the back and forth going on between employers and vendors on "approving" hardships and loans and the like that, unlike 401(k) plans, the 403(b) regs do not actually require employers to approve such things. The 403(b) "Plan Administrator" is really a much different animal than the 401 (k) Plan Administrator. It really is more like a compliance coordinator.

A Personal Thought

My friends and colleagues likely do not think of me of being particularly religious or spiritual, even given my 12 years of Catholic schooling and reading more than my fair share of the likes of Lao Tzu, William Stringfellow (lawyer and theologian), Kahil Gibran, Eckhart Tolle and others. But this holiday season causes us all to reflect, regardless of one's religious tradition, on the magnitude of personal tragedy we are witnessing today. NPR reported the other day that 1 in 7 U.S. families are struggling putting food on their tables.

So let us be thankful for what we do have and for those incredible folks who give their hearts-mostly without thanks or recognition- to righting the indignities and inequities of this time. And let us humbly remember those who are much less fortunate than us, as all of the traditions teach us that-yes-we are all our brother's keeper.

______________

Continuing the DB Demise Discussion

Robert Toth — Mon, 14 Dec 2009 20:00:18 -0500

I blogged a couple of weeks ago on the DB demise because of what I was seeing my current work on DC annuities, triggered by an interesting e-mail discussion string between fellows of the American College of Employee Benefits Counsel.

But then the PBGC held a 35th anniversary forum shortly thereafter, extolling the idea of revitalizing the current DB system. I thought this made it an opportune time to further the discussion.

The December 7 Forum on DB plans seem to hit it mostly right in its calling the attention to the fundamental value of employers providing "guaranteed income for life" to employees. The National Institute on Retirement Security also reported on the meeting, noting the critical role of Defined Benefit Plans, calling them the "Real Deal." The NIRS has also published its vision with which one can hardly argue. Under a high quality retirement system retirement system:

employers can offer affordable, high quality retirement benefits that help them achieve their human resources goals;
employees can count on a secure source of retirement income that enables them to maintain a decent living standard after a lifetime of work;
the public interest is well-served by retirement systems that are managed in ways that promote fiscal responsibility, economic growth, and responsible stewardship of retirement assets

But here's where the problem lies. Juxtapose those statements with the following quote from "The Black Swan," by Nassim Nicholas Taleb, Random House, 2007:

"Consider the following sobering statistic.Of the five hundred largest U.S, Companies in 1957, only 74 were still part of that select group, the Standard and Poors 500, forty years later. Only a few had disappeared in merger; the rest either shrank or went bust." p.22

This where the PBGC, the NIRS and Pension Rights Center (which also presented at the conference) have it all wrong: the traditional DB plan does not, and will not, meet these laudable goals if you rely upon the private employer for the financial wherewithal to insure that the funding and fund management will be adequate. Plan sponsors can be terribly conflicted, with their own corporate financial needs creating economic pressure to engage in some sort dangerous "creative accounting" in the management of these plans- which we have all too often seen in the past. I am tempted to argue that public plans do not have this problem, and that they should get a "bye" on this concern. But think again. Many state and local governments are in serous trouble because of a disturbing lack of financial discipline, as they have not really had to "pay as you go" when promising very expensive benefits. Are not these promises really of the most cruel kind, when we find the money to pay for them really is not, nor ever can be, there?

The current DB system is premised on the notion that a private employer can more cost effectively provide this benefit. Logically, this cannot be true because of the lack of sensible pooling even in the largest employers. Some employers will be able to do so today because of their current demographics, but many cannot-and even those who can may find themselves in a bind in a decade or two. The only potential cost savings is in the profit charge on this guarantee issued by an insurer.

In effect, the system believes that it can do a better job at longevity risk management than regulated insurance companies, and to get that insurance for, in effect, free. When all is said and done, it is likely far from free. We are seeing the effect of the fallacy today, with only 19,000 DB plans now being covered by the PBGC.

So if the system REALLY needs a guaranteed lifetime benefit based upon employer sponsorship, one under which employers have the ability to choose the benefits (and thereby control the cost), but one under which the employees should not be exposed to the vagaries of foolish business decisions of their employers' senior management, what IS the answer?

I truly believe the answer lies in a private insurance system which provides Annuity Transparency, in annuities purchased through the employer sponsored system. I'll talk about this on my next blog. For now, though, its back to the ski slopes of Quebec....

A footnote, added 12/21: Gretchen Morgenson reports in the Sunday NY Times on a multi-billion dollar failure in the Alaska pension system, caused in large part by the alleged error of Mercer. Again, my point: non-regulated institutions are ill-equipped to manage DB plans, particularly large ones. Had Alaska purchased insurance, the risk of error would have be borne by a well capitalized, highly regulated expert organization.

Using the Third Condition of DOL's FAB 2009-2 to Manage 403(b) Audit Expense

Robert Toth — Sun, 06 Dec 2009 21:29:39 -0500

The DOL issued FAB 2009-2 back in July, in response to the concerns of employers and investment providers that in many cases they would not be able to obtain the information necessary related to a number of "old" 403(b) contracts and accounts for the expanded Form 5500 required for 403(b) plans beginning with the 2009 plan year. Moreover, even in cases where some annual reporting with respect to the contracts would be possible, the DOL recognized that compliance efforts involved in including these contracts in the financial statements would be substantial and expensive.

The FAB was not uniformly well received initially, many expressing the thought that the relief was illusory at best. Now that we have had some time for the FAB to settle in, and now that parts of the market are beginning to try to identify past contracts and "classify" what to do with them, the usefulness of the FAB becomes more clear.

The FAB allowed contracts to be excluded from an audit if they met the following 4 conditions:

were issued prior to 1/1/09,
all contributions ceased prior to 1/1/09,
all rights under the contract are"legally enforceable" against the insurer or custodian by the individual owner "without any involvement of the employer," and
the mounts in the contract were fully vested and non-forfeitable.

The real key to making the FAB work for the employer in keeping auditing costs down is in the sensible application of the FAB's 3rd condition. I would suggest that applying it consists of two parts. First, use a reasonable effort to determine and find contracts that were related to the plan at some time in the past and, secondly, making a reasonable effort to determine whether or not the rights under those contracts are "legally enforceable" by the individual.

Finding contracts

Establish a reasonable (meaning not "perfect") method to use to find what contracts might possibly be part of your plan. Review the employer records to determine (to the best of your ability) which employees made contributions to which vendors over a reasonable period of time (perhaps the ERISA 6 year recordkeping requirement?). Do the best you can, document it, and convince your CPA that a reasonable effort should do.

Legally Enforceable

From a purely legal viewpoint, this should be "easy." Heck, just get a copy of all those contracts issued over the past (6 years?) and read them. Right? Two problems, of course:

Go ahead. Try finding them. You won't find them. This is in part because insurance companies don't typically keep actual copies of contracts. Instead, they keep records of the application, plus the "form number" they issued to the individual. Which means when you try to ask for a copy, you'll just get an assembled form-assuming the company would give the employer (who doesn't own the contract) a copy anyway.
Then try reading it. I dare you. Have you ever tried to read an annuity contract?Trying to determine whether or not rights are solely enforceable by the individual will be a difficult task, and one which an answer to this question may never be readily findable.

There may be a way a reasonable method or two to try to divine this answer. For current vendors, for example, the task is a simple one (of course, nothing is turning out to be simple nowadays in this world): have your vendors give you a list of all the contracts to which they seek your approval for something like loans or distributions.

For past vendors, this is where the gold mine should be. See if you have heard from any of those past vendors for which you have compiled a list (see "Finding Vendors"). It may well be reasonable to assume that, had you not heard from them on your former or current employees, that those employees rights are being enforced without your involvement.

Tougher questions arise when, under 2007-71, you have excluded contracts from your plan. Can these contracts be excluded for Title 1 reporting purposes? Vendors have taken a hard line on these contracts, and are submitting all sorts of decisions to employers for approval, even where the employer has advised them those contracts are not part of the plan-and many times these approvals are demanded in spite of contract language NOT requiring employer approval.

A number of employers have decided that they were subject to ERISA just this year, because of the press of the tax regulations. One needs to consider (after consulting a lawyer or accountant) whether any of the old, past contracts under such circumstances would need to be counted.

Finally, this business really is only the tip of one of those melting Antarctica icebergs. Ultimately, the lawyer, accountant and employer need to sit down and review the employer's situation, and make a case amongst themselves for the most reasonable approach. Remember, the DOL's approach right now is accommodative. It is not trying to bankrupt charities through the crushing cost of unreasonable audit requirements.

DOL Considering 403(b) FAQ

Robert Toth — Sun, 29 Nov 2009 19:31:40 -0500

The DOL continues what is actually a pretty extraordinary effort with regard to 403(b) plans. It had struggled early with the new 403(b) changes brought on by the IRS rule changes. It had not really taken a good look at these plans since 1978 when it issued its "safe harbor" which exempted many 403(b) plans from Title 1 coverage, and I do not recall ever actually dealing with a DOL investigation of a 403(b) plan prior to this year.

DOL staff has kept talking to the accounting, legal and consulting professions, as well as employers and vendors, as they try to sort out some of the unusual difficulties presented by 403(b) plans. Indeed, the biggest challenge in this market is not related to the tax code, it is in addressing the mystery of how to define and manage fiduciary issues arising from 403(b) plans funded with individually owned annuity contracts.

The DOL is about to take the next step, and is considering issuing a 403(b) "Frequently Asked Questions" as they have done twice for the Schedule C. The FAQ is to address critical year end 403(b) issues related to reporting and Title 1 status.

While applauding the DOL in its continuing efforts, there is a danger related to one particular issue it may be addressing: the question of how few vendors can be offered by a 403(b) plan (which otherwise qualifies under the safe harbor) without triggering Title 1 coverage.

Putting aside the the very real practical problem of whether a 403(b) plan of a non-church, non-public educational organization can even qualify under the safe harbor because of problems created by the new tax regs, there is a significant issue related to "open architecture" platforms and certain annuity contracts which offer a large number of unrelated investment managers and mutual funds under the programs.

DOL Reg 2510.3-2 (click for a download of the reg) permits the employer to limit the number of vendors which are offered under the plan as long as employees are offered a "reasonable choice." The reg does not specify whether the choice of "vendor" or "investment" needs to be reasonable.

The regulations were written 25 years before the first "open architecture" 403(b) programs began showing up, where these large number of mutual funds are made available, and before the advent of a significant number of variable investment alternatives were available under certain annuity contracts. It would not be unreasonable for an employer to take the position that limiting the investments to a single platform with a large ("reasonable choice") of investment options available would not jeopardize a plan's "non-Title 1" status.

DOL staff has been discussing publicly for the past year or so the position that any less than 3 vendors would not be considered offering a "reasonable choice," even if the one platform offered a large number of mutual funds unrelated to the "platform vendor." Should this position be published now, at year's end, in the FAQ , without any hint of relief for all those plans which had interpreted the "reasonable choice" rule in a good faith manner, the effect can be severely disruptive. There are a significant number of (some very significant) plans which have taken the position that a single platform offering many choices kept them from Title 1 status.

Taking this position now in a FAQ has the same practical effect of issuing a final regulation: employers would take it as THE RULE, immediately effective. There would be no room for a comment period, or proposed corrections or transition periods. In short, this could cause a great deal of problems for a large number of employers.

One other thing. We have seen estimated that there may be some 35,000 or so 403(b) plans, and perhaps less than 20,000 that will be filing Form 5500s. This number is likely to be sorely underestimated: There are a million or so private charities in this country and at least 14,550 public, k-12 school districts as well. If only 10% of the charities have 403(b) plans, and if almost all school districts have them, we are at least triple the government estimates. As mentioned, the impact of any of these rules will be significant, so their effect needs to be well considered.

Private Employer DB Demise Was Inevitable, and Should Not Be Revitalized in Current Form.

Robert Toth — Sat, 21 Nov 2009 11:41:39 -0500

The private employer-sponsored defined benefit plan has had a good run of it, supporting two generations well in its goal of providing economic security for retirees. But the last 10 years have seen gradual though substantial decline in the number of employers sponsoring these plans, and in the percentage of employees being covered by these plans-now somewhere well south of 19% of the workforce is covered.The economic collapse has exacerbated the problem even further by exposing the weaknesses of the system, as the remaining DB plans are seeking funding relief from Congress.

You can find many sound opinions which attempt to explain this demise, from over-regulation, to difficult statutory schemes, to the allure of defined contribution plans. If you step back, though, you can see that all of the reasons for the demise have a central theme: private employers are structurally ill-suited to bear the lifetime risk associated with providing this kind of benefit.

Think about it. Private business can, and indeed some must, fail. These companies grow, expand and, ultimately either fail or need to be exposed to the risk of failure. There is a lot of conversation at the policy level about the evils inherent in having companies that are "too big to fail." So what is the sense, then, to rely upon companies that we structurally need to fail from time to time to be responsible for funding a lifetime risk of their employees? One may claim that this is the function of the PBGC, but the PBGC doesn't specifically reserve for risks undertaken by plans. Its reserving system is ad hoc, at best.

Taking a close look at the current DB funding rules, you can see that they really require employers to have, or buy, sophisticated actuarial and investment expertise that you will only normally find in a regulated financial institution. We are, in effect, demanding our manufacturing base to become experts at insurance.

These employers are also seeing the changing nature of their workforce and retiree population, and they find that the DB Plan is unable to meet employee and retiree demands. DB Plans are, for the most part, proverbial “one trick ponies,” whose inflexibility has limited their usefulness in the current marketplace.

I have blogged on popular new annuity products in the marketplace, many of which are reliant upon sophisticated hedging strategies. These innovative annuity products include features well beyond anything that could be offered in a traditional DB plan. These includes features like (but not limited to) the elective, periodic purchase of a pension guarantee with each payroll; the ability to access cash balances with minimum penalties; equity participation which will raise or lower the lifetime income guarantees; guaranteed minimum withdrawal benefits; guaranteed minimum income benefits with equity participation; and variable annuitization. Employers who sponsor DB Plans are not in the business of developing and providing these sophisticated guarantees to meet changing employee and market needs. Additionally, plan sponsors generally have limited skills in even maintaining traditional DB benefits, much less having the resources to provide a wide variety of lifetime payout benefits which can adapt to change. They are also severely restricted by a regulatory scheme which discourages innovation.

What is the answer? Most will agree that the former insurance schemes are sorely inadequate: inflexibility in pricing, little transparency, little portability, and irresponsible acting in some quarters has fueled the current economic mess. What the insurance industry DOES have is the necessary skills and regulatory scheme to guarantee and manage the solvency risks inherent in guaranteeing life time income.

Mark Iwry and Phylis Borzi both have recently noted noted their commitment (and cooperation) to providing a sensible regulatory scheme for providing annuitization from defined contribution plans, which will rely upon transparency, simplicity, relevancy and portability. To make this really work, we will need legislative relief as well, in such things as providing a "double 415" limit in such plans in order to provide the same sort of tax benefit which is available for sponsors of DB plans.

Should the insurance industry be able to answer this call, we may be able to finally have a sensible approach to providing retirement income from employer sponsored retirement plans.

For further discussion on this matter, see this link.

Managing the ERISA 403(b) Transition

Robert Toth — Thu, 19 Nov 2009 23:22:29 -0500

There are still a number of critical tax issues related to the 2007 403(b) regulations that need to be resolved. For example, the iRS needs to clean up the horrible mess created by the ambiguities of Revenue Procedure 2007-71, and it needs to come to terms with the fact that mutual fund custodial accounts should be able to be distributed upon plan termination. For the most part, however, answers to the remaining tax issues are being wrought through a transition processs -albeit sometimes painfully.

What is really turning out to be the gravaman of the 403(b) marketplace, the one laden with the most liability for plan sponsors and the one with the most intractable problems are those related to the application of ERISA Title I.

For many years, a large number of 403(b) plans assumed that they fell well within the ERISA safe harbor, which permits such plans to operate without regard to ERISA. Others, because of the individual nature of the annuity selections, never considered that they were covered by Tile I, but would have realized that they have always been covered if they took a serious look.

The new regs have complicated the ERISA matters by forcing more accountability upon 403b plan sponsors, which has resulted in some serious catfights between employers and vendors about who has responsibility for what. This has ultimately resulted in a large number of even safe harbor plans finding themselves in the throes of Title 1.

Title 1 ‘s most obvious problem is the 5500, because, concurrent with the rest of this mess, is the new requirement that 403(b) plans are now subject to the full 5500 rules which have always covered 401(a) plans.

But the story does not end with 5500. Here are some thoughts (by no means exhaustive, by the way) of the true difficulty of what a non-ERISA plan has to go through when it bites the bullet and accepts ERISA responsibilities:

-Corporate Action. Recognize, by formal corporate action, the “establishment of a plan” under ERISA Title 1.

-Vendor cooperation. The vendor needs to transition its relationship with its vendors, and resolve compliance responsibilities

-Spousal consent/beneficiary designations. Perhaps the most significant issue, is working through and now applying these rules properly.

-ERISA-ify the Document and Summary Plan Description.

-Investment classes. Many investment classes under non-ERISA custodial accounts aren’t available under ERISA.

-ERISA Compliance Co-ordination.

-Establishing Plan Governance Structure including:

-ERISA Committee

-Claims and Appeals process.

-Investment Policy, geared toward the unique aspects of 403(b).

-Insurance. ERISA bondng and fiduciary insurance.

-Audit and Annual Report.

-Participant Notifications, statements and disclosures.

Its going to be a difficult and time consuming process.

SEC Chair Warns of Increased Focus On Retirement Market

Robert Toth — Fri, 23 Oct 2009 08:33:43 -0500

We have posted a number of blogs and otherwise written over the past year discussing the growing role of the SEC in the retirement plan market. See, especially, the article on the SEC' sand DOL's "Cross Agency Waltz." The ERISA sessions at the National Society of Compliance Professionals, at which I spoke, were particularly well attended.

The fact that the DOL and the SEC held their first ever joint hearings in June, reviewing target date funds, is further evidence of the SEC's continued interest in a field which has been traditionally dominated by the Treasury and Department of Labor.

The SEC's rules have always had particular applicability to the 403(b) marketplace. But the SEC also has leverage into the 401(k) market, a market which often pays scant attention to the agency. in addition to the SEC's authority to regulate registered investment products, a participant's interest in a 401(k) plan is still, legally, a "security" under its jurisdiction. 401(k) plan interests may be exempted from the registration and filing requirements of the '33 and '34 Acts, but they ARE NOT exempted from those laws' anti-fraud provisions. So, the agency has every right to investigate fraudulent activities related to the provision of 401(k) plans to plan participants. This is particularly why last year's Memorandum of Understanding between the SEC and the DOL-promising cooperation at the investigation and enforcement level- becomes so critically important to retirement plan consultants and practitioners. It will be interesting to see what level of SEC/DOL cooperation we see coming out of the DOL's Consultant and Adviser Program, which is investigating abusive practices of pension advisers.

This is all reinforced by an October 22, 2009 speech to the AARP by Mary Schapiro (Chair of the SEC), reported in BNA Pension and Benefits Daily. Here is an excerpt from that speech which really puts the retirement plan community on notice:

"In my view, financial service firms should engage in responsible product development in the retirement market. Barraging investors with retirement products that feature the latest financial gimmick or marketable fad will not ultimately serve investors’ interests.

America’s future retirees deserve products that they can understand and evaluate. This means that complex fee arrangements or product descriptions should be discarded in favor of simple, clear disclosure.

Our future retirees should have access to products that will help them meet their retirement goals without imposing inappropriate risks. Products offering enhanced leverage and avant-garde investment techniques may be appealing to those investors that want to speculate. But they are not the type of investment products that belong in the retirement portfolio of the average American seeking to provide for security in retirement.

In addition, extolling the eye-popping results of the short-term performance of certain investment products, without focusing on the long-term implications or risks, can result in disappointed investors and potentially angry plaintiffs — not to mention an SEC prepared to be aggressive in enforcing the investor protection rules.

These types of disclosure, product development and marketing issues surrounding retirement products will be areas of focus in the coming year for those of us at the SEC. The burden imposed on those investing for retirement is significant, especially after the market events of last year and we must be committed to assisting those investing for retirement."

If you didn't believe it before, you probably really need to take notice now. The SEC is very interested in your world.

Addressing Fiduciary Concerns in the Purchase of 401(k) Distributed Annuities: Dealing With The Five "I's"- Part 2, Inflexibility and Inaccessability

Robert Toth — Sun, 11 Oct 2009 19:10:00 -0500

A couple of months ago, I began writing about the fiduciary concerns related to the purchase of annuities as distributions from individual account DC plans. In that Part 1, I noted that there are five elements, so called "I's", which need to be addressed by any plan annuity. In that blog I focused on "irrevocably", the fiduciary risk of what I called the "30 year risk"-on how one gets comfortable with the inherent risk of an insurance company failing over an annuitant's lifetime.

Inflexibility and Inaccessibility

These two "I's" are closely related, as they really point out the nature of annuity products which are purchased for annuitztion from DC plans: they are plan investments. Treating them otherwise risks turning the DC plan into a DB plan, the ultimate disaster for this kind of program. So the fiduciary focus should be on how to address these elements in choosing annuities as investments under the plan.

Lets talk about what the fiduciaries need to deal with, and about what I mean when I say say irrevocable and inflexible. Traditional annuities are inflexible. Period. You get the monthly benefit you pay for. They provide a very valuable benefit which should be part of anyone's retirement planning, but this inflexibility can be scary, as it takes away from the participant the ability to address unexpected contingencies. This fear comes from the second point: the funds used to buy the traditional annuity are gone for good. Other than payments made under a survivor annuity, the traditional annuity doesn't give the participant any access to funds to pay for contingencies, nor does it typically pay a death benefit. So what's a fiduciary to do?

It's a plan investment. Unlike a DB plan, Including the annuity in a DC plan is a fiduciary decision-not a settlor function. So plug something like this into the normal fiduciary process:

Decide whether you really want this sort of traditional annuity within the plan, and whether you want to limit the purchase to a portion of the participant's account balance. Check with the annuity company. There are number companies that have a variety of features which address these issues: some have death benefits; some are "cashable," having some sort of surrender benefit; some have a guaranteed payment over time.
Check for annuity purchase rates. Though "fees" are the typical focus of fiduciaries, that's not not the proper inquiry for these sorts of annuities-it really is all about seeing how much benefit can be purchased for what price. Check commissions.
Make sure the annuity is designed for a retirement plan: make sure there are unisex mortality; that it can do the proper Schedule A reporting; that there can be appropriate valuation; and if there's a death benefit, the incidental benefit rules are met. Depending on the type of contract and features, there may be a couple of more things to check out.
Decide whether to hold the annuity in the plan and pay the benefit out from the plan; or issue the annuity from the plan as a plan distributed annuity. If distributing, make sure the plan document permits in-kind distributions.
Review the range of variable and living benefits that may be available, where, inflexibility and inaccessibility are not a problem.
If allowing participants a choice of annuities, if an advisor is used, and any of products are registered products, make sure the advisor follows FINRA's suitability rules.

Of course, check out the insurance company (see Part 1).

Next up: Invisibilty: the sale/advising side of annuities

DOL Shows Its Swagger; Annuities Pick Up Steam

Robert Toth — Thu, 17 Sep 2009 10:50:44 -0500

The Swagger

I had the privilege to speak on a 403(b) panel at the recent DOL/ASPPA "DOL Speaks" seminar, with Lisa Alexander and Susan Reese of the DOL. Our own panel went very well, with Susan and Lisa both speaking directly to and recognizing the transition problems related to this new 403(b) world. As Lisa repeatedly pointed out, many of the rules causing the challenges have always been there, but not given much attention by 403(b) employers or their advisors. The audience showed some frustration, but that arises from there not being answers to a lot of the tough questions we now face. But our take away is that the DOL is spending time and smart effort in recognizing the difficult issues now being raised, and is considering ways to approach them. You will from time to time see in this blog me disagreeing with their chosen approach, but it will never be a criticism of the seriousness of their choices nor of the professional manner in which they are being handled.

This conference was my first serious view of the direction of the EBSA under Phylis Borzi, and it is already showing some swagger under her leadership. My first clue came from the EBSA's staff's position with regard to the material being presented. We are all very used to the typical government staff comment during most such seminars that any comments of staff in their presentations reflect their own personal opinions, not that of their employing agency.

Well, at this seminar, the DOL took accountability. None of their speakers issued this disclaimer. My own presentation material was reviewed with the view that in a seminar labeled "DOL Speaks", it couldn't very well disclaim what its staff members were saying. So the staff statements took on an import we have little seen at other such conferences. This was a rare act of bureaucratic courage.

Phylis's comments about the EBSA's priorities sounded a more hardened approach to enforcing the public policy underlying ERISA. It reminded me some of my favorite line from one of the all time great movies, "Mr. Smith Goes to Washington". A "little bit more of looking out for the other guy" is what I recall Jimmy Stewart saying. Plan participants have always had this kind of advocate in the EBSA, but those efforts look to clearly become more focused.

Annuities to be addressed

At long last, both the DOL and the IRS will be taking a look at the technical rules related to the offering of annuities in 40(k) plans. The DOL announced that they will be soon be publishing an RFI on annuity issues, while the IRS announced that they will be considering auto-annuitization. This will be both challenging and fun, particularly as it comes to making annuities sensibly transparent, able to be effectively compared, and in designing programs that make sense for those with modest accumulations.

And for those of you still looking for Part 2 of my fiduciary analysis of annuities, its on the boards and will be out shortly.

Pang/Warshawsky vs. GAO: Recent Study Challenges Traditional Thinking About DC Annuities

Robert Toth — Wed, 09 Sep 2009 09:21:01 -0500

Two recently published studies demonstrate the sort of shift in the "conventional wisdom" related to annuities for DC plans that needs to occur for those products to be successful in the marketplace.

One of the struggles the market continues to encounter is the limited manner in which many policy wonks (with the notable exception of David John, Mark Iwry, Bill Gale and a few others) and advisors within the DC plan community continue to view annuities. There is still a prevailing view of annuities as being simple "straight life" annuities, a view which ignores the recent development of innovative products in the individual, "non qualified" annuity marketplace.

The first study is a troubling example of this stodgy way of thinking. It is the recently issued GAO report, written for George Miller, Chair of the House of Representative's Committee on Education and Labor, called "Alternative Approaches Could Address Risks Faced By Workers But Pose Trade-Offs." It is, by all accounts, a very thorough and well done analysis of what the authors view as the current alternatives to "decumulation" from DC plans. It ignores, however, the an entire range of "living benefits" and other sorts of guarantees which have been successfully used in the "non-qualified" marketplace. It is these sorts of guarantees which can address many of the fears of plan fiduciaries and plan participants that the purchase of an annuity is merely a bad bet made against the insurance company (see an earlier post discussing these fears).

I encourage you to look through the GAO report, and then compare it to the second study. Kelly Pechter wrote a recent article in his Retirement Income Journal of a study published in the Journal of Financial Planning by Gaobo Pang and Mark Warshawsky entitled "Comparing Strategies for Retirement Wealth Management: Mutual Funds and Annuities." These two economists analyzed 6 alternative models for for guaranteeing income out of a qualified plans, focusing on 401(k) plan accounts and IRAs. 3 of their models addressed innovative marketplace methods: the use of one of the "living benefits"-Guaranteed Minimum Withdrawal Benefits (GMWB)- as well as variable annuitization and gradual annuitization. This study does not provide all the answers, as there continues to be a number of technical/legal issues which need to be settled to make these things really work well in qualified plans (see another, earlier post discussing these issues, referencing the CCH and BNA papers). But it finally opens the door to the sorts of discussions we need to be having in order to make DC annuities work.