NUTS AND BOLTS OF RETIREMENT PLANS September 28, 2007 Curtis L. Harrington & Harrington (562) 594 -9784 curt@patentax. com http: //www. patentax. com
STATE BAR OF CALIFORNIA 80 th ANNUAL MEETING ANAHEIM MARIOTT ANAHEIM CONVENTION CTR SEPTEMBER 28, 2007 PROGRAM 112 2: 15 - 4: 15 PM Curtis L. Harrington & Harrington curt@patentax. com http: //www. patentax. com (562)594 -9784 Fx(562)594 -4414
Disclaimer: Educational Only § This Power Point Presentation is Educational Only and no part of this presentation can be considered as federal or state tax advice, opinion, or position and is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the internal revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein, nor (iii) constituting guidance on any tax or intellectual property matter. 3
Traditional Deduction Model (PRIMACY) § By allowing a deduction for monies set aside during a taxpayers working life (either by the taxpayer or his employer), the government TEMPORARILY gives up the tax portion then due and allows the taxpayer to invest both the taxpayers portion (which would have been kept by the taxpayer after tax was applied) and the IRS portion (the Tax on the amount invested in a pension plan). § At a future time, after the money has grown, the money is withdrawn, the IRS collects its tax. § Thus, if you have $1 million in your retirement account, up to $350, 000 (about 35%) belongs to the IRS!! 4
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Planning Risks & Opportunities § Changing Tax Rates: A taxpayer has some advantage when the general tax rate is high during input & low during payout. § Within a non-changing Rate Scheme: Assuming the Taxpayer lives more modestly (less expenses required) in retirement & his income is reduced within a tax rate schedule (perhaps where the tax rates were the same at retirement as they were during the working life), the taxpayer may have his retirement monies taxed at a much lower based upon lesser income needed. § It is also hoped that the amount available at retirement has grown substantially. 6
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Planning Risks & Opportunities § Note that the IRS has given up tax on any increase in value for Roth § There have been questions asked such as “what if” the government started taxing the taxpayers increase. Some believe it can be done, others say the prohibition on Ex Post Facto changes would enable the government to have a chance to tax any increases after it changed the law in order to provide such a tax. § Note that if the law were changed in future it would make for an even more complicated tax computation. In theory, one might need to know WHEN an increase occurred, rather than the beginning and ending balances. Computations would be a nightmare to administer. 9
Where to Begin Explaining our Pension System? § THEORY / INTRO § MAIN PLAYERS § IRS § ERISA WELFARE § Dept of LABOR BENEFIT PLAN § IRS/LABOR DISTINGUISHED JOINT ACTION § ERISA STATUTE § IRS STATUTE 10
Where to Begin Explaining our Pension System? § STANDARD PLAN § ANTIASSEMBLY ALIENATION § PLAN APPROVAL § WORKING PARTS § TRUSTEE APPROVAL § STOP!! WHAT HAVE WE LEARNED? § FULL PLAN § IRA/SEP/SIMPLE 11
Where to Begin Explaining our Pension System? § IRS COMPLAINCE § CIRCULAR 230: RESOLUTION OBTAINING A SYSTEM PLAN TAX § Qualification OPINION IS MORE § Voluntary DIFFICULT Compliance § Plan Re-Approval § CIRCULAR 230 § WAITING FOR IRS COVERED OPINION EFFECT APPROVAL 12
Where to Begin Explaining our Pension System? § IS PLAN § ABUSIVE TAX AVOIDANCE AVAILABILITY TRANSACTIONS AFFECTED? § LISTED TRANSACTIONS § QUALIFIED PLAN EXCEPTION § PPA-2006 ENHANCED PLAN REPORTING 13
Where to Begin Explaining our Pension System? § ILLUSTRATIVE CASE LAW DEVELOPMENTS § § § § Review Principles Preemption Plan Interference Suspension of Benefits Administrative Problems Standing Fiduciary Problems Anti-Alienation § MISCELLANEOUS: PROVISIONS § Clawback § Spouse Consent § Rollovers 14
ERISA COVERS TWO MAIN TYPES OF PLANS § WELFARE BENEFIT PLAN § This includes health insurance, life insurance, accidental death and disability, as well as any policy capable of rising to the level of “a plan”. § Welfare Benefit plans can be changed daily. § RETIREMENT & PENSION PLAN § This includes health insurance, life insurance, accidental death and disability, as well as any policy capable of rising to the level of “a plan”. § Once rights are vested in a retirement and pension plan, they cannot 15 be divested except under extraordinary circumstances. (e. g. crime)
Where to Begin Explaining our Pension System? § History: Studebaker incident, 1963. The Studebaker car company, which had a pension plan based upon the ability of the company to make payments based upon its going-business concern value, declared bankruptcy and put 11, 000 people put of work. § Money left in the bankrupt company for pensions was allocated: § Only 3, 600 of the workers, those over age 60, were given full retirement § Next 4, 000 workers, between ages 40 and 59 & 10 yrs service were awarded a scant 15% of full pension rights. § Remaining 3, 400 employees, those either under age 40 or between the ages of 40 and 70 with less than 10 years of service, received 16 nothing.
SETTING THE STAGE: MAIN PLAYERS § Main Players: § IRS § Applies the rules, examines plans to see if “Qualified” § Allows a deduction for the entity paying into the pension § Allows the pension beneficiary not to be charged with income § Administers the tax code relating to pensions 17
SETTING THE STAGE: MAIN PLAYERS § Main Players § Department of Labor § Has the ability to step in and take action for Violations § Has investigatory power for actual & potential violations § Promulgates Regulations 18
SETTING THE STAGE: MAIN PLAYERS § Main Players § IRS & Labor Joint Actions § Establishes Joint Board to Regulate Enrolled Actuaries to insure competence and compliance with valuation and discrimination rules § BROAD Mandate to arrange and agree for assistance with (a) Any Federal Agency or (b) Any state or subdivision to enforce the retirement laws. 19
SETTING THE STAGE: MAIN PLAYERS § Main Players § ERISA STATUTE: Selected Provisions § § § § 401 Coverage & Exclusive Purpose for employees § 402 Plan requires written instrument § 403 Requires Pension Assets to be held by Trust § 404 Expansive list of who is a FIDUCIARY § 405 Expansion of Liability to Co-FIDUCIARY § 406 Prohibited Transactions 20
SETTING THE STAGE: MAIN PLAYERS § Main Players § ERISA STATUTE: Selected Provisions § § § § 407 Limitation on Employer Securities (see ESOP) § 408 Transactions Exempt from those Prohibited § 409 Personal Liability for Fiduciary Breach § 410 Exceptions for Insurance Policies § 411 Felons not to be involved in Pension Operation § 412 Bonding Requirement for Asset Handlers 21
SETTING THE STAGE: MAIN PLAYERS § Main Players § ERISA STATUTE: Selected Provisions § § 501 Crim. Liability; 10 yrs; $. 5 M corp/$. 1 m individual § § 502 Civil Enforcement § § § § - By Beneficiary (Pensioner) - By the Secretary of Labor - Discretionary Award of Attorney Fees - Damages = contributions, interest, liquidated damages § 503 Formalities Required when denying Claims § 504 Power of Sec. of Labor to Investigate § 505 Power of Sec. of Labor to make Regulations § 506 Coordination with Other Agencies & States 22
SETTING THE STAGE: MAIN PLAYERS § Main Players § ERISA STATUTE: Selected Provisions § § 507 Administrative Procedure Act Applies § § 508 Civil Enforcement § - By Beneficiary (Pensioner) § - By the Secretary of Labor § - Discretionary Award of Attorney Fees § - Damages = contributions, interest, liquidated damages § § 509 Survival of Non-Invalidated Provisions 23
SETTING THE STAGE: MAIN PLAYERS § Main Players § ERISA STATUTE: Selected Provisions § § 510 Main Statute: Interference with Protected Rights § - It shall be unlawful for any person to discharge, fine, suspend, expel, discipline or discriminate against a participant or beneficiary for exercising any right to which he is entitled under the provisions of an employee benefit plan, this title, section 3001, or the Welfare and Pension Plans Disclosure Act, or for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan, this title, or the Welfare and Pension Plans Disclosure Act. It shall be unlawful for any person to discharge, fine, suspend, expel, or discriminate against any person because he has given information or has testified or is about to testify in any inquiry or proceeding relating to this Act or the Welfare and Pension Plans Disclosure Act. 24
SETTING THE STAGE: MAIN PLAYERS § Main Players § ERISA STATUTE: Selected Provisions § § 510 Makes Several Impacts § Rights and Benefits Earned are Inviolate § Anyone to acts against a pension beneficiary for asserting a right is liable § It is unlawful to retaliate for testimony § Unlawful to violate anti-discrimination provisions…. However 25
SETTING THE STAGE: MAIN PLAYERS § Main Players § ERISA STATUTE: Selected Provisions § (other) § § 511 Criminal Liability for Coersion § § 514 SUPERSEDES OTHER LAWS § § 4000 Pension Benefit Guaranty Corporation 26
SETTING THE STAGE: MAIN PLAYERS § Main Players § ERISA STATUTE: Selected Provisions § IS THIS LIKE WORKERS COMP? § It creates a regime with limited ability to sue § It pre-empts laws otherwise important to workers § It puts retirement system needs over individual needs § Without the three points above, would retirement plans have flourished? 27
SETTING THE STAGE: MAIN PLAYERS § Main Players § IRS STATUTE OVERVIEW § § 72: Rules for Annuity Contracts & Early Withdrawal § § 401: Introduces Requirements for Qualification, Permitted Disparity, Top Heavy Plans, Requirement of Joint and survivor annuity, Assignment and alienation, Compensation Limits § § 402 Employee Distribution Taxed when paid 28
SETTING THE STAGE: MAIN PLAYERS § Main Players § IRS STATUTE OVERVIEW § 403: Annuity Tax Rules § 404: Employer Deduction of Contributions § 406: U. S. Employees of Foreign Affiliates = employee of parent § 407: U. S. Employee of foreign subsidiary = employee of parent § 408: IRA limited to permitted amounts & in cash § 408 A: Roth IRA § 409: Employee Stock Ownership Plans § 409 A: NON-Qualified Deferred Compensation (penalties) 29
§ 409 A: COMPRESSION § Increased penalties for any mechanism not covered by ERISA § Specifically Exempts (a) Qualified Employer Plans, Tax-qualified plans, tax-deferred annuities, 457(b) plans, SEPs, SIMPLEs, and qualified governmental excess benefit arrangements 415(m). § Identifies Non. Pension Programs: such as sick leave, vacation, compensatory time, sick leave, death benefits, disability, bonuses and some "performance-based compensation“ § PENALTIES: (a) Inclusion of the deferred amounts in Gross Income of any amounts not subject to substantial risk of forfeiture ( Risk of forfeiture remains an important fact in all of these cases); (b) Interest on the taxes due for regular non/underpayments PLUS 1%; (c) 20% 30 penalty as an “additional tax”.
SETTING THE STAGE: MAIN PLAYERS § Main Players § IRS STATUTE OVERVIEW § 410: Minimum Participation (age, service, annual hours) § 411: Minimum Vesting Required § 412: Minimum Funding to eliminate deficiency § 413: Collectively Bargained Plans § 414: Definitions & Special Rules § 415: Limits on Contributions § 416: Top Heavy Plans § 417: Minimum Survivor Annuity Requirements 31
SETTING THE STAGE: MAIN PLAYERS § Main Players § IRS STATUTE: § 410 non-discrimination § DISCRIMINATION IS A GOOD THING § IRS Code and Regs Teach Permitted Discrimination (1/3 of the volume) , at Length 32 § Ex: Gym Eq. ; Exec’s. marginally diminished Utl.
SETTING THE STAGE: MAIN PLAYERS § § 410 Discrimination Test § (1) RATIO PERCENTAGE TEST: § % non-highly/ % highly > 70% or § (2) AVERAGE BENEFITS TEST: § benefit % non-highly / benefit % highly § (3) SAFE HARBOR: § (a) Compute Non-highly concentration ratio § (b) Apply to safe harbor table relaxing the ratio 33 percentage test from 50% to 20. 75%
SETTING THE STAGE: MAIN PLAYERS § The 20. 75% entry corresponds to a 99% non-highly concentration percentage, so the most discriminatory case occurs where the non-highly compensated employees overwhelmingly outnumber the highly compensated. § (2) Example: If you have one highly compensated employee and 99 non-highly compensated employees, it is possible to have the pension plan cover only 20. 75% of the 99 employees, or about 21 employees. § Coverage of less than 20. 75% is still possible if you are able to explain it to the commissioner. 34
SETTING THE STAGE: MAIN PLAYERS § The mathematics of non-discrimination are set forth briefly in order to illustrate and emphasize that the extremes in terms of discrimination require a high performance, bulky, “bulletproof” highly individualized plan. Where NO discrimination is had, the employer can either (1) opt for a simple, nondiscriminatory plan or (2) a non(substantial)plan option 35
SETTING THE STAGE: MAIN PLAYERS § Main Players § IRS STATUTE OVERVIEW (Punishment) § 4971: 10% tax on plan accumulated funding deficiency/liquidity shortfall & 100% if not corrected § 4972: 10% tax on non-deductible contributions to plan § 4973: 6% tax on excess contribution to IRA, Archer MSA, retirement annuity, Coverdell ed. Saving account, or Health saving account 36
SETTING THE STAGE: MAIN PLAYERS § Main Players § IRS STATUTE OVERVIEW (Punishment) § 4974: 50% tax on distributions which are less than required distributions. § 4975: 15% tax on prohibited transactions of disqualified persons & 100% if not corrected § 4976: 100% tax on provision of disqualified benefit (key/discrimination) 37
SETTING THE STAGE: MAIN PLAYERS § Main Players § IRS STATUTE OVERVIEW (Punishment Contd) § 4979: 10% tax on excess contributions Minimum Survivor Annuity Requirements § 4980: 20% tax on employer reversion, which if not replaced rises to 50% § 72(t): 10% additional tax on withdrawal from plan prior to attaining 59½ 38
§ 72(t) 10 % Penalty Exceptions § There are eight exceptions to the § 72(t) 10% penalty for IRA withdrawals prior to age 59 ½ for distributions that occur due to: § § § § § IRA owner's disability. IRA owner's death. Life expectancy of the owner/joint life Payments for unreimbursed medical expenses > 7 ½ % of AGI Payment for med. ins. premiums after 12 weeks unemployment Payments of no more than $10 k toward first‑time home purchase Payment for higher education for the IRA owner / family. Payment of back taxes re: IRS levy against the IRA. 39 However, ordinary tax is still due on any of the above withdrawals
LIST OF RETIREMENT SAVINGS “CHARACTERS” § QUALIFIED PLAN (DB, DC, Profit Share) § 401 k Elective Deferral Plan (Profit Sharing / $ Purchase § § § IRA SEP-IRA SIMPLE-IRA ROTH-IRA 457(b) Governmental Plan 403(b) Purchased Annuity for 501(c) organization 40
QUALIFIED PLAN (DB, DC, Profit Share) § 1. Can be as complicated or as simple as your needs require § 2. The codes don’t define “QUALIFIED PLAN”, but a “QUALIFIED PLAN” is one that generally meets the code requirement AND PREFERABLY will operate as a trust § 3. The main idea is that the more language you build in, and especially trust language, it will become more inviolate as to people who operate it. § 4. You can build in language on investments, trades, standards for operation, so long as the basic language 41 meeting the statutes is met.
QUALIFIED PLAN (DB, DC, Profit Share) § 1. DB can have its benefits computed based upon a dollar amount, a percentage of wages, years of service times some aspect of wages § 2. DB discrimination is measured based upon the yearly equivalent benefit which is set forth to make the retirement target formula § 3. With a formula based on salary, later year salary increases can sharply increase required contributions. 42
FACTS RELATED TO QUALIFIED PLANS Max defined benefit plan yearly output: $180, 000 Max yearly input to defined contribution plan: $45, 000 Maximum amount of annual compensation considered: $225, 000 Threshold for separating “HIGHLYS” from “non-highlys” $100, 000 Social Security Base for computing Self Employment $97, 500 Threshold where a “HIGHLY” becomes a “KEY” $140, 000 Maximum SS monthly benefit $2, 116 PBGC maximum monthly guarantee for defined benefit 43 $4, 125
QUALIFIED PLAN REQUIREMENTS § § § § § 1. Written Instrument 2. Established by Employer 3. Communicated to EE’s 4. Permanent (open ended) 5. EE benefit only 6. No clawback to ER 7. No Discrimination 8. Minimum vesting 9. Survivor Benefits 10. EE contribution vested § § § § § 11. Forced pmts at NRA 12. No SS based benefit red. 13. Pre&Post Death payout 14. Plan Termination rules 15. Merger transfer rules 16. Anti-Alienation Rule 17. Benefits clear/no discretion 18. Benefits payable for life 19. Other’s death, no effect 20. Specific Type Provisions. 44
401(k) PLANS § Defined contribution plan that allows employee salary deferrals and/or employer contributions. § Can have other retirement plans. § Can be a business of any size. § Need to annually file a Form 5500. § You can make a 401(k) plan as simple or as complex as you want to. (Preapproved 401(k) plan is 45 possible)
401(k) PLANS § Employees may contribute more to this plan than under IRA plans. § Optional participant loans and hardship withdrawals § Higher Administrative costs (since this is/can be a REAL PLAN) § Discrimination must be tested § Additional "catch‑up" contribution ~ $5000 is 46 allowed.
401(k) PLANS § Employer/Employee The lesser of 25% of compensation or $44, 000 in 2006. § Annual filing of Form 5500 is required. § Participant Loans: Permitted. § In‑Service Withdrawals subject possible 10% additional tax if under age 59‑ 1/2. 47
IRA FAMILY § § § § § Individual Retirement Annuity is a life insurance company annuity Employer and Employee Association Trust Account, (group IRA) Simplified Employee Pension (SEP‑IRA) Savings Incentive Match Plan for Employees IRA (SIMPLE‑IRA) Spousal IRA - spouse w/less than $2 k annual compensation. A Rollover (Conduit) IRA - distribution from qualified plan Inherited IRA: a non‑spouse IRA beneficiary of a deceased owner. Education IRA, not deductible but provides for education tax free Traditional IRA, for those with earned income. Roth IRA: Contributions not deductible 48
SELECTED IRA - Traditional § Documents enabling the IRA are those of the financial institution § Being individual, no discrimination, no trust operation § No real plan document need be dealt with by owner/beneficiary § Main mechanism is deposit of monies and taking deduction. § Withdrawal will cause financial institution to notify the IRS § AGI Phase out limits ($50, 000 ‑ $60, 000 )/ ( $80, 000 ‑ $100, 000) 49 § Normal contribution limit $4, 000 / Catch-up $1, 000 (For 50 yrs+)
SEP IRA § In essence, takes a same type of deposit as would be made for a traditional IRA and builds a slightly expanded rule set around it § Simplified Employee Pension (SEP). A SEP is a retirement “plan” designed for self‑employed persons, partnerships, sole proprietors, independent contractors, and owner‑employees of an unincorporated trade or business § A SEP is an easy method for a small employer to establish a retirement plan as a form which the IRS recognizes as “the plan document” is a promise to follow some of the requirements for a full qualified plan (see example next slide) 50
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SEP IRA § eliminates complex administration and expense § SEP is permissible only if employer has no other plan § contribution of up to 25% of compensation or $45 k. § Prior to January 1, 1997, a SEP‑IRA could have included a salary reduction arrangement (SARSEP) where EE’s < 25. w/50% participate. SARSEPS in existence as of 12/31/96 continue § Small math correction on the 25% of compensation to make a self employed more equivalent to a non-self employed case 52
SIMPLE IRA § Savings Incentive Match Plan for Employees (SIMPLE). § Established in 1996 for employers of <100 employees § Has a “plan document” IRS form similar to that for a SEP § Employer must have no other retirement type plan § Employees can defer up to $10, 500 per year/ catchup $3, 000 for 50+ § Employer Matching scheme for 2 -3% § Prohibition on withdrawal within 1 st 2 years (25% penalty tax) 53
ROTH IRA § Contribution limits for ROTH-IRA are generally same as deductible IRA § Contributions not deductible § AGI phaseout: married filing jointly $156, 000 - $166, 000; otherwise$99, 000 - $ 114, 000. § "Qualified" distributions/withdrawals are not taxable § Penalty for early withdrawal applies 54
ROTH IRA § No withdrawals unless made after a five year period from first contribution to the ROTH IRA the tax year in which the taxpayer first contributed to a Roth IRA. § Roth IRAs may be maintained and contributions made even after the owner reaches age 70½. § Strict prohibition on ROTH/NON-ROTH rollovers § Roth-type accounts are now possible with 401(k) and 403(b) plans 55
457(b) Governmental Plan § 457(b) Plans are for Government Entities & Non-profits § Treated here to illustrate a few economic concepts and advantages § Since the ER is a not-for-profit, deductibility is not a problem § 401 k Elective Deferral Plan (Profit Sharing / Money Purchase 56 § Government Plans generally exempt from ERISA
457(b) Governmental Plan § Exempted from operation of 409 A. This means that the government entity need not maintain an actuarially accounted for trust fund. Most government retirement plans are not separately funded and depend upon taxation to pay benefits § The 457 plan assets of tax‑exempt employers are subject to the claims of the employer's creditors, but no governmental plan assets are subject to employer’s creditors. (An indication that your retirement is as good as the size and health of your non-profit) § After 2002 government plan proceeds can be rolled over. 57
457(b) Governmental Plan § Contribution limit for non-profit funded plan (or government plan choosing to set funds aside is $15, 500 § Catchup contributions for 50+ are $5, 500 § SPECIAL CATCH-UP for three years prior to retirement of DOUBLE the normal maximum. In 2007, if retirement is planned for 2010 or earlier, maximum contribution could total $31, 000 § Uncertain if non-profit a rollover to an IRA will qualify for a Qualified Plan Rollover since funds may never have been under anti-alienation. Non-profit may be able to use 58 regular Qualified Plan
403(b) Tax Sheltered Annuity § Employers limited to (a) public school, (b) college or university, (c) a church, (d) a charitable non-proift 501(c)(3) § Economically similar to a 401(k) plan. § Other plans are possible in addition to the 403(b) plan § Salary deferment operates for public school employees only § More restrictive investment options 59
403(b) Tax Sheltered Annuity § Annual Contribution Limits are lesser of 100% of pay or $15, 500; with catchup for 50+ = $5, 500. § Investment options in the 403(b) plan are limited to annuities and mutual funds only. § Beginning in 2006, 403(b) plans MAY allow participants to make contributions through those plans to a Roth‑ 403(b) account at the discretion of the employer. The Roth pass through contribution, up to the ROTH yearly maximum limit, will be taxed to the employee, but future qualified distributions from that account will not be taxed. 60
NOW THAT WE HAVE THE ENVIRONMENT, LETS ASSEMBLE A “QUALIFIED PLAN” 61
STANDARD PLAN ASSEMBLY § 1 A. Create a main document which is consistent with ERISA and THE INTERNAL REVENUE CODE which by its terms: § § § § is established by the employer is for the exclusive benefit of employees and/or their beneficiaries account for contributions to the plan has statutory vesting standards prohibit any forfeiture of accrued benefits is communicated to the employees will not “impermissibly” discriminate § OR 62
STANDARD PLAN ASSEMBLY § 1 B. FIND A PROVIDER OF PROTOTYPE OR MASTER PLANS (SELF CONTAINED) § MASTER PLAN: Plan for employees is established using a single custodial account § PROTOTYPE PLAN: A Plan for employees includes a separate custodial account for each employer 63
STANDARD PLAN ASSEMBLY § 1 B. FIND A PROVIDER OF VOLUME SUBMITTER PLANS (PLAN KIT WITH “PLUG AND PLAY” COMPONENTS) § VENDORS of MASTER, PROTOTYPE AND VOLUME SUBMITTER PLANS MUST OBTAIN A FAVORABLE ADVISORY LETTERS ON THOSE PLANS 64
STANDARD PLAN ASSEMBLY § BOTH PROTOTYPE, MASTER, AND VOLUME SUBMITTER PLANS MAY BE AVAILABLE FROM § Banks § Trade or Professional Organizations § Insurance Companies § Mutual funds 65
STANDARD PLAN ASSEMBLY § PROTOTYPE AND MASTER PLANS ARE REVIEWED ON A STAGGERED 5 YEAR CYCLE (Rev. Proc 2005 -16 & 2005 -66) § The cyclical sweep is looking for any residual comparison between the plan an a change in the law. § Helps insure that employers will not have to file determination letter applications more often than 66 5 years.
STANDARD PLAN ASSEMBLY § HOWEVER, individual Plans, as applied to particular employers must ALSO be submitted for an individual letter ruling some cases. § A given employer therefore SHOULD NOT rely upon the opinion letter issued to the plan vendor (in which “non specific” prototype, master or volume submitter plans were granted favorable opinion) unless they are CERTAIN that they fit within the adoption guidelines. 67
STANDARD PLAN ASSEMBLY § 1. Main document will also include: § § § § § Name and type of administration Name and address of a person for service of process Name and address of the plan administrator Names, titles and addresses of trustees Description of collective bargaining agreement provisions A statement of eligibility and benefits Circumstances for disqualification or ineligibility Identity of the source of financing and source of benefits Date of the end of the plan year and timing of records Procedures for presenting claims & for redress of claims 68
STANDARD PLAN ASSEMBLY § 2. Create a SHORT FORM “outline” “SUMMARY PLAN DESCRIPTION of the document created in step 1 in 3 rd grade language; praying that it doesn’t omit any provision later held to be “important”; and then give it to the employees. 69
STANDARD PLAN ASSEMBLY § Example (Part 1) § The Plan is a “defined benefit plan. ” Under a defined benefit plan, you will receive a retirement benefit, calculated in accordance with a formula selected by your employer. The formula takes into account your earnings and period of service with your employer. The benefit is a single life annuity, and which starts on your Normal Retirement Date (NRD). If your benefit payments start before your NRD, or is paid in a form other than a single life annuity, the amount of your benefit payments will be reduced to reflect the earlier start or different form. Your employer makes periodic contributions to the Plan, in amounts determined actuarially, to fund your benefit. The retirement benefit that you will receive, however, does not depend on the level of the Plan’s funding. Rather, you will receive a retirement benefit based solely on the Plan’s formula. 70
STANDARD PLAN ASSEMBLY § Example (Part 2) § The purpose of this Summary Plan Description (the “SPD”) is to describe in general terms the primary features of the Plan. It will help you understand the benefits the Plan provides. The complete terms of the Plan are set forth in the Plan document. You may request a copy of the Plan document from the Plan Administrator. In the event of any differences between this SPD and the text of the Plan document, the Plan document will govern. Nothing in the Plan or in this SPD gives you any rights of continued employment with your employer. Moreover, your participation in the Plan does not prohibit changes in the terms of, or the termination of, your employment by your employer. 71
STANDARD PLAN ASSEMBLY § 2. Apply to the IRS for approval; i. e. that your “PLAN” is “QUALIFIED” § The next slide shows an expanded view of the fee computation table on form 8717, requesting an opinion that the plan is “QUALIFIED” 72
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STANDARD PLAN ASSEMBLY § USER FEES § Non-bank Trustee Approval § (Rev Proc 2004 -8) § Plan for Individual having less § Than $200, 000 per year income $3, 665 $ No Fee 74
STANDARD PLAN ASSEMBLY § 4. Obtain a trustee § Utilize an existing company or entity which is IRS qualified as a trustee § Request permission from the IRS to become a trustee (not recommended for YOUR asset protection ability) , but this is one path to enable non-traditional investments such as real estate. 75
STANDARD PLAN ASSEMBLY § 4 A. Obtain A PLAN ADMINISTRATOR: § The plan administrator manages the action in the plan, supervises administration, filing of tax returns, agreements with investment entities, and relationships with investment advisors § 4 B. Obtain an enrolled actuary: § The enrolled actuary checks to make sure that the proper level of contributions are made under the 76 plan and certifies the informational tax returns
STANDARD PLAN ASSEMBLY § OPTION: Non-bank Trustee. Most “professional trustees” must meet investment standards. It is possible for others to be appointed to the position of trustee provided the following conditions are met and capacity is shown(Treas. Reg. Secs. 1. 408‑ 2(e)(2) through (e)(5): § Fiduciary Ability § Continuity of performance notwithstanding death or change of owners. § Capacity to Account; and 77 § Fitness to Handle funds.
WHAT IS “TOP HEAVY” ? § When 60% of the benefits under a plan go to Key Employees, employees who (a) are officers and earn more than $135, 000, (b) 5% owners or (C) a 1% owner (non officer) earning more than $150, 000. (adjusted for inflation), TOP HEAVY RULES CAUSE: § Accelerated Vesting § Minimum benefits for Non-Key employees 78
REQUIREMENTS FOR THE OTHERS § IRA (Financial Institution Account) § SEP-IRA (5305 -SEP/5305 A Sal. Reduction) § SIMPLE-IRA (5304/5305 financial inst) § SARSEP (PRE-1997 ONLY) § ROTH-IRA(Financial Institution Account) § 457(b) (Mostly Exempt from ERISA) § 403(b) (Mostly Exempt from ERISA) § Note that non-profits and governments “could” do a regular stand-alone plan!! 79
ANTI-ALIENATION = Big Dividing Line § IRC§ 401(a)(13) STATES § “A trust shall not constitute a qualified trust under this section unless the plan of which such trust is a part provides that benefits provided under the plan may not be assigned or alienated. The antialienation language has been used to indicate a trust which is not reachable by creditors of the plan beneficiary. 80
ANTI-ALIENATION “PROBLEM” § “Trust” construction defeat creditors § Treasury Regulations § 1. 401(a)-13 states that “This section applies only to plans to which section 411 applies (minimum vesting standards) without regard to section 411(e)(2) [which excludes church plans, government plans, etc]. As a result, any “plan” which violates vesting standards will likely not have§ 401(a)(13) protection. This prevents debtors from hiding money which would not truly be held in trust for an employee. 81
ANTI-ALIENATION § “A Supreme Court case in 2004, Rousey v. Jackoway (Sct 2005 -1, USTC ¶ 50, 258) extended protection for IRA’s and SEPs (and generally any equivalent type of tax deferred plan) holding that a taxpayer may withdraw from the bankruptcy estate his right to receive payments “on account of illness, disability, death, age, or length of service”. § However the asset protection must be sought IN CONJUNCTION WITH FILING BANKRUPTCY. 82
ANTI-ALIENATION § This holding was adopted very quickly in subsequent tax legislation as section 224 of The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 to amend the bankruptcy act. You must file for bankruptcy to “exclude” the non plan/non trust account from the bankrupt estate. § Section 224 of the Act describes the protected accounts as "retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408 A, 83 414, 457, or 501(a) of the IRC 1986. "
ANTI-ALIENATION § Other protection can be had at the state level. In California, the California Code of Civil Procedure § 710. 110 provides for an exclusion, but limited such that it is exempt “only to the extent necessary to provide for the support of the judgment debtor when the judgment debtor retires” if the account is a “self‑employed retirement plans and individual retirement. Thus, the self employed are discriminated against at the state level in California, versus someone who was not self employed. § Other states’ provisions may vary. 84
ANTI-ALIENATION - SOLUTION § As a result of the foregoing, it can be seen that there is a “creditor protection gap” for debtor plan holders who do not have “trust-type” plans falling under 401(a)(13). Example: § Debtor has $5 million in a regular, non-rollover IRA, a home worth $2 million, and a judgement against him of $3 million. Outside of the problem of California’s “protection” which is an invitation to argue over the $5 million, namely that the Debtor doesn’t really need that much money anyway, the Debtor’s only recourse might be bankruptcy. 85
BEWARE CO-MINGLING IRAS BANKRUPTCY PROTECTION IS LIMITED § There is an inflation‑adjusted cap of $1 million on ‘ORDINARY” IRAs and Roth IRAs. § If a taxpayer was fortunate enough to have a QUALIFIED PLAN and “rolled over” the assets from the qualified plan into an IRA, the IRA maintains its “outside the bankruptch estate” nature so long as you can show by TRACING that the IRA was rolled over from a QUALIFIED PLAN. § This STILL doesn’t protect a large IRA from creditors “outside” of bankruptcy. If you have to move from one “qualified plan”, move it to another “qualified plan” 86
STOP!!! WHAT HAVE WE LEARNED? § Factors DICTATING FULLY QUALIFIED PLAN: § 1. Complete Anti Alienation-Trust treatment WITHOUT having to declare Bankruptcy § 2. Vastly enhanced contribution limits § 3. Need for sharply fashioned discrimination 87
STOP!!! WHAT HAVE WE LEARNED? § Factors DICTATING CHEAPER MECHANISM: § 1. Low Risk business with little or no employee or owner exposure to outside creditors § 2. Need for inexpensive administration § 3. Need to avoid ERISA liability/responsibility for 88 plan operation (let others be responsible)
IRS Compliance Resolution System § The plan has been built, approved and funded. Now its up to you and the IRS to make it operate § The IRS has a “Compliance Resolution System” to run periodic maintenance on all plans to insure that they are compliant 89
Employee Plans Compliance Resolution Sys. § Encourages Plan Sponsors to be vigilant in properly maintaining their retirement plans. Program may be divided into three tiers: § (1) Self-Correction Program (SCP) has no fee, submission, or reporting requirements § (2) Voluntary Correction Program (VCP) which has a limited fee § (3) Audit Closing Agreement Program (Audit CAP) for which there is a HIGHER fee negotiated with the IRS 90
Employee Plans Compliance Resolution Sys. § The overall design works similar to the configuration for handling non-filers § “If you confess before we find you, you will have a soft landing; If you confess after we catch you, we will be happy to hang you” § Unlike the non-filer scenario, voluntarily finding your faults doesn’t “cost” you anything. 91
Qualification Failures § EPCRS is available to correct the four types of Qualification Failures in a Qualified Plan: § (1) Demographic Failures, § (2) Employer Eligibility Failures, § (3) Operational Failures, and § (4) Plan Document Failures. 92
Voluntary Correction for Plans Under Exam is Limited § Verbal or Written Notification of Employee Plans (EP) Exam or impending referral. § Includes those cases that are now in appeals or litigation. § Includes determination letter waiting period where an EP Agent notifies the plan sponsor of a possible 93 failure.
Voluntary Correction for Plans Under Exam is Limited § Includes a plan which is aggregated (for qualification under Code section 401(a)) or 403(b) with other plans under an EP Exam § EO (Exempt Organization) Exams include cases where the plan sponsor has received verbal or written notification of an impending EO exam & includes any plan sponsor that has been under exam & is now in appeals or litigation 94
CYCLICAL RE-APPROVAL OF PLANS § Qualified plans must be restated for EGTRRA and other items identified on the Cumulative List for each respective cycle by the end of their 5 year cycle (individual) or 6 year cycle (pre‑approved). For an individually designed plan, the EGTRRA remedial amendment period generally ends on the last day of the plan's initial applicable 5 year remedial amendment cycle as provided for in section 12. 01 of Revenue Procedure 2005‑ 66, e. g. for a cycle A plan 1‑ 31‑ 07. § For an M&P or VS plan, the EGTRRA remedial amendment period is the end of the initial applicable 6 year remedial amendment cycle as provided for in section 18. 01 of Revenue Procedure 2005‑ 66. § In general, Rev. Proc. 2005‑ 66, provides that an employer who adopts, or certifies its intent to adopt, a timely‑submitted M&P plan or VS specimen plan by the end of their respective individual 5 year cycle will have until the end of the 2 year window (which will generally be the last 2 years of the 6 year cycle) to be announced by the Service upon the issuance of opinion and advisory letters, to adopt the final approved version of the preapproved plan. 95
WAITING FOR IRS APPROVAL § Contributions can be conditioned on qualification/deductibility § Funds recoverable if within one year of contribution if the employer made a mistake as to “qualified” nature. ERISA § 403(c )(2)(b) § De Minimis clawback of up to $25, 000 w/o IRS permission is possible if plan allows it Rev. Proc. 90 -49 96
CIRCULAR 230: OBTAINING A PLAN TAX OPINION IS MORE DIFFICULT § Recent changes to Circular 230 (document which governs ability of Attorneys, Accountants and CPA’s to practice before the IRS) has been severely tightened. § Given the potential for any “pre-tax entity” to engage in tax avoidance, many pension related transactions are specifically listed and require more 97 extreme attention.
CIRCULAR 230: OBTAINING A PLAN TAX OPINION IS MORE DIFFICULT § Section 10. 35 of Circular 230 (introduced in 2005) defines “Covered Opinions” as written advice by a Circular 230 practitioner relating to any transaction that the IRS considers to be a “tax avoidance” transaction published under 26 CFR 1. 6011 -4(b)(2). § Practice before the IRS goes beyond dealings which occur directly with the IRS 98
ALL PRACTITIONERS ARE MORE LIABLE FOR OPINIONS AND ENTITY STRUCTURING THAN EVER BEFORE § Sanctions for violations of Circular 230 include Suspension, disbarment in their representation of taxpayers before IRS and censure § Monetary penalties may also be imposed in addition to other disciplinary action and may equal the gross income derived from the conduct giving rise to the penalty 99
Why did the IRS focus on Circular 230? § Tax Opinions can be used to shield a taxpayer against the imposition of penalties. This mechanism is covered elsewhere in the Internal Revenue Code, and has traditionally been used to protect good faith taxpayers who choose a path of action based upon assurances by a tax practitioner as to the propriety or outcome of the action. § By placing a control in the document which governs the actions of tax practitioners, the IRS has chosen not to eliminate the benefit to taxpayers from obtaining a prophylactic opinion or advice, but instead to place the burden on the tax practitioner. 100
Circular 230 Covered Opinion Standards When giving covered opinions, practitioners must (among other things): § 1. Use reasonable efforts to identify and ascertain the facts (Independent Efforts, rather than reliance on the client) § 2. Not base the opinion on unreasonable facts 101
Circular 230 Covered Opinion Standards § 3. Relate the law to the facts § 4. Not base the opinion on unreasonable assumptions § 5. Provide his or her conclusion as to the likelihood that the taxpayer will prevail on the merits with respect to each significant federal tax issued considered in the opinion 102
Circular 230 Covered Opinion Effect § The issuance of an Opinion might violate the standard and subject you to discipline from the IRS Office of Discipline § A Tax Court, U. S. District Court or other court’s holding that the standards were not met could result in an ethical violation and disbarment. § A holding that the Standard was not met might also allow your efforts to be colored as being in collusion with the client to perpetrate a fraud on the government and subject the practitioner to liability as a coconspirator in a fraudulent tax scheme. § Any covered opinion would have to be considered as a large information gathering and investigation project to insure that the 103 standards are met and exceeded.
Circular 230 Covered Opinion Effect § Turns every comment into a potential COVERED OPINION § Turns every small opinion tangential to a tax transaction which might be required to have a “COVERED OPINION” into a “COVERED OPINION” § Turns an INTENDED task to produce a “COVERED OPINION” into a MAJOR PROJECT having a cost and depth equivalent to a MAJOR RESEARCH PROJECT not unlike the size of a dictionary § Exponentially raises the cost to the client for providing an opinion from a few thousand dollars to the cost for producing a “MAJOR PROJECT” 104 § Most Practitioners have simply stopped preparing opinions
Abusive Tax Avoidance Transactions § An abusive tax avoidance transaction (ATAT) means any listed transaction under § 1. 6011 -4(b)(2) and any other transaction identified as an abusive transaction in the IRS web site entitled “EP Abusive Tax Transactions”. § A Demographic Failure means the failure to satisfy the nondiscrimination requirements of the Code (e. g. , Code sections 401(a)(4), 410(b), or 401(a)(26)) with respect to a Qualified Plan, 403(b) Plan, SEP or SIMPLE IRA Plan. 105
Abusive Avoidance Transactions (Plan) § An egregious failure is one that involves a flagrant disregard of the applicable code requirements. Ex’s: § (a) a plan has consistently and improperly covered only highly compensated employees § (b) a plan provides more favorable benefits for an owner of the employer based on a purported collective bargaining agreement where there has in fact been no good faith bargaining between bona fide employee representatives and the employer 106
Abusive Avoidance Transactions (Plan) § (c) a contribution to a defined contribution plan for a highly compensated individual is several times greater than the dollar limit set forth in § 415. SCP is not available to correct § Operational Failures that are egregious. VCP is available to correct egregious failures; however, these failures are subject to the fees described in section 12. 06. Audit CAP is for egregious failures. 107
LISTED TRANSACTIONS: IRS Website § 401(k) Accelerated Deductions § S Corporation ESOP Abuse (Delayed Effective Date for § 409(p)) § Treasury, IRS Issue Section 409(p) Regulations The Treasury Department and IRS issued proposed and temporary regulations under Section 409(p) which generally prohibits accruals or allocations under an employee stock ownership plan (ESOP) that holds stock of an S corporation where the ownership interest in the ESOP or in rights to acquire the corporation are so concentrated among 10% owners that they hold >50% of the corp. interests. 108
LISTED TRANSACTIONS: IRS Website § Collectively Bargained Welfare Benefit Funds under § 419 A(f)(5) § Trust Arrangements Seeking Exemption from § 419 § Abusive Roth IRA Transactions 109
LISTED TRANSACTIONS: IRS Website § Deductions for Excess Life Insurance in a Section 412(i) or Other Defined Benefit Plan § Abusive transactions involving specially designed life insurance policies in retirement plans, section "412(i) plans". § As can be seen, any device which enables movement of money while taking a deduction, especially followed by ownership type manipulation 110 is fertile for tax abuse.
LISTED TRANSACTIONS: OTHER § “listed transactions” § any partnership or other entity, any investment plan or arrangement or any other plan or arrangement the principal purpose of which is the avoidance or evasion of any federal tax § any partnership or other entity, any investment plan or arrangement or any other plan or arrangement, a significant purpose of which is the avoidance or evasion of any federal tax, if such significant purpose advice is one of the following: § § A “reliance” opinion A “marketed” opinion Condition of confidentiality, or Contractual protections 111
LISTED TRANSACTIONS: OTHER § “Tax avoidance” is not (supposed to be) something that is wrong or unlawful…. § “[o]ne who avoids tax does not conceal or misrepresent. He shapes events to reduce or eliminate tax liability and, upon the happening of the events, makes a complete disclosure. ” Internal Revenue Manual 9. 1. 3. 3. 2. 1 (7/29/98) 112
EFFECT ON RETIREMENT PLANS § Enrolled Actuaries cannot rely as much upon client/employer provided data in computing benefits for plan participants. Additional Investigation will be required. § Combined effect of Circular 230 with the additional duties under PPA 2006 will place an even greater burden on Enrolled actuaries, especially as to the depth to which investigations relating to their expanded duties must be performed, including target attainment percentage and endangered or in critical status. 113
EFFECT ON PLAN SERVICE PROVIDERS § Enrolled Actuaries, Tax Attorneys, and Accounts will be less able to rely upon the data provided from the client and will be statistically forced to have greater personal oversight and inspection of company records and books when signing documents relating either to PBGC Form 1 or Form 5500 and associated documents. Because boilerplate disclaimer language cannot be incorporated into the form signatures, the only choice is due diligence, resulting in a rise in client costs. § Previous isolated systems, wherein the client provided data to an accounting service who provided summaries to various practitioners in turn, will either be duplicated by practitioners doing the same job twice, or else will undergo a shift of services to the practitioners, at least in part. 114
EFFECT ON PLAN SERVICE PROVIDERS § The combination of the above will tend to favor more vertically integrated practitioners who can bring the data investigation and treatment function in-house. § OR § Further increased reliance on non-practitioners whose practice is not regulated by Circular 230, such as financial institution employees who already have a near monopoly on the retirement plan AND 115 retirement fund industry.
Covered Advice Could Also Include: § § § Section 79 “early distribution” tax Sections 105 and 106 health benefits 402 distributions, rollovers, direct transfers 404 deductions 409 A nonqualified deferred compensation plans 412 minimum funding 403(b) plans 457 plans Stock options Mergers and acquisitions Golden parachutes Taxation to alternate payees 116
Pension Potential Gray Areas Include: § Qualified plan and trust documents § Merger and Acquisition Agreements § Cover letters transmitting documents § Situations where a plan turns out to be not qualified § SPD (simplified plan document) and SMM (summary of material modifications § 402(f) and 204(h) Notices 117
EVEN Enrolled Actuaries Are Uncertain § The Enrolled Actuaries Society have been pressing the IRS for answers to specific questions about the new Circular 230 Rules because of the Continued uncertainty in its application: § Confirmation as to whether establishment or maintenance of a qualified retirement plan is a transaction, “the principal purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code (IRC). ” § Whether making calculations and measurements based on an understanding of the law is tantamount to giving an opinion of the law. 118
Enrolled Actuaries Are Uncertain (Contd) § Whether communicating, in writing, the results of actuarial computations — constitutes the rendering of a covered opinion. § The meaning, scope and breadth of the exception in Circular 230 enabling enrolled actuaries regarding the establishment of the qualification of a qualified plan. § Guidance on clarification of the provisions of Section 10. 33 outlining “best practices. ” (This would seem to point out a “financial engineering” conflict between the plan beneficiaries who seek maximum funding to maximally insure an abundant supply of retirement funds versus the plan sponsors who are seeking to satisfy minimum funding in order to satisfy the rules and reduce costs. ) 119
Qualified Plan Issues Exception § “Covered Opinions” do not include advice that concerns the qualification of a qualified plan § Except for advice regarding a listed transaction or where the “principal purpose” of the plan or arrangement is the avoidance or evasion of taxation § “Concerns the qualification” must be interpreted very narrowly to fall within the exception § As a result of all of the foregoing relating to circular 230 and covered opinions, the Exemption for Qualified Plans 120 doesn’t mean much.
IS PLAN AVAILABILITY AFFECTED? § As the creation of a plan moves farther away from the “non discriminatory” vanilla standards and either towards sharper discrimination or toward the structuring of arrangements where increased control is had over the entities associated with ownership of investment: you will have to go there without your tax adviser. § This will move non-practitioners into position as prime advisors and plan experts for more complex plans. 121
PPA-2006 Enhanced PLAN Reporting § In addition, for regular defined benefit “QUALIFIED PLANS” have enhanced reporting rules which cause plan administrators and others to communicate more often and more completely with plan beneficiaries § Much of this new legislation and expanded rules are in response to the ENRON “event”. 122
PPA-2006 Enhanced PLAN Reporting § Report certification that adjusted funding target attainment %age of the plan is not less than 100% § Report certification relating to requests extending amortization periods § within the 90 th day of each plan year, the plan actuary must certify to the Sec Treasury and to the plan sponsor whether or not the plan is in endangered or in critical status (failure to certify can 123 result in an ERISA penalty of $1, 100 per day)
PPA-2006 Enhanced PLAN Reporting § Funding Improvements: After the adoption of a funding improvement plan, it may not be amended to increase benefits unless the plan actuary certifies that the benefit increase is consistent with the funding improvement plan § the construction of a separate mortality table upon request of the plan sponsor by the actuary based on a plans own experience 124
ILLUSTRATIVE CASE LAW DEVELOPMENTS Short Review of Preemption & Pension v. Welfare Benefit PREEMPTION PLAN INTERFERENCE THRESHOLD SUSPENSION OF BENEFITS ADMINISTRATIVE PROBLEMS STANDING FIDUCIARY PROBLEMS ANTI-ALIENATION 125
Review Pension vs. Health & Safety § Recall that ERISA governs both plans which are “pension like” and which are “health and safety-like” § Pension-Like provisions in which rights arer vested are held to an inviolate standard. § Health-Like plans can be changed at the whim of the employer every day or every week. There is generally no vested right here 126
PREEMPTION & INSURANCE § Insurance Accident Plans typically include a provision which gives them a claim to any monies recovered from the accident victim from others (typically the person who caused the accident) § The insurance plan typically enforces its rights against its own insured who obtain the double coverage. Without a subrogation provision, the accident victim would get a double recovery (which may be permitted in the victim’s jurisdiction. § Special carve out for Insurance in ERISA section 514. Distinguishes insurance from others v. self insurance (self insurance is subject to ERISA) 127
SUBROGATION RIGHTS Insurance Accident Plans typically include a provision which gives them a claim to any monies recovered from the accident victim from others (typically the person who caused the accident) The insurance plan typically enforces its rights against its own insured who obtain the double coverage. Without a subrogation provision, the accident victim would get a double recovery (which may be permitted in the victim’s jurisdiction. § Special carve out for Insurance 514 insurance from 128
REVIEW OF PREEMPTION § ERISA’s Preemption Clause preempts state law which “relates” to employee benefit plans". ( loose standard) § ERISA’s “Saving Clause” omits from preemption those state laws which are directly related to insurance. § The dividing line between these two characterizations is a rich battleground § Policy Behind Preemption: To avoid state laws & allow uniform policies to be applied to employers. 129
PREEMPTION WALL § In addition, preemption, regardless of whether the plan provision is pension-like or not, builds a wall in which legal action is severely restricted: § against the plan by beneficiaries § against the plan by the states § by the plan against others 130
CASE PREEMPTION § Preemption: Narrow nature of ERISA § 510 right to bring suit restricts the ability to bring other “tort-like” causes of action, such as INTENTIONAL INFLICTION OF DISTRESS, for example, related to decisions made with respect to a plan. § Statutes which are often used “along with” and are “related to” ERISA, and which make it past preemption include: § Title 7 & § Americans with Disabilities Act § The recent action involving cash balance conversion pension plans were defeated using age discrimination effect as the main tool. 131
CASE: PREEMPTION / SUBROGATION § Great-West Life & Annuity Ins. Co. v. Knudson (2002) 534 US 204 (Jan. 8, 2002): § ERISA Section 502 does not provide a plan with method of enforcing the plan’s subrogation provisions against participants or beneficiaries § Where participant obtained personal injury recovery against third party tortfeasor, Plan was not able to obtain reimbursement § Comment: : it may be beneficial to consider the use of an insurance company contractor & to compute a value of 132 subrogation ability versus increased contractor cost
CASE: PREEMPTION § Sereboff v. Mid Atlantic Medical Services, Inc. (2006, S. Ct. ) 2006 WL 310754 § The Supreme Court unanimously affirmed the Fourth Circuit’s decision that a group health plan’s claim against a plan beneficiary’s third-party recovery fund for the reimbursement of advanced payment of medical benefits was one for “other appropriate relief” allowed by ERISA § The action was brought to enforce the “Acts of Third Parties” provision, which thus qualified it as an equitable remedy § Comment: Here we see something other than subrogation, but the enforcement of a “trust like” duty on a third party fund and that plans can generally offensively recover to survive. 133
CASE: PREEMPTION § Hutchison v. Fifth Third Bancorp (6 th Cir. Ct. App, Nov. 30, 2006) No: 05 -4389. Contractual sweetheart promises in an agreement between merging corporations to provide a company's pre-merger employee benefit (ESOP) plan (a third party? ) additional money availability to ESOP plan members was held to be pre-empted, even where plan participants benefitting under the offer were induced to vote their shares in favor of the merger. § COMMENT: If the contract had been drawn between the Plan & the merging company, this case might have had a different outcome. The plan was not a party to the agreement, and was not lied to. Here, ERISA is seen 134 as segregating the plan away from corporate action.
CASE: PREEMPTION/NON-RELATION TO EMPLOYMENT CIRCUMSTANCES § Performance Threat is not related to forced retirement § Fischer v. Andersen Corp. , (2007, CA 8), 2007 WL 1094442 § An employer did not interfere with an employee's right to benefits under ERISA § 510 by placing him on a performance improvement plan (PIP), which “prompted” him into taking early retirement; no constructive discharge. § Facts. Rodney P. Fischer (Fischer) began his employment with Andersen Corp. (Andersen) in 1971 and worked as an engineer at Andersen's door production facility. NRA was 65 for full benefits but years of service could enable full benefits by age 62. Early retirement was possible after age 55 w/reduced pension benefits. A supervisor suggested he 135 either move to a different position or start a PIP.
CASE DEMONSTRATING NECESSITY FOR SHOWING PLAN INTERFERENCE § Rather than agreeing to the PIP, Fischer informed his supervisor he would be retiring by the end of 2003 causing the supervisor to decide it was futile to start the PIP. However, in June 2003 the supervisor presented Fischer with a PIP specifying general categories of project work, communication, & general work habits requiring improvement. § In December 2003, after taking short-term disability leave due to stress and anxiety, Fisher retired from Andersen, saying that he chose to retire to retain his existing health plan, and that he was constructively discharged. 136
CASE DEMONSTRATING NECESSITY FOR SHOWING PLAN INTERFERENCE § Later, Fischer brought an action for benefits interference under ERISA § 510, contending that Andersen had effectively offered him a choice between voluntary early retirement with reduced pension benefits that included health benefits, and inevitable termination with the same reduced pension benefits stripped of health insurance. § § HELD: no interference with prospective benefits; 8 th circuit affirmed. No causality between the employment action and the likelihood of future benefits being transformed to a nonlikelihood of future benefits. 137
CASE DEMONSTRATING NECESSITY FOR SHOWING PLAN INTERFERENCE § Fischer failed to show an adverse employment action and did not link the motive to the retirement plan. There was no constructive discharge despite a contention that his employment was made intolerable under the PIP which may have carried a risk of termination. The fact that he had been informed that he and his wife would permanently lose their health insurance benefits if terminated was irrelevant. § Fischer did not prove the PIP was setting Fischer up to fail or that it was unreasonable. Further the instructions in the PIP that Fischer believed to be unfair were either ambiguous language or undefined and Fischer should have 138 asked for clarification.
CASE DEMONSTRATING NECESSITY FOR SHOWING PLAN INTERFERENCE § Further, Fischer never asked for clarification, and an employee who quits without giving his employer a reasonable chance to work out a problem has not been constructively discharged, the court stated. § The court also determined that Fischer's evidence failed to prove that reasonable employees placed on such a PIP would have considered failure, subsequent termination, and permanent loss of medical benefits so imminent that taking early retirement was the only option. Fischer failed to show intentional interference with benefits. § Source: RIA Pension and Benefits Week (preview) 04/30/2007, 139 Volume 13, No. 18
SUSPENSION OF BENEFITS § One of the hallmarks of Pension plans is that a benefit once given, cannot be taken back. This rule is generally absolute and really contrasts pension plans from welfare benefit plans. § Anti-Cutback Rule as a General rule established under Heinz: conditions imposed after a benefit has accrued make the “accrued benefit less valuable” whether or not an actual benefit suspension occurs. (Heinz v. Central Laborers’ Pension Fund 303 F. 3 d 802 (7 th Cir. Sept. 13, 2002), aff’d, 124 S. Ct. 2230 (June 7, 2004) Very Strict Standard 140
CASE: SUSPENSION OF BENEFITS § Swede v. Rochester Carpenters Pension Fund Cir. Ct. App. Oct 20, 2006, Case Number: 06 -0112 § Court instruction to IRS not to revisit the tax-exempt status in past years of plans that were amended in reliance on” other rules and procedures, cannot be used by a Defendant to resist applying the Heinz holding between the non-permitted plan amendment and the date of the Heinz holding. § Comment: Employers can’t get away with cutbacks in the interim before the cutback rule was solidified. 141
Revenue Procedure 2005 -23 § General Rule: A plan which adopts a “reforming amendment” and complies operationally with that amendment may obtain relief from the retroactive application of Heinz prior to its June 7, 2004 issuance § Reforming Amendment must contain the following provisions: § The original (more restrictive) amendment may not apply to benefits that have already accrued § Payment of retroactive benefits to an affected plan participant must include any appropriate interest or actuarial increase for benefits that have accrued as of the applicable amendment date § The applicable amendment date is the later of the original amendment’s effective date, or the date of its adoption 142 § -
But Then, Revenue Procedure 2005 -76 § Plan must provide for the payment of retroactive benefits, and must be in operational compliance with the reforming amendment no later than January 1, 2007 § Under the Swede case rationale, any conforming amendments and actions should place the employee in at least as good a position as it would have been if no cutback had occurred. 143
ADMINISTRATIVE § Plan Administrator acts or omissions can bring/avoid disaster § PLAN OR NOT A PLAN? : An employee was discharged at age 66 but promised a pension to begin at age 70. (Perhaps an enticement to let any statute run on the improper discharge). At age 70, pension was demanded. This 1986 case held for the employer on the grounds that a “promise” doesn’t create a plan, and ERISA’s requirement that a plan be written, etc. Today, the employee might have § 409 A as a weapon. § PLAN OR NOT A PLAN? : An employer policy can become a “plan” and assume the cloak of ERISA, even inadvertently. Example: insurance company who pays stream of commissions over 5 years equal to the agent’s last years commission. Employer won this case, but todays outcome could be affected by § 409 A 144
CASE: ADMINISTRATIVE § Peralta v. Hispanic Business, Inc. , 419 F. 3 d 1064 (9 th Cir. Aug. 18, 2005) § Court held that the plan sponsor has a fiduciary duty to notify beneficiaries and participants promptly of the termination of coverage § Although the 210 day notice requirement under ERISA Section 104(b)(1) was satisfied; the court found that the plan fiduciary had an even more basic duty to provide timely notice of a plan termination under ERISA Section 404(a)(1) § However, ERISA does not provide the plaintiff with a remedy § Comment: again, the omission inures to the benefit of the plan by a holding that a fiduciary duty was breached. Note that this is a Health-like plan and not a pension-like plan. Protections in health-like plans are typically reached by fiduciary duty. 145
CASE: ADMINISTRATIVE § Securities and Exchange Commission v. Capital Consultants, LLC, 397 F. 3 d 733 (9 th Cir. Feb. 2, 2005) § A receiver in charge of distributing assets from a litigation recovery, was not in violation of ERISA for enforcing an offset provision which required a 50 percent offset against recoveries from third parties, even though receiver was an ERISA fiduciary § ERISA’s fiduciary duty provisions do not prohibit such offsets and the receiver was not otherwise legally obligated under ERISA to favor ERISA plans over non-ERISA plans. A fiduciary is a “rights balancer” and not an unbridled advocate for the plan. 146
CASE: ADMINISTRATIVE § Paul Bard V. Boston Shipping Association; International Longshoremen's Association Pension Plan (1 st Cir. Ct. App. Dec 19, 2006) No. 06 -1810. The plan is liable where its employee was prejudiced by plan numerous regulatory violations (summary plan description not updated since 1988); The reasoning withheld during a battery of appeals; Plan terms are disregarded because employee was so prejudiced) § COMMENT: Will the increase in reporting and notification provisions of under Pension Protection Act 147 2006 will put plans at further risk? YES
CASE: ADMINISTRATIVE § Richard Coleman et al, v. PBGC. (DC Columbia, Dec. 5, 2006) No. 055496. Agreement to remove improper terms from a plan is effective if the removed provision is honored, and proper memorialization of the proper change will not form the basis of a challenge under the “operational compliance requirement. ” of Treas. Reg. 1. 411(d)-4, Q&A 8(c). § COMMENT: The Retirement Equity Act of 1984 (“REA”), Pub. L. No. 98 -397, 98 Stat. 1426 (26 U. S. C. and 29 U. S. C. ) prohibits discretionary benefit provisions in pension plans, & plan provisions should be rigorously 148 tested provisions to this standard.
CASE: ADMINISTRATIVE § Tocker v. Philip Morris Co. (2 nd Cir. Ct. App, Nov 22, 2006) No. : 04 -5904. Making an Exceptions to plan provisions even for the generous benefit of an employee can trigger extreme liability. Employee seemingly diagnosed with a terminal illness is granted an extraordinary retirement benefit, including a lump sum and long term disability simultaneously (not available to other employees under the plan). The employee brought suit for inclusion of the 10 -12 years of employment time corresponding to his long term disability period. It was held that the head of the plan may have breached his fiduciary duty by not informing the employee (whom no one expected to survive more than 2 years) of the effect on his retirement of the job termination in the “special package”. COMMENT: Any “special deal” in lieu of a “regular plan provision” should be examined with the same 149 scrutiny as you would apply to a new plan.
CASE: ADMINISTRATIVE § Northcutt v. General Motors Hourly-Rate Employees Pension Plan (7 th Cir. Ct. App, Nov 22, 2006, No: 05 -4484. Contractual self-help (setoffs) are available to enforce plan provisions for Social Security reimbursement. The use of the Social Security basic retirement & disability base in pension computations to reduce employer contributions for the amounts attributable to Social Security extends to contractual “self help” deductions, even where employees receive a lump-sum from the government and thereafter squander it. § COMMENT: Although the Plan clearly wins under the broad public policy of “building onto” Social Security as a deductible base (a permitted disparity in plan discrimination testing), it would be helpful if Plans included this provision along with a 150 waiver, especially at the time that lump sum payments are made.
CASE: ADMINISTRATIVE § Hooven v. Exxon Mobil Corp. (3 rd Cir. Ct. App. Oct 20, 2006) Case Number: 04 -3773. In a time consuming merger where things develop slowly, an omission in the Summary Plan Description is not fatal where continued employment with the merged companies, or the divested division (owned by purchasing company) continues throughout the period. § COMMENT: Employees should watch the transformation of the plan like a hawk, as continuing to work after amendments will likely constitute waiver. In the alternative, the SPD is often considered a small matter unless it has a big effect, and here the SPD “omission” wasn’t big. 151
CASE: ADMINISTRATIVE § Miller v. Xerox Corp. Retirement Income Guarantee Plan (9 th Cir. Ct. App, Sep 13, 2006) No: 04 -55582. Use of “creative” phantom accounts to adjust the retirement of employees returning from retirement will be stricken. This was also a problem with the Cooper v. IBM Personal Pension Plan 243 F Supp. 2 d 1010 (S. D. Ill. 2003) cash balance conversion case. A deduction based upon prior lump sum retirement payment PLUS time accrual in the employment break period is forbidden. § COMMENT: An actuary should be utilized to re-integrate a return to service, with a computed valuation and which is agreed upon and assented to by both the employee and the employer PRIOR to re-hire; real actuarial accounting will always be favored over phony phantom accounts. 152
CASE: STANDING § Massachusetts Mutual Life Insurance Co v. Doris Russell, 473 US 134 (1985, S. Ct. ): Actions for breach of fiduciary duty under ERISA Section 502(a)(2) must be brought in a representative capacity on behalf of the plan as a whole, and not for the benefit of individual participants § Barker v. American Mobil Power Corp, (1995, CA 9) 64 F. 3 d 1397: Remedies for alleged fiduciary breach must inure to the benefit of the plan (rather than individual participants), or to all plan participants § Comment: Again note the similarity to the corporate shareholder’s derivative actions. 153
CASE: STANDING § Milofsky v. American Airlines, 2005, CA 5) 404 F. 3 d 338, vacd & remd (2006, CA 5) 2006 WL 488622§ 401(k) plan participants lacked standing to bring an ERISA Section 502(a)(2) breach of duty claim on behalf of the plan because they were seeking only individualized relief § Vacated and remanded on March 2, 2006, (Milofsky v. American Airlines, 2006 WL 488622, vacg & remg (2005, CA 5) 404 F. 3 d 338) § Comment: Again, the analogy to the approach for Section 502 standing is to that of shareholder derivative suits. 154
FIDUCIARY LIABILITY § Prohibited Transactions: § 1. Transfer of funds to or use by a DISQUALIFIED PERSON § 2. Fiduciary deals with the income or assets in their own interest. § 3. Fiduciary receipt of funds to his/her account by person who deals with the plan relating to plan assets § 4. Plan transactions with a disqualified person regarding: § Selling, Exchanging, or Leasing Plan Property § Lending money or extending credit § Furnishing goods, services or facilities § ERISA Fiduciaries cannot be relieved from Liability. § 410(a) 155
FIDUCIARY LIABILITY PROPOSALS § Comments recently requesteds on disclosure of fee and expense information to participants in individual account plans (72 Fed Reg. 20457, 4/25/2007) § DOL's Employee Benefits Security Administration (EBSA) has requested public comments on issues relating to the ERISA rules that require the disclosure of plan administrative and investment-related fee and expense information to participants and beneficiaries in participant-directed individual account plans. § Background. According to EBSA, 41 million participants in 401(k) plans are permitted to direct the investment of all or a portion of their plan accounts. While contributions and earnings increase retirement savings in 401(k) and other participant-directed plans, fees and expenses charged to participant accounts can substantially reduce that growth. For this reason, it is important that plan participants consider what and how fees and expenses are charged to their individual accounts, EBSA noted. 156
FIDUCIARY LIABILITY PROPOSALS § Participant control. Labor Reg. 2550. 404 c-1 sets forth the conditions under which participants are considered to be exercising control over the assets in their accounts, thereby relieving fiduciaries from liability for the results of participants' investment decisions. Labor Reg. 2550. 404 c 1(b)(2)(i)(B) conditions relief upon participants and beneficiaries being provided, ERISA Advisory Council. § The above will bear directly on the added Disclosure of Information Relating to Plan Investment Options, and Disclosure of Information Relating to Plan and Individual Account Administrative Fees and Expenses 157
CASE: FIDUCIARY LIABILITY § Beck v. PACE International Union, 2005 U. S. App. LEXIS 23190 (9 th Cir. 2005): The sponsor of a single employer plan breached its fiduciary duties when, rather than investigating whether it should merge its pension plan with a multiemployer pension fund, the employer decided without much analysis to annuitize the plan so as to terminate it. Comment: Similar to the “duty to bargain” even where a plant is closing, there is a “duty to try and save a pension plan in trouble” rather than terminating it (when it is sick). 158
CASE: FIDUCIARY LIABILITY § Supreme Court agrees to hear ERISA remedies case involving fiduciary's failure to carry out investment instructions : La. Rue, James v. De. Wolff, Boberg & Assoc. , Inc. , (2007, S. Ct, ) 2007 WL 1730445 § The Fourth Circuit ruled that a Code Sec. 401(k) plan participant's claim that losses resulted when the plan administrator had failed to make changes to investments in his plan account as he had directed, was not actionable under either (1) ERISA's breach-of-fiduciary-duty provision, or (2) ERISA's other appropriate equitable relief provision. To recover this loss, the complaint sought appropriate “make whole” or other equitable relief under ERISA § 502(a)(3). § The district court dismissed the case, finding that La. Rue's requested remedy was not available under ERISA. La. Rue appealed. The Fourth Circuit found that La. Rue could not qualify for relief under ERISA § 502(a)(2) because recovery under that provision must inure to the benefit of the plan as a whole, not to particular persons with rights under the plan. 159
CASE: FIDUCIARY LIABILITY § Ellis v. Rycenga Homes, Inc. , (2007, WD MI) 2007 WL 1032367 § Trustee entitled to jury trial for ERISA fiduciary breach claim against brokerage firm (Illustrates the DEPTH of reach for fiduciary claims). § A profit-sharing plan trustee was entitled to a jury trial on his ERISA claim that the plan's former stock brokerage firm breached its fiduciary duties by failing to discover that the plan's former trustee had taken illegal plan loans. § COMMENT: An important aspect of every plan is the identity of WHO IS BEING RELIED UPON TO MAKE INVESTMENT DECISIONS. 160
ANTI-ALIENATION § Anti-Alienation: (ERISA § 206(d)(1) & IRC § 401(a)(13) “Benefits may not be assigned or alienated. ” Requires that the plan prevent the participant from doing indirectly what most plans forbid directly, spending retirement savings before retirement. Much like a “spendthrift” clause (which prevents invasion of the trust for purposes of need) and makes it universal/perfunctory § Anti-Alienation of § 401(a)(13) via § 1. 401(a)-13 to apply to plans which § 411 applies without regard to § 411(e)(2) (exempting church plans, government plans, society plans and plans which had no employer contributions since 1974 (government plans are expected to meet pension obligations by appropriation and budgeting – and may always be at risk) Church plans generally treated the same way. 161
CASE: ANTI-ALIENATION § United States v. Novak, 9 th Circuit, No. 04 -55838 (March 23, 2006), the Ninth Circuit Court of Appeals held that the government could garnish vested pension benefits under a restitution order despite the anti-alienation provision of ERISA § Comment: This case might be viewed as enabling federal invasion of pension plans, but the facts were so terrible that it is unclear as to how it will be viewed if the facts were not so severe. The employee garnished had a long history of continuing THEFT of his employer’s telephone board equipment ($millions) sold in interstate commerce, and the convicted employee was subject to federal restitution order of over $1 million (even though the pension was only about $147, 000). 162
CASE: DISCRETIONARY ATTY FEES § Reasonable hourly rate for ERISA attorneys is $375 to $400 in the 9 th Cir; Welch v. Metropolitan Life Insurance Co. , (2007, CA 9) 2007 WL 656390 § A district court erred when it awarded a long-term disability benefit plan participant attorneys' fees at the rate of $250 per hour instead of the $375 to $400 per hour rate the attorney had requested, AND imposed a 20% reduction for “block billing. ” § Background. Vicki Welch sued Metropolitan Life Insurance Co. after Met. Life denied her claim for long-term disability benefits. After the lawsuit was filed, Met. Life decided to award Welch her benefits. Then Welch requested attorneys' fees under ERISA § 502(g)(1), requesting $39, 112 in fees for 11. 5 hours of work at $375 per hour & 87 hours of work at $400 per hour & produced four experienced ERISA attorneys who attested that they usually charge between $400 & $475/hr. Source: RIA Pension and Benefits Week Newsletter 04/16/2007, Volume 13, No. 16 163
MISCELLANEOUS MATTERS 164
MISCELLANEOUS: PROVISIONS § 514(b)(7) exempts QDROs from ERISA preemption § $100/day 502(c) penalty for administrator who refuses to supply a participant information to which he is entitled. § 10% TAX ON EARLY DISTRIBUTIONS DOES NOT APPLY TO A QUALIFIED RESERVIST called to active duty for at least 180 days or indefinitely. § Rollovers after 12/2006 can be made by direct trustee-trustee transfer ( which avoids the trustee sending a note to uncle sam that you have withdrawn money). § 50% Tax Credit for the Startup costs for creating a SEP, SIMPLE, or regular qualified plan. Creation costs = cost for (1) setting up, (2) initial administration, and (3) employee education. Must have 100 or less employees earning $5 k per year or more. (Form 8881) 165
MISCELLANEOUS: PENSION CLAWBACK § If a pension plan contributions result in more assets than are needed, the contributing company can claw them back (reversion)subject to a tax of 20% (or 50% where the employer fails to either provide a replacement plan [where the plan is discontinued] or plan benefits increase of at least 20% of the clawback. IRC § 4980 In other words, of 100% of monies going to reversion, the company has the choice to spend 20% on increasing employee benefits, and losing 20% on the tax to keep 60% of the clawback or alternatively keeping only 50% of the clawback after paying the 50% tax. § A 5% owner of the business maintaining the plan pays a tax of 10% on any benefit he receives from the plan in excess of what he was supposed to receive under the plan. 166
MISCELLANEOUS: SPOUSE CONSENT § Changes Related to Failure to Obtain Spousal Consent § Rev. Proc. 2003 -44 provided that if spousal consent cannot be obtained, spouse is entitled to a benefit equal to the portion of QJSA that would have been payable to spouse under the plan at the annuity starting date of the prior distribution. § Recall that Geraldine Ferraro changed the presumption quite a while ago. This solidifies the rule. 167
MISCELLANEOUS: ROLLOVERS § Rollovers after 12/2006 can be made by direct trustee transfer ( which avoids the trustee sending a note to uncle sam that you have withdrawn money). § The following IRS chart from Fall 2006 summarizes rollovers § In general, a non-institution-to-institution transfer will generate a notification to the IRS to impose tax on the beneficiary (see chart following the rollover chart) 168
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WANT A COPY OF THIS POWER POINT? § Please visit: http: //www. patentax. com And click on “LIBRARY” 171
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