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New Developments

New Rules Dramatically Expand Options for Cash Balance Plan Sponsors

November 2, 2010

Regulations Reduce Employer Investment Risk, Minimize Funding Issues and Allow for New Interest Crediting Rates

On October 19, 2010, the Internal Revenue Service (IRS) issued new regulations enhancing Cash Balance (hybrid) retirement plans. Among the highlights are new provisions allowing plan sponsors much grater investment flexibility, largely eliminating funding issues that prevented some employers from implementing Cash Balance Plans.

This information release summarizes some of the new rules and what they mean for plan sponsors. It is not a complete summary of the changes. The IRS published both final regulations, effective immediately, and proposed regulations that can be relied upon now but will officially take effect January 1, 2012.


A Cash Balance Plan is a defined benefit plan that specifies an employer contribution along with an Interest Crediting Rate (ICR) that cannot exceed a "Market Rate of Return." Plan sponsors invest plan assets collectively and each participant has an account. Until last week, the IRS had not finalized the definition of the "Market Rate of Return." Previous guidance allowed several safe harbor rates including the 30-year Treasury rate and the interest rate on long term investment grade corporate bonds. As of December 31, 2009, these rates ranged from 1.80% to 5.19% with the 30-year Treasury rate at 4.49%. These remain as safe harbor rates under the final regulations. However, the new regulations dramatically expand the definition of "Market Rate of Return," as outlined below, crating many more options for plan sponsors.

New Interest Crediting Options

Option 1: Actual Rate of Return on Plan Assets

The regulations allow the Interest Crediting Rate (ICR) to equal the "actual rate of return on plan assets," including both positive and negative returns. This option is allowed as long as the employer chooses diversified investments to minimize the volatility of returns. Investing Cash Balance plan assets in a mix of bonds and equities would be acceptable. Investing exclusively in a sector fund would be unacceptable.

This new option will be highly appealing to employers since it minimizes most of the underfunding and overfunding issues. The challenges of exceeding or falling short of a targeted ICR every year are largely eliminated under this option. However, if the ICR is set to equal the Actual Rate of Return, the "preservation of capital rule" described below will apply.

Preservation of Capital Rule

Although a Cash Balance Plan may credit a negative annual return, final regulations include a "preservation of capital rule" to protect plan participants. No participant receives less than the aggregate amount of employer contributions at the time of withdrawal. For example, suppose a participant received annual employer contributions of $1,000 for three years, but the ICR was negative each year and the account balance decreased from $3,000 to $2,800. If the participant terminated and requested a lump sum payment, the preservation of the capital rule applies, so the plan would have to pay out $3,000, even though the account balance was only $2,800.

Option 2: Equity Based Rates

The newly proposed regulations (which can be relied upon prior to being finalized) allow an ICR that is equal to the rate of return (either positive or negative) on a Registered Investment Company (RIC) such as a mutual fund that is reasonably expected to be not significantly more volatile than the broad United States equities market or a similarly broad international equities market. A mutual fund that is concentrated in one industry sector or one international region would not meet this requirement. However, a mutual fund whose investments track the rate of return on the S&P 500 or a broad-based "small cap" index would meet this requirement.

If the ICR is set to equal an Equity Based Rate, the "preservation of capital rule" described above will apply.

The plan assets do not necessarily need to be invested in the index that is being tracked. For example, the ICR could be equal to the S&P 500 index, while plan assets are invested in a fund that tracks the Russell 2000 index. If the actual return on plan assets exceeds ICR, then this might permit the investment return to provide for the interest credit to participants accounts as well as administrative expenses and additional benefit payments that may be required under the "preservation of the capital rule."

Using an Equity Based Rate rather than the Actual Rate of Return might also mitigate participants' concerns regarding the selection of investments by the employer.

Option 3: Fixed Rates and Combining Rates

The newly proposed regulations also allow for an ICR that equals a stand-alone fixed rate of up to five percent (5.00%).

It is also permissible for a plan to utilize an annual floor of four percent (4.00%) in conjunction with any of the safe harbor rates. For example, a plan could provide for the greater of the interest rate on long term investment grade corporate bonds or 4%.

The proposed regulations would not allow for the use of an annual floor in conjunction with the rate of the return on plan assets or on an Equity Based Rate. However, it is permissible to apply a cumulative floor of up to three percent (3.00%) per annum in conjunction with any permissible rate (including Equity Based Rates).

Future Growth of Cash Balance Plans

It is expected that these new regulations will accelerate the already high growth rate in Cash Balance Plans nationwide. As was reported earlier this year, there was a 359%increase in new Cash Balance Plans adopted by employers between 2001 and 2007.

The new regulations clarify lingering uncertainty about the definition of "Market Rate of Return", while opening up a broad range of ICR options that minimize employer investment risk. As traditional defined benefit plans continue to decline in popularity due to employer costs and interest rate risk, Cash Balance Plans are poised to become the dominant alternative.

Next Steps

Cash Balance Plan Sponsors and Advisors

There is much more to the new regulations that what is summarized in this information release. At this time, it is unclear how setting the ICR at a rate other than a safe harbor such as the 30-year Treasury might impact actuarial calculations, non-discrimination testing, and the conversion of account balances to annuities.

IRS Issues Notice 2010-55 regarding Single Employer DB Plan Funding Relief

August 17, 2010

On July 30, 2010, IRS issued Notice 2010-55 ( regarding guidance on the funding relief provided to single employer defined benefit pension plans under the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010. The main take-away from the notice is that filing the Form 5500 and Schedule SB for a year eligible for relief, without having elected relief and reflected it on the Schedule SB, will not preclude the plan sponsor from subsequently electing the relief after guidance is issued, provided the plan year ended before guidance is issued. This guidance was necessary because otherwise retroactively electing relief would be a prohibited change in funding method. Note that only a change in the amortization schedule would be permitted in the amended filing – not changes in assumptions or other changes in method.

The purpose of the notice appears to be to allow and encourage plan sponsors and enrolled actuaries to wait for guidance before attempting to apply the relief provisions. The notice does not prohibit filing the form with the relief election based on the actuary's interpretation of how the modified amortization schedules are applied in practice. However, if the Schedule SB is filed with the relief election before guidance is issued, and the minimum required contribution (MRC) determined under subsequent guidance results in a larger MRC, an excise tax would become payable. The notice does not provide the details on the form or content of a plan sponsor's required election to use an alternative amortization schedule, a plan sponsor's required notice of such election to the PBGC, or a plan sponsor's required notice to plan participants.

The IRS understands that this guidance will result in Schedule SB's being filed showing unpaid minimum contributions that will be reduced or eliminated when guidance is issued. We expect guidance to tell us how to deal with that situation, which includes the failure to file Form 5330 to report and pay excise taxes on a plan that has not met its minimum funding requirement.

IRS also issued Notice 2010-56 ( providing similar guidance for multiemployer plans that have filed, or will file, the Schedule MB before guidance is issued.

New IRS Proposed Regulations Will Affect Form 5500 Preparers

August 17, 2010

Both Congress and the IRS have embarked on a mission to increase oversight of Federal tax return preparers. This initiative represents the first concerted effort by the IRS to require registration for all prepares, as well as to institute competency testing and continuing education requirements for tax return preparers who are not Circular 230 practitioners (that is, "unenrolled preparers"). Treasury Department Circular 230 covered practitioners include CPAs, Attorneys, Enrolled Agents, Enrolled Actuaries ('EA") and Enrolled Retirement Plan Agents ("ERPA"). If you prepare Form 5500 filings for your clients, you are a tax return preparer – see ASPPA asap 08-24.

Additional guidance has been recently released by IRS, including an overview of the requirements and FAQs – see the links at,,id=210909,00.html. The new regulations and requirements are proposed to take effect January 1, 2011.

Registration Requirement
All preparers (whether or not Circular 230 practitioner) must obtain a Preparer Tax Identification Number (PTIN) if they prepare or file tax returns after December 31, 2010.

The IRS will be unveiling a new online system for prepares to obtain PTINs. An annual fee (estimated to be $50 to $100) will be charged for this registration. If you obtain (or previously obtained) a PTIN before the new system is available, you will have to re-apply under the new electronic system and pay the annual fee. Your PTIN, however, should not change. As part of the new PTIN process, the IRS will verify if the preparers are compliant with their personal and business tax obligations. Accordingly, any such outstanding issues should be resolved before registering for a PTIN under the new program.

The new online PTIN registration program is scheduled to open in September, 2010. You should determine who in your firm is a "preparer" and will need to register. If the prepares are Circular 230 practitioners, registration is all that will be needed. If your preparers are unenrolled preparers, they may want to apply for a PTIN as soon as the new online system is available in order to qualify for the extended deadline to complete the general tax competency test (described below) while continuing to prepare filings. Once the competency test is available (expected mid-2011) PTINs will only be available to unenrolled preparers who pass the test (as well as Circular 230 covered practitioners).

Who is a Preparer?
In general terms, an individual who is compensated for preparing, or assisting in the preparation of, all or substantially all of a federal tax return or claim for refund (including the Form 5500) is considered to be a tax return preparer. An employee who prepares his or her employer's returns as part of his or her job duties is not considered a preparer for PTIN purposes, unless he or she also prepares other Federal tax returns for compensation.

Examples from the proposed regulation are helpful in understanding which individuals may be subject to these rules, although none of them specifically reference Form 5500. The proposed regulation is fairly broad in defining who is a preparer and suggests that anyone who gathers information or otherwise communicates with the client regarding data used to complete Form 5500 may be a preparer. That said, the examples illustrate that someone who answers the telephone, makes copies, inputs information into the data fields of a preparation software on a computer, or uses a computer to file electronic returns prepared by someone else is not a preparer and does not need a PTIN to perform these clerical and incidental services. On the other hand, an individual who determines the amount and the character of entries on the return and whether the information is sufficient for purposes of preparing the return is a tax return preparer subject to the new rules. A key factor in identifying who must become a registered tax return preparer is the extent to which an individual "exercises judgment" in the preparation of a filing. ASPPA will certainly be discussing this further with the IRS to gain more insight into the specific issues associated with determining who is considered a preparer for Form 5500.

While a PTIN is required to prepare a return after December 31, 2010, the 2009 and 2010 Form 5500 series reports do not provide for the inclusion of the preparer's PTIN. The IRS has confirmed that inclusion of the PTIN is expected to be a requirement of the Form 5500 in the near future. Forms 990, 990-T, 5330, and 945 already require the insertion of the preparer's PTIN (or social security number, which will be discontinued after 2010).

Competency Testing
CPAs, Attorneys, Enrolled Agents who are active and in good standing with their respective licensing agencies are exempt from the new competency testing requirements. Enrolled Actuaries and Enrolled Retirement Plan Agents in good standing are also exempt, provided they only prepare returns within the limited practice areas of these groups (e.g., Form 5500).

According to FAQs on the IRS website, unenrolled preparers will be required to pass a competency test on general income/business tax topics, with testing expected to begin in mid-2011. Unenrolled preparers who obtain PTIN's before competency testing is available will have three years, or until December 31, 2013, to pass the test. Failure to pass the test by the deadline will result in the deactivation of the preparer's PTIN. After testing becomes available, new preparers will have to pass the test before they can obtain a PTIN. The IRS has confirmed to ASPPA that there is no intent to create a competency test on retirement plan topics. Thus, the only way for an unenrolled preparer to get a PTIN as a Form 5500 preparer is to take the general tax competency test and be subject to the general continuing education requirements described below or to become a Circular 230 covered practitioner (such as an ERPA).

Continuing Education
After completing the process to become an IRS registered tax return preparer, the individual also will be subject to a new continuing education requirement of 15 hours per year, including 3 hours of federal tax law updates, 2 hours of ethics, and 10 hours of other federal law programs. The starting date for the new continuing education requirements has not been established, but presumably it will go into effect before 2014, when all PTIN holders not otherwise exempt will have had to pass the general tax competency test. Circular 230 practitioners continue to be subject to existing continuing education requirements required therein and are exempt from these new requirements.

New IRS Designation/Standards of Conduct
Unenrolled preparers who successfully complete the general tax competency test and PTIN registration will be awarded a new, and as yet unnamed, IRS designation which will permit them to represent taxpayers in IRS examinations when the return under examination was one they prepared.

Beginning January 1, 2011, all preparers will be required to comply with the standards of conduct as outlined in Circular 230 – see .

DOL Issues Its Long Awaited Fee Disclosure Regulation

July 27, 2010

On July 16, 2010, the United States Department of Labor published its long-awaited regulations on ERISA §408(b)(2), the statutory exemption that allows plan service providers to be compensated for their services without engaging in a prohibited transaction. The published regulation is an interim final regulation, meaning that although public comments are invited, the regulations are essentially in a final form, but may be modified after additional comments are received. The deadline for additional comments is August 30, 2010.

In general, the interim final regulations require that "covered service providers" make certain fee disclosures in writing to the fiduciaries of a "covered plan" within certain timeframes. The regulations also clarify that, while the disclosures must be made in writing, the agreement or arrangement does not require a formal written contract as was the case under the proposed regulations.

Covered plan: A "covered plan" is a defined contribution or defined benefit plan within the meaning of ERISA that is not exempted from ERISA coverage under ERISA § 4(b), i.e., church plan. IRAs and SEPs are not covered under the regulations, and most significantly, welfare plans are not covered either. The DOL is planning on addressing welfare plan fee disclosure issues in separate regulations. Also excluded are vendors providing services for less than $1,000.

Covered service providers: There are categories of covered service providers.

Category A: Includes three sub-categories:

  1. A fiduciary service provider or registered investment advisor providing services directly to the plan.
  2. A fiduciary providing services to an investment contract, product or entity that holds plan assets in which the covered plan has a direct equity investment.
  3. Investment advise provided directly to the covered plan by a registered investment advisor under either the Investment Advisers Act of 1940 or State law.

Category B: Recordkeepers or brokers providing services to participant directed plans if one or more investment alterative is made available through an arrangement connected to the recordkeeper or broker.

Category C: Services for indirect compensation. This category includes, among others, any number of services such as accounting, appraisal, banking, legal, investment brokerage, or third party administration for which the covered service provider, an affiliate, or subcontractor reasonably expects to receive indirect compensation.

Covered service providers do not include an affiliate or subcontractor of a covered service provider.

Initial Disclosures: The regulations require that the initial disclosure includes details about the services that will be provided, the status of the provider and compensation.

  • Services. The covered service provider must provide a description of the fiduciary services that it is going to provide.
  • Status. The covered service provider must provide a statement that it is a fiduciary to the plan, or expects to provide services directly to the plan under a contract or arrangement as an investment advisor registered under the 1940's Act or State law.
  • Compensation. The covered service provider must disclose in writing direct and indirect compensation for the services it is providing.
  1. Direct compensation is defined as compensation received directly from the covered plan and the covered service provider must provide a written description of all direct compensation either in the aggregate or by service.
  2. Indirect compensation is defined as any compensation received from any source other than the covered plan, the plan sponsor, the covered service provider or its affiliates or subcontractors and includes, among others, any compensation paid under a 12b-1 fee or soft dollar arrangement or commissions, finder's fees, etc.
  3. The covered service provider must disclose the fees that it will pay its affiliates or subcontractors in connection with the services under its arrangement with the plan.
  4. Finally, disclosures must include any compensation for termination of the contract or arrangement.

Manner of Receipt. The regulations require that the disclosure state if the covered plan will be billed for the compensation or if the compensation will be deducted directly from the plan.

Timing of disclosures: In general, the disclosures must be made sufficiently in advance of finalizing the agreement or contract to allow the fiduciary to engage in a prudent decision with respect to the reasonableness of the fees in light of the services provided. In general, changes to the arrangement that cause a change in fees must be disclosed as soon as practicable, but at least 60 days before the change.

Impact of the non-compliance: If a fiduciary fails to satisfy the new requirements of the 408(b)(2) regulations, the contract or arrangement with the vendor may be deemed a prohibited transaction for which correction will be necessary. A failure to satisfy the requirements will also leave plan fiduciaries more exposed for litigation alleging that the plan expenses are unreasonable and therefore the contract or arrangement prohibited. The regulations however provide two forms of potential relief for the plan fiduciaries:

  • Disclosure errors made by a covered service provider made in good faith will not automatically convert the arrangement or contract into a prohibited transaction, provided that the covered service provider correct its omission as soon as practicable, but in no event later than 60 days after discovering the problem.
  • The regulations establish a class exemption for a plan fiduciary that learns about a disclosure failure after entering into a contract or arrangement with the covered service provider.

By: Tess Ferrera, Miller " Chevalier, Washington, DC ASPPA, July 23, 2010.

No Automatic Extension of Form 5500 Filing Deadlines (and other EFAST2 Updates)

July 27, 2010

No Relief from Filing Form 5558

On Sunday, July 18, Joe Canary, Deputy Director of DOL's Office Of Regulations And Interpretations confirmed that no relief from filing Form 5558 to extend the due date to file the 2009 Form 5500 series reports would be forthcoming. He made his remarks during the opening session of the Western Pension & Benefits Conference in Los Angeles. He indicated that an official announcement would be issued in a few days.

On April 23, 2010, ASPPA submitted comments to the Department of Labor and the Internal Revenue Service requesting a blanket extension for filing the 2009 Form 5500 series so that plan sponsors would not have to file IRS Form 5558 to obtain an extension of time to file 2009 reports. The basis for this request is the challenges plan sponsors and administrators face in filing reports for the first time under the new EFAST2 filing system.

For 2009 calendar year plans, because July 31st falls on a Saturday, the Form 5558 should be filed with IRS on or before August 2, 2010. Also note Form 5558 can be filed "in bulk," with multiple clients' forms all going in the same envelope (or box). It is advisable to use a delivery method that enables the practitioner to confirm receipt of the forms by IRS. The Form 5558 mailing addresses are:

By mail
Internal Revenue Service Center
Ogden, UT, 84201-0027
By private delivery service
1973 North Roulon White Boulevard
Ogden, UT, 84404

Update on Electronic Filing Using Practitioner-Signer Option

As noted in asap 10-22, practitioners should be aware that when you input your filing signer credentials as a practitioner-filer, your name appears in the Plan Administrator signature line when the filing is posted to the new electronic Public Disclosure Room. An individual perusing the filing on the Web site who is unfamiliar with the limitations of the electronic filing system and process may believe the practitioner–filer appears to be a plan administrator or other fiduciary to the plan. To alleviate such concerns, the DOL has inserted the following statement on the disclosure website:

The EFAST electronic filing system allows the plan administrator to authorize a practitioner/service provider to submit the plan's Form 5500 or Form 5500-SF. If this signature option was used, the name of the practitioner/service provider whose electronic signature was applied to the Form 5500 or Form 5500-SF will appear on the image of the form in the signature area above the text "Signature of plan administrator." The practitioner is not necessarily the plan administrator responsible for the filing.

Paper Filings of 2008 Form 5500 Being Returned

It has come to ASPPA's attention that some 2008 paper filings are being returned to filers. The post office box in Lawrence, Kansas to which such filings are sent has been closed and the Department of Labor is reportedly relying on the Postal Service to forward such filings to its offices in Washington, DC. However, you or your client may, in fact, find your envelope returned unopened by the Post Office as undeliverable.

If this happens, the envelope in which the filing was returned should be attached to the filing, together with a brief explanation of the sequence of events. For this reason, it may be even more important to use a delivery method, (e.g., registered mail will return receipt required) that provides a confirmation of receipt of the re-filed form. The Form 5500 and Form 5500-SF mailing addresses are:

By mail
P.O. Box 743
Lawrence, KS 66044-7043
By private delivery service
Attention: EFAST
3833 Greenway Drive
Lawrence, KS 66046-5502

At the Western Pension " Benefits Conference this week, a number of practitioners reported that 2008 paper filings also were being returned by the IRS offices in Ogden, UT. These are the original filings that were properly sent to the post office box in Lawrence, KS. At this point it is clear there is some kind of confusion with the governmental processing of the forms, but it should be a short-lived experience in as much as we are nearing the October 15, 2010 cutoff date for such 2008 paper filings to be submitted.


Effective July 1, 2010, the EFAST Help Line (866 GO-EFAST) provides information related only to filings submitted electronically under the new EFAST2 system. To obtain information about filings for prior years, contact the Public Disclosure Room in Washington, DC. By calling (202) 693-8673.

Extenders bill would allow for rollover of plan distributions to Roth 401(k) accounts

June 14, 2010

The American Workers, State and Business Relief Bill of 2010 (H. R. 4213), which would extend through 2010 nearly $30 billion in expired tax provisions (see Pension Plan Guide Newsletter, Report No. 1829, March 22, 2010), would also allow participants in 401(k) plans to roll over distributions to Roth account maintained under the plan.

Roth rollover restrictions

Participants in 401(k) and other employer-sponsored qualified plans may roll over plan distributions directly to a Roth IRA (thereby avoiding the need for an intervening rollover to a non-Roth IRA followed by a conversion to a Roth IRA). Plan participants are increasingly looking at Roth IRA conversions in 2010 because of the special tax rules that defer the generally applicable tax on conversions until 2011 or 2012. However, participants in a traditional 401(k) plan may not roll over distributions to a Roth 401(k) plan and are, thus, forced to take assets out the plan and convert them to a Roth IRA.

Roth 401(k) conversions

The bill would authorize a 401(k) plan to allow plan participants (or surviving spouses) experiencing a distributable event to directly roll over the distribution to a Roth 401(k) account maintained under the 401(k) plan for the benefit of the individual to whom the distribution is made. The provision would effectively keep the participant’s money in the plan, thereby potentially reducing “leakage” from the participant’s account.

A plan that does not otherwise maintain a designated Roth program may not establish a designated Roth account solely to accept rollover contributions. The distribution to be rolled over to the Roth 401(k) must be otherwise allowed under the plan. Thus, distributions subject to restriction (i.e., in-service distributions and other pre-retirement age distributions) may not be rolled over to the Roth account.

However, a plan may be amended to expand distribution options in order to allow for Roth rollovers. Under such circumstances, the Senate Finance Committee advises, the plan could condition eligibility for the new distribution option on the employee’s election to have the distribution directly rolled over to the Roth account.

The amendment would eliminate the need for participants to roll over a plan distribution to a Roth IRA in order to experience the tax benefits of Roth arrangements, including the deferred tax on 2010 conversions. An individual, however, would need to include the distribution in gross income (subject to basis recovery) in the same manner as if the distribution were being rolled into a Roth IRA. Under the special rule applicable to Roth IRA conversions in 2010, the taxpayer would be allowed to include the distributed amount in income in 2011 and 2012. However, note that the “recapture rule” will subject distributions made from the Roth account within 5 years of contribution to the 10% early distribution penalty tax.

The rollover contribution may be implemented at the election of the employee (or surviving spouse) through a direct rollover (operationally through a transfer of assets from the 401(k) plan to the Roth account). However, in order to effect the direct rollover, the employee (or surviving spouse) must be eligible for the distribution (in amount and form) and the distribution must be an eligible rollover distribution.

A plan must be amended (within a prescribed remedial amendment period) in order to allow for the rollover of 401(k) funds to the Roth 401(k). However, a 401(k) plan that includes a Roth program is not required to allow employees (and surviving spouses) to execute the Roth conversion.

Pension funding relief included in amendment to tax extenders bill

March 23, 2010

Pension funding relief for single- and multiemployer plans, which had earlier been dropped from a jobs bill, is part of an amendment to a large tax extenders measure moving through Congress. On March 1, 2010, Senate Finance Committee Chairman Max Baucus (D-MT) offered a substitute amendment to the Tax Extenders Bill of 2009 (H.R. 4213) which was approved by the House on December 9, 2009. The substitute amendment (The American Workers, State, and Business Relief Bill) would extend a large package of expired tax provisions, as well as provide pension funding relief.

According to a Senate press release, released on March 2, 2010, the Baucus amendment provides “temporary, targeted funding relief for single employer and multiemployer pension plans that suffered significant losses in asset value due to the steep market slide in 2008.” At press time, the Senate was debating the conditions for providing relief. In addition, an amendment was added to the bill that would allow distributable 401(k) account balances to be converted to Roth accounts within the 401(k) plan.

IRS Retirement News for Employers, Volume 6/Winter 2010.

Pension funding relief, stripped from Senate jobs bill, may resurface later

March 11, 2010

Pension funding relief for single-and-multiemployer pension plans, which had originally been included as part of a jobs bill offered by the leadership of the Senate Finance Committee, was dropped from the bill by Senate Majority Leader Harry Reid (D-NV) on February 11, 2010. Reid scaled back the Senate Finance Committee bill, stating that it contained proposals not directly linked to job creation. White House Press Secretary Robert Gibbs dismissed criticism of Reid’s decision to split up the jobs bill. At a press briefing, Gibbs said that he expects there will be other vehicles for advancing some of the measures dropped from the legislation.

The Senate Finance Committee would have provided temporary targeted funding relief for single-employer and multiemployer plans that suffered significant losses in asset value due to the steep market decline in 2008. The bill would have allowed, for eligible plan years, plan sponsors to elect one of two special amortization schedules ( “2 plus 7” amortization, under which plan losses could be amortized over nine years and the first two years of the nine-year amortization period would be interest-only, or 15-year amortization). Eligible plan years for relief under the bill would have included 2008, 2009, 2010 or 2011. The bill also contained provisions applying extended amortization periods to plans subject to prior law funding rules and contained special lookback provisions. Special relief rules for multiemployer plans were also included.

The bill would have also extended the 65% COBRA premium subsidy for terminated workers through May 31, 2010.

Move to drop pension funding provisions draws fire from employer groups

In statement released on February 12, 2010, Mark Ugoretz, president of ERISA Industry Committee (ERIC), said that the failure to include pension funding relief in the jobs bill is “both disappointing and short sighted.”

The ERIC president contended that pension funding relief had broad bipartisan support and a direct impact on jobs. “Employers are not asking for a financial bailout or to be relieved of their pension obligations—only for more time to meet the pension funding increases that resulted from the recession,” Ugoretz said. “Most employers were well on their way to meet the increased funding demands of the 2006 Pension Protection Act when they got slammed by the market fallout in 2008,” he added.

This view was echoed by James A. Klein, president of the American Benefits Council. “By eliminating defined benefit pension funding relief from job legislation,” said Klein, “Congressional leadership is wasting a golden opportunity to save jobs and promote economic recovery at no cost to the federal government.” He added that “immediate relief is essential to the preservation of thousands of American jobs.”

Both groups urged lawmakers to include funding relief in the jobs package. “Failure to include relief,” Ugoretz said, “will only further delay the economic recovery and put retirement security at risk.”

ERIC news release, February 12, 2010;
American Benefits Council news release February 15, 2010.

IRS issues guidance on HEART Act benefit rules for military service members

February 11, 2010

The IRS has issued guidance, in a question-and-answer format, on various provisions of the Heroes Earnings Assistance and Relief Tax (HEART) Act (P.L. 110-245). The HEART Act, enacted in 2008, contained a number of provisions affecting the pensions and employee benefits of military personnel.

The guidance covers HEART Act rules relating to survivor and disability benefits, treatment of differential military pay, distributions from retirement plans to individuals called to active duty, and contributions of military death gratuities to Roth IRAs and Coverdell education savings accounts (ESAs). The IRS also sets out the remedial amendment period for amending plans to comply with these rules. The IRS said that it is considering issuing additional guidance on the HEART Act rules and has requested comments on such possible guidance. Comments should be submitted in writing by April 9, 2010, or electronically via the Federal eRulemaking portal, and should contain a reference to Notice 2010-15.

Survivor and disability payments

The HEART Act added Code Sec. 401 (a)(37) which provides that, if a participant dies while performing qualified military service, his survivors are entitled to any additional benefits that would have been provided under the plan had the participant resumed employment and then terminated employment on account of death. The IRS has clarified that the types of benefits subject to Code Sec. 401 (a)(37) include accelerated vesting, ancillary life insurance benefits, and other survivor’s benefits provided by the plan that are contingent on a participant’s termination of employment due to death. According to the IRS, if a participant dies while performing military service but was not entitled to reemployment rights with the employer, Code Sec. 401 (a)(37) does not apply in determining survivor benefits.

Code Sec. 414 (u)(9), as added by the HEART Act provides that, for benefit accrual purposes, an employer sponsoring a retirement plan may, effective for deaths or disabilities occurring on or after January 1, 2007, treat an individual who dies or becomes disabled while in qualified military service as if the individual had resumed employment and died. The IRS notice clarifies that vesting credit must be provided for the deceased individual’s period of qualified military service.

Differential wage payments

For remuneration paid after December 31, 2008, differential wage payments (payments made by an employer to an individual in the uniformed services who is on active duty for more than 30 days that represent all or some of the wages the individual would have received from the employer) are treated as wages for income tax withholding purposes. The HEART Act provides that: (1) an individual receiving a differential wage payment is treated as an employee of the employer making the payment; (2) the differential wage payment is treated as compensation; and (3) there is no violation of any nondiscrimination requirements. However, for purposes of distributions, the individual is treated as having been served from employment during any period he or she is performing service in the informed services.

The IRS notice provides that, for purposes of determining contributions and benefits under a retirement plan, differential wage payments need not be treated as compensation. Furthermore, a plan’s definition of compensation will not fail to satisfy Code Sec. 414 (s) just because differential wage payments are excluded from the plan’s definition of compensation for purposes of determining benefits and contributions. An individual is treated as having been served from employment during any period he or she is performing military service while on active duty for a period of more than 30 days.

A credit for eligible small business employers that make differential wage payments to qualified employees on active duty for more than 30 days is provided in Code Sec. 45P, which was added by the HEART Act. There is a $4,000 maximum credit per qualified employee for a tax year. The IRS has provided that the amount of any other credit determined with respect to compensation of an employee must be reduced by the amount of the Code Sec. 45P credit if: (1) compensation paid in the current tax year is an expense used directly in determining the amount of the other credit, (2) military differential wage payments are a type of compensation taken into account in determining the amount of the other credit, and (3) the military differential wage payments taken into account for the Code Sec. 45P credit are also taken into account in determining the other credit.

Distributions to individuals called to active duty

A taxpayer who receives a distribution from a qualified retirement plan prior to age 59½, death, or disability is generally subject to a 10% additional tax, except for qualified reservist distributions. A distribution from an IRA or a distribution attributable to elective deferrals under a 401(k) or 403(b) plan to a member of reserves who has been called to active duty for a period in excess of 179 days, or an indefinite period, is a qualified reservist distribution.

Initially, the qualified reservist distribution rules applied to individuals ordered or called to active duty after September 11, 2001, and before December 31, 2007. The IRS explained that the HEART Act removed the December 31, 2007, reference; therefore, the qualified reservist distribution rules no longer have an expiration date.

Rollover of contributions of military death gratuities

Military death gratuities paid to an eligible survivor of a service member and Servicemembers Group Life Insurance (SGLI) payments are excludable from income. Under the HEART Act, the contribution to Roth IRA or Coverdell ESA of a military death gratuity or an SGLI payment is considered a qualified rollover distribution if made before the end of the one-year period beginning on the date beneficiary receives the death gratuity or life insurance payment. The IRS notice clarifies that an expansion of the definition of qualified rollovers applies to deaths from injuries occurring on or after June 17, 2008, or to deaths from injuries occurring on or after October 7, 2001, and before June 17, 2008, if contribution is made no later than June 17, 2009.

EBSA plans to issue proposed regs expanding definition of “fiduciary”

The Employee Benefits Security Administration (EBSA) has announced plans to issue proposed regulations in June 2010 to expand the current regulatory definition of “fiduciary” to include more persons, such as pension consultants, as fiduciaries. As a result of regulatory change, these persons would become subject to ERISA’s fiduciary responsibility rules and would owe a duty of undivided loyalty to their plan clients, EBSA said in a Fact Sheet posted on its website.

Pension consultants, advisors would be covered

ERISA §3(21)(A)(ii) provides that a person who renders investment advise for direct or indirect compensation is a fiduciary. The current regulatory definition (ERISA Reg. §2510.3-21(c)) institutes a five-part test, each element of which must be met before the provision of investment advice would be a fiduciary function. EBSA notes that the current regulation has not been updated or modified since its adoption in 1975, but that, since that time, practices within the employee benefit community and in the financial marketplace have changed significantly. Based on its experience in implementing the current regulation, EBSA believes there is a need to re-examine the types of advisory relationships that should give rise to fiduciary duties on the part of those providing advisory services.

Specifically, EBSA notes that an increasing number of plan fiduciaries rely on advice and recommendations from service providers such as pension consultants and financial asset appraisers in making significant investment-related decisions for their plans. However, the current regulatory definition of fiduciary limits ERISA’s ability to protect employee benefit plans from advisers and financial asset appraisers that act imprudently, or that subordinate their client’s interests to the interests of others. According to EBSA, subjecting these persons to ERISA’s fiduciary responsibility rules will help protect the interests of plans by fostering the provision of quality, impartial advice and recommendations.

Revised determination letter procedures issued by IRS

February 1, 2010

The IRS has issued revised procedures for issuing determination letters on qualified status of pension, profit-sharing, stock bonus, annuity, and employee stock ownership plans (ESOPs), and the status for exemption of any related trusts or custodial accounts. The revised procedures are effective February 1, 2010.

The first part of the revenue procedure includes instructions for requesting determination letters; the second part includes guidance on providing notice to interested parties regarding such requests; and the third part explains the processing of these requests and the effect of determination letters. The IRS has made several changes, most of which involve minor revisions such as updating citations and references to other revenue procedures. A couple of revisions reference the first submission period for Cycle E individually designed plans and Code Sec. 414(d) governmental plans for which the sponsor has elected to treat Cycle E as the initial EGTRRA remedial amendment cycle. Another change provides that documents should not be stapled or bound, so that they may be properly scanned. Also, except when a prior law verification is required, a determination letter may not be relied upon for any period preceding the beginning of the remedial amendment cycle for which the letter is issued. Information has been included regarding Form 5316 (Application for Group or Pooled Trust Ruling), which is being developed and will be available soon for group trust submissions. Other changes clarify which Cumulative List will be used in reviewing various plans and requests.

401(k) PLANS

January 4, 2010

Plan participant allowed to bring ERISA action challenging fund fees and revenue sharing payments

The U.S. Court of Appeals in St. Louis (CA-8) has allowed a plan participant to bring suit under ERISA for fiduciary breach, claiming that a plan sponsor’s allegedly flawed process for selecting investment options allowed for excess fees and that revenue sharing payments received by the plan’s trustee were kickbacks and not reasonable compensation for services rendered. The decision, which may further encourage fee litigation, is significant for the strong enforcement by the appellate court of the procedural rule that the burden of proof at the summary disposition stage lies with the party moving for judgment.

Allegedly tainted fund selection process allowed funds to charge excess fees

The employer maintains 401(k) plan that allows plan participants to invest in 10 mutual funds, a common/collective trust, employer common stock, and a stable value fund. At the end of 2007, the plan had over 1 million participants and nearly $10 billion in assets.

A plan participant brought a fiduciary breach suit under ERISA against the employer and the plan trustee, alleging generally that the process by which the mutual funds were selected for inclusion in the plan was “tainted” by the employer’s failure to consider the trustee’s interest in including funds in the plan that shared fees with the trustee. As a consequence of the flawed process, the participant charged, the investment options included in the charged excessive fees, which were borne by plan participants.

The participant specifically maintained that the company failed to take advantage of the plan’s size to secure institutional shares of mutual funds, rather than the retail shares which a generally offered to individual investors and carry much higher fees. In addition, the participant noted that 7 of the 10 mutual funds in the plan assessed 12b-1 fees, which he charged were used to benefit the fund companies rather than plan participants. Finally, the participant alleged that the revenue sharing payments received by the plan trustee from mutual fund companies whose funds were included in the plan were not reasonable compensation for services rendered by the trustee, but were kickbacks paid by the mutual fund companies to secure inclusion of their funds in the plan. Accordingly, the revenue sharing payments, which were kept confidential pursuant to the trust agreement, constituted a breach of the fiduciary duty of loyalty and prohibited transaction.

Summary judgment issued by trial court

The trial court dismissed the participant’s ERISA claims, ruling that: (1) the participant did not have standing under Article III of the U.S. Constitution to assert claims for an alleged breach of fiduciary duty that arose before he began contributing to the plan in 2003; (2) the complaint alleged insufficient facts to support the claim of imprudent or disloyal management; (3) the employer and plan trustee had no duty to disclose revenue sharing payments; and (4) the participant failed to establish that the alleged prohibited transactions engaged in by the plan trustee were not exempt. The appellate court reversed and remanded.

Participant entitled to relief

In order to avoid dismissal at the pleadings stage, a party’s complaint must (under Federal Rule of Civil Procedure 8) state a plausible claim for relief, by averring sufficient facts to allow a court to draw the reasonable inference that the defendant is liable for the alleged misconduct. The trial court dismissed the participant’s charge of breach of fiduciary duty because it did not allege sufficient facts to establish that the employer’s decisionmaking process with respect to the selection of investment options was flawed.

The appellate court rejected the trial court’s assumption that the participant was required to set forth specific facts describing the manner in which the companies breached their fiduciary duties or to rebut the companies’ explanation for their conduct. Rule 8, the court explained, did not require the participant to plead facts tending to rebut all possible legal explanations for the companies’ conduct. The trial court, the appellate court stressed, unfairly allocated the burden of proof and should have drawn all reasonable inferences in favor of the participant. Pursuant to this standard, the appellate court concluded that the participant had pled sufficient facts to proceed with a claim for breach of fiduciary duty.

Disclosure of fees

The participant alleged that the employer and plan trustee should have disclosed the fees charged by the funds included in the plan and the revenue sharing payments made to the trustee. The trial court dismissed the participant charges, ruling that ERISA does not require disclosure of revenue sharing arrangements and that the other fee information sought by the participant was not material.

The appellate court, however, found that the fee information was material in that the failure to disclose that information could have misled a reasonable participant in plan investment decisions. Similarly, the participant’s allegations were sufficient to state a claim that the companies breached their duties of loyalty by failing to disclose details about the revenue sharing payments. While conceding that there is no per se duty to disclose revenue sharing payments, the appellate court stressed that the participant had alleged sufficient facts to support an inference that nondisclosure of the details about the fees charged by the plan funds and the amount of revenue sharing payments could mislead a reasonable participant in the process of making a reasonably informed decision regarding the allocation of investments in the plan.

Revenue sharing as prohibited transaction

The participant charged that the revenue sharing payments received by the plan trustee were kickbacks and not exempt from treatment as a prohibited transaction as a reasonable compensation for services performed. The trial court rejected the claims, reasoning that, because the participant did not plead facts raising a plausible inference that the payments were unreasonable in relation to the services provided by the trustee, he failed to show that the payments were not exempt.

In reversing, the appellate court initially explained that the participant did not bear the burden of pleading facts sufficient to establish that the revenue sharing payments were unreasonable in proportion to the services rendered. The appellate court stressed that the facts alleged by the participant (revenue sharing payments in exchange for services) were sufficient to shift the burden to the appellees to prove that no more than reasonable compensation was paid for the services provided by the plan trustee. The court especially emphasized the fact that, because the trust agreement between the employer and trustee required the revenue sharing information to be kept confidential, the burden was on those parties to demonstrate the absence of self-dealing. Accordingly, the participant’s allegations were sufficient to state a claim under ERISA §406.

403(b) Plans

December 28, 2009

IRS announces remedial amendment period and reliance for 403(b) plans under upcoming guidance. The IRS has announced a remedial amendment period and reliance for employers that, under upcoming IRS guidance, either adopt a pre-approved 403(b) plan with a favorable opinion letter or apply for an individual determination letter for a 403(b) plan when available. Within the next few months, the IRS expects to publish a revenue procedure for obtaining an opinion letter that the form of a prototype or other “pre-approved plan” meets the requirements of Code Sec. 403(b) and the regulations thereunder. Subsequently, the IRS intends to publish a revenue procedure for obtaining an individual determination letter for a 403(b) plan.

The IRS will not treat a 403(b) plan as failing to satisfy the requirements of Code Sec. 403(b) and the regulations during the 2009 calendar year, provided that the employer satisfies the conditions of Notice 2009-3 (CCH Pension Plan Guide ¶17,141S). As one of the conditions for relief under Notice 2009-3, a written 403(b) plan that is intended to satisfy the 403(b) rules must be adopted on or before December 31, 2009. If this condition is met and, pursuant to the upcoming revenue procedures, the employer sponsoring the plan either adopts a pre-approved plan that has received a favorable opinion letter or applies for an individual determination letter when available, the employer will have the remedial amendment period in which to amend the plan to correct any form defects retroactive to January 1, 2010. Further, the employer will have reliance, beginning January 1, 2010, that the form of its written plan satisfies the 403(b) rules provided that, during the remedial amendment period, the preapproved plan is adopted retroactive to January 1, 2010 or the plan is amended to correct any defects in the form of the plan retroactive to January 1, 2010.

An employer that first establishes a 403(b) plan after December 31, 2009 will also have reliance beginning on the effective date of the plan, provided the employer either adopts a pre-approved plan with a favorable opinion letter or applies for an individual determination letter and corrects any defects in the form of the plan retroactive to the plan’s effective date. The upcoming revenue procedures will include this remedial amendment provision and will address the time-frames for adopting a preapproved plan or applying for a determination letter and other details regarding the remedial amendment period.

Employers may rely on the IRS announcement prior to publication of the revenue procedure for pre-approved 403(b) plans. Accordingly, the IRS cautioned that employers should not request ruling or determination letters on the form of their 403(b) plans at this time, pending publication of the revenue procedure for preapproved 403(b)plans and additional procedures on applying for individual determination letters for 403(b) plans.

IRS issues November, December Treasury, weighted average, yield curve, and segment rates

December 21, 2009

The IRS has issued the corporate bond weighted average interest rates, 30-year Treasury interest rates, yield curve and segment rates, and minimum value segment rates for November and December 2009.

Corporate bond weighted average rates. The composite corporate bond rate for November 2009 is 5.79% and the corporate bond weighted average interest rate for plan years beginning in December 2009 is 6.42%, with a 90% to 100% permissible range of 5.78% to 6.42%.

Treasury securities rates. The 30-year Treasury securities rate for November 2009 is 4.31%. The 30-year Treasury weighted average interest rate, for plan years beginning in December 2009 is 4.36%, with a 90% to 105% permissible range of 3.92% to 4.57%.

Yield curve and segment rates. The spot first, second, and third segment rates for November 2009 are, respectively, 2.35%, 5.57%, and 6.29%. The three 24-month average corporate bond segment rates applicable for December 2009 are: 4.71% for the first segment, 6.67% for the second segment, and 6.77% for the third segment.

For plan years beginning in 2008, the transitional segment rates applicable for December 2009, taking into account the corporate bond weighted average of 6.42% stated above, are: 5.85% for the first segment, 6.50% for the second segment, and 6.54% for the third segment. For plan years beginning in 2009, the transitional segment rates applicable for December 2009 are: 5.28% for the first segment, 6.59% for the second segment, and 6.65% for the third segment.

Minimum present value segment rates. For plan years beginning in 2008, the minimum present value transitional segment rates determined for November 2009, taking into account the November 2009 30-year Treasury rate of 4.31% stated above, are:3.92% for the first segment, 4.56% for the second segment, and 4.71% for the third segment. For plan years beginning in 2009, the minimum present value transitional segment rates determined for November 2009 are: 3.53% for the first segment, 4.81% for the second segment, and 5.10% for the third segment. For plan years beginning in 2010, the minimum present value transitional segment rates determined for November 2009 are: 3.13% for the first segment, 5.07% for the second segment, and 5.50% for the third segment.

Welfare Benefit Plans Redux: Here We Go Again!

December 7, 2009

It is imperative that if one of your clients or his or her advisor brings to you a “funded” welfare benefit plan purporting to give your client big deductions, your antennae must go up! One of the hallmarks of this scheme will be large amounts of life insurance; it seems like we have been through this scenario many times before. Now, what supposedly makes it different this time is that the promoters assure us that their particular promotion is different from those other programs with which the IRS has found fault. Of course, that is the same assurance that we have seen in all the prior programs that the IRS has knocked down over and over. Some of you may remember the Section 79 insurance schemes or the abusive VEBAs and multiemployer welfare plan arrangements; even more of you will remember the abusive type of fully insured defined benefit plans [412(i) plans] or the “springing” cash value policies designed to strip money, tax free, from retirement plans. Never underestimate the creative mind of the insurance industry when there are large commissions at hand.

While it is certainly true that Congress created legitimate tax deductible benefit programs within the tax code for certain welfare benefit plans, these are generally intended for unions, true multiemployer associations and large companies. It is not true that Congress contemplated these programs would be appropriate to provide, for example, lavish post-retirement medical care or cash value life insurance on a deductible basis for the small medical practice with a doctor, a spouse and two medical assistants!

Let’s make one thing clear—the IRS does not like the abusive use of these programs and they are doing everything they can to shut them down. You must take that as given, and your client must decide if he or she really wants to be challenging the IRS on this design. Some insurance companies have even announced they will no longer sell any insurance policies to a 419(e) welfare benefit plan.

Of course, as the IRS issues rules and attempts to clamp down on what it sees as abusive programs, the promoters make their own interpretations of those new rules and make modifications to their programs so that this time (at least, in their view) their program is “good” under the new rules. However, the history is that the IRS challenges even the so-called “good” programs and it could cost your clients a fortune in penalties. For example, in the 412(i) arena we are receiving many reports of huge amounts of taxes, fines and penalties being assessed on “innocent” consumers of these tax-avoidance schemes. A group of these taxpayers has even banded together to petition Congress for relief from the fines and penalties (but they accept as a given the loss of the deductions).

In my opinion, the recently published article utilized logical fallacies to conclude that the designs being suggested would be just fine. The IRS issued a series of three items as a package (two Notices and one Revenue Ruling), yet the crux of the justification in the article for the viability of these programs was the application of a narrow interpretation to one of the notices. That conclusion seems to be like trying to apply the retirement plan nondiscrimination rules by reference only to IRC Section 401(a)(4) and ignoring the complementary rules under Section 410(b), 401(1) and 414(s).

There are two significant analyses in the article with which I have problems. The first is that it appears that the author believes that if a welfare plan provides both pre- and post-retirement benefits, it is not subject to the listed transaction rules because it provides the post-retirement benefits (even though the author admits many benefit professionals believe otherwise). However, in the article, the author does go on to assume that the other benefit professionals are correct on this point, but he still tries to make his argument on other points. Even here, I believe his analysis is faulty.

From the author’s discussion, he clearly believes that the IRS will not treat annuity contracts as cash value life insurance contracts (the author’s design that includes pre-retirement benefits appears to depend on term insurance with annuities for its existence). I do not believe the IRS will be so generous. For a quick refresher, an annuity contract: (1) is a contract issued by a life insurance company; (2) depends on life contingencies for its benefit structure; and (3) has cash values. That it does not provide an insured death benefit as in a traditional whole life contract is correct; that the lack of an insured death benefit makes it any less a cash value life insurance contract is not correct. This particular analysis (that annuity contracts are cash value life insurance contracts) is something that has not been noted in any other discussions of 419 plans that I have seen anywhere, and pursuing the concept would probably be worth the solicitation of an opinion regarding it from the IRS. And if the IRS has not yet thought of it, they will.

The other, perhaps more significant oversight, again in my opinion, is the complete avoidance of a discussion of the scheme being basically a program of deferred compensation, for that is truly what it is—that is the way it is sold and that is the (only) way clients buy it. In the notice that receives particular attention in the article (Notice 2007-83), the IRS clearly states that: “Depending on the facts and circumstances of a particular arrangement, contributions to a purported welfare benefit fund on behalf of an employee who is a shareholder may properly be characterized as divided income to the owner, the value of which is includable in the owner’s gross income, and for which amounts are not deductible by the corporation”. It goes on to say (in part): “In addition, an arrangement may properly be characterized as a non-qualified deferred compensation plan for purposes for IRC Section 409A.”

The previous article includes the comment that:

“Plans that provide post-retirement benefits, such as life insurance or medical reimbursement benefits, are not described in the Notice. It should follow, then, that such plans are not listed transactions…”

It is true that a plan that provides no pre-retirement benefits but provides only post-retirement death and/or medical benefits is not the subject of Notice 2007-83, and thus the plan is not automatically going to be subject to the listed transaction rules. Because the Notice does not automatically make these arrangements listed transactions, the promoters of these programs perceive in this language a new plan design to market: “Let’s design a plan that provides no pre-retirement benefits, that only provides post-retirement death and medical benefits, and we are guaranteed not to be troubled by any IRS attacks.”

I agree that such plan will not fall into the listed transaction requirements, at least, not yet (except, possibly as noted below). However, I would be very concerned that at some later date the IRS might change its mind, so vigilance will be the hallmark. In the IRS attack on purported welfare benefit plans, they have had no compunction in applying the rules retroactively. In fact, they state that “further guidance might be forthcoming and might not apply prospectively only.” How is that for giving you a warm and fuzzy feeling in your tummy? Nonetheless, at this time, and for purposes of this article, let’s concede that it is not listed transaction.

Even though it might not be a listed transaction, the IRS very clearly states that post-retirement medical deduction will not be allowed “unless the employer actually intends to use the contributions for that purpose.” This language should concern any practitioner or client who is considering the installation of a such program. This phrase means that the IRS will be able to challenge the intent of the small business owner who is accumulating all this money; they will want to get in to his or her head to determine the intent of the program. It also likely means that all the marketing material (which usually provides examples of how this money will not be used for such purposes) will be subject to review by the IRS. And, don’t forget, just like a Notice 2007-83, the IRS can find that this program is properly characterized as dividends or as non-qualified deferred compensation subject to IRC Section 404(a)(5) or 409A (or both). Not a welcomed fight, for sure.

As noted above, there is a possible significant exception to the “post-retirement only” plan being exempt from the listed transaction rules. There is a provision in Notice 2007-83 that provides that any transaction that is substantially similar to the transaction as defined in the notice is also a listed transaction. If the IRS were to determine that a transaction involving a post-retirement benefit only plan is “close enough” to meet this provision (which is, alas, a facts and circumstances determination made by the IRS), then we might have a listed transaction which the client knew nothing about. The problem with such a result is that there are now filing requirements that most likely have not been met, with sever income tax penalties measured in the hundreds of thousands of dollars! For example, if the funding of the post-retirement benefits was exclusively with cash value life insurance, an arrangement might be made that the program is now substantially similar to the listed transactions enumerated in Notice 2007-83 (part of the reason why some insurance companies have ceased writing any insurance contracts for any of these type of welfare benefit programs). Bad news for everyone!

Let’s not forget that Notice 2007-84 also reminds us that if the IRS finds, on a facts and circumstances basis, that any of the benefits of the “post-retirement only” plan are disqualified benefits for purposes of IRC Section 4976, the employer will be subject to a 100% excise tax (and that includes any part of the fund reverting to the employer).

The IRS also may impose penalties on persons involved in the arrangements described in Notice 2007-84 or similar arrangements as follows: (1) under the accuracy-related penalties of Section 6662, 20% of the underpayment, paid by the taxpayer; (2) under the tax return preparer liability of Section 6694, the greater of $1,000 or 50% of the income for the return, paid by the preparer; (3) under the promoting of abusive tax shelters penalty of Section 6700, $1,000 per activity or, if lesser, 100% of the gross income derived, paid by the person who promotes it; and (4) under the aiding abetting the understatement of tax liability of Section 6701, $1, 000.

The area of Section 419 is under intense scrutiny at the Service, and many employers with such plans are being audited. While it is (or might be) possible that a retiree medical plan with cash value insurance would provide deductions to the sponsor, the vast majority of welfare plans that I have seen come to me via my clients are of the variety that are clearly problematic. They are almost always plans that seem to be designed for the sole purpose of selling (high commission) cash value life insurance which “primarily benefits the owners or other key employees of the businesses” (a key phrase from Notice 2007-84).

If you are involved in any situation where a client is asking for your review or for an opinion on such a program, there are two things you need to do for your client:

  1. You need to tell them that YOU are not an expert and can’t give them an opinion ( unless you actually are, and are willing to risk your own hide on that opinion); and
  2. You need to make sure that they get to a competent, independent legal/accounting advisor with substantial expertise in this area who can give them a truly informed and knowledgeable opinion.

There is another item that deserves review, and that is a Tax Court case (DeAngelis) released on December 5, 2007 and decided by the very knowledgeable Judge Laro (who also wrote the opinions on the well known Booth and Neonatology tax court cases). Although this case involved a multiple employer 419A(f)(6) plan involving several doctor groups and providing severance and pre-retirement benefits, Judge Laro’s comments are well worth reading. The benefits under this structure were provided by whole life contracts issued on doctors and an office manager.

After an extensive review of the transactions that led to the implementation of this plan and the purchase of the insurance, Judge Laro opened his opinion with the following sentence:

“We are faced once again with an issue arising from a plan designed to aggressively bolster the sale of insurance products through a claim of permissible tax savings.”

Judge Laro did not even look at the statutory language of IRC Section 419 and 419A; instead he focused on whether these deductions were permissible as “ordinary and necessary” business expenses under IRC Section 162. Judge Laro did not think they were:

“While the …plan may have been cleverly designed to appear to be a welfare benefits plan and marketed as such, the facts of these cases establish that the plan was nothing more than a subterfuge through which the participating doctors …used surplus cash of the PCs (professional corporations) to purchase cash-laden whole life insurance contracts primarily for the benefit of the participating doctors personally. While employers are not generally prohibited from funding term insurance for their employees and deducting the premiums on that insurance under Section 162(a), employees are not allowed to disguise their investments in life insurance as deductible benefit-plan expenses when those investments accumulate cash value for employees personally.”

We expect that the IRS will mercilessly wield this new approach to welfare benefit plan deductions with power and efficiency while slicing through these schemes and preserving the government’s revenue!

The last item that requires comment is Revenue Ruling 2007-65, the third and last part of the released ruling package (including the two Notices, 2007-83 and 84). Revenue Ruling 2007-65 specifically addresses the deductibility of premiums paid by the 419(e) plan on cash value life insurance policies (and remember, I think that can be expanded to include annuity contracts). It concludes that even if an arrangement is a welfare benefit plan under 419(e), and employer would not be entitled to a deduction with respect to any premiums paid if the fund or employer is directly or indirectly a beneficiary under the life insurance policy with the meaning of IRC Section 264(a). The IRS contends (and will no doubt assert) that in many of the arrangements under discussion, the fund or employer are direct or indirect beneficiaries under the policy and therefore any contributions used to pay the premiums are not deductible. That should be viewed, possibly, as the so-called “final nail in the coffin.”

The previous article omitted a discussion of this Revenue Ruling (but it did admit that the Revenue Ruling was a part of the IRS guidance package). The article attempted to suggest that a taxpayer would be able to take the deductions because they are allowed under the Internal Revenue Code (the law), but seemed to dismiss the IRS’s ability to effectively implement that law (and limit any deductions) through properly issued regulations, rulings and other processes available to it. This approach is risky, dangerous and potentially expensive approach to take. It amounts to saying “I don’t care what the IRS says you can do, the law says otherwise.” The only way you have to win that fight is in court, and it is a rare client who purposely wants to take on that very expensive fight.

The IRS has told us that they don’t like these schemes; they’ve told us that they are going to do everything possible to discredit and disallow them. Is that really a fight our clients want to take on?

Over the years, I have noted one unfailing characteristic of these schemes, and that is that the promoter specifically says that they do not guarantee the tax results, and that you should check with your own adviser for an interpretation of the law. I have had a very simple approach to dealing with these schemes over the years. After taking the client through the complex legal analysis, I simply say: why don’t you ask the insurance company that is selling the insurance to guarantee the deduction in writing, and if they won’t do that (and they won’t), ask them to apply for a private letter ruling from the IRS on your behalf that appropriately outlines the transaction and asks for IRS review and blessing. In all the years of taking this approach, neither of those things have ever happened, and all the clients who made the requests and were turned down have, wisely, realized that they were not particularly interested in playing Russian roulette with their tax returns!

Courtesy of ASPPA Journal Fall 2009, Lawrence C. Starr.

IRS Weighing Options for Helping Employers Amend Their Plans for PPA, Counsel Says

November 30, 2009

The Internal Revenue Service is considering whether to issue model amendments to help plan administrators facing a Dec. 31 deadline for amending their calendar year plans to comply with the Pension Protection Act of 2006 (Pub. L. No. 109-280), an IRS official said Nov. 18 at a meeting of the Employee Benefits Committee of the Taxation Section of the District of Columbia Bar.

“I’m not promising anything, but I think the approaches under consideration are models and conceivably some type of [deadline] extension,” said Linda Marshall, senior counsel in the Office of the Division Counsel and Associate Chief Counsel for tax-exempt and government entities at IRS. “We’re very sensitive to the timing issues by issuing the final regulations so close to this deadline, and we’re trying to figure out if should we be doing anything about that, and what should we do,” Marshall said.

IRS published final regulations on funding balances, benefit restrictions, and valuation of assets and liabilities under PPA on Oct. 15, only two and half months before PPA’s statutory deadline for amending calendar year plans (197 PBD, 10/15/09; 36 BPR 2371, 10/20/09). “You probably know how we operate by now,” Marshall said. “It takes us longer than we would prefer to do most things, and I think this is one of them.”

Plan Administrators, might want to amend their plans so that some provisions would apply only to the 2008 and 2009 plans years and others would apply to the 2010 and later plan years, Marshall added. Under a reasonable interpretation of the PPA, provisions for plan years before 2010 and after 2010 might be different because PPA regulations do not take effect until 2010, she said.

Amendments can always be improved, Marshall said. “Once you amend your plan, it starts the remedial amendment period, and once the amendment is in there, you can always fix it,” she said.

Practitioners and plan administrators have asked IRS about the extent to which employers can control the timing of a plan’s funding certification to delay or accelerate the effect of benefit restrictions, Marshall said. “We have significant concerns about that,” she said. “That’s an issue that we are going to be addressing in proposed regulations,” including whether that control would constitute impermissible employer discretion under tax code Section 411(d)(6) rules, she added.

Plan’s use of alternative benefit accrual tests did not violate vesting rules

November 17, 2009

A cash balance plan’s use of two alternative benefit accrual tests did not violate ERISA’s vesting rules, the U. S. Court of Appeals in New York City (CA-2) has ruled. In addition, the plan sponsor’s communication to participants of its intent to convert its traditional defined benefit plan into a cash balance plan did not violate the notice rules of ERISA §204(h).

Benefit accrual formula
To comply with the minimum benefit accrual rules, defined benefit plans (including cash balance plans) must satisfy one of three alternative tests set forth in ERISA §204(b)(1): the 133 1/3% test; the fractional test; or the 3% test.

In the so-called “career average” cash balance plan at issue, the benefit accrual formula made alternative use of both the 133 1/3% test and the fractional rule test. In situations where a participant’s rate of accrual would not satisfy the 133 1/3% test (which could occur due to fluctuating interest rates), the fractional test would come into play. The plan sponsor would make additional account deposits so that participant’s account would be brought into compliance with the fractional test upon termination of employment.

District court ruling
The district court found that the fractional test can never be used with respect to a career average cash balance plan. It also found the plan’s 204(h) notice to be deficient because it did not specify the benefit accrual formula the plan intended to use.

Use of fractional test
The appellate court began by noting that both the employer and the participants agreed that, contrary to the district court’s ruling, a fractional test may legally be applied to a cash balance plan without violating ERISA’s benefit accrual rules. The court went on to explain that the plan’s alternative use of the fractional test at the time of separation from employment also passes muster under both ERISA and Code. In fact, the court noted, the IRS provides an example of similar alternative test using the 133 1/3% rule and the fractional rule in Rev. 2008-7.

Adequate notice
The appellate court also concluded that the employer’s notice to participants of its intent to create the cash balance plan complied with ERISA §204(h) (as in effect prior to 2002 amendments). The notice clearly informed participants that the conversion could have the effect of reducing the rate of their future benefit accruals. Employers are not obligated to include a technical description of the benefit accrual formula in the 204 (h) notice.

ERISA Filing Acceptance System II (EFAST II)

November 5, 2009

Under Titles I and IV of ERISA, and the Internal Revenue Code, pension and other employee benefit plans are required to file annual returns/reports concerning the financial condition and operations of the plan. These requirements are generally satisfied by filing the Form 5500 Series.

EFAST2, an all-electronic system, is currently being developed to receive and display Forms 5500 and 5500-SF Annual Returns/Reports. The Form 5500-SF (Short Form) can be used by small plans (generally fewer than 100 participants) that meet certain other conditions. EFAST2 is scheduled to be available beginning January 2010.

Under the Department of Labor’s Final Rule on Annual Reporting and Disclosure, all Plan Year 2009 and later Form 5500 Annual Returns/Reports must be filed electronically. 2009 Short Plan year filers whose due date is before January 1, 2010, are granted an automatic 90-day extension from the date the EFAST2 system is available for filing, but may file on paper using the 2008 forms and schedules if filed on or before December 31, 2009. Late and amended Annual Returns/Reports for plan years before 2008 must be submitted electronically once the EFAST2 system is available for filing. Plan Year 2008 filings (including late and amended filings) can be submitted electronically using EFAST2 beginning on January 1, 2010, electronically using EFAST until June 30, 2010, or on paper until October 15, 2010; 2008 filers with late or amended filings after January 1, 2010 are encouraged to file electronically using EFAST2.

Under the all-electronic EFAST2, filers choose between using EFAST2-approved vendor software or the EFAST2 web-based filing system (IFILE) to prepare and submit the Form 5500 or Form 5500-SF. Completed forms are submitted via the Internet.

EFAST2 electronic credentials must be obtained to sign and/or submit the Form 5500 or Form 5500-SF, or to prepare a return/report in IFILE. EFAST2 electronic credentials can be obtained beginning in January 2010 by registering on the EFAST2 web site (

All filings that are received by the EFAST2 electronic filing system will be posted on the Department of Labor’s web site within 90 days of receipt to satisfy the Pension Protection Act requirement that the Department of Labor display certain information, including actuarial information (Schedule(s) MB or SB), contained in the plan's annual report. Actuarial information for 2008 filings will also be posted on the Department’s web site within 90 days of receipt, even if the filing is not received by EFAST2.

IRS issues final regs on benefit restrictions for underfunded plans, measurement of plan assets and liabilities

October 29, 2009

The IRS has issued final regulations under Code Secs. 430 and 436 regarding funding balances and benefit restrictions for underfunded plans, and the measurement of assets and liabilities for pension funding purposes in single-employer defined benefit plans. These regulations finalize the rules proposed in August 2007 and December 2007, with certain revisions. The final regulations apply to plan years beginning on or after January 1, 2010. For plan years beginning before January 1, 2010, plans may rely on the final regulations, or they may rely on the proposed regulations.

Determining funding target and target normal cost
The final regulations provides rules for determining the funding target and target normal cost for plans that are not in “at risk” status. Under the regulations, the target normal cost of a plan for the plan year is the present value (determined as of the valuation date)of all benefits under the plan that accrue during, are earned during, or are otherwise allocated to service for the plan year, subject to certain special adjustments as added by the Worker, Retiree, and Employer Recovery Act of 2009 (WRERA; P.L. 110-458). These special adjustments are optional for plan years beginning during 2008, but are required to be made for later plan years. Under the special adjustments, the target normal cost of the plan for the plan year is adjusted (not below zero) by adding the amount of plan-related expenses expected to be made during the plan year. For this purpose, the final regulations reserve the issue of the definition of plan-related expenses, which is expected to be addressed in forthcoming proposed regulations.

Effect of prefunding balance and funding standard carryover balance
The final regulations generally adopt the proposed rules relating to the application of prefunding and funding standard carryover balances under Code Sec. 430(f). Under the regulations, a plan sponsor is permitted to elect to maintain a prefunding balance for a plan. A prefunding balance maintained for a plan consists of a beginning balance of zero, increased by the amount of the excess contributions to the extent the employer elects to do so, and decreased (but not below zero) by the sum of, as of the first day of a plan year, any amount of the prefunding balance that was used to offset the minimum required contribution of the plan for the preceding plan year and any reduction in the prefunding balance for the plan year. The plan sponsor’s initial election to add to the prefunding balance constitutes an election to maintain a prefunding balance (so that no special election is necessary to establish a prefunding balance). The prefunding balance is adjusted further for actual investment return for the plan year.

The percent value of the excess contribution for the preceding plan year is the excess, if any, of the present value of the employer contributions (other than contributions to avoid or terminate Code Sec. 436 benefit limitations) to the plan for such preceding plan year over the minimum required contribution for such preceding plan year. In addition, a contribution for a plan year to correct an unpaid minimum required contribution for a prior plan year is not treated as part of the present value of excess contributions. This present value is increased with interest from the valuation date for the preceding plan year to the first day of the current plan year. The regulations provide that the plan’s effective interest rate for the preceding plan year is generally used to calculate the present value of the contributions for the preceding plan year and for adjusting the excess amount. Unlike the proposed regulations, the final regulations permit an excess contribution to be added to the prefunding balance for a plan year notwithstanding that the amount is an excess contribution solely because an election is made for the plan year to use the funding standard carryover balance or prefunding balance to offset minimum required contributions.

Valuation date and value of plan assets
Under the regulations, the determination of the plan funding target, target normal cost, and value of plan assets for a plan year is made as of the valuation date of the plan for that plan year. Except in the case of a small plan, the valuation date of the plan for any plan year is the first day of the plan year. The selection of a plan’s valuation date is part of the plan’s funding method and, accordingly, may only be changed with the consent of the IRS Commissioner. However, a change of plan’s valuation date that is required by Code. Sec 430 is treated as having been approved by the Commissioner and does not require the Commissioner’s prior specific approval.

Interest rates used to determine present value
The interest rates used in determining the present value of the benefits that are included in the target normal cost and the funding target for the plan are generally based on the 24-month moving averages of three separate segment rates for the month that includes the valuation date (which are determined based on the monthly corporate bond yield curves for the preceding 24 months). The regulations provide for elections that a plan sponsor can make to use alternative interest rates rather than the segment rates for the month that includes the valuation date.

The proposed regulations would have required plan sponsors to obtain approval for an election to use alternative interest rates. However, the final regulations do not require approval for the initial adoption of these elections for any year. Thus, for example, a plan sponsor that was using segment rates for the plan year beginning in 2010 can elect to switch to use the monthly corporate bond yield curve for the plan year beginning in 2011 and subsequent years without approval of the IRS Commissioner. However, once an election has been made, any subsequent change requires the approval of the Commissioner.

Plans in at-risk status
Significantly underfunded plans, referred to as “at-risk,” have special rules for determining funding targets. In general, regulations provide that a plan is in at-risk status for a plan year if the funding target attainment percentage (FTAP) for the preceding plan year is less than 80% (65%, 70%, and 75%, respectively, for a plan years beginning in 2008, 2009, and 2010), and the at-risk FTAP for the preceding plan year is less than 70%.

The at-risk rules do not apply to small plans, defined for this purpose as plans with 500 or fewer participants within the employer’s controlled group during the preceding plan year.

Unpredictable contingent event benefits
Code Sec. 436(b) sets forth a limitation on plant shutdown and other unpredictable contingent event benefits in situations where the plan’s adjusted funding target attainment percentage (AFTAP) for the plan year is less than 60%, or would be so, taking into account the benefits attributable to the unpredictable contingent event. The final regulations state that plans with such benefits must provide that they will not be paid to participants if the AFTAP for the plan year is less than 60%. However, the prohibition on payment will not apply during plan years where the employer makes a contribution, as specified in Code Sec. 436(b)(2), in addition to any minimum required contribution. The regulations note that if a plant shutdown or other event occurs during a plan year where unpredictable contingent event benefits are not subject to limitation, then benefits paid pursuant to that shutdown are permitted to be paid in a later plan year, even if the plan’s AFTAP for the subsequent year is less than 60%. Also, the regulations clarify that the limitations of Code Sec. 436(b) apply on participant-by-participant basis.

Limitations on plan amendments increasing plan liabilities
Code Sec. 436(c) provides that a plan amendment which increases plan liabilities by a benefit increase may not take effect if the plan’s AFTAP for the plan year is less than 80%, or would be less than 80% taking into account the amendment , unless the plan sponsor makes a specified contribution, in addition to any minimum required contribution. Under the regulations, the limitation on amendments increasing liabilities does not apply to any amendment that provides for an increase in benefits under a formula that is not based on a participant’s compensation, but if the rate of increase in benefits does not exceed the contemporaneous rate of increase in average wages of participants covered by the amendment.

Limitations on prohibited payments
Code Sec. 436(d)(1) provides that, if the plan’s AFTAP for a plan year is less than 60%, a participant or beneficiary is not permitted to elect an optional form of benefit that includes a prohibited payment, with an annuity starting date that is on or after the applicable measurement date. The final regulations clarify that, if participant requests a prohibited payment at a time when a form of payment cannot be made, the participant retains the right to delay commencement of benefits only if the right to delay commencement is in accordance with the terms of the plan and applicable qualification requirements.

Under Code Sec. 436(d)(3), if the plan’s AFTAP for a plan year is 60% or more but it is less than 80%, a participant or beneficiary is not permitted to elect the payment of an optional form of benefit that includes a prohibited payment, and the plan will not pay any prohibited payment, with annuity starting date that is on or after the applicable measurement date, unless the present value of the portion of the benefit that is being paid in a prohibited payment does not exceed the lesser of: (1) 50% of the present value of the benefit payable in the optional form of benefit that includes the prohibited payment; or (2) 100% of the PBGC maximum benefit guarantee amount.

Under the final regulations, the determination of the portion of the benefit that is a prohibited payment is made based on the applicable optional form of benefit. If the benefit is being paid in an optional form for which any of the payments is greater than the amount payable under a straight life annuity to the participant or beneficiary (plus any social security supplements) with the same annuity starting date, then the portion of the benefit that is being paid in a prohibited payment is the excess of each payment over the smallest payment during the participant’s lifetime under the optional form of benefit (treating a period during the participant’s lifetime in which no payments are made as a payment of zero). Like the proposed regulations, the final regulations require that, if an optional form of benefit that is otherwise available under the terms of the plan is not available as of the annuity starting date because of the application of the requirements of Code Sec. 436(d)(3), the plan must permit the participant or beneficiary to elect to bifurcate the benefit into unrestricted and restricted portions.

The regulations define the term “prohibited payment” under Code Sec. 436(d)(5) as any payment for a month that is in excess of the monthly amount paid under a single life annuity (plus any social security supplements) to a participant or beneficiary whose annuity starting date occurs during any period that a limitation on prohibited payments is in effect, as well as any payment for the purchase of an irrevocable commitment from an insurer to pay benefits. This includes any transfer of assets and liabilities to another plan maintained by the same employer (or by any member of the employer’s controlled group) that is made in order to avoid or terminate the application of the benefit limits of Code Sec. 436 and other payments identified as a prohibited payment in IRS guidance.

The regulations require plans to not pay any prohibited payment with an annuity starting date that is during a plan year in which the plan sponsor is a Chapter 11 bankrupt debtor, until such time as the plan’s enrolled actuary certifies that the plan’s AFTAP is not less than 100%.

Limits on benefit accruals
Under the regulations, a plan must provide that, in any case in which the plan’s AFTAP for a plan year is less than 60%, benefit accruals under the plan will cease as of the applicable measurement date, unless the plan sponsor makes an additional contribution as specified in Code Sec. 436(e)(2). Certain amendments made by WRERA are expected to be addressed in future proposed regulations.

Rules on contributions made to avoid benefit limitations
An employer sponsoring a plan that would otherwise be subject to the limitations of Code Sec. 436 can avoid the application of those limits by : (1) reducing the funding standard carryover balance and prefunding balance; (2) making additional contributions for a prior plan year that are not added to the prefunding balance; (3) making the specific contributions described in Code Sec. 436, or (4) providing security, as described in Code Sec. 436 (f) (1).

Underfunding presumptions
The regulations set forth a series of presumptions that are used to apply the Code Sec. 436 benefit limitations in situations where the plan’s enrolled actuary has not yet issued a certification of the plan’s AFTAP for the plan year and that describe the interaction of the application of those presumptions on plan operations with plan operations after the plan’s enrolled actuary has issued a certification of the plan’s AFTAP for the plan year. The rules in the final regulations have been revised from those in the proposed regulations.

IRS Announces Pension Plan Limitations for 2010

October 16, 2009

WASHINGTON — The Internal Revenue Service today announced cost-of-living adjustments applicable to dollar limitations for pension plans and other items for Tax Year 2010.

Section 415 of the Internal Revenue Code provides for dollar limitations on benefits and contributions under qualified retirement plans. Section 415(d) requires that the Commissioner annually adjust these limits for cost-of-living increases. Other limitations applicable to deferred compensation plans are also affected by these adjustments under Section 415. Under Section 415(d), the adjustments are to be made pursuant to adjustment procedures which are similar to those used to adjust benefit amounts under Section 215(i)(2)(A) of the Social Security Act.

The limitations that are adjusted by reference to Section 415(d) will remain unchanged for 2010. This is because the cost-of-living index for the quarter ended September 30, 2009, is less than the cost-of-living index for the quarter ended September 30, 2008, and, following the procedures under the Social Security Act for adjusting benefit amounts, any decline in the applicable index cannot result in a reduced limitation. For example, the limitation under Section 402(g)(1) on the exclusion for elective deferrals described in Section 402(g)(3) will be $16,500 for 2010, which is the same amount as for 2009. This limitation affects elective deferrals to Section 401(k) plans and to the Federal Government’s Thrift Savings Plan, among other plans.

Effective January 1, 2010, the limitation on the annual benefit under a defined benefit plan under Section 415(b)(1)(A) remains unchanged at $195,000. For participants who separated from service before January 1, 2010, the limitation for defined benefit plans under Section 415(b)(1)(B) is computed by multiplying the participant's compensation limitation, as adjusted through 2009, by 1.0000.

The limitation for defined contribution plans under Section 415(c)(1)(A) remains unchanged for 2010 at $49,000.

The Code provides that various other dollar amounts are to be adjusted at the same time and in the same manner as the dollar limitation of Section 415(b)(1)(A). After taking into account the applicable rounding rules, the amounts for 2010 are as follows:

The limitation under Section 402(g)(1) on the exclusion for elective deferrals described in Section 402(g)(3) remains unchanged at $16,500.

The annual compensation limit under Sections 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) remains unchanged at $245,000.

The dollar limitation under Section 416(i)(1)(A)(i) concerning the definition of key employee in a top-heavy plan remains unchanged at $160,000.

The dollar amount under Section 409(o)(1)(C)(ii) for determining the maximum account balance in an employee stock ownership plan subject to a 5-year distribution period remains unchanged at $985,000, while the dollar amount used to determine the lengthening of the 5-year distribution period remains unchanged at $195,000.

The limitation used in the definition of highly compensated employee under Section 414(q)(1)(B) remains unchanged at $110,000.

The dollar limitation under Section 414(v)(2)(B)(i) for catch-up contributions to an applicable employer plan other than a plan described in Section 401(k)(11) or Section 408(p) for individuals aged 50 or over remains unchanged at $5,500. The dollar limitation under Section 414(v)(2)(B)(ii) for catch-up contributions to an applicable employer plan described in Section 401(k)(11) or Section 408(p) for individuals aged 50 or over remains unchanged at $2,500.

The annual compensation limitation under Section 401(a)(17) for eligible participants in certain governmental plans that, under the plan as in effect on July 1, 1993, allowed cost-of-living adjustments to the compensation limitation under the plan under Section 401(a)(17) to be taken into account, remains unchanged at $360,000.

The compensation amount under Section 408(k)(2)(C) regarding simplified employee pensions (SEPs) remains unchanged at $550.

The limitation under Section 408(p)(2)(E) regarding SIMPLE retirement accounts remains unchanged at $11,500.

The limitation on deferrals under Section 457(e)(15) concerning deferred compensation plans of state and local governments and tax-exempt organizations remains unchanged at $16,500.

The compensation amounts under Section 1.61-21(f)(5)(i) of the Income Tax Regulations concerning the definition of “control employee” for fringe benefit valuation purposes remains unchanged at $95,000. The compensation amount under Section 1.61-21(f)(5)(iii) remains unchanged at $195,000.

The Code also provides that several pension-related amounts are to be adjusted using the cost-of-living adjustment under Section 1(f)(3). After taking the applicable rounding rules into account, the amounts for 2010 are as follows:

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for married taxpayers filing a joint return is increased from $33,000 to $33,500; the limitation under Section 25B(b)(1)(B) remains unchanged at $36,000; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), remains unchanged at $55,500.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for taxpayers filing as head of household is increased from $24,750 to $25,125; the limitation under Section 25B(b)(1)(B) remains unchanged at $27,000; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), remains unchanged at $41,625.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for all other taxpayers is increased from $16,500 to $16,750; the limitation under Section 25B(b)(1)(B) remains unchanged at $18,000; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), remains unchanged at $27,750.

The deductible amount under § 219(b)(5)(A) for an individual making qualified retirement contributions remains unchanged at $5,000.

The applicable dollar amount under Section 219(g)(3)(B)(i) for determining the deductible amount of an IRA contribution for taxpayers who are active participants filing a joint return or as a qualifying widow(er) remains unchanged at $89,000. The applicable dollar amount under Section 219(g)(3)(B)(ii) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $55,000 to $56,000. The applicable dollar amount under Section 219(g)(7)(A) for a taxpayer who is not an active participant but whose spouse is an active participant is increased from $166,000 to $167,000.

The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(I) for determining the maximum Roth IRA contribution for married taxpayers filing a joint return or for taxpayers filing as a qualifying widow(er) is increased from $166,000 to $167,000. The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(II) for all other taxpayers (other than married taxpayers filing separate returns) remains unchanged at $105,000.

Change is coming… and it is fast and furious!

October 15, 2009

The White House issued a White Paper calling for a fiduciary standard for all advisers – both broker-dealers and RIAs – who give investment advice to any retail investors, which would include most retirement plans. Then, the Administration followed up with proposed legislation to accomplish that purpose. Congressman Barney Frank and the Committee on Financial Services, which he chairs, are at work on that legislation.

At some time, the House Education and Labor Committee approved an updated version of the investment advice bill which would restrict investment advice – to both plans and participants – to one of two arrangements. The first is the level-fee arrangement and, in a significant change, only RIAs would qualify to be level-fee advisers. That effectively cuts out broker-dealers and benefits brokers. The second alternative is computer model advice, which could be used by RIAs, broker-dealers and insurance companies. However, even for the computer model alternative, benefits brokers and banks and trust companies are excluded.

That bill has been assigned to the House Ways and Means Committee for its review. It is possible – perhaps even likely – that the Ways and Means Committee will expand the bill from just ERISA plans to include non-ERISA 403(b)s, IRAs and 457 plans.

At the same time, the DOL and SEC have held joint hearings on target date funds – largely because of the remarkable losses suffered by 2010 funds in the market meltdown of 2008. It was shocking to many politicians and regulators that a mutual fund that was represented as being appropriate for investors and participants approaching their retirement could lose 25% to 30% in one year. The hearing was held jointly by the agencies on June 18th. Testimony was given and comments were submitted, but the outcome is still unknown.

The moral of the story to advisers is that target date funds are no longer immune from the requirement for a rigorous selection and monitoring process. In other words, target date funds no longer are entitled to a “free pass” just because the provider requires that its target date funds be used in connection with its recordkeeping system.

Some people are speculating that we are reaching a tipping point with target date funds where providers will be required, by the competitive marketplace, to include more than one on their recordkeeping platforms.

Courtesy of Reish & Reicher

The DB(k): Pension of the Future

October 13, 2009

An attractive new option for employer sponsored retirement plans becomes available next year. The “DB(k)” offers businesses with 500 or fewer employees an opportunity to provide a strong retirement plan for their employees with fewer hassles and less financial drain than a traditional pension plan. The DB(k) melds a 401(k) savings plan with a small guaranteed income stream. The key elements of the plan:

  • A defined benefit equal to 1%of final average pay for each year of the employee’s service, up to 20 years.
  • An automatic enrollment feature for the 401(k) portion. Unless an employee specifically opts out or changes the contribution level, 4% of pay is automatically shunted into 401(k) savings.
  • An employer match of at least 50% of employee 401(k) contributions, with a maximum required match of 2% of pay.

To induce employers to participate: The DB(k) is exempt from “top-heavy” rules, which are used to ensure that a company’s retirement plans are not unfairly skewed toward high paid workers. In addition, the paperwork burden is much lighter for a DB(k) plan than if a company operates separate pension and 401(k)plans. With the DB(k), a company need have only one plan document and file one Form 5500 – the annual information return for benefit plans – even though it is essentially operating two plans.

The DB(k), authorized by Congress as part of the 2006 Pension Protection Act, is designed to repair a flaw in the current retirement system. The 401(k), originally conceived as supplement to employer paid pensions, has become many people’s primary source of retirement income. But even before the stock market slide of late 2008 and early 2009, there were fears that, for many workers, voluntary savings would prove woefully inadequate in retirement. Indeed, for a majority of workers with no pension plan, the lump sum 401(k) distribution they receive at retirement, even if managed well, may not last. So Washington policymakers set out to encourage a comeback in pensions, albeit much smaller pensions that in the past. The much more limited size is intended to ensure that employers won’t find their plan in need of considerable funds, as so many pension plan sponsors have in the past several years.

While the economy continues to struggle, interest in DB(k)s will be light. With an unemployment rate soaring toward 10%, there will be no swell of companies rushing to adopt DB(k)s come Jan.1, 2010, when the gate opens. But we expect the concept to pick up steam as the economy strengthens and competition for good workers again becomes keen. Indeed, there is already discussion among pension industry officials about pushing Congress to make DB(k)s available to larger companies, too.

IRS Notice 2009-71

The IRS has issued IRS Notice 2009-71 requesting comments on guidance that it plans to issue relating to eligible combined plans under Code Sec. 414(x). An eligible combined plan (also referred to as a DB-K plan) provides a vehicle through which an employer can maintain both a defined benefit plan and a defined contribution plan (which may include a 401(k) plan) on a combined basis, thus reducing the administrative burden and cost of maintaining separate plans.

Code Sec. 414(x), which establishes DB-K plans, was added by the Pension Protection Act of 2006 (P.L. 109-280) and was amended by the Worker, Retiree, and Employer Recovery Act of 2008 (P.L. 110-458). A DB-K plan must be sponsored by a small employer with at least two employees and no more than 500 employees and must meet certain benefit, contribution, vesting, and nondiscrimination requirements. The defined benefit plan portion must provide a minimum benefit equal to the lesser of 1% of final average pay times years of service or 20% of final average pay. The defined contribution plan portion must utilize a qualified cash or deferred arrangement that contains a 4% of pay automatic contribution arrangement. The basic match contribution, under Code Sec. 414(x)(2)(C)(i)(II), is 50% of a participant's elective deferrals up to a maximum of 4% of pay.

The DB-K plan rules under Code Sec. 414(x) are effective for plan years beginning after December 31, 2009. The upcoming guidance under consideration in the IRS notice would be prospective. Written comments regarding possible issues to be addressed in guidance under Code Sec. 414(x) should be submitted by October 15, 2009.


October 8, 2009

The IRS has released Treasury Decision 9467. This document contains final regulations providing guidance regarding the determination of the value of plan assets and benefit liabilities for purposes of the funding requirements that apply to single employer defined benefit plans, regarding the use of certain funding balances maintained for those plans, and regarding benefit restrictions for certain underfunded defined benefit pension plans. These regulations reflect provisions added by PPA, as amended by WRERA.

Complete text of Treasury Decision 9467 can be found at:
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