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expand-collapse sectionRetirement Savings/401(k) Plans Overview
What do employers need to consider regarding retirement savings and 401(k) plans? One of the most popular and widely offered retirement plan options is the cash or deferred arrangement (CODA), commonly known as a 401(k) plan, after the section of the Internal Revenue Code (IRC) that authorizes them. A CODA is a special type of defined contribution plan under which an eligible employee can elect to have the employer defer part of his or her salary and contribute the deferred amount to the plan or receive the full amount of the salary as cash. If an employee chooses to defer compensation, it is not subject to income taxation until it is withdrawn from the plan.
The advent of the 401(k) plan began a major shift in the way Americans plan and save for retirement. The days of relying on traditional employer-provided pension plans as the primary source of retirement income are fast becoming extinct. In their place are 401(k) plans in which employees can save for retirement on a pretax basis, and employers can better control their retirement costs because there are no minimum funding levels or guaranteed retirement benefits.
Other employer-sponsored retirement plans that are similar to but simpler to administer than 401(k) plans include simplified employee pensions (SEPs) and SIMPLE plans. These plans have specified minimum requirements and offer less design flexibility in return for simple administration. Additionally, educational institutions and nonprofit organizations may provide 403(b) plans for their employees. Government employers may sponsor 457 plans. These plans have many of the same features and restrictions as 401(k) plans.
Despite the growing predominance of 401(k) and other defined contribution retirement plans, some employers still have defined benefit pension plans. In 2006, the Pension Protection Act (PPA) imposed new funding and disclosure requirements for these plans. PPA’s funding provisions, including minimum contributions and potential excise tax sanctions, were implemented by the Internal Revenue Service (IRS) in 2015 final rules.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted as part of a December 2019 appropriations bill, made many changes to the retirement plan requirements. These include:
• Pushing back the starting age of required minimum distributions (RMDs) from 701/2 to 72, for participants who turn 701/2 in 2020 or later;
• “Lifetime income” disclosure provisions requiring plan sponsors to quantify the payments a defined contribution (401(k) or 403(b)) plan would yield if structured as a lifetime annuity, and a fiduciary safe harbor for plan sponsors that actually offer such an annuity;
• An option for plans to allow a distribution of up to $5,000 within 1 year after a child is born to, or adopted by, the plan participant;
• Changes to the notice and contribution requirements for “safe harbor” 401(k) plans;
• A requirement that certain “long-term part-time employees” be allowed to participate, for plan years beginning in 2021 and thereafter; and
• Beginning in 2021, a new type of arrangement called the “pooled employer plan” that unrelated small employers can sponsor jointly.
CARES Act Provisions
The Coronavirus Aid, Relief, and Economic Security (CARES) Act included certain amendments to retirement plan rules to help plan sponsors and participants cope with the fallout from the COVID-19 crisis.
Plan loans. The CARES Act temporarily increases the maximum permissible plan loan amount from $50,000 to $100,000 and the maximum percentage of the vested account balance from 50 percent to 100 percent. These provisions expire September 23, 2020. For any previously outstanding loans due in 2020, the act provides a 1-year payment extension.
Distributions. The act also allows a “coronavirus-related distribution” of up to $100,000 without the usual early withdrawal penalty by someone:
• Who was diagnosed with the virus;
• Whose spouse or dependent was diagnosed; or
• Who has adverse financial consequences due to being quarantined, furloughed, or laid off; having reduced hours; or being unable to work due to lack of child care.
Small business owners whose business closed or had reduced hours due to COVID-19 are also eligible.
These distributed funds can be put back into the account within 3 years of the date the distribution was received, and the income tax on the distribution can be spread over 3 years as well.
For individuals of retirement age who don’t currently need the funds, the CARES Act waives the usual required minimum distributions (RMDs) for 2020. This applies to anyone required to take an RMD, without the need to show any specific impact from COVID-19.
Plan amendments. Even if a current plan document doesn’t allow for these distributions or loans, plan sponsors can adopt the distribution and loan provisions effective immediately. The plan would need to be formally amended before the end of the first plan year beginning after January 1, 2022.
Defined benefit plans. Sponsors of single-employer defined benefit plans may defer minimum required contributions until the end of 2020. The CARES Act also includes certain relief from meeting funding targets during 2020.
expand-collapse section401(k) Plan Requirements
Because 401(k) plans are tax-qualified defined contribution plans that include a CODA, they must satisfy all of the requirements for qualified plans, the special requirements of IRC Sec. 401(k), and all the Employee Retirement Income Security Act (ERISA) requirements that apply to defined contribution plans, including minimum participation and vesting standards, fiduciary rules, and reporting and disclosure requirements. Many special rules apply to 401(k) plans, including special vesting and nondiscrimination testing requirements. In addition, the rules on plan loans and blackout periods, while they impact other types of retirement plans, most often affect the design and administration of 401(k) plans. Please see the national ERISA, national Benefits Recordkeeping and Disclosures sections.
Design Considerations
While many 401(k) plans only include a CODA, they often also provide for employer-matching contributions and discretionary employer contributions. Many CODAs are part of a larger defined contribution plan that may include a profit-sharing component. For some employers, a 401(k) plan is part of a retirement package that may include a defined benefit plan or a hybrid plan.
Matching contributions. Perhaps the most crucial design consideration for a 401(k) plan sponsor is whether and how to provide matching contributions. Matching contributions are the best way to encourage employees to participate in a 401(k) plan. A 100 percent match is a large incentive to participation but is also expensive. Common match formulas are 50 percent of employee contributions up to the first 6 percent of compensation and no match on the portion of the contribution that exceeds 6 percent of compensation.
Contributions of unused paid time off. The IRS has ruled that a 401(k) plan may permit contributions of payments employees would receive for unused vacation or other similar leave at the end of the year or at termination of employment, whether the contributions are employer contributions or elective 401(k) contributions (Rev. Rul. 2009-31 and Rev. Rul. 2009-32). The 401(k) nondiscrimination tests must still be passed, and the contributions may not exceed any applicable limits, including the limit on total contributions to an individual's account during a year. In addition, a plan participant does not include in gross income the dollar equivalent of unused paid time off that is not contributed to the 401(k) plan until the year in which the amount is paid to the participant.
Contribution Limits
The IRS provides for dollar limitations on benefits and contributions under qualified retirement plans, including 401(k) plans. These limits are adjusted annually for cost-of-living increases. For current limits on an employee’s elective deferrals to a 401(k) plan, visit http://www.irs.gov. A plan may provide for the employer to match all, part, or none of an employee's deferrals.
Accelerated Vesting
Employer contributions to defined benefit plans, including matching contributions to 401(k) plans, must vest either 100 percent after 3 years of service or 20 percent per year of service beginning after the second year and reaching 100 percent after 6 years.
SEP and SIMPLE individual retirement account (IRA) (and other IRA-based) plans require that all contributions to the plan are always 100 percent vested.
Requirement for Deposit of Employee Contributions
Because ERISA's fiduciary rules bar employers from using plan assets for their own benefit, the Department of Labor (DOL) has issued regulations that define when employees' contributions to a benefit plan become plan assets, must no longer be in the employer's possession, and must be deposited into a plan account. This is the number one fiduciary trouble spot. Late deposits are an invitation for an audit by the DOL.
In general, amounts that a participant had withheld from his or her wages by an employer for contribution to an ERISA plan are deemed to be plan assets on the earliest date on which such contributions can reasonably be segregated from the employer's general assets. However, in no case may pension benefit plan and welfare benefit plan deposits of employee contributions be made later than the 15th business day of the month following the month in which such amounts would otherwise have been payable to the participant in cash. This rule also applies to SIMPLE IRAs and salary reduction SEPs.
Warning: The DOL's rule of thumb is that small plans sponsored by an employer with a simple payroll process should be able to make deposits of employee contributions within 7 days. Large plans, which may have multiple locations and multiple paydays, should be able to make deposits within 10 to 14 days, in the DOL's view. The deposit timing rules apply to withholding for plan loan repayments as well as employee contributions.
Small employer safe harbor. The DOL regulations create a safe harbor for plans with fewer than 100 participants if deposits of employee contributions are made within 7 business days of receipt or withholding. Thus, if such plans make their deposits within 7 business days, the deposit is deemed to be on time without having to determine when they reasonably could be segregated. To qualify for the safe harbor, loan repayments must also be deposited within 7 business days. Participant contributions are considered deposited when placed in an account of the plan, without regard to whether the contributed amounts have been allocated to specific participants or investments. The safe harbor also applies to SIMPLE IRAs and salary reduction SEPs.
Restrictions on 401(k) Distributions
Generally, distributions from a 401(k) plan cannot be made until a distributable event occurs. A “distributable event” is an event that allows distribution of a participant’s plan benefit and includes the following situations:
• The employee dies, becomes disabled, or otherwise has a severance from employment.
• The plan is terminated and no other defined contribution plan is established or continued.
• The employee reaches the age of 591/2 or suffers a financial hardship.
Tax on early distributions. If a distribution is made to an employee before he or she reaches the age of 591/2, the employee may have to pay a 10 percent additional tax on the distribution. This tax applies to the amount received that the employee must include in income. The 10 percent tax does not apply to distributions before the age of 591/2 if the distribution is:
• Made to a beneficiary (or to the estate of the employee) on or after the death of the employee
• Made due to the employee having a qualifying disability
• Made as part of a series of substantially equal periodic payments beginning after separation from service and made at least annually for the life or life expectancy of the employee or the joint lives or life expectancies of the employee and his or her designated beneficiary (The payments under this exception, except in the case of death or disability, must continue for at least 5 years or until the employee reaches age 591/2, whichever is the longer period.)
• Made to an employee after separation from service if the separation occurred during or after the calendar year in which the employee reached the age of 55
• Made to an alternate payee under a qualified domestic relations order (QDRO)
• Made to an employee for medical care up to the amount allowable as a medical expense deduction (determined without regard to whether the employee itemizes deductions)
• Timely made to reduce excess contributions under a 401(k) plan
• Timely made to reduce excess employee or matching employer contributions (excess aggregate contributions)
• Timely made to reduce excess elective deferrals
• Made because of an IRS levy on the plan
• Made as a qualified reservist distribution
Distribution starting requirements. Benefit payment must begin when required. Unless the participant chooses otherwise, the payment of benefits to the participant must begin within 60 days after the close of the latest of the following periods:
• The plan year in which the participant reaches the earlier of age 65 or the normal retirement age specified in the plan
• The plan year that includes the 10th anniversary of the year in which the participant began participating in the plan
• The plan year in which the participant terminates service with the employer
Minimum distribution requirements. A 401(k) plan must provide that each participant will either:
• Receive his or her entire interest (benefits) in the plan by the required beginning date (defined below), or
• Begin receiving regular periodic distributions by the required beginning date in annual amounts calculated to distribute the participant's entire interest (benefits) over his or her life expectancy or over the joint life expectancy of the participant and the designated beneficiary (or over a shorter period).
These required distribution rules apply individually to each qualified plan. The required distribution from a 401(k) plan cannot be satisfied by making a distribution from another plan. The plan document must provide that these rules override any inconsistent distribution options previously offered. When the participant’s account balance is to be distributed, the plan administrator must determine the minimum amount required to be distributed to the participant each calendar year.
The required beginning date for distributions is April 1 of the first year after the later of:
• The calendar year in which the participant reaches the age of 72, or
• The calendar year in which the participant retires.
The SECURE Act raised this age to 72 from 701/2. The change takes effect for individuals who turn 701/2 on or after January 1, 2020.
A plan may require that the participant begin receiving distributions by April 1 of the year after the participant reaches the age of 72, even if the participant has not retired.
If the participant is a 5 percent owner of the employer maintaining the plan, the participant must begin receiving distributions by April 1 of the first year after the calendar year in which the participant reaches the age of 72.
Distributions after the starting year. The distribution required to be made by April 1 is treated as a distribution for the starting year. (The starting year is the year in which the participant reaches the age of 72 or retires, whichever applies, to determine the participant’s required beginning date.) After the starting year, the participant must receive the required distribution for each year by December 31 of that year. If no distribution is made in the starting year, required distributions for 2 years must be made in the next year (one by April 1 and one by December 31).
Hardship Distributions
The IRS regulations set out the requirements for hardship distributions from a 401(k) plan. The plan must specifically permit such a distribution. In addition, a distribution qualifies as a hardship distribution only if it is both (1) made because of an immediate and heavy financial need of the employee and (2) is necessary to satisfy the financial need. The determination of the existence of an immediate and heavy financial need and of the amount necessary to meet the need must be made in accordance with nondiscriminatory and objective standards set forth in the plan and must be made separately. The maximum amount of a hardship distributable amount is an employee’s total elective contributions as of the date of distribution, reduced by the amount of previous distributions of elective contributions.
Determination of an immediate and heavy financial need. Whether an employee has an immediate and heavy financial need is to be determined based on all the relevant facts and circumstances. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee. A distribution is deemed to be due to an immediate and heavy financial need of the employee if the distribution is for:
• Medical care expenses of the employee, the employee's spouse, dependents, or a primary beneficiary under the plan
• The purchase of a principal residence for the employee (excluding mortgage payments)
• Tuition, related educational fees, and room and board expenses for up to the next 12 months of postsecondary education for the employee, the employee’s spouse, children, dependents, or a primary beneficiary under the plan
• Preventing eviction from or foreclosure of the mortgage on the employee’s principal residence
• Burial or funeral expenses for the employee’s deceased parent, spouse, children, dependents, or a primary beneficiary under the plan
• Repairing damage to the employee’s principal residence that could qualify for the casualty deduction on the employee's federal income tax return
Under the Tax Cuts and Jobs Act of 2017, this last circumstance is now limited to home repairs that result from presidentially declared disasters.
A “primary beneficiary under the plan” is an individual who is named as a beneficiary under the plan and has an unconditional right to all or a portion of the participant’s account balance under the plan upon the death of the participant.
For circumstances that do not fall under one of the six safe harbors listed above, regulations proposed on November 14, 2018 (83 Fed. Reg. 56763), replace the “all relevant facts and circumstances” test with a three-part standard:
1. The hardship distribution must not exceed the amount of an employee’s need, including any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution.
2. The employee already must have obtained all other currently available distributions and nontaxable loans under the plan and all other plans maintained by the employer.
3. The employee must represent that he or she has insufficient cash or other liquid assets to satisfy the financial need. Consistent with the current standard, a plan administrator will be allowed to rely on a participant’s representation of the need unless the plan administrator has actual knowledge to the contrary.
403(b) and 457 plans. The hardship distribution rules also apply to 403(b) and 457 plans.
Birth or adoption. Beginning in 2020, a plan may allow a distribution of up to $5,000 within 1 year after a child is born to, or adopted by, the plan participant.
COVID-19. The CARES Act allows special distributions in 2020 for hardships related to COVID-19 (see “CARES Act Provisions,” above).
Withdrawals for Individuals Called to Active Military Duty
There is an exemption from the 10 percent early withdrawal penalty for individuals ordered or called to active duty. A "qualified reservist distribution" is a distribution that is:
• Made from an IRA or attributable to elective deferrals under a 401(k) plan, 403(b) annuity, or certain similar arrangements;
• Made to an individual who was ordered or called to active military duty for a period in excess of 179 days or for an indefinite period; and
• Made during the period beginning on the date of such order or call to duty and ending at the close of the active duty period.
A 401(k) plan does not violate the distribution restrictions if it makes a qualified reservist distribution.
An individual who receives a qualified reservist distribution may, during the 2 years following the end of his or her active duty, make one or more contributions to an IRA of the amount of such distribution.
401(k) Plan Loans
One of the most popular features of 401(k) plans is a provision allowing participants to borrow money from their own accounts. Under the DOL regulations, the loan must be available to all participants and beneficiaries on a reasonably equivalent basis, must not be available to highly paid employees in an amount greater than available to other employees, must be specifically provided for in the plan document, must bear a reasonable interest rate, and must be adequately secured. The loan may be secured by the participant's account balance. A loan secured by 50 percent of the account balance is considered adequately secured. A loan is not treated as a distribution by the IRS (resulting in income tax consequences) if it meets at least the following specific requirements:
• The loan plus the participant's other outstanding loans from the plan may not exceed $50,000.
• The outstanding balance of loans may not exceed the greater of one-half of the participant's vested benefits.
• Unless the proceeds are used to purchase a principal residence, the loan must be paid back in 5 years or less.
• The loan must be paid back in equal payments made at least four times per year.
• The loan is evidenced by an enforceable agreement.
Note: The Sarbanes-Oxley Act Sec. 402 prohibits publicly held companies from making personal loans to their directors and executive officers. This arguably includes 401(k) loans. In view of the steep penalties that may be imposed for violating Sarbanes-Oxley, a very conservative approach would be to advise executive officers not to make new 401(k) loans or amend 401(k) plans to bar loans to executive officers. The DOL indicated in Field Assistance Bulletin 2003-1 that restrictions on loans to all officers and directors do not violate participant loan rules under ERISA.
Restrictions on Cash-Outs
Employers may not force an employee whose accrued vested benefit is worth more than $5,000 to take a distribution of benefits when the employee terminates employment. The employer must allow the employee to keep the money in the plan until retirement age. Plans may require that terminating employees with accrued vested benefits of less than $5,000 take a cash-out, thus reducing the administrative cost of maintaining small accounts and keeping track of former employees.
Required Rollovers
Employer-mandated cash-outs of more than $1,000 from a qualified retirement plan must be paid as a direct rollover to an IRA setup by the employer for the employee unless the terminating employee elects to have the amount rolled over to another retirement plan or IRA or to receive the distribution directly. In circumstances in which a portion of the distribution is attributable to a previous rollover contribution, the rollover requirement may apply to distributions of more than $5,000. The portion of the account attributable to the previous rollover is not counted for the determination of whether the present value of the accrued vested benefit is $5,000 or less. On the other hand, the amount attributable to the previous rollover is counted when determining if the cash-out exceeds $1,000.
Plans that provide for mandatory distributions have to include a provision reflecting the automatic rollover requirements.
The plan administrator must notify the distributee in writing that the distribution may be paid in a direct rollover to an IRA. The notice may be mailed to the participant's most recent mailing address in the records of the employer or plan administrator. This notice may also be distributed electronically.
The automatic rollover provisions apply to governmental plans, including deferred compensation plans under IRC Sec. 457, to 403(b) plans, and to church plans.
The DOL regulations provide for a safe harbor to protect retirement plan fiduciaries from liability when they select an institution to provide the IRAs and select the investments for these accounts. For the safe harbor to apply, the selected IRA provider must be qualified to offer individual retirement plans; the investment options must be designed to preserve principal; and the fees and expenses may not exceed those charged by the selected provider to its other IRA customers.
Avoiding the rollover requirement. Many employers are avoiding the complications of required rollovers by not cashing out accounts with a balance of more than $1,000.
401(k) Nondiscrimination Rules
Special nondiscrimination rules apply to 401(k) plans in addition to all the regular requirements for tax-favored retirement plans. These rules are designed to prevent discrimination in elective contributions, matching contributions, and employee after-tax contributions. These rules, the actual deferral percentage (ADP) test and the actual contribution percentage (ACP) test, are also very complex and discourage many employers from adopting a 401(k) plan. Under the ADP test, the ADP for eligible highly compensated employees (HCEs) must either:
• Not be more than 125 percent of the ADP for nonhighly compensated employees (NHCE); or
• Not more than 2 percentage points greater than that of the NHCE and not be more than 200 percent of that of the NHCE.
The ACP applies similar formulas to the sum of employee contributions and employer-matching contributions. If a plan is going to fail the ACP or ADP tests, corrections must be made that often involve reducing the deferrals of HCEs.
The IRS's final 401(k) regulations include a provision designed to prevent plans from circumventing the nondiscrimination rules. Under this antiabuse provision, a plan will not be treated as satisfying the nondiscrimination requirements if there are repeated changes to plan testing procedures or plan provisions that have the effect of distorting the ADP so as to increase significantly the permitted ADP for HCEs. In addition, plans are barred from otherwise manipulating the nondiscrimination rules if a principal purpose of the changes was to increase or distort the ADP for HCEs.
ADP/ACP safe harbors. 401(k) plans will generally be eligible for a safe harbor that may automatically satisfy the nondiscrimination requirements if they are designed to meet either of the following criteria:
• Provide guaranteed, 100 percent vested contributions of at least 3 percent of compensation for each NHCE who is eligible to participate; or
• Provide a 100 percent vested matching contribution on all of each non-HCE's elective contributions up to 3 percent of compensation and on 50 percent of the elective contribution that is between 3 percent and 5 percent of compensation.
401(k) plans, however, are required to specify the method they will use to satisfy the nondiscrimination requirements in their plan documents. Thus, a safe harbor plan may not specify that ADP testing will be used if the safe harbor requirements are not satisfied.
In addition, 401(k) safe harbor plans must provide each eligible employee with a written notice of the employee’s rights and obligations under the plan. This notice may be provided electronically. The notice must be sufficiently accurate and comprehensive to inform employees of the their rights and obligations under the plan, be written in a manner calculated to be understood by the average employee eligible to participate in the plan, and contain the following information:
• The safe harbor contribution formula used under the plan (including a description of the levels of safe harbor matching contributions, if any, available under the plan)
• Any other contributions under the plan or matching contributions to another plan on account of elective contributions or employee contributions under the plan (including the potential for discretionary matching contributions) and the conditions under which such contributions are made
• The plan to which safe harbor contributions will be made (if different than the plan containing the cash or deferred arrangement)
• The type and amount of compensation that may be deferred under the plan
• How to make cash or deferred elections, including any administrative requirements that apply to such elections
• The periods available under the plan for making cash or deferred elections
• Withdrawal and vesting provisions applicable to contributions under the plan
• Information that makes it easy to obtain additional information about the plan (including an additional copy of the summary plan description) such as telephone numbers, addresses and, if applicable, electronic addresses of individuals or offices from whom employees can obtain such plan information
A plan may satisfy the requirements to provide information about other contributions or matching contributions to another plan, the plan to which safe harbor contributions will be made, or the type and amount of compensation that may be deferred under the plan by providing cross-references to the relevant portions of a summary plan description that provides the same information and has been provided (or is concurrently provided) to employees.
The notice must be provided within a reasonable period before the beginning of the plan year (or within a reasonable period before an employee becomes eligible). This requirement is deemed satisfied if the notice is provided at least 30 days and no more than 90 days before the beginning of each plan year. For newly eligible employees, who become eligible after the 90th day before the beginning of the plan year, the notice must be provided no more than 90 days before the employee becomes eligible and no later than the date the employee becomes eligible.
Beginning in 2020, the annual notice is only required for matching contribution safe harbor plans (not nonelective contribution plans).
A 401(k) safe harbor plan must generally be adopted before the beginning of the plan year and be maintained throughout a full 12-month plan year. The IRS's 401(k) regulations also make it easy for employers to implement safe harbor plans by allowing plan sponsors to wait until 30 days before the end of the plan year to adopt a 3 percent automatic contribution feature. The plan must specify that it will use NHCEs' current year ADPs in the event that the sponsor decides not to utilize the safe harbor. A contingent notice must be given 30 to 90 days before the beginning of the plan year indicating that safe harbor nonelective contributions may be made. A follow-up notice must be provided at least 30 days before the end of the plan year stating that safe harbor contributions will be made. Plans are not required to continue using that feature in the following year and are not limited on the number of times that they may switch back and forth.
Although safe harbor 401(k) plans provide generous benefits, they are also attractive because they greatly simplify plan administration and eliminate the possible need for HCEs to take back a portion of their elective deferrals to satisfy nondiscrimination requirements.
Note: One of the drawbacks to adopting a safe harbor plan has been the rapid vesting of the mandatory employer contributions. With the gap between safe harbor vesting and non-safe harbor vesting narrowed by the minimum vesting requirements for matching contributions to 401(k) plans, the cost increase of adopting a safe harbor plan is diminished, especially for employers that already provide a “3 percent of” compensation match. In addition, while lower-paid employees are not likely to take advantage of the increased contribution limits because they generally make contributions that are well below the current limits, higher-paid employees are going to want to take advantage of the increased limits. This will make it more difficult for plans to pass the ADP and ACP tests. Utilizing a safe harbor may not be too much of an expense, especially when it keeps key employees happy, because they can maximize their 401(k) contributions and reduce the time and expense of performing the antidiscrimination tests and correcting any excess contributions.
Suspending nonelective contributions to safe harbor plans due to business hardship. The IRS’s final regulations allow employers to reduce or suspend safe harbor contributions (nonelective or matching) in the event of financial hardship. Safe harbor matching contributions may be reduced or suspended under a midyear amendment only if the employer is operating at an economic loss, or if the notice provided to participants before the beginning of the plan year discloses that the contributions might be reduced or suspended midyear, that participants will receive a supplemental notice if that occurs, and that the reduction or suspension will not apply until at least 30 days after the supplemental notice is provided. Additionally:
• All eligible employees must be provided a supplemental notice of the reduction or suspension when it occurs;
• The reduction or suspension of safe harbor nonelective contributions can be effective no earlier than the later of 30 days after eligible employees are provided the supplemental notice or the date the amendment is adopted;
• Eligible employees must be given a reasonable opportunity (including a reasonable period after receipt of the supplemental notice) before the reduction or suspension of the safe harbor nonelective contributions to change their contribution elections; and
• The plan must be amended to provide that the ADP test (and/or ACP test) will be satisfied for the entire plan year in which the reduction or suspension occurs, using the current year testing method.
The supplemental notice requirement is satisfied if each eligible employee is given a notice that explains:
• The consequences of the amendment reducing or suspending employer contributions;
• The procedures for changing deferred or posttax contribution elections; and
• The effective date of the plan amendment.
401(k) Blackout Periods
The Sarbanes-Oxley Act requires prior notices of 401(k) blackout periods and bars directors and executives from trading employer stock during blackout periods.
Blackout period definition. A "blackout period" is any period of more than 3 consecutive business days during which the ability of participants or beneficiaries under an individual account plan to direct or diversify assets credited to their accounts, to obtain loans from the plan, or to obtain distributions from the plan is temporarily suspended, limited, or restricted. A blackout period does not include a suspension, limitation, or restriction that:
• Occurs because of the application of the securities laws
• Is regularly scheduled under the plan and that has been disclosed to affected plan participants and beneficiaries through an official plan document
• Occurs because of a qualified domestic relations order or because of a pending determination whether a domestic relations order filed (or reasonably anticipated to be filed) with the plan is a qualified order
• Occurs by reason of an act or a failure to act on the part of an individual participant or by reason of an action or claim by a party unrelated to the plan involving the account of an individual
Blackout notice requirements. At least 30 days before a blackout period, the plan administrator is required to provide a notice to affected plan participants and beneficiaries written in simple language. A similar notice must be provided at the same time to issuers of employer securities. The DOL regulations include a model notice that may be used.
Blackout notice contents. The notice must contain the following information:
• The reasons for the blackout period
• An identification of the rights otherwise available under the plan that will be temporarily suspended, limited, or restricted
• The length of the blackout period by reference to the expected beginning and ending dates or the expected beginning or ending calendar weeks, provided that during such weeks, information about whether the blackout period has begun or ended is readily available without charge, such as via a toll-free number or access to a specific website, to affected participants and beneficiaries
• A description of how to access the blackout period information
• A statement that the participant or beneficiary should evaluate the appropriateness of their current investment decisions in light of their inability to direct or diversify assets credited to their accounts during the blackout period
• The name, address, and telephone number of the plan administrator or other contact responsible for answering questions about the blackout period
Blackout notice timing. The notice must be furnished to all affected participants and beneficiaries at least 30 days, but not more than 60 days, in advance of the last date on which such participants and beneficiaries could exercise the affected rights before the blackout period. The 30 days' advance requirement does not apply if:
• Postponing the blackout period would result in a violation of ERISA's exclusive benefit and prudence requirements, and a fiduciary of the plan reasonably so determines in writing.
• The inability to provide the advance notice of a blackout is the result of events that were unforeseeable or circumstances beyond the reasonable control of the plan administrator, and a fiduciary of the plan reasonably so determines in writing.
• The blackout period applies solely in connection with certain participants or beneficiaries becoming, or ceasing to be, participants or beneficiaries of the plan as a result of a business reorganization.
In these cases, the notice must be provided as soon as reasonably possible.
If the notice is not furnished within the prescribed time limits (unless the blackout period applies solely in connection with certain participants or beneficiaries becoming, or ceasing to be, participants or beneficiaries of the plan as a result of a business reorganization), it must include a statement that federal law generally requires that the notice be furnished to affected participants and beneficiaries at least 30 days in advance of the last date on which they could exercise the affected rights immediately before the commencement of a blackout period and an explanation of the reasons why at least 30 days' advance notice could not be furnished.
The notice may be provided electronically if recipients would have reasonable access to an electronic notice.
If the blackout period dates are changed, a revised notice must be provided as soon as reasonably practicable explaining what has changed and the reasons for those changes.
Blackout notice violations. If a plan administrator refuses or fails to provide the blackout notice in a timely manner, the DOL may assess a civil penalty of up to $100 per day for each participant or beneficiary who did not receive the notice.
Notice to issuer of employer securities. A similar notice must be provided within the same time frames to the issuer of employer securities held by the plan and subject to the blackout period.
Insider trading restrictions. The Sarbanes-Oxley Act prohibits directors or executive officers (insiders) from engaging in transactions involving employer securities outside of the plan during a blackout period. The insider trading prohibition applies to any employer securities acquired in connection with the insider's services or employment.
expand-collapse sectionRoth 401(k) Plans
The IRC allows 401(k) plans to be amended to add a "Roth" feature, which is similar to the Roth IRA. Under a 401(k) plan with the Roth feature added, an employee may make an after-tax contribution that will earn income tax-free. A qualified distribution of both the contribution and the income attributed to it will be tax-free when distributed. This is in contrast to regular 401(k) contributions, which are made before taxes, earn income tax-free but are taxed when distributed, including both the original contribution and the earnings attributed to it. The participant decides whether to designate elective contributions as Roth 401(k) contributions. A designation of an elective contribution as a Roth 401(k) contribution is irrevocable. Roth contributions must be maintained in a separate account from the time they are made until the account is completely distributed.
An employer may not have a Roth 401(k) plan only. There must always be the option of making regular 401(k) contributions.
Roth 401(k) contributions are still 401(k) contributions. This means that they:
• Are counted for ADP/ACP testing;
• Are eligible for catch-up contributions;
• Can be used to determine available loan amounts; and
• Must be immediately vested and be distributed only on occurrence of permitted distributable events.
Who may benefit from a Roth contribution? Using the Roth feature is not for everyone, but it may be beneficial to employees who will be in the same or a higher tax bracket when they retire. This will often be true of young employees who are just starting out and employees who currently have high income tax deductions (dependents, mortgage interest, property tax, etc.) that will be gone by the time of retirement. The decision to use a Roth or not is further complicated by the impact of the alternative minimum tax and the possible taxation of Social Security benefits and usually has to be made on an individual basis. In addition, an employee may designate all, part, or none of his or her contribution as a Roth contribution.
Qualified distribution requirements. A distribution is a "qualified distribution" that receives tax-free treatment if it was made after the 5-year period beginning with the first tax year for which a contribution was made to the Roth 401(k) account or to an earlier Roth 401(k) account from which a rollover occurred and was also made:
• On or after the participant attains the age of 591/2;
• After the participant's death; or
• After the participant's disability.
Roth 401(k) vs. Roth IRA. The main differences between Roth 401(k)s and Roth IRAs are:
• Roth 401(k) contributions are subject to the general 401(k) limit, while Roth IRA contribution limits are based on the IRA limit.
• Eligibility for a Roth IRA phases out at certain income levels. There is no income limit for Roth 401(k) eligibility.
• The age of 701/2 minimum distribution requirements do not apply during a Roth IRA owner's life, but they do apply during Roth 401(k) owners' lives.
• While traditional IRAs can be converted into Roth IRAs, no such option is available for 401(k) accounts.
expand-collapse sectionSimplified Retirement Plans
The IRC provides for other employer-sponsored retirement plans that are similar to but simpler to administer than 401(k) plans. SEPs and SIMPLE plans have specified minimum requirements and offer little design flexibility in return for simple administration.
SEPs
SEPs provide a means for employers, especially small employers, to provide tax-favored retirement plans for their employees without all the complex requirements of ERISA and the IRC. SEPs have simplified participation, vesting, and contribution limits. Employees aged 21 years or older who meet minimal annual earnings requirements and who have performed services for the employer in at least 3 of the preceding 5 calendar years must be included in the SEP. Contributions must be made for all employees who meet the participation standards during the calendar year, even if they are not employed at the time the contribution is made. SEPs offer deductible contribution limits similar to those for other tax-favored retirement plans. The contributions made to an employee's SEP account are 100 percent vested when made. SEP assets are managed by a financial institution that supplies information to employees. Employers sponsoring a SEP have limited reporting and disclosure duties. SEP contributions may not be made through a CODA.
SIMPLE Plans
Employers with 100 or fewer employees that do not sponsor another qualified retirement plan may adopt another kind of simplified retirement plan, the SIMPLE plan. Under a SIMPLE plan, employees can defer up to a certain amount (determined annually by the IRS) into either an IRA or a 401(k) account. For the current maximum contribution amount, visit http://www.irs.gov. Employers generally must match employee contributions on a dollar-for-dollar basis up to 3 percent of an individual's compensation. (This requirement does not apply if the employer makes nonelective contributions instead.) A lower percentage (but not less than 1 percent) may be elected in 2 out of any 5 years. Plans that meet these rules and provide 100 percent vesting automatically pass the complex nondiscrimination rules for retirement plans. SIMPLE plans are also subject to relaxed reporting and disclosure requirements.
A SIMPLE IRA may include an automatic contribution arrangement that provides for default contributions and investment options absent an employee's affirmative election not to contribute (IRS Notice 2009-66). The IRS has provided a sample amendment that may be used to add an automatic contribution arrangement to a SIMPLE IRA plan (http://www.irs.gov).
expand-collapse section403(b) and 457 Plans
IRC Secs. 403(b) and 457 provide for retirement plans that are similar to 401(k) plans with most of the same contribution limits and restrictions on distributions. Employees of educational institutions and nonprofit organizations are eligible to contribute to 403(b) plans through their employment. Government employers may sponsor 457 plans for their employees. Depending on the degree of involvement of the employer in administering the plan, 403(b) plans may or may not be covered by ERISA. Because they are government plans, 457 plans are exempt from coverage by ERISA.
403(b) Plan Requirements
A 403(b) plan may be established by a public school, a college or university, or charitable entity tax exempt under IRC Sec. 501(c)(3). 403(b) plans are similar to 401(k) plans. Just as with a 401(k) plan, a 403(b) plan lets employees defer some of their salary. In this case, their deferred money goes to a 403(b) plan sponsored by the employer. This deferred money and the earnings on it are generally not subject to taxation by the federal government or by most state governments until distributed. A 403(b) annuity can be carried with the participant when he or she changes employers or retires.
Under a 403(b) plan, employers may purchase annuity contracts or establish custodial accounts invested only in mutual funds for the purpose of providing retirement income for their eligible employees. Annuity contracts must be purchased from a state licensed insurance company, and the custodial accounts must be held by a custodian bank or IRS-approved non-bank trustee/custodian. The annuity contracts and custodial accounts may be funded by employee salary deferrals, employer contributions, or both. Although not subject to the qualification requirements of IRC Sec. 401, some of the requirements that apply to qualified plans also apply, with modifications, to 403(b) plans.
403(b) regulations. The regulations provide that a 403(b) program be maintained pursuant to a written defined contribution plan that satisfies Sec. 403(b) in both form and operation and contains all the terms and conditions for eligibility, limitations, and benefits under the plan. In addition, the regulations provide that:
• Elective deferrals are limited to contributions under a cash or deferred election as defined under IRC Sec. 401(k).
• Previously permitted eligibility restrictions are eliminated and employees must be universally eligible to make elective contributions. This change does not apply to governmental entities (such as public school districts).
• Contributions to plans not covered by ERISA must be transferred to providers within a reasonable time for proper plan administration (for example, transferring elective deferrals within 15 business days following the month in which these amounts would have been paid to the participant). These plans may terminate and distribute assets with full rollover ability, as well as recognize the occurrence of an employment severance where an employee no longer works for an employer eligible to maintain a 403(b).
ERISA exemption. 403(b) plans sponsored by a church or a government entity are exempt from ERISA. The DOL regulations also exempt 403(b)s that don't qualify for the church or government exemption from ERISA. A 403(b) plan that is funded solely through salary reduction agreements or agreements to forgo an increase in salary is not considered to be “established or maintained” by an employer and, therefore, is not an employee pension benefit plan subject to ERISA if:
• Participation of employees is completely voluntary;
• All rights under the annuity contract or custodial account are enforceable solely by the employee or beneficiary of such employee, or by an authorized representative of the employee or beneficiary;
• The involvement of the employer is limited to certain optional specified activities; and
• The employer receive no direct or indirect consideration or compensation in cash or otherwise other than reasonable reimbursement to cover expenses properly and actually incurred in performing the employer's duties pursuant to the salary reduction agreements.
The DOL has indicated that the 403(b) requirements provided in IRS regulations, including the written plan requirement, do not result in a 403(b) plan being covered by ERISA (DOL Field Assistance Bulletin No. 2007-02). The DOL specifically stated, for example, that an employer’s development and adoption of a single document to coordinate administration among different issuers and to address tax matters that apply, such as the universal availability requirement, without reference to a particular contract or account, would not result in a 403(b) program being covered by ERISA.
expand-collapse sectionCatch-Up Provisions
An increase in the otherwise applicable dollar limits on elective deferrals under 401(k) plans, 403(b) annuities, SEPs, SIMPLE plans, or 457 plans is allowed for individuals who have attained the age of 50 by the end of the year. For the current catch-up contribution limits, visit http://www.irs.gov. Catch-up contributions are not subject to any other contribution limit and are not subject to nondiscrimination rules. Plans must be amended to accept catch-up contributions and must provide that all eligible individuals may make catch-up elections. Employers may make contributions matching all or a percentage of catch-up contributions, but the matching contributions are subject to the normal rules.
expand-collapse sectionSaver's Credit
The retirement saver's credit provides a tax credit to encourage low-income and moderate-income families and individuals to save for retirement. Eligible taxpayers who contribute to an IRA or an employer-sponsored plan, including a 401(k), 403(b), or 457 plan, can receive a nonrefundable tax credit, in addition to the tax deduction for contributing to an IRA or to an employer-sponsored plan. In determining the amount of the credit, neither the amount of any refundable tax credits nor the adoption credit is taken into consideration. The eligible income brackets are indexed to inflation.
Individuals claim the credit on their federal income tax returns. The amount of the credit declines as income increases.
The credit is not available to taxpayers under the age of 18 or to full-time students. If a worker or spouse receives a preretirement distribution from a retirement plan (such as a hardship withdrawal), any credit taken in that same year and in the 2 subsequent years is reduced by the amount of the distribution.
Because it is nonrefundable, some families may not benefit from the retirement savings tax credit because they have no net income tax liability. Also, the credit may not be large enough to provide a savings incentive for families with incomes near the upper limits. On the other hand, families who increase their savings to claim the retirement savings credit and who are eligible for the earned income tax credit (EITC) may increase the amount of the EITC for which they qualify.
Because the credit is based on adjusted gross income, it increases the net benefit of contributing to a retirement plan.
For the current adjusted gross income limitations for determining the retirement savings contribution credit for married taxpayers, heads of household, and singles, visit http://www.irs.gov.
expand-collapse sectionInvestment of Participant's Accounts
Fee Disclosures--Service Provider to Plan Fiduciary
ERISA requires plan fiduciaries, when selecting and monitoring service providers and plan investments, to act prudently and solely in the interest of the plan’s participants and beneficiaries. Responsible plan fiduciaries also must ensure that arrangements with their service providers are "reasonable" and that only "reasonable" compensation is paid for services. Fundamental to the ability of fiduciaries to discharge these obligations is obtaining information sufficient to enable them to make informed decisions about an employee benefit plan’s services, the costs of such services, and the service providers.
In 2012, the DOL Employee Benefits Security Administration (EBSA) issued final regulations on requirements for the disclosure of information by covered service providers (CSPs) to ERISA-covered defined benefit and defined contribution pension plans. The rule does not apply to SEPs, SIMPLE retirement accounts, IRAs, certain 403(b) annuity contracts and custodial accounts, or employee welfare benefit plans. The rule establishes specific disclosure obligations for plan service providers to ensure that responsible plan fiduciaries (RPFs) are provided the information they need to make better decisions when selecting and monitoring service providers for their plans.
The final rule requires CSPs to provide RPFs with the information they need to:
• Assess the reasonableness of total compensation, both direct and indirect, received by the CSP, its affiliates, and/or subcontractors;
• Identify potential conflicts of interest; and
• Satisfy reporting and disclosure requirements under Title I of ERISA.
Service providers not in compliance with the final rule will be subject to the prohibited transaction rules of ERISA Sec. 406 and IRC Sec. 4975 penalties.
CSPs. CSPs are those who expect at least $1,000 in compensation to be received for services to a covered plan and include:
• ERISA fiduciary service providers to a covered plan or to a “plan asset” vehicle in which such a plan invests;
• Investment advisers registered under federal or state law;
• Recordkeepers or brokers who make designated investment alternatives available to the covered plan (e.g., a “platform provider”); and
• Providers of accounting, auditing, actuarial, banking, consulting, custodial, insurance, investment advisory, legal, recordkeeping, securities brokerage, third-party administration, or valuation services to the covered plan who also receive "indirect compensation" in connection with such services.
The final regulation includes a class exemption from the prohibited transaction provisions of ERISA for responsible plan fiduciaries that enter into service contracts without knowing that the CSP has failed to comply with its disclosure obligations. The class exemption requires that fiduciaries notify the DOL of the disclosure failure. Fiduciaries can file the notice online at http://www.dol.gov.
Disclosure of services and compensation. Information required to be disclosed by a CSP must be furnished in writing to an RPF for the covered plan. The regulation does not require a formal written contract delineating the disclosure obligations. CSPs must describe the services to be provided and all direct and indirect compensation to be received by a CSP, its affiliates, or subcontractors.
“Direct compensation” is compensation received directly from the covered plan. “Indirect compensation” generally is compensation received from any source other than the plan sponsor, the CSP, an affiliate, or subcontractor.
In order to enable an RPF to assess potential conflicts of interest, CSPs who disclose “indirect compensation” also must describe the arrangement between the payer and the CSP pursuant to which indirect compensation is paid. CSPs must identify the sources for indirect compensation, plus the services to which such compensation relates.
Compensation disclosures by CSPs are to include allocations of compensation made among related parties (i.e., among a CSP’s affiliates or subcontractors) when such allocations occur as a result of charges made against a plan’s investment or are set on a transaction basis.
CSPs must disclose whether they are providing recordkeeping services and the compensation attributable to such services, even when no explicit charge for recordkeeping is identified as part of the service “package” or contract.
Some CSPs must disclose an investment’s annual operating expenses (e.g., expense ratio) and any ongoing operating expenses in addition to annual operating expenses. For participant-directed individual account plans, such disclosures must include “total annual operating expenses” as required by the regulations on fee and expense disclosure to plan participants.
The final regulation provides a “pass-through” for investment-related disclosures furnished by recordkeepers or brokers. A CSP may provide current disclosure materials of an unaffiliated issuer of a designated investment alternative or information replicated from such materials, provided that the issuer is a registered investment company (i.e., mutual fund), an insurance company qualified to do business in a state, an issuer of a publicly traded security, or a financial institution supervised by a state or federal agency.
Service providers may use electronic means to disclose information to plan fiduciaries provided that the CSP’s disclosures on a website or other electronic medium are readily accessible to the RPF, and the fiduciary has clear notification on how to access the information.
Providing a guide to initial disclosures. EBSA strongly encourages CSPs to offer RPFs a “guide,” summary, or similar tool to assist fiduciaries in identifying all of the required disclosures, particularly when service arrangements and related compensation are complex, and information is disclosed in multiple documents. EBSA has included a Sample Guide as an appendix to the final regulation that can be used on a voluntary basis by CSPs as a model for such a guide. EBSA intends to require CSPs to furnish a guide or similar tool to assist RPFs’ review of initial disclosures.
Ongoing disclosure obligations. Generally, CSPs must disclose changes to initial information as soon as practicable, but no later than 60 days from when the CSP is informed of such change. Disclosures of changes to investment-related information are to be made at least annually. Service providers must disclose compensation or other information related to their service arrangements upon the request of the RPF or plan administrator, reasonably in advance of the date when such person states that he or she must comply with ERISA’s reporting and disclosure requirements.
Disclosure errors. The final regulation allows for timely corrections of an error or omission in required disclosures when a CSP is acting in good faith and with reasonable diligence. Such corrections must be made not later than 30 days from the date that the CSP knows of the error or omission.
Fee and Expense Disclosures to Plan Participants
The DOL EBSA has issued final regulations intended to help employees manage and invest 401(k) contributions (29 CFR Sec. 2550.404a-5). According to the DOL, the regulation ensures:
• That 401(k) plan participants are given, or have access to, the information they need to make informed decisions, including information about fees and expenses;
• That the delivery of investment-related information is in a format that enables workers to meaningfully compare the investment options under their pension plans;
• That plan fiduciaries use standard methodologies when calculating and disclosing expense and return information to achieve uniformity across the spectrum of investments that exist among and within plans so that investments can be objectively compared; and
• A new level of fee and expense transparency.
Information disclosure requirement. The regulation provides that the investment of plan assets is a fiduciary act governed by ERISA's fiduciary standards, which require plan fiduciaries to act prudently and solely in the interest of the plan’s participants and beneficiaries. Thus, when a plan allocates investment responsibilities to participants or beneficiaries, the plan administrator must take steps to ensure that the participants and beneficiaries, on a regular and periodic basis, are made aware of their rights and responsibilities with respect to the investment of assets held in, or contributed to, their accounts and are provided sufficient information about the plan and the plan’s investment options, including fee and expense information, to make informed decisions when managing their individual accounts. Thus, a plan administrator must provide to each participant or beneficiary certain plan-related information and certain investment-related information.
Liability protection. The regulation provides plan administrators protection from liability for the completeness and accuracy of information provided to participants if the plan administrator reasonably and in good faith relies on information provided by a service provider.
Plan-related information disclosure requirement. The first category of information that must be disclosed is plan-related information. This general category is further divided into the following three subcategories:
• General plan information consisting of information about the structure and mechanics of the plan, such as an explanation of how to give investment instructions, a current list of the plan’s investment options, and a description of any “brokerage windows” or similar arrangement that enables the selection of additional investments not designated by the plan.
• Administrative expenses information, including an explanation of any fees and expenses for general plan administrative services that may be charged to or deducted from all individual accounts. Examples include fees and expenses for legal, accounting, and recordkeeping services.
• Individual expenses information, including an explanation of any fees and expenses that may be charged to or deducted from the individual account of a specific participant or beneficiary based on the actions taken by that person. Examples include fees and expenses for plan loans and for processing qualified domestic relations orders.
The information in these three subcategories must be given to participants on or before the date they can first direct their investments and then again annually thereafter.
Statements of actual charges or deductions. In addition to the plan-related information that must be furnished up front and annually, participants must receive statements, at least quarterly, showing the dollar amount of the plan-related fees and expenses (whether “administrative” or “individual”) actually charged to or deducted from their individual accounts, along with a description of the services for which the charge or deduction was made. These specific disclosures may be included in required quarterly benefit statements.
Investment-related disclosure requirement. The second category of information that must be disclosed is investment-related information. This category contains several subcategories of core information about each investment option under the plan, including:
• Performance data. Participants must be provided specific information about historical investment performance with 1-, 5-, and 10-year returns provided for investment options, such as mutual funds, that do not have fixed rates of return. For investment options that have a fixed or stated rate of return, the annual rate of return and the term of the investment must be disclosed.
• Benchmark information. For investment options that do not have a fixed rate of return, the name and returns of an appropriate broad-based securities market index over 1-, 5-, and 10-year periods (matching the performance data periods) must be provided. Investment options with fixed rates of return are not subject to this requirement.
• Fee and expense information. For investment options that do not have a fixed rate of return, the total annual operating expenses expressed as both a percentage of assets and as a dollar amount for each $1,000 invested, any shareholder-type fees or restrictions on the participant’s ability to purchase or withdraw from the investment must be disclosed. For investment options that have a fixed rate of return, any shareholder-type fees or restrictions on the participant’s ability to purchase or withdraw from the investment must be disclosed.
• “Lifetime income” disclosure. The SECURE Act requires plan sponsors to quantify the payments a defined contribution (401(k) or 403(b)) plan would yield if structured as a lifetime annuity. (This will take effect 1 year after the DOL issues implementing guidance.) The law also creates a fiduciary safe harbor for plan sponsors that actually offer such an annuity.
• Internet website address. Investment-related information includes an Internet website address that is sufficiently specific to provide participants and beneficiaries access to specific additional information about the investment options for those who want more or more current information.
• Glossary. Investment-related information includes a general glossary of terms to assist participants and beneficiaries in understanding the plan’s investment options or an Internet website address that is sufficiently specific to provide access to such a glossary.
After a participant has invested in a particular investment option, he or she must be provided any materials the plan receives regarding voting, tender, or similar rights in the option. Upon request, the plan administrator must also furnish prospectuses, financial reports, and statements of valuation and of assets held by an investment option.
Comparative format requirement. Investment-related information must be furnished to participants or beneficiaries on or before the date they can first direct their investments and annually thereafter. As noted above, it also must be furnished in a chart or similar format designed to facilitate a comparison of each investment option available under the plan. The regulation includes, as an appendix, a model comparative chart that, when correctly completed, may be used by the plan administrator to satisfy the rule’s requirement that a plan’s investment option information be provided in a comparative format. The model comparative chart may be obtained at http://www.dol.gov.
Electronic distribution. The DOL's general disclosure regulation (29 CFR Sec. 2520.104b-1) applies to material furnished on fees and expenses, including the safe harbor for electronic disclosures. Please see the national Benefits Recordkeeping and Disclosures section.
Safe harbor electronic disclosure requirements. EBSA has issued a revised interim policy for the use of electronic media to satisfy disclosure requirements under the fee disclosure regulation (EBSA Technical Release 2011-03R). The technical release allows plan administrators to furnish information required under the fee disclosure rule electronically, including by the use of continuous-access websites, if certain conditions and safeguards are met. The interim policy states that the DOL will not take enforcement action based solely on a plan administrator's use of electronic technologies to make the required disclosure if the administrator complies with the following conditions:
• Voluntary provision of an e-mail address. Participants and beneficiaries entitled to receive information must voluntarily provide the employer, plan sponsor, or plan administrator (or its designee) with an e-mail address for the purpose of receiving fee disclosures. The e-mail address must be provided in response to a request accompanied by an initial notice, as described below. If the provision of an e-mail address is a condition of employment or participation in the plan, the e-mail address is not to be treated as being provided voluntarily. However, if a participant is required to provide an e-mail address electronically in order to access a secure, continuous-access website that includes the required disclosure, the provision of the e-mail address is considered voluntary if an initial notice is properly provided.
• Initial notice. The initial notice must be clear and conspicuous, provided at the same time and in the same medium as the request for the e-mail address, and contain a statement that providing an e-mail address for the receipt of the fee disclosures is entirely voluntary and that as a result of providing the e-mail address, the required fee disclosures will be made electronically plus additional information listed below.
• Annual notice. Commencing with the year beginning after the year that the participant or beneficiary voluntarily provided his or her e-mail address, and annually thereafter, the plan administrator must furnish an annual notice to each participant or beneficiary. For this purpose, “year” means a calendar year, plan year, or any other 12-month period selected by the plan administrator. The annual notice must be furnished on paper. Alternatively, it may be furnished electronically by sending it to the e-mail address on file for the participant or beneficiary if there is evidence that the participant or beneficiary interacted electronically with the plan after the date the annual notice for the preceding year was furnished (or in the case of the first annual notice, after the date the initial notice was furnished). Examples of electronic interaction include, but are not limited to, the participant or beneficiary updating, resubmitting, or confirming his or her e-mail address to the plan; the participant or beneficiary sending an electronic message to the plan; logging onto a secure, continuous-access website housing plan information; or the receipt and opening of an electronic message sent by the plan to the participant or beneficiary.
• Delivery. The plan administrator takes appropriate and necessary measures reasonably calculated to ensure that the electronic delivery system results in actual receipt of transmitted information (e.g., using return receipt or notice of undelivered electronic mail features, conducting periodic reviews or surveys to confirm receipt of transmitted information).
• Confidentiality. The plan administrator takes appropriate and necessary measures reasonably calculated to ensure that the electronic delivery system protects the confidentiality of personal information.
• Calculated to be understood. Notices furnished to participants and beneficiaries must be written in a manner calculated to be understood by the average plan participant.
Notice content. The notices must all contain the following information:
• Identification or a brief description of the information that will be furnished electronically and how it can be accessed by participants and beneficiaries;
• A statement that the participant or beneficiary has the right to request and obtain, free of charge, a paper copy of any of the information provided electronically and an explanation of how to exercise that right;
• A statement that the participant or beneficiary has the right, at any time, to opt out of receiving the information electronically and an explanation of how to exercise that right; and
• An explanation of the procedure for updating the participant’s or beneficiary’s e-mail address.
DOL Attempt to Expand Definition of ‘Fiduciary’
In April 2016, the DOL unveiled a long-awaited final rule that addressed conflicts of interest in the investment services industry by changing the 40-year-old definition of “fiduciary” as it relates to ERISA retirement plans.
The rule was designed to protect investors by requiring anyone who, for compensation, provides retirement investment advice to retirement plans and individuals to abide by a fiduciary standard—“putting their clients’ best interest before their own profits,” according to an agency fact sheet. The rule described the kinds of communications that would constitute investment advice and the types of relationships in which those communications would give rise to fiduciary investment advice responsibilities.
However, the 5th U.S. Circuit Court of Appeals struck down the rule, finding that the DOL’s attempt to expand the fiduciary definition exceeded the agency’s authority (U.S. Chamber of Commerce v. DOL, 885 F.3d 360 (March 15, 2018)). The court officially vacated the rule in May 2018.
Reducing Fiduciary Liability--ERISA Sec. 404(c)
Individual account plans such as 401(k) plans that provide for participant-directed investments can reduce or eliminate their fiduciary liability for the consequences of the participant's investment decisions if the plan meets the requirements of ERISA Sec. 404(c). In general, an individual account plan qualifies as a 404(c) plan if it:
• Provides an opportunity for a participant or beneficiary to exercise control over assets in his or her individual account; and
• Provides a participant or beneficiary an opportunity to choose, from a broad range of investment alternatives, how some or all of the assets in his or her account are invested.
A participant is considered to have the opportunity to exercise control if there is a named fiduciary to receive investment instructions who is obligated to comply with those instructions and the participant has access to sufficient information to make informed decisions when choosing between the investment alternatives. There are detailed requirements about the information that must be provided and the number and types of investment alternatives that must be offered (29 CFR Sec. 2550.404c-1). The disclosure requirements in this regulation have been amended to integrate with the fee and expense disclosure requirements to avoid having different disclosure rules for plans intended to comply with the ERISA Sec. 404(c) requirements establishing a uniform disclosure framework for all participant-directed individual account plans.
Warning: Although Sec. 404(c) may relieve plan fiduciaries of liability for participants' investment decisions, it does not eliminate liability for decisions that the fiduciary makes. These include the selection of the investment alternatives offered by the plan. Plan fiduciaries must therefore monitor the continued performance and the mix of the investment alternatives provided.
Application of 404(c) protections to default investments. The PPA extended the protections of Sec. 404(c) to plans that use default investments in the event that the participant does not make his or her own election. The protection applies if:
• The plan makes the default investments in accordance with guidelines to be issued by the DOL; and
• Affected participants receive an annual notice explaining their right to direct investments and have a reasonable opportunity to do so.
Application of 404(c) protections during blackout periods. The PPA clarified and expanded the 404(c) protections available during a blackout period when a participant is unable to direct his or her investments. In general, a fiduciary is not liable for losses incurred during a blackout period if ERISA's fiduciary obligations are satisfied and other duties or authorizing and implementing a blackout are performed. Blackout periods frequently involve a change in the investment options offered under a plan. If a participant does not make an affirmative election among the new investment options offered after the blackout, 404(c) protection applies to the plan's default investment if:
• The participant had the opportunity to redirect investments but failed to do so;
• The characteristics of the default investments are similar to those they replace; and
• The participant was provided with a written notice 30 to 60 days in advance, describing the fund changes and the default investment.
Providing Investment Advice
ERISA's prohibited transaction rules have made it difficult for plan fiduciaries to provide investment advice to plan participants. The PPA added a new prohibited transaction exemption for "eligible investment advice arrangements" so that mutual fund companies, insurance companies, and other parties-in-interest can be compensated for providing investment advice to participants who select their own investments in a 401(k) and other individual account plans.
If the requirements of the provision are met, the following are not treated as prohibited transactions: (1) the provision of investment advice; (2) an investment transaction (i.e., a sale, acquisition, or holding of a security or other property) pursuant to the advice; and (3) the direct or indirect receipt of fees or other compensation in connection with the provision of the advice or an investment transaction pursuant to the advice.
Eligible investment advice arrangements. An "eligible investment advice arrangement" is an arrangement that (1) provides that any fees (including any commission or compensation) received by the fiduciary adviser for investment advice do not vary depending on the what investment option is selected, or (2) uses a computer model that meets certain requirements to provide the advice. The arrangement must be expressly authorized by a plan fiduciary other than (1) the person offering the investment advice program, (2) any person providing investment options under the plan, or (3) any affiliate of (1) or (2).
Note: Except for the requirement that fees not vary based on the investment option selected, these requirements also apply to the fiduciary advisor and an affiliate of the fiduciary advisor. The requirement that fees not vary depending on the basis of any investment options selected does not extend to affiliates of the fiduciary advisor, unless, of course, the affiliate is also a provider of investment advice to the plan (DOL Field Assistance Bulletin No. 2007-01).
Use of a computer model. If an eligible investment advice arrangement provides investment advice pursuant to a computer model, the model must:
• Apply generally accepted investment theories that take into account the historic returns of different asset classes over defined periods of time;
• Use relevant information about the participant or beneficiary;
• Use prescribed objective criteria to provide asset allocation portfolios composed of investment options under the plan;
• Operate in a manner that is not biased in favor of any investment options offered by the fiduciary adviser or related person; and
• Take into account all the investment options under the plan in specifying how a participant's or beneficiary's account should be invested without inappropriate weighting of any investment option.
Certification. Before a model is used, an eligible investment expert must certify that the model meets these requirements. The certification must be renewed if there are material changes to the model. For this purpose, an "eligible investment expert" is a person who meets requirements prescribed by the IRS and who is not affiliated with any investment adviser or related person. If a computer model is used, the only investment advice that may be provided is the advice generated by the computer model, and any investment transaction pursuant to the advice must occur solely at the direction of the participant or beneficiary. This requirement does not preclude a participant or beneficiary from requesting other investment advice.
Audit requirement. An annual audit of an eligible investment advice arrangement for compliance with the above requirements must be conducted by an independent auditor. The auditor must be unrelated to the person offering the investment advice arrangement or any person providing investment options under the plan and must certify in writing that he or she has appropriate technical training or experience and proficiency. The auditor must issue a report of the audit results to the fiduciary that authorized use of the arrangement.
Notice requirement. Before the initial provision of investment advice and annually thereafter, the fiduciary adviser must provide written notice (which may be in electronic form) to the recipient of the advice, including information relating to the adviser's qualifications, possible conflicts, the nature of the advice that will be given, and how information about the recipient will be used. This information must also be provided on request and when there is a material change. The DOL will be issuing a model form for the required disclosure of fees and other compensation.
Selection and review of a fiduciary adviser. Employers and plan fiduciaries have a fiduciary responsibility under ERISA for the prudent selection and periodic review of a fiduciary advisor with whom an employer or plan fiduciary has made an arrangement for the provision of investment advice to plan participants and beneficiaries. An employer or plan fiduciary does not have the duty to monitor the specific investment advice given by a fiduciary adviser. The DOL has stated that a plan sponsor or other fiduciary that prudently selects and monitors an investment advice provider will not be liable for the advice furnished by such provider to the plan’s participants and beneficiaries, whether or not that advice is provided pursuant to this statutory exemption (DOL Field Assistance Bulletin No. 2007-01).
Selection guidelines. The DOL has also stated that a fiduciary should engage in an objective process designed to elicit information necessary to assess the service provider’s qualifications, quality of services offered, and reasonableness of fees charged for the service. The process also must avoid self-dealing, conflicts of interest, or other improper influence. The DOL expects that the process utilized by a responsible fiduciary will take into account:
• The experience and qualifications of the investment advisor, including the advisor’s registration in accordance with applicable federal and/or state securities law;
• The willingness of the advisor to assume fiduciary status and responsibility under ERISA for the advice provided to participants; and
• The extent to which the advice will be based on generally accepted investment theories.
Monitoring guidelines. When monitoring investment advisors, the DOL anticipates that fiduciaries will periodically review, among other things, the extent to which there have been any changes in the information that served as the basis for the initial selection of the investment advisor, including whether the advisor continues to meet applicable federal and state securities law requirements and whether the advice being furnished to participants and beneficiaries was based on generally accepted investment theories. Fiduciaries should also take into account whether the investment advice provider is complying with the contract under which it was hired; utilization of the investment advice services by the participants in relation to the cost of the services to the plan; and participants' comments and complaints about the quality of the furnished advice. The DOL has noted that if a complaint or complaints raise questions concerning the quality of advice being provided, a fiduciary may have to review the specific advice at issue with the investment advisor.
According to the DOL, plan assets can be used to pay reasonable expenses in providing investment advice to participants and beneficiaries.
Requirements for Investments in Employer Stock
The PPA added provisions to ERISA and the IRC to allow participants to divest investments in employer stock. The requirements apply to individual account plans that hold publicly traded employer stock. The diversification requirements do not apply to an employee stock ownership plan (ESOP) if there are no elective, employee, or matching contributions to the plan and the plan is separate from any other defined benefit plan or individual account plan maintained by the same employer or employers.
Employee contributions and elective deferrals. A participant must be allowed to direct the plan to immediately divest any employer securities attributable to employee contributions and elective deferrals and to reinvest an equivalent amount in other specified investment options.
Employer contributions. In the case of the portion of the account attributable to employer contributions other than elective deferrals, which is invested in employer securities, a participant who has completed at least 3 years of service must be allowed to direct the plan to divest any such securities and to reinvest an equivalent amount in other specified investment options.
Alternate investment options and restrictions. A plan must offer at least three investment options, other than employer securities, to which an applicable individual may direct the proceeds from the divestment of employer securities, each of which is diversified and has materially different risk and return characteristics. A plan may limit the time for divestment and reinvestment to periodic, reasonable opportunities occurring at least quarterly. A plan may not impose restrictions or conditions on the investment of employer securities that are not imposed on the investment of other assets of the plan.
Notice of right to divest. Not later than 30 days before the first date on which a participant was eligible to divest employer securities, the plan administrator had to provide that participant with a notice that explained the right to divest and described the importance of diversifying the investment of retirement account assets. The IRS issued a model notice, which was included in IRS Notice 2006-107 and can be found at http://www.irs.gov.
expand-collapse sectionAutomatic Enrollment
A major issue for employers sponsoring 401(k) plans is getting employees, especially lower-paid employees, to participate. Plans generally require employees to make an affirmative election to have a percentage of their pay deferred and contributed to the plan. This is a difficult hurdle for many employees. The IRS has ruled that a 401(k) plan may provide for automatic contributions of a specified percentage of an employee's compensation to a 401(k) plan unless the employee elects not to do so (Rev. Rul. 2000-8). Notice must be given to each employee that the deferral will take effect unless they elect to receive cash or have a different percentage deferred. The notice must be given at the time of hire, when the provision takes effect for current employees, and annually thereafter before the beginning of each year so that employees have an “effective opportunity” to elect to receive cash instead.
Note: Although automatic enrollment has increased 401(k) participation for many employers, the general experience is that employees stay with the default contribution rate and investment choice and thus get only a minimum benefit from plan participation. This problem has resulted in some employers reversing their decision to use automatic enrollment and looking for other ways to encourage participation, such as aggressive education and communication programs.
Employers had been hesitant to implement automatic enrollment because of worries about fiduciary violations and complications with state law requirements for deductions from pay. To encourage employers to implement automatic enrollment, the PPA provided an exemption from state payroll withholding laws, fiduciary relief for investment of participant account balances in certain default investments, and incentives for adopting automatic enrollment provisions that meet certain requirements. These include an increase in the time limit for correcting excess contributions while avoiding excise taxes from 90 to 180 days as well as a 90-day correction period for participants to reverse the initial payroll reduction and receive penalty-free return of automatic elective contributions for plans that use an eligible automatic contribution arrangement (EACA). Also provided was relief from discrimination testing and top-heavy restrictions for plans that implemented a qualified automatic contribution arrangement (QACA).
To facilitate the adoption of automatic enrollment, the IRS has provided two sample plan amendments for sponsors, practitioners, and employers that want to add certain automatic contribution features to their 401(k) plans. Sample Amendment 1 can be used to add an automatic contribution arrangement to a 401(k) plan. Sample Amendment 2 can be used to add an EACA (permitting 90-day withdrawals) to a 401(k) plan (IRS Notice 2009-65). Two sample plan amendments are provided in the Appendix of Notice 2009-65 (http://www.irs.gov/pub/irs). Plan sponsors are not required to adopt either amendment verbatim.
QACA Requirements and Benefits
A 401(k) plan that contains an automatic enrollment feature that satisfies the requirements for a QACA is treated as meeting the ADP test with respect to elective deferrals and the ACP test with respect to matching contributions. In addition, a plan consisting solely of contributions made pursuant to a QACA is not subject to the top-heavy rules. To qualify for this safe harbor, a QACA must meet certain requirements for the (1) automatic deferral and the amount of the elective contributions, (2) matching or nonelective contributions, and (3) notice to employees.
Automatic deferral/amount of elective contributions requirement. A QACA must provide that, unless an employee elects otherwise, the employee is treated as making an election to make elective deferrals equal to a stated percentage of compensation of no more than 10 percent and at least equal to:
• Three percent of compensation for the first year the deemed election applies to the participant;
• Four percent during the second year;
• Five percent during the third year; and
• Six percent during the fourth year and thereafter.
The stated percentage must be applied uniformly to all eligible employees. Eligible employees are all employees eligible to participate in the arrangement, other than employees eligible to participate immediately before the date on which the arrangement became a QACA with an election in effect (either to participate at a certain percentage or not to participate).
Providing for automatic contribution increases. The IRS has provided examples of how automatic increases to the default contribution amount may be structured. An automatic contribution arrangement under which an eligible employee’s default contribution percentage automatically increases in plan years after the first plan year of an eligible employee’s participation in the automatic contribution arrangement may be based in part on increases in the eligible employee’s plan compensation. Default contributions will satisfy the uniformity and minimum percentage requirements even if contributions for all eligible employees increase on a date other than the first day of a plan year such as the date that annual raises go into effect (Rev. Rul. 2009-30).
Matching or nonelective contribution requirement. A QACA satisfies the contribution requirement if the employer either (1) satisfies a matching contribution requirement or (2) makes a nonelective contribution to a defined contribution plan of at least 3 percent of an employee's compensation on behalf of each NHCE who is eligible to participate in the automatic enrollment feature.
An employer satisfies the matching contribution requirement if:
• It matches 100 percent of the first 1 percent deferred, plus 50 percent of the next 5 percent deferred, for a maximum match of 31/2 percent on behalf of each NHCE; and
• The rate of match for elective deferrals for HCEs is not greater than the rate of match for NHCEs.
Additional requirement for matching contribution relief. A plan with a QACA that provides for matching contributions and satisfies the safe harbor contribution requirements applicable to the QACA is deemed to satisfy the ACP test if:
• Matching contributions are not provided for elective deferrals in excess of 6 percent of compensation;
• The rate of matching contribution does not increase as the rate of an employee's elective deferrals increases; and
• The rate of matching contribution for any rate of elective deferral of an HCE is no greater than the rate of matching contribution for the same rate of deferral of an NHCE.
Vesting. Any matching or other employer contributions taken into account in determining whether the requirements for a QACA are satisfied must vest in 2 years so that employees with 2 years of service are 100 percent vested.
Withdrawal restrictions. Any matching or other employer contributions taken into account in determining whether the requirements for a QACA are satisfied must satisfy the withdrawal rules for elective contributions.
Notice requirement. Each employee eligible to participate in a QACA must receive notice of the arrangement, which is sufficiently accurate and comprehensive, to apprise the employee of his or her rights and obligations and is written in a manner calculated to be understood by the average employee to whom the arrangement applies. The notice must explain:
• The employee's right to elect not to have elective contributions made or to elect to have contributions made in a different amount; and
• How contributions made under the automatic enrollment arrangement will be invested in the absence of any investment election by the employee.
The employee must be given a reasonable period of time after receiving the notice and before the first election contribution must be made to make an election with respect to contributions and investments.
EACA Requirements and Benefits
Correcting initial automatic enrollment contributions. In the case of contributions made pursuant to an EACA, employees are allowed to opt out of or reduce their automatic enrollment contribution during the first 90 days after their first contribution. Erroneous automatic contributions may be distributed from the plan no later than 90 days after the date of an employee's first elective contribution under the arrangement. The amount that is treated as an erroneous contribution is limited to the amount of automatic contributions made during the 90-day period that the employee elects to so treat. These distributions are generally treated as a payment of compensation rather than as a contribution to and then a distribution from the plan, and the 10 percent early withdrawal tax does not apply to distributions of erroneous automatic contributions. In addition, these contributions are not taken into account for purposes of applying the nondiscrimination rules or the limit on elective deferrals and are not subject to otherwise applicable withdrawal restrictions.
Note: The corrective distributions rules apply to distributions from (1) qualified plans under IRC Sec. 401(a), (2) IRC Sec. 403(b) annuity contracts, and (3) governmental deferred compensation plans under IRC Sec. 457(b). In addition, the corrective distribution rules are not limited to arrangements meeting the QACA requirements.
Excess contributions. In the case of an EACA, the excise tax on excess contributions does not apply to any excess contributions or excess aggregate contributions that, together with income allocatable to the contributions, are distributed or forfeited (if forfeitable) within 6 months after the close of the plan year. This doubles the length of time otherwise allowed to make such distributions. Additionally, any excess contributions or excess aggregate contributions (and any income allocatable thereto) distributed within this 6-month period are treated as earned and received by the recipient in the taxable year in which the distribution is made (regardless of the amount distributed), and the income allocatable to excess contributions or excess aggregate contributions that must be distributed is determined through the end of the year for which the contributions were made.
EACA requirements. To qualify as an EACA, an automatic enrollment program must provide that if the participant does not make an investment election, the automatic contributions will be invested in accordance with regulations issued by the DOL under ERISA Sec. 404(c)(5) regarding default investments.
Notice requirement. The plan administrator of a plan with an EACA must, within a reasonable period before a plan year, provide to each participant to whom the arrangement applies for that plan year with notice of the participant's rights and obligations under the arrangement. This notice must include an explanation of the following:
• That the participant has a right to elect not to have elective contributions made on his or her behalf (or to elect to have such contributions made at a different percentage);
• That such an election must be made within a reasonable period of time after receipt of the notice and before the first contribution is made; and
• How contributions made under the arrangement will be invested in the absence of any investment election by the participant.
This is the same information that must be in the notice for a plan that has an automatic enrollment arrangement to qualify for preemption of state withholding laws.
Preemption of State Law Impediments to Automatic Enrollment
Any state law (such as a requirement of prior authorization to withhold from wages) that would directly or indirectly prohibit or restrict the inclusion in a plan of an automatic contribution arrangement is preempted. The DOL may establish minimum standards for such arrangements in order for preemption to apply. An "automatic contribution arrangement" is defined as an arrangement under which:
• A participant may elect to have the plan sponsor make payments as contributions under the plan on behalf of the participant or to the participant directly in cash such as a 401(k) plan;
• A participant is treated as having elected to have the plan sponsor make such contributions in an amount equal to a uniform percentage of compensation provided under the plan until the participant specifically elects not to have such contributions made (or elects to have contributions made at a different percentage); and
• Contributions are invested in accordance with the default investment provisions of ERISA Sec. 404(c)(5) in accordance with guidelines to be issued by the DOL, and affected participants receive an annual notice explaining their right to direct investments and have a reasonable opportunity to do so.
Notice requirement. The plan administrator of a plan with an automatic contribution arrangement must, within a reasonable period before a plan year, provide to each participant to whom the arrangement applies for that plan year with notice of the participant's rights and obligations under the arrangement. This notice must include an explanation of the following:
• That the participant has a right to elect not to have elective contributions made on his or her behalf (or to elect to have such contributions made at a different percentage);
• That such an election must be made within a reasonable period of time after receipt of the notice and before the first contribution is made; and
• How contributions made under the arrangement will be invested in the absence of any investment election by the participant.
This is the same information that must be in the notice if a plan has an EACA that qualifies for the 90-day period to reverse or reduce automatic contributions and the 180-day extended period to correct excess contributions.
Note: The preemption rules are not limited to arrangements that meet the requirements of a qualified automatic enrollment feature. A plan administrator must provide notice to each participant to whom the automatic contribution arrangement applies. If the notice requirement is not satisfied, a penalty of $1,100 per day applies.
Default Investment Safe Harbor
The DOL regulations provide guidelines for employers in selecting default investments that best serve the retirement needs of workers who do not direct their own investments. The regulations set out conditions to obtain safe harbor relief from fiduciary liability for the investment outcomes of default investments (29 CFR Sec. 2550.404c–5). The requirements for the safe harbor are:
• Assets must be invested in a “qualified default investment alternative” (QDIA) as defined in the regulation.
• Participants and beneficiaries must have been given an opportunity to direct their investments but have not done so.
• An initial notice generally must be furnished to participants and beneficiaries in advance of the first investment in the QDIA and annually thereafter.
• Material, such as investment prospectuses, provided to the plan for the QDIA must be furnished to participants and beneficiaries.
• Participants and beneficiaries must have the opportunity to direct investments out of a QDIA as frequently as from other plan investments, but at least quarterly.
• Fees that can be imposed on a participant who opts out of participation in the plan or who decides to direct his or her own investments are limited.
• The plan must offer a “broad range of investment alternatives” as defined in the DOL's ERISA Sec. 404(c) regulations.
Warning: Qualifying for the safe harbor does not absolve fiduciaries of the duty to prudently select and monitor QDIAs.
Selecting QDIAs. The DOL regulation does not identify specific investment products that are QDIAs. Instead it describes mechanisms for investing participant contributions. The intent is to ensure that an investment qualifying as a QDIA is appropriate as a single investment capable of meeting an employee’s long-term retirement savings needs. The final regulation identifies two individually based mechanisms and one group-based mechanism and also provides for a short-term investment for administrative convenience. The four types of QDIAs are:
• A product with a mix of investments that takes into account the individual’s age or retirement date (such as a life-cycle or targeted-retirement-date fund)
• An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date (such as a professionally managed account)
• A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (such as a balanced fund)
• A capital preservation product such as a money market fund for use during the first 120 days of participation only (This option is for plan sponsors wishing to simplify administration if workers opt out of or reduce their automatic enrollment contribution during the first 90 days after their first contribution.)
A QDIA must either be managed by an investment manager, plan trustee, or plan sponsor (including an investment committee made up of employees) who is a named fiduciary or by an investment company registered under the Investment Company Act of 1940. A QDIA generally may not invest participant contributions in employer securities. A QDIA may be offered through variable annuity contracts or other pooled investment funds.
Stable value funds. The safe harbor does not include stable value funds.
Initial QDIA notice. The initial QDIA notice must be provided:
• At least 30 days before the date of plan eligibility or at least 30 days before the first investment in a QDIA on behalf of a participant or beneficiary; or
• On or before the date of plan eligibility, provided the participant has the opportunity to make a permissible withdrawal without adverse financial consequences.
Annual QDIA notice. The annual QDIA notice must be provided within a reasonable period of time of at least 30 days before the beginning of the plan year. The DOL has indicated that the notice may be provided as early as 90 days before the beginning of the plan year. In addition, the QDIA notice may be combined with the automatic enrollment notice required by the IRS for plans that utilize the automatic enrollment safe harbor (DOL Field Assistance Bulletin No. 2008-03). The IRS and the DOL have collaborated to provide a "Sample Automatic Enrollment and Default Investment Notice" for satisfying both notice requirements. The sample notice may be accessed at http://www.irs.gov.
QDIA notice content. The QDIA notice must be written in a manner calculated to be understood by the average participant and must contain the following:
• A description of the circumstances under which assets in the individual account of a participant or beneficiary may be invested on behalf of the participant or beneficiary in a QDIA and, if applicable, an explanation of the when elective contributions will be made on behalf of a participant, the percentage of such contributions, and the right of the participant to elect not to have such contributions made on the participant's behalf (or to elect to have such contributions made at a different percentage);
• An explanation of the right of participants and beneficiaries to direct the investment of assets in their individual accounts;
• A description of the QDIA, including a description of the investment objectives, risk, and return characteristics (if applicable), and fees and expenses associated with the investment alternative;
• A description of the right of the participants and beneficiaries for whom assets are invested in a QDIA to direct the investment of those assets to any other investment alternative under the plan, including a description of any restrictions, fees, or expenses that might be charged for the transfer; and
• An explanation of where the participants and beneficiaries can obtain investment information concerning the other investment alternatives available under the plan.
expand-collapse section Fixing Retirement Plan Problems
In retirement or pension plan administration, mistakes happen. Complex rules, constantly changing requirements, overwhelming paperwork and, quite simply, the “human element” virtually ensure that plan administrators will err.
Sometimes, correction means appealing to the appropriate government agency (for example, the IRS, the DOL, or the Pension Benefit Guaranty Corporation) for relief and approval. Often, however, plan sponsors will not want to take relatively minor operational failures to the oversight agencies, particularly if the plan can correct the problem and put everything back to where it was before the problem occurred.
Although every administrative pension plan problem is unique, there are certain common methods that can be applied in solving, mitigating, or avoiding sanctions, penalties, and damages:
• Don’t panic. The most important step toward finding an answer to a problem is to identify the problem and recognize that something needs to be done. Once the problem is identified (hopefully as early as possible), it can be dealt with before it becomes an even bigger problem.
• Avoid artificial deadlines for action. It is always dangerous for administrators to move too quickly; sometimes the most obvious or the best answer to a problem can be overlooked simply because one is in a hurry to do something.
• Find out all the facts. Do not assume any facts or try to “mold” the facts to fit a given situation. One way of fact-finding is to conduct a self-audit from time to time.
• Develop solutions. Review the legal requirements with the particular fact situation in mind, and formulate a number of different solutions. Sometimes, only one solution is possible. In other cases, there may be several possible solutions, but they all seem to be pretty bad. Remember, though, that sometimes the best answer is the least bad answer.
• Implement the solution. This may seem obvious but is often difficult because of impediments from affected employees or organizational bureaucracy. At this point, an administrator may wish to obtain a legal opinion or other guidance from outside sources to help implement the correct approach.
It is also important to document each problem and solution, because a history of the plan’s administrative decisions can be useful going forward.
expand-collapse section Plan Audits
If being audited, plan sponsors first will receive a document request letter from whichever federal agency (for example, the IRS or the DOL) is going to audit their plan. On receiving the data request, most plan sponsors seek an extension of time to gather the necessary information. To make the process more efficient and speed resolution of plan audits, the IRS in November 2016 issued a memorandum that outlines specific time frames for the IRS examiner when preparing, issuing, and following up on an Information Document Request (IDR).
The IDR is generally a long list of documents. These can be hard to locate, especially if there has been turnover in the plan sponsor’s corporate area responsible for the plan. A recent service provider change also can complicate the data-gathering process. The new procedure requires the examiner to wait 14 calendar days after mailing an initial contact letter before taking further action.
The initial contact letter informs the plan sponsor that its plan has been selected for audit. Next, the IRS examiner will call the plan sponsor to discuss the issue being examined and the items requested in the IDR. The examiner will be looking to establish a response date or actual on-site appointment date and can assign a reasonable response date if the parties involved cannot agree on one. If the plan sponsor’s response is not complete, the examiner may grant up to two 15-day extensions.
If it is still not complete, the examiner at that point can start the delinquency notice process. If information is not received within the agreed-on time (up to 10 business days), a summons can be issued, which is a much swifter and more serious expediting process than existed previously.
Given this new procedure, it will be wise for plan sponsors to conduct periodic self-audits. At a minimum, this will help ensure that the plan sponsor can respond in a timely fashion to the IDR.
The DOL recently has stepped up its audit activities. It selects plans for audit based on:
• Participant complaints;
• Problems with a recent health and welfare plan audit;
• Referrals by other agencies;
• The DOL’s own initiatives;
• Data from Form 5500 submittals; and
• News coverage, such as reports of plant shutdowns or other disruptions.
To prepare for a possible DOL audit, if you receive a detailed comment letter from your independent auditor, read it carefully and respond to each item. Generally, it boils down to knowing your plan document, understanding what your plan’s service provider offers versus the plan administration activities occurring in-house, and the quality of the data you have on plan participants.
expand-collapse section Plan Correction Programs
Often, the terms of a qualified plan are less important than how the plan is actually being administered. The IRS has various programs in place intended to monitor qualification compliance and help plan sponsors and administrators keep their plans qualified. The IRS developed the Employee Plans Compliance Resolution System (EPCRS), which includes three programs related to qualification errors of administration:
• Self-Correction Program (SCP) for insignificant failures, allowing plan sponsors with established policies and procedures to self-correct without submission to the IRS;
• Voluntary Correction with Service Approval (VCP), allowing plan sponsors to pay a compliance fee and file with the IRS for approval; and
• Correction on Audit (Audit CAP) for plan failures identified by the IRS upon examination.
These EPCRS programs involve full corrective action and, potentially, penalties but provide a way to avoid plan disqualification. The IRS’s detailed guidance outlining the EPCRS was consolidated and updated in Revenue Procedure 2016-51.
Certain types of issues cannot be resolved through any of the EPCRS programs. For example, excise taxes and any additional penalty taxes (such as the early distribution tax) are generally not waived due to correction under the EPCRS. Nor is the EPCRS available for errors that do not implicate the plan’s qualified status, such as prohibited transactions or failing to file a required Form 5500.
Last updated on April 28, 2020.
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expand-collapse sectionRetirement Savings/401(k) Plans Overview
What do employers need to consider regarding retirement savings and 401(k) plans? One of the most popular and widely offered retirement plan options is the cash or deferred arrangement (CODA), commonly known as a 401(k) plan, after the section of the Internal Revenue Code (IRC) that authorizes them. A CODA is a special type of defined contribution plan under which an eligible employee can elect to have the employer defer part of his or her salary and contribute the deferred amount to the plan or receive the full amount of the salary as cash. If an employee chooses to defer compensation, it is not subject to income taxation until it is withdrawn from the plan.
The advent of the 401(k) plan began a major shift in the way Americans plan and save for retirement. The days of relying on traditional employer-provided pension plans as the primary source of retirement income are fast becoming extinct. In their place are 401(k) plans in which employees can save for retirement on a pretax basis, and employers can better control their retirement costs because there are no minimum funding levels or guaranteed retirement benefits.
Other employer-sponsored retirement plans that are similar to but simpler to administer than 401(k) plans include simplified employee pensions (SEPs) and SIMPLE plans. These plans have specified minimum requirements and offer less design flexibility in return for simple administration. Additionally, educational institutions and nonprofit organizations may provide 403(b) plans for their employees. Government employers may sponsor 457 plans. These plans have many of the same features and restrictions as 401(k) plans.
Despite the growing predominance of 401(k) and other defined contribution retirement plans, some employers still have defined benefit pension plans. In 2006, the Pension Protection Act (PPA) imposed new funding and disclosure requirements for these plans. PPA’s funding provisions, including minimum contributions and potential excise tax sanctions, were implemented by the Internal Revenue Service (IRS) in 2015 final rules.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted as part of a December 2019 appropriations bill, made many changes to the retirement plan requirements. These include:
• Pushing back the starting age of required minimum distributions (RMDs) from 701/2 to 72, for participants who turn 701/2 in 2020 or later;
• “Lifetime income” disclosure provisions requiring plan sponsors to quantify the payments a defined contribution (401(k) or 403(b)) plan would yield if structured as a lifetime annuity, and a fiduciary safe harbor for plan sponsors that actually offer such an annuity;
• An option for plans to allow a distribution of up to $5,000 within 1 year after a child is born to, or adopted by, the plan participant;
• Changes to the notice and contribution requirements for “safe harbor” 401(k) plans;
• A requirement that certain “long-term part-time employees” be allowed to participate, for plan years beginning in 2021 and thereafter; and
• Beginning in 2021, a new type of arrangement called the “pooled employer plan” that unrelated small employers can sponsor jointly.
CARES Act Provisions
The Coronavirus Aid, Relief, and Economic Security (CARES) Act included certain amendments to retirement plan rules to help plan sponsors and participants cope with the fallout from the COVID-19 crisis.
Plan loans. The CARES Act temporarily increases the maximum permissible plan loan amount from $50,000 to $100,000 and the maximum percentage of the vested account balance from 50 percent to 100 percent. These provisions expire September 23, 2020. For any previously outstanding loans due in 2020, the act provides a 1-year payment extension.
Distributions. The act also allows a “coronavirus-related distribution” of up to $100,000 without the usual early withdrawal penalty by someone:
• Who was diagnosed with the virus;
• Whose spouse or dependent was diagnosed; or
• Who has adverse financial consequences due to being quarantined, furloughed, or laid off; having reduced hours; or being unable to work due to lack of child care.
Small business owners whose business closed or had reduced hours due to COVID-19 are also eligible.
These distributed funds can be put back into the account within 3 years of the date the distribution was received, and the income tax on the distribution can be spread over 3 years as well.
For individuals of retirement age who don’t currently need the funds, the CARES Act waives the usual required minimum distributions (RMDs) for 2020. This applies to anyone required to take an RMD, without the need to show any specific impact from COVID-19.
Plan amendments. Even if a current plan document doesn’t allow for these distributions or loans, plan sponsors can adopt the distribution and loan provisions effective immediately. The plan would need to be formally amended before the end of the first plan year beginning after January 1, 2022.
Defined benefit plans. Sponsors of single-employer defined benefit plans may defer minimum required contributions until the end of 2020. The CARES Act also includes certain relief from meeting funding targets during 2020.
expand-collapse section401(k) Plan Requirements
Because 401(k) plans are tax-qualified defined contribution plans that include a CODA, they must satisfy all of the requirements for qualified plans, the special requirements of IRC Sec. 401(k), and all the Employee Retirement Income Security Act (ERISA) requirements that apply to defined contribution plans, including minimum participation and vesting standards, fiduciary rules, and reporting and disclosure requirements. Many special rules apply to 401(k) plans, including special vesting and nondiscrimination testing requirements. In addition, the rules on plan loans and blackout periods, while they impact other types of retirement plans, most often affect the design and administration of 401(k) plans. Please see the national ERISA, national Benefits Recordkeeping and Disclosures sections.
Design Considerations
While many 401(k) plans only include a CODA, they often also provide for employer-matching contributions and discretionary employer contributions. Many CODAs are part of a larger defined contribution plan that may include a profit-sharing component. For some employers, a 401(k) plan is part of a retirement package that may include a defined benefit plan or a hybrid plan.
Matching contributions. Perhaps the most crucial design consideration for a 401(k) plan sponsor is whether and how to provide matching contributions. Matching contributions are the best way to encourage employees to participate in a 401(k) plan. A 100 percent match is a large incentive to participation but is also expensive. Common match formulas are 50 percent of employee contributions up to the first 6 percent of compensation and no match on the portion of the contribution that exceeds 6 percent of compensation.
Contributions of unused paid time off. The IRS has ruled that a 401(k) plan may permit contributions of payments employees would receive for unused vacation or other similar leave at the end of the year or at termination of employment, whether the contributions are employer contributions or elective 401(k) contributions (Rev. Rul. 2009-31 and Rev. Rul. 2009-32). The 401(k) nondiscrimination tests must still be passed, and the contributions may not exceed any applicable limits, including the limit on total contributions to an individual's account during a year. In addition, a plan participant does not include in gross income the dollar equivalent of unused paid time off that is not contributed to the 401(k) plan until the year in which the amount is paid to the participant.
Contribution Limits
The IRS provides for dollar limitations on benefits and contributions under qualified retirement plans, including 401(k) plans. These limits are adjusted annually for cost-of-living increases. For current limits on an employee’s elective deferrals to a 401(k) plan, visit http://www.irs.gov. A plan may provide for the employer to match all, part, or none of an employee's deferrals.
Accelerated Vesting
Employer contributions to defined benefit plans, including matching contributions to 401(k) plans, must vest either 100 percent after 3 years of service or 20 percent per year of service beginning after the second year and reaching 100 percent after 6 years.
SEP and SIMPLE individual retirement account (IRA) (and other IRA-based) plans require that all contributions to the plan are always 100 percent vested.
Requirement for Deposit of Employee Contributions
Because ERISA's fiduciary rules bar employers from using plan assets for their own benefit, the Department of Labor (DOL) has issued regulations that define when employees' contributions to a benefit plan become plan assets, must no longer be in the employer's possession, and must be deposited into a plan account. This is the number one fiduciary trouble spot. Late deposits are an invitation for an audit by the DOL.
In general, amounts that a participant had withheld from his or her wages by an employer for contribution to an ERISA plan are deemed to be plan assets on the earliest date on which such contributions can reasonably be segregated from the employer's general assets. However, in no case may pension benefit plan and welfare benefit plan deposits of employee contributions be made later than the 15th business day of the month following the month in which such amounts would otherwise have been payable to the participant in cash. This rule also applies to SIMPLE IRAs and salary reduction SEPs.
Warning: The DOL's rule of thumb is that small plans sponsored by an employer with a simple payroll process should be able to make deposits of employee contributions within 7 days. Large plans, which may have multiple locations and multiple paydays, should be able to make deposits within 10 to 14 days, in the DOL's view. The deposit timing rules apply to withholding for plan loan repayments as well as employee contributions.
Small employer safe harbor. The DOL regulations create a safe harbor for plans with fewer than 100 participants if deposits of employee contributions are made within 7 business days of receipt or withholding. Thus, if such plans make their deposits within 7 business days, the deposit is deemed to be on time without having to determine when they reasonably could be segregated. To qualify for the safe harbor, loan repayments must also be deposited within 7 business days. Participant contributions are considered deposited when placed in an account of the plan, without regard to whether the contributed amounts have been allocated to specific participants or investments. The safe harbor also applies to SIMPLE IRAs and salary reduction SEPs.
Restrictions on 401(k) Distributions
Generally, distributions from a 401(k) plan cannot be made until a distributable event occurs. A “distributable event” is an event that allows distribution of a participant’s plan benefit and includes the following situations:
• The employee dies, becomes disabled, or otherwise has a severance from employment.
• The plan is terminated and no other defined contribution plan is established or continued.
• The employee reaches the age of 591/2 or suffers a financial hardship.
Tax on early distributions. If a distribution is made to an employee before he or she reaches the age of 591/2, the employee may have to pay a 10 percent additional tax on the distribution. This tax applies to the amount received that the employee must include in income. The 10 percent tax does not apply to distributions before the age of 591/2 if the distribution is:
• Made to a beneficiary (or to the estate of the employee) on or after the death of the employee
• Made due to the employee having a qualifying disability
• Made as part of a series of substantially equal periodic payments beginning after separation from service and made at least annually for the life or life expectancy of the employee or the joint lives or life expectancies of the employee and his or her designated beneficiary (The payments under this exception, except in the case of death or disability, must continue for at least 5 years or until the employee reaches age 591/2, whichever is the longer period.)
• Made to an employee after separation from service if the separation occurred during or after the calendar year in which the employee reached the age of 55
• Made to an alternate payee under a qualified domestic relations order (QDRO)
• Made to an employee for medical care up to the amount allowable as a medical expense deduction (determined without regard to whether the employee itemizes deductions)
• Timely made to reduce excess contributions under a 401(k) plan
• Timely made to reduce excess employee or matching employer contributions (excess aggregate contributions)
• Timely made to reduce excess elective deferrals
• Made because of an IRS levy on the plan
• Made as a qualified reservist distribution
Distribution starting requirements. Benefit payment must begin when required. Unless the participant chooses otherwise, the payment of benefits to the participant must begin within 60 days after the close of the latest of the following periods:
• The plan year in which the participant reaches the earlier of age 65 or the normal retirement age specified in the plan
• The plan year that includes the 10th anniversary of the year in which the participant began participating in the plan
• The plan year in which the participant terminates service with the employer
Minimum distribution requirements. A 401(k) plan must provide that each participant will either:
• Receive his or her entire interest (benefits) in the plan by the required beginning date (defined below), or
• Begin receiving regular periodic distributions by the required beginning date in annual amounts calculated to distribute the participant's entire interest (benefits) over his or her life expectancy or over the joint life expectancy of the participant and the designated beneficiary (or over a shorter period).
These required distribution rules apply individually to each qualified plan. The required distribution from a 401(k) plan cannot be satisfied by making a distribution from another plan. The plan document must provide that these rules override any inconsistent distribution options previously offered. When the participant’s account balance is to be distributed, the plan administrator must determine the minimum amount required to be distributed to the participant each calendar year.
The required beginning date for distributions is April 1 of the first year after the later of:
• The calendar year in which the participant reaches the age of 72, or
• The calendar year in which the participant retires.
The SECURE Act raised this age to 72 from 701/2. The change takes effect for individuals who turn 701/2 on or after January 1, 2020.
A plan may require that the participant begin receiving distributions by April 1 of the year after the participant reaches the age of 72, even if the participant has not retired.
If the participant is a 5 percent owner of the employer maintaining the plan, the participant must begin receiving distributions by April 1 of the first year after the calendar year in which the participant reaches the age of 72.
Distributions after the starting year. The distribution required to be made by April 1 is treated as a distribution for the starting year. (The starting year is the year in which the participant reaches the age of 72 or retires, whichever applies, to determine the participant’s required beginning date.) After the starting year, the participant must receive the required distribution for each year by December 31 of that year. If no distribution is made in the starting year, required distributions for 2 years must be made in the next year (one by April 1 and one by December 31).
Hardship Distributions
The IRS regulations set out the requirements for hardship distributions from a 401(k) plan. The plan must specifically permit such a distribution. In addition, a distribution qualifies as a hardship distribution only if it is both (1) made because of an immediate and heavy financial need of the employee and (2) is necessary to satisfy the financial need. The determination of the existence of an immediate and heavy financial need and of the amount necessary to meet the need must be made in accordance with nondiscriminatory and objective standards set forth in the plan and must be made separately. The maximum amount of a hardship distributable amount is an employee’s total elective contributions as of the date of distribution, reduced by the amount of previous distributions of elective contributions.
Determination of an immediate and heavy financial need. Whether an employee has an immediate and heavy financial need is to be determined based on all the relevant facts and circumstances. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee. A distribution is deemed to be due to an immediate and heavy financial need of the employee if the distribution is for:
• Medical care expenses of the employee, the employee's spouse, dependents, or a primary beneficiary under the plan
• The purchase of a principal residence for the employee (excluding mortgage payments)
• Tuition, related educational fees, and room and board expenses for up to the next 12 months of postsecondary education for the employee, the employee’s spouse, children, dependents, or a primary beneficiary under the plan
• Preventing eviction from or foreclosure of the mortgage on the employee’s principal residence
• Burial or funeral expenses for the employee’s deceased parent, spouse, children, dependents, or a primary beneficiary under the plan
• Repairing damage to the employee’s principal residence that could qualify for the casualty deduction on the employee's federal income tax return
Under the Tax Cuts and Jobs Act of 2017, this last circumstance is now limited to home repairs that result from presidentially declared disasters.
A “primary beneficiary under the plan” is an individual who is named as a beneficiary under the plan and has an unconditional right to all or a portion of the participant’s account balance under the plan upon the death of the participant.
For circumstances that do not fall under one of the six safe harbors listed above, regulations proposed on November 14, 2018 (83 Fed. Reg. 56763), replace the “all relevant facts and circumstances” test with a three-part standard:
1. The hardship distribution must not exceed the amount of an employee’s need, including any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution.
2. The employee already must have obtained all other currently available distributions and nontaxable loans under the plan and all other plans maintained by the employer.
3. The employee must represent that he or she has insufficient cash or other liquid assets to satisfy the financial need. Consistent with the current standard, a plan administrator will be allowed to rely on a participant’s representation of the need unless the plan administrator has actual knowledge to the contrary.
403(b) and 457 plans. The hardship distribution rules also apply to 403(b) and 457 plans.
Birth or adoption. Beginning in 2020, a plan may allow a distribution of up to $5,000 within 1 year after a child is born to, or adopted by, the plan participant.
COVID-19. The CARES Act allows special distributions in 2020 for hardships related to COVID-19 (see “CARES Act Provisions,” above).
Withdrawals for Individuals Called to Active Military Duty
There is an exemption from the 10 percent early withdrawal penalty for individuals ordered or called to active duty. A "qualified reservist distribution" is a distribution that is:
• Made from an IRA or attributable to elective deferrals under a 401(k) plan, 403(b) annuity, or certain similar arrangements;
• Made to an individual who was ordered or called to active military duty for a period in excess of 179 days or for an indefinite period; and
• Made during the period beginning on the date of such order or call to duty and ending at the close of the active duty period.
A 401(k) plan does not violate the distribution restrictions if it makes a qualified reservist distribution.
An individual who receives a qualified reservist distribution may, during the 2 years following the end of his or her active duty, make one or more contributions to an IRA of the amount of such distribution.
401(k) Plan Loans
One of the most popular features of 401(k) plans is a provision allowing participants to borrow money from their own accounts. Under the DOL regulations, the loan must be available to all participants and beneficiaries on a reasonably equivalent basis, must not be available to highly paid employees in an amount greater than available to other employees, must be specifically provided for in the plan document, must bear a reasonable interest rate, and must be adequately secured. The loan may be secured by the participant's account balance. A loan secured by 50 percent of the account balance is considered adequately secured. A loan is not treated as a distribution by the IRS (resulting in income tax consequences) if it meets at least the following specific requirements:
• The loan plus the participant's other outstanding loans from the plan may not exceed $50,000.
• The outstanding balance of loans may not exceed the greater of one-half of the participant's vested benefits.
• Unless the proceeds are used to purchase a principal residence, the loan must be paid back in 5 years or less.
• The loan must be paid back in equal payments made at least four times per year.
• The loan is evidenced by an enforceable agreement.
Note: The Sarbanes-Oxley Act Sec. 402 prohibits publicly held companies from making personal loans to their directors and executive officers. This arguably includes 401(k) loans. In view of the steep penalties that may be imposed for violating Sarbanes-Oxley, a very conservative approach would be to advise executive officers not to make new 401(k) loans or amend 401(k) plans to bar loans to executive officers. The DOL indicated in Field Assistance Bulletin 2003-1 that restrictions on loans to all officers and directors do not violate participant loan rules under ERISA.
Restrictions on Cash-Outs
Employers may not force an employee whose accrued vested benefit is worth more than $5,000 to take a distribution of benefits when the employee terminates employment. The employer must allow the employee to keep the money in the plan until retirement age. Plans may require that terminating employees with accrued vested benefits of less than $5,000 take a cash-out, thus reducing the administrative cost of maintaining small accounts and keeping track of former employees.
Required Rollovers
Employer-mandated cash-outs of more than $1,000 from a qualified retirement plan must be paid as a direct rollover to an IRA setup by the employer for the employee unless the terminating employee elects to have the amount rolled over to another retirement plan or IRA or to receive the distribution directly. In circumstances in which a portion of the distribution is attributable to a previous rollover contribution, the rollover requirement may apply to distributions of more than $5,000. The portion of the account attributable to the previous rollover is not counted for the determination of whether the present value of the accrued vested benefit is $5,000 or less. On the other hand, the amount attributable to the previous rollover is counted when determining if the cash-out exceeds $1,000.
Plans that provide for mandatory distributions have to include a provision reflecting the automatic rollover requirements.
The plan administrator must notify the distributee in writing that the distribution may be paid in a direct rollover to an IRA. The notice may be mailed to the participant's most recent mailing address in the records of the employer or plan administrator. This notice may also be distributed electronically.
The automatic rollover provisions apply to governmental plans, including deferred compensation plans under IRC Sec. 457, to 403(b) plans, and to church plans.
The DOL regulations provide for a safe harbor to protect retirement plan fiduciaries from liability when they select an institution to provide the IRAs and select the investments for these accounts. For the safe harbor to apply, the selected IRA provider must be qualified to offer individual retirement plans; the investment options must be designed to preserve principal; and the fees and expenses may not exceed those charged by the selected provider to its other IRA customers.
Avoiding the rollover requirement. Many employers are avoiding the complications of required rollovers by not cashing out accounts with a balance of more than $1,000.
401(k) Nondiscrimination Rules
Special nondiscrimination rules apply to 401(k) plans in addition to all the regular requirements for tax-favored retirement plans. These rules are designed to prevent discrimination in elective contributions, matching contributions, and employee after-tax contributions. These rules, the actual deferral percentage (ADP) test and the actual contribution percentage (ACP) test, are also very complex and discourage many employers from adopting a 401(k) plan. Under the ADP test, the ADP for eligible highly compensated employees (HCEs) must either:
• Not be more than 125 percent of the ADP for nonhighly compensated employees (NHCE); or
• Not more than 2 percentage points greater than that of the NHCE and not be more than 200 percent of that of the NHCE.
The ACP applies similar formulas to the sum of employee contributions and employer-matching contributions. If a plan is going to fail the ACP or ADP tests, corrections must be made that often involve reducing the deferrals of HCEs.
The IRS's final 401(k) regulations include a provision designed to prevent plans from circumventing the nondiscrimination rules. Under this antiabuse provision, a plan will not be treated as satisfying the nondiscrimination requirements if there are repeated changes to plan testing procedures or plan provisions that have the effect of distorting the ADP so as to increase significantly the permitted ADP for HCEs. In addition, plans are barred from otherwise manipulating the nondiscrimination rules if a principal purpose of the changes was to increase or distort the ADP for HCEs.
ADP/ACP safe harbors. 401(k) plans will generally be eligible for a safe harbor that may automatically satisfy the nondiscrimination requirements if they are designed to meet either of the following criteria:
• Provide guaranteed, 100 percent vested contributions of at least 3 percent of compensation for each NHCE who is eligible to participate; or
• Provide a 100 percent vested matching contribution on all of each non-HCE's elective contributions up to 3 percent of compensation and on 50 percent of the elective contribution that is between 3 percent and 5 percent of compensation.
401(k) plans, however, are required to specify the method they will use to satisfy the nondiscrimination requirements in their plan documents. Thus, a safe harbor plan may not specify that ADP testing will be used if the safe harbor requirements are not satisfied.
In addition, 401(k) safe harbor plans must provide each eligible employee with a written notice of the employee’s rights and obligations under the plan. This notice may be provided electronically. The notice must be sufficiently accurate and comprehensive to inform employees of the their rights and obligations under the plan, be written in a manner calculated to be understood by the average employee eligible to participate in the plan, and contain the following information:
• The safe harbor contribution formula used under the plan (including a description of the levels of safe harbor matching contributions, if any, available under the plan)
• Any other contributions under the plan or matching contributions to another plan on account of elective contributions or employee contributions under the plan (including the potential for discretionary matching contributions) and the conditions under which such contributions are made
• The plan to which safe harbor contributions will be made (if different than the plan containing the cash or deferred arrangement)
• The type and amount of compensation that may be deferred under the plan
• How to make cash or deferred elections, including any administrative requirements that apply to such elections
• The periods available under the plan for making cash or deferred elections
• Withdrawal and vesting provisions applicable to contributions under the plan
• Information that makes it easy to obtain additional information about the plan (including an additional copy of the summary plan description) such as telephone numbers, addresses and, if applicable, electronic addresses of individuals or offices from whom employees can obtain such plan information
A plan may satisfy the requirements to provide information about other contributions or matching contributions to another plan, the plan to which safe harbor contributions will be made, or the type and amount of compensation that may be deferred under the plan by providing cross-references to the relevant portions of a summary plan description that provides the same information and has been provided (or is concurrently provided) to employees.
The notice must be provided within a reasonable period before the beginning of the plan year (or within a reasonable period before an employee becomes eligible). This requirement is deemed satisfied if the notice is provided at least 30 days and no more than 90 days before the beginning of each plan year. For newly eligible employees, who become eligible after the 90th day before the beginning of the plan year, the notice must be provided no more than 90 days before the employee becomes eligible and no later than the date the employee becomes eligible.
Beginning in 2020, the annual notice is only required for matching contribution safe harbor plans (not nonelective contribution plans).
A 401(k) safe harbor plan must generally be adopted before the beginning of the plan year and be maintained throughout a full 12-month plan year. The IRS's 401(k) regulations also make it easy for employers to implement safe harbor plans by allowing plan sponsors to wait until 30 days before the end of the plan year to adopt a 3 percent automatic contribution feature. The plan must specify that it will use NHCEs' current year ADPs in the event that the sponsor decides not to utilize the safe harbor. A contingent notice must be given 30 to 90 days before the beginning of the plan year indicating that safe harbor nonelective contributions may be made. A follow-up notice must be provided at least 30 days before the end of the plan year stating that safe harbor contributions will be made. Plans are not required to continue using that feature in the following year and are not limited on the number of times that they may switch back and forth.
Although safe harbor 401(k) plans provide generous benefits, they are also attractive because they greatly simplify plan administration and eliminate the possible need for HCEs to take back a portion of their elective deferrals to satisfy nondiscrimination requirements.
Note: One of the drawbacks to adopting a safe harbor plan has been the rapid vesting of the mandatory employer contributions. With the gap between safe harbor vesting and non-safe harbor vesting narrowed by the minimum vesting requirements for matching contributions to 401(k) plans, the cost increase of adopting a safe harbor plan is diminished, especially for employers that already provide a “3 percent of” compensation match. In addition, while lower-paid employees are not likely to take advantage of the increased contribution limits because they generally make contributions that are well below the current limits, higher-paid employees are going to want to take advantage of the increased limits. This will make it more difficult for plans to pass the ADP and ACP tests. Utilizing a safe harbor may not be too much of an expense, especially when it keeps key employees happy, because they can maximize their 401(k) contributions and reduce the time and expense of performing the antidiscrimination tests and correcting any excess contributions.
Suspending nonelective contributions to safe harbor plans due to business hardship. The IRS’s final regulations allow employers to reduce or suspend safe harbor contributions (nonelective or matching) in the event of financial hardship. Safe harbor matching contributions may be reduced or suspended under a midyear amendment only if the employer is operating at an economic loss, or if the notice provided to participants before the beginning of the plan year discloses that the contributions might be reduced or suspended midyear, that participants will receive a supplemental notice if that occurs, and that the reduction or suspension will not apply until at least 30 days after the supplemental notice is provided. Additionally:
• All eligible employees must be provided a supplemental notice of the reduction or suspension when it occurs;
• The reduction or suspension of safe harbor nonelective contributions can be effective no earlier than the later of 30 days after eligible employees are provided the supplemental notice or the date the amendment is adopted;
• Eligible employees must be given a reasonable opportunity (including a reasonable period after receipt of the supplemental notice) before the reduction or suspension of the safe harbor nonelective contributions to change their contribution elections; and
• The plan must be amended to provide that the ADP test (and/or ACP test) will be satisfied for the entire plan year in which the reduction or suspension occurs, using the current year testing method.
The supplemental notice requirement is satisfied if each eligible employee is given a notice that explains:
• The consequences of the amendment reducing or suspending employer contributions;
• The procedures for changing deferred or posttax contribution elections; and
• The effective date of the plan amendment.
401(k) Blackout Periods
The Sarbanes-Oxley Act requires prior notices of 401(k) blackout periods and bars directors and executives from trading employer stock during blackout periods.
Blackout period definition. A "blackout period" is any period of more than 3 consecutive business days during which the ability of participants or beneficiaries under an individual account plan to direct or diversify assets credited to their accounts, to obtain loans from the plan, or to obtain distributions from the plan is temporarily suspended, limited, or restricted. A blackout period does not include a suspension, limitation, or restriction that:
• Occurs because of the application of the securities laws
• Is regularly scheduled under the plan and that has been disclosed to affected plan participants and beneficiaries through an official plan document
• Occurs because of a qualified domestic relations order or because of a pending determination whether a domestic relations order filed (or reasonably anticipated to be filed) with the plan is a qualified order
• Occurs by reason of an act or a failure to act on the part of an individual participant or by reason of an action or claim by a party unrelated to the plan involving the account of an individual
Blackout notice requirements. At least 30 days before a blackout period, the plan administrator is required to provide a notice to affected plan participants and beneficiaries written in simple language. A similar notice must be provided at the same time to issuers of employer securities. The DOL regulations include a model notice that may be used.
Blackout notice contents. The notice must contain the following information:
• The reasons for the blackout period
• An identification of the rights otherwise available under the plan that will be temporarily suspended, limited, or restricted
• The length of the blackout period by reference to the expected beginning and ending dates or the expected beginning or ending calendar weeks, provided that during such weeks, information about whether the blackout period has begun or ended is readily available without charge, such as via a toll-free number or access to a specific website, to affected participants and beneficiaries
• A description of how to access the blackout period information
• A statement that the participant or beneficiary should evaluate the appropriateness of their current investment decisions in light of their inability to direct or diversify assets credited to their accounts during the blackout period
• The name, address, and telephone number of the plan administrator or other contact responsible for answering questions about the blackout period
Blackout notice timing. The notice must be furnished to all affected participants and beneficiaries at least 30 days, but not more than 60 days, in advance of the last date on which such participants and beneficiaries could exercise the affected rights before the blackout period. The 30 days' advance requirement does not apply if:
• Postponing the blackout period would result in a violation of ERISA's exclusive benefit and prudence requirements, and a fiduciary of the plan reasonably so determines in writing.
• The inability to provide the advance notice of a blackout is the result of events that were unforeseeable or circumstances beyond the reasonable control of the plan administrator, and a fiduciary of the plan reasonably so determines in writing.
• The blackout period applies solely in connection with certain participants or beneficiaries becoming, or ceasing to be, participants or beneficiaries of the plan as a result of a business reorganization.
In these cases, the notice must be provided as soon as reasonably possible.
If the notice is not furnished within the prescribed time limits (unless the blackout period applies solely in connection with certain participants or beneficiaries becoming, or ceasing to be, participants or beneficiaries of the plan as a result of a business reorganization), it must include a statement that federal law generally requires that the notice be furnished to affected participants and beneficiaries at least 30 days in advance of the last date on which they could exercise the affected rights immediately before the commencement of a blackout period and an explanation of the reasons why at least 30 days' advance notice could not be furnished.
The notice may be provided electronically if recipients would have reasonable access to an electronic notice.
If the blackout period dates are changed, a revised notice must be provided as soon as reasonably practicable explaining what has changed and the reasons for those changes.
Blackout notice violations. If a plan administrator refuses or fails to provide the blackout notice in a timely manner, the DOL may assess a civil penalty of up to $100 per day for each participant or beneficiary who did not receive the notice.
Notice to issuer of employer securities. A similar notice must be provided within the same time frames to the issuer of employer securities held by the plan and subject to the blackout period.
Insider trading restrictions. The Sarbanes-Oxley Act prohibits directors or executive officers (insiders) from engaging in transactions involving employer securities outside of the plan during a blackout period. The insider trading prohibition applies to any employer securities acquired in connection with the insider's services or employment.
expand-collapse sectionRoth 401(k) Plans
The IRC allows 401(k) plans to be amended to add a "Roth" feature, which is similar to the Roth IRA. Under a 401(k) plan with the Roth feature added, an employee may make an after-tax contribution that will earn income tax-free. A qualified distribution of both the contribution and the income attributed to it will be tax-free when distributed. This is in contrast to regular 401(k) contributions, which are made before taxes, earn income tax-free but are taxed when distributed, including both the original contribution and the earnings attributed to it. The participant decides whether to designate elective contributions as Roth 401(k) contributions. A designation of an elective contribution as a Roth 401(k) contribution is irrevocable. Roth contributions must be maintained in a separate account from the time they are made until the account is completely distributed.
An employer may not have a Roth 401(k) plan only. There must always be the option of making regular 401(k) contributions.
Roth 401(k) contributions are still 401(k) contributions. This means that they:
• Are counted for ADP/ACP testing;
• Are eligible for catch-up contributions;
• Can be used to determine available loan amounts; and
• Must be immediately vested and be distributed only on occurrence of permitted distributable events.
Who may benefit from a Roth contribution? Using the Roth feature is not for everyone, but it may be beneficial to employees who will be in the same or a higher tax bracket when they retire. This will often be true of young employees who are just starting out and employees who currently have high income tax deductions (dependents, mortgage interest, property tax, etc.) that will be gone by the time of retirement. The decision to use a Roth or not is further complicated by the impact of the alternative minimum tax and the possible taxation of Social Security benefits and usually has to be made on an individual basis. In addition, an employee may designate all, part, or none of his or her contribution as a Roth contribution.
Qualified distribution requirements. A distribution is a "qualified distribution" that receives tax-free treatment if it was made after the 5-year period beginning with the first tax year for which a contribution was made to the Roth 401(k) account or to an earlier Roth 401(k) account from which a rollover occurred and was also made:
• On or after the participant attains the age of 591/2;
• After the participant's death; or
• After the participant's disability.
Roth 401(k) vs. Roth IRA. The main differences between Roth 401(k)s and Roth IRAs are:
• Roth 401(k) contributions are subject to the general 401(k) limit, while Roth IRA contribution limits are based on the IRA limit.
• Eligibility for a Roth IRA phases out at certain income levels. There is no income limit for Roth 401(k) eligibility.
• The age of 701/2 minimum distribution requirements do not apply during a Roth IRA owner's life, but they do apply during Roth 401(k) owners' lives.
• While traditional IRAs can be converted into Roth IRAs, no such option is available for 401(k) accounts.
expand-collapse sectionSimplified Retirement Plans
The IRC provides for other employer-sponsored retirement plans that are similar to but simpler to administer than 401(k) plans. SEPs and SIMPLE plans have specified minimum requirements and offer little design flexibility in return for simple administration.
SEPs
SEPs provide a means for employers, especially small employers, to provide tax-favored retirement plans for their employees without all the complex requirements of ERISA and the IRC. SEPs have simplified participation, vesting, and contribution limits. Employees aged 21 years or older who meet minimal annual earnings requirements and who have performed services for the employer in at least 3 of the preceding 5 calendar years must be included in the SEP. Contributions must be made for all employees who meet the participation standards during the calendar year, even if they are not employed at the time the contribution is made. SEPs offer deductible contribution limits similar to those for other tax-favored retirement plans. The contributions made to an employee's SEP account are 100 percent vested when made. SEP assets are managed by a financial institution that supplies information to employees. Employers sponsoring a SEP have limited reporting and disclosure duties. SEP contributions may not be made through a CODA.
SIMPLE Plans
Employers with 100 or fewer employees that do not sponsor another qualified retirement plan may adopt another kind of simplified retirement plan, the SIMPLE plan. Under a SIMPLE plan, employees can defer up to a certain amount (determined annually by the IRS) into either an IRA or a 401(k) account. For the current maximum contribution amount, visit http://www.irs.gov. Employers generally must match employee contributions on a dollar-for-dollar basis up to 3 percent of an individual's compensation. (This requirement does not apply if the employer makes nonelective contributions instead.) A lower percentage (but not less than 1 percent) may be elected in 2 out of any 5 years. Plans that meet these rules and provide 100 percent vesting automatically pass the complex nondiscrimination rules for retirement plans. SIMPLE plans are also subject to relaxed reporting and disclosure requirements.
A SIMPLE IRA may include an automatic contribution arrangement that provides for default contributions and investment options absent an employee's affirmative election not to contribute (IRS Notice 2009-66). The IRS has provided a sample amendment that may be used to add an automatic contribution arrangement to a SIMPLE IRA plan (http://www.irs.gov).
expand-collapse section403(b) and 457 Plans
IRC Secs. 403(b) and 457 provide for retirement plans that are similar to 401(k) plans with most of the same contribution limits and restrictions on distributions. Employees of educational institutions and nonprofit organizations are eligible to contribute to 403(b) plans through their employment. Government employers may sponsor 457 plans for their employees. Depending on the degree of involvement of the employer in administering the plan, 403(b) plans may or may not be covered by ERISA. Because they are government plans, 457 plans are exempt from coverage by ERISA.
403(b) Plan Requirements
A 403(b) plan may be established by a public school, a college or university, or charitable entity tax exempt under IRC Sec. 501(c)(3). 403(b) plans are similar to 401(k) plans. Just as with a 401(k) plan, a 403(b) plan lets employees defer some of their salary. In this case, their deferred money goes to a 403(b) plan sponsored by the employer. This deferred money and the earnings on it are generally not subject to taxation by the federal government or by most state governments until distributed. A 403(b) annuity can be carried with the participant when he or she changes employers or retires.
Under a 403(b) plan, employers may purchase annuity contracts or establish custodial accounts invested only in mutual funds for the purpose of providing retirement income for their eligible employees. Annuity contracts must be purchased from a state licensed insurance company, and the custodial accounts must be held by a custodian bank or IRS-approved non-bank trustee/custodian. The annuity contracts and custodial accounts may be funded by employee salary deferrals, employer contributions, or both. Although not subject to the qualification requirements of IRC Sec. 401, some of the requirements that apply to qualified plans also apply, with modifications, to 403(b) plans.
403(b) regulations. The regulations provide that a 403(b) program be maintained pursuant to a written defined contribution plan that satisfies Sec. 403(b) in both form and operation and contains all the terms and conditions for eligibility, limitations, and benefits under the plan. In addition, the regulations provide that:
• Elective deferrals are limited to contributions under a cash or deferred election as defined under IRC Sec. 401(k).
• Previously permitted eligibility restrictions are eliminated and employees must be universally eligible to make elective contributions. This change does not apply to governmental entities (such as public school districts).
• Contributions to plans not covered by ERISA must be transferred to providers within a reasonable time for proper plan administration (for example, transferring elective deferrals within 15 business days following the month in which these amounts would have been paid to the participant). These plans may terminate and distribute assets with full rollover ability, as well as recognize the occurrence of an employment severance where an employee no longer works for an employer eligible to maintain a 403(b).
ERISA exemption. 403(b) plans sponsored by a church or a government entity are exempt from ERISA. The DOL regulations also exempt 403(b)s that don't qualify for the church or government exemption from ERISA. A 403(b) plan that is funded solely through salary reduction agreements or agreements to forgo an increase in salary is not considered to be “established or maintained” by an employer and, therefore, is not an employee pension benefit plan subject to ERISA if:
• Participation of employees is completely voluntary;
• All rights under the annuity contract or custodial account are enforceable solely by the employee or beneficiary of such employee, or by an authorized representative of the employee or beneficiary;
• The involvement of the employer is limited to certain optional specified activities; and
• The employer receive no direct or indirect consideration or compensation in cash or otherwise other than reasonable reimbursement to cover expenses properly and actually incurred in performing the employer's duties pursuant to the salary reduction agreements.
The DOL has indicated that the 403(b) requirements provided in IRS regulations, including the written plan requirement, do not result in a 403(b) plan being covered by ERISA (DOL Field Assistance Bulletin No. 2007-02). The DOL specifically stated, for example, that an employer’s development and adoption of a single document to coordinate administration among different issuers and to address tax matters that apply, such as the universal availability requirement, without reference to a particular contract or account, would not result in a 403(b) program being covered by ERISA.
expand-collapse sectionCatch-Up Provisions
An increase in the otherwise applicable dollar limits on elective deferrals under 401(k) plans, 403(b) annuities, SEPs, SIMPLE plans, or 457 plans is allowed for individuals who have attained the age of 50 by the end of the year. For the current catch-up contribution limits, visit http://www.irs.gov. Catch-up contributions are not subject to any other contribution limit and are not subject to nondiscrimination rules. Plans must be amended to accept catch-up contributions and must provide that all eligible individuals may make catch-up elections. Employers may make contributions matching all or a percentage of catch-up contributions, but the matching contributions are subject to the normal rules.
expand-collapse sectionSaver's Credit
The retirement saver's credit provides a tax credit to encourage low-income and moderate-income families and individuals to save for retirement. Eligible taxpayers who contribute to an IRA or an employer-sponsored plan, including a 401(k), 403(b), or 457 plan, can receive a nonrefundable tax credit, in addition to the tax deduction for contributing to an IRA or to an employer-sponsored plan. In determining the amount of the credit, neither the amount of any refundable tax credits nor the adoption credit is taken into consideration. The eligible income brackets are indexed to inflation.
Individuals claim the credit on their federal income tax returns. The amount of the credit declines as income increases.
The credit is not available to taxpayers under the age of 18 or to full-time students. If a worker or spouse receives a preretirement distribution from a retirement plan (such as a hardship withdrawal), any credit taken in that same year and in the 2 subsequent years is reduced by the amount of the distribution.
Because it is nonrefundable, some families may not benefit from the retirement savings tax credit because they have no net income tax liability. Also, the credit may not be large enough to provide a savings incentive for families with incomes near the upper limits. On the other hand, families who increase their savings to claim the retirement savings credit and who are eligible for the earned income tax credit (EITC) may increase the amount of the EITC for which they qualify.
Because the credit is based on adjusted gross income, it increases the net benefit of contributing to a retirement plan.
For the current adjusted gross income limitations for determining the retirement savings contribution credit for married taxpayers, heads of household, and singles, visit http://www.irs.gov.
expand-collapse sectionInvestment of Participant's Accounts
Fee Disclosures--Service Provider to Plan Fiduciary
ERISA requires plan fiduciaries, when selecting and monitoring service providers and plan investments, to act prudently and solely in the interest of the plan’s participants and beneficiaries. Responsible plan fiduciaries also must ensure that arrangements with their service providers are "reasonable" and that only "reasonable" compensation is paid for services. Fundamental to the ability of fiduciaries to discharge these obligations is obtaining information sufficient to enable them to make informed decisions about an employee benefit plan’s services, the costs of such services, and the service providers.
In 2012, the DOL Employee Benefits Security Administration (EBSA) issued final regulations on requirements for the disclosure of information by covered service providers (CSPs) to ERISA-covered defined benefit and defined contribution pension plans. The rule does not apply to SEPs, SIMPLE retirement accounts, IRAs, certain 403(b) annuity contracts and custodial accounts, or employee welfare benefit plans. The rule establishes specific disclosure obligations for plan service providers to ensure that responsible plan fiduciaries (RPFs) are provided the information they need to make better decisions when selecting and monitoring service providers for their plans.
The final rule requires CSPs to provide RPFs with the information they need to:
• Assess the reasonableness of total compensation, both direct and indirect, received by the CSP, its affiliates, and/or subcontractors;
• Identify potential conflicts of interest; and
• Satisfy reporting and disclosure requirements under Title I of ERISA.
Service providers not in compliance with the final rule will be subject to the prohibited transaction rules of ERISA Sec. 406 and IRC Sec. 4975 penalties.
CSPs. CSPs are those who expect at least $1,000 in compensation to be received for services to a covered plan and include:
• ERISA fiduciary service providers to a covered plan or to a “plan asset” vehicle in which such a plan invests;
• Investment advisers registered under federal or state law;
• Recordkeepers or brokers who make designated investment alternatives available to the covered plan (e.g., a “platform provider”); and
• Providers of accounting, auditing, actuarial, banking, consulting, custodial, insurance, investment advisory, legal, recordkeeping, securities brokerage, third-party administration, or valuation services to the covered plan who also receive "indirect compensation" in connection with such services.
The final regulation includes a class exemption from the prohibited transaction provisions of ERISA for responsible plan fiduciaries that enter into service contracts without knowing that the CSP has failed to comply with its disclosure obligations. The class exemption requires that fiduciaries notify the DOL of the disclosure failure. Fiduciaries can file the notice online at http://www.dol.gov.
Disclosure of services and compensation. Information required to be disclosed by a CSP must be furnished in writing to an RPF for the covered plan. The regulation does not require a formal written contract delineating the disclosure obligations. CSPs must describe the services to be provided and all direct and indirect compensation to be received by a CSP, its affiliates, or subcontractors.
“Direct compensation” is compensation received directly from the covered plan. “Indirect compensation” generally is compensation received from any source other than the plan sponsor, the CSP, an affiliate, or subcontractor.
In order to enable an RPF to assess potential conflicts of interest, CSPs who disclose “indirect compensation” also must describe the arrangement between the payer and the CSP pursuant to which indirect compensation is paid. CSPs must identify the sources for indirect compensation, plus the services to which such compensation relates.
Compensation disclosures by CSPs are to include allocations of compensation made among related parties (i.e., among a CSP’s affiliates or subcontractors) when such allocations occur as a result of charges made against a plan’s investment or are set on a transaction basis.
CSPs must disclose whether they are providing recordkeeping services and the compensation attributable to such services, even when no explicit charge for recordkeeping is identified as part of the service “package” or contract.
Some CSPs must disclose an investment’s annual operating expenses (e.g., expense ratio) and any ongoing operating expenses in addition to annual operating expenses. For participant-directed individual account plans, such disclosures must include “total annual operating expenses” as required by the regulations on fee and expense disclosure to plan participants.
The final regulation provides a “pass-through” for investment-related disclosures furnished by recordkeepers or brokers. A CSP may provide current disclosure materials of an unaffiliated issuer of a designated investment alternative or information replicated from such materials, provided that the issuer is a registered investment company (i.e., mutual fund), an insurance company qualified to do business in a state, an issuer of a publicly traded security, or a financial institution supervised by a state or federal agency.
Service providers may use electronic means to disclose information to plan fiduciaries provided that the CSP’s disclosures on a website or other electronic medium are readily accessible to the RPF, and the fiduciary has clear notification on how to access the information.
Providing a guide to initial disclosures. EBSA strongly encourages CSPs to offer RPFs a “guide,” summary, or similar tool to assist fiduciaries in identifying all of the required disclosures, particularly when service arrangements and related compensation are complex, and information is disclosed in multiple documents. EBSA has included a Sample Guide as an appendix to the final regulation that can be used on a voluntary basis by CSPs as a model for such a guide. EBSA intends to require CSPs to furnish a guide or similar tool to assist RPFs’ review of initial disclosures.
Ongoing disclosure obligations. Generally, CSPs must disclose changes to initial information as soon as practicable, but no later than 60 days from when the CSP is informed of such change. Disclosures of changes to investment-related information are to be made at least annually. Service providers must disclose compensation or other information related to their service arrangements upon the request of the RPF or plan administrator, reasonably in advance of the date when such person states that he or she must comply with ERISA’s reporting and disclosure requirements.
Disclosure errors. The final regulation allows for timely corrections of an error or omission in required disclosures when a CSP is acting in good faith and with reasonable diligence. Such corrections must be made not later than 30 days from the date that the CSP knows of the error or omission.
Fee and Expense Disclosures to Plan Participants
The DOL EBSA has issued final regulations intended to help employees manage and invest 401(k) contributions (29 CFR Sec. 2550.404a-5). According to the DOL, the regulation ensures:
• That 401(k) plan participants are given, or have access to, the information they need to make informed decisions, including information about fees and expenses;
• That the delivery of investment-related information is in a format that enables workers to meaningfully compare the investment options under their pension plans;
• That plan fiduciaries use standard methodologies when calculating and disclosing expense and return information to achieve uniformity across the spectrum of investments that exist among and within plans so that investments can be objectively compared; and
• A new level of fee and expense transparency.
Information disclosure requirement. The regulation provides that the investment of plan assets is a fiduciary act governed by ERISA's fiduciary standards, which require plan fiduciaries to act prudently and solely in the interest of the plan’s participants and beneficiaries. Thus, when a plan allocates investment responsibilities to participants or beneficiaries, the plan administrator must take steps to ensure that the participants and beneficiaries, on a regular and periodic basis, are made aware of their rights and responsibilities with respect to the investment of assets held in, or contributed to, their accounts and are provided sufficient information about the plan and the plan’s investment options, including fee and expense information, to make informed decisions when managing their individual accounts. Thus, a plan administrator must provide to each participant or beneficiary certain plan-related information and certain investment-related information.
Liability protection. The regulation provides plan administrators protection from liability for the completeness and accuracy of information provided to participants if the plan administrator reasonably and in good faith relies on information provided by a service provider.
Plan-related information disclosure requirement. The first category of information that must be disclosed is plan-related information. This general category is further divided into the following three subcategories:
• General plan information consisting of information about the structure and mechanics of the plan, such as an explanation of how to give investment instructions, a current list of the plan’s investment options, and a description of any “brokerage windows” or similar arrangement that enables the selection of additional investments not designated by the plan.
• Administrative expenses information, including an explanation of any fees and expenses for general plan administrative services that may be charged to or deducted from all individual accounts. Examples include fees and expenses for legal, accounting, and recordkeeping services.
• Individual expenses information, including an explanation of any fees and expenses that may be charged to or deducted from the individual account of a specific participant or beneficiary based on the actions taken by that person. Examples include fees and expenses for plan loans and for processing qualified domestic relations orders.
The information in these three subcategories must be given to participants on or before the date they can first direct their investments and then again annually thereafter.
Statements of actual charges or deductions. In addition to the plan-related information that must be furnished up front and annually, participants must receive statements, at least quarterly, showing the dollar amount of the plan-related fees and expenses (whether “administrative” or “individual”) actually charged to or deducted from their individual accounts, along with a description of the services for which the charge or deduction was made. These specific disclosures may be included in required quarterly benefit statements.
Investment-related disclosure requirement. The second category of information that must be disclosed is investment-related information. This category contains several subcategories of core information about each investment option under the plan, including:
• Performance data. Participants must be provided specific information about historical investment performance with 1-, 5-, and 10-year returns provided for investment options, such as mutual funds, that do not have fixed rates of return. For investment options that have a fixed or stated rate of return, the annual rate of return and the term of the investment must be disclosed.
• Benchmark information. For investment options that do not have a fixed rate of return, the name and returns of an appropriate broad-based securities market index over 1-, 5-, and 10-year periods (matching the performance data periods) must be provided. Investment options with fixed rates of return are not subject to this requirement.
• Fee and expense information. For investment options that do not have a fixed rate of return, the total annual operating expenses expressed as both a percentage of assets and as a dollar amount for each $1,000 invested, any shareholder-type fees or restrictions on the participant’s ability to purchase or withdraw from the investment must be disclosed. For investment options that have a fixed rate of return, any shareholder-type fees or restrictions on the participant’s ability to purchase or withdraw from the investment must be disclosed.
• “Lifetime income” disclosure. The SECURE Act requires plan sponsors to quantify the payments a defined contribution (401(k) or 403(b)) plan would yield if structured as a lifetime annuity. (This will take effect 1 year after the DOL issues implementing guidance.) The law also creates a fiduciary safe harbor for plan sponsors that actually offer such an annuity.
• Internet website address. Investment-related information includes an Internet website address that is sufficiently specific to provide participants and beneficiaries access to specific additional information about the investment options for those who want more or more current information.
• Glossary. Investment-related information includes a general glossary of terms to assist participants and beneficiaries in understanding the plan’s investment options or an Internet website address that is sufficiently specific to provide access to such a glossary.
After a participant has invested in a particular investment option, he or she must be provided any materials the plan receives regarding voting, tender, or similar rights in the option. Upon request, the plan administrator must also furnish prospectuses, financial reports, and statements of valuation and of assets held by an investment option.
Comparative format requirement. Investment-related information must be furnished to participants or beneficiaries on or before the date they can first direct their investments and annually thereafter. As noted above, it also must be furnished in a chart or similar format designed to facilitate a comparison of each investment option available under the plan. The regulation includes, as an appendix, a model comparative chart that, when correctly completed, may be used by the plan administrator to satisfy the rule’s requirement that a plan’s investment option information be provided in a comparative format. The model comparative chart may be obtained at http://www.dol.gov.
Electronic distribution. The DOL's general disclosure regulation (29 CFR Sec. 2520.104b-1) applies to material furnished on fees and expenses, including the safe harbor for electronic disclosures. Please see the national Benefits Recordkeeping and Disclosures section.
Safe harbor electronic disclosure requirements. EBSA has issued a revised interim policy for the use of electronic media to satisfy disclosure requirements under the fee disclosure regulation (EBSA Technical Release 2011-03R). The technical release allows plan administrators to furnish information required under the fee disclosure rule electronically, including by the use of continuous-access websites, if certain conditions and safeguards are met. The interim policy states that the DOL will not take enforcement action based solely on a plan administrator's use of electronic technologies to make the required disclosure if the administrator complies with the following conditions:
• Voluntary provision of an e-mail address. Participants and beneficiaries entitled to receive information must voluntarily provide the employer, plan sponsor, or plan administrator (or its designee) with an e-mail address for the purpose of receiving fee disclosures. The e-mail address must be provided in response to a request accompanied by an initial notice, as described below. If the provision of an e-mail address is a condition of employment or participation in the plan, the e-mail address is not to be treated as being provided voluntarily. However, if a participant is required to provide an e-mail address electronically in order to access a secure, continuous-access website that includes the required disclosure, the provision of the e-mail address is considered voluntary if an initial notice is properly provided.
• Initial notice. The initial notice must be clear and conspicuous, provided at the same time and in the same medium as the request for the e-mail address, and contain a statement that providing an e-mail address for the receipt of the fee disclosures is entirely voluntary and that as a result of providing the e-mail address, the required fee disclosures will be made electronically plus additional information listed below.
• Annual notice. Commencing with the year beginning after the year that the participant or beneficiary voluntarily provided his or her e-mail address, and annually thereafter, the plan administrator must furnish an annual notice to each participant or beneficiary. For this purpose, “year” means a calendar year, plan year, or any other 12-month period selected by the plan administrator. The annual notice must be furnished on paper. Alternatively, it may be furnished electronically by sending it to the e-mail address on file for the participant or beneficiary if there is evidence that the participant or beneficiary interacted electronically with the plan after the date the annual notice for the preceding year was furnished (or in the case of the first annual notice, after the date the initial notice was furnished). Examples of electronic interaction include, but are not limited to, the participant or beneficiary updating, resubmitting, or confirming his or her e-mail address to the plan; the participant or beneficiary sending an electronic message to the plan; logging onto a secure, continuous-access website housing plan information; or the receipt and opening of an electronic message sent by the plan to the participant or beneficiary.
• Delivery. The plan administrator takes appropriate and necessary measures reasonably calculated to ensure that the electronic delivery system results in actual receipt of transmitted information (e.g., using return receipt or notice of undelivered electronic mail features, conducting periodic reviews or surveys to confirm receipt of transmitted information).
• Confidentiality. The plan administrator takes appropriate and necessary measures reasonably calculated to ensure that the electronic delivery system protects the confidentiality of personal information.
• Calculated to be understood. Notices furnished to participants and beneficiaries must be written in a manner calculated to be understood by the average plan participant.
Notice content. The notices must all contain the following information:
• Identification or a brief description of the information that will be furnished electronically and how it can be accessed by participants and beneficiaries;
• A statement that the participant or beneficiary has the right to request and obtain, free of charge, a paper copy of any of the information provided electronically and an explanation of how to exercise that right;
• A statement that the participant or beneficiary has the right, at any time, to opt out of receiving the information electronically and an explanation of how to exercise that right; and
• An explanation of the procedure for updating the participant’s or beneficiary’s e-mail address.
DOL Attempt to Expand Definition of ‘Fiduciary’
In April 2016, the DOL unveiled a long-awaited final rule that addressed conflicts of interest in the investment services industry by changing the 40-year-old definition of “fiduciary” as it relates to ERISA retirement plans.
The rule was designed to protect investors by requiring anyone who, for compensation, provides retirement investment advice to retirement plans and individuals to abide by a fiduciary standard—“putting their clients’ best interest before their own profits,” according to an agency fact sheet. The rule described the kinds of communications that would constitute investment advice and the types of relationships in which those communications would give rise to fiduciary investment advice responsibilities.
However, the 5th U.S. Circuit Court of Appeals struck down the rule, finding that the DOL’s attempt to expand the fiduciary definition exceeded the agency’s authority (U.S. Chamber of Commerce v. DOL, 885 F.3d 360 (March 15, 2018)). The court officially vacated the rule in May 2018.
Reducing Fiduciary Liability--ERISA Sec. 404(c)
Individual account plans such as 401(k) plans that provide for participant-directed investments can reduce or eliminate their fiduciary liability for the consequences of the participant's investment decisions if the plan meets the requirements of ERISA Sec. 404(c). In general, an individual account plan qualifies as a 404(c) plan if it:
• Provides an opportunity for a participant or beneficiary to exercise control over assets in his or her individual account; and
• Provides a participant or beneficiary an opportunity to choose, from a broad range of investment alternatives, how some or all of the assets in his or her account are invested.
A participant is considered to have the opportunity to exercise control if there is a named fiduciary to receive investment instructions who is obligated to comply with those instructions and the participant has access to sufficient information to make informed decisions when choosing between the investment alternatives. There are detailed requirements about the information that must be provided and the number and types of investment alternatives that must be offered (29 CFR Sec. 2550.404c-1). The disclosure requirements in this regulation have been amended to integrate with the fee and expense disclosure requirements to avoid having different disclosure rules for plans intended to comply with the ERISA Sec. 404(c) requirements establishing a uniform disclosure framework for all participant-directed individual account plans.
Warning: Although Sec. 404(c) may relieve plan fiduciaries of liability for participants' investment decisions, it does not eliminate liability for decisions that the fiduciary makes. These include the selection of the investment alternatives offered by the plan. Plan fiduciaries must therefore monitor the continued performance and the mix of the investment alternatives provided.
Application of 404(c) protections to default investments. The PPA extended the protections of Sec. 404(c) to plans that use default investments in the event that the participant does not make his or her own election. The protection applies if:
• The plan makes the default investments in accordance with guidelines to be issued by the DOL; and
• Affected participants receive an annual notice explaining their right to direct investments and have a reasonable opportunity to do so.
Application of 404(c) protections during blackout periods. The PPA clarified and expanded the 404(c) protections available during a blackout period when a participant is unable to direct his or her investments. In general, a fiduciary is not liable for losses incurred during a blackout period if ERISA's fiduciary obligations are satisfied and other duties or authorizing and implementing a blackout are performed. Blackout periods frequently involve a change in the investment options offered under a plan. If a participant does not make an affirmative election among the new investment options offered after the blackout, 404(c) protection applies to the plan's default investment if:
• The participant had the opportunity to redirect investments but failed to do so;
• The characteristics of the default investments are similar to those they replace; and
• The participant was provided with a written notice 30 to 60 days in advance, describing the fund changes and the default investment.
Providing Investment Advice
ERISA's prohibited transaction rules have made it difficult for plan fiduciaries to provide investment advice to plan participants. The PPA added a new prohibited transaction exemption for "eligible investment advice arrangements" so that mutual fund companies, insurance companies, and other parties-in-interest can be compensated for providing investment advice to participants who select their own investments in a 401(k) and other individual account plans.
If the requirements of the provision are met, the following are not treated as prohibited transactions: (1) the provision of investment advice; (2) an investment transaction (i.e., a sale, acquisition, or holding of a security or other property) pursuant to the advice; and (3) the direct or indirect receipt of fees or other compensation in connection with the provision of the advice or an investment transaction pursuant to the advice.
Eligible investment advice arrangements. An "eligible investment advice arrangement" is an arrangement that (1) provides that any fees (including any commission or compensation) received by the fiduciary adviser for investment advice do not vary depending on the what investment option is selected, or (2) uses a computer model that meets certain requirements to provide the advice. The arrangement must be expressly authorized by a plan fiduciary other than (1) the person offering the investment advice program, (2) any person providing investment options under the plan, or (3) any affiliate of (1) or (2).
Note: Except for the requirement that fees not vary based on the investment option selected, these requirements also apply to the fiduciary advisor and an affiliate of the fiduciary advisor. The requirement that fees not vary depending on the basis of any investment options selected does not extend to affiliates of the fiduciary advisor, unless, of course, the affiliate is also a provider of investment advice to the plan (DOL Field Assistance Bulletin No. 2007-01).
Use of a computer model. If an eligible investment advice arrangement provides investment advice pursuant to a computer model, the model must:
• Apply generally accepted investment theories that take into account the historic returns of different asset classes over defined periods of time;
• Use relevant information about the participant or beneficiary;
• Use prescribed objective criteria to provide asset allocation portfolios composed of investment options under the plan;
• Operate in a manner that is not biased in favor of any investment options offered by the fiduciary adviser or related person; and
• Take into account all the investment options under the plan in specifying how a participant's or beneficiary's account should be invested without inappropriate weighting of any investment option.
Certification. Before a model is used, an eligible investment expert must certify that the model meets these requirements. The certification must be renewed if there are material changes to the model. For this purpose, an "eligible investment expert" is a person who meets requirements prescribed by the IRS and who is not affiliated with any investment adviser or related person. If a computer model is used, the only investment advice that may be provided is the advice generated by the computer model, and any investment transaction pursuant to the advice must occur solely at the direction of the participant or beneficiary. This requirement does not preclude a participant or beneficiary from requesting other investment advice.
Audit requirement. An annual audit of an eligible investment advice arrangement for compliance with the above requirements must be conducted by an independent auditor. The auditor must be unrelated to the person offering the investment advice arrangement or any person providing investment options under the plan and must certify in writing that he or she has appropriate technical training or experience and proficiency. The auditor must issue a report of the audit results to the fiduciary that authorized use of the arrangement.
Notice requirement. Before the initial provision of investment advice and annually thereafter, the fiduciary adviser must provide written notice (which may be in electronic form) to the recipient of the advice, including information relating to the adviser's qualifications, possible conflicts, the nature of the advice that will be given, and how information about the recipient will be used. This information must also be provided on request and when there is a material change. The DOL will be issuing a model form for the required disclosure of fees and other compensation.
Selection and review of a fiduciary adviser. Employers and plan fiduciaries have a fiduciary responsibility under ERISA for the prudent selection and periodic review of a fiduciary advisor with whom an employer or plan fiduciary has made an arrangement for the provision of investment advice to plan participants and beneficiaries. An employer or plan fiduciary does not have the duty to monitor the specific investment advice given by a fiduciary adviser. The DOL has stated that a plan sponsor or other fiduciary that prudently selects and monitors an investment advice provider will not be liable for the advice furnished by such provider to the plan’s participants and beneficiaries, whether or not that advice is provided pursuant to this statutory exemption (DOL Field Assistance Bulletin No. 2007-01).
Selection guidelines. The DOL has also stated that a fiduciary should engage in an objective process designed to elicit information necessary to assess the service provider’s qualifications, quality of services offered, and reasonableness of fees charged for the service. The process also must avoid self-dealing, conflicts of interest, or other improper influence. The DOL expects that the process utilized by a responsible fiduciary will take into account:
• The experience and qualifications of the investment advisor, including the advisor’s registration in accordance with applicable federal and/or state securities law;
• The willingness of the advisor to assume fiduciary status and responsibility under ERISA for the advice provided to participants; and
• The extent to which the advice will be based on generally accepted investment theories.
Monitoring guidelines. When monitoring investment advisors, the DOL anticipates that fiduciaries will periodically review, among other things, the extent to which there have been any changes in the information that served as the basis for the initial selection of the investment advisor, including whether the advisor continues to meet applicable federal and state securities law requirements and whether the advice being furnished to participants and beneficiaries was based on generally accepted investment theories. Fiduciaries should also take into account whether the investment advice provider is complying with the contract under which it was hired; utilization of the investment advice services by the participants in relation to the cost of the services to the plan; and participants' comments and complaints about the quality of the furnished advice. The DOL has noted that if a complaint or complaints raise questions concerning the quality of advice being provided, a fiduciary may have to review the specific advice at issue with the investment advisor.
According to the DOL, plan assets can be used to pay reasonable expenses in providing investment advice to participants and beneficiaries.
Requirements for Investments in Employer Stock
The PPA added provisions to ERISA and the IRC to allow participants to divest investments in employer stock. The requirements apply to individual account plans that hold publicly traded employer stock. The diversification requirements do not apply to an employee stock ownership plan (ESOP) if there are no elective, employee, or matching contributions to the plan and the plan is separate from any other defined benefit plan or individual account plan maintained by the same employer or employers.
Employee contributions and elective deferrals. A participant must be allowed to direct the plan to immediately divest any employer securities attributable to employee contributions and elective deferrals and to reinvest an equivalent amount in other specified investment options.
Employer contributions. In the case of the portion of the account attributable to employer contributions other than elective deferrals, which is invested in employer securities, a participant who has completed at least 3 years of service must be allowed to direct the plan to divest any such securities and to reinvest an equivalent amount in other specified investment options.
Alternate investment options and restrictions. A plan must offer at least three investment options, other than employer securities, to which an applicable individual may direct the proceeds from the divestment of employer securities, each of which is diversified and has materially different risk and return characteristics. A plan may limit the time for divestment and reinvestment to periodic, reasonable opportunities occurring at least quarterly. A plan may not impose restrictions or conditions on the investment of employer securities that are not imposed on the investment of other assets of the plan.
Notice of right to divest. Not later than 30 days before the first date on which a participant was eligible to divest employer securities, the plan administrator had to provide that participant with a notice that explained the right to divest and described the importance of diversifying the investment of retirement account assets. The IRS issued a model notice, which was included in IRS Notice 2006-107 and can be found at http://www.irs.gov.
expand-collapse sectionAutomatic Enrollment
A major issue for employers sponsoring 401(k) plans is getting employees, especially lower-paid employees, to participate. Plans generally require employees to make an affirmative election to have a percentage of their pay deferred and contributed to the plan. This is a difficult hurdle for many employees. The IRS has ruled that a 401(k) plan may provide for automatic contributions of a specified percentage of an employee's compensation to a 401(k) plan unless the employee elects not to do so (Rev. Rul. 2000-8). Notice must be given to each employee that the deferral will take effect unless they elect to receive cash or have a different percentage deferred. The notice must be given at the time of hire, when the provision takes effect for current employees, and annually thereafter before the beginning of each year so that employees have an “effective opportunity” to elect to receive cash instead.
Note: Although automatic enrollment has increased 401(k) participation for many employers, the general experience is that employees stay with the default contribution rate and investment choice and thus get only a minimum benefit from plan participation. This problem has resulted in some employers reversing their decision to use automatic enrollment and looking for other ways to encourage participation, such as aggressive education and communication programs.
Employers had been hesitant to implement automatic enrollment because of worries about fiduciary violations and complications with state law requirements for deductions from pay. To encourage employers to implement automatic enrollment, the PPA provided an exemption from state payroll withholding laws, fiduciary relief for investment of participant account balances in certain default investments, and incentives for adopting automatic enrollment provisions that meet certain requirements. These include an increase in the time limit for correcting excess contributions while avoiding excise taxes from 90 to 180 days as well as a 90-day correction period for participants to reverse the initial payroll reduction and receive penalty-free return of automatic elective contributions for plans that use an eligible automatic contribution arrangement (EACA). Also provided was relief from discrimination testing and top-heavy restrictions for plans that implemented a qualified automatic contribution arrangement (QACA).
To facilitate the adoption of automatic enrollment, the IRS has provided two sample plan amendments for sponsors, practitioners, and employers that want to add certain automatic contribution features to their 401(k) plans. Sample Amendment 1 can be used to add an automatic contribution arrangement to a 401(k) plan. Sample Amendment 2 can be used to add an EACA (permitting 90-day withdrawals) to a 401(k) plan (IRS Notice 2009-65). Two sample plan amendments are provided in the Appendix of Notice 2009-65 (http://www.irs.gov/pub/irs). Plan sponsors are not required to adopt either amendment verbatim.
QACA Requirements and Benefits
A 401(k) plan that contains an automatic enrollment feature that satisfies the requirements for a QACA is treated as meeting the ADP test with respect to elective deferrals and the ACP test with respect to matching contributions. In addition, a plan consisting solely of contributions made pursuant to a QACA is not subject to the top-heavy rules. To qualify for this safe harbor, a QACA must meet certain requirements for the (1) automatic deferral and the amount of the elective contributions, (2) matching or nonelective contributions, and (3) notice to employees.
Automatic deferral/amount of elective contributions requirement. A QACA must provide that, unless an employee elects otherwise, the employee is treated as making an election to make elective deferrals equal to a stated percentage of compensation of no more than 10 percent and at least equal to:
• Three percent of compensation for the first year the deemed election applies to the participant;
• Four percent during the second year;
• Five percent during the third year; and
• Six percent during the fourth year and thereafter.
The stated percentage must be applied uniformly to all eligible employees. Eligible employees are all employees eligible to participate in the arrangement, other than employees eligible to participate immediately before the date on which the arrangement became a QACA with an election in effect (either to participate at a certain percentage or not to participate).
Providing for automatic contribution increases. The IRS has provided examples of how automatic increases to the default contribution amount may be structured. An automatic contribution arrangement under which an eligible employee’s default contribution percentage automatically increases in plan years after the first plan year of an eligible employee’s participation in the automatic contribution arrangement may be based in part on increases in the eligible employee’s plan compensation. Default contributions will satisfy the uniformity and minimum percentage requirements even if contributions for all eligible employees increase on a date other than the first day of a plan year such as the date that annual raises go into effect (Rev. Rul. 2009-30).
Matching or nonelective contribution requirement. A QACA satisfies the contribution requirement if the employer either (1) satisfies a matching contribution requirement or (2) makes a nonelective contribution to a defined contribution plan of at least 3 percent of an employee's compensation on behalf of each NHCE who is eligible to participate in the automatic enrollment feature.
An employer satisfies the matching contribution requirement if:
• It matches 100 percent of the first 1 percent deferred, plus 50 percent of the next 5 percent deferred, for a maximum match of 31/2 percent on behalf of each NHCE; and
• The rate of match for elective deferrals for HCEs is not greater than the rate of match for NHCEs.
Additional requirement for matching contribution relief. A plan with a QACA that provides for matching contributions and satisfies the safe harbor contribution requirements applicable to the QACA is deemed to satisfy the ACP test if:
• Matching contributions are not provided for elective deferrals in excess of 6 percent of compensation;
• The rate of matching contribution does not increase as the rate of an employee's elective deferrals increases; and
• The rate of matching contribution for any rate of elective deferral of an HCE is no greater than the rate of matching contribution for the same rate of deferral of an NHCE.
Vesting. Any matching or other employer contributions taken into account in determining whether the requirements for a QACA are satisfied must vest in 2 years so that employees with 2 years of service are 100 percent vested.
Withdrawal restrictions. Any matching or other employer contributions taken into account in determining whether the requirements for a QACA are satisfied must satisfy the withdrawal rules for elective contributions.
Notice requirement. Each employee eligible to participate in a QACA must receive notice of the arrangement, which is sufficiently accurate and comprehensive, to apprise the employee of his or her rights and obligations and is written in a manner calculated to be understood by the average employee to whom the arrangement applies. The notice must explain:
• The employee's right to elect not to have elective contributions made or to elect to have contributions made in a different amount; and
• How contributions made under the automatic enrollment arrangement will be invested in the absence of any investment election by the employee.
The employee must be given a reasonable period of time after receiving the notice and before the first election contribution must be made to make an election with respect to contributions and investments.
EACA Requirements and Benefits
Correcting initial automatic enrollment contributions. In the case of contributions made pursuant to an EACA, employees are allowed to opt out of or reduce their automatic enrollment contribution during the first 90 days after their first contribution. Erroneous automatic contributions may be distributed from the plan no later than 90 days after the date of an employee's first elective contribution under the arrangement. The amount that is treated as an erroneous contribution is limited to the amount of automatic contributions made during the 90-day period that the employee elects to so treat. These distributions are generally treated as a payment of compensation rather than as a contribution to and then a distribution from the plan, and the 10 percent early withdrawal tax does not apply to distributions of erroneous automatic contributions. In addition, these contributions are not taken into account for purposes of applying the nondiscrimination rules or the limit on elective deferrals and are not subject to otherwise applicable withdrawal restrictions.
Note: The corrective distributions rules apply to distributions from (1) qualified plans under IRC Sec. 401(a), (2) IRC Sec. 403(b) annuity contracts, and (3) governmental deferred compensation plans under IRC Sec. 457(b). In addition, the corrective distribution rules are not limited to arrangements meeting the QACA requirements.
Excess contributions. In the case of an EACA, the excise tax on excess contributions does not apply to any excess contributions or excess aggregate contributions that, together with income allocatable to the contributions, are distributed or forfeited (if forfeitable) within 6 months after the close of the plan year. This doubles the length of time otherwise allowed to make such distributions. Additionally, any excess contributions or excess aggregate contributions (and any income allocatable thereto) distributed within this 6-month period are treated as earned and received by the recipient in the taxable year in which the distribution is made (regardless of the amount distributed), and the income allocatable to excess contributions or excess aggregate contributions that must be distributed is determined through the end of the year for which the contributions were made.
EACA requirements. To qualify as an EACA, an automatic enrollment program must provide that if the participant does not make an investment election, the automatic contributions will be invested in accordance with regulations issued by the DOL under ERISA Sec. 404(c)(5) regarding default investments.
Notice requirement. The plan administrator of a plan with an EACA must, within a reasonable period before a plan year, provide to each participant to whom the arrangement applies for that plan year with notice of the participant's rights and obligations under the arrangement. This notice must include an explanation of the following:
• That the participant has a right to elect not to have elective contributions made on his or her behalf (or to elect to have such contributions made at a different percentage);
• That such an election must be made within a reasonable period of time after receipt of the notice and before the first contribution is made; and
• How contributions made under the arrangement will be invested in the absence of any investment election by the participant.
This is the same information that must be in the notice for a plan that has an automatic enrollment arrangement to qualify for preemption of state withholding laws.
Preemption of State Law Impediments to Automatic Enrollment
Any state law (such as a requirement of prior authorization to withhold from wages) that would directly or indirectly prohibit or restrict the inclusion in a plan of an automatic contribution arrangement is preempted. The DOL may establish minimum standards for such arrangements in order for preemption to apply. An "automatic contribution arrangement" is defined as an arrangement under which:
• A participant may elect to have the plan sponsor make payments as contributions under the plan on behalf of the participant or to the participant directly in cash such as a 401(k) plan;
• A participant is treated as having elected to have the plan sponsor make such contributions in an amount equal to a uniform percentage of compensation provided under the plan until the participant specifically elects not to have such contributions made (or elects to have contributions made at a different percentage); and
• Contributions are invested in accordance with the default investment provisions of ERISA Sec. 404(c)(5) in accordance with guidelines to be issued by the DOL, and affected participants receive an annual notice explaining their right to direct investments and have a reasonable opportunity to do so.
Notice requirement. The plan administrator of a plan with an automatic contribution arrangement must, within a reasonable period before a plan year, provide to each participant to whom the arrangement applies for that plan year with notice of the participant's rights and obligations under the arrangement. This notice must include an explanation of the following:
• That the participant has a right to elect not to have elective contributions made on his or her behalf (or to elect to have such contributions made at a different percentage);
• That such an election must be made within a reasonable period of time after receipt of the notice and before the first contribution is made; and
• How contributions made under the arrangement will be invested in the absence of any investment election by the participant.
This is the same information that must be in the notice if a plan has an EACA that qualifies for the 90-day period to reverse or reduce automatic contributions and the 180-day extended period to correct excess contributions.
Note: The preemption rules are not limited to arrangements that meet the requirements of a qualified automatic enrollment feature. A plan administrator must provide notice to each participant to whom the automatic contribution arrangement applies. If the notice requirement is not satisfied, a penalty of $1,100 per day applies.
Default Investment Safe Harbor
The DOL regulations provide guidelines for employers in selecting default investments that best serve the retirement needs of workers who do not direct their own investments. The regulations set out conditions to obtain safe harbor relief from fiduciary liability for the investment outcomes of default investments (29 CFR Sec. 2550.404c–5). The requirements for the safe harbor are:
• Assets must be invested in a “qualified default investment alternative” (QDIA) as defined in the regulation.
• Participants and beneficiaries must have been given an opportunity to direct their investments but have not done so.
• An initial notice generally must be furnished to participants and beneficiaries in advance of the first investment in the QDIA and annually thereafter.
• Material, such as investment prospectuses, provided to the plan for the QDIA must be furnished to participants and beneficiaries.
• Participants and beneficiaries must have the opportunity to direct investments out of a QDIA as frequently as from other plan investments, but at least quarterly.
• Fees that can be imposed on a participant who opts out of participation in the plan or who decides to direct his or her own investments are limited.
• The plan must offer a “broad range of investment alternatives” as defined in the DOL's ERISA Sec. 404(c) regulations.
Warning: Qualifying for the safe harbor does not absolve fiduciaries of the duty to prudently select and monitor QDIAs.
Selecting QDIAs. The DOL regulation does not identify specific investment products that are QDIAs. Instead it describes mechanisms for investing participant contributions. The intent is to ensure that an investment qualifying as a QDIA is appropriate as a single investment capable of meeting an employee’s long-term retirement savings needs. The final regulation identifies two individually based mechanisms and one group-based mechanism and also provides for a short-term investment for administrative convenience. The four types of QDIAs are:
• A product with a mix of investments that takes into account the individual’s age or retirement date (such as a life-cycle or targeted-retirement-date fund)
• An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date (such as a professionally managed account)
• A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (such as a balanced fund)
• A capital preservation product such as a money market fund for use during the first 120 days of participation only (This option is for plan sponsors wishing to simplify administration if workers opt out of or reduce their automatic enrollment contribution during the first 90 days after their first contribution.)
A QDIA must either be managed by an investment manager, plan trustee, or plan sponsor (including an investment committee made up of employees) who is a named fiduciary or by an investment company registered under the Investment Company Act of 1940. A QDIA generally may not invest participant contributions in employer securities. A QDIA may be offered through variable annuity contracts or other pooled investment funds.
Stable value funds. The safe harbor does not include stable value funds.
Initial QDIA notice. The initial QDIA notice must be provided:
• At least 30 days before the date of plan eligibility or at least 30 days before the first investment in a QDIA on behalf of a participant or beneficiary; or
• On or before the date of plan eligibility, provided the participant has the opportunity to make a permissible withdrawal without adverse financial consequences.
Annual QDIA notice. The annual QDIA notice must be provided within a reasonable period of time of at least 30 days before the beginning of the plan year. The DOL has indicated that the notice may be provided as early as 90 days before the beginning of the plan year. In addition, the QDIA notice may be combined with the automatic enrollment notice required by the IRS for plans that utilize the automatic enrollment safe harbor (DOL Field Assistance Bulletin No. 2008-03). The IRS and the DOL have collaborated to provide a "Sample Automatic Enrollment and Default Investment Notice" for satisfying both notice requirements. The sample notice may be accessed at http://www.irs.gov.
QDIA notice content. The QDIA notice must be written in a manner calculated to be understood by the average participant and must contain the following:
• A description of the circumstances under which assets in the individual account of a participant or beneficiary may be invested on behalf of the participant or beneficiary in a QDIA and, if applicable, an explanation of the when elective contributions will be made on behalf of a participant, the percentage of such contributions, and the right of the participant to elect not to have such contributions made on the participant's behalf (or to elect to have such contributions made at a different percentage);
• An explanation of the right of participants and beneficiaries to direct the investment of assets in their individual accounts;
• A description of the QDIA, including a description of the investment objectives, risk, and return characteristics (if applicable), and fees and expenses associated with the investment alternative;
• A description of the right of the participants and beneficiaries for whom assets are invested in a QDIA to direct the investment of those assets to any other investment alternative under the plan, including a description of any restrictions, fees, or expenses that might be charged for the transfer; and
• An explanation of where the participants and beneficiaries can obtain investment information concerning the other investment alternatives available under the plan.
expand-collapse section Fixing Retirement Plan Problems
In retirement or pension plan administration, mistakes happen. Complex rules, constantly changing requirements, overwhelming paperwork and, quite simply, the “human element” virtually ensure that plan administrators will err.
Sometimes, correction means appealing to the appropriate government agency (for example, the IRS, the DOL, or the Pension Benefit Guaranty Corporation) for relief and approval. Often, however, plan sponsors will not want to take relatively minor operational failures to the oversight agencies, particularly if the plan can correct the problem and put everything back to where it was before the problem occurred.
Although every administrative pension plan problem is unique, there are certain common methods that can be applied in solving, mitigating, or avoiding sanctions, penalties, and damages:
• Don’t panic. The most important step toward finding an answer to a problem is to identify the problem and recognize that something needs to be done. Once the problem is identified (hopefully as early as possible), it can be dealt with before it becomes an even bigger problem.
• Avoid artificial deadlines for action. It is always dangerous for administrators to move too quickly; sometimes the most obvious or the best answer to a problem can be overlooked simply because one is in a hurry to do something.
• Find out all the facts. Do not assume any facts or try to “mold” the facts to fit a given situation. One way of fact-finding is to conduct a self-audit from time to time.
• Develop solutions. Review the legal requirements with the particular fact situation in mind, and formulate a number of different solutions. Sometimes, only one solution is possible. In other cases, there may be several possible solutions, but they all seem to be pretty bad. Remember, though, that sometimes the best answer is the least bad answer.
• Implement the solution. This may seem obvious but is often difficult because of impediments from affected employees or organizational bureaucracy. At this point, an administrator may wish to obtain a legal opinion or other guidance from outside sources to help implement the correct approach.
It is also important to document each problem and solution, because a history of the plan’s administrative decisions can be useful going forward.
expand-collapse section Plan Audits
If being audited, plan sponsors first will receive a document request letter from whichever federal agency (for example, the IRS or the DOL) is going to audit their plan. On receiving the data request, most plan sponsors seek an extension of time to gather the necessary information. To make the process more efficient and speed resolution of plan audits, the IRS in November 2016 issued a memorandum that outlines specific time frames for the IRS examiner when preparing, issuing, and following up on an Information Document Request (IDR).
The IDR is generally a long list of documents. These can be hard to locate, especially if there has been turnover in the plan sponsor’s corporate area responsible for the plan. A recent service provider change also can complicate the data-gathering process. The new procedure requires the examiner to wait 14 calendar days after mailing an initial contact letter before taking further action.
The initial contact letter informs the plan sponsor that its plan has been selected for audit. Next, the IRS examiner will call the plan sponsor to discuss the issue being examined and the items requested in the IDR. The examiner will be looking to establish a response date or actual on-site appointment date and can assign a reasonable response date if the parties involved cannot agree on one. If the plan sponsor’s response is not complete, the examiner may grant up to two 15-day extensions.
If it is still not complete, the examiner at that point can start the delinquency notice process. If information is not received within the agreed-on time (up to 10 business days), a summons can be issued, which is a much swifter and more serious expediting process than existed previously.
Given this new procedure, it will be wise for plan sponsors to conduct periodic self-audits. At a minimum, this will help ensure that the plan sponsor can respond in a timely fashion to the IDR.
The DOL recently has stepped up its audit activities. It selects plans for audit based on:
• Participant complaints;
• Problems with a recent health and welfare plan audit;
• Referrals by other agencies;
• The DOL’s own initiatives;
• Data from Form 5500 submittals; and
• News coverage, such as reports of plant shutdowns or other disruptions.
To prepare for a possible DOL audit, if you receive a detailed comment letter from your independent auditor, read it carefully and respond to each item. Generally, it boils down to knowing your plan document, understanding what your plan’s service provider offers versus the plan administration activities occurring in-house, and the quality of the data you have on plan participants.
expand-collapse section Plan Correction Programs
Often, the terms of a qualified plan are less important than how the plan is actually being administered. The IRS has various programs in place intended to monitor qualification compliance and help plan sponsors and administrators keep their plans qualified. The IRS developed the Employee Plans Compliance Resolution System (EPCRS), which includes three programs related to qualification errors of administration:
• Self-Correction Program (SCP) for insignificant failures, allowing plan sponsors with established policies and procedures to self-correct without submission to the IRS;
• Voluntary Correction with Service Approval (VCP), allowing plan sponsors to pay a compliance fee and file with the IRS for approval; and
• Correction on Audit (Audit CAP) for plan failures identified by the IRS upon examination.
These EPCRS programs involve full corrective action and, potentially, penalties but provide a way to avoid plan disqualification. The IRS’s detailed guidance outlining the EPCRS was consolidated and updated in Revenue Procedure 2016-51.
Certain types of issues cannot be resolved through any of the EPCRS programs. For example, excise taxes and any additional penalty taxes (such as the early distribution tax) are generally not waived due to correction under the EPCRS. Nor is the EPCRS available for errors that do not implicate the plan’s qualified status, such as prohibited transactions or failing to file a required Form 5500.
Last updated on April 28, 2020.
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