It’s time to ensure year-end qualified plan deadlines are satisfied. Below is a checklist designed to help employers with this process.
A. QUALIFIED PLAN AMENDMENTS
The deadline for adopting the amendments listed below is the last day of the plan year beginning on or after January 1, 2012. For calendar year plans, the deadline is December 31, 2012. Note that some of the provisions became effective and required operational compliance prior to 2012. Plan sponsors should review their plans’ administration to ensure that the plans have been operated in compliance with the applicable provision.
1. DEFINED BENEFIT PLANS
□ Code § 436 Funding Based Benefit Restrictions. The Pension Protection Act of 2006 (“PPA”) added Section 436, which imposes restrictions on distributions and benefit accruals based on the funding status of a defined benefit plan, to the Internal Revenue Code (“Code”). Plans that do not meet certain funding targets must limit benefit accruals, cannot be amended to increase benefit liabilities, and must limit certain forms of benefit payments. These provisions are effective for plan years beginning after December 31, 2007. In Notice 2011-96, the IRS extended the due date for adopting the amendment to the last day of the plan year beginning on or after January 1, 2012 and provided sample language for the amendment.
□ Cash Balance and Hybrid Plans. PPA made several changes affecting cash balance and hybrid pension plans, including requiring three-year vesting and prohibiting interest credits at an interest crediting rate that exceeds a market rates of return. Recently the IRS issued guidance (Notice 2012-61) that extends the deadline for adopting amendments implementing the interest crediting and market rate of return requirements, the vesting requirements, but not the lump sum “whipsaw” in Code § 401(a)(13)(A). The extended deadline is the last day of the plan year before the plan year when regulations implementing the interest rate requirements become effective, which is not expected to be earlier than January 1, 2014. Amendments would not be required until 2013 at the earliest.
2. GOVERNMENTAL PLANS
Governmental plans (as defined in Code § 414(d)) must adopt several provisions added by the Heroes Earnings Assistance and Relief Tax Act of 2008 (“HEART”) and the Worker, Retiree and Employer Recovery Act of 2008 (“WRERA”) by the last day of the plan year beginning on or after January 1, 2012 (December 31 for calendar year plans).
□ HEART Act Changes
- Death Benefits: Effective for deaths occurring on or after January 1, 2007, plans must provide beneficiaries of a participant who dies while performing qualified military service with the same death benefits that would have been available to the beneficiaries (other than benefit accruals during qualified military service) as if the participant had been employed on his or her date of death.
- Military Differential Pay: The plan must include military differential pay made by the plan sponsor after December 31, 2008 as compensation for purposes of applying statutory limits and other qualification requirements, such as the limits on annual contributions or benefit accruals under Code § 415 or the nondiscrimination requirements under Code §§ 401(a)(4), 401(k), and 401(m).
□ Waiver of Required Minimum Distributions. WRERA modified the minimum distribution requirement by waiving any required minimum distributions for 2009. The amendment implementing the waiver is required by the last day of the 2012 plan year (December 31 for calendar year plans).
□ Direct Rollover by Non-Spouse Beneficiary. For plan years beginning after December 31, 2010, all plans, including governmental plans, must permit non-spouse beneficiaries to directly roll over an eligible rollover distribution. The rollover by the non-spouse beneficiary may be made only to an IRA that is treated as an inherited IRA under Code § 402(c)(11). The amendment is required by the last day of the 2012 plan year (December 31 for calendar year plans).
B. REQUIRED ANNUAL NOTICES
Plan sponsors should ensure that the required annual notices, if applicable, should be sent to participants and beneficiaries on a timely basis.
□ Section 401(k) Safe Harbor Notice. All participants in a safe harbor 401(k) plan must receive an annual notice that describes the safe harbor contribution and certain other plan features. The notice must be given by December 1 for calendar year plans and for non-calendar year plans not fewer than 30, and not more than 90, days before the first day of the plan year.
□ Section 401(k) Automatic Enrollment Notice. If the plan provides that employees will be automatically enrolled, the plan administrator must give eligible employees an annual notice that describes the circumstances in which eligible employees are automatically enrolled and pay will be automatically contributed to the plan. The notice must be given by December 1 for calendar year plans and for non-calendar year plans not fewer than 30 days before the first day of the plan year.
□ Qualified Default Investment Notice. A defined contribution plan that permits participants to direct the investment of their account balances may provide that if the participant does not give an affirmative investment direction, the portion of the account balance for which affirmative investment direction was not given will be invested in a qualified default investment. Plan sponsors must give the annual notice by December 1 for calendar year plans and for non-calendar year plans at least 30 days prior to the beginning of the plan year.
NOTE: A safe harbor 401(k) plan can incorporate two or more of the notices described above, as applicable, in a single notice.
□ Defined Benefit Plan Funding Notice. An annual notice describing the plan’s funded status for the past two years, a statement of the plan’s assets and liabilities and certain other information relating to the plan’s funded status must be furnished to participants within 120 days after the end of the plan year. For calendar year plans, the deadline is April 30. The deadline for small plans that cover fewer than 100 participants is the due date for the plan’s Form 5500.
On October 16, 2012, Institutional Shareholder Services (ISS) issued for comment several proposed proxy voting policy changes. The following would affect U.S. public companies:
Current Policy: Recommend vote against or withhold votes from the entire board (except new nominees, who are considered case-by-case) if the board failed to act on a shareholder proposal that received the support of either (i) a majority of shares outstanding in the previous year; or (ii) a majority of shares cast in the last year and one of the two previous years.
Proposed Policy: Recommend votes against or withhold votes from the entire board (with new nominees considered case-by-case) if it fails to act on any proposal that received the support of a majority of shares cast in the previous year.
The proposed change is intended to increase board accountability. ISS is specifically seeking feedback as to whether there are specific circumstances where a board should not implement a majority-supported proposal that receives support from a majority of votes cast for one year.
Say-on-Pay Peer Group
Current Policy: ISS’s pay-for-performance analysis includes an initial quantitative screening of a company’s pay and performance relative to a group of companies reasonably similar in industry profile, size and market capitalization selected by ISS based on the company’s Standard & Poor’s Global Industry Classification (GICS).
Proposed Policy: For purposes of the quantitative portion of the pay-for-performance analysis the peer group will continue to be selected from the company’s GICS industry group but will also incorporate information from the company’s self-selected benchmarking peers. When identifying peers, ISS will afford a higher priority to peers that maintain the company near the median of the peer group, are in the company’s own selected peer group and that have selected the company as a peer.
The change is likely a direct response to criticism from companies that the ISS-selected peer groups are not comparable and in many cases do not take into account multiple business lines. ISS is specifically requesting comments on whether there are additional or alternative ways that ISS should use the company’s self-selected peer group, what size range (revenue/assets) should be used for peer group determination and what other factors should be considered in constructing the peer group for pay-for-performance evaluation.
Say-on-Pay Realizable Pay Analysis
Current Policy: If the quantitative pay-for-performance screening demonstrates unsatisfactory long-term pay for performance alignment or misaligned pay, ISS will consider grant-date pay levels or compensation amounts required to be disclosed in the SEC summary compensation table to determine how various pay elements may work to encourage or to undermine long-term value creation and alignment with shareholder interests.
Proposed Policy: Rather than focusing solely on grant-date pay levels, the qualitative analysis for large-cap companies may include a comparison of realizable pay to grant-date pay. Realizable pay will consist of relevant cash and equity-based grants and awards made during the specific performance period being measured, based on equity award values for actual earned awards or target values for ongoing awards based on the stock price at the end of the performance measurement period.
In its recent annual survey, 50% of investors indicated that they consider both granted and realized/realizable pay as an appropriate way to measure pay-for-performance alignment. ISS has requested comments as to how to define realizable pay, whether stock options should be considered based on intrinsic value or Black-Scholes value and under what rationale and what should be an appropriate measurement period for realizable pay.
Update December 12, 2012: See today’s post on this issue that provides additional insight.
In the wake of the Affordable Care Act’s public exchanges, large private employers and benefit consultants have been working on establishing private health insurance exchanges, which would permit employees of participating employers to purchase health insurance from a broader array of alternatives than are available under a single employer plan. Generally, private exchanges are being marketed to large employers, many of whom self-insure, as a way to manage their health care costs through a defined contribution-style health program. It is expected that the private exchange will have multiple levels of individual health insurance coverage provided by several different insurers, in contrast to employer plans, where there may be only one or two levels of coverage.
An employer who provides health coverage through a private exchange gives each employee sum of money, through a health reimbursement account, pre-tax through cafeteria plan, or post-tax, to pay the employee’s share of the premium. Each employee selects health coverage from the options available through the exchange. The employer’s expectation is that providing health insurance through a private exchange will limit the employer’s cost and give the employees more choice and more control over their health insurance and care. Aon Hewitt has set up a private exchange and it has been reported that Sears and Darden Restaurants expect to provide their employees with health insurance through a private exchange for the 2013 plan year. However, before an employer implements a private exchange, there are several issues that should be considered, including some legal rules that need further clarification.
- ERISA: There will be enough employer involvement that the exchange would most likely be treated as an employer plan subject to ERISA, including the SPD and 5500 requirements. Benefit booklets prepared by insurers often do not include all of the provisions required by ERISA to qualify as an SPD. Where the employer has a less direct relationship with the insurer, it may be more difficult to supplement the benefit booklet. In addition, the plan document may have to describe all of the insurers and options from which the employees can choose. Similarly, the employer may be required to attach a Schedule A to its Form 5500 for each individual policy purchased through the private exchange.
- COBRA and HIPAA: As an employer plan, the alternatives available will be subject to the COBRA continuation rules as well as the HIPAA requirements, such as nondiscrimination, creditable coverage, privacy, and wellness standards, which will require coordination with many providers. For example, who is responsible for giving COBRA notices and notices of creditable coverage? Additionally, an employer that has historically been “hands on” with HIPAA protected health information may consider adopting a more “hands off” approach to PHI. If so, the employer will need to change its policies and procedures, as well as amend its plan documents to be clearer about the types of PHI it can (or cannot) receive.
- HRA, §105(h) and §125 requirements: The employer’s contribution provided through an HRA may raise nondiscrimination issues, particularly if there are higher benefits for the highly compensated. Alternatively, if an employer provides a flat contribution for all employees, but allows the rest of the cost to be paid pre-tax through a cafeteria plan, then the cafeteria plan my not satisfy the 125 nondiscrimination rules, which would make cafeteria plan contributions taxable instead of pre-tax. Additionally, it is unclear how a private exchange will be tested for nondiscrimination under the PPACA rules for insured plans, once those are issued.
- Administration: Many employers assist their employees with benefit claims. It may be more difficult to provide assistance with multiple insurers.
- Health care reform “play or pay” requirements: It is not clear whether participating in a private exchange will be treated as providing coverage that satisfies the requirement that the coverage be affordable and that it provide minimum essential benefits.
- Multi-state requirements: Multi-state employers may be faced with a myriad of policies with different benefits, due to state mandates and different definitions of “essential health benefits” under health reform. State insurance commissioners would be concerned that the coverage offered to individuals in their states satisfies the state insurance laws and is offered by an insurer licensed to do business in the state.
The issues outlined above do not necessarily mean a private exchange is impossible. However, an employer considering participating in a private exchange should consider these issues in addition to any possible cost savings the employer anticipates. And, it may make sense to wait for guidance from the Department of Labor and the IRS before signing on to a private exchange.
The regulations mandating that covered service providers disclose information, particularly fee information, required that the first “explosion” of the disclosure information occur by July 1, 2012. Prior to July 1, 2012, we provided lots of information about the disclosure requirements in an effort to assist the fiduciaries in avoiding a prohibited transaction (including some prior blog posts). After July 1, 2012, we followed up and asked if there were questions or if we could assist in any fashion. We have now had three months to take a look at what happened as a result of this first round of plan level fee disclosure and discuss the effort with other advisors. Looking primarily at defined contribution plans, and particularly 401(k) plans and ESOPs, we culled some anecdotal information, and from it, there appear to be a number of pretty consistent patterns and results.
- Diligent fiduciaries who commonly utilize the services of independent investment advisors engaged the advisors to assist them in reviewing, understanding and acting on the disclosures.
- These fiduciaries, where advisors are retained, identified the plan’s covered service providers and confirmed that all of them provided disclosures or, where something was missing or incomplete, followed the rules to obtain the disclosures.
- These same fiduciaries, with the assistance of advisors, reviewed the disclosures and many have taken steps to work with the advisor to determine reasonableness of fees and necessity of services. Some have done comparisons by benchmarking plan fees to assist in determining reasonableness. Some have done a thorough analysis and have memorialized their conclusions.
- Some diligent fiduciaries have asked their advisors, or their advisors have recommended, that the plan conduct an RFP, a “ghost” RFP, or an RFI in order to do a fee and service comparison. Some are underway at this time, and some have already been finalized.
- Even where some diligent fiduciaries may have incomplete resources, they still reviewed the disclosures and made earnest efforts to understand their plan’s fee structure.
NOT AS DILIGENT FIDUCIARIES
- Some plan fiduciaries found the disclosures difficult to review and some may have even ignored the disclosures, especially in situations where an independent investment advisor is not retained.
- Many of these same fiduciaries have difficulty identifying which of their providers are covered service providers subject to the fee disclosure rules.
- We have heard of only a few instances where these fiduciaries have been able to engage in a meaningful benchmarking effort.
- Inertia seems to be a common problem in these cases, and unless the provider does something to upset the plan sponsor, these fiduciaries are not usually persuaded to change the status quo based solely on the disclosures.
- Some of these fiduciaries contacted advisors to ask questions about the disclosures and what they meant, but it appears that only a few actually went through a process to determine reasonableness of fees even after consulting with advisors.
ALL PLANS AND CONCLUSIONS
- Fiduciaries generally are unable to determine on their own whether or not a fee is reasonable in the circumstances and rely heavily on the advisor, where there is one, to tell them that the fees are reasonable. Some rely on independent advisors and some rely on advice (possibly conflicted) from the firm offering the plan’s investments.
- Although the “necessity” of a particular service may have been discussed in general terms, anecdotal evidence suggests that there is significant difficulty in drawing prudent conclusions with respect to this requirement. When considering necessity , the fiduciaries rely on the providers, often third party administrators, to “assure” them that the services being provided are necessary for the plan’s participants and beneficiaries.
- The disclosures were often deemed to be too complex for most of the fiduciaries to understand content and import.
- We are not aware of any fee or provider changes that have resulted from an analysis of the disclosures.
- We are aware of only one plan sponsor who made a request of a covered service provider to make further disclosures.
- Those plan sponsors and fiduciaries who have conducted any sort of analysis seem quite confident that their plan’s fee and service structures already in place are compliant.
What challenges have you faced with the 408(b)(2) service provider fee disclosures? Did you find them helpful? Please post your thoughts in a comment below.
On September 7th, 2012, the 6th Circuit upheld the District Court’s decision in U.S. v. Quality Stores, holding that severance payments made to employees in connection with an involuntary reduction in force were not “wages” subject to FICA taxes. United States v. Quality Stores, Inc. (In re Quality Stores, Inc.), 424 B.R. 237 (W.D. Mich. 2010), aff’d, 10-1563, 2012 U.S. App. LEXIS 18820 (6th Cir. September 7, 2012). In so holding, the 6th Circuit reasoned that such severance payments were supplemental unemployment compensation benefits (“SUB Pay”) within the meaning of § 3402(o)(2) of the Internal Revenue Code (the “Code”) exempt from FICA taxes.
This holding is directly at odds with the position of the Internal Revenue Service (“IRS”), set forth in Revenue Ruling 90-72, that such severance payments are wages for FICA purposes and not SUB Pay. According to the IRS, the definition of SUB Pay in § 3402(o)(2) of the Code is not applicable for FICA purposes. The IRS has defined SUB Pay for FICA purposes through a series of revenue rulings. Under the IRS definition, SUB Pay must be linked to the receipt of state unemployment compensation and must not be received in a lump sum in order to be excludable from wages for FICA purposes. The 6th Circuit rejected the IRS definition reasoning that Congress intended the same definition to apply for both FICA and income tax withholding purposes and that, to the extent that Congress has permitted the IRS to decouple the definition, it must be done by regulation and not by administrative rulings.
The IRS may issue a nonacquiescence and petition the U.S. Supreme Court for certiorari. The petition may be granted because this decision has created a split in the courts. In CSX Corp. v U.S., 518 F.3d 1328 (Fed. Cir. 2008), the Federal Circuit Court of Appeals held that the severance payments at issue were subject to FICA taxes.
Employers may be entitled to a FICA tax refund for FICA taxes paid on severance payments made pursuant to an involuntary reduction in force, the discontinuance of a plant or operation or other similar condition. As a result, employers who made severance payments in any open year under these circumstances may want to assert a protective claim by filing Form 941-X prior to the applicable statute of limitations deadline. A protective claim must be filed by April 15, 2013 for payments made in 2009. In the meantime, employers should continue to treat such payments as subject to FICA taxes pending further developments.
Have you recently received fee disclosures from your plan service providers? Do you know the total compensation your service providers receive for their services? Are you aware how these costs impact plan participants? Are these fees reasonable?
All plan fiduciaries, including governmental plan fiduciaries, have the duty to make sure fees paid for services are reasonable. However, until now, there hasn’t been any formal regulatory disclosure requirement governing service provider compensation. In 2012, the Department of Labor (DOL) finalized fee disclosure rules applicable to ERISA plans. Generally, these rules were issued to assist plan sponsors and fiduciaries in determining whether plan-related fees are reasonable for and to provide transparency for plan fiduciaries and participants. Although these fee disclosure rules only apply to ERISA-governed private sector plans, governmental plans should consider following these new rules as a fiduciary best practice.
The DOL fee disclosure rules consists of two disclosure requirements: (1) the service provider fee disclosure, and (2) the participant-level fee disclosure.
Service Provider Fee Disclosure
Generally, the service provider fee disclosure requires “covered service providers” (such as recordkeepers, brokerage services, investment advisors, investment fund and managers, etc.) to provide sponsors of defined benefit plans and defined contribution plans a disclosure of their fees and services. In general, the service provider fee disclosure requires:
- A description of services to be provided pursuant to the contract or arrangement;
- Information on whether the services provided to the plan by the provider are done in a fiduciary capacity or as a investment advisor;
- A description of all compensation received by the provider in connection with the services, including all direct compensation from the plan and all indirect compensation from sources other than the plan (e.g., commissions, soft dollar fees, 12b-1 fees, sub-transfer agency fees, revenue sharing);
- Descriptions of annual operating expenses (e.g., expense ratio) of investment alternatives and other information in the control of the service provider that is considered investment-related information which must be provided automatically under the participant-level fee disclosure discussed below; and
- A description of any compensation that the service provider expects to receive in connection with the termination of the contract or arrangement and how any prepaid amounts will be calculated and refunded upon such termination.
The plan sponsor fee disclosure regulation is designed to provide plan sponsors the information needed to determine the reasonableness of fees and compensation received by service providers to the plan.
Participant-Level Fee Disclosure
The participant-level fee disclosure rules only apply to individual account or defined contribution plans. The disclosure is designed to inform participants of all fees they are paying under the plan. Most recordkeepers and third-party service providers are providing plan sponsors with the disclosures and information to comply with this rule. To comply, plan sponsors must provide participants with plan-related information such as:
- General plan information, including investment instructions and restrictions;
- An explanation of fees and expenses charged for general plan administrative services;
- A description of fees and expenses that may be charged to or deducted from the participant’s account based on the actions taken by the participant; and
- Revenue sharing arrangements must be disclosed to participants. However, specific revenue sharing amounts do not have to be broken out.
The following investment-related information must be disclosed to participants automatically with respect to each investment option offered under the plan:
- Historical investment performance data;
- Benchmark information, including the name and returns of an appropriate benchmark over 1-, 5- and 10-year periods;
- Total annual operating expenses expressed both as a percentage of assets (expense ratio) and as a dollar amount per $1,000 invested; and
- A website address to a website containing additional information regarding the investment alternatives.
Best Practices for Governmental Plans
Although the DOL fee disclosures rules do not apply to governmental plans, the rules establish a framework that governmental plan sponsors and fiduciaries should consider following as a best practice. As a matter of best practices, governmental plan sponsors and fiduciaries should consider doing the following:
1. Government plans should request the same information required by the DOL fee disclosures from their service providers. If a governmental plan fiduciary receives pushback on providing this information, there may be a problem and the fiduciary may want to consider putting the services out to bid.
2. Once the fee disclosure information is provided, plan fiduciaries should read, understand, and evaluate the information in order to determine that the fees identified in the disclosures are reasonable and that the services being provided and paid for are appropriate and necessary for the administration of the plan. This does not mean that every plan should pay the lowest possible amount for services, but rather that the fiduciaries must determine that the fees being paid are reasonable with respect to the quality of necessary services being provided. When determining reasonableness of fees, fiduciaries should consider such aspects as quality of services, costs, complexity of the plan, and needs of the participants. This analysis may require the assistance of an investment advisor who should be able to benchmark the fees by comparing them to fees charged to plans by other providers for similar services or by conducting an actual or hypothetical request for proposal.
3. Governmental plans should consider providing a participant-level fee disclosure to 401(a), non-ERISA 403(b), and 457(b) participants similar to the participant-level disclosures required for ERISA plans. As with ERISA plans, service providers should be able assist with these disclosures.
4. To the extent governmental plans and fiduciaries follow the DOL rules, those plans and fiduciaries should continue to follow the DOL fee disclosure guidance as a matter of best practices to help demonstrate that they are satisfying their fiduciary responsibilities to plan participants.
On September 13, 2012, the Sixth Circuit in Reese v. CNH Am. LLC, 11-1359, 2012 WL 4009695 (6th Cir. Sept. 13, 2012) reiterated its 2009 ruling in the same case that an employer could unilaterally modify a retiree health plan, as long as the modifications were reasonable. The September 13th ruling was the Court’s second review of the case on appeal; the sequel to an unfolding drama.
In this case, the employer and labor union entered a collective bargaining agreement which stated the employer would provide healthcare benefits for retirees and their eligible surviving spouses. The issue was whether the lifetime healthcare benefits had vested and, if so, whether, and to what extent, the employer could modify the benefits. In 2009, the Court found that the lifetime health care benefits had vested pursuant to the collective bargaining agreement, but that the employer could modify the benefits as long as the modifications were reasonable. The Court reasoned that the collective bargaining agreement provisions on retiree health benefits had not been perceived as unalterable by the parties, since they had been altered on various occasions, such as to implement a managed health care plan and to take into account the enactment of Medicare Part D.
In 2009, the Court sent the case back to the lower court to determine if the modifications of the retiree health benefits were reasonable. The lower court incorrectly assumed that the modification had to be agreed to as part of the collective bargaining process. Comparing the district court’s ruling to a disappointing film sequel, the Court reversed and remanded the case to the district court a second time, since the district court had misread its original opinion and had not resolved the reasonableness question as instructed.
The Court listed three considerations for the district court to examine in making its reasonableness determination: (1) Does the modified plan provide benefits “reasonably commensurate” with the old plan? (2) Are the proposed changes “reasonable in light of changes in health care?” and (3) Are the benefits “roughly consistent with the kinds of benefits provided to current employees?”
This case will be an interesting one to follow going forward. As plan sponsors are aware, other cases have taken much more of an “all or nothing” approach to the vesting of retiree benefits or required the consent of the union to modify the benefits. However, it is not clear how the lower court will resolve the reasonableness question or whether we’ll find ourselves tuning in for yet another disappointing sequel to this unfolding saga.
We thank our extern, Uche Enemchukwu, for her help in preparing this post.