What is the IRS thinking about when it announces that plan sponsors, even those using a qualified TPA/recordkeeper, should maintain the records for hardship distributions and participant loans?
401(k) plans particularly (although this applies to other types of qualified plans that permit participant loans) have been marketed and promoted to would-be participants as flexible retirement saving arrangements – so flexible that you can take your money back out without a problem either by borrowing it or by taking a hardship distribution. Depending on your perspective, this flexibility may be anathema to the notion of retirement savings, i.e., long-term savings and investing. America’s 401(k) saving structure is, in this respect, more “flexible” than arrangements in most other countries that have similar plan structures. The unfortunate result of this sort of flexibility is “leakage” – about which officials at Treasury and Labor seem concerned.
So, to beg the obvious question, did the IRS issue this “reminder” to plan sponsors because of its disdain for leakage? In view of the fact that the pronouncement tends to ignore how most 401(k) plans actually operate, one might certainly come to that conclusion.
The IRS says that, for hardship distributions, the plan sponsor (not its TPA) should retain these records in paper or electronic format:
- Documentation of the hardship request, review and approval
- Financial information and documentation that substantiates the employee’s immediate and heavy financial need
- Documentation to support that the hardship distribution was properly made in accordance with the applicable plan provisions and the Internal Revenue Code
- Proof of the actual distribution made and related Forms 1099-R
Fidelity came out of the box swinging. In a public reaction to the pronouncement on hardship distribution record requirements, Fidelity begins by saying, “Fidelity offers a hardship withdrawal distribution procedure that does not require that a participant submit supporting documentation.” Fidelity then describes how its electronic system works and how it is compliant with the law. Fidelity also criticizes gaps in the law. And well it should since the guidance out there makes electronic processing of hardship distributions as described by Fidelity proper. But, of course, this begs other questions – shouldn’t the plan sponsor be able to rely on Fidelity and the other capable recordkeepers, and do plan sponsors really have to have all of the documentation the IRS describes?
On the participant loan front, the IRS states that the plan sponsor “should” retain these records either on paper or electronically:
- Evidence of the loan application, review and approval process
- An executed plan loan note
- If applicable, documentation verifying that the loan proceeds were used to purchase or construct a primary residence
- Evidence of loan repayments
- Evidence of collection activities associated with loans in default and the related Forms 1099-R, if applicable
There are some other documentary requirements if the participant seeks a loan “in excess of five years” (hmm, not “within” five years) for the purchase or construction of a primary residence.
In an effort to honor the flexibility that Congress has granted to 401(k) plans, plan loan processes are mostly electronic and are designed to follow the requirements of Code section 72(p) without the complexity of all of the now seemingly required documentation. Of course, evidence of an obligation to pay can take a form other than a plan loan note, and most e-systems do not automatically generate a note, but instead, a note may be generated if desired by the participant.
The IRS in the recent past has been pushing for plans to utilize good internal controls. Apparently, reliance on your TPA no matter how competent and no matter how good its systems is not a satisfactory internal control and is inadequate when it comes to leakage. Let’s assume that this required documentation is plan documentation and that the plan sponsor is obligated to maintain it without reliance on a recordkeeper. So, what’s a plan sponsor to do?
At the present time, it may be impossible for many recordkeepers to “transfer” the hardship and loan documentation in electronic format to the plan sponsor. But every plan sponsor should probably request it from the recordkeeper and request that the electronic data be transmitted to the plan sponsor with each future hardship distribution and each participant loan. And, then, of course, there’s the fiduciary obligation to review the information and make certain of compliance with the rules since the plan sponsor may not be able to rely on the recordkeeper to do that. And failing or refusing to do this, maybe the IRS’s real objective will be met – the plan will be amended to eliminate participant loans and hardship distributions in order to avoid leakage.
If you are responsible for administering your company’s Family and Medical Leave Act (“FMLA”) policy, you know that the associated FMLA forms can be both your best friend and your worst nightmare.
On the one hand, proper use of the forms – such as the various Certifications, the Rights & Responsibilities Notice, and the Designation Notice – can provide valuable information to help you evaluate and manage employees’ leave requests. On the other hand, attempting to comply requirements surrounding the forms, not to mention trying to understand the meaning of information received from medical providers – can be an exercise in frustration.
Below are some “best practices” relating to FMLA forms that may aid in the administration of your FMLA policy:
- FMLA Employee Request Form: Although the Department of Labor (“DOL”) has not provided a template FMLA request form, employers are permitted to develop and use their own. While implementing such a form (including adding a reference to it in your policy) would not permit ignoring an oral request, requiring employees to submit requests in writing provides a clear method of requesting leave, establishes a record of what leave was requested and when, and creates an opportunity to reiterate expectations surrounding FMLA leave requests.
- Deadlines: Become familiar with the deadlines for providing various notices to employees (e.g., Notice of Eligibility due within five days of being placed on notice that FMLA leave may be needed; Designation Notice due within five days receiving sufficient information to know whether the leave is FMLA-qualifying), and comply with them. Train supervisors to recognize and report a potential FMLA leave request so that you do not miss the deadlines.
- DOL Templates: Use the template forms (notices, certifications) provided by the DOL. Doing so ensures that you meet all notice requirements as well as obtain all permitted information (and only such information). The forms can be found on the DOL’s website. Consider pulling the forms directly from the website each time you need them (as opposed to keeping copies in a file) to ensure that you are using the most up-to-date, non-expired form.
- GINA Safe Harbor Language: Although the DOL is likely to revise the Certification forms at some point to include the GINA Safe Harbor language (essentially directing the medical provider to not provide genetic information), until then, the language should be added to (or included with) the forms and any other requests for medical information from providers.
- Complete Forms: Ensure that all notices are appropriately completed. For example, if you will require a Fitness For Duty Certification in order for the employee to return to work at the end of the leave, you must inform the employee of this requirement in advance by checking the appropriate line on the Designation Notice.
- Review Certifications Carefully: This is your opportunity to gather as much information as possible in order to confirm the need for leave, determine the type and amount of leave authorized by the medical provider, and identify the appropriate timing of a future request for recertification. So, take advantage of it by requiring that the Certification form be both complete (all applicable entries completed) and sufficient (responsive and not vague or ambiguous). If the Certification form has not been properly completed, return it to the employee with specific instructions about what information is needed, the deadline by which the information must be provided (allow seven days to cure), and the potential consequences for failing to comply.
- Recordkeeping: Keep copies of all forms and other correspondence sent to and received from an employee relating to an FMLA request for at least three years. This will ensure that you not only comply with the recordkeeping requirements set forth in the FMLA and regulations, but that you have necessary evidence should an employee pursue an FMLA complaint.
The Department of Labor (“DOL“) has responded to the concerns of the broker-dealer community as expressed in myriad comment letters concerning the 2010 proposed fiduciary regulations by adding the Best Interest Contract (BIC) exemption to the new proposed rule. The DOL suggests that this addition will minimize compliance costs and allow firms to set their own compensation structures (meaning commission-based fees, revenue sharing, 12b-1 fees and subTA fees) while acting in their client’s best interest. This exemption will be available when advising IRA owners, plan participants and small plans.
Here’s the catch that has drawn a mostly negative reaction from the broker-dealer community:
First: The BIC will be a formal contract committing the advisor and her firm to act with the care, skill, prudence and diligence that a prudent person would exercise based on the circumstances. The advisor and her firm must avoid misleading statements about fees and conflicts of interest. The DOL requires compliance with “impartial conduct standards.” These standards also mandate reasonable compensation for the service rendered.
The concerns: This is a roadmap for the plaintiffs bar as prudent persons can disagree on what is prudent in various circumstances, and reasonable fees may be reasonable to some and not to others. The high cost of “fee litigation” is already a known quantity. Besides, this is a contract, and contracts can be expensive on the front end to negotiate and on the back end when someone alleges a breach.
Second: The firm must warrant that it has adopted policies and procedures designed to mitigate conflicts of interest. This would require that the firm warrant that it has identified its conflicts and fee structures that might encourage an advisor to make recommendations not in the client’s best interest and has adopted measures to mitigate any harmful result that might occur due to the conflicts of interest. The DOL theory is that these warranties and fulfillment of their objectives will permit the firm to continue its compensation practices.
The concerns: This is a form of guarantee, and guarantees can be expensive to defend. Going through the process to “clean up” will be expensive as well and will likely require significant changes in the way many firms do business. This is a complex “answer” to a problem that will have many unexpected consequences, but one consequence that the industry expects is a broad refusal to advise small plans and IRAs since the cost of doing so will be prohibitive.
Third: There are required disclosures that must met in the BIC: (1) identify material conflicts of interest; (2) advise the client that the client can get information about all fees and recommended assets; (3) disclose whether proprietary products are being used and whether third party payments are being received; and (4) identify the required website that discloses the compensation structure between the firm and the advisor.
The concerns: This will add significant additional cost to the process. There is also some concern about potential anti-competitive hiring when compensation structures are disclosed.
Fourth: Two things cannot be in the contract: (1) exculpatory provisions limiting liability and (2) waiver of any right to participate in a class action or other representative court case.
The concerns: Being unable to limit exposure may be cost prohibitive when it comes to small plans and small accounts.
The DOL believes that the concerns are not so severe as to create the impact that the advisor industry believes will result. In fact, the DOL takes the position that this approach provides flexibility to “accommodate a broad range of business practices, while minimizing the harmful impact of conflicts of interest on the quality of advice.” It will surely be interesting to read the upcoming comment letters and to consider the testimony at hearings on the proposed regulation.
Prior Posts on This Topic
How many of you remember the classic children’s’ story “Are you My Mother?” by P.D. Eastman? In that delightful story, we follow a confused but determined baby bird who is looking for his mother. He sets off to find her, asking various creatures along the way (a dog, a cow, a plane) whether they are his mother, and in the end happily finds his way beneath her protective wing.
The parallels between this story and the proposed Conflict of Interest Regulations are clear (at least to some of us). The proposed guidance examines the various service providers encountered by retirement plans and IRA owners, as well as their participants and beneficiaries (“retirement investors”) and evaluates whether or not such service providers are fiduciaries who offer a protective wing. Moreover, the guidance expands the types of services which will be treated as fiduciary in nature, thus increasing the odds that the retirement investors will in fact find the fiduciary protection they seek.
ERISA has always defined a fiduciary to include:
- a named fiduciary,
- a person who exercises discretion with respect to management or administration of the plan,
- a person who exercises discretion with respect to management or disposition of plan assets, or
- a person who provides investment advice for a fee.
Years ago, regulations were issued to further define who would be regarded as a fiduciary by virtue of rendering investment advice for a fee. The recently issued proposed regulations seek to expand those old regulations to include a much broader category of service providers.
Specifically, under the proposed regulations, a person will be treated as providing the protective wing of a fiduciary if that person provides any of the following types of advice and satisfies the agreement requirement noted below:
- Recommendations as to the advisability of acquiring, holding, disposing or exchanging securities or other property – including a recommendation to take a distribution or reinvestment of a rollover;
- Recommendations as to management of securities or property;
- Appraisals, fairness opinions or similar statements regarding the value of securities or property in connection with acquisition, disposition or exchange of that property (but NOT in connection with an ESOP); or
- Recommendations of person(s) who will receive a fee or compensation for providing any of the above advice.
In addition to providing one of the services described above, the person must also (i) represent or acknowledge that he/she is acting as a fiduciary or (ii) render the advice pursuant to an agreement (written or verbal) that the advice is individualized to, or specifically directed to, the recipient for consideration in making investment/management decisions regarding plan property.
EXCLUSIONS: The proposed regulations provide a number of specified exclusions to the definition of fiduciary. For instance a person will not be treated as a fiduciary if s/he provides advice to an independent plan fiduciary who exercises authority regarding management or disposition of assets of a large plan (> 100 Participants or at least $100 million in plans assets) if that person satisfies certain requirements, including a disclosure requirement. A person also may not be treated as a fiduciary in certain swaps or securities based swaps if the plan is represented by an independent fiduciary and certain requirements are satisfied.
A number of other specific exclusions include:
- Employee (of plan sponsor) who provides advice to a fiduciary and receives no fee for the advice
- Provider of investment alternatives platform if the provider discloses in writing to the fiduciary that it is not acting as a fiduciary
- Selection and monitoring of investment alternatives that meet objective criteria specified by a fiduciary or provide to the fiduciary objective financial data comparisons with independent benchmarks
- Provision of financial reports and valuations for reporting / disclosure purposes
- Provision of certain investment education so long as the provider does not provide recommendations regarding specific investment products or alternatives
- Provision of certain asset allocation models and interactive investment materials
- Securities transaction exclusion for a broker dealer who executes a transaction pursuant to instructions of the fiduciary
- Lawyers, accountants and actuaries who provide professional assistance regarding a particular investment transaction
The proposed regulations provide a number of exemptions deigned to preserve business practices (such as common fee and compensation practices) in the delivery of investment advice. For instance, the Best Interest Contract Exemption provides conditional relief in connection with investment advice to “retail retirement investors” (i.e., participants/beneficiaries of participant-directed plans; IRA owners; sponsors of non-participant directed plans with < 100 employees under which the sponsor is a fiduciary regarding plan investment decisions). These exemptions will be discussed in a separate blog.
When the proposed regulation becomes effective (likely in 2016), plan sponsors, IRA owners and plan participants should be asking – “Are You My Fiduciary”? Understanding whether or not the protective wing of a fiduciary pertains to the plan or IRA will require an analysis of both the proposed expansion of the rule and its complex exceptions.
Unlike the 1967 film, Cool Hand Luke, where the prison warden delivers the above line shortly after giving a beating to prisoner Luke (Paul Newman) for making a sarcastic remark, employers may be worried about a beating from the IRS if they aren’t able to communicate with multiemployer health funds or staffing companies.
Under the Affordable Care Act (“ACA”), employers are required to report on the offers of coverage made to their common law employees. Employers have to provide statements to the employees on Form 1095-C and submit them to the IRS. The reporting includes data elements such as the months coverage was offered, the lowest cost premium for self-only coverage for each month, whether spouses and dependents are eligible, and confirmation that the plan is affordable and provides minimum value. The problem is this: if an offer of coverage is made on behalf of a staffing company or multiemployer plan, how will the employer have this information?
For employers participating in multiemployer plans, the rules allow the multiemployer plan to report on the employers behalf as described in Q&A-24 here. However, even if an employer goes this route, the fund will still need certain data elements from the employer, such as the employee’s compensation or the safe harbor that the employer is using to determine affordability under the ACA. So either way, communication is necessary. Additionally, there is no similar rule for staffing companies.
The key for employers is to work with their staffing firms and their multiemployer plans now to facilitate the transfer of necessary information to conduct the reporting. Staffing firms and multiemployer plans may or may not be aware of these reporting rules, or of the scope of data needed for reporting. If they aren’t, they will need some lead time to be able to assemble the data in time for reporting in early 2016. Employers will also need some lead time to integrate the data they receive into their reporting systems.
At the moment, the IRS has not provided any relief for a reporting failure due to the inability to get the information from a multiemployer fund or staffing company. Such relief would be welcome, but it appears unlikely at this point, so employers would be well-advised to get working on this soon.