Compliance Update | Published in May 2017

Compliance Update

Summaries of the latest news from Washington and the courts—what's coming, what's contemplated and what's critical for plan sponsors to know

By PLANSPONSOR staff | May 2017
IRS Told to Look at Cash Balance Plan Benefit Formulas
Internal Revenue Service (IRS) employee plans (EP) staff reviewing benefit formulas in cash balance defined benefit (DB) plans have received new direction in the form of a recent IRS memorandum. In general, a qualified plan “within the meaning of Section 401(a) is a plan established and maintained by an employer primarily to provide systematically for the payment of definitely determinable benefits to his employees over a period of years, usually for life, after retirement,” the IRS notes. The memo has an accompanying “Issue Snapshot on Definitely Determinable Benefits,” which provides analysis and examples that are to be used by a determinations specialist reviewing a determination letter request, or by an exam agent auditing a plan in which the benefit formula is not the subject of a determination letter. The Issue Snapshot will help either one determine whether a cash balance DB plan benefit formula derived from only a portion of annual compensation, a special bonus or other measure not based on annual compensation, is “definitely determinable.” Generally, the memo says, if the terms of the plan specifically allow the employer to vary the employee’s compensation used in the benefit formula—e.g., an employee’s annual compensation less an amount designated by the employer—the plan would violate the “definitely determinable” rule. The memo, with its examples, would be a helpful guide for cash balance plan sponsors to assess whether their plan offers definitely determinable benefits.
Trump Overturns DOL Rule For Government-Run Auto-IRAs
President Donald Trump has signed a resolution overturning a Department of Labor (DOL) rule that would allow cities and municipalities of states to offer automatic-IRA [individual retirement account] retirement plans for private-sector employees that would be exempt from Employee Retirement Income Security Act (ERISA) provisions. A similar resolution to overturn a DOL rule allowing states to offer such retirement plans is pending Senate approval before going before
the president.
Following introduction of the two resolutions in the House in February, they were introduced in the Senate in March. No cities have yet established such plans, though some, such as New York City, have proposed them. Several states have done so. If the second resolution is signed by Trump, it seems the state plans would have to be subject to ERISA provisions.
Judge Deals Blow to Vanguard Fund Comparison In Self-Dealing Case
U.S. District Judge William Young of the U.S. District Court for the District of Massachusetts agreed with Putnam Investments that prohibited transactions claims against its retirement plan fiduciaries are time-barred under the Employee Retirement Income Security Act (ERISA)’s three-year statute of limitations.
Still, Young’s discussion on two points could impress findings of other courts addressing pending ERISA excessive-fee or self-dealing cases. Putnam Investments and plan fiduciaries of the Putnam retirement plan were accused of self-dealing to promote the firm’s mutual fund business and to maximize profits at the expense of the plan and its participants. The defendants observed that fees are paid out of mutual fund assets rather than plan assets and argued that cash held in mutual funds is not an asset of the plan. The plaintiffs contended that ERISA’s intent to protect participants mandates a broad definition of “plan assets.” But the judge noted that the 1st U.S. Circuit Court of Appeals’ decision in a Fidelity float income case adopted a narrow approach to identifying plan assets for the purposes of ERISA’s prohibited transactions provisions. “The Plaintiffs’ argument that the management fees paid from the value of the mutual fund shares owned by the plan (which are plan assets) is, therefore, precluded by 1st Circuit case law,” Young wrote.
Secondly, the plaintiffs argued that investment fees were materially higher than investment fees paid by other funds, relying on an expert who compared the Putnam mutual funds’ average fees with Vanguard passively managed index funds’ average fees. Young found this comparison flawed, noting that Vanguard is a low-cost mutual fund provider operating index funds “at-cost,” while Putnam mutual funds operate for profit and include both index and actively managed investments. Young wrote, “[the expert’s analysis] thus compares apples and oranges.”
DB Plan Nondiscrimination Rules
U.S. Senators Ben Cardin, D-Maryland, and Rob Portman, R-Ohio, both members of the Senate Finance Committee, and U.S. Representatives Pat Tiberi, R-Ohio, and Richard Neal, D-Massachusetts, both members of the House Ways and Means Committee, introduced updated legislation—the Retirement Security Preservation Act of 2017 (RSPA)—amending the nondiscrimination rules that apply to defined benefit (DB) plans that have been closed or frozen. The bill builds on previous legislation and Internal Revenue Service (IRS) regulations to address issues related to the rules and was approved unanimously by the Senate Finance Committee as part of a retirement-related legislative package last September. Because the grandfathered group in the closed plan generally becomes more highly compensated, closed plans almost always end up inadvertently violating the IRS nondiscrimination testing rules. RSPA addresses the problem by amending the nondiscrimination rules to protect older workers in plans that have been closed or frozen. The bill also contains anti-abuse rules related to closed and frozen plans.
Bill Encourages Employee Stock Ownership
The House of Representatives passed the Encouraging Employee Ownership Act (H.R.1343) by a bipartisan vote of 331 to 87. A release from the office of Congressman Lee Zeldin, R-New York,
says the legislation would reform the outdated Securities and Exchange Commission (SEC) Rule 701, which imposes a slew of complicated regulations on small businesses, especially newly formed startups. SEC Rule 701 exempts companies below a $5 million threshold that want to offer securities as part of employees’ compensation from having to comply with federal securities registration requirements.
Companies over the threshold must provide additional disclosure, “creating a significant obstacle for [those] that want to compensate their employees through equity or other securities such as stocks,” the release says. According to an update by the National Center for Employee Ownership (NCEO), the bill would increase to $20 million the current $5 million cap on the amount of stock that closely held companies may award employees before triggering certain SEC reporting requirements. The amount would be indexed for inflation annually. Congressman Zeldin says,
“The Encouraging Employee Ownership Act of 2017 is bipartisan legislation that will help small businesses grow and expand, encouraging job creation and economic growth, by allowing companies to retain their employees through incentives.”
Court Rules for CVS in Stable Value ERISA Challenge
A district court judge has dismissed an Employee Retirement Income Security Act (ERISA) lawsuit filed against CVS Health Systems that claims the company’s leadership breached fiduciary duties owed to retirement plan investors by “imprudently investing too much of the plan’s stable value fund assets in ultra-short-term cash management funds that provided extremely low investment returns.” The court explained, “With the benefit of 20/20 hindsight, the plaintiffs assert, inter alia, that if the fund’s allocation to cash had been invested in the same manner as the fund’s other assets, the fund would have earned more. Although that may have been the outcome in this particular case, the plaintiffs appear to suggest that, rather than keeping the fund’s assets diversified, it would have been more prudent to put more eggs into the same basket, in the anticipation of a greater gain while assuming that such a strategy would entail no additional risk.” Summarizing its decision, the court observed, “It is well-established that the test of prudence ...
is one of conduct, and not a test of the result of the performance of the investment.”
IRS Explains Computation of Plan Loans Available to Participants
In a memorandum to employee plans (EP) examination employees, the Internal Revenue Service (IRS) has clarified that there are two ways an employer can determine the highest outstanding loan balance in the past year when calculating the amount of an additional loan a participant may take from his defined contribution (DC) plan.
The IRS notes that, in general, Internal Revenue Code (IRC) Section 72(p)(1) provides that a loan from a plan is a distribution to the participant. Section 72(p)(2)(A) excludes loans that do not exceed the lesser of $50,000, reduced by any excess of the highest outstanding balance of loans during a one-year period ending the day before the loan was made, over the outstanding balance of loans on the date the loan was made, or the greater of half of the current value of the vested accrued benefit, or $10,000.
The agency gives an example: A participant borrowed $30,000 in February, which was fully repaid in April, and then $20,000 in May, which was fully repaid in July, before applying for a third loan in December. The plan sponsor may determine that no further loan would be available, as $30,000 + $20,000 = $50,000. Alternatively, the plan sponsor could identify “the highest outstanding balance” as having been $30,000 and permit a third loan in the amount of $20,000. This assumes that to meet other Section 72(p)(2) requirements, the participant has a vested accrued benefit of more than $100,000, and that the loan is repayable in five years and requires substantially level amortization.