Would You Like a Latte With that 401(k) Deferral?

SECURE 2.0 Permits Small Financial Incentives to Encourage Plan Enrollment

Effective immediately under a provision of the recently-passed SECURE 2.0 retirement reform legislation, employers may offer their employees gift cards or other “de minimis financial incentives” for enrolling in a 401(k) plan.  This post sets forth some compliance points for this new incentive opportunity.

  • Under prior law, matching contributions were the only means by which employers could encourage employees to make elective deferrals. 

Expanding access to retirement plans is one of the overriding goals of SECURE 2.0 (set forth in Division T of the Consolidated Appropriations Act, 2023).  Many employers would like to be able to encourage employees to save for retirement but may not be able to afford an ongoing employer matching contribution.  Section 113 of Division T expands the list of permitted employer incentives by allowing employers to provide a small financial incentive to employees to enroll in a 401(k) plan.  The small incentive may be just enough to get the ball rolling for employees who are otherwise not inclined to take part in a 401(k) plan.

  • The small financial incentive must be paid for by the employer, not the plan itself.

Section 113 makes clear that the employer that sponsors the plan must purchase the gift cards or other small financial incentives.  Plan assets may not be used for this purpose.

  • The gift cards or other small financial incentives will constitute taxable income to employees.

Employer-provided gift cards and other items with a clear cash value are treated as cash for income and employment tax purposes.  The “de minimis fringe” exception that may apply to a water bottle or t-shirt provided to employees does not apply to items with a readily ascertainable cash value.  (See 2023 Publication 15-B, p. 9) If your 401(k) plan’s definition of compensation for contribution purposes does not exclude gift cards, the gift cards are also “compensation” for plan contribution purposes.

  • Keep the dollar amount of the incentive small. 

There is no safe harbor amount for “de minimis” value, and the determination depends upon the facts and circumstances.  A $10 or $15 gift card probably satisfies the standard and will buy an employee a couple of cups of free coffee or a smoothie or two. Consult a qualified tax advisor if you are considering a more generous incentive.

  • Coordinate with your recordkeeper and third-party administrator on rolling out this feature.

You will need to coordinate with your plan recordkeeper and your third-party administrator to coordinate the small financial incentive with plan enrollment.  Think about how and when you will communicate this benefit to employees and about when and how you will deliver the financial incentive in connection with proof of enrollment in the plan.  It might be a good idea to draft out a timeline for a hypothetical new enrollee, and walk through it with your recordkeeper and third-party administrator before you unveil it to employees.

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2023 Christine P. Roberts, all rights reserved.

Photo credit: Tye Doring, Unsplash

Five SECURE 2.0 Changes Impacting Non-Profit Employers

On December 29, 2022 President Biden signed into law H.R. 2617, the Consolidated Appropriations Act, 2023, a $1.7 trillion omnibus spending bill that will keep the federal government funded for the 2023 fiscal year.  Of the many provisions in the massive bill, Division T, the SECURE Act of 2022, contains close to 400 pages of far-reaching changes affecting retirement plans and IRAs.  Commonly referred to as SECURE 2.0, it builds upon and adds to retirement plan provisions of the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE 1.0) which was passed in 2019, but is more extensive than the earlier law.  This post focuses on five provisions of SECURE 2.0 that specifically impact retirement plans maintained by non-profit employers. In addition to the changes listed below, which affect plans currently in existence, beginning in 2025 newly adopted Section 403(b) plans will be required to auto-enroll participants, with some exceptions.

One: Expansion of Multiple Employer Plan and Pooled Employer Plan Arrangements to Section 403(b) Plans

Effective for plan years beginning after December 31, 2022,  Section 403(b) plan sponsors can participate in multiple employer plan arrangements (MEPs) and pooled employer plan arrangements (PEPs), potentially achieving economies of scale under such arrangements (in terms of recordkeeping and investment expenses) that have previously only been available to for-profit employers.  MEPs and PEPs organized for Section 403(b) plan sponsors will be able to take advantage of relief, extended under SECURE 1.0,  from the “one bad apple” rule so that violation of one employer member of a multiple employer or pooled arrangement does not affect the tax treatment of other, compliant employer members. 

Two: Section 403(b) Plans May Invest in Collective Investment Trusts (CITs)

Since 1974, the only two permitted investment vehicles for 403(b) plans were annuity contracts and mutual funds.  Effective as of its date of enactment, SECURE 2.0 adds a third option, collective investment trusts (CITs), to that short list.  CITs are pooled investment arrangements that are made available only to qualified retirement plans, and that share some features with mutual funds but have different regulatory oversight and may offer some cost efficiencies.  Despite the immediate effective date, there will be some lead time before CITs are available to Section 403(b) plan sponsors due to the need to modify applicable securities laws.

Three: Expanded Investment Sources for Section 403(b) Hardship Withdrawals

Prior to SECURE 2.0, hardship withdrawals from Section 403(b) plans could be drawn only from employee contributions, less earnings.  Effective for plan years after December 31, 2023, SECURE 2.0 will bring Section 403(b) plans into conformity with Section 401(k) plans in this regard, so that QNECs, QMACs , in addition to elective deferrals, and earnings on these amounts, are permitted sources for hardship withdrawals.   SECURE 2.0 also permits hardship withdrawals to be made on the basis of a written certification by the participant as to the need for the withdrawal rather than on the basis of more formal documentation.

Four: Extension to Amend Section 457(b) Plans for SECURE 1.0 Required Minimum Distribution Rules

As we posted recently, December 31, 2022 was the deadline for sponsors of non-governmental Section 457(b) deferred compensation plans to amend their plan documents to incorporate changes to required minimum distribution rules under SECURE 1.0.  For tax-exempt sponsors of these plans who did not act timely, SECURE 2.0 has extended the amendment deadline under SECURE 1.0 to conform to the amendment deadline under applicable provisions of SECURE 2.0.  The new deadline is the last day of the first plan year beginning on or after January 1, 2025 (2027 in the case of governmental plans).  Note in this regard that SECURE 2.0 further modifies RMD rules, including increasing the RMD starting age in stages, first from 72 to 73, then eventually to 75, so additional amendments to RMD provisions will eventually be needed under SECURE 2.0.  Plans must operate in accordance with required provisions, in the interim.

Five: Eligibility for Long-Term, Part-Time Employees

This is a provision of SECURE 2.0 that is not unique to 403(b) plans but applies equally to 401(k) plans.  The original SECURE 1.0 rule required long-term, part-time employees, defined as employees who have worked 500 or more hours of service in three consecutive twelve-month periods, to be able to participate in the deferral-only portion of a 401(k) plan beginning in 2024.  Effective for plan years beginning after December 31, 2024, SECURE 2.0 expands this rule to 403(b) plans that are subject to ERISA and reduces the three consecutive twelve-month requirement to two consecutive periods.  This will be a significant adjustment to 403(b) plan sponsors who are accustomed to the universal availability rule, one exception to which permitted employees who normally work less than 20 hours per week, and who fail to accumulate 1,000 hours of service in an eligibility measurement period, to be excluded from making elective deferrals.  Although universal availability does not apply under 401(k) plans, the 1,000 hour rule operated in a similar way and will now yield to the 500 hour in two consecutive year standard.

SECURE 2.0 will be a topic of discussion at EforERISA in many posts to come.  If you have not subscribed to this blog yet, please take a moment to do so by typing your email address under the prompt at “Continue Reading More Articles.”  And if you are a plan sponsor, or advise plan sponsors, and have questions about provisions of the law or steps to take to get ready for their implementation, don’t hesitate to reach out using the Contact form (under “Posts Worth Revisiting”).

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2023 Christine P. Roberts, all rights reserved.

Photo credit: Ståle Grut, Unsplash

The Unsung Importance of Self-Correction Memos

Self-correction of operational errors arising in qualified retirement plans is a critical means for plan sponsors to retain their plans’ tax-qualified status. Self-correction has been promoted by the Internal Revenue Service as part of the Employee Plans Compliance Resolution System, or EPCRS, for approximately twenty years, but the rules for self-correction have evolved over that time period, and some essential requirements of self-correction are still little understood. One recommended component of self-correction that can tend to be overlooked is preparation of a self-correction memo. Below I describe what a self-correction memo is, and why preparing one is “best practices” – even if EPCRS does not mandate it.

By way of background, the Self-Correction Program or SCP is one of three component programs of EPCRS available to sponsors of qualified plans, 403(b) plans, SEP or SIMPLE IRA plans. (EPCRS is set forth in a Revenue Procedure that is updated periodically; the current version is Revenue Procedure 2021-30. The other component programs are Voluntary Correction Program or VCP, and the Audit Closing Agreement or Audit CAP.) SCP is available for operational failures (failure to operate a plan in accordance with its written terms) and plan document failures (such as failure to timely adopt a required plan amendment). With regard to operational failures, SCP divides them into two categories: “significant” operational failures, and “insignificant” operational failures. Plan document failures are always treated as significant. Insignificant operational failures are eligible for self-correction at any time. Significant operational failures are eligible for self-correction only if the corrections are both discovered and substantially completed by the last day of the third plan year following the plan year for which the failure occurred. Whether or not an operational failure is significant depends upon a number of criteria that are set forth in Revenue Procedure 2021-30, Section 8.02, including the number of affected participants, versus the total number of participants in the plan as of the Plan’s last filed Form 5500, and the amount involved in the operational failure, versus the total assets in the plan per the last-filed Form 5500. SEP and SIMPLE IRA plans may only self-correct insignificant operational errors.

Other requirements of SCP are as follows:

  • To correct a document failure or a significant operational failure, the qualified plan in question must be the subject of a favorable determination letter (for an individually designed plan) or must be a pre-approved plan that is the subject of a favorable opinion or advisory letter.
  • In addition, the plan sponsor or plan administrator must have established practices and procedure (formal or informal) that are reasonably designed to promote and facilitate overall compliance with Internal Revenue Code requirements, both in form and operation. This may take the form of annual plan administration procedures or guidelines; the plan document alone will not suffice. For SCP to be available, the procedures must have been in place and routinely followed, and the error must have occurred through an oversight or mistake in applying them. This component of SCP is also often overlooked.

What is a Self-Correction Memo?

A self-correction memo is a written memorandum, ideally signed and dated by a representative of the plan sponsor, that does all of the following: (a) describes a plan sponsor’s eligibility to use SCP; (b) describes the operational or document failure(s) and the method(s) of correction; (c) addresses whether or not the error was significant and if so whether it was substantially corrected within the necessary time period; and (d) assembles, as exhibits, all documentation of the error and its correction. Paragraph headings for a self-correction memo for an operational failure may include the following:

  • A description of the operational failure
  • The date that the plan sponsor discovered the operational failure
  • The fact that a favorable letter is in place
  • A description of the plan sponsor’s established practices and procedures for compliance with the Internal Revenue Code
  • A summary of any changes to the plan’s administrative practices designed to prevent the failure from reoccurring
  • A determination that operational errors were insignificant, or significant, following the criteria set forth in Revenue Procedure 2021-30, Section 8.02
  • The correction methodology, with citations to approved EPCRS correction methods, if appropriate
  • The number of affected participants relevant to the number of total participants
  • The manner in which affected participants were notified of the correction
  • A recitation of the actual corrections, including dates and amounts, or attached documentation proving same
  • The bases on which the plan sponsor determined the operational failure to be insignificant, if applicable
  • If the operational error was significant, the dates on which the correction period began and ended
  • If the correction involved transferred assets (which increases the time available for correction), the date of the merger, acquisition, or other similar transaction in which the assets were transferred.

Confirming that your operational failure is eligible for self-correction — and preparing the self-correction memo itself – will often require the guiding hand of an ERISA attorney.

Why is a Self-Correction Memo “Best Practices”?

That is a good question, and there is a common-sense answer. There is nothing in the Revenue Procedure 2021-30 specifically requiring that a self-correction memo be created, but it is best practices because it provides ready proof that the plan sponsor qualified for self-correction and completed all correction steps in accordance with EPCRS. Operational and document failures must be disclosed in a plan audit or during due diligence related to a merger or acquisition involving the plan sponsor. Having a self-correction memo and exhibits to hand in such an event is vastly preferable to simply asserting that self-correction was pursued, without being able to prove that SCP was both available to the plan sponsor, and properly completed within the necessary time period. The listing of recommended topics to cover, above, indicates the volume and specificity of information that is required to take advantage of self-correction. Trying to compile this information under the time pressures of a plan audit or due diligence process, when the information may be difficult to locate or reproduce, is a recipe for failure. It is far preferable to document your self-correction process with a memo as you go along, not unlike cleaning up the kitchen as you cook. You’ll thank yourself later.

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.
Photo credit: Dimitri Karastelev, Unsplash


Year End SECURE Act Deadline Looms for Tax-Exempt 457(b) Plans

Despite an extension granted to qualified plans, Section 403(b) plans, and governmental Section 457(b) plans to make necessary amendments under the SECURE Act, no extension past December 31, 2022 currently applies for Section 457(b) plans maintained by private tax-exempt organizations.  That means that, absent future guidance from IRS, these plans must be amended by the end of this year to incorporate the SECURE Act’s changes to required minimum distribution provisions.  Prompt action by those responsible for Section 457(b) benefits is required in order to meet the fast-approaching deadline. 

By way of background, Section 457(b) permits private, tax-exempt organizations to offer deferred compensation plans to a “top-hat” group, consisting of a “select group of management or highly compensated employees.”  Such plans are exempt from most provisions of Title I of ERISA and permit covered participants to defer up to the 457(e)(15) annual dollar limit annually ($22,500 in 2023) in addition to whatever they defer under the tax-exempt employer’s Section 403(b) or other retirement plan.  Governmental employers may also sponsor plans under Section 457(b) without limiting participation to a top-hat group.  Section 457(b) plans, whether sponsored by private tax-exempt employers or governmental entities, are subject to the required minimum distribution rules under Internal Revenue Code Section 401(a)(9).  Those rules require that accounts begin to be distributed to participants by their “required beginning date” or RBD, as defined under Section 401(a)(9)(C), and also govern subsequent distributions to account holders and their beneficiaries.

Enter the SECURE Act in 2019.  The SECURE Act moved the RBD for non-owners out to the later of retirement or April following the year in which a participant reaches age 72, rather than 70 ½, which has been the prior rule, and also required annual required minimum distributions following the death of an account holder to be made over a period not exceeding 10 years for most designated beneficiaries, rather than over a period covering their life expectancy, which had been the case previously.  This is a mandatory change under the SECURE Act; the Act also contains discretionary provisions such as qualified birth and adoption withdrawals. 

The original deadline to amend non-governmental plans under the SECURE Act was the last day of the first plan year beginning on or after January 1, 2022 (December 31, 2022 for a calendar plan year).   Governmental employers and multiemployer plans had until the end of 2024, however, as did 403(b) plans maintained by public schools.   In recent months, the IRS extended the SECURE Act amendment deadlines for all types of plans other than Section 457(b) plans maintained by tax-exempt employers.  This was announced in Notice 2022-33, issued in September 2022, whic was followed up by guidance in October of 2022 (Notice 2022-45) that extended the deadline to adopt amendments under applicable provisions of other laws (the Coronavirus Aid, Relief and Economic Security Act (CARES Act) and Bipartisan American Miners Act of 2019 (Miners Act) and the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act)).  (More precisely, the deadline extended under Notice 2022-33 included amendments under the CARES Act related to the 2020 waiver of RMDs and Notice 2022-45 covered amendments under other applicable provisions of the CARES Act.)

December 31, 2025 is the new amendment deadline under applicable provisions of SECURE and these other laws for qualified retirement plans, including 401(k) plans, and 403(b) plans.  For governmental pension plans and governmental Section 457(b) plans it is generally 90 days after the close of the third regular legislative session of the legislative body with the authority to amend the plan that begins after December 31, 2023. 

In the absence of further guidance from IRS, December 31, 2022 remains the deadline to amend Section 457(b) plans maintained by private tax-exempt employers to conform to the RMD provisions of the SECURE Act.  It is not unheard of for IRS to issue late-in-the-year deadline extensions, but in this instance, it has been silent on this category of plan twice in close succession.  Employers who maintain such plans should connect with their third-party administrators or benefit attorneys to arrange for timely adoption of the necessary amendment to their plan document, and an update of plan summary information provided to participants.

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.

Photo credit: Markus Winkler, Unsplash

2023 Retirement Plan Limits Announced

The Internal Revenue Service announced new dollar limits for retirement plans for 2023, with most limits showing a sizeable increase over 2022 amounts. The new annual 401(k) elective deferral limit is $22,500 with a $7,500 catch up for those age 50 or older, permitting $30,000 to be contributed annually, or $5,000 per month. Plan sponsors should also note that the compensation threshold to determine highly compensated employees increases from $135,000, to $150,000, which is measured based on prior year’s compensation. The rest of the new limits are shown below:

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.

Photo credit: Rodion Kutsaiev, Unsplash

Auto-Portability:  A Guide for Retirement Plan Sponsors

The following Q&A is geared for plan sponsors who are curious about the auto-portability process and how it might prove beneficial to their plan participants.  Auto-portability can prove especially useful in industries with lower wages and high employee turnover, which may include retail, transportation, hospitality, and restaurants, because this can often lead to numerous account balances of $5,000 or less being involuntarily rolled to default IRAs.  Note that SECURE 2.0 proposals could increase the involuntary cash-out threshold to $7,000, which could expand the potential market for auto-portability solutions.

    1. What is auto-portability?

    Auto-portability is a financial technology service that helps consolidate retirement savings accounts for individuals who have changed jobs, and who may have one or more default IRA accounts due to mandatory distribution of low-balance accounts in prior employers’ plans ($5,000 or less), or termination of their employer’s 401(k) plan. 

    2. How does auto-portability work?

      Industry leader Retirement Clearinghouse, LLC (RCH) devised a “locate, match, and transfer” process that coordinates among multiple recordkeeper systems to identify when an individual with a default IRA account has opened a new 401(k) account, and enable a “roll-in” of the IRA to the new employer’s plan.   Auto-portability can even be used by a plan to skip the default IRA step, and postpone distribution of small account balances until the former participant has established an account with a new employer’s plan.  Participant consent is requested at the time their default IRA account or small employer plan account balance is matched with an account under a new employer plan, and roll-in to the new plan becomes possible, but if consent is not provided within 30 days, a default roll-in transaction occurs.

      3. What problems does auto-portability help address?

      RCH flagged three main problems addressed by auto-portability, in a Question & Answer handout it prepared on the Portability Services Network.  [Sign up to obtain the Q&A here.]

      The first is cash out leakage, which is the phenomenon of workers cashing out small retirement account balances when they change jobs.  They cite Employee Benefit Research Institute (EBRI) as estimating that of 14.8 million annual job transitions, 41%, or 6 million, will cash out of their retirement savings completely ($92.4 billion), with two-thirds of the cash outs being for reasons other than a financial emergency.  (This last detail strongly suggests that cash outs are taking place due to the inconvenience and the time required to process the transfer of a relatively small amount.)  The cash out percentage is higher – an estimated 55% – for participants with account balances under $5,000.  Research also points to cash out at the point of job transition as disproportionately impacting minority and low-income workers, thus undermining their ability to establish financial security for retirement. 

      Two other problems that can be addressed by auto-portability are the gradual erosion, through annual account fees and anemic money-market investment returns, of low-balance default IRA accounts, and missing participants.   Auto-portability reduces the first problem by moving money out of the low-balance IRA accounts to be consolidated with future savings under employer-sponsored plans.  Auto-portability reduces the prevalence of missing participants by tracking contact information established under a new employer’s plan, which is likely to be more accurate than old contact information maintained by prior employers.

      4. How does a plan sponsor connect with auto-portability services?

      RCH recently established a consortium with major 401(k) recordkeepers Alight, Fidelity and Vanguard, called the Portability Services Network (PSN).  PSN is expected to be up and running in the first quarter of 2023.  So if your plan uses one of those recordkeepers, auto-portability may be on offer to you in the new year.  The consortium is open to other recordkeepers joining as well.  Although RCH is currently the only direct provider of auto-portability services it is likely that there will be other providers offering these services in the future.  Finally, it is also possible for a plan to work directly with RCH, without going through its recordkeeper relationship, but this may be feasible only for fairly large plans.

      5. What do auto-portability services cost, and who pays for them?

      If you use the PSN consortium, there is no cost to plan sponsors.  Plan participants whose retirement accounts are transferred are charged a one-time transaction fee not exceeding $30.  Fees are disclosed in plan documentation, which will need to be amended to incorporate auto-portability language.  Other fees and disclosures apply if your plan contracts directly with RCH for auto-portability services.  The entry of other auto-portability service providers into the market to compete with RCH will hopefully result in lower transaction costs over time.

      6. Will my company have fiduciary liability in relation to auto-portability services?

      Yes, with respect to choosing to use auto-portability services and electing to work either directly with RCH or a similar vendor, or with the PSN consortium.  Specifically, you would be responsible for ensuring that the auto-portability service is a necessary service, a reasonable arrangement, and that it charges no more than reasonable compensation for the services provided.  You would need to monitor the arrangement and periodically ensure that your plan’s continued participation in the auto-portability program is consistent with ERISA’s standards.  However, your company will not have fiduciary liability with respect to the decision to transfer a default IRA or small balance account into your plan (roll-in).  In the absence of written consent from the account holder, fiduciary liability for that decision lies with RCH.  Your plan will have fiduciary responsibility with respect to determining whether the roll-in to your plan is consistent with plan terms, and in allocating the rolled-in assets to investments under your plan (unless a QDIA is in effect, or subject to ERISA Section 404(a) if the participant has made investment elections under the new plan).  The Department of Labor addressed these issues in Advisory Opinion 2018-01A, dated November 5, 2018.

      7. What else should I be aware of, on the auto-portability front?

      The Advancing Auto-Portability Act of 2022 is a bipartisan Senate bill sponsored by Senators Tim Scot (R-SC) and Sherrod Brown (D-OH) that would provide a $500 tax credit to employers who adopt auto-portability services, to help pay for the costs of implementation.  Representatives of the Department of Labor have also indicated that the Department is concerned about retirement account portability and cash-out leakage and recognize that auto-portability can helps preserve retirement security for many workers.  Thus, the problems that auto-portability is trying to address are apparent to members of Congress as well as to key personnel at the DOL, and plan sponsors should anticipate increased access to auto-portability in the future.

        The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.

        Photo credit:  Tima Miroshnichenko, Pexels

        Lender Beware:  IRS Issue Snapshot on Third Party Loans

        The IRS recently published an Issue Snapshot meant to guide examiners who encounter third party loans among the investments of plans they are auditing.   Third party loans occur when a qualified plan trustee elects to loan plan funds to someone other than a plan participant, at a designated rate of return, in exchange for a promissory note, deed of trust, or other form of security. Below I summarize some of the key points in the IRS Snapshot and add some insights gleaned from third party loan issues I have encountered in my practice.   Note: this post is not intended as a “how to” for these risky investments, but as a roadmap for plan sponsors who may have entered into such transactions in the past and could find themselves in an audit setting.

        1. Don’t Assume Your Trust Agreement Permits Third Party Loans.   The Issue Snapshot notes that a plan document may limit the ability of a plan trustee or plan participant to invest in third party loans, and this is absolutely the case.  It is necessary to check plan trust language before making any such investment.   In my examination of plan trust agreements, I have seen language expressly permitting third party loans (e.g., allowing investments in “notes or other property of any kind, real or personal,” and I have seen language that cannot, even in broad “general powers” provisions, be construed to permit third party loans.  A loan made in the absence of plan language permitting the investment is a fiduciary breach.
        2. Avoid Prohibited Transactions.  The third party loan will be a prohibited transaction if the loan is either made directly to a “disqualified person” or indirectly benefits a disqualified person, for instance through rerouting the loan proceeds to them.  A disqualified person includes the employer, fiduciaries, persons providing services to the plan (the IRS gives the example of accountants and attorneys), and persons and corporations who own a 50% or more interest in the employer.   I sometimes see this issue arise in family-owned businesses, where the borrower is a family member who owns more than half of the plan sponsor entity.  The Issue Snapshot encourages auditors to be on the lookout for plan loan terms that disadvantage the plan, such as little or no interest rate or unsecured loans, as indicators that the loan may have been made for the benefit of a disqualified person.  I would add to that list, failure of the plan to enforce timely loan repayment, or frequent re-amortization of the loans on terms that are favorable to the borrower.  Prohibited transactions are subject to excise taxes under Code § 4975(a) and (b).
        3. Avoid Self-Dealing.  Self-dealing by a fiduciary violates the exclusive benefit rule articulated in both the Code and ERISA.   With regard to the Code, the Issue Snapshot notes that others may benefit from a transaction with a plan as long as the “primary purpose” of the investment is to benefit employees or their beneficiaries.  (Citing Shedco Inc. v. Commissioner, T.C. Memo. 1998-295.)  An IRS examiner who concludes that a third party loan fails the primary purpose test must refer the matter to the Department of Labor.  On the Department of Labor side, ERISA Section 406(b) prohibits a plan fiduciary from dealing with the assets of a plan “in their own interest of for their own account.”   In my experience, self-dealing types of third party loans arise more often than direct loans to disqualified persons.  It is not uncommon for there to be a pre-existing relationship between the plan sponsor or trustee, on the one hand, and the borrower, on the other hand, whether that of a business partner, friend, or family member, such that the loan benefits the fiduciary by assisting someone of importance to them.   If identified in an IRS audit and referred to the Department of Labor, or identified in a DOL audit, a loan of this type may result in civil penalties.
        4. Value Your Asset.  The Issue Snapshot cites Revenue Ruling 80-155 as requiring annual valuation of defined contribution plan assets and states that this rule applies to third party loans just like any other plan investment.  It also notes that plan documentation may also expressly mandate annual asset valuations, making failure to obtain them a breach of the plan’s written terms.  The Issue Snapshot does not specify that a professional valuation must be obtained but suggests that a fresh value must be assigned to the loan each year based on a number of factors including the discount/interest rate and the probability of collection.    One thing not to do is to report a static value for the loan across multiple years’ Form 5500 Return/Reports as this will indicate to the Service “that payments under the loan contract are not being made and/or that the true fair market value of the loan is not being appraised or reported.”
        5. Documentation Is Key.  This is not explicitly addressed in the Issue Snapshot but is something I observed in practice.  In one matter I was involved with, the Department of Labor audited a 401(k) plan and observed a portfolio of about a dozen third party loans.  All charged substantial rates of interest, resulting in returns that exceeded those realized by the Plan’s more conventional investments.  All were secured by deeds of trust on real property held by the borrowers.  Third party valuations of the real property parcels had been obtained at the time of the loan, and periodically updated.  Amortization and repayment schedules were up to date on all loans.  The borrowers had no relationship with the business that sponsored the plan or with the fiduciaries themselves.  The Department of Labor scrutinized the loan files and were unable to find any ERISA violations in the loans as an asset class or individually.   The plan sponsor had discontinued the practice of extending new third party loans even in advance of the audit, but by essentially operating with the procedural rigor of a commercial lender, it had maintained third party loans as successful plan investments for a number of years.

        The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.

        Photo credit: Evgeniya Litovchenko, Unsplash

          CalSavers Scoops Up Micro-Businesses Effective in 2025

          Coming close on the heels of expansion of the CalSavers program to businesses with 5 or more employees, which went into effect on June 30, 2022, California Governor Gavin Newsom signed into law a further expansion of the CalSavers program on August 26, 2022, in the form of Senate Bill 1126.  Under this new measure, as of December 31, 2025, businesses with one (1) employee or more must either enroll in the CalSavers program, or sponsor a retirement plan.

          This sweeps into the CalSavers regime even micro-businesses like home-based Etsy shops, food trucks, and the like.  Expressly excluded from the expansion are sole proprietorships, self-employed individuals, or other business entities that do not employ any individuals other than owners of the business (a company that employs two spouses, who each own half of the company’s stock, would be one example).

          For these very small businesses, enrolling in CalSavers may be preferable to establishing even the simplest format retirement plan, due to the complexities of administering these plans, and the very inflexible rules for the IRA-based retirement plans (SIMPLE and SEP arrangements).  We covered some of the potential pitfalls of setting up a plan in our earlier post. 

          That said, the financial services industry is increasingly reaching out to smaller employers with app-based service packages that allow a business owner to establish a 401(k) plan online, with “just a few clicks.”  No matter how easy it is to establish, a 401(k) plan is still a 50+ page written contract that is governed by two federal agencies (Department of Labor and Internal Revenue Service) and caution is advised.  With the proper prior planning, a SIMPLE, SEP, or 401(k) plan can be a powerful means of attracting and retaining employees and a good strategic move for even the smallest business.  But knowing what you are getting into, is key.   The persons vending the plan services may not be your best source of knowledge as to what can go wrong.  Stay on the safe side and check with an expert – either a CPA with retirement plan experience, a 401(k) plan third party administrator, or an ERISA attorney, before you sign plan documentation. 

          Finally, classifying someone as an independent contractor to avoid the 1-employee threshold is not a good idea in California, where the criteria for independent contractor are quite narrow.  If you have questions in that regard, check with the California Department of Industrial Relations, or with a qualified employment law attorney.

          The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.

          Photo credit: Anthony Persegol, Unsplash

          Will New IRS Funding Increase Plan Audits?

          The Inflation Reduction Act, H.R. 5376 stands poised for passage in the House and includes almost $80 billion in new funding for the Internal Revenue Service, of which almost $46 billion is allocated to “enforcement,” including determination and collection of taxes, legal and litigation support. What is not clear at this juncture is how much of that massive amount of new funding will trickle down to the Tax Exempt and Government Entities Division, which has oversight over retirement plans, the employers that sponsor retirement plans, and IRAs. IRS Commissioner Chuck Rettig has stated in letters to both houses of Congress that the rates of auditing households making under $400,000 per year will not increase despite the new funding, but that the resources will enable “meaningful, impactful examinations of large corporate and high-net-worth taxpayers.” Whether this includes examinations of large corporate and high-net-worth taxpayer retirement plans and IRAs is uncertain.

          A breakdown of the new IRS funding, which is set forth in Title I, Subtitle A, Part 3 of the Act, is set forth below.

          Section 10301. Enhancement of Internal Revenue Service Resources.

          It seems hard to imagine that some portion of the enforcement budget won’t ultimately increase plan audit activity. The IRS only recently announced a new plan enforcement initiative in the form of a 90-day Pre-Examination Compliance Pilot program (click on June 3, 2022 to display the program announcement). Under this new program, IRS will send a letter to a plan sponsor notifying them that their retirement plan has been selected for an examination. The letter gives the plan sponsor a 90-day window of time to review their plan’s documentation, and operations, for compliance with applicable law. If errors are noted, they may be eligible for self-correction under the terms of Revenue Procedure 2021-30. Errors that are not eligible for self-correction can be corrected under a closing agreement, with the Voluntary Correction Program fee structure forming a basis to determine the sanction amount that the IRS will impose. If the plan sponsor fails to respond to the IRS within 90 days of the letter, the IRS will contact the sponsor to schedule an exam. Since this audit initiative starts with a simple letter, there would now seem to be ample funds at IRS to pursue this agenda – in fact, postage is one of the expressly sanctioned expenses under Operations Support. Even without a specific funding line-item for TE/GE, plan sponsors should be on their guard in this new era of IRS funding.

          The author thanks Peter Gulia, Fiduciary Guidance Counsel, and other colleagues at the Benefitslink Message Boards for sharing their thoughts about the new IRS funding.

          The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.

          Photo credit:  Mathieu Stern, Unsplash

          Who Should Be Trustee of Your 401(k) Plan?

          When a company establishes a 401(k) plan it is necessary to name a trustee of the plan. This is a very important decision that is not always given the careful deliberation that it deserves. This post covers why it is such a crucial decision and outlines some of the options for naming a plan trustee.

          Why it Matters

          The trustee is responsible for the plan assets. Every 401(k) plan involves a tax-qualified trust established under Section 401(a) of the Internal Revenue Code and all plan assets are nominally held in that trust, so the trustee of that trust is in charge of all plan assets. That includes collection of contributions, their investment while held by the trust, and their ultimate disbursement to plan participants and beneficiaries. In most 401(k) plans, even though participants take on responsibility for choosing among plan investment options under Section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA), the plan trustee is responsible for selecting the menu of options from which participants choose. If problems are identified with plan investment performance, or with the amounts paid to plan service providers, the plan trustee may be called to answer in court.

          The standard of care is one of the most stringent known under law. A plan trustee is a fiduciary under ERISA. The fiduciary standard of care, often referred to as the “prudent expert” standard, is set forth under ERISA § 404(a)(1). It requires that plan trustees consistently do all of the following:

          • Act solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them;
          • Carry out their duties prudently;
          • Follow the terms of the plan documents (unless doing so is inconsistent with ERISA);
          • Diversify plan investments; and
          • Pay only reasonable plan expenses to service providers, with “reasonableness” being measured in light of the services provided to the plan.

          More information about fiduciary duties under ERISA is set forth in a booklet titled “Meeting Your Fiduciary Responsibilities” that is published by the Department of Labor, Employee Benefits Security Administration. Every person who is serving as an ERISA plan fiduciary or who is in a position to appoint a plan fiduciary should familiarize themselves with the contents of the booklet and should seek out qualified ERISA counsel to assist in applying the concepts in the booklet to their particular factual situation.

          At this juncture it is appropriate to discuss specialized types of ERISA fiduciaries who can be engaged to assist plan trustees in various ways. Perhaps the most prevalent is the ERISA 3(21) fiduciary, a paid investment advisor that assists the plan trustee in selecting plan investments, reviewing investment performance, and providing recommendations about investments to the plan fiduciary. They bear fiduciary liability, but the plan trustee carries ultimate liability for acting, or not acting, on the 3(21) fiduciary’s recommendations. An ERISA 3(38) investment manager, rather than merely making recommendations, directly selects and monitors the plan’s investment option menu, changing out funds and providers as it finds appropriate. The plan trustee is regularly advised about the investment manager’s decisions and retains fiduciary liability over the selection and monitoring of the 3(38) investment manager. An ERISA 3(16) fiduciary primarily has an administrative role, rather than having to do with plan investments. They can take over responsibility for signing and filing Form 5500 return/reports and other tasks that plan trustees would otherwise have to fulfill. (This is just a very brief overview of these various roles; there is more information about these three types of fiduciaries here and here.) Each of these types of fiduciary will charge fees for their services; selection of any of them is itself a fiduciary act and their fees must be reasonable in light of the services provided.

          401(k) litigation continues apace. Litigation against 401(k) plan trustees and other fiduciaries have been trending for almost 20 years. The lawsuits, most of which have been brought in class action format and have settled out of court, generally allege that plan fiduciaries have selected overly expensive investments or and/or are overpaying service providers such as investment managers, record keepers and third-party administrators. A recent Supreme Court opinion did not, as had been hoped, articulate a pleading standard that would have made it easier to eliminate an excessive fee lawsuit at the pleading stage. Although generally the lawsuits are directed at 401(k) plans with hundreds of millions of dollars in assets, there is nothing preventing class action counsel from targeting smaller plans.

          Who to Name as Plan Trustee

          Against that background, exercising extreme care in choosing a plan trustee is essential. There are two main options, and the sub-options within those two main categories.

          The first consideration is whether or not to choose an institutional or third-party trustee such as a bank or trust company. An institutional or “corporate” trustee will have fiduciary liability for plan assets under investment, but they often serve as “directed” trustees who take investment direction from the plan sponsor or from an ERISA 3(38) investment manager, rather than as discretionary trustees who call the investment shots themselves. It is also possible to name a discretionary corporate trustee. Corporate trustees of either variety charge fees, usually in the form of a small percentage of plan assets, with a minimum fee for start-up plans. The fees must be reasonable in light of the services performed, and as with the choice of a fiduciary advisor or manger, selection of a corporate trustee is itself a fiduciary act.

          Start-up and smaller plans often select an individual who is an executive or owner of the company sponsoring the plan to serve as plan trustee. That individual will potentially be personally liable for plan losses that are the result of their negligence or malfeasance. It is important that the individual named as a plan trustee be aware of this fact. It is also not uncommon for the company that sponsors the plan, to be named as the plan trustee. In this instance the company can only act by and through its board of directors, managers or partners (if an LLC or partnership), so if the company is named it is recommended that the board (or managers, or partners) form a plan committee to fulfill plan trustee duties. The committee should be comprised of individuals who have experience with investments and financial matters and who would be equipped to interview, select among, and monitor the performance of plan service providers such as ERISA 3(21) fiduciaries, 3(38) investment managers, record keepers, and third party administrators. Any individual serving as a plan trustee should also be comfortable performing those duties.

          Whether an individual or board committee carries out plan trustee functions, the individual(s) serving in this role should commit to introductory and ongoing fiduciary training. This would include information about the standard of care applicable to, and duties of, an ERISA fiduciary and would break down how those duties translate into tasks such as regular meetings to review plan investment performance, protocol for documenting decisions made during such meetings (e.g., minutes and resolutions), selection and monitoring of plan service providers, and the like. In addition to undergoing training, individual fiduciary(ies) will need to be diligent in fulfilling their appointed tasks.

          One further consideration is the purchase of fiduciary liability insurance. This is specialized liability coverage that is separate and different from the fiduciary bond required under ERISA Section 412(a). Fiduciary liability coverage acts like errors and omissions coverage, but with respect to a company or individual’s role as a fiduciary under an ERISA plan. 401(k) plan fee litigation has impacted the fiduciary liability insurance market, but coverage remains affordable and should be evaluated by individuals and board committees serving as plan trustees.

          The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.

          Photo credit: Joshua Hoehne, Unsplash