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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

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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

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Just Adopted a New 401(k) Plan?  Beware These Common Pitfalls

By June 30, 2022, businesses with 5 or more California employees must either enroll in CalSavers, a state-managed system of Roth IRA accounts, or establish their exemption from CalSavers by adopting 401(k) or other retirement plans of their own.  Other states have implemented or are rolling out similar auto-IRA programs.  Below are some potential pitfalls for new plan adopters that business owners should be aware of, and, where possible, take steps to avoid. 

  1. Immediate top-heavy status.  The “top-heavy” rules compare the combined plan account balances of certain owners and officers, called “key employees,” with the plan account balances of all other plan participants (non-key employees).  If the key employee account balances make up 60% or more of the combined plan account balances of all participants, the plan is top-heavy and the plan sponsor is required to make minimum contributions (generally equal to 3% of compensation) to the accounts of all non-key employees.  A plan can be top-heavy in its first year of operation, although it is more commonly a result of large account balances accumulated over time by long-term key employees, versus smaller accounts held by high-turnover, lower paid employees.   Top-heavy status is particularly likely to arise in a family-owned business, as family members of owners count as key employees, but the problem is not limited to this scenario.  Businesses that anticipate a potential top-heavy problem should consider adopting safe-harbor 401(k) plan designs, as a basic safe-harbor matching or non-elective contribution will satisfy minimum top-heavy contribution requirements.  A SIMPLE-IRA plan is also exempt from top-heavy requirements, provided you have 100 or fewer employees.
  2. ADP/ACP testing failure.     A similar and more common problem, failure of the Actual Deferral Percentage or ADP test, occurs when the average rate of elective deferrals made by Highly Compensated Employees exceeds the average rate of elective deferrals made by non-Highly Compensated Employees by more than a permitted amount.  (A related test, the Actual Contribution Percentage test, applies to matching contributions.)  Highly Compensated Employees (HCEs) are persons who own more than 5% of the company sponsoring the plan at any time during the current or prior year, or who, for the prior year, earned above a set dollar amount.  (For 2022, the amount is $135,000 and applies to 2021 earnings.)  Correcting testing failures will involve refunding amounts to HCEs, or making additional contributions to non-HCEs.  Fortunately there are a number of preventive measures to take, including using a safe harbor contribution formula, using a “top 20%” election to define HCEs, using automatic enrollment at a meaningful percentage of compensation (such as 5% or higher), and robust enrollment meetings and tools to engage employees with savings potentials under the plan. 
  3. Late deposit of elective deferrals.  When you run payroll and pull employee elective deferrals from pay, you have a deadline within which to invest them under your 401(k) plan, which is the point at which they are considered to be “plan assets” under ERISA.  Investment is generally is denoted as a “trade date” by your plan’s recordkeeper, whether Fidelity, Vanguard, or the like.   If you have under 100 participants as of the beginning of your plan year (counting those who are eligible to participate even if they don’t actively do so) you have seven business days to get from pay date, to trade date.  For larger plans, the normal deadline to invest is as soon as elective deferrals can reasonably be segregated from your general assets.  (An outside deadline of 15 business days after the end of the month following the month in which the elective deferrals would have been payable in cash applies in the event of extraordinary circumstances interrupting normal payroll functioning.)  If you fail to meet the seven business-day or “as soon as” deposit deadline, your retention of employee funds constitutes a “prohibited transaction” and an excise tax is payable to the IRS. Additionally, the Department of Labor views it as a fiduciary breach.  It is possible to seek relief from the excise tax and from potential fiduciary liability by participating in the Department of Labor’s Voluntary Fiduciary Compliance Program or VFCP.  Late deposits of employee elective deferrals (and loan repayments) must be disclosed each year on your Form 5500 Return/Report, which in turn could trigger further inquiry, so compliance with your applicable deposit deadline is important.
  4. Plan audit requirement.  As we covered in an earlier post, a business sponsoring a brand new 401(k) plan may be required to obtain an audit report on the plan’s operations and finances, prepared by an independent qualified public accountant or IQPA, at an annual expense of $5,000 – $15,000 or more.  These reports generally are required for plans with 100 or more participants as of the first day of the plan year, counting those who are eligible to participate whether or not they actually do so.  Proposed regulations for Form 5500 might change that rule, to count only those with plan account balances, but they have yet to be finalized and put into effect.  Until that time, businesses sponsoring new plans that will cover 100 or more eligible participants need to prepare for the audit process, both in terms of budgeting dollars for the cost, and time to gather responses to the auditor’s questionnaires.  New auditing standards going into effect this year put increased responsibilities on plan sponsors to account for plan operations and documentation.

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:  Goh Rhy Yan, Unsplash

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How to Prepare Business Owners for the Approaching CalSavers Deadline

CalSavers is a state-run retirement program that applies to employers who do not already sponsor their own retirement plan.  It automatically enrolls eligible employees in a state-managed system of Roth IRA accounts. It has been in place since September 30, 2020 for employers with more than 100 employees and since June 30, 2021 for employers with more than 50 employees.  On June 31, 2022, it goes into effect for employers with 5 or more employees.  Below we cover key aspects of the CalSavers program, focusing on the types of issues that California business owners might bring to their benefits advisor for further clarification. A version of this post was published in the March 2022 issue of Santa Barbara Lawyer magazine.

Q.1:  What is CalSavers?

A.1:  CalSavers is the byproduct of California Senate Bill 1234, which Governor Brown signed into law in 2016. It is codified in Title 21 of the California Government Code and in applicable regulations. It creates a state board tasked with developing a workplace retirement savings program for private for-profit and non-profit employers with at least 5 employees that do not sponsor their own retirement plans (“Eligible Employers”).  Specifically, CalSavers calls for employees aged at least 18, and who receive a Form W-2 from an eligible employer, to be automatically enrolled in the CalSavers program after a 30-day period, during which they may either opt out, or customize their contribution level and investment choices.   The default is an employee contribution of 5% of their wages subject to income tax withholding, automatically increasing each year by 1% to a maximum contribution level of 8%. Employer contributions currently are prohibited, but they may be allowed at a later date.

Q.2:  If a business wants to comply with CalSavers, what does it need to do?

A.2:  The steps are as follows:

  • Prior to their mandatory participation date – which as mentioned is June 30, 2022 for employers with 5 or more employees, Eligible Employers will receive a notice from the CalSavers program containing an access code, and a written notice that may be forwarded to employees. Eligible Employers must log on to the CalSavers site to either register online, or certify their exemption from Calsavers by stating that their business already maintains a retirement plan. The link to do so is here. To do either, the employer will need its federal Employer Identification Number or Tax Identification Number, as well as the access code provided in the CalSavers notice. 
  • Eligible Employers who enroll in CalSavers will provide some basic employee roster information to CalSavers. CalSavers will then contact employees directly to notify them of the program and to instruct them about how to enroll or opt-out online. Those who enroll will have an online account which they can access in order to change their contribution levels or investment selections.
  • Once an Eligible Employer has enrolled in CalSavers, their subsequent obligations are limited to deducting and remitting each enrolled employee’s contributions each pay period, and to adding new eligible employees within 30 days of hire (or of attaining eligibility by turning age 18, if later).
  • Eligible Employers may delegate their third-party payroll provider to fulfill these functions, if the payroll provider agrees and is equipped to do so.  CalSavers provides information on adding payroll representatives once a business registers.

Q.3:  How does a business prove it is exempt from CalSavers?

A.3:  There are several steps:

  • First, it must have a retirement plan in place as of the mandatory participation date.  This may mean a 401(k) plan, a 403(b) plan, a SEP or SIMPLE plan, or a multiple employer (union) plan. 
  • Employers with plans in place must still register with CalSavers to certify their exemption.  The link is at https://employer.calsavers.com (Select “I need to exempt my business” from the pull-down menu.)  They will need their federal Employer Identification Number or Tax Identification Number and an access code that is provided on a notice they should have received from CalSavers.  If they can’t find their notice, they can call (855) 650-6916.  

Q.4:     How does a business count employees, for the 5 or more threshold?

A.4: To count employees for purposes of the 5 or more threshold, a business takes the average number of employees that it reported to the California Environmental Development Department (EDD) for the previous calendar year.  This is done by counting the employees reported to the EDD on Form DE 9C, “Quarterly Contribution Return and Report of Wages (Continuation)” for the quarter ending December 31 and the previous three quarters, counting full- and part-time employees.   So, for example, if a business reported over 5 employees to EDD for the quarter ending December 31, 2021 and the previous three quarters, combined, and it did not maintain a retirement plan, it would need to register with CalSavers by June 30, 2022.  If a business uses staffing agencies or a payroll company, or a professional employer organization, this will impact its employee headcount. The business should seek legal counsel as the applicable regulations are somewhat complex.

Q.5: What are the consequences of noncompliance with CalSavers requirements?

A.5:  There are monetary penalties for noncompliance, imposed on the Eligible Employer by CalSavers working together with the Franchise Tax Board. The penalty is $250 per eligible employee for failure to comply after 90 days of receiving the CalSavers notification, and $500 per eligible employee if noncompliance extends to 180 days or more after the notice.  CalSavers has begun enforcing compliance with the program in early 2022, for employers with more than 100 employees who were required to enroll by the September 30, 2020 deadline.   

Q.6:  Are there any legal challenges to CalSavers?

A.6:  Yes, but the main suit challenging the program has exhausted all appeals, without success. A bit of background information is necessary to understand the legal challenge to CalSavers. The Employee Retirement Income Security Act of 1974 (ERISA) generally preempts state laws relating to benefits, but a Department of Labor “safe harbor” dating back to 1975 excludes from the definition of an ERISA plan certain “completely voluntary” programs with limited employer involvement. 29 C.F.R. § 2510.3-2(d).  The Obama administration finalized regulations in 2016 that would have expressly classified state programs like CalSavers, as exempt from ERISA coverage, and thus permissible for states to impose. However, Congress passed legislation in 2017 that repealed those regulations, such that the 1975 safe harbor remains applicable. Arguing that the autoenrollment feature of CalSavers program makes CalSavers not completely voluntary and thus takes it out of the 1975 regulatory safe harbor, a California taxpayer association argued that ERISA preempts CalSavers.   On March 29, 2019, a federal court judge concluded that ERISA did not prevent operation of the CalSavers program, because the program only applies to employers who do not have retirement plans governed by ERISA.  The Ninth Circuit affirmed.  In late February 2022, the Supreme Court of the United States declined to review the case. Meanwhile, state-operated IRA savings programs are underway in a number of other states, including Oregon, Illinois and New York, and in the formation stages in yet others. 

Q.7:  Does CalSavers apply to out-of-state employers? 

A.7:  It can.  An employer’s eligibility is based on the number of California employees it employs, as reported to EDD. Eligible employees are any individuals who have the status of an employee under California law, who receive wages subject to California taxes, and who are at least 18 years old. If an out-of-state employer has more than 5 employees meeting that description, as measured in the manner described in Q&A 4, then as of June 30, 2022 it would need to either sponsor a retirement plan, or register for CalSavers.

Q.8.  Does CalSavers apply to businesses located in California, with workers who perform services out of state? 

A.8:  Yes, if the employer is not otherwise exempt, and if they have a sufficient number of employees who have the status of an employee under California law, who receive wages subject to California taxes, and who are at least 18 years old.

Q.9: Can an employer be held liable over the costs, or outcome of CalSavers investments?

A.9:  No.  Eligible Employers concerned about lawsuits should be aware that they are shielded from fiduciary liability to employees that might otherwise arise regarding investment performance or other aspects of participation in the CalSavers program.  In that regard, the CalSavers Program Disclosure Booklet, available online, goes into significant detail about the way CalSavers contributions will be invested; notably the cost of these investments (consisting of an underlying fund fee, a state fee, and a program administration fee).

Q.10:  Can an employer share its opinions about CalSavers, to employees?

A.10.  Not really.  Eligible Employers must remain neutral about the CalSavers program and may not encourage employees to participate, or discourage them from doing so. They should refer employees with questions about CalSavers to the CalSavers website or to Client Services at 855-650-6918 or clientservices@calsavers.com.

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.

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What the Supreme Court’s Hughes Decision Means to Plan Sponsors

“The point is that you’re not insulated from making bad [investment] decisions in your — [ . . . ] plan by the fact that you’ve made some good [investment] decisions in your plan, are you?”[1]

The fiduciaries of two 403(b) plans maintained by Northwestern University were sued for ERISA fiduciary breach on the grounds that the plans paid excessive recordkeeping fees, in part because of the existence of multiple recordkeepers, offered retail share class mutual funds and annuities when cheaper and materially identical institutional class alternatives were available to a plan of Northwestern’s size, and had a too-large roster of investment options that confused participants (Northwestern made changes that corrected some of these issues by the time the Supreme Court heard oral argument.)  The Northwestern fiduciaries moved to dismiss these claims, in part, on the grounds that the participants could have chosen from among lower-priced investments offered by the plans, hence failed to successfully allege that a fiduciary breach occurred.

In a unanimous decision by Justice Sonia Sotomayor in Hughes v. Northwestern University, the Supreme Court addressed a narrow issue on the standard of pleading an ERISA fiduciary breach: 

  • Whether, if plaintiffs can allege the existence of overpriced or otherwise imprudent investment options or recordkeeping arrangements, their complaint will survive a motion to dismiss, and may proceed to trial, even if participants could have chosen from among other investments that were not similarly flawed.

The Supreme Court answered this question “yes,” and remanded the case to the Seventh Circuit to determine whether fiduciary breaches were sufficiently alleged, notwithstanding that the Northwestern University 403(b) plans included some low-cost investment options which participants, in the self-directed arrangement, were free to choose over higher-priced options.

In reaching its conclusion the Supreme Court called out the Seventh Circuit for using “flawed” reasoning in its over-reliance on participant choice: “[s]uch a categorical rule is inconsistent with the context-specific inquiry that ERISA requires and fails to take into account respondents’ duty to monitor all plan investments and remove any imprudent ones.”  Hughes Opinion at p. 2, citing Tibble v. Edison Int’l, 575 U.S. 524, 530 (2015).

In other words, because ERISA fiduciaries must continually monitor investment options (and recordkeeping contracts, and other arrangements whose costs offset the growth of ERISA assets), the maintenance of some options that reflect fiduciary prudence does not excuse the continued presence of other options that do not. 

Reliance throughout the Hughes opinion on the Tibble case is instructive.  In that case, plaintiffs alleged in 2007 that the Edison 401(k) Savings Plan added mutual funds in 1999 and in 2002 with retail share pricing when materially identical, lower-priced institutional-class mutual funds were available.  The district court allowed the allegations regarding the funds added in 2002 to proceed but not the funds added in 1999, because more than six years had passed since the overpriced funds were added to the investment mix, and that exceeded the applicable statute of limitations for fiduciary breach.

The Ninth Circuit affirmed, but the Supreme Court disagreed, holding that ERISA fiduciary’s continuing duty to monitor and remove imprudent investments meant that the statute of limitations with regard to the 1999 fund additions remained open, because imprudent retention of an investment was a fiduciary breach, separate and distinct from a breach that occurs at the point of selecting an investment. 575 U.S. at 529, citing, inter alia, A. Hess, G. Bogert, & G. Bogert, Law of Trusts and Trustees § 684, at 147-148.

While it does not provide bright-line answers to what constitutes a fiduciary breach, the Hughes decision does acknowledge the complexity that the duty of prudence encompasses, stating that examinations of fiduciary prudence “will necessarily be context specific,” turning on the factual circumstances that prevail at the time the fiduciary acts; that at times, the circumstances facing an ERISA fiduciary will implicate “difficult tradeoffs,” and that courts must give “due regard” to the “range of reasonable judgments a fiduciary may make based on her experience and expertise.” Hughes Opinion at p. 6.

What does this mean for plan sponsors, plan investment committees, and other fiduciaries of 401(k), 403(b) and other ERISA retirement plans?  Nothing that common sense did not already dictate, but seeing the issues addressed so succinctly by the country’s highest court should be an impetus for plan fiduciaries to take the proper steps, which include (but are not limited to):

  • They must regularly evaluate the performance and pricing of their entire universe of investment options, as well as their recordkeeping and other vendor relationship, in a regular benchmarking or other apples-to-apples comparison process.
  • They must also put those relationships out to competitive bid at the outset of the relationship and periodically thereafter.
  • The benchmarking and bidding process must be documented in the form of meeting minutes and resolutions as must the periodic, such as quarterly, review of investment performance.
  • Use of a carefully chosen ERISA 3(21) investment advisor or 3(38) investment manager will assist with this process, but the choice and retention of the fiduciary advisor or manager is itself subject to the fiduciary standard and failing to benchmark and bid out those relationships could lead to potential liability.
  • An investment policy statement that articulates the process through which fiduciaries fulfill their duties of prudence, loyalty, and diversification with regard to selection and retention of investments is also advisable. However, care must be taken to not create too specific a set of guidelines as drifting from them could itself give rise to fiduciary liability.

In summary, the Supreme Court has weighed in, and ERISA fiduciaries who can point to some prudent investment options will not defeat fiduciary breach allegations at the pleading stage if they have not also regularly monitored and pruned inefficient and overpriced investments and recordkeeping relationships from their plan lineup.  Plan sponsors and other fiduciaries who already have good fiduciary hygiene practices in place should have little to fear, but those who do not now have no comfort that some is good enough, for defeating allegations of fiduciary imprudence.

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: Bill Mason, Unsplash

[1] Justice Elena Kagan, Transcript of Oral Argument, Hughes v. Northwestern (19-1401), Retrieved at https://www.supremecourt.gov/oral_arguments/argument_transcripts/2021/19-1401_d18f.pdf

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Five Fast Facts About Reproductive Health Benefits

Employers are increasingly looking to offer employees assistance in starting and adding to their families, which in a growing number of cases involves dealing with infertility treatments and other reproductive health issues.   Below are five fast facts about this trending employment benefit.

  1. Reproductive health benefits are increasingly in demand.  According to a survey by the International Foundation of Employee Benefit Plans, summarized here, 24% of employers surveyed covered the cost of in vitro fertilization benefits in 2020, up from 13% in 2016.  Similar or greater increases in coverage were seen across other categories, including fertility medications, visits with genetic counselors and surrogacy advisors, genetic testing, non-IVF fertility treatments, and egg harvesting and freezing services (coverage of which jumped from 2% in 2016 to 10% in 2020). 
  2. Only some reproductive health benefits are likely to qualify as medical expenses under a health FSA or HRA.  Such expenses must be incurred “for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body [of the employee, the employee’s spouse, or the employee’s dependent.]”  IRS Publication 502, Medical and Dental expenses, mentions only in vitro fertilization, including temporary storage of eggs or sperm, and surgery to reverse procedures to prevent conception, as qualifying medical expenses.  With regard to other reproductive health measures, such as surrogacy expenses, egg donation and the like, we have only private letter rulings or other IRS guidance that is specific to the taxpayers who seek an opinion and may not be relied upon by other tax payers.  As a consequence, a comprehensive reproductive health benefit plan may have to comprise a blend of pre-tax and after-tax benefits.
  3. State laws may apply, especially with regard to surrogacy benefits.  Some states, including New York, prohibit certain types of gestational surrogacy contracts, whereas other states permit them subject to certain conditions.  This article provides a survey of state laws as of early 2020.  Employers with operations in multiple states will want to proceed cautiously in designing their reproductive health benefits so as not to offer benefits that are prohibited or restricted under state laws.
  4. A number of vendors have cropped up in this space as a consequence of the complexity around the federal tax and state law issues.  Services they offer include integration with insurance carriers, care navigation, and coaching. Some of the leading reproductive health benefit vendors include the following:
  5. Retirement plans are getting into the game.  Effective as of last year, the SECURE Act permits 401(k) plans to offer “qualified birth or adoption distributions” of up to $5,000 person, to cover expenses incurred in childbirth or adoption, that are subject to income taxes but exempt from the 10% early distribution tax under Code Section 72(t).  More information on these distributions can be found in our earlier post on this topic.  Adding this distribution feature can help support an employer’s overall reproductive health benefit offerings.

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:  Garret Jackson, Unsplash

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Five Good Reasons to Correct Retirement Plan Errors

If your business sponsors a Section 401(k) or other retirement plan, it is governed by a lengthy plan document, often a separate trust agreement or custodial account agreement, and multiple other documents (salary deferral agreements, loan policy statement, investment policy statement, etc.)  Not surprisingly, most plan sponsors get something wrong somewhere along the way, whether with respect to the plan document, or operation of the plan.  Below are five reasons why taking prompt action to correct plan errors is in the best interests of your business, and your employees.   

  1. To preserve the tax-qualified status of your plan.

Contributions to your plan are deductible to your business and excluded from your employees’ taxable compensation (i.e., are “tax-qualified”) because the plan document, and operation of the plan, conform to certain requirements under the Internal Revenue Code.  Under the Employee Plans Compliance Resolution System or EPCRS, the Internal Revenue Service permits plan sponsors to voluntarily correct a wide range of errors that, if left uncorrected, could result in a loss of the plan’s tax-qualified status and subject plan assets to taxation.   There are costs associated with participating in the EPCRS, including amounts that may be owed to the plan, attorneys’ fees, and program fees, but they are usually only a fraction of the potential expense of plan disqualification. 

  1. To correct prohibited transactions.

While the IRS monitors the tax-advantaged status of benefit plans, the Department of Labor policies the actions of plan fiduciaries, both with respect to plan assets, and in fulfilling reporting and disclosure duties.  When salary deferrals and loan repayments are withheld from employees’ pay and not promptly deposited in the plan’s trust account, the Department of Labor essentially views this as an interest free loan, by the employer, of employee money.  Technically speaking, it is a “prohibited transaction” that requires correction under the DOL’s Voluntary Fiduciary Correction Program.  Uncorrected prohibited transactions, if discovered on audit, can result in civil monetary penalties to the fiduciaries, and also triggers excise taxes payable to the Internal Revenue Service.  Prohibited transactions also must be disclosed on the annual Form 5500 Return/Report, potentially alerting the Department of Labor to initiate further inquiry or audit.  Timely participation in VFCP eliminates the fiduciary penalties and offers alternatives to payment of the excise taxes in some circumstances (e.g., if the same amount is paid to the plan). 

  1. To minimize penalties in the event of a plan audit.

The IRS, on audit, may assess penalties for uncorrected errors in plan documentation and operation, that can reach many thousands of dollars, on top of the amounts owed to the plan in order to correct operational errors.  And, as mentioned, prohibited transactions trigger potential civil monetary penalties.  Participation in IRS and DOL voluntary correction programs protects plan sponsors from these potential large assessments.  Whatever the cost of taking part in the voluntary program, whether it be costs of corrective contributions and earnings, attorneys fees, and the program fee, it is a quantifiable cost and one that is much smaller than the cost of correcting under the supervision of the IRS or DOL.

  1. To ensure the saleability of your business.

Plan sponsors sometimes think that their uncorrected plan errors are only at risk of discovery if they are audited, and point to low levels of IRS and DOL audit activity as proof that they can safely play “audit roulette.”  However they are forgetting that, if they want to sell their business – particularly stock sales – or merge with another business, the due diligence process preceding the transaction will likely require them to identify any errors in plan documentation or operation within a 3 year or longer period.  An unresolved plan error could derail the transaction, or at best require correction under terms and conditions that are not as favorable, to the plan sponsor, as self-correction would have been.  If you envision your business as a purchase target or merger partner in the future you owe it to yourself to make sure that plan errors are corrected promptly and in advance of any due diligence inquiries. 

  1. Because it’s the right thing to do.

Your retirement plan document is a contract you have entered into for the benefit of plan participants and beneficiaries and you should take it as seriously as any contract you enter into with a third party.  It spells out the right way to do things, for the most part, and the IRS and DOL self-correction programs are there to minimize the downside when plan documentation or operation falls short of perfection.  Whether your goal is to sell your business without a hitch, or glide through an IRS or DOL audit with a minimum of fuss, fixing plan errors promptly is the right choice every time.

The above information is a brief summary of legal issues 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. © 2021 Christine P. Roberts, all rights reserved.

Photo credit:  Sasun Bughdaryan, Unsplash

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When is a 401(k) Not a Retirement Plan?                 

Short answer – a 401(k) plan is not a “retirement plan” for California creditor protection purposes when it was expressly set up to protect IRA rollover assets from creditors. This was the holding in a 2019 California Court of Appeal decision that is still valid law and that is worth revisiting: O’Brien v. AMBS Diagnostics, LLC, 38 Cal. App. 5th 553, 562 (2019), rev. den. 2019 Cal. LEXIS 8003 (October 23, 2019)

Mr. O’Brien got into a legal dispute with his former business partners in AMBS Diagnostics, LLC (AMBS) and lost at trial, resulting in a judgment against him for over $600,000.  AMBS sought to collect on its judgment and filed notices of levy against Mr. O’Brien’s assets, including four IRA accounts then valued at $465,350.  (There was no dispute that the IRA funds had originally been set aside for retirement purposes.)  The court ordered an assessment of what portion of the funds in O’Brien’s IRAs were necessary for his support in retirement and what portion could be used to satisfy the judgment.

This is because, under California Code of Civil Procedure (C.C.P.) § 704.115(a)(3), IRA funds, and funds held in self-employed retirement plans, are exempt from creditors “only to the extent necessary to provide for the support of the judgment debtor,” and their spouse and dependents, upon retirement. This is to be distinguished from protection from bankruptcy creditors, which is governed by federal law (and which exempts up to $1 million, indexed for inflation), and is further to be distinguished from protection of assets held in “[p]rivate retirement plans” that are “established or maintained by private employers or employee organizations, such as unions,” including “closely held corporations.”  Assets held in this fashion are fully protected from creditors under C.C.P. § 704.115(b).  The I.R.S. generally can invade such assets pursuant to a federal tax lien, but that was not at issue in the O’Brien case. 

Mr. O’Brien was aware of the different degree of creditor protection under California law, accorded to IRAs versus employer-sponsored retirement plans.  Accordingly, within 18 days the court order to assess the IRA assets for necessity in retirement, Mr. O’Brien set up a limited liability company and formed a 401(k) plan for the LLC.  He then rolled over his IRA assets to the newly-established 401(k) plan, and then dissolved the LLC.  He also somehow got on the record as admitting that he took these actions to protect his IRA assets from his creditors. AMBS sought to levy funds from the new 401(k) plan but the trial court sided with O’Brien, holding that the funds were fully exempt as held in a “retirement plan” notwithstanding the plan’s recent vintage.

The Court of Appeal reversed on the grounds, in part, that the full exemption available to a retirement plan rests on the assumption that the plan holding the funds was principally or primarily designed and used for retirement purposes, and in light of Mr. O’Brien’s admission the LLC’s plan simply did not meet that standard. “O’Brien freely admitted his subjective intent for creating the 401(k) plan and in transferring the funds . . . ‘[T]he shielding and hiding of assets from creditors is clearly not a “use for retirement purposes.”’”  38 Cal. App. 5th at 562, citing In re Daniel, 771 F.2d 1352, 1358 (9th Cir. 1985), In re Dudley, 249 F.3d 1170, 1177 (9th Cir. 2001), In re Bloom, 839 F.2d 1376, 1378 (9th Cir. 1988).  The court concluded that the 401(k) funds were still subject to the more limited, “as necessary for retirement” protection available to IRA assets and sent the matter back to the trial court for assessment of the funds against that standard, as originally had been intended.  Interestingly, in reaching this conclusion the court favorably cited an earlier decision, McMullen v. Haycock, 147 Cal. App. 4th 753, 755-756 (2007), in which funds in a retirement plan account were held to have kept their higher level of protection against creditors after having been rolled to an IRA.  This “tracing rule” remains citable legal authority in California although it is somewhat at odds with the language of C.C.P. § 704.115(a)(3). 

Would the outcome in the case have been different had O’Brien not been so bold about stating his intentions?  Probably not, though he certainly did not help himself.  The timing of the LLC and plan setup were damning enough in themselves, and it would appear from the opinion that the rollovers were made in violation of the 401(k) plan terms (AMBS alleged that “O’Brien’s purported rollover of funds was invalid because he did not meet the qualifications set forth in the 401(k) plan itself for such a rollover.”)  58 Cal. App. 5th at 558.

Clearly, a poor plan, poorly executed, and an object lesson that creditor protection of retirement plan assets will be based on all the relevant facts and circumstances, not just the name on the account.

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. © 2021 Christine P. Roberts, all rights reserved.

Photo credit: Sasun Bughdaryan, Unsplash

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IRS Announces 2022 Retirement Plan Limits

On November 4, 2021, the IRS announced 2022 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.  The maximum annual limit on salary deferral contributions to 401(k), 403(b), and 457(b) plans increased $1,000 to $20,500, but the catch-up contribution limit for employees aged 50 and older stayed the same at $6,500.  That raises the total deferral limit for a participant aged 50 or older to $27,000.  The Section 415(c) dollar limit for annual additions to a retirement account was increased to $61,000 from $58,000, and the $6,500 catch-up limit increases that to $67,500 for participants aged 50 or older.   In addition, the maximum limit on annual compensation under Section 401(a)(17) increased to $305,000 from $290,000, and the compensation threshold for Highly Compensated Employees increased to $135,000, from $130,000.  Other dollar limits that increased for 2021 are summarized below; citations are to the Internal Revenue Code.  Unchanged were the annual deductible IRA contribution and age 50 catch-up limit ($6,000 and $1,000, respectively), and the age 50 SIMPLE catch-up limit of $3,000.  In a separate announcement, the Social Security Taxable Wage Base for 2022 increased to $147,000 from the prior limit of $142,800 in 2021.

Photo credit: Atturi Jalli, Unsplash.

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Scary Surprise for Some New 401(k) Sponsors: Plan Audit Costs

Imagine you are a California business owner, with three fast-casual restaurant operations throughout the state. You employ over 100 employees, such that by September 30, 2020, you were either required to have a retirement plan in place, or to begin to participate in the CalSavers program by forwarding employee contributions to Roth IRAs managed by a state-appointed custodian.

Your decisions about whether to adopt your own retirement plan were made in the early days of the COVID-19 pandemic when business operations, cash flow, and staffing needs were chaotic and fast-changing. On balance, however, you decided to adopt your own plan and ultimately chose a deferral-only 401(k) plan as the best fit for your business. You adopted the plan by July 1, 2020 in advance of the September 30, 2020 CalSavers deadline for employers with over 100 employees.

Your restaurants pivoted to take out and food delivery services and you were lucky not to have to furlough or lay off any employees, but employee wages were lower than before the pandemic and you had high turnover. In June of 2020 you conducted enrollment meeting for the 401(k) plan but employee response was tepid. Only a few dozen employees actually enrolled in the plan, although most all employees (well over 100) were eligible to make salary deferrals.

Fast forward to the end of 2021. You find out that as part of your Form 5500 filing obligations you need to engage the services of an independent qualified public accountant (IQPA) to audit plan operations and finances. The cost of these services run about $10,000. This is a scary surprise for you. Did things have to end up this way?

In a word, no, although the 401(k) plan design may still have been the best fit for your business, and there may be light at the end of the tunnel for you, regarding the audit requirement.

Let’s break it down.  First, the audit requirement.  Under Section 103 of ERISA, a qualified retirement plan with 100 or more participants as of the first day of the plan year generally must provide an audit report prepared by an IQPA together with their “long form” Form 5500.  “Participants” means those employees who meet eligibility requirements under the plan, even if they don’t contribute to the plan or have an account under the plan (it also includes former employees who retain an account under the plan because they have not taken a distribution or rollover).  A special rule – the “80-120 rule” applies to plans that filed a Form 5500-SF (Short Form) in the prior year and have 120 or fewer participants as of the first day of the plan year in question, but if you adopt your plan in a year where you meet or exceed the 100 participant rule – again, counting those who are eligible regardless of participation status – you will be required to provide an audit report for your first Form 5500 filing.  That is the situation of the restaurant owner in our example.

Second, plan design. The restauranteur could have adopted a SEP-IRA, which is exempt from Form 5500 filing requirements, and with it, the requirement for an audit. However, SEP-IRAs require employer contributions and the 401(k) required only employee elective deferrals, so the cost of a SEP-IRA may not have worked for the business. The hiccup here is that the “no cost” 401(k) plan carried the hidden cost of a plan audit.

Lastly, a potential change to counting 100 participants for purposes of the audit requirement may be in the offing.  Proposed regulations from the Department of Labor, Department of the Treasury, and the Pension Benefit Guaranty Corporation would change the participant headcount methodology to look only at participants with account balances, and disregard those who are eligible but not participating.  If finalized and adopted, these regulations would generally apply to plan years beginning on or after January 1, 2022.  So for the restaurant owner in question it may be that another audit is required for the 2021-2022 plan year but that the audit requirement goes away if plan participation remains low. 

The hidden cost of a plan audit is also a concern for a wider group of employers, irrespective of state auto-IRA plan mandates, in 2024 when the SECURE Act rules for long-term, part-time employees go into full effect.  If the Form 5500 proposed regulations do become law, then the fact that part-time employees are eligible to make elective deferrals under their employers’ 401(k) plans will not trigger audit requirements unless they actually participate in the plan, and the plan’s active and former participant ranks meet or exceed 100 as of the first day of any given plan year.  The coming increase in participant ranks due to long-term, part-time employees increase in plan participant ranks was identified as one reason for the proposed change in headcount methodology.

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader. Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose. © 2021 Christine P. Roberts, all rights reserved.

Photo credit: Colton Sturgeon, Unsplash