Understanding 401K Pension Law

 

 

General Introduction

The office of Employee Plans (EP) under the Tax Exempt & Government Entities (TE/GE) operating division of the Internal Revenue Service helps retirement plan sponsors, plan participants, and practitioners working in the retirement benefits arena understand and comply with the pension law.

 

Historical Background

On September 2, 1974, President Ford signed into law the Employee Retirement Income Security Act of 1974, Public Law 93-406, 93d Cong. 1st Sess. (1974), 1974-3 C.B. 1, (ERISA). The Act completely revised the legal framework of the qualified pension plan as it had previously existed. The most significant innovations of ERISA concerned minimum participation and vesting standards and the manner in which benefits were paid with some protection extending to the surviving spouse of the plan participants.  In addition, the Act imposed upon all pension plans certain minimum funding requirements.

 

Administrative Responsibility for Retirement Plans

Under ERISA, jurisdiction over employee benefit plans was divided among the Internal Revenue Service (IRS), the Department of Labor (DOL) and the Pension Benefit Guaranty Corporation (PBGC).

 

The responsibility of the IRS centers on plans covered by Internal Revenue Code (IRC) section 401(a), and includes pension, profit-sharing, and stock-bonus plans.  The DOL shares some responsibility in this area, but primarily from the perspective of fiduciary responsibility and prohibited transactions.  DOL is also responsible for such plans as health and welfare plans, legal aid plans and other plans that are not designed to provide retirement benefits or the deferral of income.

 

The PBGC is a government corporation created by ERISA that functions as insurer of a minimum guaranteed benefit for certain pension plans.  Although jurisdiction is divided among the agencies, the Act requires that they coordinate their activities.  This activity most commonly occurs between the IRS and DOL due to the overlap in the nature of their responsibilities.

 

 The pension law provides significant tax benefits for sponsors of certain retirement plans (such as 401(k) plans) and the employees that participate in them. Our EP Examinations activities promote voluntary compliance by analyzing operational features of retirement plans. A centralized examination case selection and review process is used to enhance consistency of enforcement activities and to focus resources on the areas of highest noncompliance. Through our Customer Education & Outreach office, we provide services and information about retirement plan requirements.  Our services under Rulings and Agreements are designed to help customers understand and comply with the pension law, and assist customers in correcting mistakes that may occur when administering the plan.  These services help conserve plan benefits until an employee’s retirement, and help preserve the tax benefits associated with these plans.  Additional information regarding our unique services is presented in our online brochure, Publication 3636.

 

 

Statistical Information on Retirement Plans

 

Tax Exempt/Employee Plans Statistics - Employee Plans

IRS statistics on determinations, examinations and annual returns filed.

 

 

Findings from the Contingent Work Supplement to the February, 1999 Current Population Survey

DOL statistics on employer sponsorship and coverage among wage and salary workers under pension plans.

 

 

Private Pension Plan Bulletin - Abstract of 1998 Form 5500 Annual Reports

DOL statistics on plans, participants, assets, income and expenses based upon 1998 Form 5500 filings.

 

 

PBGC 2002 Annual Report

PBGC statistics on defined benefit plans, including multiemployer plans.

 

 

Pension Insurance Data Book 2002

Detailed statistics on PBGC program operations and benefit protection.

 

 The three primary reasons why 80% of America’s small businesses do not offer 401(k) plans to their employees are: (a) perceived cost of employer-sponsored retirement plans, (b) perceived complexity of company-sponsored retirement plans, and (c) limited investment options. Mutual fund companies offering 401(k) plans to small businesses do so by pre-packaging administration with their proprietary fund investments; this pre-packaged approach, called "bundled 401(k)" tends to be pricey for small companies, limited features and limited investment options. Employees who participate in bundled 401(k) plans typically do not have access to investments not offered by the mutual fund company, and do not have access to the most popular investment option today—the individual self-directed discount brokerage account.

 Mutual fund 401(k) plans have been aggressively promoted to the small business community both by no-load fund companies (e.g., Fidelity Funds, Vanguard Funds) and load fund companies (e.g., MFS, John Hancock, and Putnam). Recent news articles, however, have reported a trend among many of these plan vendors to abandon the very small plans because the costs of providing 401(k) services for such plans versus the revenue generated from them has proved to be a losing proposition. For economic reasons, the sales target for mutual fund bundled plans has been raised, and now companies with fewer than 100 employees are not being actively solicited by most of these vendors.

According to HR Investment Consultants in Towson, MD, publisher of the "401k Provider Directory, "the cost of running a 401k plan with 25 participants and $750,000 in assets can range from as little as $6,750 per year to as much as $20,000, depending on which 401k vendor you select. (Sources: Nation's Business, September 1998, Myers, Randy "Your 401k Plan May Cost You Too Much." Business Week Online, July 2000, Brenner, Lynn "A Wealth of Choices."). By comparison, a 401(k) Easy or Easy Online system costs only $995 pear year for a 25-person plan---a savings of between 60% and 80% in plan administration fees.

 

Selecting and Monitoring 401k Pension Consultants - Tips For 401k Plan Fiduciaries
The Employee Retirement Income Security Act (ERISA) requires that fiduciaries of employee benefit plans administer and manage their plans prudently and in the interest of the plan’s participants and beneficiaries. In carrying out these responsibilities, plan fiduciaries often rely heavily on pension consultants and other professionals for help. Findings included in a report by the staff of the U.S. Securities and Exchange Commission released in May 2005, however, raise serious questions concerning whether some pension consultants are fully disclosing potential conflicts of interest that may affect the objectivity of the advice they are providing to their pension plan clients.
Under the Investment Advisers Act of 1940 (Advisers Act), an investment adviser providing consulting services has a fiduciary duty to provide disinterested advice and disclose any material conflicts of interest to their clients. In this context, SEC staff examined the practices of advisers that provide pension consulting services to plan sponsors and trustees. These consulting services included assisting in determining the plan’s investment objectives and restrictions, allocating plan assets, selecting money managers, choosing mutual fund options, tracking investment performance, and selecting other service providers. Many of the consultants also offered, directly or through an affiliate or subsidiary, products and services to money managers. Additionally, many of the consultants also offered, directly or through an affiliate or subsidiary, brokerage and money management services, often marketed to plans as a package of “bundled” services. The SEC examination staff concluded in its report that the business alliances among pension consultants and money managers can give rise to serious potential conflicts of interest under the Advisers Act that need to be monitored and disclosed to plan fiduciaries.
To encourage the disclosure and review of more and better information about potential conflicts of interest, the Department of Labor and the SEC have developed the following set of questions to assist plan fiduciaries in evaluating the objectivity of the recommendations provided, or to be provided, by a pension consultant.
1.       Are you registered with the SEC or a state securities regulator as an investment adviser? If so, have you provided me with all the disclosures required under those laws (including Part II of Form ADV)? You can check yourself - and view the firm’s Form ADV - by searching the SEC’s Investment Adviser Public Disclosure Web site. At present, the IAPD database contains Forms ADV only for investment adviser firms that register electronically using the Investment Adviser Registration Depository. In the future, the database will expand to encompass all registered investment advisers-individuals as well as firms-in every state. If you can’t locate an investment adviser in IAPD, be sure to contact your state securities regulator or the SEC’s Public Reference Branch. 2.       Do you or a related company have relationships with money managers that you recommend, consider for recommendation, or otherwise mention to the plan? If so, describe those relationships. When pension consultants have alliances or financial or other relationships with money managers or other service providers, the potential for material conflicts of interest increases depending on the extent of the relationships. Knowing what relationships, if any, your pension consultant has with money managers may help you assess the objectivity of the advice the consultant provides. 3.       Do you or a related company receive any payments from money managers you recommend, consider for recommendation, or otherwise mention to the plan for our consideration? If so, what is the extent of these payments in relation to your other income (revenue)? Payments from money managers to pension consultants could create material conflicts of interests. You may wish to assess the extent of potential conflicts. 4.       Do you have any policies or procedures to address conflicts of interest or to prevent these payments or relationships from being a factor when you provide advice to your clients? Probing how the consultant addresses these potential conflicts may help you determine whether the consultant is right for your plan. 5.       If you allow plans to pay your consulting fees using the plan’s brokerage commissions, do you monitor the amount of commissions paid and alert plans when consulting fees have been paid in full? If not, how can a plan make sure it does not over-pay its consulting fees? You may wish to avoid any payment arrangements that could cause the plan to pay more than it should in pension consultant fees. 6.       If you allow plans to pay your consulting fees using the plan’s brokerage commissions, what steps do you take to ensure that the plan receives best execution for its securities trades? Where and how brokerage orders are executed can impact the overall costs of the transaction, including the price the plan pays for the securities it purchases. 7.       Do you have any arrangements with broker-dealers under which you or a related company will benefit if money managers place trades for their clients with such broker-dealers? As noted above, you may wish to explore the consultant’s relationships with other service providers to weigh the extent of any potential conflicts of interest. 8.       If you are hired, will you acknowledge in writing that you have a fiduciary obligation as an investment adviser to the plan while providing the consulting services we are seeking? All investment advisers (whether registered with the SEC or not) owe their advisory clients a fiduciary duty. Among other things, this means that advisers must disclose to their clients information about material conflicts of interest. 9.       Do you consider yourself a fiduciary under ERISA with respect to the recommendations you provide the plan? If the consultant is a fiduciary under ERISA and receives fees from third parties as a result of their recommendations, a prohibited transaction under ERISA occurs unless the fees are used for the benefit of the plan (e.g., offset against the consulting fees charged the plan) or there is a relevant exemption. 10.   What percentage of your plan clients utilize money managers, investment funds, brokerage services or other service providers from whom you receive fees? The answer may help in evaluating the objectivity of the recommendations or the fiduciary status of the consultant under ERISA.

 

Debtors with employer-sponsored retirement plan assets no longer have to rely on the Patterson case to protect employer-sponsored retirement plan assets in bankruptcy. The Bankruptcy Act of 2005 automatically exempts any amount of such assets regardless of whether the individual filing the bankruptcy petition chooses state or federal bankruptcy exemptions.  IRA assets up to $1 million are also exempted from a bankruptcy estate, again, regardless of whether the debtor chooses the state or federal bankruptcy exemptions.  Education savings assets, as explained later in this article, are automatically excluded from a bankruptcy estate, subject to certain conditions. Additional non-profit websites that include relevant unbiased information about 401k plans include: www.401k-pro.com and www.run-it-yourself401k.com 

 

What Assets Does the Bankruptcy Act of 2005 Protect?

IRAs and Employer-Sponsored Retirement Plans

The new bankruptcy protections include assets in IRAs (Traditional and Roth), IRA-based employer plans, including savings incentive match plan for employees of small employers (SIMPLE) IRA plans and simplified employee pension (SEP) plans, and most employer-sponsored retirement plans.  Assets rolled over from employer-sponsored retirement plans (including SIMPLE IRA plans) to IRAs are also given protection in bankruptcy proceedings.

 

Degree of Protection for Traditional and Roth IRAs, and for Employer Plans

The Bankruptcy Act of 2005 provides the following protections. 

·   IRAs, IRA-based plans: Assets in Traditional or Roth IRAs, other than assets attributable to rollovers, and other than SEP or SIMPLE IRA assets, are subject to a $1 million exemption limit. 

·   Indexing: The $1 million limit may be increased, based on a review of the Consumer Price Index (CPI), every three years.

·   SEP, SIMPLE IRA assets: SEP and SIMPLE IRA plan assets have unlimited protection. 

·   Most employer plans protected: A debtor may protect retirement assets in a fund or account that is exempt from taxation under IRC Sec. 401, 403, 408, 408A, 414, 457 or 501(a), which includes, but is not limited to, profit sharing plans, 401(k) plans, tax-sheltered annuities, certain government plans and plans of tax-exempt organizations. 

·   Assets in transit: Assets moving from one arrangement to another are protected (e.g., in an indirect rollover, which has a 60-day period to complete the transaction, etc.). 

·   Plan loans not discharged:  In bankruptcy, certain obligations of the debtor may be discharged or, essentially, forgiven.  Plan loans are not dischargeable in bankruptcy.  If a plan loan is being repaid through payroll deduction, there is no automatic stay; therefore, deductions can continue, and repayment amounts will not be considered “disposable income” for bankruptcy purposes. This provision helps the debtor to keep loan payments out of the reach of creditors. However, loan terms may not be materially changed, presumably to prevent the debtor, for example, from increasing repayment amounts to shield more income from creditors. rrp