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2014 pension plan regulatory highlights

Mark Weisberg Linda Hoseman March 16, 2015

Reprinted with permission from Employee Benefit Review - February 2015

The start of the new year is as good a time as any to look back at some of the employee benefits regulatory developments of 2014 that were not previously covered in this column.

Disability Insurance Premiums

In May of 2014, the Internal Revenue Service finalized proposed regulations that had been issued in August of 2007. There was one important addition to the final regulations.

As a general matter, the payment of accident or health insurance premiums from a qualified plan is treated as a taxable distribution to the covered participant. The new rule provides for an exception to the general rule for “plan contribution replacement” disability insurance policies. The idea is that if a participant is unable to work due to a disability, the insurer will make contributions to the plan to replace the lost deferrals and employer contributions which were not made due to the disability. If the policy is qualified, premium payments are not taxed and the benefits paid are not treated as a contribution to the plan (instead they are treated as earnings).

To be qualified, the following requirements must be met:

  • premium payments must be made directly from the plan
  • benefit payments must be tied to the employee’s disability (and inability to work)
  • benefit payments are limited to the “reasonable expectation” of the contributions that would have otherwise been made and must be reduced by any contributions actually made to the participant’s account.

The rule is generally effective Jan. 1, 2015. Interested plan sponsors should work with their insurance broker or consultant to see if there is an acceptable product available, and then consider the fiduciary implications of any decision to implement (as well as make any required plan amendments).

Hybrid Plans

Final regulations on the “market rate of return” requirements for cash balance plans were issued in September of 2014. These regulations are generally effective for plan years beginning on or after Jan. 1, 2016. Under these regulations, there is a limited list of permissible rates of return. The maximum single fixed interest rate was increased from 5% under the proposed regulations to 6%, and the maximum interest rate floor was increased from 4% to 5%. The IRS indicated that it is continuing to study participant-directed interest crediting rates. In addition, the IRS stated that if this feature is ultimately banned (or limited), anti-cutback relief would only be available for plans that contained such provisions by September 18, 2014.

With respect to the “whipsaw” relief in the statute, the regulations provide that the relief is available even if subsidized early retirement and/or optional form of payment subsidies are provided, as long as such benefits are less than the benefit that is actuarially equivalent to the account balance determined using “reasonable actuarial assumptions” (a term that is not defined).

One final key point dealt with the technical issue of how to comply with the backloading rules under Section 411(b) of the Internal Revenue Code. The regulations provide that future assumed interest rate credits will not be less than zero following a year that produced a negative interest credit. Guidance with respect to multiple formulas was not provided.

Letter Forwarded Services

In the past, one of the methods that plan administrators of terminating plans could use to locate missing participants was the IRS letter-forwarding service (and/or the letter-forwarding service of the Social Security Administration). Both of these programs have been discontinued, presumably because of the awesomeness of the Internet. In light of this, the Department of Labor issued Field Assistance Bulletin 2014-01.

The 4 required search steps under the Bulletin are:

  1. Certified Mail
  2. Check Related Plan and Employee Awards
  3. Check with Designated Plan Beneficiary
  4. Use Free Electronic Search Tools

If all of these steps do not find the participant, the plan administrator must, taking into account its fiduciary duties of prudence and loyalty, consider if additional steps are required. The key considerations are size of the account balance and the cost of additional searches. A plan fiduciary may charge missing participants’ accounts reasonable expenses for efforts to find them. The additional search steps mentioned in the guidance are Internet search tools, commercial locator services, credit reporting agencies, information brokers, investigation data bases and other similar services that may involve charges.

Brokerage Windows

In August, the Department of Labor issued a request for information “Regarding Standards for Brokerage Windows in Participant-Directed Individual Account Plans.” As a very general matter, brokerage windows allow participants to select investments other than those that are selected and monitored by a plan fiduciary. As a practical matter, there is a wide range of approaches and uses of brokerage windows and the Department of Labor clearly has concerns about how they are being used and whether participants are adequately protected.

With respect to the participant-level disclosure regulations, the DOL noted that brokerage windows are not “designated investment alternatives.” Accordingly, no disclosure is necessary regarding performance or other investment-related information (though disclosure of any fees that may be charged for the brokerage window must be disclosed). The initial Field Assistance Bulletin on participant level disclosure contained language that may be interpreted as suggesting that the DOL believed that fiduciaries could be responsible under ERISA for the underlying investments offered in the brokerage window, though the DOL states that this was not intended.

The categories of information the DOL is requesting are as follows (along with any observations/highlights):

  • How to Define Brokerage Windows? For example, does a mutual fund “super market” constitutes a brokerage window or are all of the funds available designated investment alternatives?
  • Plan Investment Offerings – Brokerage Windows and Designated Alternatives. Is there a point at which the number of funds offered warrants a change in treatment from designated investment alternatives to brokerage window?
  • Participation in Brokerage Windows. Obviously the DOL wants to understand just how widespread (and utilized) brokerage windows are, including the demographics of the users. Presumably they are more interested in protecting rank and file workers than highly compensated employees.
  • Selecting and Monitoring Brokerage Windows and Service Providers. This category seems to focus more on the behavior of service providers than that of plan sponsors, fiduciaries and participants.
  • Fiduciary Access to Information about Brokerage Window Investments and Brokerage Window Costs. How much information do fiduciaries receive regarding brokerage windows, and should there be  greater disclosure?
  • Disclosure Concerning Brokerage Windows and Underlying Investments. There is clearly a tension between the DOL’s desire to make sure participants are protected and have adequate information to make informed decisions about investing, and the current state of the brokerage window industry.
  • Role of Advisors. While plan fiduciaries could make advisers available for participants using brokerage windows, this is not typically seen. Of course, individuals could select their own advisors, but this information would not normally be known by the plan fiduciary.
  • Fiduciary Duties. It would be helpful to have additional guidance on the application of the fiduciary duty rules to brokerage windows. The hope is that such rules will not make brokerage windows impractical to maintain.
  • Annual Reporting and Periodic Benefit Statements. How do (and should) certain technical reporting and disclosure requirement supply to brokerage windows?

Based on the questions asked, it seems that the DOL is likely to adopt additional guidance. That will increase the costs and administrative burdens of maintaining brokerage windows. They may also expand the application of the fiduciary duty rules, including Section 404(c) of ERISA, to such windows. This would make sense if the windows prove to be a vehicle that is utilized by a segment of the workforce for which a window is not appropriate, but is questionable in the more likely case of windows used by more sophisticated investors (who may have their own financial advisor).