Benefits and beyond c. 9 legal compliance

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Benefits and BeyondLegal Compliance C. 9

Thomas E. Murphy

October 2, 2010

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Once upon a time . . .

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Before 1974 . . .

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There was no vesting of pensions

No benefit entitlement until age 65

Employees could be discharged just prior to retirement age – no pension.

Being a “Bad employee” could invalidate your pension.

Plans were often terminated and participants were left with nothing.

There often was no proper funding of pensions.

Sponsor had no duty to disclose info about pension plan.

Sponsor had no fiduciary duty to participants.

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During those dark, cold pre-ERISA days. . .

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Pension entitlements could be attached by creditors.

Trust Funds to secure the accruals were not required.

Actuarial and investment estimates favored the sponsors.

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“Retirement” could be a hardship.

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To mitigate the huge risks borne by participants.

And, to make the dream of retirement income to sustain life after work a reality

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Then, the “government passed a law!”

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Purpose: to secure retirement income:

Reporting & Disclosure

Minimum Participation and Vesting

Minimum funding requirements – and more.

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It was called “ERISA.” (1974)

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Tax favored treatment. . .

A Big Incentive No obligation to offer plan

If sponsor complies: Deductions for

sponsor’s contributions.

No income tax on investment gains

Accruals not considered income to participants.

Tax Policy: Pensions should not

favor high earners Retirement plan should

provide real opportunity to retire and not be a source of “rainy day” funds.

At some point, the tax treatment ends if you don’t take the pension

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Tax advantages mean tax compliance – enter the IRC

Maintain Tax Qualified Status

It’s a real maze . . . Like getting a green card

IRC: §415 Limits – what’s the rationale?

No discrimination in favor of HCE – DBP and DCP participation.

Rollovers – to retain tax favored treatment

No early distributions Required distributions

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Let’s Go Deeper!

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Pop Quiz – Do you know ERISA? Is it legal? Is it not legal Explain your

answer. See theSections

of ERISA Also, check the

BLOG on C. #9.

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DBP that provides employee must work 2 years before participating in the Plan. Legal? (ERISA §202)

DCP provides that that no contributions vest until 7th year. (§203)

DCP provides that employer match does not vest until 7th year. (§203)

DBP decides to change “FAP” formula from high final 3 to final 10 years. Violation? (§204)

ERISA QUIZ – Legal? Why/why not?

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DBP prohibits all alienation of benefits! (§206(d)(1)(3)(A)) QUADRO)

DBP permits married participant to ignore designating a benefit for a survivor. (§205)

Divorced participant’s decrees says “ex-wife gets nothing,” but his DCP says she is beneficiary. Which trumps?

DBP requires all employees retire at age 65. (ADEA/§204)

ERISA Quiz

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DBP provides no benefit accruals until age 30. §202

Your investment committee has invested in junk bonds and the plan is now underfunded. Can you sue? (§404)

Your DBP has invested in a company that is owned and run by your CEO’s spouse. The Plan is underfunded. Can you sue? (§406).

Plan lends money to CEO. §406

ERISA Quiz

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Your DBP sends you a benefit statement only once – 90 days before your retirement. Is this legal? Table 9.1 at 259and §101 et seq. of ERISA

What information must be in the individual DCP benefits statement? (See DOL Summary, Table 5)

What information about investment fees must be provided to DCP participants.

See: the BLOG, C. #9) Does a non-elective

enrollment in DCP trump a state garnishment law? See §514 of ERISA.

ERISA QUIZ

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Isabella and §510 – was the layoff a violation? (page 253, 255)

Sam’s Plan and ERISA coverage? (page 257)

Mary’s lump sum and duty to disclose. (page 258)

Additional Exercises 11, 12, and 13 on the BLOG, C.#9

Plan sponsor outsources annuity payments. Was choice a violation of fiduciary duty? (page 261)

Break in service at page 266 and §203(b)(3)(A).

Mary’s lump sum at 269. What’s wrong with this Vignette? (See Blog, C#9)

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More Quizzes

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More . . .

Retiree Health Care Gross Negligence or Fraud + Reliance =

Can an employer cancel retiree health care for its current retirees? Future retirees? What if the employer sponsor is in bankruptcy? (The Blog, C.#9) What should be the determinant legal principles, facts, and obligation

11 USC §1114 of Bankruptcy Code

What if an employee of your Benefits Department tells you that you will receive $24,000 per year, and you can retire at age 57. You elect to retire, but your first pension check is a gross amount of $750? Problem: Employee failed to properly calculate the actuarial reduction. Any remedy? What about “Estoppel?” Rationale?

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And more examples . . .

What is preemption? 11 USC 522(d)(10)(E),

Preemption and non-alienation (page 272)

Preemption and health care – early discharge from the hospital. (273)

The Art and Sam Jones Pension Odyssey (276)

IRA and Bankruptcy (283)

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Mary and John rolled over some of their 401(k) money after retirement to an IRA. Their bankruptcy creditors want to exercise claims on these funds. Can they?

Rousey vs. Jacoway, 544 U.S. 320 (2005)

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And,. . . Tax rates are low . . .

See Summary of the Bill Could bring a Quiet Explosion of Roth Conversions

Should a 401(k) participant be permitted to take his “in plan assets” and “roll them over” into a Roth IRA? What are the issues, considerations, rationale?

There is a new law on this.

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The main provisions of ERISA

The Main Points The big picture

Coverage Reporting and

Disclosure Fiduciary Responsibility Minimum Participation

and Vesting No reduction in

benefit accruals Internal administration

and fairness

Benefit Distribution Minimum Funding Preemption Discharge to deny

benefits Non-alienation Insuring benefits –

PBGC Prohibited

transactions

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Repititione e` la madre d’educazione.

One more time From the top!

Let’s review some of the broad theories and provisions of ERISA that affect the design and administration of pension and health care plans.

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An enterprise that is engaged in commerce or whose business affects commerce.

That provides a pension – a plan that provides income or allows a deferral of income that is paid upon the termination of employment.

That provides a health and welfare plan for its employees.

What’s covered?

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Reporting and Disclosure

“Transparency” What does this mean?

To provide a variety of information to participants and the Government (ERISA §101and Table 9.1 at 259)

What really is an SPD? Also, see some examp

les here.

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ERISA - Reporting and Disclosure:

Employer’s obligation Do you have my SPD?

◦ Summary Plan Descriptions (SPDs

◦ Actuarial reports to IRS◦ Participant Benefit

Estimates (DBPs)◦ 401(k) Account balances

– distributed quarterly◦ Advice on the value of

investment diversification

◦ But . . . don’t tout company stock

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Reporting and Disclosure

The Employer’s Duty To Disclose

Let’s dig deeper . . Does Title I (R&D)

apply to a participant’s request for the data used to compute her lump sum payout?

What are the relevant criteria used to calculate a lump sum?

Does it require disclosure of the criteria and data used to calculate a DBP Final Average Pay pension?

Does it require access to names of participants?

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Suppose the sponsor gives a participant an estimate of his benefit at age 65 (15 years from now)

Turns out, the estimate was significantly wrong – he will get much less.

What are the legal issues and how would you resolve them?

Is DCP participant entitled to detailed information on plan fees? (See: DCP Fee Transparency Act of 2009

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Reporting and Disclosure - More

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Reporting and Disclosure

Must they tell participants?

Don’t tell anyone, but . .

Company knows that its stock is going to drop precipitously when it announces earnings next quarter.

Should it disclose this to DCP participants?

Would this possibly be a violation of SEC “insider trading” laws?

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Other Notices . . . Employer Must

Before boarding the boat You must sign a waiver!

Notify departing employees of their COBRA rights.

Notify of obligation to provide 50% -75% joint surviving spouse benefit, unless waived.

Must write SPDs in Spanish?

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ERISA - Fiduciary Responsibility

Don’t worry: I am your fiduciary.

I will take care of you . .

Act solely in the interests of plan participants. ERISA §404

Must do so with skill, prudence, and diligence of a prudent person familiar with relevant issues.

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Trustee Investment manager Service Providers Broker dealers,

investment advisors Plan administrator Record keeper Board of Directors

U.S. Sup. Ct., in LaRue vs. DeWolff, 522 U.S. 248 (2008) held fiduciary liable for damages to individual account, not just to “plan as a whole.” See: 29 CFR § 2510-3.21(c) and §3(21)(A)(ii) of ERISA

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ERISA – Who are Fiduciaries?

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Exercises discretionary control or authority over management or assets of a plan.

Renders investment advice for a fee Has discretionary authority in the

administration of a plan. Only a fiduciary for what he exercises such

discretion or control Or a fiduciary or sponsor who imprudently

chooses a fiduciary.

Who is a fiduciary?

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When did they know the company stock was going to fall?

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investments are

diversified; there are opportunities to

transfer investments; there is sufficient

information provided to make sound investment decisions;

the plan documents clearly state the fiduciary is not liable unless there are breaches of the above provisions.

Policy to encourage employee ownership.

No indication there were significant problems.

Presumption of Prudence.

Fiduciary not expected to be able to predict precipitous decline

No crisis in management

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401(k) Stock Drops – Issues!

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Asset Management - DBPs

What factors should be relevant?

Sub Prime . . .

What is investment strategy?

Is fiduciary following it?

How is fund managing risk?

Predicting loss of Asset Value?

Suppose your employer, a commercial bank sponsoring your DBP invested heavily in bundled sub prime mortgage funds causing an under-funding and failure of the Plan. See: Morgan Stanley Case.

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Investing non-elective 401(k) deferrals – a Fiduciary Issue?

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Allowed and encouraged by the PPA of 2006.

Why? What if employer

then makes a default investment on behalf of the participant? Liable?

What do you think the rules should be?

Make very conservative investments so nothing is lost, but not much is gained?

Or, a more robust mix of equities?

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Non-Elective Deferrals (DCP)

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Qualified Default investment: no employer securities, long-term appreciation and capital preservation, take into consideration age or demographics of participants – target funds, diversified to avoid large potential losses, no penalty for changing.

Non-elective participants can opt out Advised of employer action within 30 days. Given Proxy information Broad range of investment choices.

Guidelines for Non-Elective Deferrals

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Investments chosen by bona fide “investment manager” (a defined term)

Opportunity to transfer default investment without penalty.

Exceptions to employer securities prohibition – employer match is in company stock, or stock is held by a qualified investment company as part of a group of stocks.

Investments = mix of long term appreciation and capital preservation or fixed income

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Guidelines

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Poor selection or choices of investment options in 401(k)?

Fail to monitor administrative plan charges Purchase too much company stock in DBP. Poor choice of annuity service provider – low

cost was criteria? (Invested in junk bonds and trust lost significant value at page 261)

Stock was in imminent danger of collapse? Should sponsor give investment advice? Let’s try to draft our own guidelines

Fiduciary Responsibility

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Check the website to see the background and where they are as of March 2010. (“Consumer Information, Retirement Plans, Proposed

Rules”)

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The DOL drafted guidelines, punted and then drafted new ones

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Fiduciary . . more

Mistakes? Actionable?

Sponsor failed to follow participant’s investment choice in DCP

Sponsor should have known that plant closure and relocation would cause a “run” on benefits.

DBP sponsor transferred workers and their pension plan to new subsidiary. It knew subsidiary was likely to fail along with pension plan. Breach of fiduciary duty?

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Non-forfeitable rights.

Vesting Participation

Participating and vesting service.

Defined Benefit Plans Defined Contribution

plans Cash balance plans Reduction in accrued

benefits Breaks in service

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Minimum participation standards: age 21, complete 1000 hours per year, age 18 for vesting credit.(§202)

Vesting both cliff and vesting: (see various schedules in Table 9.2 (page 265, §203))

Break in service rules in Table 9.3 (page 267)

See Vignette: “A works for X” at 266.

ERISA - Participation and Vesting

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What if A works 2 years, leaves for 3, and returns for 10 years. Plan provides 5 year cliff vesting. Should pre-break 2 years count for benefit accrual? (fn. 36, page 266).

Employee starts work at age 18, Plan provides participation will begin when employee is 21 and has completed one “year of service.” Plan uses 3 year cliff vesting. Is employee vested? How many years of participating service?

Queries . . . Break in service.

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ERISA - Benefits Accrual

No back loading . . No cutbacks . .

Accrued benefits cannot be reduced.

Future benefit accruals can be.

Example: Company A, changes the FAP formula from: (years of service) X (final average pay) X (2%) to the same but changes the 2% to 1%.

Freezes and terminations

Suppose plan changes from FAP to Final Pay, but only after 30 years of service?

Suppose a plan eliminates age 55 early retirement? Legal? What should this depend upon?

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Surviving spouse (50% and 75%) Why would a spouse waive? Lump Sum versus Annuity?

◦ Investment rates, discount rates, and longevity assumptions are no longer guessing games.

◦ Go to Vignette of Mary at 269. Required minimum distributions at age 70.5

– special problems in a recession? Prohibition against early distributions before

age 59.5 – special problems in recession? Loans and hardship withdrawals in DCPs.

ERISA - Benefit Distributions

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Minimum Funding Requirements

Junior Actuary Same Principles

Remember “saving for college?”

What were the relevant factors parents used to determine how much to save?

It is the same for pensions.

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Make sure the plan can deliver on its promise to pay the benefits.

Now: standard mortality tables Now: investment return projections and

discount rates must be based upon varied bond rates from 5 to 15 years.

Must be fully funded over a 7 year period.

Minimum funding standards

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The plan’s annual contributions must equal the present value of benefits earned by participants during the current year, and be sufficient to amortize any future funding shortfall over the next seven years.

New: standard evaluation of assets – the stocks, securities, bonds, and cash held in the trust.

Minimum funding standards

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Plans cannot “overstate” its assets. Less flexibility to smooth values based upon

market fluctuations. Can fund other benefits (retiree health care)

provided plan is 120% funded; limit 10 years.

Result of new funding standards: many plans are under funded and have frozen their plans.

With recession, enforcement here is being temporarily suspended.

Minimum funding standards

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Preemption – what does it mean? To prevent each

state from having its own pension laws and creating a crazy quilt of rules that make it impossible for sponsors and participants.

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ERISA preempts and supersedes any and all state laws insofar as they may relate to any benefit plan.

Except: it does not apply to state’s authority to regulate insurance.

So, insured health care plans may be subject to state requirements such as mandates.

Examples: an insured plan must include mental health, chiropractic, homeopathic health.

Preemption . . §514(a)

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ERISA supersedes state laws even though there may be no conflicting provisions in the statute itself with respect to the state law.

Purpose: avoid balkanization of state laws of pension and health plans

Recognizes state’s right to regulate the administration of insurance and insured plans. (Health Care self-insured plans not included.)

Preemption over benefit laws

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Does it affect a traditional or exclusive area of federal concern?

Does it affect traditional ERISA entities, such as sponsors, fiduciaries, participants?

See Vignettes: testamentary distribution (at 272), suit against sponsor for loss of income and emotional distress arising out of a disability denial (at 272), refusal by TPA to approve extended stay. (at 273)

Preemption Test

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State of New York added surcharge on hospitals to help subsidize insurance companies that insure the “unhealthy,” or to fund uncompensated care.

Held: not preempted – the nexus with a benefit plan is too attenuated.

Any willing provider litigation and HMO panel?

Note: ERISA does not allow compensatory or punitive damages.

Preemption . . . examples

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ERISA - Non-Alienation

Can’t use my pension Except for . . . Divorce!

What is the policy here?

Big exception: QDROs. Non-participant

spouse gets 50% of DBP accrued benefits or DCP account value at time of divorce. Future accruals to the participant only.

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Want any pension plan to become a tax refuge for highly compensated employees?

Tax qualified plans can allow income deferrals, investment gain deferrals, rollovers, and deductibility of benefits.

This reduces government revenue. So, it has promulgated rules about

participation, limits on benefits, and distribution of benefits. What are they?

The Government Does Not

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THE IRC - Tax Treatment

The Tax Policies Waiting to see tax lawyer

What is interest of IRC?◦ Do not discriminate in

coverage!◦ Minimum participation

rules◦ §415 Limits (See Table 9.4

at page 277) and see: http:benefitsattorney.com

◦ Required Minimum Distributions (age 70.5)

◦ No early distributions (age 59.5)

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Not a refuge for HCEs!

Art Jones & Co. at 275 If one falls . . .

Minimum participation and coverage. (DCPs and DBPs)

Discrimination testing in participation (DCPs)

What’s at stake here for the plan sponsor?

What is the ultimate public policy aim?

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DBP must cover at least 40% of all employees, and the percentage of non-HCEs benefiting from the plan must equal at least 70% of the HCEs.

HCE is a person who makes $110,000 per year, or is more than a 5% owner)

With respect to DCPs, the participation rate of the non-HCEs must be proportionate (not necessarily “equal”) to that of the HCEs.

The Discrimination Rules

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Goal and Tests - DCPs

Average Deferral % Either must be met.

To Prevent HCEs from disproportionately participating in the DCP.

Average Deferral Percentage = the mathematical average of Actual Deferral Percentages of HCEs and non-HCEs

Generally speaking, ADP of HCEs must not exceed the ADP of non-HCEs by more than 2% -- or – does not exceed the non-HCEs ADP by more than 1.25.

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Here’s how it works . . .

Non Highly Compensated Highly Compensated

If ADP of non-HCE is: 2% 3 to 8% >8%

Max for HCE is: 2X2% = 4% Percentage + 2% 1.25 times percentage

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What’s the remedy?

This is a Big Deal! What’s “Safe Harbor?”

Deferrals and contributions are returned as taxable income to the HCEs.

Plan could lose its tax favored status

Or, as an alternative, the Plan could acquire “Safe Harbor Status.”

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Safe Harbor – Must offer either . . .

No discrimination testing

Get into shore quickly!

Elective deferral: 100% match on first 3% of compensation;

And, an additional 50% match on next 2% of compensation, OR . . .

Non-elective contribution of 3% of compensation

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There was a lot of confusion about certain pension plan practices.

Funding issues needed to be clarified.

New Law - Pension Protection Act

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By 2006, ERISA needed repairs.

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Cash Balance Plans – are OK provided . . .◦ No more whipsawing (on conversion of DBP to

CBPs)◦ No more wear away (on conversion)◦ Must have minimum 3 years vestingConclusion: there is no inherent age discrimination

with respect Cash Balance Plans Phased (post 62) retirement is Ok: work

reduced time, pension proportionately reduced.

Non-elective enrollment in DCPs is OK.

The PPA of 2006

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401(k)s must allow self-directed funds Faster vesting of employer matches in

DCPs. Investment advice not equal to “Prohibited

Transactions.” Excess funding of DBPs is prohibited Tax free treatment of long term care benefit

included with a retirement annuity. Minimum investment options for DCP

More PPA of 2006

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Trust is immune from creditors If, the plan is “tax qualified.” Note: non tax qualified benefits can,

however, be subject to creditors’ claims in a bankruptcy.

Can a benefit receive favorable tax treatment, but not be immune from creditors’ claims?

What about “executive deferred compensation” plans?

Bankruptcy protection for pensions

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ERISA - Enforcement

No pain and sufferingJudge Francie will decide.

Civil lawsuits can be filed by U.S. DOL and participants.

Also some criminal penalties.

IRS can revoke tax-qualified status of plan.

Lawsuits are equitable in nature.

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Terminated Plan- all participants vested All plans must contribute premiums per

capita to PBGC. PBGC guarantees payment of accrued

benefits. There are caps on insured benefits - full age

and service limit is $4125 / month.

Insuring benefit

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COBRA – extending health care coverage after a major life event.

HIPAA – Limiting right of group health plan to exclude pre-existing health conditions

FMLA – Obligating the employer to allow employees unpaid leave for health conditions of themselves or family

USERRA – continuation of employment rights and benefits during and after a military or uniformed deployment.

Other Provisions of ERISA

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See the “Benefits Chart”

Chapter 12

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COBRA also includes a prohibition against dumping patients at other emergency rooms.

Emergency Medical Treatment Act: requires hospital treatment w/o insurance.

See the chart showing the basic applications of ERISA, the IRC, and the PPA to retirement plans (Fig. 9.1, 287 of the Text.)

Potpourri

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Let’s look at each of the Exercises at end of C. #9 and the Blog, C.#9!

We’re using light weights but lots of reps.

Exercises

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Table 9.2 Vesting Schedules

Table 9.3 Breaks in Service

Table 9.4 §415 Limits

Benefits Chart (Bb – Course Information)

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Tables and Illustrations

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Legal Compliance

You need a good lawyer! But, we have come a long way since 1974.

Plan Sponsors must be aware of their legal obligations.

And those of their delegated fiduciaries.

ERISA and the relevant IRC are complicated laws requiring special legal help.

October 2, 2010