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Retirement

FAQ 1. What are the Different Types of Retirement Plans?

Overview

Retirement plans can be either qualified plans or nonqualified plans. What's the difference?

  • Qualified plans are subject to a number of income tax qualification requirements contained in the Internal Revenue Code that are generally intended to make certain that such plans do not discriminate in favor of highly compensated employees. If the retirement plan is a qualified plan, the employer is entitled to a current deduction for contributions to the plan, the participants are not taxed on the retirement benefits until they are received, and the plan's earnings grow tax-free. The different types of qualified plans are discussed below.
  • Nonqualified plans are not subject to the same qualification requirements and are typically used to provide additional or special benefits for highly compensated employees. If an employer sponsors a nonqualified plan, the employer is entitled to a deduction only when the participants are taxed, the participants may be taxed on the retirement benefits even before they receive them, and the plan might not be funded at all. Nonqualified plans can be designed with much more freedom than qualified plans (although plans sponsored by tax-exempt organizations and governmental employers are subject to special rules). However, the types of plans are generally similar to the types of qualified plans discussed below.

Although it may seem as though there are countless different types of retirement plans, most fall into two basic categories: Defined Benefit Plans and Defined Contribution Plans. Basically, the difference between the two boils down to whether the employees will know how much they'll be getting upon retirement, or whether the employees will have to retire on whatever has been accumulated and earned within their participant accounts.

Defined Benefit Plans

Under a defined benefit plan, the benefit is defined so that the employees know the amount of the benefit that they will receive at retirement. These plans usually pay a specific monthly amount beginning at retirement and continuing for the remainder of the employee's life (and possibly the life of a surviving spouse). In many cases, the amount is calculated as a percentage of the employee's average compensation.

Defined benefit plans do not maintain an individual account for each participant. Instead, the assets are pooled together and the employer makes an agreement that the plan will pay a defined benefit to each employee. Since the rules for these plans make the employer responsible for contributing enough funds to the plan to pay the promised benefits, the employer bears the risks (and rewards) of the plan's investment experience. Thus, if the plan's investment returns are significantly less than expected, the employer may be required to make larger contributions than anticipated in order to make up for the shortfall. 

In order to make sure that there will be sufficient funds contributed to and accumulated within the plan to pay the promised benefits, the services of an actuary are required. The actuary's job is to make economic projections to determine how much money will be required each year to provide the promised benefits upon retirement using various assumptions about the rate at which the plan's assets will grow, how many participants will stay until retirement, and how long retirees will live. 

Many middle-sized and larger employers prefer this type of plan because it is easy for participants to understand what they will get and when they will get it. Defined benefit plans typically favor long-term and older employees and may not provide any significant advantage to those who leave the employer early in their careers. Businesses with many younger employees or frequent employee turnover often find that their employees do not view a defined benefit plan as a meaningful benefit. 

A variation of the traditional defined benefit pension plan is the cash balance plan. A cash balance plan is a type of defined benefit pension plan that looks like a defined contribution plan. The benefit is defined by the plan (as in a typical defined benefit pension plan), rather than the amount of the contribution to each participant's account under the plan (as in a defined contribution plan), and the amount of the benefit does not vary with the actual investment performance of the plan's assets (as in a defined contribution plan). However, the big difference is the manner in which the normal retirement benefit is defined. A typical defined benefit pension plan defines a participant's normal retirement benefit by a formula that takes into account the participant's compensation and years of service. A cash balance plan, on the other hand, bases each participant's retirement benefit on a hypothetical account under the plan. Each participant's hypothetical account equals the sum of the participant's annual contribution credits (typically a percentage of compensation) as increased by the plan's interest credits to normal retirement age. Then, the plan's actuarial assumptions (mortality table and interest rate) are used to convert a participant's hypothetical account balance into an annuity, although the participant will have the option of receiving the hypothetical account balance as a single sum distribution. 

Defined Contribution Plans

Defined contribution plans do not provide a predetermined level of benefits or amount of money upon retirement. Instead, the amount to be contributed to each participant's account under the plan each year is defined (by either a fixed formula or by giving the employer the discretion to decide how much to contribute each year). The size of a participant's benefit will depend on:

  • The amounts of money contributed to the individual's account by the employer and, perhaps, by the employee as well;
  • The rate of investment growth on the principal;
  • How long the money remains in the plan (in most cases, the employee, upon retirement, has the option of either receiving the payment in a lump sum or by taking partial payments on a regular basis while the balance continues to earn interest); and
  • Whether the forfeitures of participants who leave before they are fully vested can be shared among the remaining participants as a reward to long-term employees.

Since benefits accumulate on an individual basis, these plans are sometimes referred to as "individual account plans." In these plans, unlike in defined benefit plans, the risk (and reward) of investment experience is borne by the participant. Defined contribution plans can permit, and sometimes require, that employees make contributions to the plan on either a pre-tax basis (as in a 401(k) plan) or an after-tax basis (as in a thrift plan). They may also, but are not required to, permit employees to decide how the monies contributed into their accounts will be invested. 

There are seven major types of defined contribution plans:

  1. Profit Sharing Plans 
    Profit sharing plans accumulate money through employer contributions to an account for each eligible employee. Each participant's share of the employer's contribution is generally based on the employee's level of compensation. These plans are popular because they allow the employer to determine (within certain limits) the amount of money to be contributed each year. The obvious advantage is that management is not locked into a potentially destabilizing expense if business is slow or the economy sour. In a good year, the employer might want to contribute as much as 25% of employee compensation to the profit sharing plan. In a devastating year, the employer might make no contribution at all. If, however, contributions are not made on a continuing basis, the IRS might rule that the plan has been terminated in which case the participants become fully vested. Another type of profit sharing plan that is gaining popularity is the "age-weighted" or "cross-tested" profit sharing plan. In this case, the employer still retains the discretion to decide how much it will contribute each year. Unlike a traditional profit sharing plan, however, an "age-weighted" or "cross-tested" profit sharing plan will allocate (or divide) the employer's contribution among participants based on their relative ages and years of service. This type of design, like a target benefit plan, generally favors older employees.
  2. Money Purchase Plans 
    A money purchase plan is similar to a profit sharing plan, except that the rate of contribution is a fixed percentage for each year, such as 15% of each eligible employees' compensation. Although the rate can be amended if necessary, small or newer businesses might be well-advised to avoid these plans until they are confident that they can meet the annual contribution requirement. Money purchase plans are subject to somewhat more cumbersome distribution rules than profit sharing plans. Prior to 2002, the advantage to money purchase plans over profit sharing plans was that the income tax deductible contribution was not limited to 15% of compensation. However, with the deduction limit for profit sharing plans increasing to 25% beginning in 2002, money purchase plans have become less popular.
  3. Target Benefit Plans 
    A target benefit plan is a variation of a money purchase plan. However, instead of starting with a fixed percentage for each employee, these plans specify a given benefit, such as 50% of salary at retirement, and base each participant's contribution on the amount of money needed to satisfy that obligation. The age of the employee plays a significant role here. Older workers, obviously, have a shorter time span to accumulate the necessary funds compared to their younger counterparts. In other words, the contribution for an older employee will be higher than the contribution for a younger employee making the same amount of money. It's also important to be aware that the actual retirement benefit is not guaranteed and will depend largely upon investment earnings.
  4. Cash Or Deferred Arrangements Or 401(k) Plans 
    A 401(k) plan, sometimes known as a salary deferral or cash or deferred arrangement, allows each eligible employee to specify the amount of pre-tax income that should be deducted from his or her pay check and placed into a retirement account on their behalf. Flexibility is key here, in that the participants are able to set the contribution level that best suits their personal situation. Unfortunately, some people fail to look very far in advance and, thus, discover a severe problem when retirement is just around the corner. To help counter this unfortunate element of human nature, many companies offer matching contributions to encourage their employees to make salary deferrals. The maximum amount that an employee can contribute is fixed each year by Congress and the Internal Revenue Service (e.g., $18,000 in 2017). 401(k) plans can and do involve complicated plan administration since the relative amounts of salary deferrals and matching contributions are subject to special nondiscrimination testing. Companies that wish to avoid the complications and burdens of 401(k) testing can adopt a "safe harbor" 401(k) plan design for which the special tests are partially or wholly eliminated. Furthermore, employers can "automatically" enroll their employees in their 401(k) plans.
  5. Stock Bonus Plans And Employee Stock Ownership Plans 
    Stock bonus plans and employee stock ownership plans (ESOPs) are designed to use company stock as a mechanism for building equity that will become a retirement resource for your employees. There are several ways to use an ESOP and several ways to fund it with company stock. Stock can be contributed by the employer to the plan, or purchased by the plan (on the open market, from existing shareholders, or from the company) with cash that is contributed to the plan. An ESOP can even borrow money from a bank, the company, or a selling shareholder in order to purchase company stock. By contributing cash to the plan to allow the ESOP to pay off its loan, the principal and interest on the loan is deductible. Since the company can contribute stock instead of cash to the plan, it can obtain a "cash-less" tax deduction. In many respects, a stock bonus plan, or ESOP, has the attributes of either a profit sharing plan or a money purchase plan depending upon whether the plan has a fixed obligation to repay money which it has borrowed. Publicly traded companies can even allow employees to elect to purchase stock in their ESOP using pre-tax salary deferrals made to a 401k plan which is part of the ESOP. Privately held companies do not have this option and, in addition, must have the ESOP trustee appraise the company stock owned by the ESOP annually. ERISA permits ESOPs to be used as both a corporate finance tool as well as a retirement plan. They have been designed to allow privately held company owners to sell their stock to an ESOP using pre-tax cash flow and without recognizing capital gain on the sale of the shares. Tax on the sale is deferred if the selling shareholder reinvests the proceeds within 12 months in stocks and bonds of other American companies. No tax is paid unless and until the reinvestment securities are sold. Finally, ESOPs are permitted shareholders in subchapter S corporations; thus allowing an ESOP owned company to be partially to 100% employee owned and tax exempt. For example a company owner is nearing retirement. However, he realizes that he has no one to pass his business to (his daughter has no interest in the business), that his young employees have expressed an interest in acquiring the business, and that their benefits under the existing retirement plan are not substantial. One solution would be for the company to adopt an ESOP and for the owner to sell his stock to the ESOP, over time using company cash contributions to the ESOP or by using money borrowed from the local bank which the ESOP repays over time.
  6. SEPs 
    SEPs (simplified employee pensions) are a unique type of defined contribution plan. They operate similarly to a profit sharing plan or a money purchase plan in that the employer decides how much to contribute to each participant's account each year. However, instead of making a contribution to a retirement trust for all of the participants, the contribution for each employee is made to an IRA for that employee. The employee then has control over the amounts in his or her IRA.
  7. Tax Sheltered Annuities Or 403(b) Arrangements 
    A 403(b) arrangement, sometimes known as a tax sheltered annuity, allows each eligible employee of certain tax-exempt organizations to specify the amount of pre-tax income that should be deducted from his or her paycheck and contributed to either an annuity contract or a custodial account on their behalf. Such an arrangement is similar to a 401(k) plan in many respects, although the administration of a 403(b) plan may be less complicated because it is possible to avoid nondiscrimination testing and annual returns/reports (Forms 5500) might not have to be filed.

FAQ 2:  What Should I Consider When Designing a Retirement Plan?

This information will be helpful to the employer if:

  • The employer does not have a retirement plan and the employer wants to know how to approach the task of designing the most appropriate plan or plans for the company; or
  • The employer has a plan and is not sure if it is the right kind of plan for the company's business.

Who Is To Benefit?

The first step in retirement plan design is to determine who the employer intends to benefit and why. The scope of coverage and the employees that are to be covered by the plan will be the first limiting factor in the number of alternatives available. For example, if the plan is to cover a select group of executives, both qualified and nonqualified plans may be available. On the other hand, if the plan is to be a broad based plan covering executives and rank-and-file employees, then only qualified retirement plans will be an option.

Typically, for smaller companies, retirement plan design focuses on maximizing the benefits to highly compensated employees while managing the cost of funding a reasonable benefit for nonhighly compensated employees. Larger companies, on the other hand, will often have broad based levels of benefits that are required to be competitive in the marketplace and, in addition, levels of qualified retirement plan benefits or nonqualified retirement plan benefits for executives. Finally, tax-exempt organizations historically have had different legally available choices of retirement plans, but within those available options typically design their plans and the level of benefits based upon the size of the organization.

Determining the scope of coverage in the proposed retirement plan also involves identifying which employees must be covered. For example, the qualified retirement plan nondiscrimination rules require coverage of a sufficient number of nonhighly compensated employees versus highly compensated employees. If the employer is a member of a controlled group or an affiliated service group, the employees of all members of the group must be taken into account when testing for nondiscrimination. Leased employees must also be taken into account. Employees of such related entities and leased employees may have to be covered by the plan unless they can be excluded without the plans failing the nondiscrimination tests by creative plan design. Therefore, a complete and accurate census must be prepared when determining which employees to benefit. It will also be key in the following steps for plan design.

What Type Of Benefits Will Be Provided?

As indicated above, retirement plans can be either qualified plans or nonqualified plans. In addition, regardless of whether the plan is a qualified plan or a nonqualified plan, the plan can be either a defined benefit plan or a defined contribution plan. The employer needs to decide which of these approaches to take.

How Will The Benefits Be Provided?

If the plan is a qualified plan, the benefits will be provided from a retirement trust, through an annuity contract, or through a custodial account depending on the type of plan. If the plan is a nonqualified plan, the benefits must be provided from the employer's general assets unless the plan is a nonqualified deferred compensation plan sponsored by a governmental employer or the employer wants to establish a "rabbi" trust.

Who Will Administer The Benefits?

Each retirement plan requires some level of administration. The employer must determine what is required and who is going to handle it. Will it be handled internally? By a third party administrator? By an investment provider under a bundled services arrangement?

How Much Will It Cost?

An important step is to determine the employer's budget for the benefits to be provided. The amount the company is willing to spend may be determined by factors such as the company's financial condition, the level of benefits to be provided to key employees, and the level of benefits that the company must provide to remain competitive. Regardless of the approach, the budget will often be the predominant factor in selecting the ultimate plan design.

A key aspect of budgeting for benefits is determining whether the employer can commit to any annual level of funding. Some retirement plans such as money purchase pension plans or other defined contribution plans that have a stated level of contribution will impose an annual funding obligation on the employer. Defined benefit plans go even further and require an employer to fund the plan up to the necessary level of benefits after taking into account earnings on investments in the plan, interest-rate assumptions, and the demographics of the employees covered by the plan.

The administrative cost of operating the plan is also a factor in budgeting for the benefits. While some costs can be paid by the plan out of plan assets, the employer must assume certain costs and should be wary of cutting costs (or cutting corners) in the operation and maintenance of the plan. Part of the budget should include the cost of high quality administration and compliance whether it is provided by outside professionals or by building an internal capability within the human-resources or finance department of the company. Trying to save too much money up front on administration can be extremely costly when it is discovered that the company got what it paid for. Obtain several cost estimates for the work, but carefully compare the services that are being provided and who is responsible.

Analyzing The Alternatives

The next step involves taking your proposed plan census of employees to be benefited as well as your budget and creating alternative plan design and funding scenarios. For this you'll need an expert plan consultant or actuary to apply your assumptions to alternative plan designs using their plan administration and nondiscrimination testing software. If the plan design involves complex assumptions (for example, subtle interpretations of new regulations or IRS guidance), then assistance and review by an expert benefits attorney will be advantageous.

The range of plan design alternatives has increased in recent years. For example, defined contribution plans such as profit sharing plans and money purchase pension plans can utilize formulas as simple as allocating contributions by relative compensation or as complex as "cross-tested formulas" that simulate the accruals that occur in a defined benefit plan. Generally speaking, the more complex the formula, the more likely the formula will provide highly compensated employees with the maximum permissible amount of benefit accrual in the plan design.

The available alternatives for employer contributions in a defined contribution plan include:

  • Pro rata by compensation;
  • Integration with Social Security;
  • Age or service weighted formulas; and
  • Cross-tested plans.

Assuming the employer is interested in funding towards a benefits objective rather than budgeting an annual contribution amount, the employer will likely want to evaluate the use of a target benefit plan or a defined benefit plan. While both plans determine a level of funding based upon an objective at retirement, the defined benefit plan will involve a legal obligation to ensure the benefit is funded and, if the plan is subject to ERISA, regulation by the Pension Benefit Guaranty Corporation. While the use of defined benefit plans has declined in recent years for large corporations and small companies alike, changes in the Code have made cash balance pension plans, a newer type of defined benefit plan, much more attractive. Some small employers may wish to fund a defined benefit plan on top of, or in addition to, the maximum amount they can contribute annually to a defined contribution plan.

In the arena of 401(k) plans, "safe harbor" formulas for 401(k) plans permit employers to make a 100% vested matching contribution or employer discretionary contribution and avoid nondiscrimination testing for employee deferrals. This means that a 401(k) plan design can include simplified administration by avoiding the actual deferral percentage (ADP) and actual contribution percentage (ACP) nondiscrimination tests by making these safe harbor contributions. Thus, employers can be assured that the highly compensated employees can defer the maximum dollar amount each year without regard to the level of deferrals by the nonhighly compensated employees.

Finally, in the area of nonqualified retirement plans, the plan funding or allocation formula can replicate any of the above described formulas that are used for a qualified retirement plans. Thus nonqualified retirement plans can be of a defined contribution variety or of a defined benefit variety. Further flexibility is available in nonqualified retirement plans due to the fact that such “top hat” plans are not required to keep their benefits in a trust. Thus no assets need to be set aside or actual contributions made until benefits need to be paid. The key in this area is to ensure that the plan covers only a select group of management or highly compensated employees that constitutes a "top hat" group under ERISA.

FAQ 3:  What Documents and Policies Does a Retirement Plan Need to Have?

Plan Must Be In Writing

Under the Code and ERISA, every qualified retirement plan should be embodied in a written plan document. The plan document should be sufficient to enable the plan administrator (the person operating the plan) to determine who is eligible to be in the plan, when eligible employees enter the plan, what benefits are available, how the plan is financed (i.e., employer contributions, employee contributions, or both), how and when the benefits are paid, and how claim disputes are resolved. If the plan is intended to be a "qualified" plan in accordance with the Code and IRS rules, it must contain certain plan language. To make sure that the plan document contains the plan language necessary and appropriate for a qualified plan, the employer should use either a pre-approved form of plan (e.g., an IRS approved prototype or volume submitter plan) or obtain IRS review of its individually designed plan document as part of the IRS's determination letter program. The plan document should be kept with the sponsoring employer's important papers and it should be kept up to date as the employer makes changes to the plan.

Summary Plan Description (SPD)

ERISA requires that every plan be summarized in lay terms in an SPD. The specific requirements for the contents of an SPD are contained in regulations published by the United States Department of Labor (DOL). The SPD must be provided to each participant in the plan within 90 days after he or she becomes a participant. A copy of the SPD need not be sent to the DOL unless the DOL requests a copy. If a subsequent amendment to the plan results in a change in any of the information required to be in the SPD, a supplement to the SPD must be distributed to all participants within 210 days after the end of the plan year in which the change was adopted. If the plan has been amended, an SPD incorporating all amendments to the plan must be provided to the participants every 5 years. If the plan has not been amended, another copy of the SPD must be provided to the participants every 10 years.

Summary Annual Report (SAR)

Each year, the plan administrator of a plan that is not exempt from filing a Form 5500 must provide an SAR to the participants within nine months after the end of the plan year. The SAR summarizes the information provided on the Form 5500 and tells the participants how to obtain a copy of the Form 5500. The requirements for a SAR are set forth in the DOL's regulations.

Claims Procedures

ERISA requires that employee benefit plans provide claims procedures. These procedures must allow a claimant to appeal a denial of benefits.

Other Policies And Procedures

In order to ensure that all of the required notices, elections, disclosures, and tests are handled in a timely and uniform manner, the plan administrator (with the help of its advisors) should adopt various policies and procedures. The policies and procedures that may need to be adopted are those for:

  • Enrolling participants;
  • Governing participant-directed investments;
  • Making hardship distributions;
  • Making participant loans;
  • Making retirement distributions;
  • Reviewing and processing qualified domestic relations orders (QDROs);
  • Investing plan assets on a pooled basis;
  • Nondiscrimination testing; and
  • Plan reporting to the government (including the preparation of an accountant's opinion if required).

FAQ 4:  What Do I Need to Do to Keep the Plan "Qualified"?

The sponsor of a qualified retirement plan agrees to establish and maintain its plan in accordance with the various plan qualification rules under Code section 401(a). In exchange, the plan is treated as "qualified" and receives special tax-favored treatment, as follows:

  • The employer receives a current tax deduction on amounts it contributes to the plan even though the participants are not currently taxed on such contributions;
  • The trust that receives and holds the contributions is tax-exempt so that the gains on its investments generally are not taxed;
  • Participants are not taxed on amounts in their accounts even though these amounts are set aside in trust for them and may be fully vested; and
  • Distributions from the plan are afforded favorable treatment, such as tax-deferred rollover to an individual retirement account.

The Code's qualification rules establish two types of requirements for plans: document requirements (that is, certain provisions must be contained in the plan) and operational requirements (that is, certain operational rules and tests must be met). A failure to keep a plan in compliance with the document requirements is a document failure. A failure to satisfy the various operational rules and testing requirements is an operational failure.
If a qualified plan is audited and is found to have operational or document failures, the plan could become disqualified. The tax consequences of disqualification are as follows:

  • The plan sponsor is not permitted to take income tax deductions for the contributions to the plan using the special rules that apply to a tax qualified retirement plan; and
  • Contributions to a "nonqualified" plan cannot be deducted by the employer until the year in which they are made and are taxable to the participants. Therefore, for each open tax year of the employer, there is a potential loss of its tax deduction for all contributions to the plan, although (unless the plan is a defined benefit pension plan) those deductions may be shifted to future tax years or the current tax year, depending upon the particular facts and circumstances in the situation;
  • Each participant is taxed on the contributions made to the plan during the year(s) when the plan was not a qualified plan, to the extent the participant was vested at the time the contributions were made (or as the participant vests in subsequent years) for those years that are still open years;
  • The trust is no longer a trust for a "qualified" plan and, therefore, it loses its tax exempt status and becomes a taxable trust. The trust must pay trust income taxes for all open years to the extent that the trust has net taxable income; and
  • Distributions from a "disqualified" plan are not eligible for favorable income tax treatment, such as a tax-free rollover to an individual retirement account or special income averaging (to the extent available).

IRS Plan Defect Correction Program

The IRS has established several correction programs to permit the sponsors of qualified retirement plans to correct document and operational failures and maintain the tax qualified status of their plans. There are essentially three types of correction mechanisms (two of which are voluntary "self help" mechanisms):

  • SCP - The Self-Correction Program is for operational failures corrected within a relatively short time period (i.e., two years) after the failure occurred and minor and insignificant operational failures;
  • VCP – The Voluntary Correction Program provides general procedures for correction of all qualification failures: operational, document, demographic and employer eligibility failures; and
  • Audit CAP - The Audit Closing Agreement Program is used by plan sponsors to correct serious operational failures, document failures and demographic failures discovered during an employee benefit plan audit.

The corrections under VCP require IRS supervision, involve paying sanctions, and can take from nine to 18 months or more to complete. SCP, on the other hand, permits the voluntary self-correction of operational failures under certain circumstances without the need for reporting to the IRS or payment of any fee or sanction. If any failures are discovered on audit (rather than being corrected voluntarily), a plan sponsor would be forced to negotiate an audit closing agreement. The sanction under Audit CAP can be substantial since it is based on the aggregate value of lost tax-favored treatment upon the plan's disqualification. 

Our Recommendation

The rules and requirements for retirement plan compliance are too complex and rapidly changing for most employers to handle alone. Because the consequences of plan disqualification are so severe (and embarrassing in terms of employee relations), we strongly believe that every employer should select and actively work with a team of competent plan advisers.

FAQ 5:  What Are the Reporting and Disclosure Obligations for Retirement Plans?

Form 5500

ERISA and the Code require each retirement plan to file Form 5500 by the end of the seventh month after the end of each plan year (extensions of time are available) unless the DOL and the IRS have granted an exemption to this requirement. Under the IRS's regulations, certain retirement plans are not required to file a Form 5500 (e.g., if the plan covers only the sole owner or owners of the employer and has less than $250,000 in assets at the end of the year). If a Form 5500 is required and the plan is funded through a trust, formal plan financial reports and an independent qualified public accountant's opinion may be required.

The failure to file a Form 5500 required by ERISA can result in a penalty imposed by the DOL of up to $2,063 per day with no maximum unless the penalty is excused based upon reasonable cause.  That penalty is the 2017 number and will be adjusted for inflation.  Late filers may obtain relief from these penalties under the DOL's Delinquent Filer Voluntary Compliance (DFVC) Program under which late forms can be filed subject to a fixed penalty schedule that is less onerous than the penalties that might otherwise apply.

There is a separate late penalty due to the IRS for failure to file a Form 5500 required by the Code. The IRS may also impose penalties under the Code for the failure to file a Form 5500 of $25 per day with a maximum of $15,000 per Form 5500.

Summary Annual Report (SAR)

Each year, the plan administrator of a plan that is not exempt from filing a Form 5500 must provide a summary annual report (SAR) to the participants within nine months after the end of the plan year. The SAR summarizes the information provided on the Form 5500 and tells the participants how to obtain a copy of the annual return/report. The requirements for a SAR are set forth in the DOL's regulations.

Summary Plan Description

ERISA requires that every plan be summarized in lay terms in a summary plan description (SPD). The specific requirements for the contents of an SPD are contained in regulations published by the United States Department of Labor (DOL). The SPD must be provided to each participant in the plan within 90 days after he or she becomes a participant. A copy of the SPD need not be sent to the DOL unless the DOL requests a copy. If a subsequent amendment to the plan results in a change in any of the information required to be in the SPD, a supplement to the SPD must be distributed to all participants within 210 days after the end of the plan year in which the change was adopted. If the plan has been amended, an SPD incorporating all amendments to the plan must be provided to the participants every 5 years. If the plan has not been amended, another copy of the SPD must be provided to the participants every 10 years.

The willful violation of the requirement to provide SPDs, SARs and certain other information requested by participants to the participants can result in a fine of up to $5,000, imprisonment for up to 1 year, or both if the person convicted is an individual. If the person convicted is not an individual (e.g., it is a corporation), the fine can be as high as $100,000. In addition, the failure to provide certain information requested by a participant or beneficiary within 30 days after a request can result in a civil penalty of up to $110 per day. This amount is payable to the participant or beneficiary involved.

Determination Letters

In addition, the following filings are optional, but generally recommended:

  • A Form 5300 series application may be filed with the IRS for a favorable letter of determination on the plan's documents. Although not required, such a filing is advisable because you can receive confirmation from the IRS that your plan documents are in compliance with the applicable law.
  • A Form 5310 is generally filed as part of an application for determination from the IRS concerning the termination of a plan (the failure to get such approval may increase the likelihood of an audit by the IRS).

Reporting To The PBGC

If a defined benefit pension plan is subject to PBGC reporting, it is required to file PBGC Form-1 on an annual basis and pay an appropriate PBGC premium along with such filing. In addition, if the plan encounters funding problems, a report must be filed with the PBGC. It may also be necessary to notify the PBGC when certain "reportable events" happen with respect to your defined benefit plan. If a plan is subject to the jurisdiction of the PBGC, the plan must notify the PBGC before the plan can be terminated.

FAQ 6:  What Do California Governmental Employers Need to Know About Their Plans?

The information in this FAQ relates to plans sponsored by:

  • State and local government units, such as counties and cities;
  • School districts and municipal and public corporations;
  • State and local commissions; and
  • Public water, irrigation and other special districts.
  1. What is a "governmental" retirement plan?

A governmental retirement plan provides pension or other deferred compensation benefits to the employees of the state or local government, including any of their subdivisions, agencies or instrumentalities. In contrast, a non-governmental retirement plan provides benefits to the employees of a private employer, including most tax-exempt entities.

  1. In California, what laws apply to governmental retirement plans?

Governmental retirement plans in California are subject to California statutory law, mostly under the Government Code, as well as certain federal and state tax requirements that apply to plans that are intended to provide tax-favored benefits.

  1. Does the Employee Retirement Income Security Act of 1974 (ERISA) apply to governmental plans?

No. Governmental plans are exempt from the requirements of ERISA, although many of the ERISA requirements (e.g., responsibilities of plan fiduciaries) have been incorporated into California statutory law and thus made applicable to California-based governmental plans.

  1. What governmental plans are sponsored either by the state of California or by one of its political subdivisions or agencies?

Several plans are sponsored either by the state or another governmental entity within California. The largest of such plans is the California Public Employees' Retirement System (CalPERS), which provides both retirement and welfare benefits to various categories of employees, including both safety (e.g., police and fire) and miscellaneous employees of the state and those local governmental entities, such as cities, counties and special districts, that enter into a contract for CalPERS to provide such benefits.

Other state or local government sponsored plans include (among others): the State Teachers' Retirement System (CalSTRS), which provides retirement and certain other benefits to primary, secondary, community college and adult education school teachers within the state; the University of California Retirement System; various county retirement systems established under the County Employees Retirement Law of 1937; and systems established under the Legislators' Retirement Law and the Judges' Retirement Law.

  1. Must a California governmental employer provide its retirement or other benefits through a state or locally sponsored retirement system?

Most California state employees are required to participate in the applicable state retirement system. However, local government entities, such as cities, counties, commissions and special districts, can elect to participate either in the applicable state retirement system (generally, CalPERS) or in an individual system that is established specifically for such entity. In addition, if certain requirements are met, a local governmental entity can participate in both the state system and an individually-sponsored plan.

  1. What are some of the advantages and disadvantages of joining CalPERS?

CalPERS and the other government-sponsored retirement systems generally provide a well-defined system that can work well as an agency's primary retirement plan for all of its eligible employees. In addition, most of the administrative duties and obligations involved with maintaining a retirement plan are managed and overseen by CalPERS.

On the other hand, our experience is that a governmental employer will generally come out ahead both in terms of benefit flexibility and employer cost by adopting its own properly designed plan. This is especially true in cases where the employer wants to provide supplemental benefits to a particular group of employees, such as those who are nearing retirement age.

  1. What types of plans are available for a governmental employer that wants to maintain a retirement plan outside of CalPERS?

Governmental employers can maintain tax-qualified plans of two basic types outside of CalPERS, either as a supplement to or a replacement for CalPERS. First, a defined benefit pension plan provides a stated benefit for employees upon retirement, usually based on a percentage of compensation multiplied by the number of years of employment. A defined contribution plan generally provides that the employer will contribute a stated percentage of employees' compensation to the plan during their years of employment, and the employees' benefit will be whatever those contributions and earnings add up to when the employees retire.

In addition, a governmental employer can establish a 457(b) plan, with public schools also able to adopt a 403(b) tax-sheltered annuity program.

  1. Are qualified retirement plans of governmental employers subject to different tax qualification rules than qualified plans of private employers?

Yes. In general, qualified governmental plans are subject to the tax qualification rules that existed prior to the enactment of ERISA. Therefore, many of ERISA's and subsequent legislation's tax-qualification requirements, including a prohibition on discrimination in favor of highly compensated employees, accelerated vesting, etc., do not apply to governmental plans. This fact makes such plans an ideal vehicle for providing either a broad-based plan for all employees or enhanced benefits for targeted employees or groups of employees with maximum flexibility in plan design and a minimum of cost. 

  1. Why must government employers be particularly careful when designing their retirement and welfare plans?

California governmental employers are prohibited from impairing the contract rights of public employees to their retirement and certain other benefits. The California Supreme Court and other courts in California, as well as the applicable state agencies, have interpreted this constitutional requirement as prohibiting a governmental employer, in most cases, from reducing or eliminating the most valuable benefit that is offered at any time during an employee's public employment. However, the full impact of this requirement can be avoided, and a governmental entity's flexibility to amend or terminate its benefits can be preserved, if certain legal steps are taken as early as possible.

  1. Can governmental employers offer 401(k) plans to their employees?

With the exception of a few special and grandfathered situations, governmental employers cannot sponsor 401(k) plans. However, governmental employers and their employees can enjoy similar benefit rights through adoption of a properly designed 457(b), or a 403(b) arrangement (schools only).

  1. What is a 457(b) plan or "eligible deferred compensation" plan?

Section 457 of the Internal Revenue Code provides the requirements that apply to virtually all non-tax-qualified deferred compensation plans that are adopted by governmental entities. If such an entity adopts an "eligible deferred compensation plan" under section 457(b), and its requirements are met, then amounts deferred under the plan and accumulated net income will not be taxed until the particular employee terminates employment and actually receives a distribution of such amounts.

  1. What rules apply to governmental 457(b) plans?

The maximum annual amount that can be deferred under such a plan either by or for any employee is $18,000 for 2017 or 100% of the employee's compensation. Such amount may be increased for inflation by the IRS, in $500 increments. In addition, catch-up contributions can be made either during the last three years prior to attaining normal retirement age under the plan or after attainment of age 50.

Also, section 457(b) imposes limits on the circumstances in which benefits can be paid to employees, such as upon employment termination or in the event of an unforeseeable emergency, and all plan assets must be held "in trust" for the exclusive benefit of the plan's participants and beneficiaries.

  1. Can participants direct the investment of their 457(b) accounts?

Most governmental 457(b) plans are designed to permit participants to direct the investment of their accounts. This right must be spelled out in the plan documents.

  1. What fiduciary duty rules apply to such arrangements?

In general, the trustee and named fiduciaries of the plan are legally responsible for the prudent investment of all plan assets. In the case of a participant-directed 457(b) plan, maintained by a California public agency, these individuals or entities may be relieved of their fiduciary duties for plan investments if the agency complies with the rules described in ERISA section 404(c), even though ERISA is not applicable to the plan.


PLAN INVESTING

FAQ 1:  What Is Investing on a Pooled Basis?

We consider plan assets to be invested on a "pooled basis" whenever it is the responsibility of the plan sponsor, the plan trustee, a plan investment committee, or a plan investment manager to decide how all of the plan's assets will be invested. Since defined benefit plans and welfare plans do not have individual participant accounts, and cannot permit participant directed investments, they must be invested on a pooled basis. 
If you are charged with responsibility for investing a plan's pooled assets, you should:

  • First, gain an overall appreciation for what you are dealing with (that is, the size of the plan, where it is currently invested, who if anyone is advising it, and whether there is an existing investment policy).
  • Second, you should become familiar with the financial goals and constraints of the plan as well as your duties as an ERISA fiduciary.
  • Third, you should develop (or update) the plan's investment policy so that you have a roadmap against which to measure your investment decisions and progress.
  • Fourth, you should carefully evaluate whether you have the time, experience, skills and knowledge to handle your plan's investments, or whether it make sense to hire a professional investment manager to take on this responsibility.

FAQ 2:  What Is Participant Directed Investment?

Defined contribution retirement plans, such as 401(k) plans, profit sharing plans, and money purchase pension plans, all maintain individual participant accounts that track the amount of employer and employee dollars that are allocated to each account as well as the investment earnings and losses allocated to the account. Because a participant account in defined contribution plan operates much like a savings account, the participant is considered to be at risk (that is, directly affected) with regard to the success or failure of the plan's investments.

ERISA contains special rules for defined contribution retirement plans (but not defined benefit plans or welfare plans) that permit an employer to design and operate its plan so that participants will have the responsibility for investing their own accounts. If certain ERISA rules are met, the person(s) who normally would have been responsible for plan investments will not be and participants generally will be responsible for the results of their own investment decisions.

The special ERISA rules governing participant directed investments are contained in ERISA section 404(c) and related Department of Labor regulations under section 404(c).


HEALTH & WELFARE

FAQ 1:  What Are the Various Health & Welfare Plan Types?

The terms "welfare plans" and "employee welfare benefit plans" generally refer to employee benefit plans other than retirement plans. Most welfare plans can be provided by an employer to its employees on a tax-favored basis so that the value of the benefit under the plan is not taxable to the participant. However, some welfare plans will result in additional gross income to a highly compensated employee or a key employee unless the plan meets the nondiscrimination requirements imposed by the Internal Revenue Code. We have described the most popular welfare plans below.

Group-Term Life Insurance Plan

An employer can provide up to $50,000 of group-term life insurance coverage for its employees on a tax-favored basis under Code section 79. Although it is possible to provide coverage greater than $50,000 under a group-term life insurance plan, the participant will be taxed on the value of coverage in excess of the $50,000 limit. A group-term life insurance plan cannot discriminate in favor of key employees.

Health Benefits

An employer can provide health benefits for medical expenses (e.g., major medical, prescription drug, dental and vision) on a tax-favored basis to both active employees and retired employees. Such a plan can be provided on an insured basis, a self-insured basis, or a combination of the two. There are currently no nondiscrimination requirements if the plan is fully insured. That is, the employer can provide different or better insurance coverage to various groups of employees or retirees as long as the benefits are all provided through health insurance policies. However, if the plan is not fully insured, there can be no discrimination in favor of highly compensated employees (e.g., a medical expense reimbursement plan (MERP) that provides only highly compensated employees with reimbursement for medical expenses not covered by the employer's insured medical plan).

Disability Insurance

Long-term disability benefits can be provided to employees with differing income tax results depending on how the plan is structured. If the premiums for the coverage are not included in an employee's gross income, the benefits received by the employee are taxable. If, however, the premiums for the coverage are included in an employee's gross income, the benefits received by the employee are income tax free.

Cafeteria Plan

A cafeteria plan (sometimes called a Code section 125 plan or a flexible benefits plan) is a plan that allows an employee to reduce his or her compensation in order to pay the employee's share of the cost of the benefits provided by the employer. For example, if an employer offers health insurance to its employees and their dependents, but the employer is willing to pay for employee-only coverage, the employees could pay for coverage for their dependents on a pre-tax basis, instead of an after-tax basis, through a cafeteria plan. A cafeteria plan must not discriminate in favor of either highly compensated employees or key employees.

Educational Assistance

Employers can provide educational assistance to employees on a tax-favored basis in two ways. First, an employer can provide employees with benefits if the education is job related. Second, an employer can reimburse its employees for education that is not necessarily job related as long as the plan does not discriminate in favor of highly compensated employees.

Dependent Care Assistance Program

An employer can reimburse employees for their dependent care expenses (e.g., day care for children) on a tax-favored basis as long as certain requirements are satisfied, including that there be no discrimination in favor of highly compensated employees. This benefit is often part of a cafeteria plan where employees can reduce their compensation to pay their day care expenses on a pre-tax basis.

Severance Benefits

Although severance benefits are not excluded from the employee's gross income, an issue often arises as to whether such benefits are welfare benefits or a form of deferred compensation. The difference can be significant under both the Code and ERISA.

VEBA

A voluntary employees' beneficiary association (VEBA) is not really a separate welfare benefit. Instead, it is a method for delivering welfare benefits to employees. A VEBA is an entity (e.g., a trust or a corporation) to which one or more employers make contributions in order to provide benefits such as health benefits. The VEBA is exempt from taxation. In order to be a VEBA, an application for a tax exemption must be filed with the IRS and the benefits must not be discriminatory.

FAQ 2:  What Documents and Policies Does a Health & Welfare Plan Need to Have?

Under ERISA, every employee welfare benefit plan should be embodied in a written plan document. The plan document should be sufficient to enable the plan administrator (the person operating the plan) to determine who is eligible to be in the plan, when eligible employees enter the plan, what benefits are available, how the plan is financed (i.e., employer contributions, employee contributions, or both), how and when the benefits are paid, and how claim disputes are resolved. The plan document should be kept with the sponsoring employer's important papers and it should be kept up to date as the employer makes changes in the plan. The plan document does need not to be filed with any governmental agency.

Summary Plan Description (SPD)

ERISA requires that every plan be summarized in lay terms in a summary plan description (SPD). The specific requirements for the contents of an SPD are contained in regulations published by the United States Department of Labor (DOL). The SPD must be provided to each participant in the plan within 90 days after he or she becomes a participant. A copy of the SPD need not be sent to the DOL unless the DOL requests a copy. If a subsequent amendment to the plan results in a change in any of the information required to be in the SPD, a supplement to the SPD must be distributed to all participants within 210 days after the end of the plan year in which the change was adopted. In addition, if there is a material reduction in covered services or benefits provided under a group health plan, a summary of the change must be given to participants within 60 days after the adoption of the change (unless the employer provides such a description at regular intervals of not more than 90 days). If the plan has been amended, an SPD incorporating all amendments to the plan must be provided to the participants every 5 years. If the plan has not been amended, another copy of the SPD must be provided to the participants every 10 years.

COBRA

The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) amended ERISA, the Code and the Public Health Service Act (applicable to governmental plans) to require that group health plans that are subject to COBRA must offer the continuation of health coverage for a limited period of time to a participant and the participant's beneficiaries when a "qualifying event" occurs that would otherwise cause the person to lose such coverage. If a group health plan is subject to COBRA, the plan should have procedures in place for complying with COBRA's notice and election requirements.

QMCSO

ERISA requires that group health plans comply with the terms of a qualified medical child support order (QMCSO). A QMCSO is an order issued by a domestic relations court (or certain administrative agencies) that orders a plan to provide health coverage to a child of a participant in the plan in connection with a divorce or family support proceeding. The plan must adopt procedures for reviewing medical child support orders in order to determine if they are QMCSOs.

Claims Procedure

ERISA requires that employee benefit plans provide claims procedures. These procedures must allow a claimant to appeal a denial of benefits.

FAQ 3:  What Are the Reporting and Disclosure Obligations for Health & Welfare Plans?

Form 5500

ERISA requires each plan to file Form 5500 by the end of the seventh month after the end of each plan year (extensions of time are available) unless the DOL has granted an exemption to this requirement. Under the DOL's regulations, certain employee welfare benefit plans are not required to file a Form 5500 (e.g., if the plan covers fewer than 100 participants at the beginning of the plan year and the benefits are paid either (i) exclusively from the employer's general assets, (ii) exclusively through insurance contracts or an HMO, or (iii) through a combination of the two). If a Form 5500 is required and the plan is funded through a trust, formal plan financial reports and an independent qualified public accountant's opinion may be required.

The failure to file a Form 5500 required by ERISA can result in a penalty imposed by the DOL of up to $2,063 per day with no maximum unless the penalty is excused based upon reasonable cause. Late filers may obtain relief from these penalties under the DOL's Delinquent Filer Voluntary Compliance (DFVC) Program under which late forms can be filed subject to a fixed penalty schedule that is less onerous than the penalties that might otherwise apply.

Summary Annual Report (SAR)

Each year, the plan administrator of a plan that is not exempt from filing a Form 5500 must provide a summary annual report (SAR) to the participants within nine months after the end of the plan year. In addition, a totally unfunded plan, under which the benefits are paid solely from the general assets of the employer, where there are no employee contributions, is exempt from the SAR requirement even if the plan administrator must file a Form 5500 because there are at least 100 participants. The SAR summarizes the information provided on the Form 5500 and tells the participants how to obtain a copy of the Form 5500. The requirements for a SAR are set forth in the DOL's regulations.

Summary Plan Description

ERISA requires that every plan be summarized in lay terms in a summary plan description (SPD). See FAQ 2 above for the SPD disclosure requirements. The willful violation of the requirement to provide SPDs, SARs and certain other information requested by participants to the participants can result in a fine of up to $5,000, imprisonment for up to 1 year, or both if the person convicted is an individual. If the person convicted is not an individual (e.g., it is a corporation), the fine can be as high as $100,000. In addition, the failure to provide certain information requested by a participant or beneficiary within 30 days after a request can result in a civil penalty of up to $110 per day. This amount is payable to the participant or beneficiary involved.

ACA Reporting and Disclosure Requirements

The Affordable Care Act requires that "Applicable Large Employers" distribute Form 1095-C to employees enrolled in the employers group health plan showing that the employer has complied with ACA rules on offering health coverage that meets minimum requirements. Form 1095-C must also be filed with the IRS.  Employers with self-insured health plans must distribute and file Form 1095-B to enrolled employees and file the form with the IRS regardless of whether they are an “Applicable Large Employer.”  We recommend checking with your legal advisor as the status of these rules has been in flux and there are additional requirements for employers that are part of a controlled group.   


Team & Fiduciary Responsibilities

FAQ 1:  What Is the Employer's Role in an Employee Benefit Plan?

If you are the employer, your role on the benefits team is to:

  • Determine the plan design, adopt the plan document, and keep the plan document up to date with the ever-changing employee benefit plan laws and regulations.
  • Make contributions to or pay benefits under the plan to the extent required by the plan.
  • Administer the plan or appoint the plan administrator (see separate role description below).
  • Appoint the plan's trustee, if necessary (see separate role description below).
  • Adopt an investment policy, if necessary.
  • Hire third parties to assist you, if necessary, such as a third party administrator, a benefits consultant, an actuary, an employee benefits attorney, and an accountant (see separate role descriptions below).
  • Make decisions involving the amendment or the termination of the plan.

As the sponsor of an employee benefit plan, you are ultimately responsible for the overall design of the plan, such as the categories of employees who can participate and the benefits to be provided. You also decide the general manner in which the plan will be administered, as well as the circumstances under which it will be amended and terminated.

Once the overall objectives of your company's plan have been determined, you need to adopt a plan document and a trust document if the plan is going to be funded (e.g., a qualified retirement plan). You must then decide whether to act as the plan administrator or appoint a plan administrator and, if the plan is funded with a trust, appoint the trustee(s) and adopt an investment policy.

You may also want to hire a third party administrator (TPA) to assist you with the administration of the plan because you may not be familiar with the rules and regulations that govern employee benefit plans or do not have the human resources to handle all of the administrative requirements of such plans internally. A TPA will work with you, the plan administrator, and the trustee(s) in determining who meets the plan's eligibility requirements, the amount of the contributions, and the extent of the participants' benefits. A TPA will also assist you in keeping each of your employee benefit plans in compliance with the numerous employee benefit plan laws. This function is extremely important because a plan that does not comply with such laws can result in adverse tax consequences to you and the participants and subject the plan's fiduciaries to personal liability. You should have a written service agreement with each TPA to avoid misunderstandings as to the TPA's role and your responsibilities.

Once all the plan documents and the players are in place, the plan can be implemented and administered by:

  • Determining who is eligible to be in the plan.
  • Funding the plan in the manner required by the plan.
  • If the plan is funded with a trust, making contributions to the trust from employer contributions, employee contributions, or both, and determining how the trustee will invest the trust's assets.
  • If the plan is fully insured, paying insurance premiums from employer contributions, employee contributions, or both, or, if plan benefits are to be paid out of your general assets, making sure that the funds are available.
  • For plans that are not fully insured, processing claims for benefits and paying approved claims either out of the trust, if the plan is funded with a trust, or out of your general assets if it is not.
  • Testing the plan each year under the applicable nondiscrimination tests.
  • Complying with the various reporting and disclosure requirements applicable to the plan.

Employer Fiduciary Liability In General

Although the employer is the plan's sponsor, whether it is a plan fiduciary will depend on how the plan is administered and what the plan document says. If one or more employees (or members of the board of directors) of the plan sponsor are responsible for the day to day administration of the plan or are responsible for the investment of plan assets, the employees and their employer probably will be treated as fiduciaries of the plan. Furthermore, many plan documents, particularly prototype documents, specify that the employer is the ERISA plan administrator of the plan. It is important for you to read your company's plan document to determine who is the designated plan administrator.

In general, you should avoid the plan's designation of the employer as the plan administrator. If the employer is the designated plan administrator, the employer's board of directors and officers can be held liable as fiduciaries of the plan even though they may know very little about the day to day operations or investments of the plan. Generally, we recommend that the plan provide that an administrative committee designated by the employer will be the plan administrator. In this way, the employer can designate as the plan administrator a group of individuals who understand that they will be plan fiduciaries and who have some appreciation for the operation of the plan. Of course, the employer will be responsible for the prudent selection and monitoring of the administrative committee.

Limiting Employer Fiduciary Liability

Apart from designating an administrative committee to serve as the plan administrator, there are other ways for the employer to limit its fiduciary liability. These include:

  • Designating an institution rather than an employee (particularly the owner) of the company to serve as the plan's trustee.
  • Hiring a registered investment advisor to take responsibility for the investment of the plan's assets.
  • Making plan participants responsible for the investment of their own accounts, in the case of a defined contribution plan, such as a 401(k) plan or a profit sharing plan (see the FAQ regarding participant-directed investments).
  • Making sure that the company and the plan administrator receive appropriate and expert outside advice and assistance from benefits experts such as a third party administrator, an employee benefits attorney and a benefits consultant.

FAQ 2:  What Is the Plan Administrator's Role?

If you are the plan administrator, your role is to:

  • Develop written policies and procedures for the operation of the plan (e.g., enrollment forms, claims forms, qualified domestic relations procedures for a retirement plan or qualified medical child support procedures for a health plan, or procedures for allowing participants to direct the investment of their accounts under a retirement plan).
  • Advise participants and beneficiaries on how the plan works, such as through the publication of a summary plan description (SPD).
  • Keep track of the participants' eligibility for benefits under the plan (e.g., for each employee, keep track of name, address, social security number, marital status, date of birth, date of hire, compensation, and job classification).
  • Make decisions on benefit claims and the payment of benefits.
  • Assure compliance with the applicable laws and regulations to include maintaining the paperwork for both the employer and any interested government agencies, such as the Internal Revenue Service, the Department of Labor, and, for certain retirement plans, the Pension Benefit Guaranty Corporation.

The plan administrator may be the employer or an administrative committee made up of key executives who are familiar with personnel matters. Because of the complexities of the employee benefit plan rules, you (or the employer) may wish to hire a third party administrator (TPA) to assist you and the employer with the administration of the plan. Remember, however, that even if a TPA is hired, you are still responsible for supervising the TPA and making any discretionary decisions with respect to the operation of the plan.

Plan Administrator Liability In General

As mentioned earlier, ERISA requires every plan to have a plan administrator or named fiduciary (this is not the “third party administrator” or “TPA”). Generally speaking, the plan administrator designated under the plan has the responsibility for making decisions with respect to:

  • Eligibility to participate in the plan.
  • The determination of the amount of benefits payable under the plan.
  • The approval or denial of benefit claims.

Given these responsibilities, employers generally find it best to designate a specific employee or group of employees (an "administrative committee") with first-hand knowledge of, and responsibility for the operation of the plan, as the plan administrator.

There are several advantages to appointing a specific employee or employee committee as plan administrator in that it:

  • Enables the employer to clearly identify the person or persons who make a formal action on behalf of the plan, thereby achieving continuity and consistency in plan interpretation and benefit decisions.
  • Removes the employer itself, or its management, from becoming party to any lawsuits brought with respect to plan benefits, thereby limiting the introduction of other issues involving the employee's employment relationship (e.g., poor employee performance) and focusing the inquiry upon the decision made in terms of the plan.
  • Permits the establishment of a clear and consistent benefit claims procedure that has the best chance to be carried out and, as a result, has the best chance to withstand a court challenge.

The decision to make the plan administrator a single individual or a committee depends upon the preferences of the employer. Appointment of a single individual who is most familiar with the plan such as an employee benefits manager may be appropriate in the cases of some smaller companies. For larger companies, the appointment of a small committee, for example, one comprised of the director of human resources, the benefits manager, and a human resources manager, may be equally appropriate.

The appointment of the individual or individuals to serve as the plan administrator should be made in light of the objectives mentioned above, namely to:

  • Establish the most efficient and effective structure for administration of the plan.
  • Allocate and delegate functions to the entity or persons best suited for the particular task.
  • Clearly delineate such allocations and delegations in the plan documents.

Although there are always exceptions to the rule, our general recommendation is that the employer should appoint, as plan administrator, the person or persons who are most familiar with the day to day administration of the plan, are charged with its maintenance and operation, and who have the particular expertise to interpret the plan and apply it in the proper manner to the employer's work force.

Limiting Plan Administrator Liability

The best way for the plan administrator to limit its liability under ERISA is to practice procedural prudence. That is, acting in a deliberate and prudent manner after fully consulting the relevant plan documents and expert advisers (if needed). The prudent plan administrator should:

  • Make sure it has carefully read and understands the plan document.
  • Establish uniform written policies to govern areas of plan administration that are not adequately addressed in the plan document, such as plan loans, hardship withdrawals, and the handling of QDROs.
  • Carefully document its decisions and the basis for each significant decision.
  • Retain qualified advisors and experts to assist it with areas of plan administration where it does not have the requisite knowledge.
  • If you are an employee and have been asked to serve on your company's administrative committee, you may want to ask whether your company will indemnify you (hold you harmless) from legal liability, except in cases of a willful fiduciary breach. Many companies also provide fiduciary liability insurance for members of their administrative committee.

FAQ 3:  What Is the Plan Trustee's Role?

If you are a trustee, your role is to:

  • Invest the plan's assets held by the trust, which may consist of employer contributions, employee contributions, or both, within the guidelines established by ERISA (if it applies to the plan).
  • Distribute benefits based on instructions from the plan administrator.
  • Report to the plan administrator (and in some cases the IRS).
  • Not all employee benefit plans are funded with a trust, however, most retirement plans are funded with a trust (unless the plan is fully insured or a nonqualified deferred compensation plan that funded out of the employer's general assets). Some welfare plans are funded with a trust, usually a tax-exempt trust under the rules applicable to a voluntary employees' beneficiary association (VEBA).

A trustee can be an individual, such as the company owner or a key employee, or an institution, such as a trust company or the trust department of a bank. If there is more than one trustee, you may share responsibility for all duties equally or each might become personally responsible for specific duties. In either case, it is critical that you have an accurate understanding of your respective responsibilities from the outset.

Note that some defined contribution retirement plans allow participants to direct the investment of their own accounts. Under such arrangements, your role will be to execute those instructions in an efficient and timely fashion on behalf of the participants. Contrary to popular belief, however, this feature does not totally relieve you from your fiduciary responsibilities with respect to the investment of the plan's assets.

Plan Trustee Liability In General

A plan trustee can have a considerable amount of authority and legal responsibility if it is an active trustee – one that is primarily responsible for the holding and investment of the plan's assets. Alternatively, a passive plan trustee can have a much more limited role – one that involves holding title to plan assets and following the investment directions of an investment committee, an investment manager, or plan participants. Whether a trustee will serve as an active or passive trustee generally is a matter of plan design. It is very important to review the plan and trust agreement to determine the nature and extent of the trustee's duties and authority.

Apart from handling plan investments, a plan trustee is responsible for keeping detailed trust accounting records with respect to the trust's investment transactions, including the fair market value of plan assets as of the "valuation" date specified under the plan. Certainly, difficulties can arise in valuing plan assets that are not readily tradable. In these instances, it is sometimes desirable to obtain an independent appraisal of such assets.

Limiting Trustee Liability

Before a person consents to serve as the trustee (or one of the trustees), the person should make sure that he fully understands the nature of his appointment and the theoretical extent of his liability. Will he be responsible for investing the plan's assets? Will he be asked to hold title to and to value non-tradable assets?

If a person accepts appointment as a plan trustee, he can limit his fiduciary liability by:

  • Agreeing to serve only as a passive/directed trustee.
  • Having a regulated financial institution (e.g., a bank, trust company, or investment company) serve as the actual custodian of the plan assets.
  • Making sure that he will have access to proper and adequate legal advice (if warranted).
  • Properly documenting in writing all of his significant decisions as trustee and basis for each such decision.
  • Obtaining fiduciary liability insurance coverage.

FAQ 4:  What Is the TPA's Role?

If you are the third party administrator (TPA), your role is to:

  • Advise the employer and the plan administrator regarding the administration of the plan in general.
  • Assist the plan administrator in keeping track of the participants' eligibility for benefits under the plan.
  • Assist the plan administrator and the employer in determining the appropriate funding for the plan.
  • Assist the plan administrator in handling benefit claims and the payment of benefits.
  • Assist the employer and the plan administrator with reporting and compliance.

Because most employers and plan administrators are not familiar with the rules and regulations that govern employee benefit plans or do not have the human resources to handle all of the administrative requirements of such plans internally, you are hired to assist the employer, the plan administrator, and the trustee(s). You help them to determine who meets the plan's eligibility requirements, the amount of the contributions, and the extent of the participants' benefits. You also assist them in keeping their employee benefit plans in compliance with the numerous employee benefit plan laws. This function is extremely important because a plan that does not comply with such laws can result in adverse tax consequences to the employer and the participants and subject the plan's fiduciaries to personal liability. You should have a written service agreement with each employer or plan administrator that hires you in order to avoid misunderstandings as to your role and their responsibilities.

Although you can provide important assistance to the employer and the plan administrator as the plan's TPA, all responsibility ultimately falls on the employer and the plan administrator to make sure that the plan is properly maintained. Therefore, you may give advice, but the employer and plan administrator must make the final decisions and oversee the operation of the plan.

Third Party Administrator (TPA) Liability In General

Whether a TPA will be exposed to fiduciary liability under ERISA depends on how it establishes and maintains its service relationship with the plan sponsor or plan administrator. The TPA is in business to render aid to plan administrators but not to do the plan administrator's job. A plan administrator may employ a TPA to give it options and advice, to help it keep abreast of the changes in the law that do or may affect the plan, its operation and its participants, to perform the ministerial tasks, such as number crunching, and to do whatever other recordkeeping tasks that the parties agree upon. Note that the TPA is working at the plan administrator's direction just as any other agent would. The TPA gives advice, but the plan administrator makes the decisions. The TPA prepares reports based on information from the plan administrator (and from the trustee), the plan administrator distributes and signs those reports as the party responsible for their accuracy. The TPA should not be able to make discretionary decisions about the plan's operation and should not have any control over the plan or its assets. In most cases, the TPA is not a plan fiduciary.

If, however, a TPA exercises discretion and control over the plan, or some part of it, then, to that extent, the TPA may become a plan fiduciary. The courts often examine the issues of differing fact patterns to determine who is and who is not a plan fiduciary and although they seem to be becoming more and more liberal in their interpretations of facts the underlying rule remains the same. Discretion and control over the plan, its operation and its terms are the key. If you are a TPA, make sure that the plan administrator you are assisting takes its position seriously.

Limiting TPA Liability

The best way for a TPA to control and limit its ERISA liability is to educate the plan sponsor, the trustee and the plan administrator about their roles regarding the operation and administration of the plan and to make sure it does not make discretionary decisions with respect to the plan. In order to keep the respective roles and duties straight, we strongly recommend that the TPA use a written service agreement that clearly spells out its role, its services, and most importantly, those responsibilities that do not belong to it but rather to the other parties.

FAQ 5:  What Is the Benefits Consultant's Role?

If you are the benefits consultant, your role is to:

  • Provide advice concerning the design and operation of a plan.
  • Assist with the preparation and review of plan documents.

You may be totally independent of the plan's TPA or an experienced member of the TPA's staff. You usually provide assistance to the employer with respect to plan design issues. For example, if the employer wants to implement an insured medical plan, you may recommend the best plan design and the insurance company with the most appropriate policy features and rates. You also assist the plan administrator with making sure that the plan administrator understands its responsibilities with regard to the overall operation and compliance of the plan. Occasionally, you will help to represent the plan in connection with any audits or investigations by the Internal Revenue Service or Department of Labor.

Benefits Consultant Liability In General

Much like the situation of a TPA, whether a benefits consultant will be exposed to fiduciary liability under ERISA depends on how it establishes and maintains its service relationship with the plan sponsor or plan administrator. The benefits consultant is in business to advise plan sponsors and plan administrators but not to do their jobs. A plan administrator may employ a benefits consultant to give it options and advice or to help it keep abreast of the changes in the law. The sponsor may employ the benefits consultant to assist it with plan design issues. In most cases, the benefits consultant is not a plan fiduciary.

If, however, a benefits consultant exercises discretion and control over the plan, or some part of it, then, to that extent, the benefits consultant may become a plan fiduciary. The courts often examine the issues of differing fact patterns to determine who is and who is not a plan fiduciary and although they seem to be becoming more and more liberal in their interpretations of facts the underlying rule remains the same. Discretion and control over the plan, its operation and its terms are the keys.

Limiting Benefits Consultant Liability

The best way for a benefits consultant to control and limit its ERISA liability is to educate the plan sponsor, the trustee and the plan administrator about their roles regarding the operation and administration of the plan and to make sure it does not make discretionary decisions with respect to the plan. In order to keep the respective roles and duties straight, we strongly recommend that the benefits consultant use a written service agreement that clearly spells out its role, its services, and most importantly, those responsibilities that do not belong to it but rather to the other parties.

FAQ 6:  What Is the Actuary's Role?

If you are the actuary, your role is to:

  • Calculate contribution levels for defined benefit pension plans and certain employee welfare benefit plans (e.g., a self-insured medical plan funded through a trust).
  • Provide any required certifications or reports to the IRS or the PBGC with respect to the plan's funding status and funding methods.
  • Assist the plan administrator with the determination of an individual participant's accrued benefit under a defined benefit pension plan.

Your services will be needed if a company plans to institute a defined benefit pension plan, certain types of cross-tested defined contribution retirement plans, or certain self-insured employee welfare benefit plans. You are trained in mathematics and statistics. You review the funding status of the plan and determine the contributions that should be paid to a plan in order to fund the promised benefits as they become payable. You generally are responsible for filing an actuarial certification (Schedule B) as part of a defined benefit pension plan's annual return/report (Form 5500).

Actuary Liability In General
Much like the situation of an attorney or an accountant, an actuary is in business to provide specific plan related services (in this case, actuarial) to plan sponsors and plan administrators. In most cases, the actuary is not a plan fiduciary.

In rare cases, an actuary that exercises discretion and control over the plan, or some part of it, may become a plan fiduciary. The courts often examine the issues of differing fact patterns to determine who is and who is not a plan fiduciary and although they seem to be becoming more and more liberal in their interpretations of facts the underlying rule remains the same. Discretion and control over the plan, its operation and its terms are the keys.

Limiting Actuary Liability
The best way for an actuary to control and limit its ERISA liability is to educate the plan sponsor, the trustee and the plan administrator about their roles regarding the operation and administration of the plan and to make sure it does not make discretionary decisions with respect to the plan. In order to keep the respective roles and duties straight, we strongly recommend that the actuary use a written service agreement that clearly spells out its role, its services, and most importantly, those responsibilities that do not belong to it but rather to the other parties.

FAQ 7:  What Is the Attorney's Role?

If you are the attorney, your role is to:

  • Provide legal advice concerning the design of the plan.
  • Assist with the preparation and review of the plan documents and any amendments to the plan.
  • Provide legal advice concerning the operation of the plan (including assisting the employer or the plan administrator with the correction of any defects) and cautioning the plan's fiduciaries against prohibited transactions.
  • Assist the employer and the plan administrator with government audits and investigations.

As the employer's employee benefits attorney, you are expected to provide expert advice on the overall strategy and development of the plan itself, plus answer any questions surrounding the roles and responsibilities of all parties involved. You are expected to review plan and trust documents, participant communications, the overall operation of the plan and, most crucially, any audits or investigations by the Internal Revenue Service or the Department of Labor.

Many of the laws applicable to retirement plans are extremely complex. A violation can result in fines, otherwise avoidable excise taxes, and even the disqualification of the entire plan to the detriment of the employer and the participants. More and more frequently, you may be asked to work with the plan administrator and the TPA to determine if a plan compliance issue has occurred and the best way to correct any identified problems.

Attorney Liability In General

Much like the situation of an actuary or an accountant, an attorney is in business to provide specific plan related services (in this case, legal) to plan sponsors and plan administrators. In most cases, the attorney is not a plan fiduciary.

In rare cases, an attorney that exercises discretion and control over the plan, or some part of it, may become a plan fiduciary. The courts often examine the issues of differing fact patterns to determine who is and who is not a plan fiduciary and although they seem to be becoming more and more liberal in their interpretations of facts the underlying rule remains the same. Discretion and control over the plan, its operation and its terms are the keys.

Limiting Attorney Liability

The best way for an attorney to control and limit its ERISA liability is to educate the plan sponsor, the trustee and the plan administrator about their roles regarding the operation and administration of the plan and to make sure it does not make discretionary decisions with respect to the plan. In order to keep the respective roles and duties straight, we strongly recommend that the attorney use a written service agreement that clearly spells out its role, its services, and most importantly, those responsibilities that do not belong to it but rather to the other parties.

FAQ 8:  What Is the Accountant's Role?

If you are the accountant, your role is to:

  • Handle trust accounting if the plan is funded with a trust (unless this task has been assigned to someone else).
  • Prepare and review tax and information returns (unless this task has been assigned to someone else).
  • Verify the trust financial reports through a financial audit if the plan is funded with a trust and an audit is required.

Your principal task is to audit the financial statements that go to the Department of Labor for a large employee benefit plan (generally, at least 100 participant's on the first day of the plan year). In addition, if the plan is funded with a trust, you may be asked to determine whether any of the plan's investments result in unrelated business taxable income (UBTI). If the trust income includes UBTI, the trustees must file income tax returns and pay resulting income taxes. Because you are generally familiar with the financial and tax status of the employer that sponsors the plan, you also may become involved in working with other plan advisors on plan design and income tax deduction issues.

Accountant Liability In General

Much like the situation of an actuary or an attorney, an accountant is in business to provide specific plan related services (in this case, accounting) to plan sponsors and plan administrators. In most cases, the accountant is not a plan fiduciary.

In rare cases, an accountant that exercises discretion and control over the plan, or some part of it, may become a plan fiduciary. The courts often examine the issues of differing fact patterns to determine who is and who is not a plan fiduciary and although they seem to be becoming more and more liberal in their interpretations of facts the underlying rule remains the same. Discretion and control over the plan, its operation and its terms are the keys.

Limiting Accountant Liability

The best way for an accountant to control and limit its ERISA liability is to educate the plan sponsor, the trustee and the plan administrator about their roles regarding the operation and administration of the plan and to make sure it does not make discretionary decisions with respect to the plan. In order to keep the respective roles and duties straight, we strongly recommend that the accountant use a written service agreement that clearly spells out its role, its services, and most importantly, those responsibilities that do not belong to it but rather to the other parties.