While some may interpret the regulation as a safe harbor limit, in practice, the key words in the regulation are that the monies must be remitted “as soon as they can reasonably be segregated”.  This means that if the funds can be segregated within a shorter period than the outside limit – for example, within a few days of the date of payroll – the funds must be remitted by this shorter time.

If contributions are not remitted in a timely manner, the failure could be held to be a prohibited transaction, a fiduciary breach or both.  There are significant penalties for both of these violations and, if there is a breach of fiduciary duty, then the plan’s fiduciary could be held personally liable.  Prohibited transactions, which can include a delay in the deposit of employee deferrals, continue until corrected by the plan sponsor.

Both the IRS and DOL have self-correction programs which can be followed to correct many qualification and fiduciary violations, including violations associated with the late remittance of retirement contributions.  In order to correct an issue with timely remittance of employee contributions, the voluntary compliance programs generally require that the plan sponsor make the participant whole by depositing the outstanding contributions as well as any lost earnings/interest or restoration of profit applicable during the time the employer held the participants’ funds.

The DOL has an online calculator that can be used to assist with this process.  An employer enters the required information into the calculator, which then performs the interest calculations and provides the plan sponsor with the amount of interest and/or lost profit due based on the greater of the two options. The online calculator uses the Internal Revenue Code (IRC) 6621(a)(2) underpayment rate for calculating interest owed and the IRC 6621(c)(1) underpayment rate for calculating restoration of profits.  The IRC underpayment rate is the sum of the federal short-term rate plus 3 percentage points.  The federal short-term rate changes quarterly, so the interest percentage used under this method will probably change every quarter contributions are delayed.

The IRS has recently indicated that, although full restoration is generally required, reasonable estimates of restoration amounts may be used when it is not feasible to obtain actual investment results.  If it is either (1) possible to precisely calculate the actual investment results but the difference between the estimate and the actual is insignificant and the administrative cost to determine the actual investment results would significant exceed the probable difference; or (2) it is not possible to determine actual investment results, then the DOL’s online calculator rates will be accepted by the IRS as a reasonable interest estimate.

Timely remittance of employee 401(k) funds is a process of which every fiduciary should be aware.  Additionally, fiduciaries and employers who use the 15th business day of the month following pay dates as a safe harbor need to take a close look at how payroll deductions are transmitted to determine reasonable segregation dates for their particular circumstances and take action to deposit the deferrals into plans on a more timely basis.

Where there have been violations, employers should consult with benefits counsel to understand the steps that will need to be taken to analyze which self-correction program is right for their individual situation and to ensure that all necessary steps of the program are taken.  Please contact our office for more information.

Unfortunately, just hoping that your retirement plan operations are working correctly is not enough.  In the ERISA retirement plan world, some of the biggest mistakes made by employers are operational errors rather than errors in the actual structure or documents of the plan.  Because not all operational mistakes are “bad” or harmful to employees, many employers do not feel there is an issue if they make an operational error, provided it is to the benefit of the employee.  However, even errors that result in favor of the employee cause a plan operation issue.

For example, a plan document provides that employees are eligible to participate only after 1 year of service, but the employer generously allows newly hired employees to participate immediately upon employment.  This generosity on the part of the employer, while beneficial rather than harmful to employees, is a failure to follow the terms of the plan and would constitute an operational failure that could create problems for the plan’s qualification if not corrected.

According to the IRS, some of the reasons employers give to explain why their plans are not operationally compliant include:

• Not knowing how to identify and fix any errors.
• Not wanting to have any unnecessary contact with the IRS.
• Assuming that the required annual financial audit identifies any errors that need to be addressed.
• Assuming that auditing the plan for operational compliance would be too expensive.

Employers should routinely self-audit their retirement plans for operational compliance.  This self-audit should be performed at least annually or more often if there are any significant change in demographics or if the employer is involved in a merger or acquisition.  Unfortunately, the annual financial audit performed by your CPA won’t necessarily catch all operational issues that might exist.

If operational mistakes are found, employers need to use the tools available to them to correct the errors quickly and with the minimum of expense.  The IRS recently released the “401(k) Fix-It Guide”, available on the IRS’ website, which provides employers with a list of the most common plan errors and advice on how to fix mistakes for 401(k) plans.

Additionally, one of the best tools available to employers in their quest to correct operational plan errors is the IRS’ Employee Plans Compliance Resolution System (EPCRS).  The EPCRS is a comprehensive system of correction programs offered by the IRS to employers who offer qualified retirement plans.  This program allows employers/plan sponsors to correct plan failures through three separate components:

• The Self-Correction Program (SCP),
• The Voluntary Correction Program (VCP), and
• The Audit Closing Agreement Program (Audit Cap).

The EPCRS was recently updated to assist employers in their voluntary compliance efforts.  The changes are effective as of September 2, 2008 and include:

• Standardized application forms,
• Reduced filing fee for some plan loan failures, and
• Expanded situations where waiver of income and excise taxes are allowed.

Everyone knows that mistakes happen.  Under ERISA, the trick is to identify and correct those mistakes quickly and cost-effectively.  Contrary to popular opinion, the IRS is more interested in ensuring plans are compliant than in “catching” employers doing something wrong.  Benefits counsel can assist your organization in self-auditing your plan to help identify any errors and working with you and any necessary governmental agency to resolve issues.  Please contact our office with any questions or for more information.

Section 415 was originally added to the Code by the Employee Retirement Income Security Act of 1974(ERISA), and the initial regulations were issued in 1981.  In general, Section 415 sets limits on annual contributions allowed to qualified defined contribution (DC) plans and annual benefits provided under qualified defined benefit (DB) plans.  Included in Section 415 is a definition for compensation (§415(c)(3)) that is also used in a number of other instances for qualified plans, such as determining highly compensated employees and nondiscriminatory compensation for testing purposes.  One of the most significant provisions of the Section 415 final regulations involves post-employment compensation or severance pay.

The proposed regulations generally did not allow post-employment compensation to be considered compensation under Section 415 with 2 exceptions: (i) if the payments would have been paid if employment had been continued (such as overtime or commissions); or (ii) if the payments were due to accrued bona fide leave (such as vacation or sick leave) that would have been available if employment had been continued.  These exceptions would only apply if the compensation was paid out no later than 2 ½ months after termination of employment. 

With regard to the post-employment compensation, the final regulations adopted the proposed regulations with one adjustment.  The final regulations extend the time period for severance compensation payout.  Instead of requiring payment within 2 ½ months after termination of employment, payment of post-employment compensation (as allowed by the exceptions) must be made by the later of 2 ½ months after severance or the end of the limitation year that includes the participant’s termination date.

In addition, the final rules addressed areas such as:

• Post-termination payments from non-qualified deferred compensation plans as compensation
• Compensation paid to permanently and totally disabled participants
• Calculation of average compensation under a qualified defined benefit plan
• Combined contribution limits for participants in both a qualified DB plan and a qualified DC plan
• Required modifications due to the PPA

With certain exceptions, the final regulations are applicable to limitation years beginning on or after July 1, 2007.  For most plans, this means that the final regulations took effect as of January 1, 2008.  Generally, plans are required to be amended to comply with the Section 415 final regulations.  The plan amendments must be made by the employer’s deadline for filing its income tax return (including extensions) for tax year 2008 (sometime in 2009).  With 2008 already half gone, employers are encouraged to contact their benefits counsel to have their plans reviewed and amended for Section 415 changes as soon as possible.  For further questions about Section 415 changes, please contact our attorneys.

The well-publicized problems that some companies have experienced with their pension plans gives the impression that DB plans are no longer viable alternatives as employer-sponsored retirement vehicles.  However, that is not necessarily true.  In the right circumstances, DB plans could be the best option for some companies. 

A DB plan is a qualified retirement plan that is structured to provide a predetermined benefit to plan participants, usually defined in the plan as a specific amount or as a percentage of annual compensation.  Employer contributions to a DB plan are determined annually by an actuary and are non-discretionary.  Generally, the limitation on the annual benefit under a DB plan is the lesser of $185,000 in 2008 or 100% of the participant’s average compensation (limited to $230,000 in 2008) for the three highest consecutive years.  In comparison, the annual limitation for defined contribution (DC) plan contributions for 2008 is $46,000.  DB plans offer the opportunity for small business owners to possibly double or triple the maximum DC contribution limit applicable to 401(k) and profit sharing plans.

DB plans are making a resurgence for certain companies.  DB plans can be wonderful retirement vehicles for small business owners looking to maximize retirement savings in a relatively short time period, while minimizing the company’s tax burden.  Companies that have a predictable earning stream over a long period of time, with significant profits in excess of the owner’s salaries, should look at DB plans when considering their retirement planning strategy.  For example, a physician’s office, a law firm, a small CPA firm, or an investment advisor partnership may find a DB plan to be the best option for them.

A word of caution – while DB plans have many advantages, some of which are detailed above, they are not for every company.  DB plans tend to be more administratively expensive and burdensome than other qualified retirement vehicles, and they have less flexibility when it comes to annual contributions.  However, these drawbacks can be more than offset by the increased annual contribution amounts allowed and the accompanying significant tax savings for the right company. 

Employers interested in establishing a DB plan should consult with professional advisors before making any decisions.  Each employer’s situation is unique and should be objectively reviewed to determine what the best course of action is based on the employer’s own circumstances.  Some of the factors that will need to be considered are:  the company’s employee demographics, the company’s short and long-term growth projections, and the company’s historical revenue stream.  These and other factors can significantly impact whether a DB plan is right for a business.

Please contact our office for more information about whether establishing a DB plan is right for your business.

H.R. 6081, among its many provisions, includes changes to the Internal Revenue Code of 1986, as amended, that may impact certain employee benefits plans.  The provisions of H.R. 6081 are effective at differing dates and include provisions that:

• Amend existing rules governing cafeteria plans to allow Health Flexible Spending Accounts to distribute account balances to reservists who are called for active duty for indefinite periods or 180 days or more
• Require qualified retirement plans to provide additional benefits that would have been provided to the participant had he/she resumed employment prior to death to the survivors of plan participants who die during qualified military service
• Allow employers to make contributions to qualified retirement plans on behalf of participants who die or become disabled in combat
• Allow employers to treat the day prior to the day of the participant’s death or disability as the day the participant returned to work from military duty so as to provide the retroactive benefit accruals available under USERRA
• Require qualified plans to treat differential military pay as compensation for plan purposes and as wages subject to withholding
• Provide a tax credit under certain circumstances for small employers that provide differential military pay
• Authorize qualified plans to treat participants on active duty for greater than 30 days as terminated in order to access distribution from a qualified retirement plan
• Make the PPA waiver of the 10% penalty tax for early retirement distributions permanent

As mentioned above, it is expected that President Bush will sign the legislation and it will therefore become law.  Employers should make plans to begin reviewing their plans for areas that need amending to comply with the required provisions.  Additionally, employers should review the non-mandatory provisions to determine whether they wish to amend their plans to allow for these provisions. 

During the plan review, employers need to keep in mind the differing effective and/or application dates of the provisions.  Benefits counsel can assist employers with the review and amendment of plan documents to ensure that plans are updated appropriately.

The following are some of the major laws passed along with a very brief description of a few of the provisions contained within the statute:

• National Defense Authorization Act (NDAA) – amends the Family and Medical Leave Act (FMLA) to create 2 new FMLA leave entitlements and modifies some Department of Defense contracting requirements.
• Pension Protection Act of 2006 (PPA) –  makes several modifications to retirement plans including funding requirements for defined benefit plans, authorizing the use of cash balance and hybrid pension plans and requiring more disclosure to plan participants.
• American Jobs Creation Act of 2004 (AJCA) – provides significant new rules for non-qualified deferred compensation plans, including the enactment of Internal Revenue Code Section 409A.
• Medicare Prescription Drug, Improvement and Modernization Act of 2003 (MMA) – expands the Medicare program including prescription drug coverage for post-65 and disabled Medicare beneficiaries and provides for a Medicare subsidy, which is excludable from income, payable to employers who provide retiree health coverage that is at least actuarially equivalent to the Medicare drug benefit.
• Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) – provides significant changes to retirement plans including increasing the allowable participant elective deferrals, allowing “catch-up” contributions, increasing compensation limits for some pension plans and changing the definition of compensation for deduction purposes.
• Health Insurance Portability and Accountability Act of 1996 (HIPAA) -  limits restrictions that a health plan can place on benefits for preexisting conditions, defines numerous offenses relating to health care and sets civil and criminal penalties for them and establishes regulations for the use and disclosure of Protected Health Information (PHI).
• Older Workers Benefit Protection Act of 1990 (OWBPA) – allows retirement plans to continue to have minimum age for eligibility and to have subsidized early retirement benefits provided it is voluntary.
• Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA) -  requires specified employers to offer continuation of group health plan coverage to beneficiaries who no longer qualify for coverage due to certain events.
• Pregnancy Discrimination Act of 1978 (PDA) – requires employers to cover costs of pregnancy, childbirth and related medical conditions under the same terms as other medical conditions.

The above information is just a small portion of what is required by these laws as applied to benefit plans.  Additionally, there are many more laws that impact employee benefits plans then those few described above.  For example, the PPA, in addition to the brief overview already provided, requires additional extensive compliance for retirement plans and makes some of the other changes under previous laws mandatory.

Benefit plans and operational policies and procedures that have not remained current with new requirements are at risk for being non-compliant and subject to fines and penalties.  All employers should review their ERISA plans, including retirement and heath and welfare plans, as well as their operational policies and procedures, to verify that their plans, policies and procedures have been updated and amended for all applicable changes in the law.

Once plans, policies and procedures are current, employers need to remain vigilant to ensure continued compliance with changing laws.  Employment and benefits counsel can assist employers in reviewing and updating their existing plans to ensure compliance with all applicable laws, as well as assisting employers to proactively update their policies, plans and procedures as required for future changes.

Defined Contribution (DC) Plans

A DC plan is a type of pension plan where there is an individual account for each participant and for benefits are based solely upon the amount contributed to the participant’s account and their earnings. The annual contribution is defined in the plan document, and the contribution is subject to minimum and maximum allocation rules.

The actual benefit a participant receives from a DC plan upon retirement depends solely on the accumulation of annual contributions and fund earnings. Provided that the sponsoring employer prudently invests the plan assets in the best interests of the plan participants, the employer is not liable for investment losses. In these plans the investment risk is borne by the participants.

There are four categories of DC plans that are allowed. These are profit sharing plans, money purchase plans, stock bonus plans, and target benefit plans. Examples of these plans include 401(K) plans, Savings Incentive Match Plan for Employees (SIMPLE) plans, and Employee Stock Ownership Plans (ESOPs).

Defined Benefit (DB) Plans

A DB plan is defined as “any pension plan other than” a DC plan. These plans are the traditional “pension plans”, where an employer pays their retirees a set monthly benefit until the retiree’s death. In a DB plan, the plan document specifies the benefit due to a participant at retirement.

These plans are subject to minimum funding requirements and must provide a qualified joint and survivor annuity option. The accrued benefit amount is guaranteed to the participant, regardless of any investment fluctuations; therefore, the employer bears the fund’s investment risk, not the participant.

There are generally three types of DB plans, based on the method of calculating the accrued benefit. These are a flat benefit plan, a fixed benefit plan and a unit benefit plan.

Requirements for Plan Qualification

In order to become a “qualified” plan under the Code, all plans must meet certain requirements. Although the substantive requirements under the Code can vary depending on what type of plan is at issue, the fundamental and formal requirements of qualification apply to all “qualified” plans.

The fundamental requirements include that the plan must:

• Be provided for the exclusive benefit of the participants and/or beneficiaries;
• Be established with the intent to be permanent; and
• Prohibit the use of plan assets for anything other than providing plan benefits or paying administrative and investment expenses.

The formal requirements for plan qualification are that the plan:

• must be in effect by the end of the employer’s taxable year in which the deduction is claimed;
• must be documented as a formal, written plan; and
• must be communicated to employees.

Additionally, all qualified plans must follow certain basic requirements, including minimum coverage requirements, non-discrimination requirements, minimum vesting requirements, limitations on benefits and contributions, and distribution requirements.

Qualified retirement plans can be complex and the rules that govern them are very specific. Additionally, the laws relating to these plans can change. One of the most recent laws that affect retirement plans is the Pension Protection Act of 2006 (PPA). Employers should periodically review or have their benefits attorney review their plans to ensure compliance with changing laws. Additionally, when contemplating establishing a plan, employers should work with their benefits attorney to discuss options and find a plan that will work best for them.

1. Failure to amend plans for tax law changes within the time required by law
2. Failure to determine contributions using the plan’s definition of compensation
3. Failure to either include eligible employees in the plan or exclude ineligible employees from the plan
4. Failure to satisfy plan loan provisions
5. Allowing impermissible in-service withdrawals
6. Failure to satisfy the minimum distribution rules
7. Adoption of a plan which the employer is not legally permitted to adopt
8. Failure to pass the ADP/ACP nondiscrimination tests
9. Failure to properly provide the minimum top-heavy benefit/contribution to non-key employees
10. Failure to adhere to the contribution limits of IRC 415

Employers should have their plan documents and their plan operations regularly reviewed and analyzed to ensure ongoing compliance and avoid possible future problems.  Problems with plans are easier - and less expensive - to correct when they are caught early.  However, without regular review, catching little problems before they grow into big problems is much more difficult, if not almost impossible.

As an added benefit, an independent outside review of the plan and its operations may not only identify existing problems, but may also assist in spotting opportunities for changes to the plan that will improve benefits for participants or decrease the costs of plan administration.

Errors in retirement plan design or operations almost never get resolved on their own. They usually persist year after year until they’re found and fixed, possibly compounding the original problem with each year that passes.  The IRS has several programs in place that allow employers to correct problems that they self-identify before an examination becomes necessary.  Employers should consult with their benefits counsel to arrange for an independent review of their retirement plans for compliance with recent legal changes and to ensure the plan is operating in accordance with its governing documents.  If an error is found, your benefits counsel can also assist you in working with the IRS to correct the plan before an examination becomes necessary.

In general, an individual becomes a fiduciary either by title or by action.  Under ERISA, plans are usually required to name a specific person, organization or association who will act as fiduciary.  Additionally, ERISA contains a definition of a fiduciary that can create the duties by action:  a fiduciary is a person or entity which takes any of the following actions with regard to a retirement plan -

• Exercises control or influence over the management of the plan or it’s assets
• Provides investment advice on plan assets for compensation
• Has discretionary authority over the plan’s administration

Because of this broad definition, plan sponsors are almost always considered fiduciaries of their retirement plans, even if they have assigned other fiduciaries to manage the plan.

Fiduciaries are required to act with prudence and in the best interests of the plan and its participants and beneficiaries.  Under ERISA, if a fiduciary relies on the outside service providers/organizations in performing his/her duties, the original fiduciary must establish guidelines with which to monitor and ensure that the service provider/organization is acting within the requirements of a fiduciary – that is, prudently and in the best interests of the plan and its participants and beneficiaries.  Additionally, ERISA specifically addresses prohibited transactions that constitute a breach of fiduciary duty.  A plan fiduciary breaches his/her fiduciary duties by engaging in or allowing certain transactions between the plan and a “party-in-interest”, including lending of money, furnishing goods and services, and the using of plan assets for personal benefit. 

All fiduciaries to retirement plans (including plan sponsors) must take their fiduciary responsibilities very seriously.  It is a fiduciary’s duty to fully understand their duties to the plan, as well as the duties owed by all other plan fiduciaries.  A few areas that plan sponsors commonly neglect, which can leave a plan sponsor exposed to fiduciary risk are:

• Ensuring that actual plan operations are in compliance with all governing plan documents and established procedures
• Appointing a policy committee/individual to be responsible for the oversight of the retirement plan’s policies without providing the advice or training on the required duties and responsibilities of a fiduciary
• Appointing an investment committee/individual to be responsible for the oversight of the retirement plan’s investment strategy without providing the advise and training on the required duties and responsibilities of a fiduciary

Employers who sponsor retirement plans are usually considered to be plan fiduciaries under ERISA, and are therefore exposed to the possibility of suits by plan participants for a breach of that fiduciary duty.  Employers should consult with an employee benefits attorney to either develop policies and procedures for their sponsored retirement plan, or review and amend the existing processes.  This advice and assistance can be invaluable in limiting a plan fiduciaries’ exposure to risk.