"Fog lights" now available for terminating 403(b) plans

In November, 2008, we published a series of blog posts called, 403(b) Crunch Time Series. The purpose of which was to help 403(b) plan sponsors get ready for the January 1, 2009 deadline for new IRS 403(b) regulations.

It was the first time in over 40 years that the IRS provided comprehensive guidance for 403(b) plans who now had to deal with such issues as:

  • Requirement for a plan document
  • Rigorous application of the non-discrimination rules
  • Employer responsibility for complying with contribution limits
  • Timing of contributions.
  • Transfers to other 403(b) contracts
  • Employer responsibility for coordinating and tracking loans
  • Plan termination

Most recently the IRS addressed the last issue, plan termination, in recently released Revenue Ruling 2011-7

Attorney Bob Toth who joined me in the afore-mentioned 403(b) Crunch Time Series and now has his own blog, The Business of Benefits, discusses what's been clarified and what hasn't in his recent post, 403(b) Terminations Under Revenue Ruling 2011-7: Establishing the Base

Terminating a 403(b) plan is not just one of those technical tax issues. It involves one of those basic retirement tax planning objectives, tax deferral. 

Because if a 403(b) plan hasn't been "terminated", then there is no been no distributable event. And if there has been no distributable event, then any participant who had his account transferred to an IRA or another retirement plan would find himself or herself with a tax liability. Hardly, the desired outcome.

So while Bob Toth and the other 403(b) experts are starting to lift the fog, 403(b) sponsors still should step carefully before "terminating" the plan and distributing the benefits. The law of unintended consequences may apply. 

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Giller and Calhoun launch new blog, the Business of Benefits

We welcome a new blog to the employee benefit blogging community. It's the Business of Benefits, the focus of which is issues facing insurance companies, financial service providers, and plan sponsors.

It's being published by the law firm of Giller & Calhoun. The named partners are Evan Giller in New York City and Monica Dunn Calhoun, Denver. Bob Toth in Ft. Wayne, Indiana has recently joined Evan and Monica as of counsel to the firm. Bob, you may recall, was my co-author in our recent 403(b) Crunch Time Series.

Each of the three attorneys who comprise the firm - what I call a "boutique, virtual law firm" - have over 20 years experience in the "business of benefits." That is, a law practice which combines elements of ERISA, tax law, insurance law, securities law and investment law that affect 403(b) and qualified retirement plans.

I'm looking forward to hearing what they have to say.

Posted In 401(k) Plans , 403(b) Crunch Time Series , 403(b) Plans , Cash Balance Plans , Defined Benefit Pension Plans , Individual Retirement Accounts , Pension Protection Act of 2006 , Public Employee Plans
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403(b) Crunch Time Series signing off (for now)

Last month, my blogging buddy, attorney Bob Toth, and I started the 403(b) Crunch Time Series to help 403(b) plan sponsors get ready for the January 1, 2009 effective date for the IRS final 403(b) regulations. We had intended to have the series run until year end, but only got to #6 before the IRS last Friday issued IRS Notice 2009-3 (see Plop plop, fizz fizz, oh what a 403(b) relief it is: IRS Notice 2009-3).

The clock starts ticking again, but 403(b) plan sponsors aren’t home free. While the plan document requirement has been extended to December 31, 2009, plan sponsors must be mindful that

  1. The 403(b) plan sponsor must have a written plan document retroactive to January 1, 2009;
  2. During 2009, the plan sponsor mus operate the plan in accordance with a reasonable interpretation of Section 403(b), taking into account the final regulations; and
  3. Before the end of 2009, the plan sponsor must make its best efforts to retroactively correct any operational failure during the 2009 calendar year to conform to the terms of the written Section 403(b) plan, with such correction to be based on the general principles of correction set forth in the IRS' Employee Plans Compliance Resolution System (EPCRS).

Here’s Bob’s take on what “relief” really means.

The relief is very welcome, but advisors and employers need to know what it REALLY means. It DOES NOT mean there is a delay in the compliance rules, it merely delays the requirement that a plan document be signed by January 1. When you think about it, the plan document was the most manageable of the new 403(b) risks that the employers were facing. This does not delay the requirement that the employer monitor contribution limits, loans and distributions. It only means that the plan document outlining all of this doesn’t have to be in place until the end of next year. It buys time to do that in a sane way.

Probably the biggest relief is the ability to use a “reasonable interpretation of 403(b) taking into account of the regulations.” I read this as meaning that you have the ability to figure out a reasonable answer to the tough technical questions for which we have few answers, based upon the statute itself-using the regs as a guideline. This will help immensely when trying to figure out what contracts will be “grandfathered” and in determining what a distribution will be when terminating a plan.

All in all, a very helpful act by the IRS which helps provide a way through some of the ambiguity created by the regs and various other pronouncements by the IRS.

 But what happens if 403(b) plan sponsors don’t meet the requirements of the regulations. Then there’s the above-mentioned IRS' Employee Plans Compliance Resolution System (EPCRS) which allows plan sponsors to correct certain errors in employee retirement plans, in some cases without having to notify the IRS. The advantage to correcting retirement plans in this way is, or course, to allows participants to continue receiving tax-favored retirement benefits and protects the retirement benefits of employees and retirees.

There are three levels of correction programs in EPCRS:

  1. The Self-Correction Program (SCP) permits a plan sponsor to correct insignificant operational failures in plans such as qualified plans, 403(b) plans, SEPs or SIMPLE IRA plans without having to notify the IRS and without paying any fee or sanction. In many instances, a plan sponsor may correct significant operational failures without notifying the IRS and without paying a fee or sanction.
  2. The Voluntary Correction Program (VCP) allows a plan sponsor, at any time before an audit, to pay a limited fee and receive the IRS’s approval for a correction of a qualified plan, a 403(b) plan, SEP or SIMPLE IRA plan.
  3. The Audit Closing Agreement Program (Audit CAP) allows a sponsor to correct a failure or an error that has been identified on audit and pay a sanction based on the nature, extent and severity of the failure being corrected.

EPCRS was recently updated and expanded in Revenue Procedure 2008-50. The IRS continues to make it easier to use so that more plan sponsors will make submissions under EPCRS instead of waiting for an IRS audit to discover plan failures. and with no disrespect intended, 403(b) plan sponsors will get to know EPCRS better.

Here's a link to the entire 179 page PDF version of Revenue Procedure 2008-50.

Posted In 403(b) Crunch Time Series , 403(b) Plans
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403(b) Crunch Time Series #6: Timing of Depositing Employee Contributions

This is the sixth in our 403(b) Crunch Time Series, the purpose of which is to help 403(b) plans get ready for the January 1, 2009 compliance deadline for the new Internal Revenue Service regulations. On Monday, Bob Toth , our guest blogger, discussed 403(b) Service Agreements: “Harmonizing” the 403(b) Plan.

Now it’s my turn, and today’s post is about the Timing of Depositing Employee Contributions.

So let’s start with the rules before the final regulations. Hard to imagine in today’s environment, but the employer actually had until the end of the year as permitted by an old 1967 IRS Ruling,  Revenue Ruling 67-69. So to take the extreme example, if the employee had his or her salary reduced in January, the employer did not have to forward the contribution to the 403(b) provider until December.

Now for the first time, non-ERISA 403(b) plans will have to transfer employee money to the 403(b) plan within a strict time frame. In essence, the ERISA timing rules are effectively extended to cover all 403(b) plans. The final regulations require that plan sponsors transmit all contributions to 403(b) plans to the vendor as soon as is administratively feasible. The IRS considers that to be within 15 business days following end of month in which contributions are withheld from pay.

For plans subject to ERISA, there will not be any changes. The Department of Labor which oversees this matter requires that for “large plans” (those with 100 or more participants) employee contributions must be transmitted to the investment provider by the earlier of

  • 15 business days following the month in which the amount was withheld from the employee's pay, or
  • The earliest date on which it is administratively feasible to remit the contributions.

But what about “small plans” (those with less than 100 participants. On February 28, 2008, the Department of Labor (DOL) announced that employee contributions to a "small" retirement plan (one with less that 100 participants) will be deemed to be made in compliance with the law if those amounts are deposited with the plan within 7 business days of receipt or withholding.

The DOL said in its announcement that the department would not accuse a plan sponsor of an ERISA violation while the proposal is being finalized if 401(k) contributions are deposited within the 7-day time limit. Sounds reasonable doesn't it? Well, maybe not according to Bob Toth and his Partner Nick Curabba and in their blog post, A Potentially Dangerous 'Safe Harbor'. They caution that:

As with any safe harbor, of course, the seven-day safe harbor could easily become the expected standard practice. We might even expect future investigations by the Department to focus on whether contributions were forwarded within seven days, rather than attempt to determine when assets were reasonably segregable. In other words, everything outside of the safe harbor could become dangerous waters for plan sponsors.

And what happens if these time frames are not met? That’s a topic for another time.

That’s it for now. The afore-mentioned Bob Toth will be back next  Friday to discuss Church 403(b)(9) Retirement Income Accounts.

Posted In 403(b) Crunch Time Series , 403(b) Plans
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403(b) Crunch Time Series #5: 403(b) Service Agreements: "Harmonizing" the 403(b) Plan

This is the fifth post in our 403(b) Crunch Time Series, the purpose of which is to help 403(b) plans get ready for the January 1, 2009 compliance deadline for the new Internal Revenue Service regulations. I’ve been joined by Bob Toth as a guest blogger. Bob, a Partner in the Baker & Daniels law firm, has over 25 years experience advising 403(b) plans and service providers.

On Wednesday before the Thanksgiving Holiday, I discussed The Change in 403(b) Universal Availability. Now it’s Bob’s turn, and here’s his post on 403(b) Service Agreements: “Harmonizing” the 403(b) Plan.

We are now rushing toward year's end, and all the challenges that it brings in getting some sort of minimal compliance structure in place which will enable 403(b) plan sponsors to meet the demands of the new regulations. The biggest of these challenges seems to be coming from the mundane (though some wags may call it the "inane"!). The regs have created so many new moving pieces that we find ourselves spending an inordinate amount of time organizing the detailed work which is necessary to make it all work.

What is becoming clear is that the most critical operational document (besides, of course, the plan document) is something we have rarely seen in the past: the 403(b) service agreement. It seems to me that it is only through this sort agreement that you can really hope to develop and manage some sort of sane compliance scheme. It is the way to "harmonize", if you will, the often disparate parts and sometimes contradictory parts of your new 403(b) system.

The key to this service agreement is for it to specifically identify which party will be specifically responsible for which specific task (get the sense that specificity is the key?). My approach to plan documents has been the polar opposite, as I attempt to draft with very broad strokes. But with service agreements, the only way to hold anyone accountable for the variety of tasks involved is to make sure all parties involved fully understand the task for which they will be held responsible.

Be careful with these agreements-do not make the mistake of using a standard 401(k) service agreement and merely "change numbers". The compliance work that needs to be done is often spread between a number of different parties, and financial services may often be handled separately.

Be careful also about compliance with security laws, as that is not the responsibility of the employer.

And finally be careful with Information Sharing Agreements (ISA)-often times they are actually service agreements, containing much more than merely information sharing rules. Combining ISAs with service agreements can actually be a very good idea, but vendors will need to make sure they are consistent with other agreements they sign with any employer, and employers need to make sure they understand the nature of the agreement being signed.

That's it for now. On Wednesday, I'll be back with Timing of Depositing Employee Contributions.

Posted In 403(b) Crunch Time Series
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403(b) Crunch Time Series, #4: The Change in 403(b) Universal Availability

This is the fourth in our 403(b) Crunch Time Series, the purpose of which is to help 403(b) plans get ready for the January 1, 2009 compliance deadline for the new Internal Revenue Service regulations. On Monday, Bob Toth , our guest blogger, wrote about Terminating Tax Deferred Annuity Plans.

Now it’s my turn, and today’s post is about the Change in 403(b) Universal Availability.

The rules have changed for those employers who have excluded certain classes of employees from making elective deferrals to their 403(b) plans. Those employers now must check their plans before January 1, 2009 to make sure they are excluding properly.

Technically, the regs changed the Universal Availability rules. These are the rules that an employer must follow to determine which employees can and cannot be excluded from making elective deferrals to a 403(b) plan. Note that employer contributions are still subject to the discrimination rules under Section 401(m) and 401(a)4 of the Internal Revenue Code.

The current IRS interpretation of the Universal Availability rules go all the way back to Notice 89-23, issued by the IRS in 1989. That Notice permitted the following classes of employees to be excluded:

  • Nonresident aliens with no US source income
  • Employees eligible to defer to a 401(k) or 457(b) plan of the same employer
  • Employees who will not make at least a $200 deferral per year
  • Employees who are expected to work less than 20 hours per week
  • Students performing services under a work-study program,
  • Employees whose normal work week is less than 20 hours
  • Employees covered by a collective bargaining agreement
  • Visiting professors
  • Individuals who make a one-time election to participate in a governmental plan
  • Certain employees affiliated with a religious order who take a vow of poverty

The final regulations revoked several of the previous exclusions that were provided in Notice 89-23. The following four groups can no longer be excluded from making salary deferrals:

  • Employees covered by a collective bargaining agreement.
  • Visiting professors
  • Individuals who make a one-time election to participate in a governmental plan
  • Certain employees affiliated with a religious order who take a vow of poverty.

The final regulations also require that all eligible employees be given an “effective opportunity” to participate in the plan. This means that on an annual basis, employers should not only review their new employees to determine compliance with the Universal Availability rules, but are also required to provide to their employees another “effective opportunity” to participate notice.

It’s a little more complicated than that in practice so here are a few suggestions to help meet the new compliance requirements:

  1. Make sure the plan document has the new exclusion rules.
  2. Identify all employees eligible to participate.
  3. Provide employees with a written notice when they are hired and at least once a year about their eligibility to participate.
  4. Conduct employee educational sessions that review the plan provisions and available investment options.

That’s it for now. Bob will be back on Monday with 403(b) Service Agreements: “Harmonizing” the 403(b) Plan. Have a happy and safe Thanksgiving holiday,

Posted In 403(b) Crunch Time Series , 403(b) Plans
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403(b) Crunch Time Series #3, Trouble Terminating Tax Deferred Annuity Plans

This is the third post in our 403(b) Crunch Time Series, the purpose of which is to help 403(b) plans get ready for the January 1, 2009 compliance deadline for the new Internal Revenue Service regulations. I’ve been joined by Bob Toth as a guest blogger. Bob, a Partner in the Baker & Daniels law firm, has over 25 years experience advising 403(b) plans and service providers.

On Friday, I discussed Complying With The 403(b) Contribution Limit. Now it’s Bob’s turn, and here’s his post on Trouble Terminating Tax Deferred Annuity Plans.

Okay, okay, so I thought I would lighten the load some by trying a bit of alliteration with the "traditional" term for 403(b) contracts: the Tax Deferred Annuity (the "TDA"). Whether or not the alliteration works is one thing, but its pretty clear that many terminations may not work well.

The new regulations are causing advisors and employers alike to take pause and to assess whether or not its worthwhile to continue with their current 403(b) arrangements. Many are seriously considering terminating the 403(b) plan and replacing them (where possible) with a 401(k) plan.

Pretty straightforward, you would think, eh? After all, the regs allow for the termination of 403(b) plans, terminations which then become distributable events. The whole deal seems simple enough. The problem, however (as always seems to be the case with 403(b) plans), is in the details.

The rules require that all of the assets of the plan be distributed upon termination in order for the termination to be effective. IRS spokesmen have said that this distribution must occur within a 12 month period following the action terminating the plan. To facilitate this, the regs actually recognize that a terminating distribution can be in the form of a fully paid annuity contract. Sounds simple enough? Just terminate the plan, notify the insurance carrier to either distribute a fully paid annuity contract or to take the employer's name off of its files, and life is good.

Well , the IRS has complicated matters by taking the position that custodial accounts-in spite of statutory language apparently to the contrary- will not be honored as annuity contracts for termination distribution purposes.

Making matters even worse, Bob Architect, the IRS’ Senior Tax Law Specialist and the resident expert on 403(b) plans, has recently stated that even a conversion of group annuity contracts to individual contracts may not even be recognized upon termination as being valid. As Bob Stevenson, a Partner in the Stevenson Keppleman Associates ERISA law firm in Ann Arbor, MI said in a letter to his clients, "it may be that Mr. Architect spoke out of confusion."

All of this confusion has a real, practical effect: If a 403(b) plan has custodial accounts (or the type of annuity contracts to which Mr. Architect refers) within them, and the employer has no right to distribute the assets upon termination, AND some employees refuse to take a distribution of the cash from the contract, then the plan has never been terminated.

If the plan has not been terminated, then there has been no distributable event. If there has been no distributable event, any rollover to an IRA or another plan for those who HAVE taken a distribution will fail. Those attempted rollovers will become taxable because no distributable event has occurred. This sounds pretty draconian, but this is what happens.

So step carefully if you are attempting to terminate a 403(b) plan and distribute the assets. Check with the vendors to see if their contracts allow terminating distribution, and how it will be done. Without that kind of groundwork, you could be making a very expensive mistake for plan participants.

Thanks, Bob. Look for #4 in our 403(b) Crunch Time Series on Wednesday when I’ll be talking about The Change in 403(b) Universal Availability.
 

Posted In 403(b) Crunch Time Series , 403(b) Plans
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403(b) Crunch Time Series #2: Complying With The 403(b) Contribution Limits

This is the second post in our 403(b) Crunch Time Series, the purpose of which is to help 403(b) plans get ready for the January 1, 2009 compliance deadline for the new Internal Revenue Service regulations. On Tuesday, Bob Toth , our guest blogger, wrote about Avoiding Problems with Custodial Accounts.

Now it’s my turn, and today’s post is about complying with the 403(b) contribution limits. So let’s start with some background. One of the concerns that the IRS had in their audits over the last several years was cases in which the contribution limits were exceeded and corrections not being done.

Those contribution limits are governed by Section 402(g) of the Internal Revenue Code and are adjusted annually. For 2009:

  • Elective deferrals are limited to the lesser of $16,500, or 100% of the participant’s includible compensation.
  • Designated Roth contributions count toward the $16,500 402(g) limit.
  • A catch-up contribution of $5,500 is available for participants age 50 and older.

In addition, there is a special life-time catch-up of $3,000 per year, not to exceed $15,000 for an employee of a qualified organization. If a plan participant is eligible for both types of catch-up contribution, then the special catch-up contribution limit is applied first to their accounts.

Sounds simple, doesn’t it, but it won’t be. The new regulations take the approach that the employer is generally responsible for compliance with the 402(g) limits and the correction of any excess that occur. This will be a big departure from the current 403(b) environment in which there is an individual relationship between the employee and the 403(b) investment provider.

Here’s two examples of potential problems for employers.

Monitoring Special Catch-Up Contributions. Pre-regulations, the employer could rely on the employee’s representations regarding his or her eligibility for and the amount of special catch-up contributions. It’s a complicated calculation based on the availability of extensive employee historical data. Many employers, I would think, would avoid this responsibility by not permitting the special catch-up.

Returning Excess Contributions. For those 403(b) plans in which there are individual contracts, the employer has no ability to direct the return of excess contributions. So what if the employee who must have contributions returns, simply doesn’t comply. That is, not notify the investment provider to return the excess funds. The answer, it would seem to me, would be for the employer to inform the provider who would then do the appropriate tax reporting to the IRS.

There are serious issues since the penalty for failure to comply with the contribution limits can be harsh – adverse tax consequences for both the employer and the employee.

The practical solution for those employers who decide not assume responsibility for this plan compliance is to do what 401(k) plan sponsors do - delegate the responsibility to a third party adviser or to the investment provider.

Coming Attractions: Bob will be back on Monday with with #3 in the 403(b) Crunch Time Series, Trouble in Terminating Tax Deferred Annuities.
 

Posted In 403(b) Crunch Time Series , 403(b) Plans
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403(b) Crunch Time Series #1: Avoiding Problems With 403(b) Custodial Accounts

Yesterday, I introduced our forthcoming 403(b) Crunch Time Series. It will be geared towards helping 403(b) plans get ready for the January 1, 2009 compliance deadline for the new Internal Revenue Service regulations.

During this series, I’ll be joined by Bob Toth as a guest blogger. Bob, a Partner in the Baker & Daniels law firm, has over 25 years experience advising 403(b) plans and service providers.

And since it all starts with the new plan document requirement, here’s Bob with his guest post, Avoiding Problems With 403(b) Custodial Accounts.

The 403(b) Custodial Agreement. You know, that piece of paper you use in a 403(b) implementation that no one ever reads or understands, and is just signed because the Tax Code requires it? Heck, they’ve been used for years by the 403(b) vendors, so they’ve got to be pretty standard by now. How can they cause my 403(b) plan ANY problems at all?

Well, they generally still won’t cause you any problems in plans funded individual 403(b) custodial accounts. The problems are arising when folks are trying to set up 403(b) plans on a “401(k)-like” investment platform using a “group” or “master” custodial arrangement. Here, the “forms” are anything but settled.

There are two common errors:

Using a 401(k) Trust Document. The first common error occurs when you try to take a standard 401(k) trust document, change the word “trust” to “custodian,” place some gratuitous 403(b) language in the document, and think you are done.

This is almost right. But you need to make sure that the rules under 403(b)1(B)-(E) are also included in the document and, if the custodial account is also going to hold an annuity contract, have language which defers to that group contract (including the fact that the custodian won’t control the assets in the contract).

It is probably best for the custodial account NOT to hold annuity contracts; though its OK for the employer to hold that group annuity contract outside of the custodial agreement. By the way, collective trusts (often referred to in these 401(k) trusts) can’t serve as the “cash” holding account for the plan unless its “registered” as a “registered investment company.”

Using an Individual Custodial Document as a Group Document. The second common error is the “jury-rigged” use of the individual custodial account form with some modifications to try to make it serve as a group contract. This actually can cause you serious problems. Those custodial contracts DO have the necessary language that you wont find in the 401(k) trust. The problem is that they have too much language.

The individual custodial document was designed to serve the purpose of a plan document/service agreement, so they often have much language you would never otherwise find in a group trust document. There will often be language related to loans, hardships, distributions and the like, so that they almost look like a “quasi” plan document. And that is what causes the problem.

Plans using a group custodial document almost invariably also have a separate plan document-usually from a different vendor than who wrote that custodial document. So you have dramatically increased the probability of inconsistent terms, which can disqualify the document. You no more want your custodian having to monitor plan compliance than you would want your 401(k) trustee having that monitoring duty.

Thanks, Bob. Look for #2 in our 403(b) Crunch Time Series on Thursday when I’ll be talking about Complying With Contribution Limits For 403(b) Plans

Posted In 403(b) Crunch Time Series , 403(b) Plans
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It's crunch time for 403(b) plans

Much has been said and written about the new 403(b) regulations effective January 1, 2009, but most 403(b) plans haven’t even started to get ready for compliance. And so it’s crunch time for 403(b) plans.

Crunch time is nothing new for 401(k) plans who have been dealing with compliance deadlines since the passage of the Employee Retirement Income Security Act of 1974 (ERISA). But it’s a first time challenge for 403(b) plans. The IRS has constructed this challenge by providing comprehensive guidance for 403(b) plans for the first time in over 40 years. 403(b) plans will now have to deal with such issues as:

  • Requirement for a plan document
  • Rigorous application of the non-discrimination rules
  • Employer responsibility for complying with contribution limits
  • Timing of contributions. 
  • Transfers to other 403(b) contracts 
  • Employer responsibility for coordinating and tracking loans
  • Plan termination

So between now and year-end, I’m going to be posting a series of articles on how to get ready for the January 1, 2009 deadline. We’re calling them the 403(b) Crunch Time Series. I’ll be joined by Bob Toth as a guest blogger. Bob, a Partner in the Baker & Daniels law firm, has over 25 years experience advising 403(b) plans and service providers.

And since it all starts with a new plan document, Bob will kick off the series tomorrow with his guest post, Avoiding Problems with 403(b) Custodial Accounts.

Posted In 403(b) Crunch Time Series , 403(b) Plans
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