Source: PurchasingPower, LLC
IRS Makes Permanent Relief Program for Delinquent Form 5500-EZ
That’s the sigh of relief you may have heard recenly when the IRS announced Revenue Procedure 2015-32.
The Rev. Proc. made permanent a pilot program that ended Tuesday, June 2 that provided administrative relief for delinquent Form 5500-EZ for owner-only plans with over $250,000 in plan assets.
Business owners will be able to avoid substantial penalties for late 5500-EZ filings by following the program and paying $500 for each delinquent return for each plan, up to a maximum of $1,500 per plan.
It was a long time in the making. Here’s the back story.
Since 2002, business owners and their spouses could set up their own 401(k) plans in which they were the only participants to take advantage of increased deduction limits. No matter if the entity in which they were receiving otherwise taxable income was a Sole Proprietorship, Partnership, C-Corporation, S-Corporation, or LLC, the tax benefit were the same as plans in which common law employees participated.
It didn’t take long for practically every major financial service company, e.g., insurance companies, brokerage firms, and mutual funds, to offer a low 401(k) plan that came to be known as Solo-K Plans. It also didn’t take long for many owners to accumulate more than $250,000 in their plans, and that’s the point at which many owners had compliance problems.
Once that $250,000 threshold was passed, owners now had the obligation to file Form 5500-EZ each year. For those of us who work with business owners, we were never surprised that some new clients had never filed Form 5500-EZs – ever!
Until recently delinquent Form 5500-EZs were not eligible for the Department of Labor’s Delinquent Filer Voluntary Compliance (DFVC) program which caps penalties at $750 for one delinquent Form 5500 and $1,500 for more than one year, however many years are involved. The penalty for non-compliance could be large which plans with at least one non-owner can avoid.
How large?
- IRS penalties: $25 per day up to a maximum of $15,000.
- DOL penalties: Up to $1,100 per day (no maximum). For willful violations, individuals face up to a $100,000 fine and/or imprisonment up to 10 years.
So there was huge sigh of relief from those of us in the retirement business on May 9, 2014 when the IRS published Revenue Procedure 2014-32. The Rev. Proc. established a temporary one-year Pilot Program providing administrative relief from the imposition of penalties for failure to timely file Form 5500-EZ and similar filers. The termination date of which was June 2, 2015.
Our collective anxiety about “would they or won’t they” make the program permanent was eliminated when the IRS announced Revenue Procedure 2015-32. The new Rev Proc makes the pilot program permanent. You can get all the details here.
How the re-proposed Fiduciary Rule came to be
As everyone in the ERISA world knows, the Department of Labor (DOL) on April 20, 2015 published a proposed regulation in the Federal Register relating to the definition of fiduciary within the meaning of ERISA section 3(21)(A)(ii). ERISA section 3(21)(A)(ii) is that part of the definition of fiduciary that addresses investment advice for a fee or other compensation.
If you’re not part of our ERISA world, my guess is that you would have probably heard about it or read about in terms other than the above-referenced legal title. Most likely, you’ve probably heard it called the “Fiduciary Rule”, the “Fiduciary Standard”, “Conflict of Interest Rule”, or some other name depending on one’s point of view or financial interest.It’s become the most controversial ERISA regulation in recent memory.
But I’m not here to express a point of view – political, economic, or otherwise. Rather, this article is my attempt to put it all into context by providing a timeline of how it got to where it is today. Context, after all, can help planning.
The Common Law of Trusts: The Beginning
ERISA, or course, codified a fiduciary relationship with respect to employee benefit plans that provide retirement income or welfare benefits. The core principles of which are derived from the common law of trusts, the law of trusts that developed over time from the ruling of judges rather than by statutes enacted by legislatures.
Much of the common law of trusts originated in England, but an 1830 case decided by the Supreme Court of Massachusetts, Harvard College v. Amory, was an important decision relating to the meaning of prudence. It’s believed that this case was the first time the “Prudent Man Rule” was articulated.
Prohibited Transaction Exemption (PTE) 75-1
ERISA and the Internal Revenue Code (the “Code”) didn’t incorporate all of the core principles of the common law of trusts and added two key components.
First, the ERISA prudence standard is a prudent expert standard. (Memo to plan sponsors who want to self-manage plan assets, but do not have in-house expertise).
Second, Congress recognized that modifications had to be made because of the unique nature of employee benefit plans. One of those modifications was to prohibit a broad group of activities and transactions between an employee benefit plan and a “party in interest “under ERISA and a “disqualified person” under the Code. The violation of which could result in an excise tax.
Because of the broad scope of prohibited transactions, investment providers would effectively be unable to perform their duties unless there were statutory and Department of Labor exemptions. The DOL did exactly that in PTE 75-1 which provided an exemption to employee benefit plans and broker-dealers and banks from certain of the prohibited transactions of ERISA and excise taxes.
December, 2006 Government Accounting Office Fee Report
But PTE 75-1 was, of course, before Congress added Section 401(k) to the law as part of the Revenue Act of 1978 followed by IRS regulations in 1981. By the end of 2005, the Investment Company Institute reported that 401(k) plans had more active participants and about as many assets as all other private pension plans combined. The numbers were significant:
- 47 million people participating
- in 417,000 plans
- with approximately $2.5 trillion in assets.
No surprise then that fees, disclosures and conflict of interest became part of the public consciousness. In December, 2006, Government Accounting Office (GAO) issued its report, Changes Needed To Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees.
The GAO Report was commissioned by Rep. George Miller, D-Cal. The Congressman announced that the House Education and the Workforce Committee that he was in line to chair under the new Democratic-controlled Congress should hold hearings in 2007 to examine the “fee issue”. I described it back then as a shot fired across the 401(k) industry bow.
Indeed, in March 2007, 401(k) fees officially became part of the political debate Congressman Miller held hearings with comments falling across party lines. The Democrats using verbiage such as “hidden fees erode retirement savings”, and the Republicans saying more information is confusing.
Proposed Amendment of PTE 75-1 in 2010
Then three years later, the DOL proposed a change to the definition of fiduciary that would have expanded the scope of those who become fiduciaries. Significant objections were voiced by numerous industry groups and by Members of Congress from both parties. The DOL withdrew its initial proposal and stated it would conduct further economic analysis.
In February 2015, President Obama announced that the DOL should move forward with its proposed rule making. But before we fast forward those five years, two events in 2013 put 401(k) plans right back into the public consciousness.
2013: The Year of the Headline
The first event was the PBS Frontline documentary, The Retirement Gamble, aired on April 25, 2013 by investigative reporter, Martin Smith. The documentary created a firestorm of comment on the state of retirement and was highly critical of the financial services industry.
Later that year in November 2013, Forbes added a seasonal touch in an article saying
PBS ran it again in late October–just in time for Halloween. It revealed a scary picture on the state of retirement and all its shortfalls including the big costs that come with a 401(k). It’s hard to watch this program without a sense of horror at the way our retirement plan system is rigged to rip off Americans struggling to save for retirement.
There were, of course, less emotional and more reasoned responses. One of which was fee-based financial planner, Roger Wohlner who in his blog post, My Thoughts on PBS Frontline The Retirement Gamble, pointed out where the documentary fell short.
Then in July, Yale law professor Ian Ayres mailed 6,000 letters to plan sponsors warning them they are paying too much for their 401(k) plans and encouraging them to make changes with the threat of exposure in some versions of the letter. The letter included a draft of a white paper written by Ayres and Prof. Quinn Curtis, an associate professor of law at the University of Virginia School of Law, entitled: Measuring Fiduciary and Investor Losses in 401(k) Plans.
While the industry view was that the study was terribly flawed, it once again put 401(k) plans and the financial service industry back into the spotlight.
2015
Now back to the present. In February, 2015, the White House released a Council of Economic Advisors Report, The Effects of Conflicted Advice on Retirement Savings, indicating that the aggregate annual cost of conflicted advice is approximately $17 billion each year
On April 14, 2015, the DOL announced a re-proposal of the rule, which is now followed by a period for public comment. The DOL responded to demands from members of both parties in Congress by extending the original comment period and indicating that a public hearing will begin the week of August 10. It is likely that changes will be made when the Rule is finalized.
Nobody knows for sure how the re-proposed rule will actually affect 401(k) plan sponsors, participants, or the financial service industry. Opinions, of course, are not in short supply. The actual impact will play themselves out over time. But there is one thing about which I am confident. Retirement plan service models will change.
The Fiduciary Hierarchy
The recent Department of Labor’s re-proposed Fiduciary Rule has generated many opinions on how it will affect fiduciary service models. One constant, however, cuts through all of the debate: the Plan Sponsor still has the fiduciary responsibility to select and monitor those service providers.
But as you can see, there is a hierarchy of service models available in the 401(k) marketplace. Each of which offers Plan Sponsors a different level of support with regard to investment selection and monitoring. Here is a brief description of each in the order of lowest to highest fiduciary protection:
1. Due Diligence Support.
Providers offering this service have an evaluation process for the investment options they offer under their retirement programs usually known as due diligence support. The provider offers a wide array of funds, and plan sponsors use the tool to help construct an appropriate line-up for their plan. However, the plan sponsor is still responsible for selecting and monitoring the plan’s investment options.
2. Fiduciary Certificate or Warranty.
Providers offering this service provide a Certificate or Warranty generally available to plan sponsors if they select at least one fund in designated asset classes. There is due diligence support for evaluating their funds combined with last-resort fiduciary liability protection if numerous conditions are met.
3. Directed Trustee
Under this arrangement, an institutional Trustee will usually provide a custodial arrangement, and to take instruction from the Plan Sponsor that are consistent with the plan document and ERISA. Directed Trustees will usually disavow fiduciary status.
Section 3(21) Fiduciary
Some 401(k) programs use the services of an independent Registered Investment Adviser (RIA) who agrees to become an investment advice fiduciary under section 3(21)(A)(ii) of ERISA. Under this service, the RIA recommends and monitors funds for the plan’s fund menu. However, employers are still responsible for selecting and monitoring the specific funds used on the menu.
5. Section 3(38) Fiduciary
Under this arrangement, the Plan Sponsor hires a Fiduciary to manage the investment process of its retirement plan. It must be an RIA, bank, or insurance company who is solely responsible for the selection, monitoring, and replacement of plan investment options.
6. Discretionary Trustee
There a few providers who will act as a Discretionary Trustee under Section 403(a) of ERISA. A Discretionary Trustee goes beyond the investment services offered by a Section 3(38) Trustee by providing services such as a) custody of the assets, b) responsibility for Section 404(c) compliance, c) and c) 408(b)(2) fee disclosures.
Takeaways
Which fiduciary service is best? There is no “best” one. Each Plan Sponsor must decide based on its own situation. individual facts and circumstances. But here are some basics.
First, there must be an agreement between the Plan Sponsor and the service provider.
Second, the service provider must acknowledge its fiduciary status in writing.
Third, the Plan sponsor still has the duty to prudently select and monitor service providers.
As always, make sure to read the fine print, and consider having an ERISA attorney review the service agreement.
Who is responsible for service provider mistakes?
It took nine years in the case of Butler v. United Healthcare of Tennessee to determine who was responsible for a denied group health benefit claim.
The patient, covered by her husband’s ERISA health benefit plan, sought treatment for inpatient rehabilitation for substance abuse. Treatment for which was denied by United. The patient ultimately received the benefits to which she was entitled.
The important takeaway from this case is who is responsible for the improper administration of a welfare benefit plans: the plan sponsor or claims administrator?
Here’s the short version.
Background
After seven years’ worth of internal claims reviews, trips to the Federal district court, remands to the plan for reconsideration, the Federal District Court required United to pay benefits plus interest and $99,000 in statutory penalties for its “arbitrary and capricious” decisions. The statutory penalty was awarded on the basis of United’s failure to play fair under the Department of Labor regulations governing the internal claims appeal process.
On appeal, the U.S. Court of Appeals for the Sixth Circuit, agreed that United had improperly denied the group health claim, but reversed the lower court’s award of statutory penalties. However, the statutory penalty of up to $110 per day applies to Plan Administrators that fail or refuse to respond to participant’s requests for documents and information enumerated in Section 104(b)(4) of ERISA within 30 days.
United’s failure to comply with the claims review requirements under a different statutory provision was determined not to be subject to the statutory penalty for violating ERISA Section 104(b)(4).
The Court’s opinion also concluded that the ERISA statutory penalty could not be assessed against United because it applies only to the “Plan Administrator,” not just any service provider. The Court held that the plan sponsor was the “Plan Administrator” in the absence of any contrary designation in the plan document. Accordingly, United, as the claims administrator, could not be tagged with the statutory penalty.
Comments
This case reflects the real world in that the plan sponsor is almost always the “Plan Administrator” with ultimate responsibility for plan operations. It follows that plan sponsors, as fiduciaries, could be saddled with liability for the conduct of non-fiduciary plan service providers.
But note that the holding in Butler that statutory penalties do not apply to violations of the DOL’s claims review regulations is not universal, and some courts have ruled otherwise. So, it is entirely possible that a case like Butler in another jurisdiction could result in the assessment of statutory penalties against the employer in addition to the judgment against the service provider for payment of the contested benefits plus interest.
Recommendations
A typical service agreement for a “claims administrator” vests ultimate authority over claims decisions with the employer as Plan Administrator. At the same time, most employers hire a TPA or claims administrator so they are not involved in deciding claims.
In an insured welfare plan, claims decisions govern the expenditure of insurance company funds, so the employer’s supposed ultimate authority over claims is probably a fiction. However, employers should not have to spend lots of money in attorneys’ fees to prove that proposition in court. Here are two practical suggestions
- The service agreement with the TPA or claims administrator should indemnify the employer for any mistakes of the service provider.
- Adequate fiduciary insurance coverage should be considered for the employer and employees with administrative or investment responsibilities for the plan. Remember, the ERISA fidelity bond protects the plan, not its fiduciaries, so fiduciaries should never rely on a plan’s fidelity bond.
You can read the entire court decision here.
Image: Canstock Photo
The above material is intended for general information purposes and should not be relied on or construed as professional advice. Under the applicable Illinois Rules of Professional Conduct, the contents of this article may be considered to be attorney advertising. The transmission of this information is not intended to create, and receipt of it does not create a lawyer-client relationship.
What We Can Learn From Australia’s Superannuation
Superannuation is what Australia calls its retirement system, and they are doing something right.
According to the 2014 Melbourne Mercer Global Pension Index (8o-page report if downloaded), an annual study that ranks national retirement systems based on the relative importance of adequacy, sustainability, and integrity, Australia only trails Denmark graded A, and tied with the Netherlands graded B. The United States? Grouped with France, Poland, South Africa, Austria, and Brazil with a grade of C.
The subtitle of the Study, by the way, is “Including Trust and Transparency in Pensions”. Apparently an issue not unique to the U.S.
So what makes the Australian system so different, and according to the Mercer Study, better than ours? We’ll get the details when our friend, Paul Secunda, returns from Australia.
Paul, a professor of law at Marquette and director of the Law School’s labor and employment law program, recently earned a Senior Fulbright Scholar Award. He’ll spend the Fall 2015 semester in Australia as a Senior Fellow at Melbourne University Law School teaching and doing research focused on the country’s national pension program.
No doubt that he’ll bring back valuable ideas on how to improve our retirement system. But in the meantime, here’s my take on the difference between a grade of B and a C. It’s foresight.
In 1992, the Australian government introduced a major reform package addressing Australia’s retirement income policies. The concern was that increased in pension payments due to demographic shifts would place an unaffordable strain on the Australian economy.
Through a tripartite agreement between the government, employers and the trade unions, the country adopted a “three pillars” approach to retirement income consisting of:
- A safety net consisting of a means-tested Government age pension system
- Private savings generated through compulsory contributions to Superannuation
- Voluntary savings through superannuation and other investments
Now can you imagine our government, employers, and the unions all agreeing on a national retirement income policy? That’s not a political question, it’s a hopeful one.
Picture Credit: Physical map of Australia, Lambert equal-area projection courtesy of FreeWorldMaps.net.
Hey! What’s My Number? How To Improve The Odds You Will Retire In Comfort (Book Review)
Let’s say, for example, you’re concerned about not having enough money saved for retirement. You’re certainly not alone based on the myriad number of polls, surveys, and studies that have been in the news. So where do you start?
You might start at Amazon and search under “Retirement Savings”. At this frozen moment in time when I’m writing this blog post, there were 12,618; or if you were a Prime member, you could whittle that number down to 10,576.
(If you’re an Amazon customer, consider signing up for Amazon Smile, though which Amazon will donate a portion of the purchase price to your choice of one of nearly one million charitable organizations).
Allow me to save you time and point you in the right direction. It’s Chris Carosa’s new book, What’s My Number: How to Improve the Odds You Will Retirement in Comfort.
If you’re someone who is in the retirement industry, it’s likely you know who Chris Carosa is. You may be a subscriber to his Fiduciary News or have read one of his many books, one of which I covered on this blog, 401(k) Fiduciary Solutions.
But that one was for us pension people as evidenced by the subtitle:
Expert Guidance for 401(k) Plan Sponsors on How to Effectively and Safely Manage Plan Compliance and Investments by Sharing the Fiduciary Burden with Experienced Professionals
But as you can see from the subtitle of his new book, How To Improve The Odds You Will Retire In Comfort, this one is written for those of you that are concerned about not having enough money to retire and would like expert guidance on the journey to get there. In plain language, Chris provides a 4-step process for that journey with a Retirement Readiness Calculator to check in along the way.
You can make up your own mind by checking out Chris’s book here.
In the meantime, I’m going to take the next step as a grownup beyond Robert Fughum’s best seller, All I Really Need to Know I Learned in Kindergarten.
That’s Chris’, A Pizza The Action: Everything I Ever Learned About Business I Learned by Working in a Pizza Stand at the Erie County Fair.
The Dirty Dozen Tax Scams for 2015: Infographic
Every year around this time, the Internal Revenue Service publishes a list of the year’s “Dirty Dozen Tax Scams”. Here they are as an infographic courtesy of The Accounting School Guide.
Source: AccountingSchoolGuide.com
You can find more detailed information from the testimony of the IRS’ Timothy P. Camus before the Committee on Finance U.S. Senate on Tax Schemes and Scams During the 2015 Filing Season.
Illinois Secure Choice Savings Program?
Illinois legislation, the first in the country, recently authorized a new state sponsored retirement savings vehicle called the Secure Choice Savings Program (Secure Choice). The program is aimed at upwards of 2 million Illinois workers who are not currently covered by an employer provided retirement plan. There are at least 16 other states considering legislative proposals providing similar retirement programs.
The Secure Choice program offers a pooled investment fund for employees who are not covered by employer provided qualified retirement plans. With a promise of low fees and competitive investment results, the program is mandatory for businesses and not-for-profit employers with 25 or more employees age 18 and over that have been in existence for at least two years. Smaller employers can participate but that participation is optional.
The highlights of the Secure Choice program include:
- Covered employees will be auto-enrolled to make contributions by payroll deduction at a default contribution rate of three percent of compensation (employees can adjust this rate or opt out of participation at any time).
- Employer contributions are not permitted (this helps keep the program from imposing the federal compliance burdens on employers).
- Limited investment options will be provided including a default “life cycle” fund for employees who do not make their own investment choices.
- Employee contributions will, like Roth IRA contributions, not be deductible for income tax purposes but investment gains are to be sheltered from tax until distribution.
- Participating employees will have access to their funds at any time but tax advantaged distributions can be made only after the employee attains age 59½.
- Program assets are in a single investment pool managed by the state treasurer and others on a seven person board that includes a majority of elected officials, state employees and government appointees.
- Non-compliant employers can be punished with a fine of $250 per employee per year.
The program is to be rolled out in Illinois by 2017 when the complicated program infrastructure needs to be up and running to enroll all eligible employees. The cost to Illinois of the rollout process has not been estimated but it could be substantial. The program is also subject to regulatory review by the federal government for consistency with federal laws.
From an employer’s perspective, the promise of administrative simplicity could prove to be illusory. There will have to be ongoing employee communications, an enrollment process, a deposit arrangement, and account management functions that will have to accommodate employees who do not have access to internet portals that are customarily provided to manage personal retirement funds.
From an employee’s perspective, how reliable is the pledge of low cost, competitive investments? The program is to be managed, at no cost to the state, by a private administrator for a projected fee of .75 percent of account assets. Is this on top of management fees of the mutual funds that will likely be included as investment choices? Will there be additional charges for the custody of plan assets? Will the plan charge participants for specific services such as plan distributions or the processing of domestic relations orders?
And from the tax payers standpoint, is it really free? Won’t there have to be detailed regulations? And even though the management board is not compensated, what about the costs of the infrastructure set up and rollout? The challenges could be comparable to that of the Affordable Care Act rollout which involved substantial expenses just for outside contractors ($135 million was spent for advertising and PR alone).
It is entirely possible that Governor Rauner’s administration will pull the plug on this program or that it will not make it through the federal regulatory hurdles. Other alternatives might make more sense. The federal “myRA” program is now up and running to provide participant contributions by direct deposit to a cost-free Roth-IRA type savings vehicle. Also pending in Congress is the Secure Annuities for Employees (SAFE) Act that proposes a simplified 401(k) plan for smaller employers. In any event, subject employers have until the 2017 deadline to consider alternatives. Many will find that adopting an IRA-based retirement plan makes more sense.
And keep in mind, this is Illinois, an insolvent state with a history of insider deals and corruption involving the management (and mismanagement) of state pension funds – a state with its own funding liability for state sponsored retirement benefits measured in tens of billions of dollars. So, what could possibly go wrong?
The above material is intended for general information purposes and should not be relied on or construed as professional advice. Under the applicable Illinois Rules of Professional Conduct, the contents of this article may be considered to be attorney advertising. The transmission of this information is not intended to create, and receipt of it does not create a lawyer-client relationship.
401(k) Loans: A “Temporary Band-Aid”?
That’s not my metaphor which is why it’s in quotes. It belongs to Eve Tahmincioglu, the Career Diva, about whom I wrote in 2008. Eve wrote a blog post about the increasing number of 401(k) loans, It’s for retirement stupid…, which very directly expressed her sentiments. Just to reinforce it, her parting words were
People, this is a temporary Band-aid, and it’s going to hurt when you have to rip it off.
That’s pretty much been the opinion since then until recently. J.R. Robinson, writing in the Christian Science Monitor yesterday says Now could be a great time to borrow from your 401(k). He provides a number of advantages why this could be an appropriate personal financial strategy.
Mr. Robinson also cites a November, 2014 article in the Journal of Financial Planning to support his premise. That article, Benefits and Drawbacks of 401(k) Loans in a Low Interest Rate Environment, written by Jarrod Johnston, Ph.D., CFP®; and Ivan Roten Ph.D., CFP® provides a number of scenarios in which 401(k) loans are advisable.
The authors do point out that a major disadvantage is a deemed distribution if the loan is not paid back. The defaulted loan is taxable at ordinary income tax rates. In addition, a 10% early withdrawal penalty applies f the borrower is younger than age 59½.
But just how prevalent is this major disadvantage of loan default, and what is it’s impact on retirement savings? A February, 2014 Pension Research Council Working Paper written by Timothy (Jun) Lu, Olivia S. Mitchell, Stephen P. Utkus, and Jean A. Young provides us the answers. Their study, Borrowing from the Future: 401(k) Plan Loans and Loan Defaults (registration required to download), focused on answering the questions:
- Who borrows from their 401(k) plans?
- Who defaults on an outstanding loan?
- What are the implications of 401(k) borrowing for retirement security?
Here is what their research shows:
- At any one time, 20% of defined contribution participants have an outstanding loan.
- Approximately 40% of all participants borrow against their 401(k) accounts over a 5-year period.
- While 90% of all loans are repaid, 86% of employees who terminate with loans default.
The authors estimate that loan defaults are approximately $6 billion per year which is larger than previous estimates. The data implies, the authors say, that this high rate of defaults could be for reasons of low financial literacy, impatience, or inattention. Many employees, they found, were surprised by an unanticipated job change or its effect on an outstanding loan.
Public policy and plan design considerations aside, the takeaway for me is more immediate: more and better financial education in the workplace.
