Sunday, October 22, 2017

Financial Reporting and Regulatory Update on the Horizon

Posted by OnCourse Staff November 9, 2015 11:41am

Photo Credit: Murali Nath

By James Redding, Senior Manager, Financial Audit

 

Retirement Plan

Taking a look at what pension-related legislative initiatives are winding their way through the halls of Congress, it is apparent that we have a very thin legislative agenda.

The Treasury Department has announced inflation-adjusted figures for retirement account savings for 2016, and there are only a few minor tweaks to income phase-outs for certain IRA contributors and to the adjusted gross income limits.

During 2014, the pension contribution limits stayed the same as in 2013. Last year, we saw small increases in the maximum amounts you could save for 2015, and those increases are carried over for 2016. The increases are driven by the cost-of-living index which did not meet the legal thresholds that trigger increases for 2016. Here are the details:

  • 401(k)s: The annual contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan, is $18,000 for 2016, the same as in 2015.
  • The 401(k) Catch-Up: The catch-up contribution limit for participants age 50 or older in these plans also stays the same at $6,000 for 2016. Participants who turn 50 on or before December 31, 2016, are eligible to make the additional $6,000 catch-up contribution for the year.
  • Defined Benefit Plans: The limitation on the annual benefit of a defined benefit plan remains unchanged at $210,000 for 2016.

On May 13, 2015, Senators Johnny Isakson (R-GA) and Christopher Murphy (D-CT) introduced the Lifetime Income Disclosure.  The bill is similar to legislation introduced in prior congresses, and it would require participant statements to include annuity equivalents. An annuity equivalent is the monthly annuity payment that would be made if an employee’s total account balance were used to buy a life annuity that commenced payments at the plan’s normal retirement age (generally 65). The Department of Labor (“DOL”) would be directed to provide the assumptions that would be used in converting a participant’s balance to a projected lifetime income stream.

In early June, the bipartisan Receiving Electronic Statements to Improve Retiree Earnings (“RETIRE”) Act was introduced. This initiative has long been supported by the retirement industry, and it would allow electronic delivery of participant notices to be the default. Participants would have the ability to opt out and receive hard copy notices and would receive an annual notice of their ability to opt out on paper.

Recent DOL Guidance for Locating Missing Participants

A challenge sometimes faced by plan sponsors is how to locate missing participants. For one reason or another, a plan on occasion may still be holding benefits for someone when contact with the individual is lost.

On August 14, 2014, the DOL issued new guidance on how fiduciaries of terminated defined contribution plans can fulfill their obligations under ERISA to try and locate missing participants/beneficiaries and distribute their account balances. This guidance removes the old requirement of using the IRS and SSA letter-forwarding services, which are no longer in existence, and replaces it with using internet search tools. Otherwise, the guidance is similar, namely – the preferred method of distributing assets is to open an individual retirement plan in the name of the missing participant or beneficiary.

General concept

When terminating a defined contribution plan, all participants become immediately vested in their account balance, and distribution of assets must occur as soon as administratively feasible. As part of the termination process, the plan administrator must notify and obtain direction from all participants (or their beneficiaries) about account balance distribution. However, participants may have moved, passed away, or simply failed to respond to correspondence related to the plan termination. Where a plan administrator is unable to obtain direction about how to distribute assets, plan fiduciaries must decide how to handle distribution of these “missing participant” accounts.

The decision to terminate a plan is a settlor function; however, the decision of how to distribute the terminating plan’s assets is a fiduciary one. Fiduciaries must act prudently and solely for the exclusive benefit of the participant or beneficiary when exercising that decision, or risk potential legal action.

Steps for locating missing participants

Regardless of the size of the account, plan sponsors who cannot locate participants using routine methods, such as first class mail or electronic notification, must take all of the following steps before concluding that an individual cannot be located. These steps, outlined in FAB 2014-01, the new guidance, are generally considered low cost with a high potential for success:

  1. Use certified mail. The DOL previously provided a model notice that can be used for such mailings, but use of that specific language is not required.
  2. Check related plan and employer records. When the retirement plan records are not current, plan sponsors should check with administrators of related plans, such as medical plans, for a more current address of a missing participant. Due to privacy issues, the plan sponsor may need to request that the other administrator forward a letter on its behalf to the missing participant or beneficiary.
  3. Use free electronic search tools. Plan fiduciaries should make reasonable use of Internet search tools that do not charge a fee. Such online services include search engines, public record databases (such as those for licenses, mortgages, and real estate taxes), obituaries, and social media.
  4. If these steps do not work, the fiduciary should determine if additional search steps are appropriate. Additional steps might include the use of commercial locator services, credit reporting agencies, information brokers, investigation databases, and other services that may involve charges. In determining whether these additional steps are appropriate, a fiduciary is allowed to take into account the size of the benefit and the amount of the additional expense. The cost of using these methods can be charged to the participant’s account as long as it is reasonable and consistent with the terms of the plan and ERISA’s general fiduciary rules.

Disposing of missing participants’ account balances

Generally, once a plan sponsor is satisfied that it has taken appropriate steps to find missing participants, and has documented those efforts, it should review the terms of the plan for direction as to how to treat the participant’s account. Plan documents often provide for the funds in question to be moved to the plan’s designated forfeiture account. If participants later make a claim for benefits, the amount should be restored to their accounts and paid out in accordance with their direction.

The DOL makes it clear that applying 100% tax withholding and turning the entire account over to the IRS is not an appropriate method of handling the accounts of missing participants.

FAB 2014-01 describes the DOL’s preferred method of disposing of a missing participant’s account as a rollover to an individual retirement account or annuity (“IRA”). The DOL offers a safe harbor from fiduciary liability if this approach is used. In reality, it may be hard to find an IRA provider willing to establish an account for a person who cannot be located. Other options the DOL offers for consideration if the IRA approach is not viable for whatever reason are to establish an interest-bearing, federally insured bank account for the participant, or to transfer the account to a state’s unclaimed property fund. Due to the adverse tax consequences for the participant, these last two options are not the preferred approaches, and fiduciaries must determine if they are prudent to use.

Federal Appeals Court Strengthens ERISA Fiduciary Duty of Prudence

The U.S. Court of Appeals for the Fourth Circuit recently held that a plan fiduciary will be liable for losses caused by breaches of their ERISA fiduciary duty to act prudently unless they are able to show that a fiduciary in a similar situation “would have” made the same decision. Other federal courts have applied a “could have” standard under which a fiduciary would generally not be held liable if another fiduciary in the same situation could have made the same decision. In its decision to apply a “would have” standard, the Fourth Circuit Appeals Court substantially raised the standard under which fiduciary decisions will be reviewed to determine if the fiduciaries are liable for losses caused by fiduciary breaches under ERISA.

In this case, the participants in the plan brought a breach of ERISA fiduciary duty claim against the plan fiduciaries alleging that the plan fiduciaries failed to act prudently when they decided to sell company stock held by the plan. The company stock was sold near all-time lows but rose substantially higher months after the sale. The plan participants claimed that the plan fiduciaries failed to engage in a prudent process and conduct a thorough investigation before selling the company stock.

The lower court held that although the plan fiduciaries had in fact breached their fiduciary duty to act prudently by not conducting a thorough investigation before selling the stock, the plan fiduciaries were not liable for the loss because the decision was one that a prudent fiduciary “could have” made after performing an investigation. The Appeals Court rejected the lower court’s ruling and held that as the evidence showed that the plan fiduciaries had breached their duty of prudence to the plan, in order to avoid liability for the loss, the fiduciaries must show that a prudent fiduciary in the same situation “would have” made the same decision had they undergone a proper investigation. The case was sent back down to the lower court for a determination of liability based on the “would have” standard.

Considerations for plan sponsors

This case highlights the need for plan fiduciaries to have a strong process in place for investigating and reviewing investment options when making plan decisions. Although this case dealt with decisions related to company stock, the court’s analysis and holding would apply to any fiduciary decision regarding plan investments. Plan sponsors should evaluate their plan investment review and documentation process with their plan advisors to ensure that it is thorough and demonstrates the exercise of procedural prudence.

 

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