Pozek On Pension

The Not-So-Safe-Harbor 401(k) Plan

In a recent presentation, Monika Templeman (IRS Director of Employee Plans Examinations) announced that it has come to the attention of the IRS that a number of safe harbor 401(k) plans may not be in compliance.  As a result, they are planning an audit initiative to investigate the matter.  You may be asking what many have asked me on numerous occasions…“So, what?  Safe harbor plans get a free pass, what compliance issues are there to worry about.”

The reality is that the rules that apply to safe harbor 401(k) plans can be more stringent than those that apply to regular plans.  While safe harbors provide a free pass on the ADP test and sometimes the ACP test and top-heavy requirements, it comes at a price.  Let’s take a quick look.

Mandatory Safe Harbor Contribution

One of the fundamental requirements of a safe harbor plan is that the employer is required to make either a matching or non-elective contribution on behalf of eligible non-highly compensated employees, and the formula must follow what is written in the plan document.  This means no cutting back during slow economic times and no trueing-up matching contributions for HCEs who front load their deferrals when the plan calls for a pay period match.

The safe harbor rules require that contributions be deposited no later than the last day of the year to which the contributions relate, e.g. December 31, 2012, for the 2011 safe harbor contributions.  For safe harbor match plans that calculate the match on a frequency other than annually, the match must be deposited no later than the end of the quarter following the quarter to which the match relates.  Deposits made after these deadlines represent compliance failures that can subject the plan to penalties.

Top Heavy Minimum Contribution

A common misperception is that the safe harbor relief from the top heavy requirements is absolute.  There are some common fact patterns in which a top heavy contribution may still be due.  Consider two quick examples.

1. A top heavy plan provides for immediate eligibility to make deferrals but requires a waiting period for safe harbor eligibility.  Those eligible to defer but not to receive the safe harbor contribution are not covered by the top heavy relief, so the employer must make the 3% top heavy contribution.
2. A top heavy plan includes a profit sharing provision.  Since the top heavy relief is conditioned on the only contributions being deferrals and safe harbor contributions, that relief is lost for the entire plan for any year for which a profit sharing contribution is made.

These issues typically arise with safe harbor match plans when participants who defer less than 3% of pay don’t receive an employer contribution of at least 3%.  However, there can be issues even with higher deferral rates and with safe harbor nonelective plans.  The reason is that plans can use alternative definitions of compensation, e.g. compensation from plan entry, to calculate the safe harbor contribution, but the top heavy contribution is required to be calculated using full-year compensation.

Amendments

When amending safe harbor plans, timing is critical.  A few years ago, the IRS published guidance indicating that it is ok to amend a safe harbor plan mid-year to add a Roth feature or to provide for hardship distributions.  Some interpreted this as being a partial list and believed that other types of changes were also permitted as long as they made the plan more generous.  However, at the 2011 ASPPA Annual Conference IRS Q&A Session, one of the panelists indicated that the guidance on adding Roth and hardships is pretty much an exclusive list, meaning that no other changes are permitted once the year begins.  No accelerating eligibility requirements; no increasing the deferral limit or adding catch-up contributions; no changing your safe harbor match from pay period to annual.

To those who might be tempted to skip the annual compliance review on a safe harbor plan, I will remind you of the adage that an ounce of prevention is worth a pound of cure.  The IRS is coming to a safe harbor plan near you, and fixing any problems on your terms is far preferable to waiting for them to show you that your safe harbor plan isn’t quite as safe as you thought.

Why Ostriches and Retirement Plans Don't Mix a/k/a The Right Way To Sponsor A MEP

I am pleased to bring you a guest post authored by friend, colleague and benefits-attorney-extraordinaire Ilene Ferenczy.  Seems a good follow up to my Mountains and Molehills post.  And, just for the record, I am not the TPA to which she refers.

The Right Way To Sponsor A MEP

by Ilene H. Ferenczy, Esq.

When the idea of doing an Open Multiple Employer Plan (MEP) first became popular, a few of my TPA clients approached me about it.  I thought it was a great idea from their perspective.  It’s a way to improve compliance on the things that normal TPAs leave to their uninformed clients, and also helps create a tighter relationship between the clients’ plans and the TPA than a normal engagement.  My clients asked me to research MEPs to look for any problems of which they were not aware.  At that point, I came across the issue of the DOL’s historic rulings on multiple employer plans (i.e., that many do not constitute a single plan, but a grouping of individual plans), asked a DOL representative about Open MEPs in a meeting between the DOL and ASPPA’s Government Affairs Committee, and the rest is – at least in the small plan community – something like history.

The issue, just to remind everyone, is that a DOL finding that an Open MEP is really a grouping of individual plans means that each employer’s portion of the MEP needs its own Form 5500 and, if it has sufficient participants, a CPA audit.  Assuming that such a finding, if it occurs, happens several years down the road, the preparation and filing of the Forms and audits that are in arrears would be required.  Unless, of course, the DOL makes its ruling and provides that it will be enforced only prospectively, which would be a relatively welcome result that is in no way guaranteed.

When meeting with one of my TPA clients last week, we began discussing Open MEPs again, and he said to me, “So, you still think I shouldn’t get involved with one, right?”

I was shocked.  “No, that’s not what I think!” I protested.

But, then I realized that this is what everyone who knows me in the benefits community thinks.  I have a reputation for being anti-MEP.

The fact is, I’m not anti-MEP.  I’m anti-ostrich.  Ostriches see danger around them and put their heads into the sand and pretend that they are safe.  I don’t want a single one of my TPA clients or one of their plan sponsor clients to get into horrible trouble if the DOL ultimately decides that Open MEPs are not single plans.

The approach being taken by many practitioners is the ostrich approach.  They convince themselves that the DOL will never take the position towards retirement plan MEPs that it takes in regard to health plan MEPs.  These same practitioners also, by the way, ignore the second MEP problem, which is what has become known as the “one bad apple” rule.  This is the acknowledgement that an adopting employer in an Open MEP can take certain actions that will cause a disqualifying failure to occur in the MEP.  The IRS position is, and always has been, that a disqualifying failure in a plan taints the entire plan, not just the portion of the plan that is responsible for the failure.  This applies whether the failure is because of a bad action by an adopting employer or an error by the TPA that is the Open MEP sponsor.  One way or the other, the plan will need to fix the problem under the Employee Plans Compliance Resolution System (EPCRS).  While a contractual provision in the MEP can hold the bad adopting employer responsible, it is possible that this individual may not or cannot accept financial responsibility for fixing the plan.

So, in summary, an Open MEP sponsor who wants to “do things right” needs to acknowledge the two risks it faces:  a DOL holding that an Open MEP is not one plan, plus a plan error that needs correction without a willing and culpable adopting employer to accept the cost of fixing the problem.

This is akin to the risks taken by insurance companies.  Surely a company that insures earthquake damage in California does not bury its head in the sand and plan its premiums based on the idea that an earthquake will never occur or, if it does occur, it won’t damage anything!  What insurance companies do is plan the premiums so that they throw off enough extra to create reserves for the eventuality that something bad may happen.

This is the approach that I encouraged my TPA client who wants to sponsor an Open MEP to take.  Charge adopting employers sufficiently so that you can have reserves to pay for the possible costs that result from the negative risk coming to light. 

It will be possible, if not even common, that administrative errors will take place in your Open MEP.  Some of them will be attributable to a given client, and that client will do what it is contractually obligated to do and pay the costs of correction.  But others will not, and some of the errors may even be attributable to an error by the sponsoring TPA.  You need to have amounts in reserve to pay for the costs of correction and any necessary filing with the government.

It is also possible that the DOL will rule that Open MEPs are a grouping of individual plans and not a single plan.  If that happens, your clients will need to get and pay for individual audits and Forms 5500 in arrears.  You should have enough funds in reserve to pay for the costs of this process – or enough of the costs of this process – that you don’t end up being sued by every adopting employer for misrepresentation and damages.

There may be other ways to plan for possible financial problems.  You could disclaim responsibility in your contract and require an assessment of the adopting employers if something untoward occurs.  However, you then need to deal with the fact that, while you are trying to sell this idea to your clients, you are telling them that it may not fly.

What if none of these problems comes to pass?  You may choose after a positive DOL ruling (if it occurs) or several years of error-free administration to take part of your reserves as profit.  Insurance companies certainly do that when their experience is more favorable than the actuaries originally thought.  Or, you can give your clients a fee holiday to let them share in the good experience of your plan.  It’s up to you.

So, the moral is:  I’m not anti-MEP, I’m anti-ostrich.  A smart business person plans for possible problems in the future, and doesn’t pretend that there is no potential for concern.  Before you put a significant part of your business at risk, plan how to insure yourself against that risk so that you live to fight another day.

Mountains or Molehills?

I have been trying to resist the urge to blog about the “new” phenomenon of Multiple Employer Plans, but temptation got the better of me.

In very broad terms, there are two general types of MEPs – the “common” MEP and the “open” MEP.  The gist of the common MEP is that it covers companies that, though unrelated by ownership or direct business relationship, have some sort of commonalty, e.g. members of a Chamber of Commerce or doctors’ offices in a certain geographic area.  By contrast, an open MEP covers businesses that have no commonality.  Although open MEPs seem to be causing some controversy these days (as Ilene Ferenczy describes in this post), there are important details that must be considered with all MEPs.

Some tout MEPs as bulk purchasing arrangements in which many small employers band together to obtain a level of service they might not otherwise be able to obtain cost-effectively…a kind of Costco for retirement plans.  However, not everything at Costco is cheaper, and you may be forced to buy 5 bottles of aspirin that will expire before you use up the hand-bag sized bottle you went in to purchase. Similarly, some MEP features are available in stand-alone plans with similar price-tags, more flexibility and in more reasonable amounts.

Others promote MEPs as a way for employers to completely absolve themselves of fiduciary responsibility.  An employer joins a MEP along with the pre-determined investment menu, service-providers, etc. but completely escapes any legal responsibility for the prudence of the decision?  In an era when plaintiff’s lawyers and the DOL are seeking to broaden the fiduciary net?  Really?

Some MEPs are designed to give maximum plan design flexibility to adopting employers.  This might seem to make sense, but with more flexibility comes complexity and the increased possibility of mistakes that could lead to penalties.  Similarly, if an adopting employer with a stand-alone plan in which there are unresolved errors merges in to the MEP, those errors come along with the merger.  Although MEPs are usually large plans, they are often comprised of smaller employers who might not have the time or resources to establish the internal controls necessary to prevent oversights.

Some say these are non-issues, since errors can be corrected.  Ok, but who pays the associated expenses?  They can’t be paid from plan assets, so somebody has to write the check.  The lead employer?  The adopting employer that caused the error?  What if the adopting employer refuses to pay?  Is the entire MEP left hanging?  The IRS correction program does allow filing fees to be based on the adopting employer at fault, but it provides that “the plan administrator (rather than any contributing or adopting employer) must request consideration of the plan under VCP.”

Another issue is whether and how a neglectful adopting employer can be kicked out of the MEP.  An employer leaving (or being removed) does not entitle participants to a distribution, so those balances remain in the MEP unless there is a formal spin-off into a stand-alone plan.  If there is a spin-off, the question of fees comes up again.  Who is responsible to write the check?  How does one compel the excommunicated employer to sign the plan documents for the spin-off plan?

As with most types of business partnerships, the best time to address these concerns is at the beginning of the relationship before any actual problems arise.  MEP issues can be easily addressed through carefully drafted plan documents, participation agreements and contracts.  When (not if) mistakes happen, how will they be handled?  What information does the MEP provide to help adopting employers demonstrate they followed a prudent decision-making process?

MEPs that are properly established and maintained by providers with the requisite expertise can be excellent mechanisms to provide cost-effective retirement benefits under the right cirsumstances, but one size does not fit all.  If you are considering involvement with a MEP, make sure those in charge have acknowledged and addressed these issues rather than simply blowing them off as unimportant or unlikely to occur.  Otherwise, what should be MEP molehills may turn into MEP mountains very quickly.