Pensions & Benefits Law : Canada Pension & Benefits Lawyers & Attorneys : Osler Hoskin & Harcourt Law Firm: Post-Employment Benefits & Defined Benefit Plans : Toronto, New York

In prior posts (June 15, 2010 and December 17, 2009), I pointed out that even though plaintiffs were losing their lawsuits challenging 401(k) plan fees, the legal issues were still far from settled. The Court of Appeals for the Eighth Circuit reinstated claims against the huge WAL-MART 401(k) Plan, challenging the use of retail instead of comparable institutional class mutual funds for the plan, and new law and regulations could be forthcoming.

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The Pension Protection Act of 2006 required faster funding of defined benefit plans, generally funding shortfalls over 7 years. These new requirements began to phase in just as asset values plunged and employers became strapped for cash in the recession. Employer groups have been pressing Congress to provide relief since the new rules became effective.

The Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010 (the Act) was finally signed by President Obama on June 25, with a significant catch that ties funding relief to expenditures for taxable executive compensation over $1 million and payments to shareholders. In general, to use the funding relief, extra pension contributions will be required equal to the amount of these payments.

Canadian companies with U.S. subsidiaries need to know that the Act does not look only at compensation and shareholder payments of the U.S. entities, but also at all affiliated entities – generally, the parent and all subsidiaries, which are at least 80% owned. For example, taxable compensation paid to U.S. citizens outside the U.S. may trigger additional contribution requirements in the Act.

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Some U.S. health care reform rules apply to all plans, but many do not apply to grandfathered plans – that is, plans in existence on March 23, 2010 that have not materially changed benefits. For example, grandfathered plans do not have to provide non-discriminatory insured benefits or eliminate employee co-pays for preventive care, although they are subject to many aspects of the reform.

On June 14, 2010 the three agencies responsible for interpreting health care reform clarified which changes end grandfathered status. The rules permit benefit increases, but take a very strict view about which new costs or benefit limits grandfathered plans are permitted to make.

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Complaints that participants get a lower investment return because they pay excessive and hidden 401(k) retirement plan fees through practices such as revenue sharing have been in the news for years. Plaintiffs have not prevailed in the court challenges decided on the merits so far, although as indicated in an earlier blog post , an appeals court refused to dismiss a challenge against the huge WAL-MART 401(k) plan.

Further, the U.S. Department of Labor proposed regulations – which are not yet finalized – requiring more extensive disclosure of fees by service providers to plan sponsors and also by sponsors to participants. There has also been proposed legislation to establish clear rules for disclosure repeatedly introduced in Congress. One of these bills recently took a major step forward towards enactment, although the provisions were dropped by the Senate.

 

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IRS has announced that it will be sending, at the end of this month, a seemingly innocuous compliance questionnaire to twelve hundred 401(k) plan sponsors who filed 2007 Forms 5500. While the questionnaire seems on its face to be a survey of plan practices, the wrong answers to the questions or simply failing to respond to the questionnaire could result in a real plan audit.

If you are on the receiving end of one of these questionnaires, suppress the urge to toss it or rush through it, and make every effort to answer the questions carefully and accurately. IRS recently announced that it will be auditing some colleges and universities that sent in questionnaires under a prior compliance program, presumably because of their answers. This gives a further indication of where the new program is heading, but these audits won’t happen immediately. 

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U.S. health care reform comes into effect years from now, right? Well, not quite. A number of important provisions will be coming into effect soon, generally on January 1, 2011 for non-union calendar year plans. U.S. plan sponsors need to know about them even if their plans are insured. In fact, in addition to making sure that certain family members are eligible for coverage under the new rules, companies with retiree coverage (particularly retiree drug coverage) need to make decisions now.

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True or false? If you adopted a 401(k) plan offered by a U.S. prototype vendor, you can leave compliance entirely up to the vendor. You may be surprised to know that the answer is “false”.

An easy way to quickly adopt a U.S. tax-qualified savings plan, “prototype 401(k) plans” are marketed by mutual fund families, financial institutions and insurers and have become a popular way for U.S. employers to adopt 401(k) plans without being responsible for satisfying complicated and changing legal requirements. Or so the employers who adopted these plans assumed based on marketing material from the vendors.

However, there is no such thing as a tax-qualified retirement or savings plan that runs itself correctly without employer involvement. Even if the vendor promises to create required reports and filings for the plan, you are still responsible for compliance with some plan documentation requirements and for correct plan operations.

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Many compensation and pension actions require the approval of a company’s board of directors, or a committee of the board, and for good reason. Employers should not skimp on the finalization of corporate approval via signed and dated board or committee resolutions.

U.S. Case in Point: A federal judge in New York recently denied enhanced retirement benefits to the CFO that would have been due to him under the terms of an amended SERP because the board resolutions from seven years before his retirement seem to have never been finalized. The court ruled against the executive seeking benefits, despite the undisputed facts that the board had agreed “in concept” to the SERP enhancements and that two other executives had been paid out under the amended plan terms. The reason? Under the terms of the SERP, only the Board could amend the plan and the Board never formally approved the amendments.

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Does your U.S. group health plan have separate deductibles for medical benefits and mental health benefits? Even if they are the same dollar amount, new regulations provide that these plan provisions will violate federal benefit parity requirements.

Sponsors of U.S. group health plans who have been preoccupied with COBRA premium subsidies and new state COBRA requirements may have missed the October 3, 2009 effective date of new mental health and substance abuse benefit rules. (They apply as of January 1, 2010 for non-union calendar year plans.)

While U.S. law does not require employers to provide mental health or substance abuse benefits to their employees, employers who include these benefits in their U.S. medical plans are subject to a host of new requirements under the Paul Wellstone and Pete Domenici Mental Health Parity and Addiction Equity Act of 2008  (PDF) (the Act). The Act expanded parity requirements of 1996 legislation, which required that annual and lifetime limits for mental health benefits could not be more restrictive than the limits that applied for medical and surgical benefits, to also require parity in financial restrictions such as deductibles, co-pays, out-of-pocket maximums and treatment caps, such as visit limits, and to include substance abuse benefits.

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Whenever the U.S. Pension Benefit Guaranty Corporation, the ultimate insurer of participant benefits under U.S. pension plans, re-evaluates the vast scope of its risk exposure, you can be sure that private employers will be subject to increased responsibilities and monitoring. This time, the increased obligation is a proposed new reporting requirement that may turn out to have an impact on every-day, run of the mill business transactions even for employers with well-funded pensions.

Under current rules, plan sponsors are required to notify the PBGC within 30 days of events that are deemed to increase the PBGC’s risk of having to take over an underfunded defined benefit plan. Every transaction that results in a change in the composition of the sponsor’s worldwide controlled group of businesses and every transaction in which defined benefit plan assets are transferred from one controlled group to another involves a potential reportable event, unless a waiver applies, but there are many existing waivers and extensions.

The PBGC proposed towards the end of 2009 to eliminate most waivers and extensions for reportable event filings under Section 4043 of the Employee Retirement Income Security Act of 1974 (ERISA). Under the new proposal (PDF), waivers would be eliminated even for sponsors of well-funded plans that would not increase the PBGC’s risk and for transactions involving foreign entities.

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Employers trying to comply with one of the most complex U.S. tax code sections can breathe a little easier this week. The IRS has issued relief for certain inadvertent plan language failures under Section 409A of the U.S. tax code that would otherwise trap employers who improperly drafted deferred compensation plans.

IRS Notice 2010-6, issued January 5, 2010, is long-awaited welcome news for employers who encounter minor documentation errors. It even provides a small amount of relief for plans not meeting even basic rules under Section 409A (e.g., that don’t require payment only upon permissible payment events) by limiting penalties that result from documents with certain impermissible plans terms after corrections are made.

The notice addresses the following written documentation errors, among others:

• failure to include the required six-month delay for specified employees;
• interpretations of ambiguous language for payment timing, such as “as soon as practicable” (which may not be treated as a document failure at all);
• payments conditioned on employment-related actions, such as the execution of a non-competition agreement or a release of claims, which may affect the timing of payment;
• impermissible payment periods, such as “within 180 days following separation from service”; and
• impermissible payment events, such as payment “upon an initial public offering” or impermissible discretion to accelerate the timing of payment.

Some corrections can be made without any penalties, others require payments and tax reporting, but all applicable corrections are subject to reduced penalties. In all cases, eligibility for correction requires satisfaction of additional requirements, including that neither the employer nor individual taxpayer is being audited by the IRS, and that all other substantially similar document failures in other non-qualified deferred compensation plans be corrected at the same time.

The new guidance provides a helpful reminder that it is important to skillfully apply knowledge of Section 409A’s detailed rules when drafting deferred compensation arrangements, and it will also assist employers who acquire non-compliant plans in acquisitions.

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The Fiscal Year 2010 Defense Appropriations Act just signed by President Obama extends eligibility for the 65% COBRA premium subsidy through February 28, 2010, as well as the maximum period during which the subsidy is available from nine to fifteen months.  The two month eligibility extension wipes out an interpretation of the law by the U.S. Department of Labor that would have disqualified individuals terminated by December 31, 2009, but who would not lose health coverage until January 1, 2010.

The Department of Labor has explained that individuals who have used up their nine month subsidy and remain eligible will be given additional time to make their payments for the extension period. Eligible individuals who elected to continue paying in full for COBRA coverage after the subsidy expired will be entitled to refunds or credits against future premiums. Employers need to keep an eye out for further guidance on their notice obligations. The Department of Labor website has a COBRA section that is a good place to bookmark for this purpose.

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Plaintiffs have not prevailed in 401(k) plan fee decisions issued on the merits -- up to now.  A recent decision by the Court of Appeals for the Eighth Circuit has overturned the dismissal of challenges to fees paid by the WAL-MART 401(k) Plan (PDF), one of the largest in the U.S.  Coming after a recent agreement by Caterpillar Inc. to settle similar claims (PDF) against it, the WAL-Mart decision is sending shock waves through the U.S. investment and fiduciary communities.

Past cases include the highly-publicized Court of Appeals for the Seventh Circuit decision, dismissing claims against John Deere and Fidelity Investments, and a recent decision by the Court of Appeals for the Second Circuit upholding the dismissal of claims against United Technologies (PDF).

In the past, plaintiffs have argued unsuccessfully that 401(k) plan fees are excessive and that revenue sharing should be disclosed to participants. (Revenue sharing is a common U.S. practice in which plan service providers receive part of the fees paid to other parties, such as the adviser to mutual funds in which the plan participants invest, as payments towards the recordkeeping, custodial or administrative fees paid by the plan.). Plaintiffs also contended that revenue sharing is a form of “kickback” for selecting particular funds under the U.S. prohibited transaction rules, rather than permissible compensation for services rendered. Plan fiduciaries who were initially concerned about their exposure may have become complacent as decisions in favor of defendants were released.

The WAL-MART appeal found that the following were viable claims to be decided by the trial court:

• Whether WAL-MART should have negotiated to use institutional mutual funds instead of retail funds, which typically have higher fees.
• Whether WAL-MART should have avoided funds with 12b-1 fees, which allegedly benefit the fund companies, not the participants.
• Whether WAL-MART was required to disclose its fund selection process and revenue sharing to participants, and whether revenue sharing is an improper kickback.

Other fee cases are also headed to trial, including a major case against Nationwide Financial Services by a class of trustees of 24,000 plans, making the law still highly unsettled regarding permissible fees and the obligations of fiduciaries. In the meantime, plan fiduciaries would be well-advised to pay more attention to this aspect of fund selection, retaining independent advisers if they lack the expertise to make this evaluation themselves and taking care to disclose all direct and indirect fees in communications to plan participants.

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The US Internal Revenue Service has just issued Notice 2009-97 (PDF), extending by one year the deadline to make certain required qualified plan amendments. The operative word here is “certain”. This is not a blanket extension of any amendments required by the Pension Protection Act (PPA) or the Worker, Retiree and Employer Recovery Act of 2008 (WRERA) that would otherwise have been required to be made to most plans by December 31 of this year. A careful reading of Notice 2009-97 indicates that the extension is available only for amendments that:

• Comply with the funding-based benefit limitations that apply to defined benefit plans.
• Apply certain of the new rules to cash balance and other hybrid plans.
• Implement the diversification requirements for 401(k) and other defined contribution plans that invest in employer stock.

The reason for this extension is that the IRS expects to be issuing additional guidance on how to comply with these new requirements, but both defined contribution and defined benefit plans must make additional amendments that are not subject to the extension by the original deadline. These additional amendments include the new interest rates and mortality table used to calculate lump sums in defined benefit plans, new faster vesting for nonelective employer contributions to defined contribution plans, and new requirements to make a qualified optional survivor annuity option (usually a 75% survivor annuity) available.

Plan sponsors who have not yet adopted the PPA and WRERA amendments for which the deadline has not been extended still need to do so, generally before the end of this year. If they do not do so, they will be exposed to penalties under the IRS correction programs or on plan audit.

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Do you think you reserved the right to amend your U.S. retiree medical benefits? Think again.

Most U.S. federal court decisions have found that retiree medical benefits did not vest on retirement. Rather, employers had the right to modify non-union post-retirement medical coverage if they had reserved this right in the plan’s summary plan description (SPD) (which is the basic plan disclosure all participants receive).

For example, in a case involving the retirees of John Deere & Co. (PDF), a federal district court held that John Deere did not violate the U.S. Employee Retirement Income Security Act of 1974 (ERISA) when it imposed significantly higher deductibles and co-pays on retirees, and removed a cap on out-of-pocket expenses, because John Deere had unambiguously reserved the right to amend the plan.

However, a recent federal appeals court decision involving Unisys Corporation (PDF) suggests that employers must follow specific rules in order to implement cuts to retiree coverage. Unisys was ordered to reinstate its plan without the right to alter benefits for the following reasons:

• Although the Unisys SPD reserved the right to amend or terminate the plan in the future, the SPD was not distributed until after employees had retired and enrolled in the plan.
• Employees who were about to retire were told that after age 65, they would not have to contribute towards benefits, and were not advised at that time of the reservation of rights.

Timing is apparently everything, at least for employers in the 3rd Circuit.

Employers with U.S. plans should also be aware that the health reform bill passed by the House of Representatives (PDF) contains a provision (Section 110) which would make it extremely difficult to change retiree coverage regardless of the communications retirees have received. This provision would prevent reductions in retiree benefits unless comparable reductions were made in the coverage of active employees. Thus, any employer contemplating changes in retiree coverage should also keep an eye on the status of health care reform legislation.

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The IRS recently issued a ruling that allows 401(k) plans to be amended to accept contributions equal to the dollar value of unused vacation or other paid time off as either automatic (non-elective) contributions, or as elective contributions if the employee has the option of receiving cash. (PDF) 

This option may be attractive to plan sponsors who don’t provide for or who limit the carryover of unused time off. However, the catch is that special monitoring will be required to make sure that the contributions do not exceed IRS limits.

The traps for the unwary are as follows:

• Section 415 limits: Total contributions to a 401(k) plan in any year may not exceed the lesser of a dollar amount (currently $49,000) or 100% of Section 415 compensation.  Non-elective plan contributions are not treated as compensation, and particularly in the case of employees who have terminated employment, contributions in a later year may run up against the compensation limit.
• Maximum Elective Deferrals: Pre-tax contributions for a participant under all plans of all employers may not exceed the dollar limit in effect for the calendar year (the limit for employees under age 50 is currently $16,500) and must be made from Section 415 compensation.
• Non-Discrimination Testing: Because contributions of unused time will be variable, plans should evaluate their potential impact on any required non-discrimination testing.

Plan sponsors considering whether to add this feature to their plans need to factor these possible additional compliance tasks and costs into their decision.

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On October 15, 2009, the Internal Revenue Service announced that there will be no cost-of-living adjustments to U.S. pension limitations for the calendar year 2010. This may come as a surprise to administrators or employees who have become accustomed to annual increases in the qualified plan limitations, as has been the case for most of the prior ten years.  We are pleased that, given the current economic climate, the limitations were not reduced, as some had worried.

Among other things, these limitations restrict the amount of compensation that can be contributed to a defined contribution plan, or the amount that can be considered when calculating defined benefit accruals in a qualified retirement plan. 

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U.S. plan sponsors have so many new requirements to meet that they may not appreciate the significance of new regulations under the Genetic Information Nondiscrimination Act of 2008 (PDF) (GINA), which prohibit most uses of genetic information in underwriting and operating group health plans.

The GINA regulations, which come into effect for most plans on January 1, 2010, were jointly issued by the Department of Labor, the Internal Revenue Service, and the Department of Health and Human Services. They interpret the statute broadly and have a particular impact on the use of health risk assessments in popular wellness and disease management programs.

What is new in the GINA regulations? One item of interest is that GINA’s protected group defines family members of participants to include up to fourth degree relatives and any dependents who could be covered under a plan because of a relationship with the participant. It even includes a fetus or embryo. The regulations also broadly interpret “underwriting” to extend far beyond activities relating to pricing and rating a policy, and state that prohibited underwriting includes providing rewards, such as lower premiums, to individuals who complete health risk assessments that request genetic information about the individual or family medical history.

Participants can sue noncompliant plans for damages of $100 per day of noncompliance or for equitable relief, and there could be monetary penalties up to $500,000 for even unintentional violations of the new rules. 

Plan sponsors looking to avoid unpleasant surprises should take steps to ensure compliance now, particularly for plans that are self-funded and are not run by insurers. Preparing for compliance involves coordinating software, procedures, forms and communications as well as document amendments, and it won’t be possible to do all of this on December 31.

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