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Defined Contribution Plans: Hot Topics
Andrée St. MartinDavid PowellRoberta UffordJennifer Eller
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Autoenrollment
Beginning 2008, plans that adopt an automatic enrollment arrangement will satisfy the actual deferral percentage ("ADP") test, actual contribution percentage ("ACP") test, and top-heavy rules, if — Plan sponsor automatically defers employees’ compensation,
beginning at least 3% in first year, unless an employee affirmatively elects otherwise.
The automatic deferral percentage increases by at least 1% each year, up to 6% in fourth year (10% cap).
Sponsor matches up to 3½% of compensation (100% of first 1%, 50% of next 5%), or makes a 3% non-elective contribution.
Participants are 100% vested in employer contributions after two years of service.
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Autoenrollment
Autoenrollment arrangement must cover all new employees; employers may include current non-participating employees.
Notice requirements — New employees - no more than 90 days before the
employee becomes eligible, no later than the time of eligibility.
Current participants - at least 30 but not more than 90 days before the beginning of each plan year.
Notice must explain participant’s right to not contribute, and how contributions will be invested in the absence of an election.
New participants must have a reasonable time before automatic contributions begin to make elections.
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Autoenrollment
Clarifies that ERISA preempts state laws restricting “automatic contribution arrangements.” DOL may establish minimum standards for qualified arrangements. Contributions must be invested in defaults under new ERISA §
404(c)(5) and administrator must notify participants annually about arrangement.
New DOL Proposed Regulations Effective Aug. 17, 2006.
Participants may unwind automatic contributions within 90 days of first contribution. (Matching contributions are forfeited and contribution is included in income.) No 10% excise tax
Special correction rule for ADP/ACP violations under auto-enrollment: within 6 mos. of end of plan year, no 10% excise tax Note: This is an advantage to using autoenrollment even if not
applying the nondiscrimination safe harbor
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Default Investments: The Issue
Under § 404(c), a plan sponsor won’t be responsible for investment losses in a participant’s account if those losses are the “direct and necessary” result of participants’ exercise of control.
Two typical situations in which participant may not exercise control (investment directions may be lacking -
in auto-enrollment and other plans where participants are not required to provide investment instructions to enroll, or
if participant account balances are currently allocated to an investment option that will be deleted (typically in a plan conversion).
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Default Investments: The Issue
Under current law, no ERISA § 404(c) relief for investment of “undirected” balances (affirmative participant direction is required) In the absence of an affirmative participation direction,
the fiduciary is fully responsible for investment and must act “prudently,” giving “appropriate consideration” to relevant facts and acting accordingly. ERISA § 404. Arguably, this decision must be customized to the individual.
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Default Investments: The PPA
New ERISA § 404(c)(5) - a participant is treated as exercising control over his or her plan account “in the absence of a direction,” if the account is invested according to DOL regulations. DOL to issue regulations within 6 months on
appropriateness of designating default investments that include a "mix of asset classes consistent with capital preservation, long-term capital appreciation, or a blend of both."
Participants must receive annual notice about default and right to provide alternative instructions.
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Default Investments: DOL Prop. Regs
DOL Proposes Regulations (Sept. 26, 2006). Relief provided for investment in the absence of a participant direction if -- Assets are invested in a “qualified default investment alternative” The participant is given the opportunity to direct the investment, but does
not. The participant is given notice at least 30 days before the first investment
and at least 30 days in advance of each new year Under the plan terms, any material provided to the plan relating to the
investment is provided to the participant (prospectus, proxies) The participant is permitted to transfer out consistent with other options
(but no less than once within every 3 months) The plan offers a “broad range of investment alternatives” as defined in
404c.
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Default Investments: DOL Prop. Regs
3 Types of Qualified Default Investment Alternatives: Funds/portfolios designed to provide varying
risk/return based on participant’s age Single fund/portfolio appropriate for the
participants as a whole (e.g., a balanced fund) An investment management service under
which a professional manages the participant’s account based on participant’s age
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Default Investments: DOL Prop. Regs
QDIA must be (1) a registered investment company under the Investment Company Act of 1940, or (2) managed by an investment manager that qualifies under ERISA section 3(38)
QDIA must be diversified so as to minimize the risk of large losses
QDIA may not hold employer securities, unless it is a registered investment company or other regulated pooled vehicle, or, in connection with the managed services option under some circumstances;
QDIA may not impose penalties or restrict the ability of a participant to transfer out of the investment alternative;
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“Mapping” under the PPA
New ERISA § 404(c)(4) - participants are treated as “exercising control” over their accounts in a “qualified change in investment options” if participant provided prior instructions.
A “qualified change” is a reallocation of the participant’s account among other plan options or new plan options, if — replacement options (including their risk and return
characteristics) are “reasonably similar” to replaced options previously elected by the participant.
Notice to participants at least 30 days/not more than 60 days before change must compare options and inform participants how their accounts will be invested if they don’t object.
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Investment Advice: Background
Providing “investment advice” is a fiduciary act.
A person who advises plans or participants to invest in an investment product that pays the adviser or its affiliate fees and commissions may violate ERISA’s prohibited transaction rules (i.e., section 406(b)).
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Investment Advice: Existing Approaches
Existing approaches to participant advice programs: Independent advice services, Adv. Op. 2001-09
(SunAmerica). Adviser levels or offsets fees so that advice does not
change adviser’s compensation, Adv. Op. 2005-10A (COUNTRY Bank).
Rely on class exemptions, e.g., PTE 84-24, 77-4, 75-1.
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Investment Advice: New Exemption
New ERISA § 408(b)(14): Exempts the provision of investment advice to a
plan participant by a “fiduciary adviser,” and Exempts the adviser’s receipt of direct or indirect
compensation (including sales commissions and any other fees) in connection with plan investments pursuant to the advice.
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Investment Advice:New Exemption
New ERISA § 408(b)(14) Only covers advice provided under an “eligible
investment advice arrangement.” Discretionary management programs and advice
to plan sponsors (e.g., fund selection) are not covered.
Available for advice provided after December 31, 2006.
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Investment Advice: New Exemption
ERISA § 408(b)(14) — Includes two types of “Eligible Arrangements”:
Adviser’s fees do not vary based on advice
Adviser uses a computer model to provide advice
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Investment Advice:New Exemption
ERISA § 408(b)(14) — Requirements
Plan fiduciary must authorize arrangement for plan
Independent expert must annually certify computer model
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Investment Advice:New Exemption
ERISA § 408(b)(14) — Requirements
Participants must be provided detailed disclosures, including all program fees and the fiduciary adviser’s compensation arrangement. (DOL required to issue model form)
Annual independent audit of services
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Investment Advice:New Exemption
ERISA § 408(b)(14) — Plan Sponsor “Shield” Plan sponsor or other fiduciary who selects an
“eligible investment advice arrangement” — does not fail to meet ERISA requirements solely
because the sponsor contracts for or arranges for the provision of advice to participants,
has no duty to monitor specific investment advice provided by a fiduciary adviser,
Sponsor still must prudently select and monitor the fiduciary adviser.
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Investment Advice:Open Issues
ERISA § 408(b)(14) — Issues Does fee-leveling condition apply only to individual
advisers, or to the advisers’ employer organization and its affiliates?
May advisers provide “off-model” advice in response to participant questions?
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Investment Advice:IRAs
ERISA § 408(b)(14) — Issues DOL may issue a broader exemption for IRAs if it
concludes that computer models are not feasible. DOL must continue to review new information
about whether a computer model is feasible for IRAs, and revoke the exemption if it reaches new conclusions.
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Investment Advice:New Exemption vs. Current Approach
ERISA § 408(b)(14) - Comparison to Existing Approaches:
PPA provides that existing exemptions are not altered; but does not specify that interpretations under DOL Advisory Opinions (SunAmerica and COUNTRY Bank) are not affected.
DOL informally says AOs are not affected
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Investment Advice:Future Prospects?
Will plan sponsors prefer statutory sponsor shield provided by ERISA § 408(b)(14), as compared to other participant advice programs?
ERISA § 405(c) and (d) may provide similar protection to sponsors, under certain conditions.
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Mutual Fund Issues
“Late Trading” – Mutual funds/intermediaries accepted orders for mutual fund trades after market close. SEC “hard 4 p.m.” rule proposal would require orders to be received by fund/NSCC by 4 p.m.
SEC Rel. No IC-26288, 68 Fed. Reg. 70388 (Dec. 17, 2003).
“Market Timing” – Frequent trading to benefit from inter-day price changes, which disrupts fund and harms other shareholders. SEC proposed a 2% redemption fee. Final rule 22c-
2 requires fund boards to consider redemption fees.
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Mutual Funds – Rule 22c-2
Final SEC Redemption Fee Rule – Rule 22c-2 Fund boards must consider whether redemption fees
are necessary, but are not required to adopt fees. Allows redemption fees up to 2%; minimum redemption
fee period is 7 days. Requires funds to enter written agreements with
“financial intermediaries” allowing funds to identify shareholders whose trading violates fund policies. “Shareholders” include plan participants. “Intermediaries” include ERISA plan
“administrator” and entities who maintain participant records.
SEC Rel. No. IC-267782, 70 FR 13328 (March 18, 2006)
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Mutual Funds – Rule 22c-2
Final Rule Amendments “Shareholder information agreements” only required
between funds and “first-tier” intermediaries. “First-tier” intermediaries submit orders directly to
the fund, its transfer agent, principal underwriter or a registered clearing agency.
Funds may not accept orders for share purchases from a first-tier intermediary if there is no agreement.
Funds may treat “small intermediaries” as one investor.
SEC Rel. No. IC-27504, 71 FR 58257 (Oct. 3, 2006)
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Mutual Funds – Rule 22c-2
Shareholder information agreements must require first-tier intermediaries to: Provide shareholder TIN and shareholder
transaction information promptly upon fund request.
Carry out fund directions to restrict/prohibit additional share purchases by shareholders violating fund policies.
Use “best efforts” to determine whether a person submitting orders is an “indirect” intermediary and arrange for delivery of shareholder information by indirect intermediaries.
Restrict share additional purchases by indirect intermediaries upon fund request.
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Rule 22c-2 – Plan Issues
Non-Uniform Redemption Fees SEC not willing to adopt uniform standards, e.g.,
de minimis limits on fees collected, exempt plan transactions other than participant-directed exchanges, uniform fee amount/period.
Non-Uniform Trading Restrictions Funds may impose limits on frequent trading, e.g.
exchange and “round-trip” limits, and suspend share purchases by shareholders that violate their policies.
Information Sharing – funds’ information-sharing requests could be burdensome. Some industry efforts may mitigate.
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Rule 22c-2 – Plan Issues
DOL Guidance Redemption fees, and limits on exchanges within a
specific time period, are permitted under 404(c), if disclosed and permitted by plan terms.
Inadequate disclosure of limitations on investment changes may raise issues under black-out rules. See ERISA § 101(i).
(published Feb. 17, 2004, available at www.dol.gov/ebsa/newsroom/sp021704.html)
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Trading Limits – 404(c) Concerns
404(c) regulations require that participants have “opportunity to exercise control.” This requires that: Participants receive information about investment options. Plan allows participants to give directions to a plan fiduciary,
who is obligated to carry out the instructions. Plan provides a “broad range” of investment options.
29 C.F.R. §§2550.404c-1(b)(2)(i)(B) Fund trading limits raise issues:
Do participants receive appropriate information? Does plan allow fiduciaries to reject participant instructions
that violate fund policies? Do restrictions violate “volatility” related rules under 404(c)
regulations?
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Trading Limits – 404(c) Concerns
“General volatility rule” – participants must be able to give instructions for an investment option with a frequency appropriate to the volatility to which the investment option is subject.
29 C.F.R. § 2550.404c-1(b)(2)(ii)(C) “Specific volatility rule” requires that,
At least three “core” investment options (constituting a “broad range”) allow instructions at least once every three months, and
At least one core alternative allows transfers in as often as other alternatives allow transfers out.
29 C.F.R. § 2550.404c-1(b)(2)(ii)(C)(1) and (2)
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Trading Limits – Fiduciary Concerns
“Black-out” Rules – require that participants receive at least 30 days’ notice of any “temporary” restriction on their rights to give instructions Some mutual funds impose restrictions with little or no notice. A market timing restriction may not be a “black-out” if it is:
A permanent restriction, A regularly scheduled suspension disclosed to participants, Caused by participant misconduct.
Notice is not required for a suspension or restriction caused by reasons beyond the plan administrator’s control, but plan administrator must record reasons in writing.
29 C.F.R. § 2520.101-3
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Trading Limits - Litigation
Trading restrictions are enforceable, if restrictions are allowed by plan terms, disclosed and enforced as disclosed.
Strauss v. Prudential Employee Savings Plan, 253 F. Supp. 2d 438 (E.D.N.Y. 2003)(participant claim dismissed where plan terms gave plan administrator authority to enforce restrictions).
Borneman v. Principal Life Ins. Co., 291 F. Supp. 2d 935 (S.D. Iowa 2003) (court allowed (i) claim for fiduciary breach where plan policy against market timing was not enforced as disclosed and (ii) ERISA section 510 claim where adverse employment action was threatened.
See also Prusky v. Reliastar Life Ins. Co., 445 F.3d 695 (3rd Cir. 2006)(plan could enforce contact allowing daily transfers).
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Settlement Funds
Settlements with SEC between 12/18/03 and 2/9/05:
Approximate total value of Settlement Funds: $1,770,113,262
- Alliance Capital Management - Massachusetts Financial Services Corp.
- Banc of America Capital Management
- PA Fund Management LLC
- Banc One Investment Corporation - Pilgrim, Baxter & Associates, Ltd.
- Franklin Advisors, Inc. - Putnam Investment Management, LLC
- Invesco Funds and AIM Advisors - RS Investment Management Inc.
- Janus Capital Management - Strong Capital Management
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Settlement Funds
FAB 2006-01 (April 19, 2006) Addresses distributions to ERISA plans from settlement funds
relating to late trading and market timing. Independent distribution consultants (IDCs) are not ERISA
fiduciaries because assets of settlement funds are not “plan assets” until distributed from the fund.
“Intermediaries” (e.g., recordkeepers, brokers and others holding shares of plans in omnibus accounts) receiving settlement proceeds on behalf of plans assume “fiduciary” duties, even if not otherwise a plan fiduciary. The proceeds must be held in trust, invested and
administered consistent with ERISA’s requirements.
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Settlement Funds
FAB 2006-01 (con’t) Intermediaries will meet their duty to “prudently” allocate to plans
by following a methods provided by IDC. Otherwise, intermediary must develop a “reasonable” method to
allocate among omnibus account clients. Generally, reasonable to allocate in relation to how late
trading/market timing affected clients. Intermediaries may weigh costs and not allocate where
allocation costs could exceed amount to be allocated; forfeited amounts should be allocated to other clients.
Unless service contract specifies fees, intermediaries may only charge “direct expenses” for allocation services.
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Settlement Funds
FAB 2006-01 (con’t) Plan administrators must prudently allocate settlement fund
proceeds among plan participants. Prudent to allocate following IDC method. Otherwise, method must be “reasonable” - reflecting how
late trading/market timing affected participants. May weigh costs and benefits of alternate approaches. If
facts and circumstances warrant may – Allocate only to current plan participants, or Apply de minimis amounts to plan expenses.
Receipt and use should be documented.
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Settlement Funds
Proposed Distribution Plans – SEC proposed distribution plans for market timing/late trading settlement funds. Notice of Proposed Distribution Plan for Banc One Advisors Corp.
SEC Admin. Proc. File No. 3-11530; Notice of Proposed Distribution Plan for Columbia Management Advisors, Inc. and Columbia Funds Distributor, Inc., SEC Admin. Proc. File No. 3-11814.
ABA/SPARK Concerns Proposed plans do not
consider individual activity within omnibus accounts, or provide reasonable methods for making distributions to plan
participants who invested through omnibus accounts. 180-day distribution period too short. Intermediary costs not covered by distribution plans.
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Roth 401(k)/403(b) Plans
Introduced in 2006 Starting slow, in part due to uncertainties
Unlike Roth IRA, no AGI limits Interest on the upswing
January, 2006 proposed regulations on distribution rules, final regulations on elections/contributions
Basic premise: it is a separate account
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Roth 401(k)/403(b) Plans (cont’d)
Key Provisions of Proposed Regulations “Qualified distributions” are tax-free
5 taxable years of Roth participation (1st day of 1st year of Roth contribution), death or disability
Deemed distributions on loan defaults not QDs ESOP dividends reinvested in Roth accounts may later
be distributed as QDs; dividends paid in cash under 404(k) not QDs
In a direct Roth-to-Roth rollover/transfer, 5-year period commences with earlier Roth contribution date of either plan
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Roth 401(k)/403(b) Plans (cont’d)
Key Provisions of Final Regulations: Cannot have Roth-only plan Roth elections are irrevocable
Retroactive recharacterization not permitted Must be permitted to revoke prospectively at least once
a year Roth catch-up contributions okay Auto enrollment okay Roth account treated as separate plan for $200 direct
rollover de minimis rule Can specify which account excess contributions
distributed from
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Proposed Regulations - Nonqualified Distributions Not treated like nonqualified Roth IRA distributions
After-tax returned first from Roth IRA After-tax distributed pro rata under section 72 from
Roth 401(k)/403(b) Hardship distributions from Roth contributions (not
earnings) okay, but taxed pro rata Nonqualified distributions of employer securities
subject to regular NUA rules
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Rollovers
If nonqualified distribution, rollover is deemed to be of taxable portion first
Rollovers from plans to Roth IRAs - basis carries over to Roth IRA
Proposed regs allow plan-to-plan rollovers only direct and only to same type of plan (e.g., Roth 410(k) to Roth 401(k)) Comments have asked for more flexibility
Plan must track 5-year period Provide statement of whether QD or not, and if not, year
of 1st Roth contribution Must be provided within 30 days of request or direct
rollover
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Miscellaneous
Reporting New reporting of indirect plan-to-plan rollovers New W-2 and 1099-R Roth reporting
Plan amendments for Roth for 2006 due by 12/31/2006