The US Treasury Department and Internal Revenue Service (IRS) issued final hybrid plan regulations (or “new regulations”) on November 13, 2015 to address the conflict that plans face when transitioning impermissible interest crediting rates to those that are permitted by existing final hybrid plan regulations—a move that, on its face, would violate the anticutback restrictions of ERISA and the Internal Revenue Code (Code).

The Code and final regulations issued in 2014 prohibit an interest crediting rate greater than a market rate of return and provide an exclusive description of interest crediting rates that satisfy this requirement. Plans with interest crediting rates that may exceed these permissible rates must be amended to reduce their current rates, which would ordinarily violate anticutback restrictions. The final hybrid plan regulations provide relief from this conundrum.

The new regulations do not change or expand permissible interest crediting rates. The prescribed transitional corrections are specifically tailored to a particular compliance failure of a plan's current interest crediting rate. Generally two or more alternatives are offered for each category of compliance failure, and the new regulations expressly allow rounding of annual and less frequently determined interest rates, within prescribed parameters.

Today, the Internal Revenue Service (IRS) announced the 2016 dollar limitations for retirement plan contributions and other retirement-related items based on its annual cost-of-living adjustments.

Many limitations will remain unchanged because, as the IRS explained, “the increase in the cost-of-living index did not meet the statutory thresholds that trigger their adjustment.” Accordingly, the elective deferral (contribution) limit for 401(k), 403(b), most 457 plans, and the government’s Thrift Saving Plan remains at $18,000. Likewise, the catch-up contribution limit for employees ages 50 and older who participate in these plans remains at $6,000. The limit on annual contributions to an Individual Retirement Arrangement (IRA) also remains unchanged at $5,500, with the catch-up contribution limit remaining at $1,000.

Some limitations will change based on the increase in the cost-of-living index. Those include increases to the adjusted gross income (AGI) phase-out range for taxpayers who make contributions to a Roth IRA and the AGI limit for a saver’s credit (otherwise known as the retirement savings contribution credit) for low- and moderate-income workers.

As the calendar year rapidly wanes, 401(k) plan required notices for calendar-year plans will soon be due. Three of the most common year-end notices are Section 401(k) plan safe harbor notices, Qualified Default Investment Alternative (QDIA) notices, and automatic contribution notices. These notices must be provided no more than 90 days (and not less than 30 days) prior to the new plan year. Accordingly, for calendar year plans, December 1, 2015 is the notice distribution deadline.

Safe Harbor Notices

  • Standard Safe Harbor. Section 401(k)(12) of the Internal Revenue Code provides that a cash or deferred arrangement is deemed to meet the nondiscrimination requirements of Section 401(k)(3)(A)(ii) if the arrangement provides at least one of two types of safe harbor employer contributions and if a safe harbor notice is provided to each employee eligible to participate in the arrangement. The notice must be provided at least 30 days (but no more than 90 days) before the beginning of each plan year and must be sufficiently comprehensive to inform employees of their rights and obligations under the plan. It must include (among other things) a description of the safe harbor employer contribution, other contributions made under the plan and the conditions under which they are made, and compensation on which deferrals are based. The safe harbor notice must include any scheduled changes to the plan that will apply in the new plan year.
  • QACA Safe Harbor. Section 401(k)(13) sets forth a slightly different nondiscrimination safe harbor that relates to a qualified automatic contribution arrangement (QACA)—that is, an arrangement under which, in the absence of an election to defer, an employee eligible to participate in a plan is treated as having elected to defer a certain percentage of compensation. The annual timing requirement of the notice for this QACA safe harbor is the same as under the standard safe harbor. The content requirement is also the same, with the exception that a QACA safe harbor notice must describe the automatic contributions that will be made on the employee’s behalf, the employee’s right to elect not to have elective contributions made (or to elect to have them made at a different percentage), and how contributions made under the QACA will be invested in the absence of any investment election by the employee.

On September 11, 2015, the Pension Benefit Guarantee Corporation (PBGC) issued final reportable events regulations that are intended to reduce the burden of reporting for plan sponsors that present the least risk of not being able to fund their plans in the future. The PBGC estimates that the new rules will exempt approximately 94% of plans and plan sponsors from many reporting requirements.

By way of background, under the Employee Retirement Income Security Act of 1974, as amended (ERISA), sponsors of defined benefit pension plans are required to notify the PBGC of certain so-called “reportable events” that may signal financial issues with the plan or a contributing employer that could potentially put the pension plan at risk of a need for PBGC intervention. These “reportable events” include plan sponsor events such as bankruptcy, corporate transactions, extraordinary dividends, and loan defaults, as well as plan events such as missed contributions, insufficient funds, and large pay-outs.

It's not hard to find stories in the business and popular press these days about the impending "retirement crisis" in the United States created by the demise of the defined benefit plan, the increased reliance by employees on 401(k) plans as their primary source of retirement income (other than Social Security), and the inadequate level of retirement readiness of most Americans.

The last point is generally viewed as the result of certain shortcomings among American workers participating in 401(k) plans: they wait too long to start saving; they don't save enough when they start (and often leave matching employer contributions on the table); they don't invest their savings effectively; and when they change jobs, they take their money and spend it rather than keeping it in a tax-favored retirement savings account (the so-called "leakage" problem, which we will discuss in a future post).

While perfect solutions to these problems have yet to be developed, one approach on the savings and investment front that has gained traction in the last ten years—particularly following the Pension Protection Act of 2006 (PPA '06)—is the "lead the horses to water" approach. That is, automatically enrolling employees in a defined contribution plan and then defaulting those who do not otherwise make an affirmative investment election into an appropriate investment fund, subject to opt-out. This approach relies on the incredibly strong power of inertia to keep employees in these choices, and data has shown that employees largely stay in the investment fund into which they were defaulted.

Administrators of tax-qualified retirement plans (or their delegated payor) are responsible for both withholding on distributions and for reporting the tax withheld. If taxes are under-withheld, the administrator/delegated payor may be subject to penalties.

Although the rules governing withholding on distributions to US citizens and resident aliens are clear and generally well-understood, administrators may not be aware of the rules applicable to distributions to individuals who are (at the time of distribution) non-resident aliens (NRAs). As a result, an administrator could end up under-withholding on NRA distributions, since NRAs are subject to a higher rate of withholding than US persons (unless a treaty exemption applies, as discussed below).

By way of background, NRAs might participate in a plan either because they spent all or part of their career with the plan sponsor working in the United States before returning to their home country, or because the sponsor’s plan allows NRAs to participate. In either case, the NRA withholding rules apply based on the status of the payee at the time of distribution—if the individual is an NRA at the time of distribution, the NRA withholding rules apply, even if the individual spent all or part of his/her related service working in the United States.

On August 17, the US Court of Appeals for the Fifth Circuit affirmed the dismissal of an action brought by a company’s pension plan participants against the company and the plan's fiduciaries. The dismissed action alleged that the company's decision to de-risk its pension plan by transferring approximately $7.4 billion in pension obligations to a third-party insurer through the purchase of a single-premium group annuity contract ran afoul of various ERISA rules and requirements.

Among other allegations, the company’s plan participants asserted that the plan, plan sponsor, and plan fiduciaries violated ERISA by (1) failing to obtain participants' consent to the annuitization transaction, (2) failing to disclose to participants (in the plan's summary plan description or otherwise) that the transaction might result in a “loss of benefits” (e.g., the loss of Pension Benefit Guaranty Corporation (PBGC) guarantees and other ERISA protections), and (3) using $1 billion of plan assets to pay the third-party insurer and other third-party providers for administrative costs associated with the annuity transaction.

The Fifth Circuit’s decision uniformly dismissed all of the participants’ claims, noting that (1) the related decision to settle pension obligations through an annuity purchase is a settlor decision that is immune from fiduciary obligations; (2) the plan was amended appropriately to allow for the annuity purchase; (3) the plan fiduciary timely communicated the annuity purchase-related changes to plan participants through a summary of material modifications; (4) ERISA does not provide an absolute entitlement to PBGC protections, and there was no loss of benefits associated with the annuity purchase; and (5) the type of expenses paid from the plan did not raise ERISA concerns, and the participants provided no information to support the conclusion that the amount of the expenses was unreasonable.

All in all, the court's decision should provide additional comfort to plan sponsors and plan fiduciaries (particularly in the Fifth Circuit) that pension de-risking initiatives implemented through an annuity purchase do not run afoul of ERISA.

Readers of a certain generation will remember the 1980s G.I. Joe cartoon that often ended with the tagline "Knowing is half the battle." On August 26, in Mirza v. Insurance Administrator of America, Inc., the US Court of Appeals for the Third Circuit made a similar pronouncement: when seeking to enforce an ERISA plan's imposed statute of limitations, the court stated that "notice of the statute of limitation is half the battle." On the heels of this decision, plan administrators are cautioned to make certain that their benefit denial letters clearly disclose any applicable statute of limitations in the plan that may shorten the period for filing suit.

Often described as a "statute of repose," a statute of limitation (SOL) imposes a deadline by which an individual must bring a claim. After that deadline, the claim is considered "time-barred," meaning that the claimant is SOL . . . that is, in this case, "simply out of luck." If a lawsuit is brought after the expiration of the SOL, the court is empowered to dismiss the case without ever considering the merits in the underlying dispute.

ERISA contains a six-year SOL for fiduciary breach claims but does not impose a limitations period for benefit claims. As a consequence, courts typically look to an applicable state SOL for breach of contract claims (by analogizing ERISA plans to contracts). However, as the Supreme Court recently affirmed, an ERISA plan can impose its own SOL, and that provision will be enforced, provided that the limitations period is "reasonable."

These days, it’s not uncommon for pension plans to be in some sort of frozen state. It is important for plan sponsors to remember that even though their pension plans may be totally frozen (with no one accruing benefits), partially frozen (closed to some or all new participants), or in some other “frozen status,” the plans are still subject to the PBGC reportable event rules under section 4043 of ERISA. Only once a pension plan is fully terminated and all assets are distributed do the reportable event rules no longer apply. Of course, the reportable event rules also apply to active pension plans. Failure to comply with the rules may result in steep penalties of up to $1,100 a day.

Although there may be a few reportable events that are not likely to occur if a pension plan is frozen, most reportable events can occur regardless of a pension plan’s status. These reportable events include, among others,

One of the most popular pension derisking strategies for the last few years—which shows no sign of slowing down in 2015—has been offering lump-sum windows (LSWs) to terminated vested participants. (As discussed in an earlier blog post, after the issuance of IRS Notice 2015-49, lump-sum offers to retirees in pay status are no longer permissible, but the vast majority of LSWs have not been extended to retirees in any event.) LSWs offer plan sponsors the opportunity to reduce their pension plan liabilities and headcount, and the associated Pension Benefit Guaranty Corporation (PBGC) premiums and administrative expenses without the premium required to settle liabilities through an annuity purchase (and, in some cases, at a discount to the related balance-sheet liabilities). The knowledge that new updated mortality tables will be required in determining lump-sum amounts (and will increase those amounts by 5–8%) as early as 2016 (although, more likely, in 2017) has added some wind to the lump-sum sails this year.

But, as LSWs have proliferated, so have concerns among the various federal agencies that regulate pension plans. As noted, the IRS has served notice that lump-sum offers can no longer be made to retirees in pay status. The US Department of Labor's ERISA Advisory Council held hearings in 2013 on derisking, including LSWs, and issued a report that raises a number of concerns, including whether participants understood the risks that they were assuming by taking a lump-sum distribution and whether current disclosure requirements were sufficient. Additionally, the PBGC has recently begun requiring pension plans sponsors to provide reporting to PBGC regarding derisking activities, including LSWs.