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Current developments in employee benefits.

The past year brought significant changes to the employee benefits area. This two-part article summarizes those changes and suggests planning opportunities for employers sponsoring benefit plans. Part I, below, discusses changes related to qualified retirement plans, excluding the changes enacted as part of the Small Business job Protection Act. Part II, to be published in December, will examine changes related to employee stock ownership plans, compensation, Sec. 403(b) plans and welfare benefits plans.

Qualified Plan Distributions

Final Regs. Secs. 1.401(a)(31)-1, 1.402(f)-1 and 31.3405(c)-1 provide guidance on direct rollover options and the 20% withholding tax on plan distributions not directly rolled over(1); Temp. Regs. Secs. 1.411(a)-11T and 1.417(e)-1T were also issued to offer guidance on the notice requirements.(2) Most employers want to coordinate the timing of the direct rollover notice with the participant and spousal consent notices.

The Unemployment Compensation Amendments (UCA) were enacted in July 1992; UCA Section 522(a) added Sec. 401(a)(31) and modified Secs. 402 and 3405 to require plans to give employees taking a distribution a choice between a (1) direct rollover into an individual retirement account (IRA) or another qualified retirement plan and (2) direct payout option. (UCA Sections 521 and 522 added an equivalent rule for Sec. 403(b) plans.) Under the UCA, if an employee could but does not choose a direct rollover, the plan administrator must withhold 20% of the distribution as income tax withholdng The disclosure rules were therefore amended to require that notice be given before the distribution, so that a participant has sufficient information to make an informed choice. In general, notice to participants and spouses has to be given no less than 30 days and no more than 90 days before the annuity starting date.

Notice 93-26(3) permitted most profit-sharing and stock bonus plans to allow employees to waive the 30-day waiting period (provided employees had notice of such period). Temp. Regs. Sec. 1.417(e)-1T (b)_(2)(3)(i) extends the 30-day waiver rule to plans subject to spousal consent, provided certain conditions are met. The regulations do not eliminate or change the 90-day period, thus, the employee must receive a Sec. 402(f) notice no more than @O days before a distribution. (Some daily valuation plans have addressed the 90-day requirement by sending out notice with each quarterly benefit statement.) Regs. Sec. 1.402(f)-1, Q&A-4, makes clear that posting the notice on an employee information board does not constitute giving notice within 90 days, and reiterates the Sec. 402(f) (1) requirement that notice be in writing. (Daily valuation companies had asked for an annual written notice supplemented by electronic bulletin board availability; the IRS has not approved this approach.)

Under Temp. Regs. Sec. 1.417 (e)-1T(b), assuming a plan has received an "affirmative distribution election" (i.e., an affirmative election as to the form of distribution, to which the spouse consents, if necessary), the employee (with spousal consent) can waive the 30-day waiting period; distributions can begin no less than seven days after the qualified joint and survivor annuity (QJSA) notice was given to the participant. The participant and spouse must be told that they have 30 days to reconsider whether to waive the QJSA and consent to a different form of distribution, and that they can revoke their election up to the annuity starting date. The participant (and spouse) must have, the right to revoke the election until the later of the annuity starting date or the end of the seven-day period that begins the day after QJSA notice is given. The annuity starting date must be after the date QJSA notice is given.

Example 1: Prior to the issuance of the regulations, G, a newly laid-off employee, enters the human resources department at her firm, asks for a distribution from the pension plan in which she participates, and is given all the applicable forms. G would be advised that, assuming all of the paperwork is timely completed, she would receive a distribution at the end of 30 days (thus, in the absence of a severance package, G would have to survive for one month without pay). After the regulations, G can enter the human resources department on a Friday, receive the forms, be advised that the annuity starting date is Monday and that if G so elects, she can receive the distribution in one week (assuming all of the paperwork is timely completed).

It is not clear how many plans can take advantage of the new rule; presumably, daily valuation companies can now sell their voice response/fast distribution systems to money purchase an defined benefit plans. In most quarterly or annual valuation plans, the 30-day period is not usually a concern, because the plan will not make a payment until after the next valuation date.

Other noticeable changes from previously issued guidance are highlighted below: * According to Regs. Sec. 1.402(c)-2, Q&A-3, ancillary benefits and benefits not protected by Sec. 411(d)(6) are included in the definition of eligible rollover distribution and cannot be excluded in determining the amount available for rollover or for mandatory 20% withholding. * Reg. Sec. 1.402(c)-2, Q&A-5(d) adds examples slightly clarifying the definition of "substantially equal periodic payments" (a distribution that consists of substantially equal periodic payments over at least 10 years is exempt from the direct rollover and mandatory withholding rules). The general rule is that if a payment stream is expected to significantly change over time, it may not be "substantially equal." The regulations reiterate that the calculation methods in Notice 89-25(4) (for determining whether the 10% early distribution tax applies) can be used. The regulations further provide that a defined contribution plan can calculate the term of a distribution using a "declining balance of years" method. If the plan intends to use a flat payment until the account is exhausted, this calculation must use reasonable actuarial assumptions to determine whether the payments are likely to run for more than 10 years. * In response to questions from defined benefit plan administrators concerning plans with a Social Security supplement, Regs. Sec. 1.402(c)-2, Q&A-5(b) provides that payments reduced when Social Security payments are made are still "substantially equal," unless the reduction will be more than the anticipated Social Security benefits. * Many commentators raised questions about plans (mostly union-type plans) that issue "13th checks" if the fund has done well in a particular year or pays supplements in certain years and not in others (usually under collective bargaining agreements). The general rule is that such additional payments are independent of the normal payment stream and thus are eligible rollover distributions. However, Regs. Sec. 1.402(c)-2, Q&A-6(b) (2) provides a safe harbor, under which supplemental payments are not independent payments if they are (1) given to all similarly situated annuitants and (2) not more than the greater of (a) 10% of the annual payment or (b) $750. In addition, Regs. Sec.1.402(c)-2, Q&A-6(b) notes that corrective payments are not independent payments.

Example 2: A plan miscalculates an annuity payment and for two years pays out a smaller amount than required. In the third year, the plan makes a lump-sum payment to make up the difference. This is not an independent payment subject to the direct rollover rules.

* Based on comments from frustrated payors, Regs. Sec. 1.401(a)(31)-1, Q&A-17(b) allows plan administrators to assume that the $5,000 death benefit exclusion applies to the benefit being paid, thus, up to the first $5,000 of payments can be ignored in determining 20% withholding on death-benefit payments. * Regs. Sec. 1.401(a)(31)-1, Q&A-7 and -13(b) clarify administrative provisions added to the proposed regulations to ease the burdens of plan administrators. First, the plan can provide a "default" procedure for employees who fail to make an affirmative distribution election if the employee is notified of such procedure (some plans make default distributions into IRAs, avoiding the 20% withholding administrative problems). Second, a plan receiving a direct rollover will generally not be tainted by taking in an illegal rollover (e.g., a rollover of a minimum required distribution) if it obtains a letter from the sending plan indicating that the latter has a determination letter. Regs. Sec. 1.401(a)(31)-1, Q&A-6(b) provides that a plan may not have direct rollover rules that "substantially impair" the right to take a direct rollover. Some employers have established rules that "encourage" employees to take distributions rather than rollovers (e.g., one employer required an opinion from "competent counsel" stating that the receiving plan was qualified). * Regs. Secs. 1.402(c)-2, Q&A-2 and 31.3405(c)-1, Q&A-8 provide that a plan may permit a direct rollover to a define benefit plan (Sec. 402(c)(8)(B) says "defined contribution plan"). Regs. Sec. 31.3405(c)-1, Q&A-3 provides that plans may offer the option of withholding more than 20% of the distribution (thereby relieving employees of estimated tax filings); withholding less than 20% is not an option.

Sec. 404(a)(6) and the All-Events Test

An Industry Specialization Program (ISP) Coordinated Issue Paper for the Retail Industry(5) (ISP Paper) states that contributions to a Sec. 401(k) plan or Sec. 401(m) matching contributions are not deductible by the employer for a specific tax year if attributable to compensation earned by plan participants after the end of such year. The ISP Paper expands the rationale of Rev. Rul. 90-105,(6) which addressed the application of Sec. 404(a)(6) to the deduction of Sec. 401(k) and (m) contributions and concluded that such contributions are not deductible in a given tax year if attributable to compensation earned after the end of such year.

The ISP Paper acknowledges that Sec. 404(a) deems a payment made after the end of the tax year to have been made on the last day of that tax year, but does not make a contribution deductible in a year in which it otherwise could not have been deducted had it been paid on the last day of that year, citing the Supreme Courts decision in Don E. Williams Co.,(7) the ISP Paper concludes that Sec. 404(a)(6) does not eliminate the all-events test and provides a grace period to make otherwise deductible contributions to a qualified plan, but does not transform contributions otherwise nondeductible for a tax year into deductible ones if made by the return due date.

Independent Contractors


The Eleventh Circuit in Butts(8) affirmed the Tax Court's rulings that two Allstate property and casualty insurance agents were independent contractors. The taxpayers were participants in the company's pension plan and received matching contributions under the Sec. 401(k) plan.

Allowing independent contractors to participate in a qualified plan could affect the plans qualified status and have other negative implications for both the independent contractor and the employer. The worker must include his elective deferrals and employer matching contributions in income. For defined benefit plans, the increase in the actuarial value of the individual's benefit would be included in income and the employer would be unable to deduct the contributions.

Letter Ruling 9546018

The IRS held in Letter Puling 9546018(9) that a pension plan will not be disqualified due to an independent contractor's participation if corrective measures are taken. in that ruling, the IRS had audited American Family Insurance Company (American) and classified a number of its independent contractors as employees. Subsequently, American treated these individuals as employees for FICA, FUTA, and Federal income tax withholding purposes, and reported their wages on Forms W-2. American allowed these workers to participate in its group health insurance plan, group-term life insurance plan, flexible spending account, defined benefit plan and Sec. 401(k) plan.


Francis D. Feivor was one of the Independent contractors reclassified as an employee. Despite this classification, he took the position on his 1987 and 1988 returns that he was an independent contractor. Feivor reported his W-2 income as wages, deducted his unreimbursed business expenses on Schedule C and did not report or pay self-employment (SE) tax. Feivor did not object to his treatment as an employee by American and did not seek to change his status to that of independent contractor. Feivor participated in American's defined benefit and Sec. 401(k) plans and employee benefit programs.

The IRS rejected Feivor's claim that he was an independent contractor, and issued a notice of deficiency for his failure to report unreimbursed business expenses on Schedule A. In Feivor,(10) he successfully challenged the IRS's position; the Tax Court held that Feivor was an independent contractor for the years in issue (mainly due to American's lack of control over his performance of services) and entitled to deduct his expenses on Schedule C.

Required Corrective Action

In response to the Tax Courts holding in Feivor, American requested a letter ruling on (1) the corrective action needed to comply with Secs. 6041 and 6051 and (2) and (2)the remedial action required to ensure the qualified status of its defined benefit and Sec. 401 (k) plans.

Correction of reporting requirements: The IRS ruled in Letter Ruling 9546018 that American (1) could file Forms W-2 for Feivor showing zero taxable income for 1987 through 1994 and (2) had to file Forms 1099 reflecting as SE income the value of any health, medical care, group-term life insurance and cafeteria plan benefits originally reported as wages on Form W-2.

Citing Rev. Rul. 56-400(11) the IRS noted that the Sec. 106 exclusion for coverage under an accident or health plan is not available for premiums paid for an independent contractor. It also pointed out that the cost of life insurance protection for an independent contractor is the reasonable net premium cost, as determined under Regs. Sec. 1.83-1(a)(2) and Rev. Rul. 64-328.(12)

Qualification of retirement plans: The IRS then addressed the consequences to American's defined benefit and Sec. 401(k) plans, but noted that its rulings on this issue are being reconsidered. The IRS ruled that Feivor's continued participation in those plans would be inconsistent with Sec. 401(a)(2) exclusive benefit rule, which provides that a plan is qualified only if the trusts assets are used for the exclusive benefit of the employers employees. The IRS cited Darden v. Nationwide Mutual Insurance(13) and Professional & Executive Leasing, Inc.,(14) which held that a taxpayers pension and profit-sharing plans did not meet the exclusive benefit rule because they benefited workers who were not common-law employees.

The IRS noted that American and its plan administrator believed Feivor was an employee and eligible to participate in both plans; consequently, it ruled that the plans would not be qualified on account of Feivor's participation, provided corrective measures were taken. American was permitted to retroactively cancel Feivor's participation in the defined benefit plan from 1987 forward. In accordance with the plan terms, American could issue corrected benefit statements showing at no additional benefits accrued to Feivor after 1986.

The IRS also stated that American could retroactively cancel Feivor's participation in the Sec. 401(k) plan from 1987 forward and distribute all of his elective contributions and earnings thereon in 1995. The amounts distributed that are allocated to contributions (and earnings thereon) made during years in which the statute of limitations was open (1992-1994) were to be reported on a corrected Form 1099 for the year in which the contributions were made. For contributions (and earnings thereon) made for closed years, the distributions were to be included in Feivor's 1995 income under Secs. 61 and 72 and the "duty of consistency doctrine," and therefore, had to be reported on a 1995 Form 1099-R.

Early Retirement Subsidies

The Third Circuit ruled in Dade v. North American Philips Corp.(15) that an employer that sells a business but retains the pension plan covering employees of that business is not required under Employee Retirement Income Security Act of 1974 (ERISA) Section 204(g) to credit service with the purchaser in determining eligibility for an early retirement subsidy. In reaching that conclusion, the court distinguished its 1993 decision in Gilles v. Hoechst Celanese Corp.(16)

The treatment of qualified plan early retirement benefits is of concern because they must be valued for funding purposes. This funding becomes critical in situations in which an employer is considering selling a company (whether through a sale of assets or stock) or amending its plan to eliminate or add such benefits.

In Dade, James Dade and Jerome Budde were employed in the Magnavox division of North American Philips Corporation (Philips), and were participants in the Philips pension plan. Normal retirement age under the plan was 65, but participants who were at least 55 could elect to retire earlier. Under the plan's "Rule of 85," benefits for early retirement would not be reduced if the sum of the participant's age and years of eligible service at retirement was at least 85.

Philips sold Magnavox to MESC Electronics Systems, Inc. (MESC) in October 1993; Dade and Budde then ceased to be Philips employees and became MESC employees. Philips remained the plan sponsor after the sale, and there was no transfer of plan assets or liabilities. The plan was amended to credit Magnavox employees with up to one years additional service toward the Philips plans Rule of 85 requirements if they continued working with MESC, even with that additional year of credited service, Dade and Budde could not satisfy the Rule of 85 requirements; Budde was not yet 55 and Dade did not have enough credited service. When they were denied the early retirement subsidy, Dade and Budde sued Philips, arguing that both ERISA and the plan terms required Philips to credit them for all their service for purposes of satisfying the Rule of ultimately, the Third Circuit disagreed.

Court's Analysis

The Third Circuit found that the plan terms did not require Philips to credit employees for all their service with MESC. The court then turned to ERISA Section 204(g), which states that the accrued benefit of a plan participant may not be decreased by a plan amendment, other than an amendment described in Section 302(c)(8) (certain amendments made shortly after the close of the plan year) or 4281 (certain amendments made on termination of a multiemployer plan). A plan amendment that has the effect of eliminating or reducing an early retirement benefit or a retirement-type subsidy, or eliminating an optional form of benefit, with respect to benefits attributable to service before the amendment, is treated as reducing accrued benefits. For a retirement-type subsidy, the prescription against elimination of a benefit only applies with respect to a participant who satisfies (either before or after the amendment) the preamendment conditions for the subsidy.

The Third Circuit explained that a plan sponsor could prospectively eliminate an early retirement benefit by amendment, but the amendment could not adversely affect the early retirement benefit of a participant who satisfied the preamendment conditions for the benefit either before or after the amendment. Thus, if Philips had adopted such an amendment, it would have had to allow employees who remained with Philips after the amendment to "grow into" the benefit by crediting post-amendment service with Philips or an affiliate. But Philips did not adopt an amendment reducing an accrued benefit - only an amendment that increased the early retirement benefit by expanding the number of participants who could qualify for it. Because MESC was not an affiliate, ERISA Section 204(g) did not apply.

Dade and Budde relied primarily on the Third Circuit's decision in Gilles, which involved a plan sponsor that sold a division. The plan offered a similar early retirement benefit, but Gilles did not qualify for it at the time of the sale. The Gilles court had concluded that under ERISA Sections 204(g) and 208, the selling plan sponsor had not transferred sufficient plan assets to the spun-off plan, because the transferred assets were insufficient to fund the early retirement benefits under the plan. In reaching that conclusion, the Third Circuit held that the employees of the successor employer were entitled to earn early retirement benefits even though they were not eligible for them at the time their division was sold.

The Dade court distinguished Gilles because, in the latter case, the original plan sponsor transferred all the plan's liabilities and assets to the purchaser (i. e., there was a plan spinoff). Under ERISA Section 208, a plan spinoff is permissible only if the participants would receive no less on a hypothetical termination of the plan just after the spinoff than they would have received on a hypothetical spinoff just before. Moreover, the purchaser in Gilles agreed to provide all of the same early retirement benefits as had the previous plan. In Dade, ERISA Section 208 did not apply, because there was no spinoff, and, as noted earlier, ERISA Section 204(g) did not apply because there was no amendment reducing an early retirement benefit. Thus, neither of those sections required that Philips credit service with MESC in determining Dade's or Budde's eligibility for the early retirement subsidy under the Philips plan.

The court acknowledged that portions of its Gilles opinion could be read to be inconsistent with Dade. However, in the Dade court's view, the result in Gilles was attributable to the requirements of ERISA Sections 208i and 204(g), while the result in Dade was consistent with the Eighth Circuit's decision in Hunger v. AB.(17)

Early Retirement Offers

The Supreme Court unanimously ruled in Lockheed Corp. v Spink(18) that plan provisions requiring an employee to execute a release of all potential claims against the employer before electing to receive increased early retirement benefits under the plan do not constitute a prohibited transaction with a party in interest under ERISA Section 406(a)(1)(D). The ruling reversed a Ninth Circuit decision finding such a waiver to be a per se ERISA violation.


Spink worked for various Lockheed Corp. subsidiaries and divisions between 1939 and 1950. In May 1979 at age 61, Spink again began working for Lockheed. At the time he was rehired, the Lockheed Corporation Retirement Plan for Certain Salaried Employees, a defined benefit plan, lawfully excluded Spink from participation because he was over 60 years old. However, to lure him back to Lockheed, the company represented that he would be a participant in the plan and that his former years of service would count toward plan benefit calculations. Lockheed then notified Spink in 1984 that he was ineligible to participate in the plan because of his age when rehired. In May 1990, Lockheed amended its plan to establish a "1990 Special Retirement Opportunity" (SRO) and a "1990 Voluntary Retirement Program," which were available to certain employees until June 30, 1990, and offered increased retirement benefits to eligible employees as an incentive to terminate their employment. Such benefits were paid out of the plans surplus assets. To partake in the increased pension benefits, Lockheed required employees to release virtually all their potential employment-related claims.

Although he was eligible for the SRO option, Spink did not elect it because he did not wish to waive any age discrimination and ERISA claims he might have had against Lockheed. Spink sued, alleging that he and others in his class were entitled to benefits under the plan and that the plan amendments constituted a breach of fiduciary duty and a prohibited transaction under ERISA. Spink argued that Lockheed violated ERISA when it adopted amendments requiring employees to execute a release of all potential claims against the employer in order to elect the early retirement options. In Spinks view, this arrangement involved the use of existing plan assets to pay off potential discrimination claims against Lockheed as an employer, thus, plan assets were used for the benefit of Lockheed, a party in interest, not plan participants, constituting a prohibited transaction with a party in interest, a per se violation of ERISA Section 406(a)(1)(D).


The Supreme Court rejected Spinks arguments. The Court ruled that, in amending the plan to include the early retirement benefits, Lockheed acted as an employer in the role of the setlor of a trust, not as a fiduciary. The ERISA limits on fiduciary action did not apply to Lockheeds role as a setdor. The Court then addressed whether the retirement committee members violated fiduciary rules in paying benefits. The Court noted that the Ninth Circuit had not made a finding as to whether the committee members were fiduciaries. However, the Court found that issue to be immaterial, because the committee members did not engage in a prohibited transaction. In the Court's view, the payment of benefits in exchange for the performance of some condition by the employee is not a "transaction" within the meaning of ERISA Section 406(a)(1). The Court concluded that the payment of benefits pursuant to a amended plan, regardless of what the plan requires of the employee in return, is not a prohibited transaction. The opinion suggests that the outcome might be different if the payment were a "sham transaction."

The Spink decision enables plan sponsors to require broad-ranging waivers in return for early retirement packages. Presumably, the Courts language would permit broad-ranging employment-related waivers as a condition for receiving any benefits under a plan (including ordinary retirement benefits), as long as such conditions are spelled out in the plan document.

Benefit Accrual Reduction Notices

Temp. Regs. Sec. 1.411(d)-6T(19) addresses the participant notice requirement under ERISA Section 204(h), under which plan administrators must provide written notice to plan participants when future benefit accruals are reduced in defined benefit plans or individual account plans subject to the ERISA Section 302 funding requirements. The notice must set forth the plan amendment (or a summary) and its effective date; it must be provided after adoption of the amendment and not less than 15 days before the amendments effective date.

Temp. Regs. Sec. 1.411 (d)-6T, Q&A-5 indicates that for defined benefit plans, ERISA Section 204(h) notice is required only if the reduction in benefit accruals affects the future annual benefit commencing at normal retirement age. Plan amendments that do not affect the future annual benefit payable at normal retirement age, but affect optional forms of payment (e.g., single-sum distributions) or benefits commencing at a date other than normal retirement age (e.g., early retirement benefits), are not subject to the notice requirement. For individual account plans, only amendments that change the amount of future allocations to participants, accounts are subject to the notice requirement. Changes in investments or investment options are not taken into account. Temp. Regs. Sec. 1.411 (d)-6T, Q&A-6(a) lists the types of plan provisions that may affect the rate of future benefit accruals.

Temp. Pegs. Sec. 1.411(d)-6T, Q&A-4 further indicates that notice is required only if the amendment significantly reduces the rate of future benefit accruals. According to Temp. Regs. Sec. 1.411(d)-6T, Q&A-1 this is to be determined based on reasonable expectations, taking into account all relevant facts and circumstances.

Temp. Regs. Sec. 1.411(d)-6T, Q&A-4(b) delegates to the IRS the authority to determine whether ERISA Section 204(h) notice needs to be provided for plan amendments made to comply with law changes. The IRS may exercise this authority only through the publication of revenue rulings, notices, and other guidance in the Internal Revenue Bulletin.

Under Temp. Regs. Sec. 1.411(d)-6T, Q&A-8 and -9, a plan administrator is not required to provide notice to a participant or alternative payee if the individuals rate of future benefit accruals is reasonably expected not to be reduced by an amendment. For example, notice need not be provided to participants not entitled to accrue future benefits under the plan (e.g., former employees with vested plan benefits). Also, notice need not be provided to an employee who has not yet become a plan participant.

Plans terminated in accordance with title IV of ERISA are deemed to satisfy the ERISA Section 204(h) notice requirement not later than the termination date established under ERISA Section 4048. The IRS suggests the use of a separate notice if an amendment is effective before the termination date established under that section. However, under Temp. Pegs. Sec. 1.411(d)-6T, Q&A-14(b), amendments effective prior to the termination date (e.g. amendment freezing benefit accruals) are subject to the notice requirement.

Two rules address the failure to timely provide notice to some participants. Under Temp. Regs. Sec. 1.411 (d)-6T, Q&A-12, if the plan administrator fails provide notice to more than a de minimis percent of participants required to receive it, the amendment will be effective only for those who timely received notice. Temp. Regs. Sec. 1.411(d)-6T, Q&A-13 applies when the plan administrator has made a good-faith effort to comply with the notice requirement, but failed to provide notice to no more than a de minimis percent of participants required to receive it. If the plan administrator, on discovery of the omission, promptly provides the notice to the omitted parties, the plan amendment is effective in accordance with its terms with respect to all parties. The IRS does not indicate the percentage that would be considered de minimis.

Temp. Regs. Sec. 1.411(d)-6T, Q&A-10 and -11 indicate that notice may be provided to the affected participants by any method reasonably calculated to ensure receipt, such as first-class mail to the last-known address and hand delivery. Merely posting the notice on bulletin boards (even electronic ones) will not suffice.

Missing Participants in Plan Terminations

Effective for plan years beginning after 1995, the Pension Benefits Guaranty Corporation (PBGC) issued final regulations under ERISA Section 4050 for distributing benefits under a terminating single-employer defined benefit plan for any individual whom the plan administrator has not located when distributing benefits under ERISA Section

ERISA Regs. Section 4050.4 requires that a "diligent search" be made for a missing participant before paying the benefit to the PBGC. "Missing participant" is defined by ERISA Pegs. Section 4050.2 to include beneficiaries and participants and, under ERISA Regs. Section 4050.12(c), may include alternate payees under a qualified domestic relations order.

According to ERISA Regs. Section 4050.4(b), a search is diligent only if it includes (1) inquiries of any known beneficiaries of the missing participant for the missing participants address and (2) use of a commercial locator service. The search must begin not more than six months before notices of intent to terminate are issued and in a manner reasonably expected to permit timely distributions to located participants and beneficiaries. Additional search methods (such as the IRS's letter-forwarding program) can be used by plans attempting to locate missing individuals; in addition, correspondence can be mailed to the missing plan participant's last-known address with a request to the post office for an address correction. The search may be made by someone other than the plan administrator, as long as the administrator certifies that a diligent search was made. The participant cannot be charged for such searches.

Under ERISA Regs. Section 4050.7(b) a plan administrator who does not purchase an annuity for a missing participant must pay the PBGC an amount (the "designated benefit") representing the value of the missing participants plan benefit. The method for determining this amount depends mainly on the plans provisions, but the regulations outline the assumptions and calculation methods the PBGC will use in determining the designated benefit. PBGC will also charge a $300 administration fee for each such designated benefit in excess of $3,500, under ERISA Regs. Section 4050.2.

ERISA Regs. Section 4050.8 outlines the PBGC's method of payment to participants who are no longer missing (late-discovered participants). In general, under ERISA Regs. Section 4050.5(a)(1), the PBGC would pay a lump sum to a located missing participant if the plan would have paid him a mandatory lump sum, the lump sum equals the amount paid to the PBGC, plus interest. If the plan would have paid a de minimis (i.e., $3,500, or less) amount, under ERISA Regs. Section 4050.5(a)(2), the PBGC would permit the participant to decline the lump sum and receive an annuity to the extent the PBGC's guaranteed benefits program provides that option.

Under ERISA Regs. Section 4050.9, in other cases (e.g., annuity payments of living missing participants), the PBGC will pay the benefit in the forms available under the guaranteed benefits program. If the missing participant is a living missing participant, the form typically is a QJSA (for unmarried participants, a single-life annuity). A living missing participant's annuity equals the annuity that can be purchased with the amount the plan administrator paid to the PBGC (minus the $300 loading charge), using the missing participant's annuity assumptions in effect at the deemed distribution date. A missing participant whose benefit was in pay status before becoming missing receives back payments and continuation of the original benefit. Under ERISA Regs. Section 4050.9(c), a missing participant who could have received an immediate lump sum as of the deemed distribution date under the plan may elect a lump-sum payment from the PBGC (after obtaining any required spousal consent) that equals the amount paid to the PBGC, plus interest.

According to ERISA Regs. Section 4050.6(a)(1), the plan administrator would pay the designated benefits to the PBGC by the due date of the post-distribution certification required under the PBGC's plan termination regulation. (Interest would be assessed if the payment is late.) At the same time, the plan administrator would be required to give the PBGC certifications and information about all missing participants, as required by new PBGC Schedule MP and its instructions.

Special rules apply under ERISA Regs. Section 4050.2 for participants discovered to be missing on or after the 90th day before the deemed distribution date (recently missing participants) and for participants located 90 days or less before the deemed distribution date (late-discovered participants).

Under ERISA Regs. Section 4050.12(b), the PBGC can return to the plan administrator the designated benefit of a missing participant found within 30 days after the PBGC receives the designated benefit. The plan administrator would then distribute the benefit under the plan to that individual. ERISA Regs. Section 4050.12(h) gives the PBGC discretion to extend the plan administrators filing and distribution periods when missing participants are found or in other unusual circumstances.

The PBGC will review comphance with the missing participant program as part of its standard termination audits. The six-year recordkeeping requirement that applies generally to plan records associated with the termination process also applies to missing participant records.

State Taxation of Nonresident Pensions

On Jan. 10, 1996, President Clinton signed into law P.L. 104-95, to prohibit states from taxing the pension income of former residents. The law applies to amounts received after 1995 and is broadly grafted to cover retirement plans under Secs. 401(a) 403(a) and (b) 408(a) and (b) (IRAs). 408(k) (simplified employee plans), 414(d) (government plans), 457 (nonprofit deferred compensation plans), 501(c)(18), and most nonqualified plans (as defined in Sec. 3121(v)(2)(C)).

To be exempt from state taxes, income from nonqualified plans within the meaning of Sec. 3121(v)(2)(C) must be either (1) part of a series of periodic payments made over life expectancies or a period of 10 years or more or (2) received after termination of employment under a plan designed solely to provide benefits in excess of limits imposed by Secs. 415, 401(a)(17), 401(k) and (m), 402(g), 403(b) and 408(k). There is no similar provision for benefits from other plans.

Sponsors of certain nonqualified plans offering only a lump-sum option may want to expand that option to include annuity payments or term-certain payments over 10 or more years to bring income from such plans under the protection of the new law. The fact that the plan offers a lump-sum payments option will not cause annuity payments or payments paid over 10 years to become subject to state tax withholding.

Employee Investment Education

The Pension and Welfare Benefit Administration (PWBA) released on June 11, 1996, Interpretive Bulletin (IB) 96-1, "Participant Investment Education," outlining permissible investment-related education for participants in participant-directed individual account plans that will not be considered "investment advice" under ERISA. An exposure draft was released in December 1995. The IB, issued as ERISA Regs. Section 2509.96-1, contains only one substantive change from the exposure draft; the preamble to the IB contains a number of clarifications.

The only substantive change in the IB involves the description of asset classes. Under the IB, unlike the earlier draft, if the description of a class of assets (e.g., bonds) refers to one specific plan investment option that fits that class, it does not have to describe all the other plan investment options that might fit that class. Commenters had criticized this requirement, saying that educational materials provided by one investment vendor should not classify the investments offered by another; in response, the IB requires that if the educational material identifies a specific investment as meeting an asset class description, the material must also include a statement that other plan investment options may also fit in that asset class and where information on those investments can be obtained.

The Department of Labor (DOL) continues to stress that the test for "investment advice" under ERISA examines the facts and circumstances and urges plan sponsors to emphasize that participants should: * Participate in available plans as soon as they are eligible. * Make the maximum possible contribution to the plan. * If they change employment, refrain from withdrawing their retirement savings, and opt instead to directly transfer or roll over their plan account into an IRA or other retirement vehicle.

The preamble addresses the DOL's clarification as to when a plan sponsor or fiduciary may be viewed as having fiduciary responsibility by virtue of endorsing a third party who has been selected by a participant or beneficiary to provide participant education or investment advice. The DOL continues to stress that whether a plan sponsor or fiduciary has effectively endorsed or made an arrangement with a particular service provider is an inherently factual inquiry that depends on all the relevant facts and circumstances. However, in the DOL's view, a uniformly applied policy of providing office space or computer terminals for use by participants or beneficiaries who have independently selected a service provider to provide investment education does not, in and of itself, constitute an endorsement of or arrangement with the service provider for purposes of the IB.

Definitely Determinable Allocations

The IRS issued an Employee Plans Field Directive(20) (EPFD) that rescinded a prior field directive on allocations to profit-sharing plans. The initial field directive had caused large profit-sharing plans a number of problems and had raised issues concerning the treatment of qualified nonelective employee contributions (QNECs) in Sec. 401(k) plans.

The prior field directive noted that a profit-sharing plan that had a definite contribution formula but gave the employer discretion to determine different contributions for different groups of employees did not satisfy the "definitely determinable", requirement of Regs. Sec. 1.401-1(b)(1)(ii). The field directive's position was that the contributions were not under a definite allocation formula (as required by regulations) if the employer had discretion over the amounts to be contributed to each group. The field directive was intended for a small group of plans that gave the employer discretion to decide contributions among a small group of employees (e.g., secretaries versus associates in law firms), but was read broadly. The usual reading of the directive was that, if the employer had discretion with respect to one aspect of the plan (e.g., the total contribution made), it could not have discretion over how that contribution was allocated.

The EPFD notes that the field directive has been applied not only to the intended plans, but also to many other acceptable plan designs. The IRS stated in the EPFD that it was not intended that these long-standing plan designs @e.g., different contributions for different profit centers or based on matching contributions and QNEC formulas in Sec. 401(k) plans) be treated as failing to satisfy the definite predetermined allocation formula requirements.

However, the IRS also noted that a plan that provides different contributions for different groups of employees, with the amount determined by the employer, will not be an acceptable plan design for a regional prototype plan.

Based on the prior field directive, the IRS had refused to issue determination letters for plans that gave the employer discretion to determine the contribution for different groups of employees. Some employers, trying to circumvent this restriction, had decided to place definite language in the plan, and then make amendments each year as needed. If an employer has a plan with this language, it may want to consider amending the plan in accordance with the EPFD and obtaining a new determination letter, rather than amending the allocation formula each year.

Depositing Participant Contributions

The PWBA issued ERISA Regs. Section 2510.3-102. reducing the maximum time for depositing participant contributions in ERISA pension plans, but leaving the rules for welfare plans essentially unchanged. The preamble notes that for purposes of the regulation, the DOL treats employee elective contributions, such as salary deferrals, as "participant contributions."

For pension plans, the final rule retains the requirement that participant contributions must be made by the earliest date that they can reasonably be segregated from the employers general assets. The maximum period an employer may hold such contributions is changed from the current 90-day limit to no later than the fifteenth business day of the month following the month in which (1) the participant contributions are received by the employer (if the employee pays amounts to the employer for benefits), or (2) the amounts would have been payable to the participant for amounts withheld by the employer for benefits). A "business day" is any day other than Saturday, Sunday, or a Federal holiday. State holidays that are not also Federal holidays count as business days.

A procedure is established in limited circumstances that gives the plan sponsor an additional 10 business days for deposit in any one payment cycle. To obtain the additional time, the employer must (1) notify employees and the DOL of the delay and the reason for it within five business days after the end of the extension and (2) post a bond guaranteed by a state or federally insured bank or other institution that win remain in effect for three months after the extension. Only two 10-day extensions are permitted within one plan year, unless the employer pays interest on the amounts involved, such interest must be set at the higher of the rate (1) the contributions would have earned had the amounts been invested under the plan in the highest rate of return investment option or (2) applied under Sec. 6621(a)(2) to underpaid taxes.

For welfare plans, the time limit for depositing employee contributions remains at 90 days and ERISA Technical Release 92-1(21) continues to apply (i.e., the DOL will not assert a violation of trust or reporting requirements solely because certain welfare plans or cafeteria plans fail to hold participant contributions in trust).

For noncollectively bargained plans, the effective date of the final rules is Feb. 3, 1997. For collectively bargained plans, the new maximum pension deposit date will not apply until the later of that date, or the first day of the plan year that begins after expiration of all applicable collective bargaining agreements in effect on Aug. 7, 1996.

An employer may obtain a postponement of the pension plan requirements for up to an additional 90 days beyond the generally applicable effective date. To use the 90-day postponement, the employer must notify participants and the DOL of the postponement before the original effective date, the reasons therefor and when the postponement win expire. The employer must also post a bond guaranteed by a state or federally insured bank or other institution and extending for three months after the end of the postponement. During the postponement, the deposit standards for welfare plans apply.

These final regulations will be far easier to comply with than the proposed regulations, which would have required employee contribution deposits in the same time frame used for depositing Federal income and FICA tax withholding; those time limits range from one to 30 days, based on the employer's size.


* A plan receiving a direct rollover will generally not be "tainted" by taking in an illegal rollover if it obtains a letter from the sending plan indicating that the latter has a determination letter. * An ISP Paper provides that contributions to a Sec. 401(k) plan or Sec. 401(m) matching contributions are not deductible by the employer for a specific tax year if attributable to compensation earned by plan participants after the end of such year. * Temporary regulations under Sec. 411(d) explain the written notice to be provided to plan participants when future benefit accruals will be reduced.

(1) TD 8619 (9/15/95). (2) TD 8620 (9/15/95). (3) Notice 93-26, 1993-1 CB 308. (4) Notice 89-25, 1989-1 CB 662. (5) Deduction of Contributions to IRC Section 401(k) Plans Attributable to Compensation Paid After Year End Under IRC Section 404(a)(6) (effective 9/5/95). (6) Rev. Rul. 90-105, 1990-2 CB 69. (7) Don E. Williams Co., 429 US 569 (1977)(39 AFTR2d 77-77-1 USTC [paragraph] 9221). (8) Dan P. Butts, 49 F3d 713 (11th Cir. 1995), afff'g TC Memo 1993-478 and A. Wayne Smithwick, TC Memo 1993-582. (9) IRS Letter Ruling 9546018 (8/18/95). (10) Francis D. Feivor, TC Memo 1995-107. (11) Rev. Rul. 56-400, 1956-2 CB 116. (12) Rev. Rul. 64-328, 1964-2 CB 11. (13) Darden v. Nationwide Mutual Insurance, 503 US 318 (1992). (14) Professional & Executive Leasing, Inc. 89 TC 225 (1987), aff'd 862 F2d 751 (9th Cir. 1988) (63 AFTR2nd 89-427, 88-2 USTC [paragraph]9622). (15) Dade v. Northern American Philips Corp., 3d Cir., 1995. (16) Gilles v. Hoechst Celanese Corp., 4 F3d 1137 (3d Cir. 1993), cert. denied. (17) Hunger v. AB, 12 F3rd 118 (8th CiR. 1993). (18) Lockheed Corp. v. Spink, Sup. Ct., 6/10/96, rev'g 60 F3d 616 (9th Cir. 1995).
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Title Annotation:part 1
Author:Richardson, Terry
Publication:The Tax Adviser
Date:Nov 1, 1996
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