4. There was no vesting of pensions No benefit entitlement until age 65 Employees could be discharged just prior to retirement age – no pension. Being a “Bad employee” could invalidate your pension. Plans were often terminated and participants were left with nothing. There often was no proper funding of pensions. Sponsor had no duty to disclose info about pension plan. Sponsor had no fiduciary duty to participants. October 2, 2010 Thomas E. Murphy 4 During those dark, cold pre-ERISA days. . .
5. Pension entitlements could be attached by creditors. Trust Funds to secure the accruals were not required. Actuarial and investment estimates favored the sponsors. October 2, 2010 Thomas E. Murphy 5 “Retirement” could be a hardship.
6. To mitigate the huge risks borne by participants. And, to make the dream of retirement income to sustain life after work a reality October 2, 2010 Thomas E. Murphy 6 Then, the “government passed a law!”
7. Purpose: to secure retirement income: Reporting & Disclosure Minimum Participation and Vesting Minimum funding requirements – and more. October 2, 2010 Thomas E. Murphy 7 It was called “ERISA.” (1974)
8. Tax favored treatment. . . A Big Incentive No obligation to offer plan If sponsor complies: Deductions for sponsor’s contributions. No income tax on investment gains Accruals not considered income to participants. Tax Policy: Pensions should not favor high earners Retirement plan should provide real opportunity to retire and not be a source of “rainy day” funds. At some point, the tax treatment ends if you don’t take the pension October 2, 2010 Thomas E. Murphy 8
9. Tax advantages mean tax compliance – enter the IRC Maintain Tax Qualified Status It’s a real maze . . . Like getting a green card IRC: §415 Limits – what’s the rationale? No discrimination in favor of HCE – DBP and DCP participation. Rollovers – to retain tax favored treatment No early distributions Required distributions Thomas E. Murphy 9 October 2, 2010
11. October 2, 2010 Thomas E. Murphy 11 Pop Quiz – Do you know ERISA? Is it legal? Is it not legal Explain your answer. See theSections of ERISA Also, check the BLOG on C. #9.
12. DBP that provides employee must work 2 years before participating in the Plan. Legal? (ERISA §202) DCP provides that that no contributions vest until 7th year. (§203) DCP provides that employer match does not vest until 7th year. (§203) DBP decides to change “FAP” formula from high final 3 to final 10 years. Violation? (§204) Thomas E. Murphy 12 ERISA QUIZ – Legal? Why/why not? October 2, 2010
13. DBP prohibits all alienation of benefits! (§206(d)(1)(3)(A)) QUADRO) DBP permits married participant to ignore designating a benefit for a survivor. (§205) Divorced participant’s decrees says “ex-wife gets nothing,” but his DCP says she is beneficiary. Which trumps? DBP requires all employees retire at age 65. (ADEA/§204) Thomas E. Murphy 13 ERISA Quiz October 2, 2010
14. DBP provides no benefit accruals until age 30. §202 Your investment committee has invested in junk bonds and the plan is now underfunded. Can you sue? (§404) Your DBP has invested in a company that is owned and run by your CEO’s spouse. The Plan is underfunded. Can you sue? (§406). Plan lends money to CEO.§406 Thomas E. Murphy 14 ERISA Quiz October 2, 2010
15. Your DBP sends you a benefit statement only once – 90 days before your retirement. Is this legal? Table 9.1 at 259 and §101 et seq. of ERISA What information must be in the individual DCP benefits statement? (See DOL Summary, Table 5) What information about investment fees must be provided to DCP participants. See: the BLOG, C. #9) Does a non-elective enrollment in DCP trump a state garnishment law? See §514 of ERISA. Thomas E. Murphy 15 ERISA QUIZ October 2, 2010
16. Isabella and §510 – was the layoff a violation? (page 253, 255) Sam’s Plan and ERISA coverage? (page 257) Mary’s lump sum and duty to disclose. (page 258) Additional Exercises 11, 12, and 13 on the BLOG, C.#9 Plan sponsor outsources annuity payments. Was choice a violation of fiduciary duty? (page 261) Break in service at page 266 and §203(b)(3)(A). Mary’s lump sum at 269. What’s wrong with this Vignette? (See Blog, C#9) October 2, 2010 Thomas E. Murphy 16 More Quizzes
17. More . . . Retiree Health Care Gross Negligence or Fraud + Reliance = Can an employer cancel retiree health care for its current retirees? Future retirees? What if the employer sponsor is in bankruptcy? (The Blog, C.#9) What should be the determinant legal principles, facts, and obligation 11 USC §1114 of Bankruptcy Code What if an employee of your Benefits Department tells you that you will receive $24,000 per year, and you can retire at age 57. You elect to retire, but your first pension check is a gross amount of $750? Problem: Employee failed to properly calculate the actuarial reduction. Any remedy? What about “Estoppel?” Rationale? October 2, 2010 Thomas E. Murphy 17
18. And more examples . . . What is preemption? 11 USC 522(d)(10)(E), Preemption and non-alienation (page 272) Preemption and health care – early discharge from the hospital. (273) The Art and Sam Jones Pension Odyssey (276) IRA and Bankruptcy (283) Thomas E. Murphy 18 October 2, 2010 Mary and John rolled over some of their 401(k) money after retirement to an IRA. Their bankruptcy creditors want to exercise claims on these funds. Can they? Rousey vs. Jacoway, 544 U.S. 320 (2005)
19. And,. . . Tax rates are low . . . See Summary of the Bill Could bring a Quiet Explosion of Roth Conversions Should a 401(k) participant be permitted to take his “in plan assets” and “roll them over” into a Roth IRA? What are the issues, considerations, rationale? There is a new law on this. October 2, 2010 Thomas E. Murphy 19
20. The main provisions of ERISA The Main Points The big picture Coverage Reporting and Disclosure Fiduciary Responsibility Minimum Participation and Vesting No reduction in benefit accruals Internal administration and fairness Benefit Distribution Minimum Funding Preemption Discharge to deny benefits Non-alienation Insuring benefits – PBGC Prohibited transactions Thomas E. Murphy 20 October 2, 2010
21. Repititione e` la madred’educazione. One more time From the top! Let’s review some of the broad theories and provisions of ERISA that affect the design and administration of pension and health care plans. Thomas E. Murphy 21 October 2, 2010
22. An enterprise that is engaged in commerce or whose business affects commerce. That provides a pension – a plan that provides income or allows a deferral of income that is paid upon the termination of employment. That provides a health and welfare plan for its employees. Thomas E. Murphy 22 What’s covered? October 2, 2010
23. Reporting and Disclosure “Transparency” What does this mean? To provide a variety of information to participants and the Government (ERISA §101and Table 9.1 at 259) What really is an SPD? Also, see some examples here. Thomas E. Murphy 23 October 2, 2010
24. ERISA - Reporting and Disclosure: Employer’s obligation Do you have my SPD? Summary Plan Descriptions (SPDs Actuarial reports to IRS Participant Benefit Estimates (DBPs) 401(k) Account balances – distributed quarterly Advice on the value of investment diversification But . . . don’t tout company stock Thomas E. Murphy 24 October 2, 2010
25. Reporting and Disclosure The Employer’s Duty To Disclose Let’s dig deeper . . Does Title I (R&D) apply to a participant’s request for the data used to compute her lump sum payout? What are the relevant criteria used to calculate a lump sum? Does it require disclosure of the criteria and data used to calculate a DBP Final Average Pay pension? Does it require access to names of participants? Thomas E. Murphy 25 October 2, 2010
26. Suppose the sponsor gives a participant an estimate of his benefit at age 65 (15 years from now) Turns out, the estimate was significantly wrong – he will get much less. What are the legal issues and how would you resolve them? Is DCP participant entitled to detailed information on plan fees? (See: DCP Fee Transparency Act of 2009 October 2, 2010 Thomas E. Murphy 26 Reporting and Disclosure - More
27. Reporting and Disclosure Must they tell participants? Don’t tell anyone, but . . Company knows that its stock is going to drop precipitously when it announces earnings next quarter. Should it disclose this to DCP participants? Would this possibly be a violation of SEC “insider trading” laws? Thomas E. Murphy 27 October 2, 2010
28. Other Notices . . . Employer Must Before boarding the boat You must sign a waiver! Notify departing employees of their COBRA rights. Notify of obligation to provide 50% -75% joint surviving spouse benefit, unless waived. Must write SPDs in Spanish? Thomas E. Murphy 28 October 2, 2010
29. ERISA - Fiduciary Responsibility Don’t worry: I am your fiduciary. I will take care of you . . Act solely in the interests of plan participants. ERISA §404 Must do so with skill, prudence, and diligence of a prudent person familiar with relevant issues. Thomas E. Murphy 29 October 2, 2010
30. Trustee Investment manager Service Providers Broker dealers, investment advisors Plan administrator Record keeper Board of Directors U.S. Sup. Ct., in LaRue vs. DeWolff, 522 U.S. 248 (2008) held fiduciary liable for damages to individual account, not just to “plan as a whole.” See: 29 CFR § 2510-3.21(c) and §3(21)(A)(ii) of ERISA October 2, 2010 Thomas E. Murphy 30 ERISA – Who are Fiduciaries?
31. Exercises discretionary control or authority over management or assets of a plan. Renders investment advice for a fee Has discretionary authority in the administration of a plan. Only a fiduciary for what he exercises such discretion or control Or a fiduciary or sponsor who imprudently chooses a fiduciary. Thomas E. Murphy 31 Who is a fiduciary? October 2, 2010
32. Thomas E. Murphy 32 When did they know the company stock was going to fall? October 2, 2010
33. investments are diversified; there are opportunities to transfer investments; there is sufficient information provided to make sound investment decisions; the plan documents clearly state the fiduciary is not liable unless there are breaches of the above provisions. Policy to encourage employee ownership. No indication there were significant problems. Presumption of Prudence. Fiduciary not expected to be able to predict precipitous decline No crisis in management October 2, 2010 Thomas E. Murphy 33 401(k) Stock Drops – Issues!
34. Asset Management - DBPs What factors should be relevant? Sub Prime . . . What is investment strategy? Is fiduciary following it? How is fund managing risk? Predicting loss of Asset Value? Suppose your employer, a commercial bank sponsoring your DBP invested heavily in bundled sub prime mortgage funds causing an under-funding and failure of the Plan. See: Morgan Stanley Case. October 2, 2010 Thomas E. Murphy 34
35. Thomas E. Murphy 35 Investing non-elective 401(k) deferrals – a Fiduciary Issue? October 2, 2010
36. Allowed and encouraged by the PPA of 2006. Why? What if employer then makes a default investment on behalf of the participant? Liable? What do you think the rules should be? Make very conservative investments so nothing is lost, but not much is gained? Or, a more robust mix of equities? October 2, 2010 Thomas E. Murphy 36 Non-Elective Deferrals (DCP)
37. Qualified Default investment: no employer securities, long-term appreciation and capital preservation, take into consideration age or demographics of participants – target funds, diversified to avoid large potential losses, no penalty for changing. Non-elective participants can opt out Advised of employer action within 30 days. Given Proxy information Broad range of investment choices. Thomas E. Murphy 37 Guidelines for Non-Elective Deferrals October 2, 2010
38. Investments chosen by bona fide “investment manager” (a defined term) Opportunity to transfer default investment without penalty. Exceptions to employer securities prohibition – employer match is in company stock, or stock is held by a qualified investment company as part of a group of stocks. Investments = mix of long term appreciation and capital preservation or fixed income October 2, 2010 Thomas E. Murphy 38 Guidelines
39. Poor selection or choices of investment options in 401(k)? Fail to monitor administrative plan charges Purchase too much company stock in DBP. Poor choice of annuity service provider – low cost was criteria? (Invested in junk bonds and trust lost significant value at page 261) Stock was in imminent danger of collapse? Should sponsor give investment advice? Let’s try to draft our own guidelines Thomas E. Murphy 39 Fiduciary Responsibility October 2, 2010
40. Check the website to see the background and where they are as of March 2010. (“Consumer Information, Retirement Plans, Proposed Rules”) October 2, 2010 Thomas E. Murphy 40 The DOL drafted guidelines,punted and then drafted new ones
41. Fiduciary . . more Mistakes? Actionable? Sponsor failed to follow participant’s investment choice in DCP Sponsor should have known that plant closure and relocation would cause a “run” on benefits. DBP sponsor transferred workers and their pension plan to new subsidiary. It knew subsidiary was likely to fail along with pension plan. Breach of fiduciary duty? Thomas E. Murphy 41 October 2, 2010
42. Non-forfeitable rights. Vesting Participation Participating and vesting service. Defined Benefit Plans Defined Contribution plans Cash balance plans Reduction in accrued benefits Breaks in service Thomas E. Murphy 42 October 2, 2010
43. Minimum participation standards: age 21, complete 1000 hours per year, age 18 for vesting credit.(§202) Vesting both cliff and vesting: (see various schedules in Table 9.2 (page 265, §203)) Break in service rules in Table 9.3 (page 267) See Vignette: “A works for X” at 266. Thomas E. Murphy 43 ERISA - Participation and Vesting October 2, 2010
44. What if A works 2 years, leaves for 3, and returns for 10 years. Plan provides 5 year cliff vesting. Should pre-break 2 years count for benefit accrual? (fn. 36, page 266). Employee starts work at age 18, Plan provides participation will begin when employee is 21 and has completed one “year of service.” Plan uses 3 year cliff vesting. Is employee vested? How many years of participating service? Thomas E. Murphy 44 Queries . . . Break in service. October 2, 2010
45. ERISA - Benefits Accrual No back loading . . No cutbacks . . Accrued benefits cannot be reduced. Future benefit accruals can be. Example: Company A, changes the FAP formula from: (years of service) X (final average pay) X (2%) to the same but changes the 2% to 1%. Freezes and terminations Suppose plan changes from FAP to Final Pay, but only after 30 years of service? Suppose a plan eliminates age 55 early retirement? Legal? What should this depend upon? Thomas E. Murphy 45 October 2, 2010
46. Surviving spouse (50% and 75%) Why would a spouse waive? Lump Sum versus Annuity? Investment rates, discount rates, and longevity assumptions are no longer guessing games. Go to Vignette of Mary at 269. Required minimum distributions at age 70.5 – special problems in a recession? Prohibition against early distributions before age 59.5 – special problems in recession? Loans and hardship withdrawals in DCPs. Thomas E. Murphy 46 ERISA - Benefit Distributions October 2, 2010
47. Minimum Funding Requirements Junior Actuary Same Principles Remember “saving for college?” What were the relevant factors parents used to determine how much to save? It is the same for pensions. Thomas E. Murphy 47 October 2, 2010
48. Make sure the plan can deliver on its promise to pay the benefits. Now: standard mortality tables Now: investment return projections and discount rates must be based upon varied bond rates from 5 to 15 years. Must be fully funded over a 7 year period. Thomas E. Murphy 48 Minimum funding standards October 2, 2010
49. The plan’s annual contributions must equal the present value of benefits earned by participants during the current year, and be sufficient to amortize any future funding shortfall over the next seven years. New: standard evaluation of assets – the stocks, securities, bonds, and cash held in the trust. Thomas E. Murphy 49 Minimum funding standards October 2, 2010
50. Plans cannot “overstate” its assets. Less flexibility to smooth values based upon market fluctuations. Can fund other benefits (retiree health care) provided plan is 120% funded; limit 10 years. Result of new funding standards: many plans are under funded and have frozen their plans. With recession, enforcement here is being temporarily suspended. Thomas E. Murphy 50 Minimum funding standards October 2, 2010
51. October 2, 2010 Thomas E. Murphy 51 Preemption – what does it mean? To prevent each state from having its own pension laws and creating a crazy quilt of rules that make it impossible for sponsors and participants.
52. ERISA preempts and supersedes any and all state laws insofar as they may relate to any benefit plan. Except: it does not apply to state’s authority to regulate insurance. So, insured health care plans may be subject to state requirements such as mandates. Examples: an insured plan must include mental health, chiropractic, homeopathic health. Thomas E. Murphy 52 Preemption . . §514(a) October 2, 2010
53. ERISA supersedes state laws even though there may be no conflicting provisions in the statute itself with respect to the state law. Purpose: avoid balkanization of state laws of pension and health plans Recognizes state’s right to regulate the administration of insurance and insured plans. (Health Care self-insured plans not included.) Thomas E. Murphy 53 Preemption over benefit laws October 2, 2010
54. Does it affect a traditional or exclusive area of federal concern? Does it affect traditional ERISA entities, such as sponsors, fiduciaries, participants? See Vignettes: testamentary distribution (at 272), suit against sponsor for loss of income and emotional distress arising out of a disability denial (at 272), refusal by TPA to approve extended stay. (at 273) Thomas E. Murphy 54 Preemption Test October 2, 2010
55. State of New York added surcharge on hospitals to help subsidize insurance companies that insure the “unhealthy,” or to fund uncompensated care. Held: not preempted – the nexus with a benefit plan is too attenuated. Any willing provider litigation and HMO panel? Note: ERISA does not allow compensatory or punitive damages. Thomas E. Murphy 55 Preemption . . . examples October 2, 2010
56. ERISA - Non-Alienation Can’t use my pension Except for . . . Divorce! What is the policy here? Big exception: QDROs. Non-participant spouse gets 50% of DBP accrued benefits or DCP account value at time of divorce. Future accruals to the participant only. Thomas E. Murphy 56 October 2, 2010
57. Want any pension plan to become a tax refuge for highly compensated employees? Tax qualified plans can allow income deferrals, investment gain deferrals, rollovers, and deductibility of benefits. This reduces government revenue. So, it has promulgated rules about participation, limits on benefits, and distribution of benefits. What are they? Thomas E. Murphy 57 The Government Does Not October 2, 2010
58. THE IRC - Tax Treatment The Tax Policies Waiting to see tax lawyer What is interest of IRC? Do not discriminate in coverage! Minimum participation rules §415 Limits (See Table 9.4 at page 277) and see: http:benefitsattorney.com Required Minimum Distributions (age 70.5) No early distributions (age 59.5) October 2, 2010 Thomas E. Murphy 58
59. Not a refuge for HCEs! Art Jones & Co. at 275 If one falls . . . Minimum participation and coverage. (DCPs and DBPs) Discrimination testing in participation (DCPs) What’s at stake here for the plan sponsor? What is the ultimate public policy aim? Thomas E. Murphy 59 October 2, 2010
60. DBP must cover at least 40% of all employees, and the percentage of non-HCEs benefiting from the plan must equal at least 70% of the HCEs. HCE is a person who makes $110,000 per year, or is more than a 5% owner) With respect to DCPs, the participation rate of the non-HCEs must be proportionate (not necessarily “equal”) to that of the HCEs. Thomas E. Murphy 60 The Discrimination Rules October 2, 2010
61. Goal and Tests - DCPs Average Deferral % Either must be met. To Prevent HCEs from disproportionately participating in the DCP. Average Deferral Percentage = the mathematical average of Actual Deferral Percentages of HCEs and non-HCEs Generally speaking, ADP of HCEs must not exceed the ADP of non-HCEs by more than 2% -- or – does not exceed the non-HCEs ADP by more than 1.25. Thomas E. Murphy 61 October 2, 2010
62. Discrimination Testing For HCEs . . . Deferrals and Actual Contributions. . . Or . . . Actual contribution percentage of HCEs do not exceed the lesser of (a) 2% points above, or (b) 2 times the deferrals of non-HCEs ACP includes deferrals, matches, and non-elective contributions. Thomas E. Murphy 62 October 2, 2010
63. Here’s how it works . . . Non Highly Compensated Highly Compensated If ADP of non-HCE is: 2% 3 to 8% >8% Max for HCE is: 2X2% = 4% Percentage + 2% 1.25 times percentage Thomas E. Murphy 63 October 2, 2010
64. What’s the remedy? This is a Big Deal! What’s “Safe Harbor?” Deferrals and contributions are returned as taxable income to the HCEs. Plan could lose its tax favored status Or, as an alternative, the Plan could acquire “Safe Harbor Status.” Thomas E. Murphy 64 October 2, 2010
65. Safe Harbor – Must offer either . . . No discrimination testing Get into shore quickly! Elective deferral: 100% match on first 3% of compensation; And, an additional 50% match on next 2% of compensation, OR . . . Non-elective contribution of 3% of compensation Thomas E. Murphy 65 October 2, 2010
66. There was a lot of confusion about certain pension plan practices. Funding issues needed to be clarified. New Law - Pension Protection Act October 2, 2010 Thomas E. Murphy 66 By 2006, ERISA needed repairs.
67. Cash Balance Plans – are OK provided . . . No more whipsawing (on conversion of DBP to CBPs) No more wear away (on conversion) Must have minimum 3 years vesting Conclusion: there is no inherent age discrimination with respect Cash Balance Plans Phased (post 62) retirement is Ok: work reduced time, pension proportionately reduced. Non-elective enrollment in DCPs is OK. Thomas E. Murphy 67 The PPA of 2006 October 2, 2010
68. 401(k)s must allow self-directed funds Faster vesting of employer matches in DCPs. Investment advice not equal to “Prohibited Transactions.” Excess funding of DBPs is prohibited Tax free treatment of long term care benefit included with a retirement annuity. Minimum investment options for DCP Thomas E. Murphy 68 More PPA of 2006 October 2, 2010
69. Trust is immune from creditors If, the plan is “tax qualified.” Note: non tax qualified benefits can, however, be subject to creditors’ claims in a bankruptcy. Can a benefit receive favorable tax treatment, but not be immune from creditors’ claims? What about “executive deferred compensation” plans? Thomas E. Murphy 69 Bankruptcy protection for pensions October 2, 2010
70. ERISA - Enforcement No pain and suffering Judge Francie will decide. Civil lawsuits can be filed by U.S. DOL and participants. Also some criminal penalties. IRS can revoke tax-qualified status of plan. Lawsuits are equitable in nature. Thomas E. Murphy 70 October 2, 2010
71. Terminated Plan- all participants vested All plans must contribute premiums per capita to PBGC. PBGC guarantees payment of accrued benefits. There are caps on insured benefits - full age and service limit is $4125 / month. Thomas E. Murphy 71 Insuring benefit October 2, 2010
72. COBRA – extending health care coverage after a major life event. HIPAA – Limiting right of group health plan to exclude pre-existing health conditions FMLA – Obligating the employer to allow employees unpaid leave for health conditions of themselves or family USERRA – continuation of employment rights and benefits during and after a military or uniformed deployment. Thomas E. Murphy 72 Other Provisions of ERISA October 2, 2010
73. Thomas E. Murphy 73 See the “Benefits Chart” Chapter 12 October 2, 2010
74. COBRA also includes a prohibition against dumping patients at other emergency rooms. Emergency Medical Treatment Act: requires hospital treatment w/o insurance. See the chart showing the basic applications of ERISA, the IRC, and the PPA to retirement plans (Fig. 9.1, 287 of the Text.) Thomas E. Murphy 74 Potpourri October 2, 2010
75. Let’s look at each of the Exercises at end of C. #9 and the Blog, C.#9! We’re using light weights but lots of reps. Thomas E. Murphy 75 Exercises October 2, 2010
76. Table 9.2 Vesting Schedules Table 9.3 Breaks in Service Table 9.4 §415 Limits Benefits Chart (Bb – Course Information) October 2, 2010 Thomas E. Murphy 76 Tables and Illustrations
77. Legal Compliance You need a good lawyer! But, we have come a long way since 1974. Plan Sponsors must be aware of their legal obligations. And those of their delegated fiduciaries. ERISA and the relevant IRC are complicated laws requiring special legal help. October 2, 2010 Thomas E. Murphy 77
http://www.dol.gov/ebsa/regs/fedreg/final/07-5147.pdfWhat about automatic enrollments and choice of investments? (§404(c)(5) See also: http://www.dol.gov/ebsa/regs/fab2008-3.html/and: http://www.butzel.com/pdf/071105enBEN.pdf/
