IRS Issues Helpful Partial Termination Guidance for Defined Contribution Plans
A retirement plan is not qualified unless the plan, following a partial termination, fully vests the benefits an affected participant accrued as of the date of the partial termination. Whether or not a partial termination of a qualified plan occurs on account of participant turnover depends on all the facts and circumstances in a particular case. For many years, plan sponsors have been looking for clear and uniform standards for determining when a partial termination is deemed to occur. A new Internal Revenue Service (IRS) ruling brings welcome guidance.

The IRS recently ruled that a partial termination of a qualified defined contribution retirement plan occurred when 23 percent of the plan participants ceased active participation in the plan due to a severance from employment (excluding any severance from employment that is either on account of death or disability, or retirement on or after normal retirement age) during the plan year. In this case, some of the affected participants were already fully vested because they either completed three years of service or attained age 65.

In reaching its decision, the IRS indicated that, depending on the facts and circumstances, there is a presumption that a partial termination of the plan has occurred if the turnover rate is at least 20 percent for the applicable period. The applicable period for calculating the turnover rate is a plan year (or, in the case of a plan year that is less than 12 months, the plan year plus the immediately preceding plan year) or a longer period if there are a series of related severances from employment. The turnover rate is determined taking into account only employer-initiated severances from employment. An employee’s severance from employment is employer-initiated even if it is caused by an event outside of the employer’s control, such as severance due to depressed economic conditions. All participating employees are taken into account in calculating the turnover rate, including vested as well as nonvested participating employees. (Revenue Ruling 2007-43)

IRS Reaching Out to Public Schools to Assure 403(b) Compliance
The IRS is expanding its efforts to ensure that public schools are complying with the universal availability requirement for the 403(b) plans they offer. This universal availability rule requires an employer that permits any employee to defer salary into a 403(b) plan to generally extend the same offer to all employees of the organization with the following limited exceptions: employees who will contribute $200 annually or less; employees who participate in a 401(k) or 457 plan or in another 403(b) plan; non-resident aliens; employees who normally work less than 20 hours per week; and students performing services described in Internal Revenue Code § 3121(b)(10). Some schools and school districts may not be offering all eligible employees the opportunity to participate in 403(b) plans, as required by the universal availability rule. Typical noncompliance involves excluding 403(b) plan participation by certain classes of employees, such as substitute teachers, janitors, cafeteria workers, and nurses.

To assess the level of compliance, the IRS is sending questionnaires to public school districts in all 50 states under the auspices of its 403(b) Universal Availability project. School districts may be contacted as part of the project through 2008. Schools that receive the questionnaire should answer it completely and accurately. If a potential problem is identified, the IRS has indicated that it will correspond with the school or district to help it analyze its 403(b) plan to determine whether it is in compliance. The IRS also has indicated that IRS-sanctioned correction methods will be made available to correct a noncompliance problem and that the IRS will not impose a sanction if a school makes timely corrections. (IR-2007-123)

Prototype Roth IRA Sponsors Must Amend Documents to Accept Rollover Contributions
The IRS announced that sponsors of prototype Roth IRAs who wish to accept rollover contributions from designated Roth accounts under a qualified Roth contribution program that is part of a § 401(k) plan or a § 403(b) plan must amend their prototype Roth IRA documents to allow these rollover contributions. For a Roth IRA that is intended to be a prototype Roth IRA to accept an eligible rollover contribution from a designated Roth account, the prototype Roth IRA document must be amended no later than December 31, 2007. If a prototype Roth IRA accepts a rollover from a designated Roth account prior to the date of amendment, the mere acceptance of the rollover contribution will not affect the Roth IRA’s prototype status, as long as an amendment is adopted on a timely basis. IRS Model Roth IRAs (Forms 5305-R, 5305-RA, and 5305-RB) already contain language permitting the acceptance of rollovers from designated Roth accounts. Thus, users of those forms do not need to amend their IRA document to permit such rollovers. (IRS Announcement 2007-55)

Chief Financial Officers No Longer Covered By $1 Million Limitation on Deduction of Compensation
Internal Revenue Code (IRC) § 162(m) generally provides that a publicly traded company may not deduct compensation with respect to “covered employees” to the extent that the compensation exceeds $1 million unless the compensation meets some exception, such as performance based compensation. The definition of “covered employee” under IRC § 162(m) provides that an individual is a covered employee if on the last day of the taxable year the individual is the chief executive officer or is an individual whose compensation is required to be reported under the executive compensation disclosure rules of the Securities Exchange Act by reason of being among the four highest paid officers other than the chief executive officer.

Recently the Securities and Exchange Commission (SEC) modified the disclosure rules to provide that executive compensation disclosure is required for the company’s principal executive officer/CEO, the principal financial officer/CFO, and the three other most highly compensated officers at the end of the year. Because of this modification, the IRS needed to clarify which individuals were subject to the limitations of IRC § 162(m).

In Notice 2007-49, the IRS has indicated that the term “covered employee” means the individual who at the close of the taxable year is the principal executive officer/CEO and any employee for whom disclosure is required based on their compensation. This interpretation excludes individuals where disclosure is required because the individual is the principal financial officer/CFO. This change means that only four individuals would be covered employees for purposes of IRC § 162(m).

While the notice did not specifically state an effective date, it would appear that this interpretation would be tied to the SEC’s effective date for executive compensation disclosure, which applies to fiscal years ending on or after December 15, 2006. (IRS Notice 2007-49)

IRS Announces Mid-Year Adoptions Do Not Threaten Safe Harbor Status of 401(k) Plans
In response to employer concerns about mid-year changes endangering the “safe harbor” status of their 401(k) safe harbor plans, the IRS issued Announcement 2007-59. The announcement provides that a plan will not fail to be a 401(k) safe harbor plan because of a mid-year adoption of a qualified Roth contributions program or additional hardship withdrawal provisions. The guidance clarifies that, although the required pre-year safe harbor notice did not include the added provisions, the protection of safe harbor status will not be forfeited. (IRS Announcement 2007-59)

CASES

Supreme Court Rejects Plan Merger as a Means of Termination
The distinction between “settlor” functions and fiduciary functions for employee benefit plans is an important one for employers and plan fiduciaries. Settlor functions include the decisions to establish and terminate a plan, to amend or change it, and other similar business decisions about the form or structure of a plan. A recent U.S. Supreme Court case examined the question of whether an employer had a fiduciary responsibility to consider a plan merger as a means to terminate its single employer defined benefit plan. The employer in this case maintained several defined benefit plans covering its employees. In the course of a bankruptcy liquidation, the employer considered the purchase of an annuity contract or the payment of lump sums as a means to effect the termination of one of its defined benefit plans covering the members of the PACE International Union. The plan had about $5 million more in assets than needed to settle the plan obligations under the Pension Benefit Guaranty Corporation's termination rules. The union proposed that the employer merge the plan and its surplus assets into a multi-employer plan benefiting the covered employees. While such a plan merger would be a permissible transaction, the court concluded that a merger is not a means of plan termination. The union’s argument in this case was based on a Employee Retirement Income Security Act of 1974 (ERISA) mandate that plan fiduciary decisions be made for the exclusive benefit of plan participants and beneficiaries. The union argued that the employer decision to purchase an annuity (and to realize a $5 million reversion of surplus assets) rather than to merge the plan and all its assets into a multi-employer plan was a fiduciary decision that breached ERISA’s “exclusive benefit” rule. The court rejected this argument on the basis that a plan merger is not a method of terminating a pension plan. This decision permits the realization of the $5 million asset reversion. Beck v. PACE International Union (U.S. Sup. Ct. 2007)

Lawsuit to Compel Expanded Mutual Fund Disclosures Dismissed
A lawsuit filed to compel disclosure of the distribution of mutual fund fees utilized in the administration and maintenance of a 401(k) plan and attacking the reasonableness of those fees has been dismissed in a federal district court. Plaintiffs in this case alleged that the 401(k) plan maintained by Deere & Company was obligated under ERISA disclosure requirements to more fully disclose the application of asset-based fees. The fees were included as part of the mutual funds used in a Deere & Co. 401(k) plan. Under the funds, a portion of the revenue from asset-based fees was shared with other parties to cover the costs of plan administration. The asset-based fees taken out of the mutual funds were generally disclosed by the plan through reports and prospectuses, but these disclosures did not describe the precise entities and amounts paid to compensate for various plan services. Fidelity and the plan argued that the additional disclosures were not mandated by ERISA. The plaintiffs also asserted that the fees were unreasonably high and thus violated fiduciary standards for an ERISA plan. The court rejected these claims and granted a dismissal of the lawsuit. The pressure to provide more fee and revenue-sharing disclosures may continue through the Department of Labor rules; it will not come in the first instance from this court. Hecker v. Deere & Company (W.D. Wisc. 2007)

Retiree Medical Plans May “Wrap Around” Medicare
It is common for sponsors of retiree medical plans to coordinate retiree medical benefits with Medicare (i.e., to provide reduced benefits or no benefits for Medicare-eligible retirees). In a controversial case decided in 2000, the Court of Appeals for the Third Circuit in Erie County Retirees’ Association v. County of Erie (3rd Cir. 2000) held that a plan sponsor would violate the Age Discrimination and Employment Act (ADEA) if it reduced a retiree’s health benefits upon the retiree’s entitlement to Medicare. Concerned that Erie County would cause plan sponsors to reduce or eliminate retiree medical plans, the Equal Employment Opportunity Commission (EEOC) issued a proposed regulation permitting the medical plan design at issue in Erie County (i.e., permitting the coordination of retiree medical benefits with Medicare). In response to the EEOC regulation, the AARP filed suit in federal court to prevent finalization of the proposed regulation. In the October 2005 issue of Employee Benefits Developments, we summarized the complex litigation that followed. In the end, the Court of Appeals for the Third Circuit upheld the regulation, affirming the EEOC’s authority to exempt arrangements that are “reasonable” and “necessary and proper in the public interest.” This ruling, if it stands, removes any reasonable doubt concerning the legality under ADEA of retiree medical plans that provide for the reduction or elimination of benefits for retirees who are Medicare eligible. (AARP v. Equal Employment Opportunity Commission, 3rd Cir. 2007)

Ex-Wife is Only “Surviving Spouse” Entitled to Benefits
In a recent decision from the Western District of Kentucky, an ex-wife who was named a surviving spouse under a qualified domestic relations order (QDRO) was awarded the entire surviving spouse benefit in her ex-husband’s defined benefit plan, even though the ex-husband was married to another at the time of his death. A 1994 QDRO had awarded a portion of a participant’s benefits in the Ford Motor Company UAW Retirement Plan (the Plan) to the participant’s first wife. The QDRO also stated that she was to “be treated as a surviving spouse under the Plan.” The participant later remarried, and, at the time of his retirement in 2004, he elected to receive his Plan benefits in the form of a qualified joint and survivor annuity, designating his second wife as his surviving spouse. On the participant’s death in 2004, the Plan began paying the entire surviving spouse benefit to the first wife. The second wife ultimately sued the Plan, claiming she was entitled to a portion of the surviving spouse benefit. The court denied her claim, finding that the QDRO did not affirmatively state that the first wife would receive only a portion of the surviving spouse benefits. Noting that the terms of a QDRO could be overturned only if they were ambiguous, the court found no ambiguity in the language. The court found nothing in the QDRO to indicate the alternate payee “was to receive anything less than the full surviving spouse benefit.” The lesson for participants is that if the intent is to award only a portion of a surviving spouse benefit in a retirement plan to an ex-spouse following divorce, the QDRO must state so unambiguously. Braehler v. Ford Motor Co. UAW Retirement Plan (W.D.Ky., 2007)

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