DOL Issues Interim Regulations Clarifying QDROs

In response to a specific statutory directive contained in the Pension Protection Act of 2006, the Department of Labor’s Employee Benefits Security Administration issued interim final regulations that clarify the qualified status of certain domestic relation orders. The interim regulations make clear that certain situations, relating to timing and order of issuance, do not threaten the qualified status of an otherwise qualified domestic relations order (QDRO).

The following examples are used in the regulations to illustrate that a QDRO does not lose its qualified status solely because the order is issued after or revises a prior domestic relations order (DRO) or QDRO:

• A second DRO between a participant and an ex-spouse will not fail to be a QDRO solely because the amount assigned under the first DRO has been reduced by the second.
• A subsequent DRO between a participant and a second ex-spouse will not fail to be a QDRO, so long as the benefits assigned to the second ex-spouse were not already assigned under the first QDRO.

The following examples are used by the regulations to illustrate circumstances where a QDRO will not lose its qualified status because of the time at which it is issued:

• A QDRO issued to correct a defective DRO will not fail to be qualified, even if the corrective QDRO is issued after the participant’s death.
• A QDRO issued after a divorce will retain its qualified status even though it treats a former spouse as a spouse for the purposes of receiving death benefits.
• A QDRO issued after the participant’s annuity starting date may assign benefits to an ex-spouse even if that ex-spouse previously waived rights to a survivor benefit.

The effective date for the interim regulations is April 6, 2007.

IRS Allows Employer to Fund HRAs With Unused Vacation and Sick Leave

The Internal Revenue Service issued a private letter ruling (PLR) allowing an employer to fund Health Reimbursement Arrangements (HRAs) for retirees with the retirees’ unused vacation and sick leave. Under the arrangement, eligible employees are automatically covered by the plan and are not permitted to elect out of coverage.

Contributions to the HRAs include discretionary employer contributions and the value of the retirees’ unused sick leave and vacation time. The employees are not allowed to elect to receive any amount of the unused vacation time or sick leave in cash. Moreover, any HRA balance remaining after the deaths of the retiree, the retiree’s spouse, and dependent children will be forfeited.

The IRS determined that this funding arrangement does not violate the requirement that HRAs be funded solely by the employer. Because the value of the unused vacation and sick leave can not be converted into cash, the contributions are treated as employer contributions. As a result, the contributions are excludable from the retired employees’ income as employer provided health benefits.

PLRs are often used as guidance as to how the IRS interprets specific issues; however, PLRs may not be cited as precedent and may only be relied on by the taxpayer requesting it. (PLR 200708006)

IRS Notice Issued on Pension Protection Act Deduction Limits

The IRS issued Notice 2007-28 to describe some of the new deduction limits under the Pension Protection Act of 2006 (PPA) that apply for years beginning in 2006. Additional changes under PPA will first be applicable in 2008 and are not covered under this notice. The notice deals with some of the complex new funding rules for defined benefit plans, including situations where an employer’s taxable year differs from the plan year of the plan and cases where an employer maintains both a defined benefit plan and a defined contribution plan covering the same employees. Some of the 2006 rules relate to the permissible range of interest rates that may be used to calculate defined benefit liabilities and limitations related to a defined benefit plan’s overall current liabilities. For any employer maintaining defined benefit plans, consultation with the plan actuary is recommended to clarify the impact of these new rules. The notice also describes new rules that permit an employer to maintain a 401(k) plan with salary reduction contributions together with employer contributions (matching as well as other employer contributions) without regard to the rules limiting deductions for combined plans. If the employer contributions to a 401(k) plan (not counting any employee elective deferrals) do not exceed 6% of the sum of all participant compensation, the combined plan limits do not apply. A later notice will be issued by the IRS dealing with the 2008 deduction limits. (IRS Notice 2007-28, IRB 2007-14)

Cases

Oral Promise of Benefits Did Not Establish an ERISA Plan

At times, courts have found plans to exist under the Employee Retirement Income Security Act of 1974 (ERISA), even in the absence of a formal, written plan document, but a different conclusion was reached in a recent court case.

During negotiations over employment terms, an employer allegedly told an employee that if he accepted a job, the employer, in addition to a his salary, would establish a pension fund for him. The employee alleges that the terms were written on a legal writing pad, but a copy of that writing was never produced. The employee also alleges he was assured on numerous occasions that the employer had “taken care of” his pension benefit. The employer’s business failed and the employer ultimately did not deliver the promised benefit. The employee sued to recover the benefit.

The trial court rejected the employee’s ERISA claims after finding that there were “no surrounding circumstances other than [the employer’s] alleged oral assurances from which a reasonable person could ascertain that [the employer] intended to set up the pension fund for [the employee].” The employee appealed and the federal appellate court upheld the ruling of the trial court. The appellate court noted that a plan, fund, or program under ERISA “is established if from the surrounding circumstances a reasonable person can ascertain the intended benefits, a class of beneficiaries, the source of financing, and procedures for receiving benefits.”

Viewing the available evidence in the light most favorable to plaintiff, the appellate court concluded that no reasonable fact finder could find that the employer had established or maintained a pension plan under ERISA. (Guilbert v. Gardner (2d Cir. 2007))

Eighth Circuit Rules Pregnancy Discrimination Act of 1978 (PDA) Does Not Encompass Contraception

An employer provided health care benefits that excluded coverage for both male and female contraceptive methods, including prescription and non-prescription, when used for the sole purpose of contraception. Coverage for contraception was available only when it was medically necessary for a noncontraceptive purpose (regulating menstrual cycles, treating skin conditions, avoiding serious health risks associated with pregnancy, etc.).

A class-action lawsuit was brought by female employees of child-bearing age who used prescription contraception for contraceptive purposes. The trial court found that the employer’s failure to cover prescription contraception violated Title VII of the 1964 Civil Rights Act, as amended by PDA, because “it treats medical care women need to prevent pregnancy less favorably than it treats medical care needed to prevent other medical conditions that are no greater threat to employees’ health than is pregnancy.” The employer appealed the case.

Neither the federal circuit courts nor the United States Supreme Court had previously considered whether PDA applies to contraception. In a 2 to 1 decision, the Eighth Circuit court overturned the lower court ruling and held that PDA “does not require coverage of contraception because contraception is not ‘related to’ pregnancy for PDA purposes and is gender-neutral.”

The law on this issue, however, is by no means settled. Further appeals of the Eighth Circuit case are quite possible. Other federal circuit courts have yet to take up this issue, and district court decisions coming from some of the other circuits are split. (In re Union Pac. R.R. Employment Practices Litig. (8th Cir. 2007))

Details of Actuarial Reduction Not Required in SPD

A group of former employees sued the Dunn & Bradstreet Master Retirement Plan (Plan) over the calculation of actuarial reductions for benefits commencing prior to normal retirement age.

The Plan provides that early retirement benefits could begin as early as age 55. The Plan and the related Summary Plan Description (SPD) provide that, for employees who are employed by Dunn & Bradstreet at the time they become eligible for early retirement, the actuarial reduction is a factor of 3% per year from age 65. For employees no longer employed by Dunn & Bradstreet when they attain age 55, the Plan provides for a reduction by a using a discount factor of 6.75% per year and a reduction for a mortality factor from age 65.

The SPD does not provide the details of this actuarial reduction but merely states that the plan benefit will be actuarially reduced. The plaintiffs claimed that the failure to describe the details of the actuarial reduction in the SPD violates ERISA.

The Court of Appeals for the Second Circuit, upholding the district court decision, held that “…neither ERISA nor the Labor Department’s regulation require a summary plan description to describe or illustrate every method by which a plan benefit may be limited under an early payment option or similar such limitations.”

The former employees also claimed that the 6.75% factor is an unreasonably high discount rate. Again, the Second Circuit upheld the district court decision that there is no requirement in ERISA for a plan to use a zero risk discount rate or a rate that is practically risk free, finding that the regulations allow a degree of discretion in setting discount rates according to reasonable actuarial assumptions. (McCarthy v. Dun & Bradstreet Corp., 2d Cir., 2007)

Fund Manager Is Plan Fiduciary; Self-Approved Pay Increases Violate Fiduciary Duty

The Court of Appeals for the Second Circuit ruled that a multiemployer fund manager, who was paid out of plan assets, breached his fiduciary responsibilities to the plan for granting himself and his son pay raises for work done for the plan.

The fund manager attempted to justify his actions on the basis that the plan trustees either knew or should have known of the increases he granted himself and his son, and thus the raises were tacitly approved by the trustees. The appeals court concluded, however, that the increases were actions taken by the manager in his own personal interest, and this violated the statutory requirement that a plan fiduciary cannot “deal with the assets of the plan in his own interest or for his own account.” Thus, a breach of duty occurred regardless of whether the trustees knew about or should have known about the action.

Given the self-serving nature of the decisions at issue, other fiduciaries in similar circumstances now know or should know that approval from independent trustees or other fiduciaries is an indispensable prerequisite to any similar action. (LaScala v. Scrufari, 2d Cir. 2007)

When is a Brokerage Firm a Fiduciary?

The District Court for the Western District of Michigan held that an investment broker was an investment fiduciary with respect to a 401(k) plan, even though the broker was not a named fiduciary of the plan, had not expressly agreed to assume fiduciary status, and did not have discretionary authority to make investment decisions.

In this case, the plan’s former trustee made substantial loans to the employer-sponsor of the plan resulting in substantial losses to the plan’s investments. The loans were prohibited transactions. Upon learning of the loans, the successor trustee filed suit against the plan’s investment broker (among others) seeking compensation for the plan’s losses.

The successor trustee claimed that the investment broker was a fiduciary, breached its duties to the plan and, by reason of its breach, caused the investment losses. The broker asked the district court to dismiss the suit, arguing (among other things) that it was not a fiduciary because it had not exercised discretionary control over the investment of the plan’s investments.

The court rejected the broker’s argument, ruling that investment discretion is not a necessary element of fiduciary status. In so ruling, the court noted that ERISA’s definition of fiduciary includes any person who renders “investment advice” for a fee or other compensation, and not just persons with discretionary investment authority. Under Department of Labor regulations, a person (e.g., a nondiscretionary broker) provides investment advice to a plan if the person provides:
(a) individualized advice (i.e., advice specific to the plan),
(b) on a regular basis,
(c) pursuant to a mutual agreement or understanding, whether or not written, that the advice will serve as a primary basis for investment decisions.

Applying the facts to the articulated elements, the court found the broker was an investment fiduciary: the broker received commissions and, therefore, compensation for the services rendered; the advice given was specific to the plan (i.e., based on the plan’s risk/reward profile); the advice was the plan’s only source of investment advice and had always been followed (i.e., it was the “primary” basis for plan investment decisions).

A brokerage firm that does not intend to assume fiduciary status should document its non-fiduciary status in its agreement with the plan’s investment fiduciaries and avoid the kinds of individualized services that could lead to a finding of fiduciary status. (Ellis v. Rycenga Homes, Inc, W.D. Mich. 2007)

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