Volume 41 | Issue 87 | November 2, 2018
Download this FYI In-Depth as a printable PDF
The calendar provided in this FYI In-Depth will help you set up your own schedule of activities to address as the year progresses so that you do not miss important deadlines for your qualified plans. As you evaluate the various tasks, you can confirm suitable deadlines with your vendors for their completion. Our Reporting and Disclosure Guide will help you identify and address other activities that are event-based and participant specific. As you make your plans, we have a number of key issues for you to consider (along with the calendar deadlines) as we head into 2019.
Communicating with Your Actuary
Rising interest rates and the longest bull market since WWII should have plan sponsors evaluating the future of their qualified pension plans to determine if the level of risk is appropriate. While there continues to be significant volatility in the markets, overall funded status continues to improve for many plans. Further, adjustments to funding policy in light of the eventual phasing out of funding relief, management of escalating PBGC premiums, and preparation for changes to mortality tables used to determine funding requirements should be on your checklist for serious discussions with your plan’s actuary.
Set an endgame strategy for closed or frozen plans. Employers managing a closed or frozen pension plan should map out a strategy either to eventually terminate their plan or, alternatively, to manage the plan in a low risk state (referred to as “hibernation”). Employers should establish realistic goals and objectives that take into account their ability to fund, risk tolerance and time horizon — and risk tolerance should be expressly articulated in the plan’s Investment Policy Statement (IPS). The plan’s investment strategy should also be reviewed and appropriately adjusted to achieve best risk-adjusted returns, in particular if a change to the plan, such as freezing benefits, has recently occurred. Plan data will also need to be cleaned up to terminate a plan. Remediation steps (e.g., identify missing or incomplete data, prepare benefit calculations, ensure adequate documentation of plan provisions, locate missing participants, etc.) can take time, so the cleanup process should begin well in advance of the termination. Risk transfers prior to formal termination (e.g., lump sums, selected retiree annuitization) may also make sense, but they need to be reviewed in the context of the overall exit strategy. For example, a strategy that annuitizes retirees ahead of plan termination and leaves a plan with only deferred vested participants could lead to higher costs down the road, because the stand-alone deferred vested population may not be as attractive to insurers as a plan that has a mix of immediate and deferred participants. One consideration for this could be just to annuitize retirees that have small annuity amounts. This would eliminate expensive PBGC premiums for this group of retirees in addition to transferring the risk of their benefits, without greatly impacting the expected cost for annuities at plan termination.
Evaluate asset allocation. As of September 30, discount rates for an index of sample plans had increased 60 basis points since the end of 2017, and discount rates have increased even further in October. (Exact increase will vary by plan depending on the shape of their benefit payment stream.) In addition, in October there has been a fair amount of discount rate volatility. The rise in interest rates and the increase in volatility has led to opportunities for plan sponsors.
- Sponsors who were holding off on exploring plan terminations due to high cost associated with low interest rates, may wish to revisit this topic. Even with the October equity market correction, sponsors may find that their funded ratios have improved enough that important goals — plan termination, eliminating PBGC variable premiums — are in reach.
- The volatile interest rate environment may lead to temporary windows of opportunity to de-risk before interest rates potentially drop. To take advantage of these opportunities, plan sponsors will want to consider implementing a de-risking glide path in their plan’s Investment Policy Statement so that investment managers can act on de-risking while the opportunity exists. Waiting for the next Pension Committee meeting may lead to missing such opportunities. Outsourcing investment responsibilities to a third-party Outsourced Chief Investment Officer who monitors funded status daily may be an effective way to implement this strategy.
- Also, in light of rising interest rates, plan sponsors will want to consider whether the duration of their assets and/or liabilities has changed enough that an adjustment to the asset allocation is warranted.
Finally, given increased equity volatility in the past month, plan sponsors should consider whether their asset portfolio is appropriately diversified, whether the plan’s interest rate hedge ratio is appropriate, and whether the level of “return generating assets” including equities is appropriate for the plan sponsor’s risk tolerance and risk budget. These conversations would ideally include the plan’s investment advisor and actuary, so that decisions can be made taking both assets and liabilities (and their interplay) into consideration.
Prepare for the phasing out of funding relief. Recent legislation has extended funding relief provided through interest rate corridors through 2020. The 10 percent corridors will begin increasing by 5 percent per year in 2021, reaching an ultimate level of 30 percent in 2024. Our November 2, 2015 FYI Alert spells out the details. Funding policies and budgeting should be adjusted to reflect the funding relief fading away. For example, while the extension of funding relief has temporarily lowered the plan’s minimum required contributions, you may consider contributing more now to prepare for funding interest rates that will eventually align closer to the unsmoothed, lower rates and thus higher liabilities and contribution requirements. Making additional contributions would also help to proactively reduce some of the contribution volatility during this period as well as lower PBGC variable premiums. Employers should keep in mind that the ultimate cost of a plan is the amount paid out in benefits, and reduced funding today will translate to higher funding requirements tomorrow. Each plan sponsor should develop a funding policy that will achieve business objectives, like avoiding a funding spike once the corridor widens, being able to terminate the plan within a desired time frame, and enhancing participant benefit security — such as assuring participants have access to intended benefit distribution options.
Address escalating PBGC premiums. Further escalation of both the flat-rate premium paid for all defined benefit plans, as well as the additional variable rate premium paid for underfunded plans, are phased in through 2019. The flat rate premium, now $74 (for 2018) per plan participant, will increase to $80 in 2019, while the variable rate premium will increase from the current (2018) $38 per $1,000 of plan underfunding to $43 in 2019. In addition, the per-participant cap on variable rate premiums will increase from $523 to $541 in 2019. Increasing contributions to address underfunding can help lower or even eliminate the variable rate premium. Other tactics, such as cleaning up data to eliminate “phantom participants” and risk transfers through annuity purchases or offering lump sum cashouts to former employees with deferred vested benefits, can also help lower both premiums. Employers should review forecasts of future premiums and determine which tactics to employ to manage this expense.
Note: Some employers have considered multi-step processes to take advantage of special rules in PBGC’s regulations that significantly reduce variable rate premium obligations. PBGC has announced that they may challenge “two-step” approaches that manipulate the substance of their rules — premium instructions have been modified accordingly. Caution is in order — sponsors could face higher premium bills if these strategies fail.
Consider mortality and other assumptions. We continue to see the effect of plan participants’ improving longevity on the cost of defined benefit plans. While recent studies indicate the rate at which mortality is improving has slowed, plan liabilities will generally continue to increase over time due to increasing longevity. As they are released, the most recent updates by the Society of Actuaries (SOA) to standard annuitant tables are reflected in plan and employer financial statements, and now, as explained in our October 10, 2017 For Your Information, the Treasury has mandated their use in determining ERISA minimum funding requirements and PBGC premiums beginning with 2018 or 2019 valuations (depending on use of a transition option). With a 2018 update from the SOA last month showing further slowing in the rate of improvement, the 2020 table may prove less costly for plans than the previously announced table for 2019 based on earlier updates (see our December 15, 2017 FYI Alert).
The 2015 Bipartisan Budget Act allows greater flexibility in setting plan mortality assumptions for these purposes. The change in law allows plans to adjust the standard mortality assumptions so that they are more in line with their own plan populations’ past and expected mortality experience. Plan sponsors may wish to change the funding assumption to fully generational tables or explore adjustments to the SOA’s RP-2014 base mortality table to better reflect plan experience. Recent IRS guidance has at last indicated how this can be done, beginning as early as the 2018 plan year. You should discuss with your actuary whether the mortality assumption for minimum funding and PBGC premium purposes might be customized to reflect your plan’s expected experience. In addition to evaluating the assumptions for funding requirements, plan sponsors should also consider what assumptions are most appropriate for a rational funding policy. For this purpose, assumptions based on alternatives to the SOA standard table may lead to better budgeting forecasts.
Plan sponsors and their actuaries may also want to consider changes in other assumptions that may coincide with mortality improvements. In response to longer life expectancy and the longer period for making retirement savings last, many employees are planning to continue working beyond their plan’s “normal” retirement date. Aligning plan retirement assumptions with this new paradigm can reduce plan liabilities, particularly for retiree medical plans and pension plans with suspension of benefits provisions and generous early retirement subsidies. On the other hand, it can also boost liabilities for a plan that provides for generous actuarial increases to those electing late retirement.
Monitor requirements for reportable events and ERISA 4010 filings. Employers must report certain events to the PBGC either before or shortly after they occur. However, PBGC rules include waivers for select events based on the financial health of the plan sponsor and on SEC reports made by public companies, as described in our September 16, 2015 For Your Information. The waivers, however, will not always apply, so plan sponsors still need to be aware and monitor plan and corporate events on an ongoing basis to assure that reporting obligations are satisfied. But a determination early in the year that the new low-default-risk safe harbor, the well-funded plan safe harbor, or the small plan waiver is met, can significantly reduce the events that require monitoring.
Note: PBGC recently asked OMB to approve revised forms for submitting reportable events. Notably, the revised forms require the submission of more information for five events. For example, PBGC hopes to collect controlled group information, company financial statements, and the plan’s actuarial valuation report with the submission of an “active participant reduction” reportable event.
In addition, the PBGC updated ERISA 4010 reporting rules for underfunded plans as described in our March 25, 2016 For Your Information.
Consider discretionary funding. As noted in several of the sections above, there can be compelling reasons for employers to fund beyond required minimums, including more predictable budgeting, reduced PBGC premiums, allowing for risk transfer opportunities, and taking significant steps towards reducing plan risk to attain the ultimate end game strategy for the plan. Fortunately, many plan sponsors can either issue debt or access other borrowing sources at low rates to pay down higher cost pension deficits. Arguably, borrowing to fund is balance sheet neutral for most companies, with the new debt simply replacing the unfunded pension liability. With tax reform that lowered the corporate tax rate significantly in 2018, many companies made discretionary contributions before the tax rates changed to take advantage of a higher deduction. But for those that did not take advantage ahead of the tax change, it may still be worth running the numbers to determine if discretionary funding is a viable option for your company.
Review of Plan Administration
In addition to verifying that routine tasks are monitored in accordance with plan terms and administrative policies — such as making required minimum distributions, sending suspension of benefits notices, and attending to the myriad annual reporting and disclosure requirements — administrators must be on the alert for some not-so-common tasks. Here are some key areas to watch:
Update the “Special Tax Notice” for eligible rollover distributions. In September, the IRS issued Notice 2018-74 to update its Safe Harbor Explanations for eligible rollover distributions to take into account certain legislative changes and other recent guidance (see our September 19, 2018 For Your Information). The explanations, also known as the “Special Tax Notice Regarding Plan Payments” or the “Section 402(f) Notice,” generally must be provided to a recipient of an eligible rollover distribution between 30 and 180 days before an eligible rollover distribution is issued. If you haven’t done so already, make sure these notice updates are addressed in a timely manner and incorporated into distribution materials issued to recipients by the plan and its service providers.
Implement benefit restrictions if funding shortfall or top-25 highly compensated employees rules apply. Plans with funding levels that fall below select thresholds are required to hold the line on offering lump sum distributions and certain other payment options. Our October 28, 2009 For Your Information provides an overview of the Code Section 436 distribution restrictions. In addition, there are distribution limitations for plans subject to liquidity shortfalls and an employer’s (controlled group) top-25 highly compensated employees. The high-25 restrictions in one form or another have been present in IRS regulations since the pre-ERISA era but occasionally fall off the radar. Consider putting a date on your calendar to assess whether these restrictions apply.
Get set to trigger automatic payments. Plans can call for the automatic distribution of former employees’ benefits with values up to the $5,000 cashout limit without the participant’s affirmative consent. For values between $1,000 and $5,000, absent directions from the participant about how to make the payment, a default IRA rollover is often required under plan terms. Some plan sponsors had reduced the plan cashout limit to $1,000 to avoid the obligation of selecting a suitable vendor for the IRA. Some are reconsidering this decision in light of ever-increasing PBGC premiums and the larger number of established IRA providers that now offer such services. Amend your plan as appropriate if a change is warranted, and assure administration is in keeping with the plan document.
Caution: If a plan termination is underway, or will be soon, processing default IRA rollovers as a new or existing procedure for “missing” participants may be problematic. The PBGC may require the plan to either send funds to them under their missing participants program or buy the missing participant an annuity.
In addition to the automatic cashouts of small payments, two situations may trigger payments without specific plan participant elections. Many defined benefit plans specify that terminated vested participants must begin receiving benefits when they reach the plan’s normal retirement age. Plan administrators need to provide suitable qualified joint and survivor (QJSA) notices prior to that date and then begin payments in accordance with the terms of the plan. In the absence of a QJSA waiver, a plan in this situation would automatically begin distributions in the QJSA form. The second trigger for automatic payments arises in the case of active participants who must commence distributions under Code Section 415 regulations because their benefits are approaching the 100 percent high-three-year average compensation limit. Plans are not permitted to forfeit previously accrued benefits and, for post-normal retirement date periods, must either suspend benefits (if appropriate under the terms of the plan) or commence their payment.
Identify lost participants with vested benefits. Returned plan notices, statements or distribution checks should be researched timely to find lost participants. The sooner the search is started, the more likely it will be that terminated participants whose addresses have changed can be located. Although default rollover IRAs can be set up for participants with benefit values up to the cashout limit, other missing participants must be addressed at some point, and the DOL has been auditing the extent to which plan sponsors fulfill this obligation (see our March 15, 2016 For Your Information). More recently, audits have intensified with DOL alleging fiduciary breaches and assessing prohibited transaction penalties over missed payments. At plan termination, PBGC will accept funds to cover missing participants but will generally require the administrator to make a diligent effort to find former workers due a pension. PBGC will also accept funds for uncashed checks that have not been cashed by the “cash-by” date prescribed on the check or by a notice. Final changes to the program (see our January 2, 2018 For Your Information) modified their search requirements to generally match DOL guidance for terminating DC plans, but the DOL’s requirement to search other employer plan records would not be required for DB plans that use a commercial locator service.
The IRS provided a memo to its employee plan examiners on the steps plan sponsors must take before challenging the plan as failing to make required minimum distributions to missing participants. Specifically, the memo requires a plan sponsor to: (1) search plan and related plan information as well as public records for alternative contact information, (2) use a commercial locator service, credit reporting agency, or Internet search tool, and (3) send a letter by certified mail or make phone calls.
Remind participants of any opportunity to name beneficiaries. Many plan administrators have had to sort out competing claims for death benefits because of unclear or missing beneficiary designations. These disputes can sometimes result in costly litigation. Most plans must make a participant’s spouse the default beneficiary. If the plan offers a choice, and a participant wants survivor benefits paid to someone else, such as children, parents or a favorite charity, a properly executed beneficiary designation is the ticket. Make a point of reminding plan participants to update their beneficiary designations and let them know if they must use specific plan forms to make their designation.
Address foreign asset reporting obligations. To address tax evasion, money laundering and terrorist financing concerns, compliance requirements mandate reporting of assets held by foreign financial institutions (including retirement plans) and benefit distributions to certain individuals. Plan fiduciaries will want to assess compliance with these requirements, particularly the Foreign Account Tax Compliance Act (FATCA), the Report of Foreign Bank and Financial Accounts (FBAR), and regulations issued by Treasury’s Office of Foreign Assets Control (OFAC). Our June 12, 2014 For Your Information outlines these requirements; our April 4, 2017 For Your Information provides an update on filing timing.
Review and analyze insurance coverage. Two basic types of insurance are available to protect the plan:
Fidelity bond. A fidelity bond is required for every fiduciary of an employee benefit plan and every person who handles funds or other property of such a plan, with a few exceptions. On an annual basis, plans that require a fidelity bond should review existing bonds to ensure they have at least the required minimum coverage and that the elected level is appropriate for the plan. (In most circumstances, the amount of the required bond is capped at $500,000 for a plan without an employer securities fund and $1,000,000 for plans that hold employer securities.)
Fiduciary liability insurance. Insurance can be purchased to protect fiduciaries and the plan against liability or losses occurring due to a plan fiduciary’s act or omission. Fiduciaries are personally liable for losses incurred by a plan due to their breach; insurance can cover some or all of these losses. So, obtaining fiduciary liability insurance in the appropriate amount has become imperative. DOL has stepped up reviews and is keeping score of ever-increasing monetary recoveries resulting from their investigations — 1,707 investigations were undertaken in 2017 with 65.3% resulting in corrective action. This is in addition to dramatic settlements arising from ERISA class action litigation.
It’s important to analyze the insurance policy’s major defined terms to understand exactly what risks the policy covers. Furthermore, understanding when these policies are triggered is crucial to knowing whether the plan and its fiduciaries are adequately protected. An annual review of these policies may illuminate the requirement to report certain events to the insurer within a specific time frame to collect on a claim.
Key Point: Many policies cover compliance fees and penalties, such as those imposed by the IRS under their Voluntary Correction Program, but require timely notification to the insurer.
Plan Amendments, Filings and Documentation
Do your plan documents correctly describe the plan provisions as intended, and are summary plan descriptions (SPDs) and administrative procedures in sync with the official documents? Now that IRS has limited its determination letter program, an annual self-check should be considered.
Evaluate the need for plan amendments – and deadlines. IRS procedures call for executing discretionary amendments by the end of the plan year in which the amendment is operationally put into effect and provide extended amendment periods (generally to the end of the second calendar year following the year a topic is included on IRS’ Required Amendments (RA) list for individually designed plans) for modifications necessary to address changes in legal requirements. If you implemented discretionary changes during the year, make sure documentation is inked before the plan year is over. Our December 12, 2017 For Your Information discusses topics on the most recent RA list. These include the following:
Cash balance and other hybrid plans. Under final regulations for these plans, amendments needed to comply with the market-rate-of-return regulation were generally required by the end of the 2016 plan year, as reported in our November 16, 2015 For Your Information. The interest crediting rate under the plan may not be the only issue that required an amendment. Many plans need to adjust other provisions for 2017, such as lookback and stability periods, early and late retirement factors, and plan termination rules.
Partial annuity distributions. Final IRS regulations change the rules for plans that offer mixed distribution options, such as a partial lump sum and an annuity. Effective for distributions on or after January 1, 2017, some plans may need or want to change either benefit calculations or plan provisions. For details, see our September 14, 2016 For Your Information; for IRS’ model amendment, see our August 25, 2017 For Your Information. Then stay tuned for more guidance on distribution rules — IRS issued proposed regulations that may affect how your plan calculates lump sums and Social Security level income options. When finalized, additional plan amendments may be needed. Our December 1, 2016 For Your Information explains those changes.
Benefit restrictions for eligible cooperative or eligible charity defined benefit plans under Section 104 of PPA. An eligible cooperative plan or eligible charity plan that was not subject to the IRC Section 436 benefit restrictions for the 2016 plan year ordinarily became subject to those restrictions for plan years beginning on or after January 1, 2017. However, a Cooperative and Small Employer Charity (CSEC) plan continues not to be subject to those rules unless the plan sponsor has made an election to not treat the plan as a CSEC plan.
Additional amendments to attend to include changes in disability claim procedures (typically in documents, but not required for maintaining qualification) and possible compensation changes stemming from modifications in the 2017 Tax Cuts and Jobs Act:
Disability claims procedures. Retirement plans that make their own determinations of disability rather than relying on a determination by the employer’s long-term disability plan or the Social Security Administration, need to amend their claim procedures to meet DOL requirements that went into effect on April 1, 2018 as noted in our January 9, 2018 For Your Information.
Changes in compensation definitions. The Tax Cuts and Jobs Act changed the tax treatment of certain fringe benefits such as moving expenses for non-military personnel and bike commuting expenses for 2018. These changes may affect whether these items count as plan compensation for purposes of determining contributions and benefits. Even if there is no impact on plan compensation, it may be necessary or desirable to amend the definitions of pay used to apply the 415 limits and identify HCEs. Also, changes may need to be made in data collection and payroll practices.
If you missed making required amendments, consider IRS’ Voluntary Correction Program (VCP). IRS announces the VCP fees and associated rules each January in its Revenue Procedure for written determinations. Beginning in 2018, discounted VCP fees are no longer available to sponsors who voluntarily correct plan document failures within one year after the applicable deadline, which was the case for earlier years. Although VCPs are costly, the alternative of self-correction without filing is not permitted in this circumstance.
Make sure your summary plan description matches your plan document. In addition to being a disclosure required under ERISA, the SPD plays an important role in ERISA disputes, and a well-drafted and well-integrated plan and SPD will minimize successful challenges to plan determinations or fiduciary decisions. Make sure it, or a timely summary of material modifications (SMM), reflects any plan amendments made during the plan year. Don’t forget that an SPD must generally be restated and redistributed every five years.
Key Point: A factor in many plan challenges is the statute of limitations for taking an official complaint to the federal courts for review. Sponsors should confirm that plan documents state a statute of limitations period and announce that period in SPDs as well as benefit claim denial communications.
Assemble and maintain documentation. Keeping plans up to date is crucial — but don’t toss the old documents. Plan participants and beneficiaries may request prior plan materials, and plan administrators need to address requests within a 30-day window. Failure to comply can lead to legal challenges; a court may hold a plan administrator who fails to comply personally liable for up to $110 per day per affected person from the date of failure. Along with plan documents, SPDs and SMMs, be sure to create and maintain records of participant data, such as proof of benefit distributions, benefit elections and beneficiary designations. Arrange for continued access even after termination of the plan.
Key Point: PBGC asks plan sponsors to produce evidence about plan termination close-out distributions to address this recordkeeping issue. Provider information is required on benefits settled through annuities; and copies of canceled checks or a bank statement listing names and distribution amounts are generally required for benefits distributed in a lump sum.
Service Providers Need to Know
Have you provided your actuary, consultant, TPA, etc. with copies of current signed documents? Have you informed them of any changes in your controlled or affiliated service group? Your service providers need up-to-date information about you and your plans to be able to spot issues and assure quality service. Make sure to keep them in the loop!
In Closing
Planning with trusted advisors to identify tasks and set compliance goals for the coming year is an important first step for assuring smooth operation in 2019. In addition to the key items noted above, plan sponsors may want to perform an annual “checkup” (i.e., a review of operational practices and fiduciary responsibilities) to address plan expenses, design considerations, and investments and confirm compliance with the terms of the plan document and investment policy statement, if any. Review compliance test results with an eye toward making necessary plan design changes to improve testing results or eliminate testing altogether. You may elect to conduct your own review or contract with an independent party. Regardless of who performs the review, identifying problems and initiating corrections in advance of any audit by a government agency is the preferred course of action.
Open Calendar of Significant Defined Benefit Plan Compliance Tasks
We’ve published a companion to this planner:
FYI In-Depth: 2019 Planning for ERISA Single-Employer Defined Contribution Plan Operations.