United States: Qualified Retirement Plans: October 2004 Developments

Special Editions of this Newsletter in October covered the nonqualified deferred compensation provisions of the American Jobs Creation Act of 2004 (AJCA) and the cost-of-living adjustments to certain dollar limitations for pension plans. (*please click on 'Next Page' link at bottom of page to view these articles). The AJCA became law when the President signed it on October 22, 2004, and we encourage you to focus on your nonqualified deferred compensation plans soon. The top four things to do are:

• Identify the covered plans or programs in your organization.

• Consider advantages and disadvantages of preserving prior law "grandfathering" for deferred amounts as of December 31, 2004.

• Identify the changes needed to continuing programs for amounts deferred after 2004.

• Don’t make any material modifications to existing deferred compensation arrangements without consulting with your legal advisor. Such action may make pre-2005 deferred compensation subject to the new law and its restrictions.

We are actively advising clients in this area and are well-prepared to assist you in your review and analysis.

Safe harbor rollovers are coming March 28, 2005. We summarized the final regulations in the regular October Newsletter. Since this is a time-sensitive matter, we want to emphasize the need to start thinking about how your qualified plans will comply. The final rule applies the safe harbor it creates to rollovers of mandatory distributions of $1,000 or less as appropriate, allows fiduciaries to rely on plan provider agreements with IRA providers, and drops the earned income cap on fees and expenses included in the proposed regulations. The information concerning automatic rollovers must be included in the plan’s summary plan description or summary of material modifications. The IRA provider agreement is an important document that should be reviewed with your legal advisor.

The Labor Department’s Employee Benefits Security Administration (EBSA) issued guidance on what steps fiduciaries of terminating defined contribution plans should take to find missing participants to make final distributions. When deciding how far to go with the recommended search methods, EBSA indicated that "a plan fiduciary must consider the size of the participant’s account balance and the expenses involved in attempting to locate the missing participant." Reasonable search expenses may be charged to the participant’s account. The search methods to be considered, according to EBSA, include:

• Using certified mail

• Checking records of related employer plans, such as group health plans.

• Checking with a designated plan beneficiary named by the missing participant for updated information, or asking that beneficiary to forward a letter to the missing participant.

• Using a government letter-forwarding service, such as the one sponsored by the IRS or the Social Security Administration.

• Using internet search tools, commercial locator services, or credit reporting agencies.

• If a missing participant cannot be located, then EBSA said there may be a distribution of the participant’s assets in one of the following ways:

• Open an Individual Retirement Account. Following the steps in the safe harbor rules for automatic rollovers will satisfy fiduciary responsibilities with regard to this transfer.

• If no rollover IRA is possible, then an interest bearing account may be opened at a federally-insured bank, or the funds may be transferred to the unclaimed property fund of the state where the missing participant was known to have lived most recently. These will be taxable transfers. The customer identification and verification provisions (CIP) of the USA Patriot Act will not apply until the missing participant or beneficiary contacts the IRA custodian or bank to assert ownership of the account.

Church pension plans are now able to invest in collective trusts. H.R. 1533 became Public Law 108-359 in October. It amends the Investment Company Act of 1940, the Securities Act of 1933, and the Securities Exchange Act of 1934 to permit church pension plans to invest in collective trusts. The legislation makes it easier for church plans to diversify their investments and to share expenses with other pension plans.

ERISA lawsuits are at an all time high, according to news reports. The trend is attributed to problems with 401(k) plans and corporate governance scandals at major corporations. Most recently, the insurance industry has come under attack with allegations of bid rigging to keep prices (paid in some cases by ERISA plans) artificially high. Other service providers to ERISA plans are also under scrutiny with respect to their fee arrangements, including "placement fees." What can responsible plan fiduciaries and administrators do?

• Make sure your plan documents, summary plan descriptions, and other employee communications offer maximum insulation to allegations of breach of fiduciary duty.

• ERISA fiduciaries must adhere to the principles of "procedural prudence." Identify those actions that are subject to fiduciary standards and create paper trails of the decision making process.

• Monitor investment performance and the reasonableness of all fees charged to the plan.

• Keep in contact with qualified ERISA legal counsel on ERISA plan matters to help avoid or minimize exposure to loss. (We know this sounds self-serving, but that does not mean it is not good advice during these difficult times for retirement plans!)

The Securities and Exchange Commission (SEC) has asked companies with very large liabilities for pension and retiree health benefits (including GM, Ford, Delphi, and Northwest Airlines) to provide information as part of an SEC inquiry into corporate pension and health care accounting practices. There is, according to the SEC, no knowledge of violations at these or other companies, but a review is apparently underway to examine whether corporations may be manipulating earnings improperly by altering projections for the future cost of retiree health care, future pension plan investment returns, and other factors. As reported in the New York Times, a one percent increase by GM in its health care inflation assumption would add $7.6 billion to its future health care liability for retirees and reduce annual earnings by $539 million (or more than the company made in its most recent quarter).

The Working Families Tax Relief Act of 2004 (WFTRA), enacted in October, extends the Mental Health Parity Act to December 31, 2005. WFTRA also establishes a uniform definition of "qualifying child" for purposes of the Internal Revenue Code’s dependency exemption, the child tax credit, the earned income credit, the dependent care tax credit, and head of household filing status for taxable years beginning after December 31, 2004. The Code’s definition of "dependent" in Code Section 152 is also significantly revised, now categorizing a "dependent" as either a "qualifying child" or a "qualifying relative."

The Archer MSA and Health Care Spending Account limitations, adjusted for cost-of-living increases, are announced for 2005. For Archer MSAs, a high deductible health plan is a plan with an annual deductible of at least $1,750 and not more than $2,650 in the case of individual coverage, with an annual deductible of at least $3,500 and not more than $5,250 in the case of family coverage, and under which the annual out-of-pocket expenses doesn’t exceed $3,500 for individual coverage and $6,450 for family coverage. HSAs may only be maintained by persons covered by a high deductible health plan (HDHP). An HDHP for 2005 will have an annual deductible of at least $1,000 for individual coverage ($2,050 for family coverage) and maximum out-of-pocket expenses of $5,100 for individual coverage ($10,250 for family coverage). Unlike Archer MSAs, which limit establishment to the self-employed and employees of small employers, an HSA may be established by anyone who has an HDHP.

The American Jobs Creation Act includes the long-sought after determination that income generated upon the exercise of incentive stock options and employee stock purchase plan stock options ("statutory stock options") is not subject to wage withholding and employment taxes. The legislation was adopted in response to Treasury regulations proposed in 2003 that threatened to apply FICA and FUTA taxes beginning in 2003. High tech industry and payroll and business groups are relieved.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.