New England Biz Law Update
The rules and requirements governing the Employee Retirement Income Security Act of 1974 are as myriad as they are complex and they are constantly changing.
The sanctions that can be imposed are truly draconian and most are personal to plan fiduciaries that have discretionary authority over administration and management of the plan and its assets (e.g., an employer, CFO, CEO, board of directors, HR director, and general counsel).
These sanctions were a hindrance to employers contemplating establishing and maintaining tax-qualified plans (e.g., 401(k) plans, defined benefit pension plans) as well as welfare benefit plans (e.g., health insurance, long term disability).
For this reason, the government decided to use a carrot-and-stick approach to legal compliance for ERISA plans. The “carrot” consists of self-correction programs that plan sponsors may use if mistakes are made. The “stick” is the extremely onerous tax and penalty regime imposed if a plan sponsor is caught out of compliance on audit or by a whistleblower.
The government has created voluntary compliance programs as a way to get the private sector to bring pension and welfare plans into legal compliance. Since the potential sanctions are so significant for violating the ERISA rules, the voluntary correction programs are very attractive.
However, these programs are not available if a plan is under governmental audit.
Therefore, it would behoove most employers to engage in a due diligence check or self-audit of their ERISA plans – both pension and welfare benefit – to determine if all is in good order, and if not, to seriously consider using the applicable self-correction programs.
This article describes the self-correction programs and the typical plan deficiencies that can be corrected.
Employee Plans Compliance Resolution System
There are many ways a tax-qualified plan may become disqualified. If disqualified, the plan will lose, retroactively as well as prospectively, its tax advantages and subject the plan sponsor to taxes and penalties that can easily exceed half of the value of the plan’s assets.
Penalties include denial of deductions at the corporate level, taxation of the pension trust, denial of rollover ability to IRAs, and income inclusion to participants of their pension accounts.
The most typical plan disqualification defect is known as a form defect where the terms of the plan are not updated for tax law changes, for example, GUST and the Economic Growth and Tax Relief Reconciliation Act of 2001. If your plan has not been updated for these laws between 2003 and 2005, it is likely disqualified.
Another common type of defect is known as an operational defect where the terms of the plan are fine, but it is not operated in accordance with its terms. For example, enabling entry into a plan that requires 12 consecutive months of service prior but only six months have, in fact, been used; or making late contributions to a plan that requires 401(k) elective deferrals to be timely; or having only one employer participate in a plan that requires that all employers in the controlled group participate.
A demographic defect occurs when a plan initially satisfies the various nondiscrimination testing rules, but because of a change in workforce (e.g., controlled group expansion, layoffs, hiring), the demographics change significantly enough to push the plan out of compliance.
Employer eligibility defects occur when an employer adopts a plan that it legally cannot (e.g., a for-profit entity adopts a 403(b) plan, or a governmental instrumentality adopts a 401(k) plan).
These disqualification defects may be cured under an Employee Plans Compliance Resolution System (EPCRS) by placing plan participants in the position they would have been in had the defect not occurred.
Therefore, EPCRS is conditioned on correction by the plan sponsor. EPCRS provides general guidelines on correction principles and some specific, acceptable correction methods.
The correction programs are available only if an IRS audit has not commenced. The correction program entails making a submission to the IRS and paying a fairly minimal user fee (especially given the potentially astronomical costs of plan disqualification), the amount of which depends on the disqualification defect and the size of the plan sponsor.
Voluntary Fiduciary Correction Program
Under a Voluntary Fiduciary Correction (VFC) Program, plan officials and employers that engaged in prohibited transactions may apply to the Department of Labor (DOL) for relief related to their voluntary correction of specific violations of the law.
A prohibited transaction is, in general, a non-arms’-length transaction between an ERISA plan and “parties-in-interest” – i.e., persons related to the plan or the employer, and plan service providers.
Applicants must fully correct any prohibited transactions, restore any resulting plan losses with interest, and distribute any supplemental benefits owed to eligible participants. If properly corrected, plan officials will receive a “no action” letter indicating the DOL will take no further enforcement action on the corrected transaction.
Some of the fiduciary breaches eligible for correction under the VFC program include:
Given that prohibited transactions can result in up to a 100 percent excise tax on the amount included in the transaction (plus interest and penalties), in addition to significant exposure to participant litigation, it is usually prudent to consider utilizing the VFC.
Delinquent Filer Voluntary Compliance Program
Most pension plans, and all welfare benefit plans with more than 100 participants, must file an annual Form 5500 with the DOL. Failure to do so can result in penalties of more than $1,100 per day.
To encourage plan sponsors to submit Forms 5500 and become legally compliant, the DOL created the Delinquent Filer Voluntary Compliance Program. Under this program, if a plan sponsor submits late Forms 5500 voluntarily before audit, the following greatly reduced penalties apply:
Marcia S. Wagner ([email protected]) is president of The Wagner Law Group, a Boston firm specializing in ERISA, employee benefits and employment law. Marcia advises on the legal and practical requirements of qualified retirement plans, including plan design, document drafting, plan administration, plan qualification requirements, fiduciary responsibilities, as well as all aspects of executive compensation, and welfare benefit (insurancez) issues (e.g., COBRA, HIPAA, and plan documentation). The Wagner Law Group’s clients include plan sponsors of all sizes, plan administration professionals, pension investment managers and advisers, large financial institutions, accountants, plan participants and plan fiduciaries.
