BNA Pension and Benefits Blog

Prohibited Transactions and IRAs

Recently we observed promotional and seminar materials that advocated putting your IRA to work for you or your business. A client also sent us a story from a newspaper in a major city extolling the virtues of using your IRA money to help in your business. While our experience is no measure of what is going on generally, we do think that the problems of putting IRA money to work directly or indirectly in an entity related to the IRA owner presents prohibited transaction issues. While DOL generally does not have jurisdiction over IRAs, it does have regulatory authority to determine whether a prohibited transaction exists in connection with an IRA. Given the fact that a prohibited transaction may disqualify the entire IRA, a cautious approach with IRA investments in the IRA owner’s business is warranted.

A DOL advisory opinion letter issued at the beginning of this year (AO 2006-01A) exemplifies the importance of looking for prohibited transactions in IRA investments in related entities. In the letter, H&W (husband and wife) owned 68% of S Corp. The remaining 32% was owned by G a third party. H proposed creation of an LLC which would be owned 49% by his IRA and the remainder owned by R. R was the comptroller of S Corp and DOL stated he could not be deemed independent. It was proposed that the LLC would purchase land, build a warehouse and lease the warehouse to S Corp. The lease terms would be determined by an independent expert to be arms length and at least as favorable to the LLC and its IRA Investors as an arms length transaction. The question posed to DOL was whether the arrangement created a prohibited transaction. In DOL’s view, H was a fiduciary since he exercised discretion over his IRA. As a fiduciary H was a disqualified person. DOL found that the lease would amount to an indirect prohibited transaction between H’s IRA and S Corp. in violation of Code sections 4975(c)(1)(A) and (D) and dealing with assets of the plan in the fiduciary’s own interest in violation of Code section 4975(c)(1)(E). Almost as a postscript DOL stated that the investment may also be a violation of the exclusive benefit rule of Code section 401(a)(2). Given DOL’s broad interpretations above, it seems to us that the use of self directed IRA’s to invest in or somehow support a business owned bythe IRA owner may be a very risky business. Jeffrey N. Clayton jeffclayton@cnmlaw.com

PPA Health Plan Relief

One of the more obscure provisions of the Pension Protection Act is Section 843, which amends IRC §419A(c) by adding new subsection (6). The new provision permits a health benefit plan sponsored by a “bona fide association” (as defined in 42 U.S.C. 300gg-91(d)(3)) to maintain a reserve of up to 35% of current operating costs. Prior to the amendment no reserve was permitted.

So, is this just another special interest goodie that slipped in under the radar? Not really. It actually provides much needed relief for many small business association health programs. Here’s the reason why. Under IRC §419A annual deductions for contributions to funded health benefit plans (other than retiree medical plans) are limited to “qualified costs,” which are defined as current claims and related administration expenses for the year, plus a reasonable cost for “run out” claims, sometimes referred to as IBNR - incurred, but not reported claims. The run out cost must either be actuarially determined or limited to a percentage of current claims, as set by statute. An exception to the annual deduction limitation is available to “10 or more employer” plans. (IRC §419A(f)(6)). However, as the statute states and the final regulations issued by the IRS and Treasury in 2003 (§1.419A(f)(6)-1) clearly explain, a plan which “experience rates” claims or costs cannot be a 10 or more employer plan. Many small business associations maintain health benefit programs for their members, some have for 50 years or more. These programs typically allow participating members to obtain health care for their employees at reduced cost through a group purchasing or funding arrangement. In order to obtain the lowest rates these programs often provide health coverage under a tiered premium arrangement, which is then made available to members from year to year according to prior usage - a clear experience rating arrangement under the final regulations.

As many who are familiar with this area know, one of the primary purposes of the (f)(6) regulations was to curb welfare plan abuses, particularly in the area of life insurance (death benefits) and severance pay plans. Unfortunately, the wide net cast by the regulations also put the association health plans in a difficult position: either they operated at break-even or at a loss each year (which created significant concerns for the plan fiduciaries under ERISA’s prudent man standard) or they had to inform their participating members that portions of their annual heath premiums paid to the group plan were non-deductible. A number of the affected associations approached their congressional representatives about the problem, and with the help of Treasury, hammered out the statutory language which is now part of the PPA. The new law will permit bona fide association health plans that experience rate their members to maintain a reserve of slightly more than 4 months’ annual premiums, enough to help these plans keep a cushion available for contingencies, while retaining competitive lower cost and fully deductible health benefits for their members. (Under the Public Health Service Act a “bona fide association” must (A) have been actively in existence for at least 5 years; (B) have been formed and maintained in good faith for purposes other than obtaining insurance; (C) not condition association membership or health insurance coverage on any health status-related factor or offer coverage to non-members; and (D) meet any additional State law requirements.

Kudos to Senators Hatch, Grassley, Baucus, Snowe and Bennett, who all worked to get Section 843 included in the PPA. Of course, Senator Snowe has long championed the right of small business associations to provide low cost health care to their member employers. Does this new provision signal possible help for her much-beleaguered proposed legislation which she touts as “giving small businesses greater access to medical care for their employees"? We will see. jeffclayton@cnmlaw.com (Submitted by my partner, W. Waldan Lloyd)

DOL and Service Provider Fee Disclosure

On May 16, 2005, the SEC issued a Staff Report Concerning Examinations of Select Pension Consultants.

In connection with the SEC report, on June 1, 2005,  DOL and the SEC jointly released tips to help ERISA plan fiduciaries in selecting and monitoring fiduciaries.

The staff report and the jointly released tips focused on whether pension consultants were fully disclosing potential conflicts of interest, particularly where investment consultants' recommendations of money managers to clients might be based on financial incentives from the managers instead of the quality of the managers.

DOL has expressed concern about the difficulty that plan fiduciaries have in discerning the actual costs of services provided to 401(k) plans and has promoted on its WEB site a 401(k) Fee Disclosure Form.

DOL has in its regulatory agenda and in several public venues stated it is working on a section 408(b)(2) regulation update project. Section 408(b)(2) is a primary statutory exemption which allows service providers to provide services to ERISA plans and receive compensation for those services. It seems likely that in the revised regulation under 408(b)(2), DOL will require significant additional disclosure regarding direct and indirect compensation.

On July 21, 2006, DOL a proposed new rule for 5500 disclosure which would require plans to report insurance carriers that fail to provide required information on insurance fees and commissions. In addition, there would be expanded disclosure of direct and indirect service provider fees including revenue sharing.

Apparently, DOL is serious about increased fee disclosure by service providers. This raises some interesting questions:

Ultimately, what kind of disclosures for both 5500 reporting purposes and for compliance with 408(b)(2) will be required?

Assuming greater disclosure, will something positive come of it or will it merely add to the regulatory burden faced by ERISA plans and their service providers?

Benefits Related Blogs

I thought you might be interested in other benefits-related blogs. I'm sure I've missed some, so if you know of other benefits-related blogs, please add it through a comment.

• Actium's Managed 401(k) / 403(b) Blog
Promotes managed accounts for 401(k), 403(b) and 457 plans.

• BenefitsBlog and The ERISA Blog by Janell Grenier
Interesting tidbits on a wide variety of benefits related topics from a benefits lawyer in the Philadelphia area. If you’re only in legal stuff, go to The ERISA Blog. Otherwise, check out Benefits Blog, which has the same legal items but also has other benefits posts.

• Benefits in the News from BenefitsLink
While not designated as a blog, probably because it started before blogs began, this is the best free site on the web to get information on employee benefits.

• Boston ERISA & Insurance Litigation Blog by Stephen Rosenberg
Interesting and thoughtful discussions of litigation-related topics from a defense litigator in Boston, not all of them ERISA-related, but enough to make it worthwhile to check it out regularly even if you're not a litigator.

• The Disabled Worker Law Blog by Troy Rosasco
Written from a plaintiff perspective, with an emphasis on New York where the author practices.

• ERISA and Disability Benefits Law Blog by John Wood and James Streett
From a plaintiff firm in Tennessee, this blog covers disability litigation.

• ERISA Law Blog by Brian S. King
Written by a plaintiff lawyer in Salt Lake City, this blog focuses on health and disability litigation.

• Fiduciary Investor by Prudence Mann
Information, data and news on investment topics for fiduciaries of defined benefit and 401(k) plans.

• Florida ERISA Blog by Marcus Castillo
Blog from a plaintiff litigator in Clearwater devoted to recent developments in ERISA and employee benefits law in Florida and the 11th Circuit.

• Health Plan Law by Roy F. Harmon
Written by a lawyer in Greenville, South Carolina, this blog provides nformation about group health plans, claims administration and related ERISA fiduciary issues. In addition to the blog, this site includes relevant ERISA statutory provisions, regulations and other resources.

• Long-Term Disability Benefits Blog by J. Kevin Morton
From a plaintiff lawyer in Winston-Salem, North Carolina, this blog provides news and information on long-term diability claims and appeals under ERISA and Social Security.

• Pension Actuary Blog by  Alberto Dominguez
Random career thoughts and observations by an actuary, mixture of news items and personal reflections.

• Pensions and Benefits Weblog by "Fuguerre"
Anonymous but knowledgeable blogger on a wide range of benefits topics

• Pension Reforms Blog
From the UK Department for Work and Pensions, this blog discusses pending reform proposals for the UK pension system.

• Pension Risk Matters by Susan M. Mangiero
Written by a certified financial analyst (CFA) in Connecticut, this blog focuses on financial risk issues for pension plans, with a governance and fiduciary emphasis.

• Public Pensions News by H.K. Anders
Items of interest on federal, state and local pension plans.

• The Retirement Plan Blog by Jerry Kalish
From a benefits consulting firm in Chicago, this blog focuses on design issues for defined benefit and 401(k) plans rather than legal issues

• Rick Mattoon on Pensions
Written by a Senior Economist and Economic Advisor at the Federal Reserve Bank of Chicago, this blog focuses on economics topics related to state and local government plans. Unfortunately no new entries since March.

• Workplace Profs Blog edited by Richard Bales and Paul Secunda
As the name suggests, this blog covers a wide range of employment issues from an academic perspective. I’ve linked to the benefits-related posts but you may want to check out the full blog periodically if you are interested in labor and employment law.

SEC Mutual Fund Settlements

Beginning in 2003, the SEC and state officials brought enforcement actions for improper trading practices involving mutual funds. Settlements reached by the SEC and state regulators were put into what the SEC call “fair funds” to compensate investors who were harmed by the violation. A list of the fair funds can be found on the SEC website. Distribution plans for three of those funds have been published to date: Pilgrim Baxter & Associates, Columbia Management Advisors and Banc One Investment Advisors. To assist plans entitled to share in the settlements, links to the proposed distribution plans and comments are posted on the ERISA Settlements Clearinghouse website.

For each fair fund, the SEC has appointed an independent distribution consultant (IDC) to establish a plan to distribute the monies from the settlement fund to the shareholders of the relevant mutual fund or series of funds harmed by the late trading or market timing. Proposed distribution plans are published on the SEC website and there is typically a 30 day comment period following publication. The SEC is to finalize these distribution plans within 30 days after the comment period closes, but may extend the period. The 30-day comment period has ended for all of the proposed plans issued to date, so fiduciaries of plans that invested in mutual funds managed by those advisors should begin to think about how the distributions to participants should be made.

On April 19, 2006, the DOL issued Field Assistance Bulletin 2006-1, which provides useful guidance to plan fiduciaries about how proceeds from the fair funds are to be allocated. The plan fiduciaries may use the same method used by the IDC or may use any other prudent allocation method. If distributions to plan participants are not cost-effective, the plan fiduciaries may allocate them to current participants invested in the particular mutual funds or use the recoveries for other permitted purposes, such as plan expenses.

PPA Tidbits

On the ABA Joint Committee on Employee Benefits teleconference last Thursday, Bill Bortz from Treasury cleared up some issues that have been creating uncertainty under the newly-enacted Pension Protection Act of 2006:

• Bill said the restrictions on funding executive benefits when the defined benefit plan is underfunded won't be effective until the funding rules become effective in 2008 or later. The restrictions resulting from the employer's bankruptcy, however, are effective immediately.
• On faster vesting for cash balance plans, he confirmed it only applies to the cash balance portion of the plan, not to traditional benefits that are grandfathered or benefits for participants in the plan that only have traditional benefits.
• On how the 2-year averaging works for calculating the funding interest rate under the new rules, he said it was a simple average not a weighted average as under current law.

I've attempted to summarize the new funding rules and related benefits restrictions in one page. Certainly not all you'll need by 2008 when these rules become effective, but hopefully enough to get you started. BNA has established a Pension Protection Act Center with materials from a number of sources to help you come to grips with the new Act.

Nell Hennessy
nell.hennessy@fiduciarycounselors.com
202-558-5141

ERISA Hotties

We wanted to start the BNA Pension and Benefits Blog with something a little light hearted that you might not see in the regular BNA publications. The winners of the first (last?) ERISA Hotties Contest are Professor Bruce Wolk of UC Davis and Sarah Downie in Orrick's New York office. Check out the winners and their competition at Above the Law. I'm sure BNA's sorry they didn't think of it first.

Nell Hennessy
nell.hennessy@fiduciarycounselors.com
202-558-5141

Welcome!

Welcome to the BNA Pension & Benefits Blog: Insight from the Advisory Board.

For more than 30 years, since the enactment of the Employee Retirement Income Security Act (ERISA), BNA and our subscribers have benefited from the experience and knowledge of a varied group of practitioners in the area of pensions and benefits. These attorneys, accountants, actuaries, consultants, and academics meet regularly as our advisory board to consider and discuss key topics of interest in their field.

Many of the questions and issues considered by the board find their way into BNA's publications and reference services. However, we felt that the vehicle of a blog would give our board members a chance to develop and present their ideas in a public forum and perhaps spur a lively dialogue on the topics of the day.

To that end, each week one of our advisory board members will act as the resident author and will post his or her thoughts on one or more topics. Blog readers will be able to comment on the posts and add their ideas.

Since this is a pilot project we encourage feedback. You can contact me at sstevens@bna.com or (202) 452-7508 with your suggestions. Thanks so much and please come back often.

-- Sarah Stevens, Managing Editor, BNA Pension & Benefit Publications