IRS Releases 2014 Limits for Welfare Benefit Plans

The IRS has released the 2014 inflation-adjusted maximums for certain employee welfare benefit plans and the dollar amounts used for certain discrimination tests. 

For the definition of "highly compensated employee", which is used in several welfare plan discrimination tests, the threshold remains at $115,000 when determinations are based on compensation from the preceding year.

For adoption assistance plans, because of a change in the law, the maximum amount that can be excluded from an employee's gross income for adoption expenses has increased to $13,190 (a $220 increase from 2013).

Eligible long-term care premiums that are treated as medical care expenses cannot exceed: $370 for individuals age 40 or less; $700 for ages 41 to 50; $1,410 for ages 51 to 60; $3,720 for ages 61 to 70 and $4,660 for those over age 70.

The 2014 limit on contributions to health savings accounts ("HSAs") increases to $3,300 for a self-only HSA and $6,550 for a family HSA.  For 2014, a high deductible health plan ("HDHP") plan must have a minimum deductible of $1,250 for self-only coverage, and $2,500 for family coverage.  The maximum out-of-pocket amount for a HDHP (including deductibles, co-payments and other amounts, not including premiums) cannot exceed $6,350 for self-only coverage and $12,700 for a family.

Employees' pre-tax employee contributions to health care flexible spending account plans are limited to $2,500 per year as of the first day of the first plan year beginning on or after January 1, 2014.

In 2014, the monthly limit on non-taxable qualified parking expense reimbursements will increase to $250 (up $5 from 2013).  However, because of an expiring law, the monthly limit on non-taxable qualified transportation expense reimbursements will decrease to $130 (a $115 reduction from 2013).

The maximum tax-exempt benefit from a dependent care assistance plan remains at $5,000, as this amount is not indexed to inflation. 

IRS Releases Guidance Concerning Same-Sex Marriages

Supreme Court Ruling

In United States v. Windsor (June 2013), the U.S. Supreme Court upheld a lower court decision declaring Section 3 of the federal Defense of Marriage Act ("DOMA") unconstitutional. Section 3's definition of "marriage" as "a legal union between one man and one woman as husband and wife" was determined to violate constitutionally required due process and equal protection principles. With this decision, same-sex couples in states that recognize marriages between persons of the same sex clearly obtained marriage-based federal rights and benefits under the tax laws, including rights relating to 401(k) plans governed by the Internal Revenue Code. 

The Windsor decision did not address the validity of Section 2 of DOMA, which gives individual states the right to recognize, or not recognize, same-sex marriages of other states. The effect of the decision on same-sex spouses who reside in states that do not recognize same-sex marriage was not clear, and awaited regulatory guidance. On August 29, the IRS issued the first installment of such guidance in the form of Revenue Ruling 2013-17 and two sets of frequently asked questions and answers.

IRS Ruling

The IRS guidance resolves the debate over the territorial scope of the Windsor decision by adopting a general rule respecting a marriage of same-sex individuals for federal tax purposes. This rule holds that if such a marriage was validly entered into in a state whose laws authorize same-sex marriages, it will be recognized under the tax laws even if the married couple resides in a state that does not recognize the validity of same-sex marriages. The IRS cited historical precedent as well as practical considerations for this decision. With regard to employee benefit plans, it noted the need for nationwide uniformity and pointed to the difficulty that employers would have in applying rules, such as spousal elections, consent and notices, if the rules changed every time a same-sex couple moved to a state with different marriage recognition rules. The IRS ruling eliminates the need for plans to continually track the state of domicile of same-sex couples.  

While the uniformity rule may make sense for many, it may lead to legal challenges under Section 2 of DOMA. It should also be noted that the uniformity rule applies to same-sex marriages contracted outside the United States in foreign jurisdictions having the legal authority to sanction marriages. Since Revenue Ruling 2013-17 does not purport to address the treatment of same-sex couples in domestic partnerships or civil unions, the uniformity rule has no application to these relationships.

Effective Date

The uniformity holding of Revenue Ruling 2013-17 is to be applied prospectively as of September 16, 2013. For example, in the case of a defined contribution plan providing for default distributions to a participant's spouse upon the participant's death, the plan must presumably pay the death benefit to a same-sex surviving spouse if the participant's death occurs on or after the effective date. However, the ruling does not provide guidance with regard to the Windsor decision's application to employee benefit plans with respect to periods before September 16, 2013, although the IRS promises to do so in a manner that considers the potential consequences to all involved, including the plan sponsor, the plan, and affected employees and beneficiaries. But even if the IRS is true to its word, any rule it promulgates will not have the power to prevent certain parties, such as the surviving same-sex spouse of a deceased participant, from pursuing claims against a benefit plan or its sponsor. 

Specific 401(k) Issues

Most plans subject to ERISA and tax-qualified retirement plans, other than government plans and non-electing church plans, must contain a number of provisions that hinge upon the marital status of the plan participant. With respect to 401(k) plans, these provisions may raise the following issues: 

Spousal Death Benefit

A retirement plan may not pay a death benefit to a beneficiary other than the participant's surviving spouse unless the spouse consents to the designation of a non-spouse beneficiary, and the participant's spouse is generally the default beneficiary if there is no beneficiary designation. A plan provision that automatically designates a surviving spouse as the plan beneficiary enables a 401(k) plan not only to avoid the need to pay benefits in the form of an annuity, as described below, but also eliminates the requirement to obtain spousal consent as a condition of granting a plan loan. As noted above, the Windsor decision and Revenue Ruling 2013-17 require a participant who has designated a beneficiary other than his or her same-sex spouse, or wishes to designate such an individual as his or her beneficiary to obtain the consent of the same-sex spouse to the designation. 

Spousal Annuity

For those plans subject to the joint and survivor annuity rules, lifetime benefits in a qualifying joint annuity form will need to be offered to participants with same-sex spouses, and same-sex spousal consent will now be required for non-annuity benefit payments or annuity payments that do not provide for a survivor annuity to the spouse. 

Plan Loans

Many tax-qualified retirement plans that permit participant loans require spousal consent to any such loan. A same-sex spouse's consent will now be required unless the plan provides that the spouse is the participant's designated beneficiary 

Qualified Domestic Relations Order

Domestic relations orders requiring the payment of a participant's benefit to his or her same-sex spouse or their children will now be enforceable against the plan. 

Hardship Distributions

Under the hardship distribution rules applicable to 401(k) plans, the rules allowing such distributions for certain medical, tuition or funeral expenses of spouses will now apply to same-sex spouses.  

Required Minimum Distributions

Under the minimum distribution requirements applicable to tax-qualified retirement plans, including 401(k) plans, spouses of deceased plan participants may delay the commencement of benefits for a longer period after the participant's death than non-spouse beneficiaries. Same-sex spouses will now be able to take advantage of this opportunity to defer payment of death benefits. 

Rollovers

A same-sex spouse entitled to receive a death benefit distribution from a tax-qualified retirement plan will now be able to roll over the distribution to an employer plan, as well as to certain other retirement vehicles, and will no longer be limited to making a rollover to an inherited IRA. 

Summary

Many uncertainties remain as to the impact of the Supreme Court's decision, even after the IRS's recent guidance.   Additional guidance addressing open questions has been promised but may face resistance and/or challenge from employers, same-sex spouses or relatives of the parties to a same-sex marriage based on Section 2 of DOMA or how the IRS resolves the issue of retroactivity. While this guidance is being developed, 401(k) sponsors and their advisers should now be considering the following actions:

• Communicating the Supreme Court's decision to employees;
• Identifying all past and present employees who are in a same-sex marriage;
• Identifying those plan provisions that may be affected by a changed definition of the terms "spouse", "marriage" and "husband and wife"; and
• Preparing plan amendments removing any requirement that the forgoing relationships be limited to members of the opposite sex.

ERISA Accounts Meet Plan Asset Rules in New DOL Guidance

Duty to Review Plan Expenses. Revenue sharing payments, such as 12b-1 and sub-transfer agency fees, are paid by mutual funds to 401(k) plan service providers to compensate them for services undertaken on behalf of plans. For example, a plan recordkeeper may receive sub-transfer agency fees to track participant-level ownership of shares. The DOL has recognized that such payments can improve efficiency and reduce the cost of administrative services.  At the same time, the complexity of revenue sharing practices contributes to the need for the plan-level fee information required by recently effective regulations. Among other things, these regulations are intended to give plan sponsors the tools to oversee revenue sharing and ensure that plans do not pay excessive amounts for services as a result of such indirect payments.

Levelizing Provider Compensation through ERISA Accounts. One of the strategies developed by recordkeepers to assist plan sponsors in this regard is the so-called ERISA account (sometimes referred to as an ERISA budget or an ERISA expense account). Where such an account is used, some or all of the revenue sharing allocated to a plan may be used to compensate a plan service provider, such as the recordkeeper itself or the provider of accounting, advisory or third party administrator services. From a recordkeeper's perspective, this approach ensures that the recordkeeper's compensation will not exceed the fee stated in its plan contract. Because the recordkeeper does not retain revenue sharing payments for its own benefit, its compensation remains level which eliminates its incentive to steer plan clients to investment options with high revenue sharing.

In one version of this technique, revenue sharing dollars are paid to a plan account and are part of plan assets. If the account is not zeroed out at the end of the year by payments to service providers, the plan allocates the remainder to participants in order to comply with the IRS requirement that all plan assets be fully allocated to participant accounts.

An alternative version of the ERISA account (sometimes referred to as a pension expense reimbursement account or PERA), requires revenue sharing to be credited to a hypothetical bookkeeping account maintained by the recordkeeper. Under this arrangement, the actual dollars remain with the recordkeeper as part of its general assets and do not belong to the plan. The plan may, however, direct the recordkeeper to use the assets (up to the credited amount) in a number of ways, as specified by its agreement with the recordkeeper, including the compensation of plan providers. This type of account carries over from year to year; however, if the plan discontinues the services of the recordkeeper, the account may be forfeited in which case the recordkeeper retains the remaining revenue sharing payments that generated the account.

The Plan Asset Question. In Advisory Opinion 2013-03A, the DOL recently issued guidance to Principal Life Insurance Company clarifying the application of plan asset rules to a PERA-type arrangement. The issue is important, because if revenue sharing payments held by a recordkeeper are treated as plan assets before being applied for the benefit of the plan or its participants, there would be a violation of ERISA's requirement that all plan assets be segregated and held in a plan's trust. Moreover, possession of plan assets would confer fiduciary status on the recordkeeper holding them and, as a result, the recordkeeper would engage in a fiduciary breach as well as violate the prohibited transaction rules by commingling the revenue sharing moneys with its own assets.

The new advisory opinion's analysis of what constitutes plan assets begins with the observation that "the assets of an employee benefit plan generally are to be identified on the basis of ordinary notions of property rights." This breaks no new ground, since numerous DOL advisory opinions have previously made this point. The new opinion goes on to note that plan assets generally include any property in which a plan has a beneficial ownership interest and that to determine whether such an interest exists requires consideration of any contracts or legal instruments involving the plan, as well as the actions and representations of the parties involved with the ERISA account.

Thus, according to the opinion, the requisite beneficial interest generally arises if particular assets are held in trust on behalf of the plan, or in a separate account in the plan's name with a third party, such as a bank. In addition, the plan would have a beneficial interest in an ERISA account maintained by a recordkeeper if a document or legal instrument indicates that the funds in that account belong to the plan. The new opinion also indicates that a plan could have a beneficial interest in an ERISA account if an intent has been expressed (presumably by the recordkeeper or other party holding revenue sharing funds, although the opinion does not say) to grant such an interest to the plan. Moreover, a representation (again, presumably by the recordkeeper or other service provider) sufficient to lead plan participants and beneficiaries reasonably to believe that revenue sharing funds separately secure promised benefits would create the beneficial interest that turns those funds into plan assets.

On the other hand, the opinion notes that the mere segregation of a service provider's funds to facilitate the administration of its service contract with a plan would not in itself create a beneficial interest in the segregated assets on behalf of the plan. Thus, merely crediting revenue sharing payments to an ERISA account maintained by a recordkeeper, without more, should not create a beneficial interest in the plan.

In the case of Principal Life, to which Advisory Opinion 2013-03A was addressed, the DOL noted that Principal's arrangements and communications with each plan from whose investments Principal received revenue sharing could potentially lead to the conclusion that such amounts are plan assets. Advisory opinions do not attempt to resolve such factual questions, so that Principal could not have expected to receive an ironclad guaranty that the revenue sharing amounts in its possession are not plan assets. It did, however, receive assurance that the DOL saw nothing in the typical PERA arrangement presented by Principal which would lead it "to conclude that amounts recorded in the bookkeeping account as representing revenue sharing payments are assets of a client plan before the plan actually receives them." Thus, the new guidance does not seem to require changes to the standard PERA arrangement.

Caveats. Advisory Opinion 2013-03A makes several observations as to the obligations of plan fiduciaries with respect to an ERISA expense account. First, the client plan's contractual right to receive payments (or have such payments applied to plan expenses) under the arrangement would be a plan asset. If a recordkeeper or other service provider fails to make a required payment under the arrangement, the plan would have a claim against the service provider that would itself be a plan asset.

Since the contractual arrangement that underlies an ERISA account is a plan asset, plan fiduciaries must act prudently in negotiating the specific formula and methodology under which revenue sharing will be credited to the plan and paid back to the plan or to its service providers. The new opinion indicates that the plan fiduciary must understand the formula, methodology and assumptions to be used by the service provider in implementing the ERISA account. The plan fiduciary should also be capable of monitoring the service provider's performance under the ERISA account arrangement to ensure that amounts payable to the plan are correctly calculated and applied for the plan's benefit. The implication appears to be that if the plan fiduciaries do not have the capability to oversee the service provider's implementation of the ERISA account, the plan should not enter such an arrangement.

Plan Sponsor Obligations

Plan sponsors have certain obligations to monitor and negotiate fees associated with their 401(k) plans.  Plan sponsors should be able to demonstrate they have undergone a suitability analysis and made a determination that the cost of their plan is reasonable in relation to the value of services received by the plan.  If you have not done this analysis recently, now might be a good time to do it.

Plan cost review:  Plan sponsors need to clearly identify and review all of the various services to the plan and what the plan is paying for such services (including any revenue share from investments).  To do this plan sponsors need answers to the following questions: 

• What are the different fees and services?  Schedule C of your Plan's most recently filed Form 5500 lists the plan's services providers and, for many service providers, the services provided and the fee paid for the services.  Each service provider's service contract and/or fee disclosure should be reviewed for more specificity.  By knowing who is providing the service, the cost of the service and the source of the fee payments, plan sponsors can begin to get a handle on cost and on whether the cost is reasonable in relation to the service provided.

• Was a benchmark used to measure reasonableness and is it appropriate?  Were current service providers selected as a result of a vendor search?  Were current service providers' fees compared to other service providers servicing 401(k) plans similar in size to yours?  Knowing the market, service providers and industry tools available to determine the appropriate benchmarks against which you can measure your plan's services and expenses is a must.

• What conflicts exist, if any, with the plan's service providers?  Plan sponsors often rely primarily on information provided by their service providers as to the reasonableness of services, investment options, and fees.  However, plan sponsors must remember service providers may have a commercial, not a "co-fiduciary", relationship with the plan and, thus, may not be impartial.  Accordingly, it is important to know who shares in direct and indirect revenue from plan assets or receives revenue (from another source) due to a relationship with the plan.  Does the relationship between the payer and payee give them the ability to affect their own compensation or that of an affiliate without your approval?  Did an advisor have a material financial, referral or other relationship or arrangement with a money manager, broker, or other entity that may create a conflict of interest in performing services for your plan? 

• Are the services provided and their fees the result of due diligence?  Has the plan leveraged its bargaining power, if any, to acquire, when able, lower cost funds or services for the plan?  When was the last time the plan sought a request for proposal ("RFP") to determine what other service providers might provide in terms of services and cost? 

It's still all about the process.  As has always been the case, a plan sponsor's potential liability lies not in the outcome of the decisions made, but in the decision process itself.  Plan sponsors must be prepared to support their internal decision making, especially on matters involving the reasonableness of plan cost. By asking who is providing services, what services they provide, how they are being paid and from where and to whom the money flows, plan sponsors can begin to get a handle on exactly what is the cost of their plan and answer the most important fiduciary question of all, which is not, is the Plan the absolute lowest dollar cost plan on the market, but rather, is the value the plan receives for its cost reasonable.  If it is not reasonable, the plan sponsor must take action to reduce the plan's cost.

The Wagner Law Group is available to assist you with any questions you have regarding retirement and benefit matters, including reviewing plan services and cost or assisting with RFPs to gauge the market position of your plan.

Section 404(a)(5) Annual Fee Disclosure Notice Extension

The Department of Labor, in Field Assistance Bulletin ("FAB") No. 2013-02[1] released July 22, 2013, has provided plan sponsors and their service providers with flexibility on when they need to give participants in participant-directed individual account plans (e.g., 401(k) plans) the second annual fee disclosure notice (the "Notice") due under 29 CFR §2550.404a-5 ("§404a-5").

§404a-5 requires plan sponsors to communicate the following information to plan participants and plan beneficiaries:

• general plan information;
• investment information including a comparative chart; and
• fee information. 

The Notice was originally required to be provided no later than 60 days after the effective date of the §408(b)(2) regulations (i.e., July 1, 2012)[2] which meant plan sponsors had until August 30, 2012 to provide the initial Notice to participants.   Thereafter, a Notice was required "at least once in any 12 month period" without regard to whether the plan is a calendar or fiscal year plan.  

Accordingly, with the first anniversary of the initial August 30, 2012 date fast approaching, plan sponsors needed to  determine if, to comply with the "at least once in any 12 month period" requirement, a subsequent Notice was due by August 30, 2013.   

However, thanks to FAB 2013-02, plan sponsors can now provide the second Notice no later than 18 months from the date of the initial Notice.  The extension is meant to allow Plan Sponsors to send the Notice at a time that will benefit participants (e.g., by reducing administrative costs or by providing the information at a more relevant time such as open enrollment) or to align it with other participant notices typically made either just before or just after the beginning of a plan year.  For example, if a plan sponsor who provided the initial Notice on August 25, 2012 believes providing the Notice on a different twelve-month cycle would be more meaningful, it can provide the second Notice no later than February 25, 2014.   

Thereafter, Notices would be due once in the 12 month period measured from the date the second Notice is provided and anniversaries thereof. 

The one-time election to delay the Notice for up to 18 months also applies to a plan sponsor who timely furnished the first Notice and has furnished the second Notice already.  Under the FAB, this plan sponsor could provide its next Notice (the 2014 Notice) no later than 18 months from the date of the second Notice.  This gives everyone the same opportunity for a one-time "re-set" of the timing for their annual Notice. 

If you have any questions on FAB 2013-02, the Notice requirements or your obligations as a plan sponsor or plan administrator, please give us a call at 617-357-5200. 

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[1] The full text of the FAB can be found here:  http://www.dol.gov/ebsa/regs/fab2013-2.html.

[2] The DOL amended its §404(a)(5) regulations at 76 Fed. Reg. 42539 (July 19, 2011) to postpone the effective date of the disclosure requirements until at least 60 days after the effective date of the §408(b)(2) regulations.