Current developments.

• Author: Walker, Deborah
• Position: Employee Benefits & Pensions, part 2

This two-part article provides an overview of current developments in employee benefits.

Part II focuses on significant retirement plan developments.

Part I of this two-part article, published in the November 2004 issue, focused on recent developments in executive compensation and welfare plans. Part II, below, highlights the Significant retirement plan developments of the last 12 months. During that time, the IRS issued several regulations and numerous revenue rulings and procedures on qualified plans; the Department of Labor (DOL) also issued significant regulations and advisory opinions.

Qualified Plans

Audit Programs

The Service started two separate audit programs targeting qualified retirement plans--the Focused Audit (FA) initiative and the Employee Plans Team Audit (EPTA) program. Under the FA initiative, it is targeting plan sponsors in certain geographical locations for specific issues endemic to certain types of plans in particular industries. Initially, the Service selected approximately 1,000 plans for examination. For issues with significant non-compliance, it will expand the scope to include more plans.

The EPTA program targets large plans in conjunction with the Large and Mid-Sized Business Division function, rather than specific issues. A large plan is one with more than 2,500 participants. Although IRS research indicated that such plans hold assets of around $2 trillion, historically, the Service has not audited them. The Service recently announced that large plans are subject to selection under either the FA initiative or the EPTA program. Currently, the EPTA program has approximately 50 plan sponsors under examination.

Cash-Balance Formulas

In Cooper, (27) the litigants challenged two successive incarnations of a defined-benefit plan--the first, a version of a pension-equity plan, and the second, a cash-balance formula. The court concluded that the plan violated both Sec. 411 (b)(1)(G) and (H).

Under Sec. 411 (b) (1) (G), a defined-benefit plan is not qualified if it reduces a participant's accrued benefit on account of any increase in his or her age or service. That did not occur under either of the plan's formulas. The court, however, compared the benefit accruals of two participants of different ages, with the same compensation and service, and held that the formulas were illegal. The younger participant's annual accrual translated into an annuity beginning at normal retirement age that was larger than the older participant's. This application of the statute is controversial.

The court also cited a violation of Sec. 411(b)(1)(H), which bars any benefit formula that reduces the rate of an employee's benefit accrual because of the attainment of any age. Under both of the formulas at issue, the participant's accrued benefit was a lump sum that increased yearly at a rate that did not diminish. Thus, on its face, neither formula presented an age discrimination issue. However, the court found a prohibited reduction, by interpreting "rate of benefit accrual" to mean the rate at which the participant's accrued benefit, as defined in Sec. 411(a)(7), increases. As this section converts lump-sum benefits into annuity form, the effect was to make equal lump-sum accruals into unequal annuity accruals at different ages.

On Sept. 29, 2004, IBM announced that it agreed in principle to a partial settlement, in which plaintiffs would receive an incremental pension benefit in exchange for the settlement of some claims. IBM will appeal to the Seventh Circuit the remaining two claims--that its cash-balance formula and transition arrangements were age discriminatory. Some in the benefits community have concluded that Cooper's reasoning is unlikely to survive on appeal. If it does survive, it could have an adverse effect on all cash-balance plans, by requiring employers to provide significantly more generous interest credits for older workers than for younger ones.

Master Trusts

An Employee Retirement Income Security Act of 1974 (ERISA) Advisory Opinion (28) serves as a reminder that a master trust and the plan trusts that use it as an investment vehicle are separate entities. Five defined-benefit plans within a controlled group pooled all of their investments into a master trust that held employer stock. No plan's holding exceeded the 10% limit on employer stock imposed by ERISA.

In the course of union negotiations, the employer agreed to spin off plan assets and liabilities to a multiemployer plan, whose trustee declined to accept the employer stock as an investment. The master trustee thus proposed to allocate the employer stock to the remaining four plans, leaving only liquid assets to be spun off. Unfortunately, after the spinoff, one plan's holding exceeded the 10% limit on employer securities. The parties hoped to obviate this surface violation by arguing that compliance is tested only when new shares are acquired, which is true, and that the reallocation was not an "acquisition"

The DOE disagreed, viewing the transaction as an exchange between the departing plan and the other plans. Moreover, to the extent that the same fiduciary made the investment decision for plans on both sides of the exchange, it was, the DOL averred, representing adverse parties in violation of ERISA Section 406(b)(2). While that would probably not have mattered had the stock been publicly traded, it did when the shares' value was not ascertainable by reference to sales between unrelated parties.

PEO Plans

Rev. Proc. 2002-21 (29) effectively required professional employer organizations (PEOs) that maintain defined-contribution plans for the benefit of their clients' employees either to terminate the plans or convert them into multiple employer plans. The alternative is to face disqualification under Sec. 401(a)(2), which permits qualified plans to cover only employees of the employer maintaining the plan. The deadline for termination or conversion is the end of the plan year beginning in 2003.

Rev. Proc. 2003-86 (30) presented transition rules for plans to comply with the earlier procedure. Terminated Sec. 401(k) plans can make distributions to participants, even if the client company establishes its own successor defined-contribution plan. In performing top-heavy and actual deferral percentage/actual contribution percentage (ADP/ACP) testing for plans converted into multiple employer plans, each participating employer's portion of the plan may be treated as if it were new; thus, assets accumulated before the conversion are ignored in top-heavy calculations and the special first-year rule for nonhighly compensated employees' (NHCEs') ADP percentages may be used. Following a conversion, the required beginning date for minimum distributions to 5% owners who remain employed after age 70 1/2 will be no earlier than April 1, 2005. On the other hand, compensation received before the conversion must be taken into account in determining HCE status.

Disclosure of Benefit Relative Values

For distributions beginning after Sept. 30, 2004 (see below for special transition rules), Regs. Sec. 1.417(a)(3)-1 (31) requires all non-governmental, nonchurch defined-benefit plans to provide a plethora of comparative data on the present values of different forms of benefits, as part of written explanations furnished to participants making benefit elections. At a minimum, the explanation must describe all of the forms of distribution generally available under the plan and present examples showing their relative value for representative participants.

On a participant's request, the plan administrator must disclose all of the options specifically available to him or her and compute their relative value based on the participant's facts. A few simplifications are allowed, such as grouping benefit forms with nearly equal value. The actuarial assumptions used for comparative purposes do not need to be included in the explanation, but must be disclosed on request.

Responding to complaints about the burdens imposed by this scheme, Ann. 2004-58 (32) limits the information that must be furnished to participants whose annuity starting dates fall between Oct. 1, 2004 (the original effective date) and Feb. 1, 2006. During that period, relative value disclosure is required only for lump-sum and Period-certain installment options and if the optional form is less valuable than a qualified joint and survivor annuity (QJSA) (or a life annuity for an unmarried participant). That situation arises when the plan's lump-sum benefit disregards early retirement subsidies...