I have been trying to resist the urge to blog about the “new” phenomenon of Multiple Employer Plans, but temptation got the better of me.
In very broad terms, there are two general types of MEPs – the “common” MEP and the “open” MEP. The gist of the common MEP is that it covers companies that, though unrelated by ownership or direct business relationship, have some sort of commonalty, e.g. members of a Chamber of Commerce or doctors’ offices in a certain geographic area. By contrast, an open MEP covers businesses that have no commonality. Although open MEPs seem to be causing some controversy these days (as Ilene Ferenczy describes in this post), there are important details that must be considered with all MEPs.
Some tout MEPs as bulk purchasing arrangements in which many small employers band together to obtain a level of service they might not otherwise be able to obtain cost-effectively…a kind of Costco for retirement plans. However, not everything at Costco is cheaper, and you may be forced to buy 5 bottles of aspirin that will expire before you use up the hand-bag sized bottle you went in to purchase. Similarly, some MEP features are available in stand-alone plans with similar price-tags, more flexibility and in more reasonable amounts.
Others promote MEPs as a way for employers to completely absolve themselves of fiduciary responsibility. An employer joins a MEP along with the pre-determined investment menu, service-providers, etc. but completely escapes any legal responsibility for the prudence of the decision? In an era when plaintiff’s lawyers and the DOL are seeking to broaden the fiduciary net? Really?
Some MEPs are designed to give maximum plan design flexibility to adopting employers. This might seem to make sense, but with more flexibility comes complexity and the increased possibility of mistakes that could lead to penalties. Similarly, if an adopting employer with a stand-alone plan in which there are unresolved errors merges in to the MEP, those errors come along with the merger. Although MEPs are usually large plans, they are often comprised of smaller employers who might not have the time or resources to establish the internal controls necessary to prevent oversights.
Some say these are non-issues, since errors can be corrected. Ok, but who pays the associated expenses? They can’t be paid from plan assets, so somebody has to write the check. The lead employer? The adopting employer that caused the error? What if the adopting employer refuses to pay? Is the entire MEP left hanging? The IRS correction program does allow filing fees to be based on the adopting employer at fault, but it provides that “the plan administrator (rather than any contributing or adopting employer) must request consideration of the plan under VCP.”
Another issue is whether and how a neglectful adopting employer can be kicked out of the MEP. An employer leaving (or being removed) does not entitle participants to a distribution, so those balances remain in the MEP unless there is a formal spin-off into a stand-alone plan. If there is a spin-off, the question of fees comes up again. Who is responsible to write the check? How does one compel the excommunicated employer to sign the plan documents for the spin-off plan?
As with most types of business partnerships, the best time to address these concerns is at the beginning of the relationship before any actual problems arise. MEP issues can be easily addressed through carefully drafted plan documents, participation agreements and contracts. When (not if) mistakes happen, how will they be handled? What information does the MEP provide to help adopting employers demonstrate they followed a prudent decision-making process?
MEPs that are properly established and maintained by providers with the requisite expertise can be excellent mechanisms to provide cost-effective retirement benefits under the right cirsumstances, but one size does not fit all. If you are considering involvement with a MEP, make sure those in charge have acknowledged and addressed these issues rather than simply blowing them off as unimportant or unlikely to occur. Otherwise, what should be MEP molehills may turn into MEP mountains very quickly.
Living in the Boston area these days, there is plenty of talk about the Bruins’ inexorable march to the Stanley Cup finals as well as the continuing series of checks, hits, fights and bites. While “no harm, no foul” may apply on the ice, those who seek to apply it to qualified retirement plans may face more than just a few minutes in the penalty box.
ERISA Section 406 prohibits individuals who have a relationship with a plan (referred to as parties-in-interest) from engaging in certain transactions with the plan if there are conflicts of interest. In many circumstances, these Prohibited Transactions (“PTs”) can be addressed through disclosure of the conflict and/or a determination by plan fiduciaries that any compensation paid is reasonable in light of the services being provided.
However, when a plan fiduciary interacts with the plan in a way that results in a personal benefit, that fiduciary is generally considered to be self-dealing, which is a PT. Unlike other PTs, self-dealing is always prohibited and cannot be cured through disclosure or reasonableness, even if there is no harm to participants and even if the fiduciary has only the best intentions. Consider two examples.
The Line of Credit
A plan sponsor needs to hire a new recordkeeper for its 401(k) plan. The sponsor has a banking relationship with a large, national bank that responds to the recordkeeper RFP. The bank offers to discount the interest rate on the sponsor’s line of credit by 25 basis points if selected. What a great deal, right?! Not quite. Since the sponsor, not the plan, receives the benefit of discounted interest, they would engaged in self-dealing by selecting the bank and accepting the discount.
What if the sponsor still wants to hire the bank and declines the discount? That may address the PT issue, but it would also raise a question of fiduciary prudence. Is it really a good idea to hire a service provider who attempted to solicit your business via a legally prohibited transaction?
Freebies For The Owners
Another plan sponsor is looking for a new investment advisor for its plan. One of the finalists offers free financial planning for all of the shareholders if selected. Again, although no harm befalls the plan, the fact that the shareholders receive personal benefits based on their plan-related decision makes this a self-dealing PT.
The rules regarding PTs are extremely complicated. For more detail and citations, check out this whitepaper written in 2009 by Fred Reish and Joseph Faucher.
These two examples are among the more straight-forward ones. Others are significantly murkier. Consider the question of whether a fiduciary advisor to a 401(k) plan is permitted to accept a rollover from a departing participant in that plan. While DOL has not addresses the question directly on-point, they have provided some guidance in Advisory Opinion 2005-23A (see final paragraph under Q&A 2). A recent discussion from the 401(k) Recon group on LinkedIn illustrates the many variables that are introduced in an attempt to answer this question.
One key factor is whether the advisor's compensation increases as a result of accepting the rollover. What about the advisor's employer or an affiliate? If so, it would seem to indicate a PT…by virtue of the advisor’s position as a plan fiduciary, s/he engaged in a transaction with the plan that resulted in increased compensation. The answer is less clear if the advisor's compensation and the participant's fees remain level.
One commenter suggested that it depends on whether the advisor solicits the rollover or the participant seeks out the advisor. Another suggested the transaction is acceptable because it is beneficial for a participant to work with someone s/he already knows. Still another took the view that many politicians are less than ethical, so they shouldn’t take issue with a well-intentioned advisor trying to help participants…and what’s the big deal if the advisor earns an extra few bucks for his or her efforts.
While some of these arguments may have merit in other arenas, they all ignore the simple fact that ERISA prohibits self-dealing…period. It doesn’t matter who initiates it, how pure their intentions might be, or how much the participants also benefit.
There may be no harm, but there can still be a big foul.
In Part 1 of this post, I discussed some of the DOL rules that can make real estate not all it’s cracked up to be as a 401(k) investment. Here in Part 2, we will take look at some IRS wrenches that get thrown into the works.
Nondiscrimination
More often than not, real estate holdings in a qualified plan are limited to one or several of the highly compensated employees. There might be any number of seemingly valid reasons for this limitation. Nonetheless, the option to invest in a particular type of asset is generally considered to be a benefit, right or feature subject to nondiscrimination testing. That means if HCEs invest in real estate, the plan must offer the opportunity to a sufficient percentage of NHCEs. It is not enough to simply say, "Well, I would have let them if they expressed an interest." Offering the opportunity means communicating it to them.
Unrelated Business Taxable Income
A qualified plan is normally exempt from income tax. However, if a plan derives income from carrying on a trade or business, that income is unrelated to the primary purpose of the plan. So-called Unrelated Business Taxable Income or UBTI may be subject to tax even though the plan is otherwise tax-exempt. Certain forms of income, e.g. rental income, are generally exempt from the UBTI rules, but other forms are not. If the plan is in the business of buying and selling real estate, the proceeds of the sales may trigger taxation. If a limited partnership is involved, the plan may be required to look through to the activities of that partnership to determine the applicability of UBTI. These rules can become extremely complex, so it is often necessary to seek the advice of an accountant or tax attorney specializing in this area.
Distributions on Plan Termination
This really crosses both agencies in that it raises qualification and fiduciary issues. While maybe not as big of a problem in fully participant-directed plans, real estate in a plan with pooled accounts can create significant challenges in a plan termination. Basically, the property must be liquidated to cash so that distributions can be paid; however, it is not always possible to find a buyer.
One solution that is frequently proposed is to liquidate all other assets to cover distributions to employees, leaving the owner(s) with the real estate. Although that may sound plausible, the problem is that every participant in the pooled account “owns” a piece of each investment. That means that no participant, including the owner, can claim the real estate as belonging only to him or herself no matter how noble their intentions may be.
Another option that is sometimes suggested is for the owner to use outside assets to purchase the real estate from the plan. Since transactions between the plan and an interested party are generally prohibited, this solution might not work either. In limited circumstances, plan fiduciaries can use the DOL’s Voluntary Fiduciary Correction Program to request permission for the owner to purchase illiquid real estate, but the fees associated with going through this process can easily reach five figures.
One of the only remaining options is to have the plan distribute the real estate to a liquidating trust, established so that the plan termination process can be completed. Each participant receives a proportionate share of the trust. Of course, someone must recordkeep the trust accounts until such time as the real estate can ultimately be liquidated and the cash proceeds paid.
The esteemed Mr. Trump may be wise to love real estate, and it may be an extremely profitable investment...outside of a qualified plan. However, when a plan is doing the investing, the cost of complying (and probably correcting) the issues raised by both DOL and IRS may make any excess investment returns as elusive as Mr. Vonnegut’s elves and pixies.