September 18, 2013

Chapter 11: Exercise Caution When Using a Pre-approved “Governmental” Retirement Plan

In the governmental non-ERISA marketplace, there are a number of investment providers and plan recordkeepers that offer and provide retirement plan documents for use by governmental employers that have been “pre-approved” by the IRS. Typically, these plans consist of a basic plan document, about 30 to 50 pages in length, that sets forth “boilerplate” plan language that cannot be modified, along with an adoption agreement containing a number of fill in the blanks and check the box options that are used by the adopting employer to select its plan’s features. When a plan is pre-approved by the IRS, it issues an opinion letter or advisory letter. The IRS letter indicates that the form of the plan has been vetted by the IRS and the IRS has determined that it meets the basic requirements for a tax-qualified plan under Internal Revenue Code section 401(a).

Generally speaking, a governmental employer can complete, execute, adopt and utilize a pre-approved plan without the necessity of obtaining its own favorable determination letter regarding the plan’s tax-qualification from the IRS. However, as with so many things, life is not always that simple. Here are a few cautions and concerns that public agencies that utilize such plans, particularly in California, should be aware of:

  • Many pre-approved plans for governmental employers are sent out to public agencies for their completion and use with almost no guidance or instruction as to how they should be completed. Adopting employers need to get appropriate advice and help in filling out the various optional provisions of their plans – the failure to properly complete the proffered forms could lead to serious adverse tax consequences.
  • Most public agency retirement plans adopted in California are now subject to the requirements of the Public Employees Pension Reform Act of 2013 (PEPRA). PEPRA requires affected plans to be amended to comply with its provisions. In many cases, PEPRA applies to defined contribution plans, as well as defined benefit plans, maintained by California public agencies. If an agency amends its pre-approved plan to comply with PEPRA it will, most likely, take its plan out of pre-approved status. An agency using pre-approved plans should get advice on the application of PEPRA to its plans and the advisability of getting its own IRS determination letters.
  • Some pre-approved plans do not have sufficient flexibility to be used in some cases. For example, most of the pre-approved plans we have reviewed cannot accommodate an employer “matching” contribution made to one plan, which is based on the elective deferrals made under another plan. Also, many pre-approved governmental plans cannot accommodate the sponsor’s desire to provide designated allocations to various employee groups on a basis other than relative compensation. If an agency changes the pre-approved plan to accommodate this desire, it will, most likely, take its plan out of pre-approved status. At that point, it would be advisable for the agency to obtain its own determination letter.
  • Some pre-approved plan documents automatically appoint the sponsoring entity as the “trustee” for the plan. In many instances, this will violate the California Financial Code.
  • In some cases, the governmental pre-approved plan may be written in a way that confuses the adopting employer about its administrative and fiduciary duties under applicable state law.
  • Many pre-approved plans are provided as part of a “bundled” retirement package that includes plan recordkeeping and plan investment services. While there is nothing inherently wrong with such bundled arrangements, it is important for public agencies to understand that they do not necessarily have to use a provider’s plan document in order to gain access to its recordkeeping services or investment options. Most providers will unbundle these services from the plan document at the agency’s request.

In future chapters, we will talk about the process of selecting providers in connection with an agency’s retirement plans and how to evaluate their offerings.

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June 5, 2013

Chapter 10: Are You “Bitaxual”? If So, Watch Out!

This entry comes to you with the help of my colleague Wendy Tauriainen.

In our office, we enjoy the inside jokes of the pension and benefits world (yes there actually are jokes). One of them is the label “bitaxual” for those entities that are lucky enough to be both exempt from tax based on the fact that they are an “instrumentality” of government and because they have received a tax-exemption from the IRS as a Code section 501(c)(3) organization. One example of a governmental entity that might hold this special status is a public hospital district. So-called bitaxual entities are special because they can simultaneously maintain an eligible deferred compensation plan under Code section 457(b) and a Code section 403(b) plan.

We want to alert our readers to a development that is taking some governmental entities by surprise.  Recently, a number of our governmental clients, which are also 501(c)(3) tax-exempt organizations, have come to us after the IRS revoked their 501(c)(3) tax-exempt status for failing to file a Form 990 – Return of Organization Exempt from Income Tax.  This can be especially alarming for governmental 501(c)(3) entities that sponsor a 403(b) plan – a type of plan that can be sponsored only by a
501(c)(3) entity or a public education employer.  Without that 501(c)(3) status, a 403(b) plan that is sponsored by a governmental employer that is not a public education employer has suddenly lost its tax-favored status with potentially disastrous results for plan participants.

Here’s how it happens.  The IRS maintains a list of 501(c)(3) entities.  These entities, with certain exceptions, are required to file an annual Form 990.  Generally, governmental entities meet one of those exceptions and are not required to file a Form 990.  However, the IRS checks its database of 501(c)(3) entities looking for charities that haven’t filed their Form 990.  If the IRS finds one, and doesn’t know that the 501(c)(3) is also a governmental entity, it will automatically revoke the entity’s 501(c)(3) status if no Form 990 was filed for three consecutive years. 

How does the IRS know if your 501(c)(3) is also a governmental entity exempt from filing a Form 990?  It doesn’t, unless you apply to the IRS for a ruling on that question.  While such a ruling is not required for the Form 990 governmental entity exemption to apply, it may be worth considering.  Also pay careful attention to any letter you receive from the IRS demanding that your 501(c)(3) file a Form 990.  Ignoring these letters could result in an automatic revocation of 501(c)(3) status and the attendant consequences to your ability to raise funds or sponsor a benefit plan available to 501(c)(3) entities only.  Further, once 501(c)(3) status is automatically revoked, reinstatement can be an arduous process with no assurance that the reinstatement application will be successful. 

To sum up, if you are a governmental 501(c)(3), consider applying to the IRS for a ruling that you are a governmental entity exempt from filing Forms 990.  Also, keep a close eye on the mail and make sure to let the IRS know of your governmental status if the IRS starts asking for Forms 990.   It is much easier to deal with the IRS before it revokes your 501(c)(3) status than after it has taken that step.

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May 7, 2013

Chapter 9: Suffering A California Pension Reform Confusion Headache? This Might Help

A recent matter that came to our firm involving interpretation of the California Public Employees’ Pension Reform Act of 2013 (PEPRA) brought to light yet another painfully confusing question. What exactly is a “new member?”

During a recent phone call with counsel for a local agency, we discussed whether a new manager that the agency was planning to hire should be treated as a “new member” for PEPRA purposes. The determination would have significant financial implications for both the agency and the new manager. If, for example, the new manager could be viewed as a “classic member” rather than a “new member,” he would (among other things):

  • Be able to participate in the higher pre-existing pension formula used by the agency;
  • Not be required to contribute at least one-half of the employer’s normal cost for his pension; and
  • Be able to take advantage of the final pay provision of the pre-existing plan rather than be subject to the 36-months, highest average pay rule.

Conversely, if the new manager was a “new member” under PEPRA, the agency’s costs for providing regular retirement benefits presumably would decrease because of the various PEPRA limitations, but both the agency and the new manager could have a more difficult time negotiating an overall package of compensation and benefits that the parties felt were comparable to those for other similar managers.

In our case, the agency’s counsel informed us that the new manager:

  1. Had been employed by another California public agency over ten years ago;
  2. Had participated in a public retirement system during that time; and
  3. Had been employed by a private sector employer for the last ten years.

The agency’s counsel also informed us that his client had already determined that the proposed manager was a new member for PEPRA purposes. To this, we asked, “Has the agency looked into whether there is reciprocity between the manager’s original public retirement system and the one in which the agency participates?”  His response was that the agency had concluded that the new manager must be a new member because he had not been employed by a public agency for over six months and, therefore, must have suffered a six-month break in service.  We explained that the new law was not that simple and that the “six-month break in service rule” applied only to an individual who had participated in a public retirement system, such as CalPERS, had a six-month break in service, and then returned to the same retirement system, but with a new participating employer. This was not the case in our situation. So what was missed?

First, the agency had “relied” on information it had read in a summary of PEPRA. One that stated: In addition, if an individual has a break in service of more than six months, and then returns to a retirement system with a new employer, that individual will be considered a new member and must be provided the lower benefit formulas specified by PEPRA.

While this statement is on its face accurate, agencies must bear in mind that this description deals with only one of three ways an individual can be a new member and pertains only to participation and re-participation in the same retirement system. In our case, the new manager had participated previously in a pubic retirement system that was different than the one in which the hiring agency participated.

Second, there were two other ways that an individual could be a new member under PEPRA.  Government Code section 7522.04(f) states (as relevant here):

“New member” means any of the following:

  1.  An individual who becomes a member of any public retirement system for the first time on or after January 1, 2013, and who was not a member of any other public retirement system prior to that date.
  2. An individual who becomes a member of a public retirement system for the first time on or after January 1, 2013, and who was a member of another public retirement system prior to that date, but who was not subject to reciprocity under subdivision (c) of Section 7522.02.
  3. An individual who was an active member in a retirement system and who, after a break in service of more than six months, returned to active membership in that system with a new employer.

Even though the third basis for being a new member was inapplicable in this case, we still needed to look at clauses (1) and (2).  Clause (1) clearly didn’t apply because the new manager had previously participated in a public retirement system prior to 2013. However, clause (2) could apply if there was no reciprocity between the retirement system in which he previously participated and the agency’s retirement system.  The agency needed to determine whether such reciprocity existed.  If it did, the new manager would not be a “new member.” 

Painful PEPRA headache gone for now? Just wait.

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April 9, 2013

Chapter 8: Retiree Health Benefits – “To Infinity … And Beyond!”

I couldn’t help but think of Buzz Lightyear’s famous exhortation as I thought about the implications of the appellate court’s decision that I had just read – International Brotherhood Of Electrical Workers, Local 1245 v. City Of Redding (2012) 210 Cal. App. 4th 1114 [148 Cal. Rptr. 3d 857; 2012 Cal. App. LEXIS 1149] (Redding).

This case involves a challenge by the International Brotherhood Of Electrical Workers, Local 1245 (IBEW) to Redding’s unilateral decision to retract a promise to pay 50% of medical insurance premiums for City employees after retirement. The lower court ruled in favor of the City. Now the California Court of Appeal has overturned that decision. Although the case still must be reconsidered by the trial court in light of the appellate court’s ruling, as things stand now, it appears that IBEW members may be obtaining the benefits of subsidized retiree health costs . . .  to infinity and beyond!

THE PLAY-BY-PLAY

  1. Since 1979, the City and IBEW have had MOUs, which, among other things, provide (emphasis in bold added): “The City will pay fifty percent (50%) of the group medical insurance program premium for each retiree and dependents, if any, presently enrolled and for each retiree in the future who goes directly from active status to retirement and continues the group medical insurance without a break in coverage.”
  2. In 2008, the City and IBEW began to negotiate a new MOU. In 2010, the City changed its position and offered to pay 2% per year of service, up to 50%, of retirees’ medical insurance premiums. In 2010, when the parties were unable to reach an agreement, the City unilaterally imposed its new proposal.
  3. IBEW then brought an action in the trial court seeking to block the City’s unilateral change in the retiree health benefit. The trial court dismissed IBEW’s challenge and ruled for the City. IBEW then appealed the trial court’s ruling.
  4. (NOW HERE’S WHERE THE STORY GETS INTERESTING) After IBEW appealed the trial court’s dismissal of its petition, the California Supreme Court held in Retired Employees Assn. Of Orange County, Inc. v. County Of Orange (2011) 52 Cal.4th 1171 [134 Cal. Rptr. 3d 779, 266 P.3d 287] (REOC) that “a vested right to health benefits for retired county employees can be implied under certain circumstances from a county ordinance or resolution.” In this case, the Supreme Court’s ruling turned out to be a game changer.
  5. After reviewing the REOC ruling, the Court of Appeal reversed the Redding trial court’s ruling and sent the case back for further consideration. In doing so, it made a number of points:
    1. The union’s case should not have been dismissed out of hand because the union’s pleadings were sufficient to demonstrate an arguable obligation by the City to continue to provide the higher benefits for all active employees.
    2. Because the rights of public employees and the obligations of public employers with respect to things such as retiree health and pension benefits generally are interpreted by the same rules as private contracts, not only may local governments be bound by implied contracts, but they also will be bound by the express terms of their MOUs. The IBEW MOU could be interpreted to create a benefit obligation that not only extended to current or active employees, but to “future retirees” as well.
    3. Although the City Council did not expressly and specifically approve the subsidized retiree health benefit (but instead ratified the earlier MOUs after their adoption), the Council’s actions were sufficient legislative authorization of the benefits.
    4. The question of whether an employee’s right to retiree health benefits was “vested” was dependent on the parties’ intent. At this point in its analysis, the court seemed to confuse the concept of a “vested contractual right to retiree benefits” with the question of whether each employee was individually vested in those benefits.

WHAT SHOULD YOU BE THINKING ABOUT?

This case is interesting and bears further monitoring for a number of reasons:

  1. Will the courts ultimately determine that the City has saddled itself with a vested benefit obligation that it cannot unilaterally modify or reduce – for any affected employee, active and not-yet-hired?
  2. Will the courts determine that, despite its unfortunate choice of words, the City should be allowed to reduce the level of benefits for workers who have not yet been hired? If not, such an adverse ruling could have a dramatic impact on recent attempts at pension reform.
  3. The language of MOUs has become extremely important with respect to the description of employee benefits. 
  4. Every benefit description should contain a reservation of rights by the employer to amend or terminate (at least as to future hires or benefits not yet accrued and vested).
  5. It is critical for MOUs to clearly describe and illustrate the extent to which benefits at the individual level are vested and nonforfeitable.
  6. Negotiating strategies may make a significant difference. One has to wonder whether the case would have turned out differently if the City had decided to impose the reduction only on future (not-yet-hired), but not active, employees.
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February 21, 2013

Chapter 7: What’s It Worth?

With the January 31 deadline for issuing 2012 Forms W-2 behind you, many agencies are breathing a sigh of relief. However after reviewing what we have to say, some of you may decide that it’s time for a “do-over.”

WHAT ARE WE TALKING ABOUT?

  1. Most, if not all, public agencies in California provide health coverage to domestic partners of their employees on the same basis as they would for the employees’ spouses.
  2. Although the “value” of such coverage for a “registered domestic partner” is nontaxable for California tax purposes, it will be taxable for federal tax purposes, unless the domestic partner qualifies as the employee’s “dependent” for federal tax purposes.
  3. Even if an agency is including the value of domestic partner health coverage on an employee’s form W-2, this value may be understated if it represents only the difference between the single premium and single plus one premium.
  4. The rules regarding what is taxable get even more complicated when you consider the natural or adopted children of a domestic partner.

WHAT SHOULD YOU BE THINKING ABOUT?

Unless you know that your agency has fully analyzed these issues and their application to those of your employees with domestic partners, you should consider the following:

  1. If you are not including the value of domestic partner health coverage in your employees’ taxable wages, can you substantiate the basis for this treatment? If not, you may be exposing your agency to additional taxes and penalties for under withholding and under reporting of income. For more on the topic of under withholding and under reporting, see Chapter 5 of this blog.
  2. If you are including the value of such coverage in your employees’ taxable wages, are you (a) including amounts that should not be taxable for federal purposes because the domestic partner qualifies as a dependent or (b) including the wrong amount because you are not valuing the benefit correctly?

Because this issue has come up on several occasions, Chang, Ruthenberg & Long has provided a number of agencies with the explanations, checklists, forms and procedures needed to sort this situation out.

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January 15, 2013

Chapter 6: The New Year Brings Compliance With Pension Reform

Although there has been much talk, good and bad, about California’s recent attempt at public pension reform, the fact is that the Public Employees Pension Reform Act of 2013 (PEPRA) is now the law of the State and public employers are obliged to comply with it. For those of you who have not had time to focus on PEPRA until now, you may be interested in the following documents and summaries:

  1. A.B. 340 (Chaptered) http://leginfo.ca.gov/pub/11-12/bill/asm/ab_0301-0350/ab_340_bill_20120912_chaptered.html;
  2. CalPERS Summary of PEPRA http://www.calpers.ca.gov/eip-docs/employer/program-services/summary-pension-act.pdf;
  3. Chang, Ruthenberg & Long’s Summary of PEPRA http://www.seethebenefits.com/showarticle.aspx?show=5878.

FIXES AND CLARIFICATIONS ON THE WAY
Even before the new law was to take effect, legislative staff had been receiving numerous questions and comments concerning the intent and scope of A.B. 340. Not surprisingly, technical corrections bills (S.B. 13 and S.B. 24) already have been introduced and are expected to fix or clarify a number of provisions, including:

  1. Clarifying that PEPRA does not prohibit the adoption of new defined contribution plans;
  2. Elimination of the legislative approval requirement for new defined benefit formulas that are determined to be less expensive than those required by PEPRA;
  3. How the “normal cost rate” for defined benefit plans is to be determined for cost-sharing purposes;
  4. What “similarly situated” means for cost-sharing purposes;
    That the new restrictions regarding health benefit vesting should only apply to new members hired on or after January 1, 2013.

LESSONS LEARNED
Because, with the exception of PEPRA changes directly within the purview of CalPERS, CalSTRS, or ’37 Act systems, there is no administrative body with the authority or responsibility for issuing interpretive guidance on PEPRA, many California agencies are left to interpret PEPRA on their own – or with the assistance of their legal advisors. In some many cases, legal positions taken by CalPERS and CalSTRS with respect to their own systems may not be applicable to standalone plans maintained by public employers. Documenting the basis for your interpretations of PEPRA may become important because you may be forced to defend the positions you have taken. Although you shouldn’t rely solely on something you read in a blog, here are a few items that we have come to understand about PEPRA:

  1. PEPRA does not apply to plans that consist solely of employee pre-tax elective deferrals, such as a deferral only Code section 457(b) plan. If your 457(b) plan provides for any employer contributions, it would be subject to PEPRA.
  2. PEPRA definitely applies to collectively-bargained employees hired on or after January 1, 2013, even though the impact of PEPRA is not set forth in the current MOU and may not have been the subject of bargaining. For example, if you maintain a defined benefit pension plan (whether it is through CalPERS or not), your new union employees likely will become subject to newer, less generous benefits formulas – effective immediately – even though you have not yet had an opportunity to discuss this with your union representatives.
  3. To the extent that any of your retirement plans cross-reference the “normal retirement age” in another of your plans (including CalPERS or CalSTRS), a common practice in many 457(b) plans, you should evaluate how this might affect the administration of the plan containing the cross-reference. This is because PEPRA new mandatory benefit formulas seem to establish a range of possible normal retirement ages, rather than a single normal retirement age.
  4. CalPERS has taken the position that its plans, which are set forth in the California Government Code, are “automatically” amended for PEPRA and that participating employer contracts with CalPERS need not be amended immediately to comply with PEPRA. This is not the case for the thousands of standalone section 401(a) that public agencies maintain in addition to, or instead of, participation in CalPERS. We believe that standalone plans must be separately amended to comply with PEPRA. Otherwise, they run the risk of compromising their tax qualified status because their compliance with PEPRA will not be consistent with what is in their plan documents.

We continue to monitor updates and clarifications relating to PEPRA. Let us know if you are running into specific PEPRA issues that you need help with.

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September 18, 2012

Chapter 5: Why Governmental Employers Should Care About Their Reporting Of Employee’s Wages

This entry comes to you with the help of my colleague Wendy Tauriainen.

A couple of weeks ago we got to talking about the fact that dozens, if not hundreds, of local governments and special districts appeared to be ignoring the proper tax treatment and reporting of additional income due to the way they handle cash-outs of PTO. For more on this situation, see When Having Your Cake And Eating It May Be a Bad Thing: Cautions About Cash-Outs Of Unused Leave Or PTO. We had heard special district managers and their outside counsel ask, “What are the chances we will ever get audited about this?” While this is, on the surface, a reasonable question, it really is no different than asking, “Why should we bother reporting our employees’ taxable wages accurately?”

Here are a few thoughts on this subject.

INCREASED IRS AUDIT ACTIVITY ON GOVERMENTAL EMPLOYERS

State and local governments cannot afford to ignore payroll tax issues like withholding on PTO cash-outs. The consequences of failing to find and resolve problems in this area can be extremely expensive in terms of money, human capital and other resources. While we do not have hard data on IRS audit activity regarding State and local governments, anecdotally, we have heard that the IRS has stepped up its activity in this area. We have personal knowledge of at least five IRS audits of California State and local government entities within the last three years, including one city and one county.

PAYROLL TAXES ARE THE OBVIOUS TARGET

Obviously, employment tax issues and benefit plans are the only audit targets for the IRS with respect to state and local governments because government entities do not pay income taxes and are not subject to income tax audits. In these difficult economic times, it makes sense that the IRS would devote resources to audits in areas where the rules are complex, because they know compliance problems are easy to find. The employment tax rules, including PTO cash-outs, are complex, and the IRS is virtually assured of finding at least one significant failure to comply with those rules. The best way to minimize the impact of an audit is to find and fix problems before the audit happens.

IRS’s Employment Tax National Research Project Is Still Ongoing
Beyond anecdote, we do know for a fact that we are in the third year of the IRS’s three-year Employment Tax National Research Project (“NRP”). The NRP was designed to allow the IRS to collect data on payroll tax compliance on a large scale. The three-year project involves a random selection of 2,000 taxpayers per year, including State and local government agencies, to undergo a comprehensive payroll audit. The NRP audits are focused on three main areas: worker classification, fringe benefits, and officer compensation. Obviously, officer compensation is not relevant for governmental employers; however, worker classification and fringe benefits are areas where there is a potential for assessments of sizable taxes, penalties and interest. The specific fringe benefits issues the IRS is asking about include:

  • Employer-provided automobiles;
  • De minimis fringe awards (such as gift cards);
  • Education assistance including tuition reimbursement and scholarships;
  • Meal reimbursements and travel per diem plans;
  • Dependent care assistance programs;
  • Adoption assistance;
  • Leave banks;
  • Moving expenses;
  • Fitness memberships;
  • Life insurance over $50,000 in value;
  • Qualified transportation fringe benefits (mass transit, van pools and employer-provided parking);
  • Qualified retirement planning;
  • Listed property such as personal computers for home use;
  • Severance payments, outplacement counseling and SUB (Supplemental Unemployment Benefits) payments;
  • Vacation cash-out provisions.

FAILING TO BE IN COMPLIANCE CAN BE MORE EXPENSIVE IN MORE WAYS THAN ONE

The IRS asks detailed questions about the benefits listed above, and others, as part of the audit process. The IRS also requires documentation to back up the answers. The following are some of the consequences of not being able to provide the right answers to those questions supported by the proper documentation:

  • Penalties for failing to file correct information returns;
  • Penalties for failing to provide workers with correct Forms W-2;Cost of preparing and distributing corrected Forms W-2;
  • Loss of employee goodwill when they realize they must file amended income tax returns and pay additional tax
  • If income is being under-reported on Form W-2, then it may be under-reported elsewhere as well such as for worker’s compensation, Social Security; and qualified retirement plans (which could result in plan disqualification problems); and

The IRS will likely share with the State Of California adjustments it makes as a result of the audit, which could lead to a State audit.

HOW PENALTIES ARE CALCULATED

Filing a Form W-2 with the IRS with incorrect or incomplete information is subject to “failure to file” penalties under Code section 6721 unless excused for reasonable cause. The penalty is generally $100 per return up to a total annual amount for all such failures of $1,500,000. Corrective filings, the sooner the better, can lessen the amount of the penalty.

The Form W-2 itself is a “payee statement,” subject to “failure to provide” penalties under Code section 6722. Penalties are imposed for the failure to supply the Form W-2 to the payee or providing the payee with incorrect or incomplete information. The “failure to provide” penalty is a separate penalty from the penalty for failure to file an information return, however, the penalty amounts are calculated in the same manner as described above

WHAT TO DO GOING FORWARD

The IRS has already decided that fringe benefits like vacation cash-out provisions are a big enough issue to be worth a three-year study. It is unlikely that the IRS will decide to discontinue its efforts in this area once the study is over. It is more likely that they will simply refine their efforts. We recommend that State and local government entities prepare for the distinct possibility of an employment tax audit before it occurs. Voluntary internal review and problem-solving is much more cost-effective than being forced through the process as part of an IRS audit.

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June 25, 2012

Chapter 4: A Lesson From The “Show Me” State

Although governmental plans are not subject to ERISA, all are subject to a combination of State and common law fiduciary rules – many of which (including California’s) contain language identical to the standards of ERISA. Most fiduciaries of public agency plans understand this to some extent. A number of the largest public plans pay close attention to ERISA’s requirements regarding the investment and administration of their plans and view them as “best practices” to which they aspire. Unfortunately, because of limited resources, the fiduciaries of many smaller and medium-sized public plans remain somewhat uninformed of the potential consequences of violating their fiduciary duties.

To the extent that public officials and public employees have the time and support to spend on the proper investment and operation of their retirement plans, they could learn a lot of “what not to do as a plan fiduciary” by familiarizing themselves with the Tussey v. ABB, Inc. ruling recently issued by the U.S. District Court for the Western District of Missouri. The Court in Tussey found that the plans’ fiduciaries had breached their duties to the plans and ordered them to pay a judgment to the plans in excess of $35 million!

Ken Ruthenberg’s article, ”In A Tizzy Over Tussey … How Not To Act As A Plan Fiduciary“  is a good, short summary of the case.

Without an entire rehash of the case, readers can take note of a few salient facts and findings as follows:

  • The plans involved had been using a well-known investment provider and investment adviser: Fidelity Investments and Fidelity Management & Research Company. Using and relying on a big, well-known provider is not a substitute for properly analyzing what your plan is being charged.
  • The fiduciaries breached their duties to the plans and the participants by failing to understand and evaluate the excessive levels of recordkeeping fees that Fidelity was charging plan accounts.

As with the private sector, many governmental plan fiduciaries would benefit from a more careful review of Tussey and should spend more time analyzing the fees that are being taken from their participants’ accounts.

For public agencies with such plans, a good first step to begin the process of understanding the fees that are being charged and the impact on participants is to follow the new ERISA fee disclosure and participant disclosure rules that take effect (for private sector plans) this summer. For more specifics on these rules see, “Fiduciary Alert! Are You Ready To Comply With Rules Requiring Investment And Fee Disclosures To Participants?” and “Deadline Finally Set For New 408(b)(2) Fee Disclosure Rule Compliance – Less Work, More Work, And Coming Up Fast.”

Although these rules like ERISA itself apply specifically to private sector plans, it is worth noting that the administrators and fiduciaries of many of the country’s largest public defined contribution plans are embracing these rules and standards. A recent survey by the National Association of Government Defined Contribution Administrators reported that over 94% of public plans intend to comply with the disclosure regulations as a best practice. For more on NAGDCA’s survey, see “Rising To The Challenge Of New Fee Disclosure Requirements.”

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February 14, 2012

Chapter 3: The Trouble With Being “Governmental” – Falling On The Wrong Side Of This Definition Could Hurt

Last fall, the IRS announced that it would begin the process of issuing regulations to clarify what is a “governmental plan” under Internal Revenue Code section 414(d) and asked interested parties to comment on the general approach it was taking with respect to the regulation. February 6, 2012 was established as the deadline for submitting comments on the Service’s Advanced Notice of Proposed Rulemaking (also known as Announcement 2011-78).

Because we deal with so many different types of public agencies in our practice, and have sought IRS guidance on this issue on numerous occasions, we know that the process of developing a helpful and administrable definition of a governmental plan will be challenging and difficult. More importantly, based on what we have seen so far, we think that many, many organizations and entities that currently view themselves as governmental for retirement plan purposes could be in for rude awakenings when the final rule comes out. For example, we know that the IRS has had difficulty in the past in deciding whether some of the following types of entities would qualify as governmental plan sponsors:

  • A joint powers authority consisting of both governmental subdivisions and public nonprofit organizations;
  • Certain charter schools; and
  • Certain auxiliary organizations connected with State and community colleges and universities.

Along with many other organizations, we filed comments with the IRS. If you care to view them, click here.

If you are involved with a public agency that is not 100% sure of its governmental status, you most likely are aware of the potential problems that could arise if the agency were determined to be not a governmental plan sponsor. Lurking among the possible parade of horribles are:

  • What happens to your past and future participation in a State retirement system like CalPERS or CalSTRS?
  • Will your agency’s tax qualified retirement plans be retroactively disqualified because you adhered to the wrong set of qualification rules?]
  • What will become of your Social Security replacement plan, and the fact that you and your employees have not been paying into Social Security for years?
  • Could your participation, along with many other “nongovernmental” employers, ruin the tax-exempt status of CalPERS or CalSTRS?
  • What about that section 457(b) plan of yours? Remember, you’ve been operating under the governmental rather than the
    tax-exempt set of rules.
  • If the IRS’s final rules would treat your entity as nongovernmental, is there any chance you would be grandfathered under the
    pre-existing rules, or be eligible for some type of transition relief?

Obviously, there is a lot to think about, particularly if you know you exist in that gray area of the law. If you believe you could be adversely affected by the final rules, you should look into joining forces with other similarly-situated entities and letting the IRS know about your concerns. The IRS rulemaking process is just beginning and there is still much that can be done to address some of the difficult issues raised here.

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December 28, 2011

Chapter 2: Don’t Stand Around Asking If The Sky Is Falling – The Wrong Question Is More Dangerous Than The Wrong Answer

Since the Stanford Institute For Economic Policy Research (SIEPR) issued its latest report on California’s public pension spending, a fair amount has been written by those who are seriously concerned about the potentially enormous size of the unfunded liability of California’s principal public retirement system and those who believe that such reports are alarmist and politically motivated. For others, the debate makes for interesting reading and conversation. However, for those of us who regularly work with public agencies and their retirement obligations, the tendency to discuss “the pension crisis” at the macroeconomic level allows taxpayers and impacted agencies to rationalize that: (a) if the sky is truly falling, there is nothing we can do about it; or (b) yes, there may be signs of a serious problem, but they involve other parts of the State and other agencies, not us.

The fact of the matter is that the overall problem – the problem at the macro level – is too much for most people to get their heads around. As a result, it will be very difficult, if not impossible, for the California Legislature to deal with any of the underlying issues in a meaningful way. Let’s face it, the Legislature has serious problems resolving annual budget issues involving a fraction of the dollars.

So debating whether the SIEPR study is correct is the more dangerous “wrong question.” Forget the “macro” and focus on the “micro.” The right question, which needs to be asked at the State agency and local level basis, is “Will our pension demands allow us to serve our critical mission and support our retirees in the future, and if not, what do we need to do?”

Most, if not all, public agencies have some sense of what their unfunded pension liabilities are. Those who don’t, or haven’t at least looked into it, are serving neither their employees nor taxpayers. After all, CalPERS is simply an aggregate of the retirement benefits and funding of hundreds of agencies.

What happens when we rephrase the question on a micro level?

  • By focusing on whether there’s a problem at the public agency level, we can more easily see whether the “problems” are individualized or are common to all agencies. We suspect that there is a very wide variety of benefit/funding issues and it is this diversity that is making it hard to come up with global fixes to the situation.
  • More can be done, and more quickly, at that level. For example, a CalPERS participating agency can (without the need for our legislators to act):
    • Renegotiate its collective bargaining agreements to provide for increased employee contributions towards pension benefits;
    • Consider terminating its CalPERS contract;
    • Seek re-amortization of its current CalPERS liabilities; or
    • Establish a new tier of benefits.

We know that many agencies and particularly many cities have already been taking many of these actions. Much of this activity has been driven by the budgeting process and the collective bargaining process. However, we also know that many CalPERS agencies have done little or nothing to determine not only where they stand, but what options may be available to them – once they determine that they too must address the same astronomical economic challenges as non-CalPERS agencies.

 

 

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