Chapter 28: Why Cashing Out PTO Next Year Doesn’t Work

Our efforts to educate employers about the dangers and surprises associated with PTO cash‑outs (see, Chapter 13 and “When Having Your Cake and Eating It May Be a Bad Thing: Cautions About Cash-Outs of Unused Leave Or PTO”) are having an effect. Unfortunately, some of the changes and adaptations to MOUs regarding PTO cash-outs simply do not go far enough.

One of the newer “variations” that we have come across gives employees that have already accrued a certain amount of PTO the right to make an irrevocable election in calendar year 1 to receive a cash-out of a portion of their already accrued PTO as of the beginning of calendar year 2. For example, an employee who has already accrued 120 hours of PTO has the right prior to the end of this year to elect to receive a cash-out of up to 60 of those hours, which will not be paid until the beginning of next year.

Presumably the “thinking” behind this variation is that the employee must make an irrevocable election to receive additional compensation (or not to receive it) in the year prior to the year of actual receipt – and that this timing rule somehow avoids application of the “constructive receipt” doctrine. In our view, it doesn’t.

The reason it doesn’t work to prevent the employees who have the election from being taxable in   year 2 is because the employees have already accrued or earned the PTO that is being cashed out. The consequence is that the employees are being given the absolute right to decide this year whether they will receive additional cash early next year. Yes, the fact that they cannot receive the cash-out this year will prevent the money from being taxed this year, but it will not keep the amount subject to the election from being taxable in year 2. Therefore, all employees who are given the election will have additional taxable income in year 2 even though they do not elect to cash out anything.

So, what’s still missing? In order for the above scenario to turn out correctly, the irrevocable election in calendar year 1 to cash out PTO must be made with respect to PTO that has not yet been earned and which will be earned in calendar year 2 or years into the future. Because the employee does not know whether he or she will earn a specific amount of PTO as of the beginning of year 2, the policy will have to be adapted to account for rates of accrual and the chance that the employee may leave early or not earn the PTO he or she elected to cash out.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

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Chapter 27: Do You Have a Proper Cafeteria Plan?

The recent Ninth Circuit decision in Flores v. City of San Gabriel focused on the circumstances under which the value of certain non-cash-wage benefits (such as those provided under “cash-in-lieu” programs or cafeteria plans) must be included in the determination of FLSA overtime wages. We thought that many public agencies would be asking us about whether their cafeteria plans met the “bona fide plan” exception mentioned in the case. However, we were surprised to learn that quite a large number of public agencies still do not have a proper cafeteria plan document even though they maintain “cash-in-lieu” arrangements or benefit programs that operate as nontaxable cafeteria plans. In order to avoid the risk that the IRS might take the position that your cafeteria plan does not have the required “written plan” and that, as a result, your employees are taxable on the amounts that they could have received as wages (even if they selected nontaxable benefits), you should have a cafeteria plan document that satisfies the following requirements:

  1. A specific description of each of the benefits available through the plan;
  2. Rules on participation and requiring that all participants be employees;
  3. Procedures governing employees’ elections under the plan, including the period when elections may be made, the periods with respect to which elections are effective, and providing that elections are irrevocable, except to the extent that the optional change in status rules are included in the cafeteria plan;
  4. How employer contributions may be made under the plan;
  5. The maximum amount of employer contributions available to any employee through the plan, by stating the maximum amount of elective contributions available to any employee through the plan, expressed as a maximum dollar amount or a maximum percentage of compensation or the method for determining the maximum dollar amount;
  6. The plan year;
  7. If the plan offers paid time off, the required ordering rule for the use of nonelective and elective paid time off;
  8. If the plan includes flexible spending arrangements (FSAs), the plan’s provisions complying with any additional requirements for those FSAs;
  9. If the plan includes a grace period, the plan’s provisions complying with the grace period requirements; and
  10. If the plan includes distributions from a health FSA to employees’ HSAs, the plan’s provisions complying with the applicable requirements.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

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Chapter 26: Controlling Retiree Health Costs: I’ve Got Some Bad News And Some Not So Bad News…

Originally published in “The Public Retirement Journal,” March-April 2016, and reprinted with permission.

So, here’s the bad news. Governor Jerry Brown referred to the State’s grossly underfunded pension and retiree health obligations in his 2016 State of the State address as “liabilities…so massive that it is tempting to ignore them.” The State’s unfunded retiree health obligation (well in excess of $65 billion) has now surpassed its unfunded pension obligations – and, more importantly, there is no statutory or administrative construct in place (like CalPERS) to force State agencies, cities and local governments to properly fund for these growing obligations. Sure, GASB 45 now forces government to “account for” these liabilities to acknowledge that they really exist; however, it does not by itself mandate funding of these obligations or efforts to control future costs.

None of this is really “new” news. Most of us have seen this coming for some time now. So, what’s the “not so bad news”? Depending on whether you are wearing the hat of someone charged with the responsibility of controlling these liabilities and costs, someone who may be adversely affected by a future reduction in retiree health benefits, or both, the not so bad news is that State agencies, cities and local governments have the tools needed to begin to control retiree health care costs and unfunded liabilities. The real question is whether they have the political skill and will to use them.

In the simplest terms, California law regarding “vested rights” of public employees does not protect retiree health benefits to the same extent that it currently protects pension benefits. With respect to public pension benefits, the courts judicially “imply” a contract (or a vested right) that generally arises when an individual is first hired, which prevents the employer/public agency from reducing or adversely modifying pension benefits unless the employer provides a simultaneous enhancement of pension benefits that is of comparable value. Not so with respect to retiree health benefits. Instead, the California courts recognize that public employers may, if they choose, provide their employees with vested rights to retiree health benefits; however, the extent to which they are protected or vested is strictly a matter of contract law. In other words, the courts have not inferred or presumed some immutable right arising upon hire, as they have in the pension arena.

Of course, things are never so simple. Contracts can be “expressed” – where the terms of the agreement are clearly determined from the written words of the contract, or they can be “implied” – where some or all of the terms of the agreement may be based on the conduct of the parties and, in some cases, relevant written communications outside of the contract.

There have been a number of significant court cases dealing with the rights of California public employees to vested retiree health benefits, most notably the series of federal and California rulings involving the dispute between the retired employees of Orange County and the County of Orange[i] that took over six years to resolve (REOC) and the intervening rulings involving the City of Redding[ii] (Redding). Without going into all of the messy details of these cases (something lawyers love to do), here are the major takeaways from REOC and Redding:

  • It is possible for public employees in California to obtain “vested” rights in their retiree health benefits.
  • Whether and when retiree health benefits become vested and protected against unilateral modification is a matter of “contractual analysis.” That is, what did the parties negotiate and agree upon?
  • A right to vested retiree health can arise by either implied or express contract.
  • In analyzing whether there is an express or implied contract to provide vested retiree health benefits, the courts will look at the employer’s legislative acts (i.e., resolutions, ordinances, and approved MOUs). If the parties’ intent to confer a contractual right to retiree health benefits is not explicit, the party asserting the right (i.e., the retirees) has a heavy burden to overcome.
  • To find a binding obligation to provide permanent retiree health benefits, the courts will look for resolutions, ordinances, or approved MOUs that:

Explicitly provide for health benefits in perpetuity;

Guarantee that the level of benefits will continue; and

Indicate that the benefit is a continuing obligation.

  • A long-term practice of providing a retiree health benefit is not, by itself, enough to create a vested retiree health benefit.
  • MOU language conferring retiree health benefits upon “each retiree and dependent…currently enrolled and for each retiree in the future” is enough to create vested retiree health benefits – potentially in perpetuity.

Let’s go beyond the legal takeaways and focus on what public employers need to understand about their retiree health benefits and what can be done with them.

  • In most cases, California public employers do not have the kind of language in their MOUs that was present in Redding. In other words, very few employers have contractual obligations to provide retiree health benefits beyond the terms of the current MOUs. Start immediately by having legal counsel look at your resolution/ordinance/MOU language.
  • Assuming that the employer is not constrained from making changes in existing retiree health benefits (or future retiree health benefits) by the terms of its contracts, there needs to be an honest assessment of:

The current and projected liabilities associated with retiree health, whether these liabilities (and the assumptions underlying them) are realistic, and how important it is for the employer to control overall benefit costs by reducing retiree health benefits.

The changes that might be available to reduce or control retiree health costs and liabilities (e.g., moving away from a defined benefit retiree health system to a defined contribution system that focuses on what employers can afford to contribute).

Whether there are other aspects of employees’ total compensation and benefits that can be negotiated or reduced in lieu of complete or immediate changes to retiree health.

  • Once the numbers have been reviewed and the issue of financial “sustainability” has at least been raised, there needs to be political discussion about the willingness of the employer and its governing board/council to take on this issue.
  • Again, assuming that there is the need and the will to make changes, there are a number of things that can be done to begin to control these costs and liabilities:
  • Even if the employer is a participating employer in CalPERS and subject to the Public Employees Medical and Hospital Care Act (PEMHCA) and its equal contribution rule, there are adjustments that can be made by using rate groups.[iii]
  • Apart from the use of rate groups, employers that are subject to PEMHCA may also be able to lower their mandatory equal contribution rate for both active employees and retirees and then make separate subsidies (outside of PEMHCA) through the use of a cafeteria plan for active employees and a health expense reimbursement arrangement for certain retirees.[iv]
  • Some employers such as the County of Sacramento have “re-characterized” their retiree health benefit subsidy as an ad hoc benefit that may or may not be conferred on employees. If this is done, there would be no contractual right, but there might be a benefit conferred if there is sufficient room in the budget.
  • If things are really bad, there is always bankruptcy. Based on the experiences of Vallejo, Detroit, Stockton and San Bernardino, literally hundreds of millions of dollars in retiree health obligations were eliminated as part of these bankruptcies.

Given the State of California’s law with respect to public employees’ retiree health benefits, there is bound to be continuing discussion and scrutiny as to what if anything can be done, or is being done, to control these multigenerational obligations.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the web site. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or email us at contactus@seethebenefits.com.

[i] See Retired Employees Association Of Orange County, Inc., v. County Of Orange, 742 F. 3d 1137 (9th Cir. 2014) and Retired Emps. Ass’n of Orange County v. County of Orange, 52 Cal. 4th 1171 (Cal. 2011).

[ii] See International Brotherhood Of Electrical Workers, Local 1245, v. City Of Redding, 210 Cal. App. 4th 1114 (Cal. App. 3rd Dist., 2012); petition for review denied, 2013 Cal. LEXIS 462 (Cal. 2013).

[iii] See Chapter 12: When Treating Everyone The Same May Not Work – Working With PEMHCA’s Equal Contribution Rule, http://focusonpublicbenefits.com/?p=322

[iv] Id.

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Chapter 25: The Salary Continuation Trap

We often are asked to review the tax and employee benefits provisions of employment agreements between public agencies and their key executives. Because we recently have come across the same problem in several of these contracts, I decided to share with you what I will refer to as the “salary continuation trap.”

Experienced and capable chief executives can be hard to find, particularly when it comes to leadership positions of a limited duration – such as oversight of a large public works project or filling a key management position on an interim basis. Usually, these contracts provide for a specified term of employment, which invariably gets modified and extended. They also often contain provisions that allow the executive or the agency to cut short or terminate the agreement in certain cases. Under the circumstances, it is understandable that the executive would want the agreement to contain protections against the premature or unanticipated termination of the contract by the hiring agency.

Sometimes these protective provisions take the form of “severance pay benefits” that provide for the payment of additional monies to the executive following a unilateral termination of the executive’s employment by the agency without cause. Sometimes they just call for the payment of additional monies. As is explained below, it is important for these payments to be characterized as “severance pay” and not as “deferred compensation.”

If future payments of compensation, provided by a State, local government or tax-exempt entity, fall into the category of deferred compensation, they will be subject to taxation under Internal Revenue Code (IRC) section 457(f). This means that any amounts of compensation that are “deferred” under the agreement – that is, payable in the future – will be taxable as and when they are no longer subject to a substantial risk of forfeiture. In other words, if an executive’s contract provides for the payment of deferred compensation (not severance pay) at a specified time in the future and the executive’s rights to such payments are fully vested, the executive will be taxable at the time his vested rights to such compensation were created (i.e., when the contract was formed) even though he or she may not be entitled to actual payment of the monies until sometime in the future. How’s that for a trap?

In case the nature of the trap was not made clear, I’m talking about the fairly common practice of providing for between six and 24 months of so-called “salary continuation” following the expiration or termination of the executive’s contract. The contracts that we have seen simply provide that upon the expiration or termination of the contract by either party (and for whatever reason), the executive will continue to receive “salary continuation” for the specified period. Unless these payments are properly structured as a “bona fide severance pay plan” under IRC section 457(e)(11) – that is, payable only upon the unanticipated termination of employment – the executive and the agency likely have an income tax (or income tax reporting) problem.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

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Chapter 24: 457(b) Plan Fees And Revenue Sharing

Many public agencies pay little attention to their 457(b) plans because the agencies are not “paying” for them out of their own budgets. See Have You Checked Your Retirement Plan Fees Lately?

Plan fiduciaries are legally required, at least in California, to make sure that plan assets are used only to provide benefits and to defray the “reasonable expenses of administering” the plan. See California Constitution, article XVI, section 17(a). Therefore, it is surprising that so many public agencies have little or no idea how much is being “taken” from their plans as custodian/trustee, recordkeeping, third-party administration, fund management, and investment advisory fees. To compound the confusion, many 457(b) plans are provided through “bundled” arrangements where various plan services are provided by a single third party (e.g., an insurance company) and the fees for those services are “bundled” together (arguably, for the convenience of the plan sponsor). Such arrangements make it difficult to determine exactly how much the plan and its participants are paying for each of the services being provided.

How does “revenue sharing” factor into the mix? Revenue sharing is a common practice where mutual funds pay some of their revenue to the plan providers who perform recordkeeping functions for 457(b), 401(k), 401(a) defined contribution and 403(b) plans. These payments are to compensate plan recordkeepers and third-party administrators for providing plan accounting and participant servicing functions that the mutual funds would normally provide. However, revenue sharing makes it more difficult for plan sponsors and fiduciaries to figure out exactly how much is being paid for recordkeeping and plan administration assistance and exactly who is paying those fees. The “how much” question arises because shared revenue is always defined as a percentage of plan assets (i.e., a set number of basis points). Under this approach, the amount of shared revenue can increase over time to a point where it bears no real relationship to the level of services provided. Sometimes, the plan provider recognizes that it has taken too much revenue out of the plan and refunds some of that revenue into a “plan expenses account.” The problem with such accounts is that the plan fiduciaries must decide how to prudently and fairly allocate these amounts among the participants. The “who” question arises because the amount of revenue shared can vary by mutual fund. In such cases, participants who have invested in certain funds are paying a disproportionate share of the plan’s recordkeeping fees.

Does your plan’s service arrangement provide for revenue sharing? And, do you really understand how it works? Are you leaving too much money on the table?

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

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Chapter 23: Have You Checked Your Retirement Plan Fees Lately?

Many public agencies’ 457(b) plans, where all fees are paid by the plans, may be neglected for years or even decades.  And while this neglect may not cost the district or the city any more money, it is definitely costing plan participants.

Recently, we advised a number of public agencies that for one reason or another had not reviewed their 457(b) plan fees and expenses for quite a number of years. Here’s what we found:

  • Recordkeeping and investment advice fees often are structured to yield a targeted amount of revenue – an amount that may be grossly inappropriate if the plan’s assets increase dramatically. Unsophisticated plan sponsors often permit recordkeepers to express their fees as a percentage of plan assets. For example, take a small special district’s 457(b) plan with 20 participants and $1,000,000 in total assets.  While it might be reasonable for a recordkeeper to initially charge something like 50 basis points for its annual recordkeeping services (the equivalent of $250 per participant), it would be inappropriate and unreasonable for the recordkeeper to continue to receive 50 basis points ten years later when the plan’s assets have increased to $3,000,000.  The plan still only has 20 participants. However, due to plan contributions and investment earnings, the average balance is now $150,000 (not $50,000). If you recognize that the recordkeeper’s job is largely an accounting function, the fee for keeping track of participants’ accounts should remain the same no matter how large the account grows. In this case, plan participants are paying approximately three times too much for the recordkeeping services they are receiving.
  • A large number of public agencies maintain multiple 457(b) plans.  Usually, this situation has evolved to accommodate employee calls for more investment choices.  Apart from the likely compliance problems associated with multiple uncoordinated plans, the plan participants often lose out because the fees they are paying are based on three smaller pools of assets rather than on one larger pool of assets.  In one recent case involving three 457(b) plans with total assets of $10,000,000, the participants were paying “retail” costs for their mutual fund choices when they could have been “wholesale” through the use of institutional class funds. A single larger plan has more purchasing power.
  • Excess fees and expenses matter.  According to the SEC, a participant investing $100,000 over a 20 year period and earning a 4% annual return will end up with $30,000 less if his/her fees are just 75 basis points higher than what might be considered normal (.25%).

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

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Chapter 22: Social Security Replacement Plans – An Introduction

For many American workers, the Old-Age, Survivors, and Disability Insurance (OASDI) program serves as an important component of their retirement savings. This is not necessarily the case for the millions of workers whose State, local government and public agency employers have “opted out” of OASDI’s combined (employer and employee) 12.4% payroll taxes and are instead participating in a Social Security replacement plan (SSRP).  This article provides a brief introduction to such plans.

In a back-handed way, Section 3121(b)(7)(F) of the Internal Revenue Code states that most individuals’ employee services performed for a State, a political subdivision thereof, or of any instrumentality of a State or a wholly owned political subdivision or instrumentality thereof will be subject to OASDI provided that such individuals are not members of a “retirement system” of such State, political subdivision, or instrumentality.  The term “retirement system” is defined in Section 218(b)(4) of the Social Security Act (Act). These are SSRPs.

So, how does a governmental employer determine whether it must participate in OASDI or if it can opt out by providing some or all of its employees with benefits under a SSRP?

Steps for analyzing OASDI coverage:

  1. If the employee’s position is covered by an agreement under Section 218 of the Act (Section 218 Agreement) and no exclusion applies, the employee is covered. A Section 218 Agreement is a written agreement in which a State or local government voluntarily agrees to participate in Social Security. Note that once a State or local government agency becomes covered by a Section 218 Agreement, it is not permitted to withdraw or cancel its participation.
  2. If the employee’s position is not covered under a Section 218 Agreement and the employee is covered by a SSRP, the employee’s coverage under OASDI is not mandatory – the sponsoring employer can opt out of OASDI.

Based on numerous cases and inquiries involving these issues, we’ve noticed that:

  • Many public agencies do not know whether they and their employees are subject to a Section 218 Agreement. To find out, an agency can contact the State Social Security Administrator for its State. A list of State contacts can be found here.
  • Many agencies do not understand whether their retirement plans satisfy all of the requirements for being SSRPs. There are different requirements for defined contribution SSRPs and defined benefit SSRPs.
  • Many public agencies that use defined contribution SSRPs do not operate or invest them in accordance with applicable IRS guidelines.

In future posts, I’ll address more of the specific problems that can arise with SSRPs.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

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Chapter 21: Auto-Enrollment For Some Non-ERISA Plans

One of the more compelling recent trends in the world of tax-deferred savings (i.e., 401(k), 403(b) and 457(b) plans) has been the growth in the use of automatic enrollment, or auto-enrollment, features.  In a typical auto-enrollment situation, the employer enrolls the employee without the employee’s consent at a predetermined level of employee contributions and a default investment option. Under applicable rules, employees must be given notice of the arrangement and the ability to “opt-out.” There is a growing body of research pertaining primarily to 401(k)s that strongly suggests that once employees “automatically” set aside part of their wages in their employer-sponsored retirement plan, they will tend to stay the course and continue the savings practice on their own.

So, if auto-enrollment is such a great idea, why isn’t everyone using it? Like so many things, the answer is, “there may be legal problems.”

In the past, the problem with most auto-enrollment features was that many states’ laws restricted or prohibited an employer from deducting amounts from an employee’s paycheck without the employee’s written consent.  For example, California Labor Code section 221 prohibits such unilateral wage reductions and is punishable both as a misdemeanor crime and through civil penalties. This problem of state laws conflicting with what seemed like a good concept was resolved (partially) as part of the Pension Protection Act of 2007 (PPA), which expressly preempted conflicting state laws as they applied to ERISA plans.

So, the state law problem with auto-enrollment was removed for ERISA-covered plans; but not for non-ERISA plans (those maintained by state and local governments, public agencies and most churches).  The non-ERISA plans are still required to comply with state laws that prohibit deducting amounts from an employee’s paycheck without consent. Despite these impediments, we see news reports and studies suggesting a few local governments, at least, have adopted, or are in the process of adopting, auto-enrollment features in their 457(b) plans. The most notable is the City of Los Angeles.

They’re a non-ERISA plan sponsor, so how come they can do it? It appears that L.A. is relying on an exception contained in California Labor Code section 224 that provides that a wage deduction for pension plan contributions should not violate section 221 as long as it is expressly approved in a collective bargaining agreement.  This strategy/technique appears to open the possibility of auto-enrollment to a much larger potential audience including sponsors of non-ERISA plans like state and local governments, public agencies and churches.  Because of the potential criminal and civil penalties, non-ERISA employers in California should get legal advice before adopting such an arrangement.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

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Chapter 20: Opting Into A Pick-Up Plan

A recently issued IRS private letter ruling (PLR) puts the kibosh on the fairly common practice of allowing public agency employees to elect whether and at what level to participate in the agency’s mandatory contribution pension plan.

This plan design stems from several PLRs issued in the early 2000s that implied, without explicitly approving, that such elections did not cause income tax problems for the participants or plan qualification problems for the employer. Basically, eligible employees were given a one-time, irrevocable election of whether to participate and, if participating, the specific level of mandatory (picked‑up) employee contributions the employee would make.  In theory, if the employee mandatory contributions, which are normally after-tax, were properly picked up by the employer, such amounts would be treated as pre-tax contributions – not currently taxable to the employee.

In what to some of us is not a particularly surprising ruling, the IRS clarifies that:

1.    Giving an employee the choice of receiving a certain amount of cash or contributing that amount to a retirement plan would generally constitute a cash or deferred arrangement within the meaning of the 401(k) rules.

2.    Unless the adopting employer is eligible to maintain a “grandfathered 401(k) plan,” it is not possible for a governmental employer to offer such an arrangement as part of a tax‑qualified, or section 401(a), plan. Note, this ruling and discussion has no application to 457(b) plans of governmental employers.

3.    Although there is an exception under the cash or deferred arrangement rules for irrevocable, one-time elections that are made “no later than the employee’s first becoming eligible under the plan or any other plan or arrangement of the employer,” this exception does not apply when the employees are already participating in another qualified plan (or 403(b) plan) of the employer – such as CalPERS.

The result of this ruling is that plans with this feature need to be carefully examined to determine how participants will be treated from an income tax perspective and how the plan itself may need to be restructured or fixed in order to maintain its tax-favored status.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

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Chapter 19: Get the IRS’ Blessing for Your 401(a) Plan – Before It’s Too Late

The IRS has just announced major changes to its program for reviewing and approving the qualified status of certain retirement plan documents (see, Announcement 2015-19).  Essentially, the Service is doing away with its program for issuing determination letters as to the qualified status of so-called “individually-designed plans,” except upon initial qualification and plan termination.  Because practically every “governmental plan” intended to be a section 401(a) tax-qualified plan is an individually-designed plan, this means that most sponsors of such plans have a limited opportunity to seek one more IRS review and “blessing” for their plans.  Most public agencies with a tax-qualified plan that does not have a current determination letter will have until January 31, 2016 by which to review, update and submit the plan.

Virtually all benefits practitioners recommend that clients with individually-designed plans obtain a current determination letter with respect to their plan. Having a current determination letter provides legal and tax assurance (as well as peace of mind) that your plan document complies with numerous Internal Revenue Code requirements that apply at the time.  Failure of a governmental plan to meet the qualification requirements could at a minimum result in:

  • Immediate taxation of participants’ vested benefits
  • Loss of favorable tax-free rollover treatment
  • Withholding and payroll tax problems
  • Required financial audit disclosures and explanations

Although having a current determination letter does not prevent a plan from jeopardizing its tax-qualified status due to an operational failure, it certainly helps a plan sponsor (and the plan’s administrator) by providing them with an IRS-approved document to work with.

As mentioned earlier, almost all governmental qualified plans are also individually-designed plans, even if they have been prepared or provided by a nationally recognized plan servicer such as Lincoln, Great-West or VALIC.  If you are a governmental qualified plan sponsor, you should immediately determine whether your plan is individually-designed and whether it is eligible to be submitted to the IRS for approval “one last time.”

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

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Chapter 18: It’s Supposed To Go To Whom? Beneficiary Designation In Governmental Defined Contribution Plans

Here’s an interesting difference between public and private industry plans that we were reminded of recently and that we’d like to share with our governmental clients and their advisors because it can be so problematic.

In most private industry plans, federal law requires that the spouse be the automatic death benefit beneficiary of the participant’s interest under the plan or that the spouse consent to any beneficiary designation that doesn’t name them as the sole primary beneficiary. Not always so in governmental plans.

Take for example the designation of a death benefit beneficiary or beneficiaries under a governmental defined contribution plan or 457(b) plan in a community property state like California. We’ve found that in many cases, local governments are using generic plan documents that don’t even recognize the fact that the respective interests of the participant and the spouse may be governed by state community property laws.

California courts recognize that a defined contribution plan account balance that was accumulated during the course of a marriage is community property and may be subject to division upon marital dissolution.  As importantly, the courts also recognize that the participant may only be able to clearly designate the death benefit beneficiary as to the participant’s one-half community property interest and that the spouse has a one-half interest in the account, based on community property laws.

This can be a huge problem in the case of any governmental plan in a community property state where the plan’s document, forms and procedures do not adequately explain the rights of the participant and those of the spouse to decide how their respective community property interests under the plan will be distributed in the event of their deaths.

The best way to handle this is to make sure that the relevant plan document, plan summary, applicable procedures and beneficiary designation forms and instructions all clearly spell out the respective rights of the participant and the spouse in connection with any beneficiary designation. A commonsense, best practice would be to not allow any beneficiary designation to be made or changed by one spouse without the knowledge and express written consent of the other spouse.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or email us at jcc@seethebenefits.com.

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Chapter 17: Bankruptcy Ruling Cuts CalPERS Down To Size

On February 4, 2015, the Judge overseeing the City of Stockton bankruptcy issued an opinion, overruling Franklin Templeton’s lone objections to the City’s plan of reorganization and, very pointedly, clarifying the true role of CalPERS – at least in a bankruptcy context.

For those new to the case, some quick background. When the City filed for chapter 9 protection in 2012, it successfully negotiated away over $2 billion in long-term debt with all of its creditors except one. Facing a potential loss over $32.5 million, Franklin Templeton rejected the City’s settlement offer and filed suit, arguing against CalPERS’ claim of public pension inviolability and basically asserting that the pension giant needed to get in line with its hand out for its money like everyone else.

According to the judge’s ruling, Franklin Templeton may have been right, but it didn’t win. And in the sense of a “win,” neither did CalPERS, which Judge Klein characterized as a bully with a glass jaw (really, read the opinion).

So what does it all mean? Here are my takeaways:

  1. A careful examination of the relationships between CalPERS, a participating employer and its employees reveals that CalPERS is not a major creditor of any participating employer because it does not guarantee the funding of employees’ pensions. “CalPERS is merely a servicing agent that does not guarantee payment.”
  2. In evaluating the respective rights and responsibilities of various chapter 9 creditors, it is the employees and retirees of a city who are one of the largest, if not the largest creditor. An insolvent city must negotiate with them to obtain appropriate wage and benefits concessions.
  3. Because CalPERS does not guarantee the pensions it “services,” CalPERS appears to lack standing to object to pension modifications in a chapter 9 proceeding.
  4. Provisions in the Public Employees Retirement Law that purportedly forbid the rejection in bankruptcy of a CalPERS contract and provide for a CalPERS lien for termination liabilities are both ineffectual in a federal bankruptcy context.
  5. The vaunted “vested rights” doctrine under both California case law and the state and federal Constitutions does not prevent Congress from enacting a law (the federal bankruptcy act) impairing a state or local government’s obligation of contract.

How will this all affect other pending and future municipal bankruptcies? Stay tuned.

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