More Changes for Retirement Plans on the Horizon
Erik Daley, CFA
The U.S. Department of the Treasury and the Internal Revenue Service (IRS) announced on August 29, 2013 that same-sex couples lawfully married under state law (including any domestic or foreign jurisdiction having legal authority to sanction marriages), will be treated as married for federal tax purposes, regardless of whether they live in a state that does not recognize same-sex marriage.
In United States v. Windsor, the Supreme Court’s decision invalidated a key provision of the 1996 Defense of Marriage Act (DOMA), overturning the section of the federal law which defined marriage as between a man and a woman, and spouses only as persons of the opposite sex. Now, a same-sex couple legally married in a state that recognizes same-sex marriage will also be recognized as married under federal law.
However, the Court’s holding did not make any determination regarding recognition of same-sex marriage at the state level. It did not, for example, express any opinion about what happens when legally married same-sex spouses cross state lines into states where same-sex marriage is not recognized. Since the Court’s decision, one of the pivotal concerns has been how to treat, for federal tax purposes, a same-sex couple legally married in one state, but living in another state where the marriage was not recognized.
Revenue Ruling 2013-17 holds that "individuals of the same sex will be considered to be lawfully married under the Code as long as they were married in a state whose laws authorize the marriage . . . even if they are domiciled in a state that does not recognize the validity of same-sex marriages."
The ruling applies to all federal tax provisions where marriage is a factor. That includes income taxes, estate and gift taxes, health insurance, retirement accounts and employee benefits. Among other things, the IRS plans to issue further guidance on cafeteria plans and on how qualified retirement plans and other tax-favored arrangements should
treat same-sex spouses.
The ruling does not apply to registered domestic partnerships, civil unions or other formal relationships recognized under state laws. Further, the ruling does not impact the application of state tax law (except to the extent that a state’s tax law follows or incorporates federal tax law).
Occasionally larger legal issues outside of standard legislative action impact retirement plan sponsors. DOMA is one such example. The Supreme Court, in U.S. v. Windsor, ruled that Section 3 of the Defense of Marriage Act is unconstitutional. Section 3 provided that only persons of the opposite sex could be recognized as "spouses" and "married" for purposes of federal law. Two of the more than 1,300 federal laws impacted by this ruling were the Internal Revenue Code ("IRC") and the Employee Retirement Income Security Act ("ERISA").
DOMA had created an environment where state-recognized¹ same-sex spouses were treated differently than opposite-sex spouses in issues related to both ERISA and governmental retirement plans. While the Windsor decision eliminates the disparities in treatment of same-sex spouses in states that recognize those marriages, it creates new challenges for plans in states that do not legally recognize same-sex marriages but have employees with same-sex spouses who are legally married in other states. For employers in those states additional regulatory guidance will be necessary. For employers in states that recognize same-sex marriage, changes to plan operations will be immediate.
|Pension Plans - QJSA
(Qualified Plans and ERISA 403(b))
|Same-sex spouse treated as non-spouse beneficiary - not required to consent to single life annuity, lump sum, etc. payouts (though plan may require)||Same-sex spouse now entitled to 50% survivor annuity protection (and participant may elect 75% survivor annuity), unless consent to form of payout other than QJSA|
|Pension Plans - QPSA (Qualified Plans and ERISA 403(b))||Same-sex spouse not treated as spouse for qualified pre-retirement survivor annuity protection (though plan may allow)||Same-sex spouse now entitled to 50% survivor annuity protection unless consent to waive (where plan doesn't subsidize cost)|
|401(k) Plans - Payment of Account Balance at Death||Same-sex spouse treated as non-spouse beneficiary - not required to consent to another beneficiary designated by participant||Same-sex spouse now entitled to 100% of account balance at death unless consent to another beneficiary|
|Hardship Distribution (401(k) and 403(b) Plans)||If plan allows, participant may designate same-sex spouse as primary beneficiary when electing hardship distribution for medical, tuition and funeral expenses of such spouse||Plans now required to recognize same-sex spouse as primary beneficiary for purposes of these hardship distributions|
|Rollovers (all Plans)||Same-sex spouse may make direct rollover only to an inherited IRA||Same-sex spouse now able to roll over plan distribution to own IRA or employer plan account|
|Loans (mainly money purchase pension plans)||Same-sex spouse is not required to consent to a plan loan||Same-sex spouse must consent to a plan loan|
|QDROs (all Plans)||Same-sex spouse does not have rights of "alternate payees" to obtain QDROs awarding share of participant's benefits||Same-sex spouse now able to obtain QDRO if state law recognizes the rights of same-sex spouse (or is entitled to share in community property states)|
Source: "A Quick Look at the Impact of Windsor on Benefit Plans" Groom Law Group
Without a tremendous amount of legal guidance from the Department of Labor ("DOL"), it has become commonplace for plan service providers in the mid- and large-plan market to provide a direct accounting of the income they receive from plan investments. In the event that this income exceeds the income they are contractually entitled to, providers have developed solutions to enable the plan to recapture the excess. While the names of these programs vary be vendor, they fall into one of two structures, a bookkeeping account and a plan account.
Bookkeeping Account - In a Bookkeeping Account, the provider captures and retains the excess revenue, but contractually may be obligated to use excess revenues to pay reasonable and necessary expenses incurred by the plan. Typically the agreement to recapture and pay expenses would be a contractual obligation of the service provider and end when the service relationship ends.
Plan Account - In a Plan Account, the provider captures excess revenue and deposits those excesses into the plan. The plan, assuming the document permits pays reasonable and necessary expenses from the account. Typically, amounts deposited into the plan would be used to pay expenses in the same plan year. However, amounts may also be returned to plan participants in the form of an additional earnings credit.
On July 3, 2013 the Department of Labor issued Advisory Opinion 2013-03A, which addressed (albeit in a very limited way) the issues related to the collection and use of revenue sharing payments from investment providers. The guidance reaffirmed our position that there are significant differences in reporting related to Bookkeeping Accounts and Plan Accounts. Those differences center on the issue of when a recapture account would or would not be a plan asset.
It is clear that Plan Accounts would be considered plan assets by the Department of Labor and plan sponsors should treat and report on them accordingly. While Bookkeeping Accounts would generally not be considered plan assets, they impact reporting and the status of service providers paid through those accounts.
In 2010, the U.S. Securities & Exchange Commission (SEC) adopted Rule 2a-7 which introduced several significant changes to money market fund operations, including stress testing, liquidity "baskets," and new minimum credit quality requirements. In the fall of 2012, the Financial Stability Oversight Council issued a recommendation on additional money market reforms. While these reforms previously stalled under former SEC Chairman Mary Shapiro, the Commissioners recently voted unanimously to move forward with these recommendations and the proposed rules are in the comment period.
The SEC has put forth several proposed rules as part of a package of money market reforms. The most significant of these rules would impact money market fund valuation, tax treatment of withdrawals, and restrict redemptions. The SEC may adopt or reject one or both of these rules, based on their review of comments submitted during the comment period.
Money market funds currently operate using a stable NAV where each share held will always equal $1. Under the proposed floating NAV rules, which affect only municipal and prime money market funds, these mutual funds will be further divided into "retail" and "institutional" funds. The SEC would adopt a formal definition of retail funds as those that limit individual investors to $1M per redemption, per day. Retail funds would be excluded from the new rule.
So-called institutional municipal and prime money market funds would calculate NAV out to 4 decimals (currently 2). On an individual's $10,000 investment, any up or down movement of 0.0001 would result in a $1 change to their account value.
The SEC acknowledges that there are areas of significant concern under the floating NAV rule, namely tax and accounting treatment. Under the current stable NAV system, investors do not need to track investment gains or losses, and there are no "wash sale" concerns (where investors may incur a penalty for sells and buys of the same product during a 30 day window). Under floating NAV, investors could potentially be exposed to a number of taxable events. The SEC is working with the IRS to determine how transactions in floating NAV funds would be treated for tax purposes.
Under current accounting rules, money market funds are considered to be "cash equivalent." While the SEC expects that to continue, investors will need further guidance from the Financial Accounting Standards Board.
The SEC has also proposed a rule that would create restrictions on fund redemptions in retail and institutional municipal and prime money market mutual funds. This rule is designed to discourage a "run" on these funds during times of severe market stress. (As Treasury and government bonds typically experience inflows resulting from a flight to quality during times of market stress they are not impacted by this rule.) Under the redemption rule, funds would need to impose a 2% redemption fee whenever weekly liquidity falls below 15%. The fund's Board of Directors could opt to lower the redemption fee or eliminate it, but they would need to meet a significant fiduciary hurdle.
Alternately, funds could choose to impose a liquidity "gate," suspending all redemptions for a period of up to 30 days whenever weekly liquidity falls below 15%. No more than one gate would be allowed in any 90 day period.
As part of the proposed regulations, the SEC has also put forth additional requirements for enhanced and timely liquidity disclosures, enhanced stress testing, and asset holdings disclosures.
The SEC anticipates there will be a lot of comments made on their proposal and significant time needed for review, so adoption, revision or rejection won't likely occur before Q1 2014. And under the current proposal, affected money market mutual funds would have 1 year to implement redemption restrictions, 2 years to implement a floating NAV.
The extent of the potential impact on retirement plan sponsors is difficult to gauge at this time. Municipal/tax-exempt and prime funds could opt to qualify as "retail" funds, thus avoiding the floating rate rule, but a redemption cap at $1M per investor per day could limit their use in pooled investment environments. We don't yet know how redemption fees would be allocated where custodians and recordkeepers utilize aggregated "omnibus" trading on behalf of a retirement plan or plans. And the threat of a liquidity gate may prove too much of a burden for some investors. A move to floating NAV products may encourage plan sponsors to switch to other solutions such as stable value funds or short-term bond funds that already have a floating NAV.
On May 2, 2013 the IRS released their Executive Summary of Final Report for their Compliance Project, reporting that more than 90% of the examinations were complete. The examination revealed the following.
Most relevant to our clients was the results of the retirement plan audit, which revealed problems in one-half of those institutions audited. Examinations resulted in more than $200,000 in taxes and penalties.
On June 3, 2013 the Employee Plans Compliance Unit ("EPCU") of the IRS announced that they will be checking a broad array of "Top Hat" plans to learn more about the operation of these plan and to verify their compliance with the Internal Revenue Code. Similar to recent checks conducted by the EPCU, the results of this project will likely drive their audit priorities in future years.
Tax-exempt employers should review their own plans with respect to the audit check issues to ensure they are in compliance with the Code. The EPCU will be focusing on the following issues:
On July 22, 2013, the Department of Labor released Field Assistance Bulletin No. 2013-02, which provided that the DOL would not seek enforcement against plan administrators who furnish “the 2013 comparative chart” (the comparative format required under 29 CFR 2550.404a-5) to participants no later than 18 months after the 2012 comparative chart was furnished.
The 2012 comparative chart was due on or before August 30, 2012 and many plan administrators have already furnished the 2013 comparative chart. In this case, the DOL has stated that plan administrators who have already provided the 2013 comparative chart will have 18 months from the date that chart was provided to furnish the 2014 comparative chart.
The DOL has extended the timing to allow plan administrators to schedule the timing of these required disclosures to be in line with other annual disclosures. However, it is important to note that the relief provided under the FAB is limited to the required annual disclosure of information under paragraphs (c)(1)(i) and (d)(1) and (2) of the regulation. Plan administrators are not relieved from other obligations under the regulation that are intended to ensure that participants and beneficiaries have access to updated investment-related information. For example, any changes to the plan’s investment instruction procedures or designated investment alternatives must be timely disclosed to participants and beneficiaries as required by the regulation. Further, investment-related information that is made available via the web must be updated in accordance with the regulation.
Additionally, the DOL is considering whether to allow a 30-day or 45-day window during which any subsequent annual comparative chart would have to be furnished, rather than fixing the 12-month “at least annually” period to end on one specific day.
For more information, please see Field Assistance Bulletin No. 2013-02.
Information herein is provided for general informational purposes and is not intended to be completely comprehensive regarding the particular subject matter. Multnomah Group does not represent, guarantee, or provide any warranties (express or implied) regarding the completeness, accuracy, or currency of information or its suitability for any particular purpose. Receipt of information does not create an adviser-client relationship between Multnomah Group and you. Neither Multnomah Group nor our advisory affiliates provide tax or legal advice or opinions. You should consult with your own tax or legal adviser for advice about your specific situation.