Managing Employer Fiduciary Issues for 401k and 403b Plan Sponsors in 2013

Managing Employer Fiduciary Issues for 401k and 403b Plan Sponsors in 2013 Questions and Answers from Verisight s Presentation, January 30 th, 2013 What is the difference between a qualified plan and a nonqualified plan? A qualified plan is governed by the Employee Retirement Income Security Act of 1974 ( ERISA ) and the Internal Revenue Code. As such, a qualified plan is subject to stringent coverage, nondiscrimination, and governmental reporting requirements. These plans include profit sharing, 401k, money purchase pension, Employee Stock Ownership Plans (ESOPs) and defined benefit pension plans. A major advantage of a qualified plan is the tax treatment of contributions to the plan. Contributions made to a qualified plan are tax deductible to the employer when the contribution is made, and with the exception of Roth deferrals or other after-tax employee contributions, the participant defers paying taxes until he or she receives a distribution from the plan. In addition, benefits accumulated under a qualified plan are protected from creditors of both the employer and the participant. A nonqualified plan does not have the same special tax advantages. Dollars set aside in a nonqualified plan are not deductible to the employer until the funds are actually taxed to the participant. Participants are taxed on nonqualified plan amounts when they earn the right to receive the funds (in other words, when they vest ) even if they do not actually take a distribution from the plan. This vesting event can be many years in the future, thereby delaying the company s tax deduction. A nonqualified plan, such as a Supplemental Employee Retirement Plan (SERP), is generally only for a select group of management or highly compensated employees and therefore requires the employer to be very selective as to whom the plan covers. In addition, any amounts set aside for a participant in a nonqualified plan are still considered the assets of the employer and therefore are subject to the claims of creditors. We often see nonqualified plans established when a company desires to create an incentive for key executives to stay with the company. Nonqualified plans are subject to IRS regulations even though they are not generally subject to ERISA. There is much more information regarding the differences between qualified and nonqualified plans and we would be happy to discuss these rules with you. Feel free to contact us at info@verisightgroup.com. If an employee goes on maternity leave and is paid with short term disability insurance, do we have to contribute employer and employee contribution on those funds? The plan document defines the specific types of compensation that are used to determine plan contributions. When the employer pays the premium for disability insurance, the benefits are treated as compensation to the employee. Whether your qualified retirement plan treats short-term disability as compensation for employee deferral and employer contributions can only be determined by reviewing your specific plan document. If short term disability is treated as eligible compensation for employee deferral

purposes, you must coordinate with your insurance carrier to issue two separate checks: one to the employee and one to the plan in the appropriate amount to cover the deferrals. You also may consider amending your plan to change this definition prospectively in order to exclude short term disability. It is a good idea to review all types of compensation periodically to ensure you have been treating them properly with regard to plan contributions. Why do individuals who worked for us through a temporary service agency have to receive credit for the services they performed before we actually hire them as employees? Internal Revenue Code 414(n)(4) requires employers credit service when individuals worked for them in a temporary worker capacity as described on the attached white paper. This statute is in place to prevent employers from extending the service requirements under their plan by using temporary staffing agencies or similar arrangements. This service credit applies to qualified retirement plans and certain other employee benefit plans. Do participant fee and investment disclosures apply to separate sub diversification ESOP accounts? Many Employee Stock Ownership Plans (ESOPs) do not allow participants to direct the investment of their plan accounts. Since the participant disclosure rules apply only to those qualified plans that permit participant direction, it would appear that ESOPs are exempt from these rules at first glance. However, all ESOPs must comply with Internal Revenue Code statutes requiring participants, under certain circumstances depending upon whether the employer stock is privately held or publicly traded, be allowed to diversify a portion of their plan accounts into investments other than employer stock. Some ESOPs comply with these rules by requiring a participant exercising his or her diversification rights to transfer the funds out of the ESOP. In these cases, there is no participant disclosure requirement for the ESOP because there is no participant direction within the ESOP. Other ESOPs are drafted to allow participants to invest within a menu of mutual funds within the ESOP. In this scenario, participant disclosures would be required because participants have the right to direct a portion of their plan account. Under a third example, an ESOP may allow participants to self-direct the investment when exercising their diversification election by using a brokerage window. Participant disclosures would be required in this case to provide the General and Expense Information. However, under present guidance, the Investment Related Information would not be required. Does Verisight have samples of a change of investment letter that we can provide to the Plan Sponsor? Verisight provides participant disclosures for our clients use in complying with these rules. If you would like to discuss a participant disclosure document, please contact your account representative. www.verisightgroup.com 2 P age

Do the participant disclosure rules apply to pension plans where employees don t make any contributions, Defined benefit/death Benefit Plans? Participant disclosure rules apply to any defined contribution plan including money purchase pension plans that permit participants to direct the investment of their plan accounts, regardless of whether the employees make any contributions. These rules do not apply to defined benefit plans. Does Verisight take care of all these regulatory issues for us? Depending on the services we provide your plan, Verisight will provide the participant disclosures for you to distribute to your participants. Please consult with your account manager to confirm the services you have contracted Verisight to perform on your behalf. Can certain groups of employees be excluded from making elective deferrals? Yes, however your plan document must include this exclusion. It s important to note however that excluding certain groups of employees may cause you to fail coverage testing. There are statutory exclusions such as union employees and employees who are under the age of 21 or employees who have worked less than 1 year of service that can be excluded without impacting your coverage test. Again, it s important that you work with an experienced consultant who can guide you through the decision making process in the event you seek to exclude certain groups of employees. Our consultants at Verisight would be happy to discuss our services further with you. Email us at info@verisightgroup.com if you would like someone to contact you. Do you have to provide notices or annual disclosures to individuals who are no longer with the company but have not closed or transferred their 401k account? Yes, the notice must be provided to such individuals as long as their accounts remain in the plan and they continue to have the right to direct the investments in their account. Do you have to keep proof that you send out the annual disclosures? You should always retain documentation/proof that as the plan sponsor, you are in compliance with any and all disclosure requirements to participant. This is especially true in the event of a DOL audit. I am assuming that since we use Verisight for our plan documents that you will let us know when our 5 or 6 years is up and we need to do the restatement. Yes, Verisight proactively reminds those clients using our documents of any required amendments or restatements. By statute an RIA is a fiduciary, but what is the difference between a 3(21) and a 3(38) advisor? The terms 3(21) advisor and 3(38) advisor are often used to distinguish between the level of fiduciary responsibilities. ERISA 3(21) defines a fiduciary to include an advisor who renders investment advice for a fee. Such an advisor serves in a co-fiduciary capacity to the plan by providing advice to other plan www.verisightgroup.com 3 P age

fiduciaries that have the ultimate decision authority on whether to implement the RIA s advice. ERISA 3(21) advisors are co-fiduciaries with other plan fiduciaries to the extent of the advice they provide to the plan. ERISA 3(38) defines the term investment manager as a fiduciary who also is responsible for providing investment advisory services, but with the important distinction of having discretionary control over the investment decisions for the plan. This type of advisor is often referred to as a Discretionary Advisor because of the discretion to actually implement investment decisions he or she has been given by the plan. The RIA s service agreement with the plan must clearly specify the amount of discretion the plan has given the advisor. Are volume submitter plans required to file by January 31, 2013? No. Volume submitter and prototype plans are restated on a six-year cycle. The next restatement cycle for these pre-approved plans is expected to begin in 2014. How does the DOL define reasonable fees? The DOL considers reasonable fees to be determined on a facts and circumstances basis. This means there is no black and white definition of reasonable fees. Plan sponsors need to perform sufficient due diligence to be able to determine whether fees are reasonable for the services received. For example obtaining quotes from other service providers is one method to confirm that the fees being paid from plan assets are reasonable for the services being provided. Another method would be to obtain benchmarking information from independent sources. Whatever the method, care must be taken to insure that the services being performed are included in the comparison quote or benchmark. It is not uncommon for plan sponsors to assume all service providers perform the same services; however, this is quite often not the case. Make certain you are comparing apples to apples. Who is responsible for auto-enroll? The recordkeeper or the plan sponsor? Ultimately, the plan sponsor is always responsible for ensuring that an employee who meets the plan s eligibility requirements is automatically enrolled in a timely fashion. Often, employers outsource portions of the enrollment process to their service providers. Although the third party record keeper may be fulfilling specific tasks in the enrollment process, the responsibility to insure all eligible employees are timely enrolled (whether under an auto-enroll arrangement or traditional enrollment) rests with the plan sponsor. If you have a TPA, aren't they keeping track of the deadline to file the 5500? Generally, yes the TPA is keeping track of the Form 5500 deadline; however, it is the plan sponsor s responsibility to make sure the Form 5500 is timely filed. www.verisightgroup.com info@verisightgroup.com 855-751-2127 www.verisightgroup.com 4 P age

Temporary Staffing Agencies and Your Benefit Plans WHITE PAPER DO YOU KNOW THE IMPACT? Over the past several years, many employers have increased their usage of temporary staffing agencies to meet their labor demands. Whether using these outside agencies for a short-term need, a longer term purpose, or as a means of trying out the individual prior to offering permanent employment, the use of temporary workers has become a common practice for many businesses today. When using temporary staffing agencies, employers need to be aware of the effect these individuals may have on their retirement and other employee benefit plans. Throughout the remainder of this article, we will reference retirement plans in our explanation and examples. It is important to note that the term retirement plan includes: 401(k) plans, profit sharing plans, money purchase pension plans, defined benefit plans, SEPs, and SIMPLE IRAs. Basically all types retirement plans except nonqualified deferred compensation plans. In addition to retirement plans, these rules also apply to many non-retirement benefits, such as group term life insurance, qualified tuition reduction plans, group legal assistance plans, educational assistance plans, dependent care assistances plans, VEBAs, health insurance plans, flexible spending account plans, COBRA, and many fringe benefit plans. Temporary Staffing Agency Workers Temporary staffing agency workers are often referred to by various names, such as: Temps, Contingent Workforce, Project Labor, Outside Labor, etc. Regardless of the term your organization uses, it is important to understand the effect these individuals may have on your retirement plan. The three primary ways that temporary staffing agency workers affect your retirement plan are: 1. recognition of service when the individual is later hired by your company, 2. participation in your retirement plan, and 3. inclusion in the retirement plan s annual nondiscrimination testing. Recognition of Service Under certain conditions, you must credit an individual with the service he or she performed for your company through a temporary staffing agency if you later hire that person as your employee. The conditions that require you to credit prior service are discussed below in the section entitled Temporary Worker. This recognition of prior service will affect the individual s entry and vesting under the plan. For example, your company sponsors a retirement plan that requires 90 days of employment prior to entry. You engage Temps R Us to provide temporary labor, and as a result, Jane Smith works for you through Temps R Us for 60 days. You later hire Jane as your employee; she will receive credit for the 60 days of service she worked for you through Temps R Us. In other words, Jane will need to work only 30 days from her hire date with your company in order to meet the 90 day employment requirement to enter your retirement plan. Most employers are unaware of this requirement and often are not crediting employees with the correct service when they hire individuals who previously worked for them through a temporary staffing agency. If the company does not credit all the required service to an employee, they will not be able to enroll the employee in the retirement plan in a timely manner or properly track his or her vesting service. Failure to timely enroll employees in the retirement plan may subject the company to corrective contributions for the employee s missed deferral opportunity, employer matching contributions, and any other employer 2001 North Main Street, Suite 500 Walnut Creek, CA 94596 855-751-2127 www.verisightgroup.com 2012 Verisight, Inc. All Rights Reserved - WP0001 1

Temporary Staffing Agencies and Your Benefit Plans WHITE PAPER contributions along with associated earnings. Over time, these corrective amounts can add up to significant unplanned costs for the company. Since these individuals are paid by the staffing agency, most companies do not have sufficient records to track the length of service for each temporary staffing individual. Yet, this information is critical to properly crediting service under your retirement plan. If your company uses temporary staffing agency workers, you should determine whether they meet the conditions that require you to credit them with service under the retirement plan - see Temporary Worker below. If so, you should make certain you are receiving all necessary information from the temporary staffing agency to track the time each individual worked for your company. Additionally, you need to establish procedures that will identify these individuals if you later hire them as your employees. Participation in Your Retirement Plan In addition to recognizing prior service when you hire temporary workers, you may have to enroll them in your retirement plan - even if you never hire them as your employee! Hard to imagine that you may have to provide retirement benefits to someone who isn t your employee, but that is exactly what the IRS requires when a Temporary Worker, as described below, performs services for you on a substantially full-time basis for at least 12 months. The IRS defines substantially full-time basis as the lesser of: 1,500 hours per year or 75% of the hours customarily worked in the position. Therefore, if you have a position in your company that normally requires 30 hours per week (1,560 hours per year), a temporary staffing individual would be considered substantially full-time if he or she works for you at least 22½ hours per week (1,170 hours per year). The IRS refers to individuals who meet these conditions as Leased Employees. Once an individual is determined to be a Leased Employee, he or she will be treated as your employee for retirement plan purposes. Consequently, unless your retirement plan expressly excludes Leased Employees from participation, you must enroll these individuals in your plan. When determining whether a Leased Employee has met the service requirements of the retirement plan, you must credit him or her with all the service performed for your company, including the service performed prior to meeting the 12 month condition. For example, your retirement plan does not exclude Leased Employees from participation, and it requires six months of service to become a participant. Through an agreement you have with the Temps R Us staffing agency, John Smith performs services for you, working 35 hours per week for 12 months. John began working for your company through Temps R Us on January 1, 2009. On January 1, 2010, you must treat John as a Leased Employee because he will have worked for you as a temporary worker on a substantially full-time basis for at least 12 months. On January 1, 2010, John is credited with 12 months of service under the plan because he receives credit for his service retroactively back to the first day he performed services for you - January 1, 2009. As such, John will be treated as having met the plan s sixmonth service requirement on January 1, 2010, the date he is first treated as a Leased Employee. You must provide John with enrollment materials and treat him as eligible for your plan even though John is employed by Temps R Us and you have not hired him as your employee. Offering your retirement plan to Leased Employees who are not on your payroll can become very cumbersome to administer. It requires coordination between your company and the temporary staffing agency on many issues, such as, the amount of compensation paid to the individual for services he or she performed for your company. Since many temporary staffing workers perform services for various employers over the course of a year, this may be time consuming to determine. You also would 2001 North Main Street, Suite 500 Walnut Creek, CA 94596 855-751-2127 www.verisightgroup.com 2012 Verisight, Inc. All Rights Reserved - WP0001 2

Temporary Staffing Agencies and Your Benefit Plans WHITE PAPER need to coordinate the deductions from the employee s paychecks and the remittance to the plan. The majority of employers do not wish to undertake the complexities associated with offering their retirement plans to temporary staffing workers. In these cases, it is imperative that your retirement plan expressly excludes Leased Employees from participation. If your plan excludes them as an ineligible category of employees, you will not have to enroll them in your plan. You will, however, need to maintain records documenting the period of time they work for you in the event you ever hire them as employees and for the required nondiscrimination testing discussed in the next section. If your retirement plan is a 403(b) plan or ESOP, you must determine whether the temporary staffing agency meets the eligible employer criteria for your plan. Eligible employers for 403(b) plans must be a tax-exempt 501(c)(3) organization or public school system. If the temporary staffing agency is not an eligible employer, the Leased Employee cannot participate in your plan regardless of the amount of service he or she performs for you. Eligible employers for ESOPs must have enough common ownership with your company to be included with your company in a controlled group of corporations, as defined under Internal Revenue Code Section 1563. If the staffing agency is not a member of a controlled group with your company, the Leased Employee cannot participate in the ESOP regardless of the number of hours he or she works for you. Although the Leased Employee may not be able to participate in your 403(b) or ESOP retirement plan, he or she still must receive credit for service if you later hire him or her as your employee. Furthermore, the Leased Employee must be included in the annual testing described below. Annual Nondiscrimination Testing Once an individual meets the definition of a Leased Employee, as described above, he or she must be included in your retirement plan s annual coverage, participation and nondiscrimination testing. All qualified retirement plans have qualification tests that must be administered at least annually. In general, this testing must demonstrate that the plan does not discriminate in favor of highly compensated employees over the rank-in-file employees. When performing this testing each year, Leased Employees must be included in the testing even if your plan does not allow them to participate. The exception to this rule occurs when Leased Employees comprise no more than 20 percent of your total rank-in-file employee population, AND the temporary staffing agency covers the Leased Employee under a Money Purchase Pension Plan that provides for immediate entry and vesting along with a contribution equal to 10 percent of pay. It is uncommon for temporary service agencies to have this type of retirement plan for their employees; therefore, it is very likely that you will be required to include the Leased Employees in your plan s testing. Having Leased Employees in the nondiscrimination testing can produce less favorable results when they are excluded from participating. However, the IRS permits you to include in your testing certain contributions made for the Leased Employee by the temporary staffing agency to their retirement plan. Specifically, contributions made by the temporary staffing agency to its plan for a Leased Employee may be treated as if you made those contributions to your plan provided that you may only count contributions that relate to compensation and services the individual performed for your company. Including the temporary staffing agency s retirement plan contributions in your retirement plan testing will require coordination with the agency. In many cases, employers have not performed sufficient planning in advance of the annual nondiscrimination testing, preventing them from receiving this information in time to include in the testing. In other cases, the temporary staffing agency is reluctant to provide this information or they do not sponsor a retirement plan to their employees. 2001 North Main Street, Suite 500 Walnut Creek, CA 94596 855-751-2127 www.verisightgroup.com 2012 Verisight, Inc. All Rights Reserved - WP0001 3

Temporary Staffing Agencies and Your Benefit Plans WHITE PAPER If you have Leased Employees, contact the temporary staffing agency to determine whether they have a retirement plan; if so, determine whether their retirement plan meets the 10 percent Money Purchase Pension Plan exception above; and if not, establish a process to obtain the necessary information each year in a timely manner. Additionally, many third party administrators who perform retirement plan testing ask companies to provide the number of Leased Employees each year. Since this information can change the testing results, be certain the individuals in your company who are providing this information understand the rules. Temporary Worker As we noted above, there are specific circumstances that must be present in order for the service credit and Leased Employee rules to apply. Internal Revenue Code Section 414(n) dictates the conditions as follows: 1. The services provided by the individual must be covered under an agreement between your company and the staffing agency. Although such agreements are almost always in the form of a written document, the IRS expressly states they do not have to be written to be subject to these rules; in other words, less formal oral agreements count. 2. The individual must be a common-law employee of the temporary staffing agency. For purposes of this article, the individual is assumed to be a common-law employee of the temporary staffing agency and not a common-law employee of your company. The detailed determination of whether an individual is a commonlaw employee will be discussed in a future article. 3. The services must be performed under your company s primary direction or control. Although there are no regulations to specifically define the term primary direction or control, the IRS made clear in an ongoing compliance project by their Employee Plans Compliance Unit, they are applying the same factors that were included in the Senate and House Committee Reports when the law originally was enacted. The individual s services will be performed under your company s primary direction or control if your company exercises the majority of direction or control over the individual; note it does not require total control. Factors used in this determination include whether the individual is required to comply with your instructions about when, where, and how he or she is to perform the services, whether the services must be performed by a particular person, whether the individual is subject to your company s supervision, and whether the individual must perform services in the order or sequence you set. Factors that generally are not relevant to the determination include whether your company has the right to hire or fire the individual, or whether the individual works for other companies. If you determine the location (such as your company site), the hours, and oversee the temporary worker s performance, you are likely exercising primary direction or control. Summary Although many employers incorrectly believe workers they engage from temporary staffing agencies have no effect on their company benefits, these individuals can create a significant cost to the company through required contributions, failed nondiscrimination testing, and administrative time to coordinate all the necessary functions with the temporary service agency. Making the necessary determinations to properly treat Temporary Workers and Leased Employees can be comprehensive and complex. To insure you have made the determinations correctly, contact your Verisight specialist for assistance. The information contained in this paper is for informational purposes only and does not constitute legal advice. The contents of this paper are provided on an as is basis without warranty of any kind and Verisight does not assume any liability for any errors, omissions or damages resulting from the use of information contained herein. This document may not be reproduced or transmitted in any form or by any means without Verisight s written permission. 2001 North Main Street, Suite 500 Walnut Creek, CA 94596 855-751-2127 www.verisightgroup.com 2012 Verisight, Inc. All Rights Reserved - WP0001 4