Plan sponsors customarily seek the Internal Revenue Service’s (“IRS’s”) approval that the form of their plans complies with all legal tax-qualification requirements under the IRS determination letter program. In 2005, the IRS adopted a staggered system to process applications for determination letters on a more regular, periodic basis. Under this system, individually designed retirement plans are assigned to one of five 12-month cycles within a five year period based upon the last digit of the sponsor’s federal employer identification number (“EIN”), and preapproved (prototype or volume submitter) retirement plans fall under a six-year cycle system. The first submission period under the IRS’s system for both individually designed retirement plans and preapproved retirement plans was referred to as the “EGTRRA remedial amendment period”; although not yet named, the second remedial amendment period under the IRS’s system began for many plans on February 1, 2011.
Remedial Amendment Period
A plan sponsor generally must adopt a required interim amendment by the due date of its tax return for the taxable year in which the amendment was required, unless a statute or regulation provides a different deadline. A plan’s “remedial amendment period” is the period during which a plan may be retroactively revised to correct incorrect or inaccurate language contained in such an amendment. By making a correction, the plan will be deemed to have satisfied the qualification requirements as of the date the change was originally required. This is important because if the plan’s language cannot be retroactively corrected, the plan could lose its tax-qualified status. Moreover, if a document failure is discovered after a plan’s remedial amendment period ends, the failure generally can only be fixed with the IRS’s approval at significant cost.
A plan’s remedial amendment period is automatically extended if good faith amendments are timely adopted and the amended plan is submitted to the IRS for review in an application for a determination letter. The determination letter request must be submitted by the otherwise applicable deadline for the automatic extension to apply. Thus, by applying for a determination letter during the plan’s appropriate cycle, the plan sponsor preserves its right to retroactively correct defective plan language that is discovered during the IRS’s review of the plan.
Individually Designed Plans
For individually-designed qualified retirement plans, the last of the five cycles within the initial five-year remedial amendment period ended January 31, 2011, and sponsors of such plans should have filed an application for a determination letter during their applicable cycle. The second five-year remedial amendment period for individually-designed qualified retirement plans began February 1, 2011, and the following deadlines apply to each of the 12-month cycles within the five-year remedial amendment period:
| EIN ends in: | Cycle: | First day of cycle: | Last day of cycle: |
| 1 or 6 | A | February 1, 2011 | January 31, 2012 |
| 2 or 7 | B | February 1, 2012 | January 31, 2013 |
| 3 or 8 | C | February 1, 2013 | January 31, 2014 |
| 4 or 9 | D | February 1, 2014 | January 31, 2015 |
| 5 or 0 | E | February 1, 2015 | January 31, 2016 |
There are several exceptions to these rules. For example, a multiple employer plan that covers employers that are not members of the same controlled group is submitted during Cycle B, a multiemployer plan that covers collectively bargained employees is submitted during Cycle D, and a governmental plan maintained by a state or municipality is submitted under Cycle C.
In addition, an election may be made jointly by the members of a controlled group that maintain more than one plan for the group to submit the determination letter filings for all of the plans sponsored by the members of the controlled group during Cycle A. The parent of the members of a controlled group that maintain more than one plan may elect for the group to submit the determination letter filings for all of the plans sponsored by the members of the controlled group during Cycle A or during the cycle determined by the EIN of the parent.
The protection provided by a plan’s favorable determination letter is limited to the required plan provisions in effect at the end of each of its remedial amendment cycle. Thus, it is important for plan sponsors of individually designed plans to amend their plans as required and to apply for new determination letters during the plan’s next remedial amendment cycle.
Preapproved Plans
Preapproved plans are maintained by document providers that “sponsor” the plans; these providers are responsible for obtaining the IRS’s approval of their documents and preparing required amendments from time to time. Employers adopt these preapproved plan documents and required amendments and rely on the document providers to maintain the legal form of their plans.
Employers that had previously adopted a preapproved defined contribution plan had to adopt amended and restated plans no later than April 30, 2010.
Note: If you missed this deadline, please contact us to rectify the situation and decrease the risk of plan disqualification.
Employers that have adopted preapproved defined benefit plans must adopt amended and restated plans no later than April 30, 2012. An employer that wishes to request a determination letter from the IRS that its preapproved defined benefit plan, as adopted, satisfies tax-qualification requirements, may submit an application for a determination letter by April 30, 2012 (the deadline to apply for a determination letter for preapproved defined contribution plans was April 30, 2010).
Document providers who maintain preapproved defined contribution prototype and volume submitter plan documents generally must submit applications to the IRS for opinion/advisory letters for their plans for the second remedial amendment cycle by January 31, 2012. The IRS will review the documents and approve them between February 1, 2012 and January 31, 2014. The six-year cycle for preapproved defined benefit prototype and volume submitter plans is two years later than the six-year cycle for defined contribution plans, so the deadline to submit preapproved defined benefit plans to the IRS for opinion/advisory letters for the second remedial amendment cycle (once the IRS opens this program) is January 31, 2014.
403(b) Plans
To date, the IRS has not created a determination letter program for 403(b) plans, which are retirement plans sponsored by tax-exempt employers that are designed to satisfy Section 403(b) of the Code. Last year the IRS stated that it would begin a determination letter application program for prototype 403(b) plans, and that after the prototype program is established, the IRS will establish a determination letter program for individually designed 403(b) plans.
The IRS has issued proposed procedures for the preapproval of prototype 403(b) plans, and we expect such a system will be implemented in the near future. The IRS will release guidance describing such a program for individually-designed 403(b) plans and listing the procedures under which applications may be submitted to the IRS.
User Fees
An application for a determination letter generally requires payment of a fee to the IRS. The IRS has increased the fees it charges to review almost every kind of determination letter request, effective February 1, 2011.
For plans that satisfy a “design-based safe harbor” or that are not seeking determination letters with respect to special testing requirements, the user fees have changed as follows:
| Type of Filing | Old User Fee | New User Fee |
| Single employer plan (Form 5300) | $1,000 | $2,500 |
| Single employer plan – termination filing (Form 5310) | $1,000 | $2,000 |
| Multiple employer plan (Form 5300 or Form 5310) | ||
| — Two to ten employers | $1,500 | $3,000 |
| — 11 to 99 employers | $1,500 | $3,000 |
| — 100 to 499 employers | $10,000 | $15,000 |
| — 500 or more employers | $10,000 | $15,000 |
For plans that do not satisfy a design-based safe harbor or that are seeking determination letters with respect to special testing requirements, the user fees have changed as follows:
| Type of Filing | Old User Fee | New User Fee |
| Single employer plan (Form 5300) | $1,800 | $4,500 |
| Single employer plan – termination filing (Form 5310) | $1,800 | $4,000 |
| Multiple employer plan (Form 5300 or Form 5310) | ||
| — Two to ten employers | $2,300 | $5,000 |
| — 11 to 99 employers | $2,300 | $5,000 |
| — 100 to 499 employers | $15,000 | $25,000 |
| — 500 or more employers | $15,000 | $25,000 |
A multiple employer plan may submit its application in accordance with the “Simplification” Option provided in Section 10.02(1) of Revenue Procedure 2008-6 and Announcement 2001-77, as described in the EP Determinations Quality Assurance Bulletin dated April 18, 2007. By doing so, a single application may be filed on behalf of the plan sponsor for a determination as to the form of the plan only, and the other adopting employers may rely on that determination letter without having to submit their own applications. This can provide significant cost savings for a multiple employer plan with a large number of adopting employers.
Best Practices
Having a current determination letter represents an essential “best practice” for all plan sponsors. It is strongly recommended that plan sponsors receive updated determination letters during the appropriate cycle. Although the determination letter system anticipates that plan sponsors will file for a new determination letter only during their appropriate cycle, all plans must still be amended from time to comply in good faith with changes in the law and regulations governing tax-qualified plans.
Note: Marcia Wagner was the Chair of the Employee Plans Subcommittee of the IRS’ Tax Exempt and Governmental Entities Advisory Committee. In that capacity, she was the primary author of a series of recommendations to the Internal Revenue Service concerning modifications to the determination letter process. This report is available at: http://www.wagnerlawgroup.com/pdf/ACT_Recommendations_Re_Determination_Letter_Process.pdf
“In Plan” Roth Conversions
In September 2010, President Obama enacted the Small Business Jobs and Credit Act of 2010 (the “Act”). The Act authorizes 401(k), 403(b) and 457(b) plan sponsors to permit Roth conversions within the plan without forcing plan participants to distribute funds from the employer’s retirement plan. In December, the Internal Revenue Service (the “IRS”) provided informal guidance on issues related to “In Plan” Roth conversions. As a result, plan sponsors can now amend their plans to permit such Roth conversions.
In particular, the Roth conversion provision allows plan participants to convert a non-Roth account balance that qualifies as an eligible rollover distribution to a Roth account within the plan. A plan participant’s account may be distributable as an eligible rollover distribution after the occurrence of certain events, such as the termination, disability, or death of the participant or the participant’s attainment of age 59-1/2. Hardship distributions, corrective distributions and required minimum distributions are not eligible rollover distributions and, therefore, cannot be the basis for a conversion into a Roth account.
Plan sponsors that are considering amending their 401(k) plans to permit Roth conversions should be aware of the following:
- Adoption of the Roth conversion provision is voluntary (i.e., plan sponsors are not required to include Roth conversions in their plans).
- A plan that is amended to include a conversion provision also must be amended to provide a Roth feature to accept Roth contributions within the plan.
- The Roth conversion election may only be made available to participants who experience a distributable event allowing them to withdraw their accounts from the plan.
- Plan sponsors are not required to add a new withdrawal types to plans for all participants and instead can tailor new withdrawal types only for participants that wish to make “In Plan” Roth conversions.
- The Roth conversion election can only apply to amounts that are treated as eligible rollover distributions.
- All or any part of a participant’s vested account balance that qualifies as an eligible rollover distribution may be converted to a Roth account within the plan.
- Taxable amounts converted into Roth accounts will be taxable to the participant in the tax year in which the conversion takes place.
- Both participants and spousal beneficiaries are permitted to make Roth conversion elections.
Note: If you would like to explore amending your plan to permit In Plan Roth conversions, please contact us.
New Puerto Rico Internal Revenue Code Requires Significant Changes to Retirement Plans for Puerto Rico Employees
Introduction
On January 31, 2011, the Commonwealth of Puerto Rico adopted a new Internal Revenue Code (the “2011 PR Code”) which substantially overhauls the tax qualification requirements for retirement plans that cover Puerto Rican employees. The qualified retirement plan provisions found in the 2011 PR Code (which, in general, are effective as of January 1, 2011) contain requirements that parallel the requirements found in Section 401(a) of the U.S. Internal Revenue Code (the “U.S. Code”) governing qualified retirement plans. However, the 2011 PR Code made a number of changes to the requirements applicable to Puerto Rican qualified plans thereby creating significant differences between the U.S. Code and the 2011 PR Code. Employers sponsoring Puerto Rican plans or United States plans covering Puerto Rican employees should review their plans carefully to ensure compliance with these changes.
Significant Changes
Some of the more notable changes include the following:
- Benefit and contribution limits: For taxable years beginning on or after January 1, 2012, new annual benefit and contribution limits are imposed on defined benefit and defined contribution plans. The Puerto Rican defined benefit plan limit for a participant’s benefits has been increased to the lesser of $195,000 or 100 percent of the participant’s average annual compensation over a three-consecutive-calendar-year period. The Puerto Rican defined contribution plan limit for a participant’s annual contributions has been increased to the lesser of $49,000 or 100 percent of the participant’s compensation for the plan year. Unlike U.S. Code Section 415, the dollar limits are not adjusted for cost-of-living under the 2011 PR Code.
- Compensation limits: For taxable years beginning on or after January 1, 2012, a new annual compensation limit is imposed. Annual compensation exceeding $245,000 cannot be considered when determining contributions or benefits, applying nondiscrimination tests, and limiting benefits and contributions. Unlike U.S. Code Section 401(a)(17), there is no cost-of living adjustment provided under the 2011 PR Code. It should be noted that dual-qualified plans (i.e., retirement plans qualified under both the U.S. Code and Puerto Rico Internal Revenue Code) apply the limits found under U.S. Code Section 401(a)(17), which does includes cost-of-living adjustments.
- Adoption of controlled group rules: For purposes of the qualified retirement plan provisions under the 2011 PR Code (including nondiscrimination testing), employees of all corporations, partnerships or other entities that are members of a controlled group or an affiliated service group are now deemed to be employees of the same employer; this is similar to the related U.S. Code provisions.
- Excess contribution correction: A new 10% tax will be imposed on plan sponsors that do not correct excess contributions before the sponsor’s deadline to file its income tax return (including extensions) with the Puerto Rico Treasury Department (the “PR Treasury”).
- Elective Deferral Limits: The amounts of pre-tax contributions that can be made to a 401(k) plan are limited as follows: $10,000 in 2011; $13,000 in 2012; and, $15,000 in 2013. However, the applicable limits imposed under U.S Code Section 402(g) will apply to dual-qualified plans.
- Catch-up Contributions: Under the 2011 PR Code, the catch-up contribution limit for 2011 will remain at $1,000, but will increase to $1,500 for 2012 and beyond.
- Definition of Highly Compensated Employee (“HCE”): The definition of HCEs in the 2011 PR Code is now similar to that found in U.S Code Section 414(q) in that the HCE definition includes officers, 5-percent shareholders, spouses or dependents of an HCE and individuals earning $110,000 or more. However, the $110,000 compensation limit does not contain a cost-of-living adjustment. Additionally, the 2011 PR Code does not contain the “top 20%” alternative definition found in the U.S. Code. This new HCE definition applies to nondiscrimination testing performed for the 2011 plan year.
- Taxation and withholding of plan distributions:
- Special 20% Tax Rate for Lump-Sum Distributions: The 20% tax withholding and taxation rate that previously applied only to lump-sum distributions as a result of a separation of service now applies to lump-sum distributions due to a plan termination.
- Withholding Applicable to Other Distributions: Distributions, other than lump-sum distributions or participant loans, are subject to a 10% withholding on any part of the distribution not previously subject to taxation.
- Sponsor’s Withholding Obligation: The employer sponsoring the plan is jointly responsible for the withholding agent’s withholding and reporting obligations.
- Rollovers: Participants may now rollover partial or complete distributions or only the pre-tax portion (and not the after-tax portion) of a distribution into an individual retirement account, annuity or Puerto Rican qualified retirement plan.
- Determination Letter: For taxable years beginning on or after January 1, 2012, retirement plans intended to be qualified under the 2011 PR Code must request and obtain a favorable determination letter from the PR Treasury as to the qualified status of the plan. The request must be filed no later than the plan sponsor’s deadline (including extensions) to file its income tax return with the PR Treasury for the year in which the plan began to cover residents of Puerto Rico.
It should be noted that the 2011 PR Code does not allow Roth contributions or pass through of dividends from employee stock ownership plans.
Action Items
Employers with employees based in Puerto Rico must carefully evaluate the impact of these significant changes to the requirements for qualified retirement plans resulting from the enactment of the 2011 PR Code. For example, these changes may impact an employer’s decision to maintain a dual-qualified plan or a Puerto Rican plan. Furthermore, prompt action will be required by employers to comply with tax and withholding requirements for plan distributions from both dual-qualified retirement plans and Puerto Rican qualified plans. Additionally, employers with qualified plans covering Puerto Rican employees will need to take the following actions before December 31, 2011:
- Perform nondiscrimination testing using the new rules, and if necessary, modify plan design;
- Amend their plans for the new law and submit them to the Puerto Rican Treasury Department for review.
- Update Summary Plan Descriptions; and
- Update forms used to administer the plans.
DOL Releases Final Disclosure Regulation for Participant-Directed Individual Account Plans
In October 2010, the U.S. Department of Labor (“DOL”) issued its final regulation under §404(a) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) that requires fiduciaries of participant-directed individual account plans to disclose certain plan and investment-related information to plan participants and beneficiaries. The DOL believes that these required disclosures will allow participants to make more informed investment decisions when electing investment options available under their plans.
Analysis
Section 2550.404a-5 of the DOL Regulations (the “Regulation”) clarifies that the act of investing plan assets is a fiduciary act governed by the standards set forth under ERISA §404(a)(1)(A) and (B). Such standards require plan fiduciaries to act prudently and solely in the interest of plan participants and beneficiaries. To satisfy this principle, fiduciaries of participant-directed individual account plans are now required to provide participants and beneficiaries with certain information concerning the investment options provided under their plan. The Regulation became effective on December 20, 2010, however, its disclosure requirements apply starting with plan years that begin on or after November 1, 2011 (for calendar-year plans, January 1, 2012).
Selection and Monitoring of Investment Options
The Regulation clearly states that providing plan and investment-related information to participants and beneficiaries does not in fact “relieve a fiduciary from its duty to prudently select and monitor providers of services to the plan or designated investment alternatives under the plan.”
Affected Plans
The Regulation applies only to participant-directed individual account plans. Under ERISA § 3(34), participant-directed account plans are defined as plans that provide an individual account for every participant and pay benefits based solely on the amount contributed to each account (including income, gains, expenses, losses and forfeitures allocated to the participant’s account). Generally, any defined contribution plan (e.g., 401(k), 403(b) and profit-sharing plans) that permits its participants to make investment decisions is considered a participant-directed account plan regardless of size. However, the Regulation provides that individual retirement accounts or individual retirement annuities are not participant-directed account plans.
The Regulation, as one of its primary goals, requires plan sponsors to disclose certain information to participants and beneficiaries about each designated investment alternative (“DIA”) available under their plan. Under the Regulation, a DIA is defined as a plan investment in which participants and beneficiaries can direct the investment of plan assets held in their individual accounts. A DIA does not include brokerage windows, self-directed brokerage accounts or comparable arrangements that allow participants or beneficiaries to choose investments beyond those offered by the plan. However, if they are available under the plan, the plan sponsor must disclose certain basic information about brokerage windows to participants and beneficiaries if they are available under a plan.
Impact on Plan Sponsors
As the fiduciaries, plan sponsors must comply with the disclosure requirements described above. The Regulation affords some relief to plan sponsors, stating that plan sponsors are not responsible for the completeness or accuracy of the information contained in the required disclosures if they reasonably and in good faith rely on information provided by a service provider.
Generally, plan sponsors are now required to disclose certain plan-related and investment-related information to participants and beneficiaries. These disclosures must be made in a manner that allows the average participant to understand them, and be provided to all eligible employees and beneficiaries who have the right to direct the investment of their individual accounts.
Plan-Related Information
Plan sponsors are required to provide each participant or beneficiary with the following plan-related information: general plan information, administrative expenses, and individual expenses.
General Plan Information
Plan sponsors must provide each participant or beneficiary with the following general plan information:
- The procedures for participants and beneficiaries to give investment instructions;
- Any limitations on investment instructions, including restrictions on transfers to or from a DIA;
- A description of every DIA offered under the plan;
- A description of any plan provisions that relate to the exercise of voting, tender and similar rights accompanying investment in a DIA;
- The plan’s designated investment managers (if any); and
- A description of any brokerage windows, self-directed brokerage accounts, or similar arrangements that allow participants to select investments beyond plan-designated investments.
Administrative Expenses
Plan sponsors must provide each participant or beneficiary with an accounting of all fees and expenses paid by the plan for general administrative services (e.g., legal, accounting or recordkeeping) that are permitted to be deducted from all individual accounts and are not reflected in each DIAs total annual operating expenses. In addition, plan sponsors must explain whether the plan’s administrative expenses will be allocated to each individual account on a pro rata or per capita basis.
Individual Expenses
Plan sponsors are required to provide each participant or beneficiary with a statement explaining any fees and expenses that can be charged on an individual basis (as opposed to a plan-wide basis) and that are not reflected in each DIA’s total annual operating expenses. The following are examples of fees and expenses that can be charged on an individual basis:
- Fees for processing plan loans or qualified domestic relations orders;
- Fees for investment advice;
- Fees for brokerage windows;
- Commissions;
- Front-end or back-end loads or sales charges;
- Redemption fees;
- Transfer fees; and
- Optional rider charges in annuity contracts.
Timing and Method of Plan-Related Information Disclosures
The Regulation requires plan sponsors to provide plan-related information disclosures to each participant or beneficiary on or before the date they can first direct their investments, and then annually from that time forward. The Regulation also contains a transitional rule that allows plan sponsors to provide the initial disclosure to existing participants and beneficiaries within 60 days after the first day of the plan year beginning on or after November 1, 2011 (i.e., March 1, 2012 for calendar-year plans).
In addition, plan sponsors must communicate any changes in plan-related information between 30 to 90 days before such changes take effect, or, if the change is the result of an unforeseeable event or uncontrollable circumstance, as soon as reasonably practicable.
Statement of Actual Charges
Each quarter, plan sponsors must provide participants or beneficiaries with a statement that includes the following information:
- The dollar amount of the plan-related fees and expenses that were actually charged to the participant’s or beneficiary’s account over the past quarter;
- A description of the services that the above charges relate to; and
- An explanation that some of the plan’s administrative expenses for the preceding quarter were paid out of the total annual operating expenses of one or more of the plan’s DIAs (if applicable).
Investment-Related Information
Under the Regulation, plan sponsors are required to provide participants or beneficiaries with the following investment-related information for each DIA offered under the plan: identifying information, performance data, benchmark information, fee and expense information, each DIA’s internet web site address, and a glossary. It is anticipated that service providers will make this information available to plan sponsors, but plan sponsors will need to review the information for accuracy and clarity.
Identifying Information
Plan sponsors are required to provide the name of each DIA and the type or category of the investment (e.g., money market fund, balanced fund, large-cap stock fund, employer stock fund or employer securities).
Performance Data
Plan sponsors are required to provide information regarding each DIA’s historical performance. For variable return DIAs (i.e., DIAs that do not have a fixed rate of return) the required disclosure must include the average annual total return for one-year, five-year and ten-year periods as of the date of the most recently completed calendar year. Additionally, the required disclosure must include a disclaimer stating that a DIA’s past performance does not necessarily indicate how it will perform in the future.
For fixed (or stated rate of return) DIAs, the required disclosure must provide information regarding the annual rate of return and the term of the investment. If the DIA’s issuer has reserved the right to adjust the fixed or stated rate of return prospectively during the investment term, the required disclosure must include the current rate of return, the minimum rate guaranteed under the contract, and an explanation that the issuer has the right to adjust the rate of return prospectively, and where participants and beneficiaries can obtain the DIA’s most recent rate of return.
Benchmark Data
For DIAs without fixed rates of return, the required disclosure must provide the name and returns of an appropriate broad-based securities market index over the one-year, five-year and ten-year periods that are similar to the performance data periods mentioned above. This index cannot be rendered by an affiliate of the investment issuer, its investment adviser, or a principal underwriter. (An exception applies for indexes that are widely recognized and used.)
For DIAs with a mix of equity and fixed income elements (e.g., balanced funds or target date funds), plan sponsors can combine and present the returns of more than one appropriate broad-based index in the required disclosures. Nonetheless, the returns of the single required benchmark index must still be presented.
DIAs with fixed rates of return are not subjected to the benchmarking requirement.
Fee and Expense Information
Required disclosures must include the following fee and expense information for DIAs that have fixed rates of returns:
- The amount and description of any shareholder-type fees (e.g., commissions, sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees, and purchase fees); and
- All restrictions and limitations placed on a participant’s ability to purchase, transfer or withdraw the investment.
Required disclosures must provide the following fee and expense information for DIAs that do not have a fixed rate of return:
- The amount and description of any shareholder-type fees;
- All restrictions and limitations placed on a participant’s or beneficiary’s ability to purchase, transfer or withdraw the investment;
- The aggregate annual operating expenses of the investment, shown both as a percentage and as a dollar amount for a one-year period for each $1,000 invested;
- An explanation that fees and expenses are only one of several factors that participants and beneficiaries should consider when making investment decisions; and
- An explanation that the long-term effect of fees and expenses can substantially lower the growth of participants or beneficiaries plan accounts, and that the DOL’s Employee Benefit Security Administration website contains an example that demonstrates the long-term effects of fees and expenses.
Internet Web Site Address
The required disclosures must provide an internet web site address that allows participants or beneficiaries to access additional information about the plan’s DIAs. The web site must include the following:
- The name of the DIA’s issuer;
- The objective or goals of the DIA;
- The principal strategies and risks of the DIA;
- The portfolio turnover rate of the DIA;
- Performance data regarding the DIA (updated at least quarterly); and
- Fee and expense information regarding the DIA.
Glossary
Finally, the required disclosures must include a general glossary of terms to help participants and beneficiaries understand certain terms related to the plan’s DIAs (or an internet web site address that provides access to such a glossary).
Timing and Method of Investment-Related Information Disclosures
Disclosures of investment-related information must be provided to each participant or beneficiary before such participant or beneficiary can first direct their investments, and then annually from that time forward. Under the Regulation’s transition rule, initial investment-related disclosures must be furnished to existing participants or beneficiaries no later than 60 days after the applicability date.
Format of Investment-Related Information
Plan sponsors are required to provide the investment-related information in a chart (or similar scheme) that allows participants or beneficiaries to compare information about each of the DIAs offered under the plan. The chart must clearly display the date and include the following:
- The name, address and telephone number of the plan sponsor (or its designee) to allow participants or beneficiaries to make requests for further information;
- An explanation that additional investment-related information about the DIAs can be accessed at the listed web site address; and
- A description of how participants and beneficiaries can obtain (free of charge) paper copies of the information contained on such web site.
Plan sponsors can include additional information to further enable DIA comparisons as long as this information is not inaccurate or misleading. The Regulation contains a “Model Comparative Chart” in the Appendix, which includes four model tables (variable return investment table, fixed return investment table, fee and expense table and an annuity options table). The Model Comparative Chart is available at: www.dol.gov/ebsa/participantfeerulemodelchart.doc.
Additional Investment-Related Information
After a participant or beneficiary invests in a DIA, plan sponsors must provide any materials the plan receives regarding the exercise of voting, tender and similar rights of a DIA if such rights pass through to the participant or beneficiary.
Plan sponsors must also provide the following information about plan DIAs when a participant or beneficiary requests such information:
- Prospectuses;
- All financial statements and/or reports (including statements of additional information);
- A report on the value of a single share or unit of every DIA, along with the date the valuation was made; and
- A list of the assets contained in the portfolio of each DIA (but only to the extent that the assets are considered plan assets under DOL regulations) and the value of such asset.
Special Rules
The Regulation adds special disclosure rules for DIAs consisting of qualifying employer securities, annuity options or fixed-return investments.
Qualifying Employer Securities
For DIAs designated to invest in qualifying employer securities, plan sponsors are required to provide participants and beneficiaries with a statement regarding the importance of a diversified investment portfolio. Under the Regulation, qualifying employer securities are exempt from certain requirements such as providing fee and expense information and total annual operating expenses to participants and beneficiaries.
Annuity Options
For DIAs consisting of a contract, fund or product that allows participants and beneficiaries the option of allocating contributions toward the purchase of an annuity, plan sponsors are required to provide the following information:
- Name of the contract, product or fund;
- The objectives or goals of the contract, product or fund;
- The factors that determine the price of the contract, product or fund;
- All limitations on a participant’s or beneficiary’s ability to withdraw or transfer amounts allocated to the contract, product or fund, along with any costs associated with doing so;
- All fees that will reduce the value of amounts allocated by participants or beneficiaries to the contract, product or fund;
- An explanation that an insurance company guarantee is subject to its financial strength and claims-paying ability; and
- The internet web site where additional information can be obtained.
Fixed-Return Investments
The Regulation contains internet web site rules for a DIA whose return is fixed for the investment term. Generally, this information will be made available by the service provider. Plan sponsors are required to provide an internet web site that includes the following information:
- Name of the DIA’s issuer;
- The DIA’s goals or objectives;
- Performance data about the DIA (updated at least quarterly); and
- Fee and expense information related to the DIA.
Target Date Funds
Within the Regulation, the DOL reserved a subsection to provide disclosure rules specific to target date and life-cycle funds. These are funds that are invested in anticipation that monies will be distributed at a specific time. Currently, many plans offer these funds as default investments.
In November 2010, the DOL issued a proposed regulation that, if adopted, would require plan sponsors to disclose the following additional information about the design and operation of any target date funds offered under the plan:
- A statement of each fund’s asset allocation;
- A statement of how each fund’s allocation will change over time; and
- An explanation of when each fund will reach its most conservative asset allocation.
If a target date or life-cycle fund is related to a specific date, the disclosure is required to include a statement of what age group the fund is designed for, the significance of that date, and assumptions made about a participant’s or beneficiary’s contribution and withdrawal intentions on or after that date.
Plan sponsors must also provide a statement to participants and beneficiaries explaining that they may lose money investing in a target date fund and that there is no guarantee that the target date fund will provide sufficient retirement income.
The above disclosures are required to be made to all participants and beneficiaries, regardless of whether or not the target date fund serves as the plan’s default investment.
New Electronic Deposit Rules for Payment of Retirement Plan Withholding Taxes
The IRS finalized regulations that, in general, require taxes withheld from retirement plan distributions to be deposited using the Electronic Federal Tax Payment System (“EFTPS”).
Under the prior regulations, taxes withheld from retirement plan distributions could be deposited at an authorized financial institution using Form 8109, Federal Tax Deposit coupon. However, effective January 1, 2011, taxes withheld from retirement plan distributions must be deposited using the EFTPS. EFTPS is a free service from the U.S. Department of the Treasury that allows the taxpayer to schedule payments online or by phone.
As under the prior regulations, plans with under $2,500 in federal tax withholding for a year may continue to make such deposits to the IRS when filing Form 945, but the IRS will assess penalties if the withholding amount exceeds $2,500. If the deposit will be made with Form 945, the Form 945 and deposit are due by the January 31st following the calendar year of withholding.
The timeframe for depositing taxes withheld from retirement plan distributions remains unchanged; monthly depositors can make such deposits up to 15 days after the close of the calendar month in which the tax was withheld.
Plan sponsors that used Form 8109 between June 2009 and June 2010 were sent letters by the IRS that provided the PIN necessary to effectuate the plan’s enrollment in EFTPS. Plan sponsors that did not receive such a letter can apply for EFTPS by calling 202-969-2800 or enroll online at www.eftps.com. When enrolling, be sure to use the plan Trust Identification Number (“TIN”) as opposed to the plan sponsor’s Employer Identification Number (“EIN”).
If a plan sponsor cannot deposit the withheld taxes using EFTPS, certain financial institutions, tax professionals and payroll services are able to make payments on behalf of plan sponsors. Plan sponsors may be charged a fee for using such services.
If a plan sponsor fails to correctly deposit the withheld taxes, the IRS will assess a 10% penalty. The IRS will also assess interest on late deposits of withheld taxes. Plan sponsors are not permitted to pay such penalties or interest assessments out of plan assets.
Finally, when preparing any related Forms 1099-R, 1096 and 945 (the “Forms”), plan sponsors must be sure to include on such Forms the Identification Number (i.e., TIN or EIN) that was used when depositing the retirement plan’s withholding.
New Form ADV Part 2
In July 2010, the Securities and Exchange Commission (the “SEC”) finalized its amendments to Part 2 of Form ADV and the related rules under the Investment Advisers Act of 1940, as amended. The new Part 2 requires “plain English” narrative disclosures, as opposed to the “check the box” and Schedule F disclosures required under the prior rules.
Components of New Form ADV Part 2
The revised Part 2 contains two basic components or “sub-parts”:
- Part 2A, referred to as the “Brochure” or “Firm Brochure,” incorporates much of the information required under the original Form ADV Part 2 and Schedule F.
- Part 2B, referred to as the “Brochure Supplement,” contains relevant biographical and disciplinary information regarding the individuals that will be providing advisory services to the client.
Registered investment advisers (“RIAs”) that sponsor wrap fee programs will also need to complete a “Wrap Fee Program Brochure” for Part 2A Appendix 1 of the Form ADV, which is designed to replace the Schedule H disclosures required under the prior rules.
Summary of Changes Related to Form ADV Part 2 Part 2A – Firm Brochure
Unlike the prior Part 2, there is no prescribed template that RIAs must use for their Firm Brochures. Instead, RIAs must use the 18 disclosure item headings mandated by the SEC and present them in the required order. If a given item does not apply to an RIA’s business model, the RIA must still include the item heading in its Firm Brochure and indicate that it is not applicable. Although the required item headings are quite similar to the item headings previously used in the prior Form ADV Part 2, there are material additions and expanded items that should be noted by all RIAs. Some of the more significant disclosure items include:
- Item 2: Summary of Material Changes.
o RIAs must now identify and discuss any material changes made to the Firm Brochure since its last annual update. The Summary of Material Changes must be located on the cover page, or the immediately following page, of the Firm Brochure or in a separate document.
- Item 4: Advisory Business.
o RIAs are now required to disclose whether it specializes in any particular services (e.g., wealth management, retirement planning or financial planning), if clients are permitted to impose restrictions on their investments, and if firm “assets under management” are calculated any differently under Part 2 than under Part 1 of the Form ADV.
- Item 5: Fees and Compensation.
o RIAs are required to disclose their compensation arrangements (including any intrinsic conflicts and how they are managed) and a description of all other fees and expenses clients may pay.
- Item 6: Performance-Based Fees and Side-by-Side Management.
o RIAs must disclose if performance-based fees apply and how any conflicts of interest arising out of such arrangements are managed.
- Item 8: Methods of Analysis, Investment Strategies and Risk of Loss.
o In addition to disclosing methods of analysis, RIAs must now explain the material risks involved.
- Item 9: Disciplinary Information.
o RIAs are required to disclose relevant information regarding legal or disciplinary actions that might influence a client’s evaluation of its honesty and integrity.
- Item 12: Brokerage Practices.
o RIAs must disclose the factors considered for selecting broker-dealers, including any “soft dollar” arrangements.
Brochures are now required to be electronically filed with the SEC so as to allow public access to them. Previously, although the Part 2 disclosures had to be delivered to clients, they were not subject to filing with the SEC.
Part 2A Appendix 1 – Wrap Fee Program Brochure
RIAs sponsoring wrap fee programs must continue to prepare a separate specialized firm brochure for clients participating in wrap fee programs. The item headings contained in Wrap Fee Program Brochures are essentially the same as contained in the previous Schedule H to Form ADV Part 2. However, Wrap Fee Program Brochures now require RIAs to identify whether any related person is a portfolio manager under the wrap program, and if so, to identify any conflicts of interest and how they are addressed. In addition, RIAs must now disclose whether related portfolio managers are subject to the same selection and review criteria as other portfolio managers. Finally, Wrap Fee Program Brochures are also required to be electronically filed with the SEC.
Part 2B – Brochure Supplement
The Brochure Supplement consists of six items of disclosure and must be completed for each individual that will provide investment advisory services on behalf of the RIA. Thus, Brochure Supplements need only contain information about individuals who formulate investment advice for, and have direct contact with, clients. Biographical information regarding the RIA’s principal executives (which was formerly required under the prior Schedule F) does not need to be included in Brochure Supplements. Brochure Supplements are designed to include certain information that the SEC believes will help a client more easily evaluate its investment adviser and advisory personnel.
As with the Firm Brochure, RIAs must use “plain English” for their Brochure Supplements and present the required disclosures in accordance with the following six required item headings:
- Cover Page;
- Educational Background and Business Experience;
- Disciplinary Information;
- Other Business Activities;
- Additional Compensation; and
- Supervision.
Unlike Firm Brochures, Supplements are not required to be filed with the SEC. However, RIAs must deliver Brochure Supplements to each new client and make them available to the SEC upon request.
Delivery Requirements
RIAs are now required to deliver the Firm Brochure and the Brochure Supplement to any potential client before or at the time the RIA enters into an advisory agreement with such client. Prior to this new rule, clients received a 5-day right to terminate the advisory agreement if the ADV disclosures were not provided at least 48 hours before entering into such agreement. As a result of this new rule, clients will no longer receive this 5-day termination right.
An RIA whose Firm Brochure has materially changed since its last annual updating amendment must now provide each client, within 120 days after the end of the fiscal year, either a current amended Brochure which includes a Material Changes Summary section, or a separate document that contains the Material Changes Summary and an offer to provide an amended Brochure without charge. Previously, RIAs had to offer an amended Brochure within 90 days after the end of the fiscal year but were not required to specifically highlight any of the material changes contained in the updated Brochure. RIAs are not required to deliver Brochure Supplements annually.
Compliance Dates
RIAs in existence before December 31, 2010, must file Firm Brochures with the SEC by the date that its annual updating amendment is required to be filed (March 31, 2011, for RIAs with a December 31, 2010 fiscal year end). RIAs had until March 31, 2011, to provide Firm Brochures to their clients. Investment advisers applying for registration with the SEC after January 1, 2011, are required to file Firm Brochures with their registration applications and, upon successful registration with the SEC, distribute Firm Brochures to all existing or prospective clients.
In response to industry concerns, the SEC announced an extension for compliance dates related to the initial delivery of Brochure Supplements to clients. RIAs registered with the SEC as of December 31, 2010, and whose fiscal year ends on December 31, 2010 through April 30, 2011, have until July 31, 2011, to provide Supplements to new clients, and until September 30, 2011, to provide Supplements to existing clients. All other RIAs registered with the SEC as of December 31, 2010, must provide Brochure Supplements to new clients upon filing their annual updating amendment to Form ADV, and to existing clients within 60 days after such filing. Investment advisers filing applications for registration with the SEC between January 1, 2011, and April 30, 2011, have until May 1, 2011, to begin providing Supplements to new clients, and until July 1, 2011, to provide existing clients with Supplements