There has been much upheaval in the retirement world as of late and it centers around the new fiduciary rule. The New Fiduciary Rule means that many investment professionals that weren’t previously considered fiduciaries will now have to take on that role. So, why is that such a bad thing? Well, it’s not per se, but the implications of how this may change the way the investors and their companies function may leave them frustrated and tentative towards some future business. But before we get too bent out of shape, let’s break it down and see what we’re truly looking at.
In April 2016, the Department of Labor (DOL) laid out its plan to implement the “New Fiduciary Rule” or “Best Interest Rule.” At its core, the rule raises the fiduciary standard of investment advisers to match that which already applied to RIA’s (registered investment advisers). The central focus of the DOL guidelines is to protect plan participants from conflicts of interest related to investment advice that could threaten their retirement savings. Since its inception, the rule has been met with confusion, controversy, delays, and lawsuits as providers struggle to understand how the new rule will affect the way in which they do business. The rule, originally scheduled to begin phase one in April 2017, was partly implemented in June. After several delays, further phases of the rule meant to be implemented in January 2018 have now been pushed back to July 2019.
Who is subject to the new rule?
The rule expands the “investment advice fiduciary” definition under the Employee Retirement Income Security Act of 1974 (ERISA). As of June 9, 2017, all financial professionals who provide advice on retirement plans are considered fiduciaries and must act in their clients’ best interests. Previously, only RIA’s who charged a fee for service on retirement plans were considered fiduciaries. While the rule will have an overall impact on the retirement industry, it will heavily impact advisers whose compensation is paid on a commission basis. A fee-based adviser, or RIA, gets paid the same amount regardless of the investment offering or investment selection provided within the plan. A commission-based adviser can be paid in a myriad of ways from different investment companies. These fees are typically volume based and can vary from fund to fund and even share class to share class. This is not to say that a commission-based broker cannot provide good advice for your plan. They did not create the system by which they are paid. But true or not, the DOL views commission based pay as a deterrent to being able to provide objective investment advice to plan sponsors and participants.
Does the new rule only apply to investments in our retirement plan?
No. In addition to qualified retirement plans, the new rule expands the fiduciary standard applied to both traditional and Roth IRA’s. So, any advice or investments offered for plan distributions will be subject to the rule. In addition, Health Savings Accounts (HSAs), Medical Savings Accounts (MSAs), SIMPLE IRAs, and SEP IRAs also fall under the new rule’s protection. Now, a financial professional who advises on the investments in an HSA is considered a fiduciary. The result is that brokers and advisers will be limited to how they can be compensated for the guidance they provide on these types of accounts.
If this is about protection, what’s the downside?
The DOL’s new rule has a large impact on the investment industry. Not only have the compensation models that the rule aims to remove been in place for a long time, compliance with the expanded fiduciary rule is not clearly defined at this point. Moreover, the industry will have to implement sweeping changes to contracts with their advisers, compensation models, systemization and compliance oversight, etc. It isn’t as though they are unwilling, but the scope of the changes to an already heavily regulated industry shouldn’t be minimized. In addition, many wonder if the regulations will even survive the administrative review process. Implementing the change required to handle the increased fiduciary responsibility and proof of compliance may raise the cost of doing business, so plans could see investment fees increase in the future.
Some firms are prohibiting brokers and advisers from giving rollover advice on 401(k) assets and taking up a strictly educational role to avoid liability. Investment professionals that give advice must produce additional documentation on plan fees and services to determine if a rollover is in their best interest, which can prove difficult.
What Plan Sponsors Need to Know
Why do you care about this and what should you be doing? According to a 2017 Personal Capital survey, 46% of Americans thought that their financial adviser was already required to meet this level of fiduciary responsibility. Financial advisers play a pivotal role in retirement planning and their advice can make an enormous difference in retirement savings. While the rule is targeted primarily at providers of retirement plan products and services, it will also affect plan sponsors. Plan sponsors should expect to receive new disclosures and amended contracts from their advisers and need to review and understand the nature of the relationships they have with their advisers. The decision to hire or retain service providers remains a fiduciary decision, and plan sponsors have an ongoing duty to monitor those advisers. Failure to do so could subject plan sponsors to potential ERISA fiduciary violations.
Since rollover or distribution recommendations will be covered by the new conflict of interest rule, some service providers may be less willing to assist participants with the decision of whether, or not, to roll over their plan assets to an IRA. This will effectively allow them to avoid being held to the standard of fiduciary in giving advice on such a decision. It’s a notable change to the rules and may result in participants electing to leave assets in the plan following termination.
Plan sponsors should also take a close look at the investment education that is provided to plan participants and beneficiaries to ensure that the investment education qualifies as education rather than advice under the new rules.
Technically Speaking
Back in our June 2017 issue we took time to address the uptick in automated financial advice that is getting a foothold in the investment world in our article “Rise of the Machines”. It appears the new rules being issued will give even further cause for advisers to consider the possible value in utilizing the Robo-Adviser platforms as an investment tool for their clients.
With future compliance challenges arising, development of this technology and its application may greatly aid broker-dealers in their efforts to comply with the new regulations. Updated software solutions may alleviate some of the fiscal impact associated with the stiffer compliance rules as well. Automated programs employed to create trading algorithms that are always in compliance with the DOL rules, regardless of market conditions or client circumstances, and devoid of human error continue to make them an attractive tool for investors and advisers alike. Regulator approval may be garnered by the fact that many of these programs already use low-cost index funds for their trading.
Don’t Get Ahead of Yourself Quite Yet…
So, what does all of this mean? The back and forth nature of proceedings with regards to the new rule is a bit mysterious to many in the retirement and investment communities but there is hope that some further clarity will be provided when the Dept. of Labor releases its proposal. The 18-month delay would allow for the DOL to coordinate with the Securities and Exchange Commission (which could possibly offer up its own fiduciary rule), broker-dealer regulator FINRA (Financial Industry Regulatory Authority), and state insurance commissioners.
For now, compliance will be pushed back and the question remains whether the delay is to allow for more efficient implementation of the rule as is or to allow time for revisions, making the outcome even more uncertain.
Whatever the coming months hold for the New Fiduciary Rule, the resulting outcome is going to require a level of greater fiduciary responsibility for those directly involved with influencing the retirement plan process. Despite what possible cost and increased responsibility the new rule may bestow upon us, it is time to accept this new level of accountability as a positive next step in the overall picture of retirement planning. Familiarizing yourself with the details of your plan, and your responsibilities to it, is paramount to becoming a successful fiduciary. It’s important to utilize all the information available to you and maintain a strong relationship with your adviser and TPA.
Houston, We Have a Problem…
Times can get tough for people. With the onset of Hurricane Harvey having decimated parts of the Gulf Coast and Hurricane Irma following its destructive lead, we are reminded that at any point we may find ourselves in hardship. Companies make layoffs, natural disasters occur, emergencies… well, emerge. With nowhere else to turn, some will look to their 401k for their own disaster relief. A withdrawal in the form of a “hardship distribution” is one of the tools that participants may use in this situation. This year the IRS released new examination guidelines for documenting hardships. Their intent is to clarify the documentation process of proving the existence of a hardship and verifying that the amount withdrawn did not exceed the actual financial need.
Before we go into the regulations surrounding a hardship withdrawal, it is important to define what a hardship is. A hardship distribution is a withdrawal from a participant’s retirement account made because of an immediate and heavy financial need. It is limited to the amount necessary to satisfy that financial need but may include amounts required to pay the taxes and penalties. While living conditions and lifestyle choices differ for everyone, the government has created a universal list of events that may cause undue financial strain. The list includes:
- Qualifying medical expenses.
- Costs related to a principal residence (But not mortgage payments).
- Tuition.
- Prevention of eviction.
- Burial or funeral expenses.
- Repair of damages to principal residence (Especially important during hurricane season).
Does your plan allow for hardship distributions? This is an important question to consider as the plan sponsor and if the answer is yes, there are certain responsibilities you must undertake to justify the withdrawal from your plan’s assets. Many 401(k) plans allow for hardship withdrawals since it is generally believed to encourage participation levels. Participants seem more at ease knowing that they could access their accounts in the event of an immediate financial need.
So, how does a participant justify and their employer verify that the withdrawal amount of a hardship requested complies with the regulations? The IRS regulations require that the plan administrator obtain source documents (or a summary of that information), issue the required employee notifications that accompany a hardship withdrawal, and verify they meet the hardship requirements.
So, how have things changed? Historically, to keep employers from being in a position of reviewing the employee’s financial situation or judging how critical their hardship need is, the participant was able to demonstrate their hardship through an “attestation”. While it was understood that if audited the participant would have to produce the proof, problems producing that proof arose at times, especially when the participant was no longer available. This left the plan in a precarious position with distributions not being justified or not for the proper amount. However, a participant attesting to the fact that they need a hardship distribution isn’t enough to move forward anymore. Difficulty in verifying the need and the appropriate distributable amount was simply leading to too many problems.
How does one avoid trouble with a hardship in an audit? Two words… source documents. Auditors will look for documentation supporting the event like receipts, medical bills, tuition expenses, contracts, or a summary of these examples, and they can be provided electronically. The recipient also must agree to keep these documents and be able to produce them upon request if needed (say… for an audit). This documentation is critical and especially helpful in instances where the employee has moved on.
The second key step in the guidelines is disclosure. You must provide the employee who requests a hardship with all pertinent tax and possible withdrawal penalty information. It also needs to be made clear exactly what can be taken as a distribution and from what sources. Depending on the source of the funds, different rules apply to the participant’s ability to make a withdrawal and will be outlined in the plan documents.
If you’ve been going about hardships in this fashion, keep going, you’re doing great. If you haven’t and your plan offers them, tighten up your procedures moving forward. While hardship withdrawals from retirement savings should be a participant’s last resort, they have increased every year over the last five years and that trend is likely to continue. Your familiarity and efficiency in relation to the process will help participants navigate otherwise stormy seas.
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.
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Spring will arrive soon, promising new growth and a fresh beginning. It could also be the perfect time to do some spring cleaning for your plan. Let’s look at some areas that you might consider reviewing to ensure your retirement plan is operating efficiently.
Document your processes and procedures to make certain that plan tasks can be handled in case of any absences during an enrollment or pay period. Having a backup in place can prevent errors and delays that could lead to penalties.
Make sure to have a process in place to notify all new enrollments of their eligibility, regardless of whether the plan has automatic enrollment. Depending on the timing for plan entry, including the plan enrollment paperwork with the new hire paperwork could make entry easier for you. Please reach out with any questions regarding when an employee enters the plan.
Deposits of employee deferrals and loan repayments must be submitted to the plan as soon as possible to avoid penalties and corrections. For plans with less than 100 participants, a safe harbor rule allows deposits to be made within seven business days. For larger plans, the expectation is that the money will be deposited more quickly. Depositing these funds on the pay date will avoid the possibility of being late.
Monitoring deferral contribution limits during the calendar year will avoid refunds after year end. Make sure that your payroll is set up to stop deferrals once the limit is reached, including any catch-up contributions for those who have reached age 50.
To keep the plan in compliance, employer contributions must be deposited timely. Due dates are impacted by the type of contributions, required status and tax deductibility. If you have questions on when to deposit your employer contribution or even whether to make an employer contribution, please contact us.
Most plans must be covered by a fidelity bond. The minimum coverage is 10% of plan assets (rounded up to the next $1,000) and the maximum coverage is $500,000. Additional requirements apply to plans with employer securities or non-publicly traded assets. If your fidelity bond is insufficient, now is the time to raise the coverage. Inflation clauses that increase the bond amount as the plan assets increase can ensure that your bond coverage is always adequate. Contact us or your insurance provider if you don’t have a fidelity bond.
Another area to review is communication with participants. Helping your employees understand and trust the plan can increase their contributions. Be sure that your procedures include distributing any plan-related communications—including required participant notices.
Distributions also involve communication, including some of the aforementioned notices. Discussing distribution options with terminated participants, possibly as part of an exit interview, can help to reduce risk of lost participants. We’ll provide instruction on distributions for force-out distributions for small balances, testing corrections and required minimum distributions.
Your plan document is the legal source on how the plan should be administered; operating within its parameters is critical. It’s always worth taking time to review the plan document to ensure that you fully understand and are following its provisions. We’ll cover more details about the plan document later in this newsletter. We’re here to support you in keeping your plan in compliance. Please feel free to reach out with any questions.
Addressing the Challenge of Uncashed Distribution Checks
Uncashed distribution checks present a persistent and often overlooked challenge for retirement plan sponsors. Despite the best efforts of plan administrators, some participants fail to cash their distribution checks, leading to administrative burdens, fiduciary concerns and potential compliance issues. A recent publication by Retirement Management Services (RMS) sheds light on this issue and offers practical guidance for employers seeking to manage and mitigate the risks associated with uncashed checks.
Uncashed checks can arise for various reasons. Participants may have moved without updating their contact information, may not recognize the check as legitimate or may simply forget to deposit it. Regardless of the cause, the responsibility for addressing these uncashed funds ultimately falls on the plan sponsor. This creates a fiduciary obligation to act in the best interest of the participant while ensuring compliance with IRS and Department of Labor (DOL) regulations.
Sponsors are encouraged to maintain up-to-date contact information for all plan participants and to follow up promptly when checks remain uncashed. This may involve sending reminder letters, making phone calls or using certified mail to confirm receipt. In some cases, plan sponsors may also consider using electronic payment methods to reduce the likelihood of checks going uncashed in the first place.
The IRS and DOL have issued guidance on how to handle these situations, including the use of forfeiture accounts and escheatment to state unclaimed property programs. However, these options come with their own set of rules and potential pitfalls. For example, using a forfeiture account may require the plan document to explicitly allow for such treatment. Escheatment laws, which allow the government to assume control of unclaimed property, vary by state. As such, plan sponsors must carefully evaluate their options and consult with legal or compliance experts as needed.
Another important consideration is the documentation of all the efforts made to contact participants and resolve uncashed checks. Maintaining a clear audit trail can help demonstrate fiduciary prudence and protect the plan sponsor in the event of an audit or legal challenge. It is extremely important to have a written policy in place that outlines the steps to be taken when a check remains uncashed beyond a certain period.
By taking a proactive, well-documented and compliant approach, employers can fulfill their fiduciary duties, reduce administrative burdens and ensure that participants receive the benefits they are entitled to.
Source: Retirement Management Services – “Uncashed Distribution Checks” https://www.consultrms.com/Resources/59/Plan-Sponsor-Tips-and-Help/212/Uncashed-Distribution-Checks
Divorce and the Retirement Plan
When a participant in a qualified retirement plan undergoes a divorce, the participant’s account balance may be an asset that is split with the former spouse. As the plan exists for the exclusive benefit of its participants, a court order is required to transfer the participant’s benefits to the ex-spouse. Once approved by the plan administrator, this court order is called a Qualified Domestic Relations Order (QDRO).
The QDRO is a judgment, decree or order that must be issued by a state authority (usually a court). It can be part of the divorce settlement or it may be a separate document. Because of the serious nature of separating the participant’s account balance, the QDRO is more than just an agreement made by both parties — it must also be signed by a judge.
A QDRO will describe how to divide the participant’s account balance between the participant and the ex-spouse, referred to as the alternate payee. In some cases, a set dollar amount will be allocated; in others, a percentage of the account may be designated. In the latter case, the amount assigned to the alternate payee represents the given percentage of the participant’s total vested account balance as of a specified valuation date. This percentage will apply to all sources — such as deferrals, matching or profit sharing — unless specified by the QDRO. Any interest and investment gains/losses that accrue between this valuation date and the date the funds are separated into an account for the alternate payee are often factored into this final calculation. If the participant has outstanding loans, the QDRO will usually indicate how the loans are handled.
Contributions such as deferrals and employer matching made after the valuation date are credited to the participant’s account. Earnings and losses are applied to the account balances. Once the division is complete, the alternate payee’s portion (either dollars or shares) is transferred to an account in the alternate payee’s name.
If the plan allows, the alternate payee may be paid out in a cash or rollover distribution. Not all plan documents allow the alternate payee to receive a distribution before reaching normal retirement age, so it’s important to follow the terms of the plan. In addition, the QDRO cannot violate the provisions of the plan document by requiring a plan to provide an alternate payee or participant with any type or form of benefit not otherwise provided under the plan.
Although the most common situation for a QDRO is a divorce, it can be issued in other situations, such as to a dependent in the case of child support. If the alternate payee is a minor child or legally incompetent, the order can also require payment to the individual with legal responsibility for the alternate payee. If a participant or their attorney provides you with a copy of a divorce decree that references the plan or a QDRO, please contact us immediately, and we will work with you to ensure it meets the requirements of the plan.
Important note for defined benefit plans: For 2025 plan years, PBGC premiums are due one month earlier than usual, specifically on the 15th day of the ninth month after the beginning of the plan year. For calendar year plans, this means the premium is due on September 15, 2025, instead of the usual October 15. This accelerated deadline is due to a provision in the Bipartisan Budget Act of 2015.
Upcoming Compliance Deadlines for Calendar-Year Plans
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