Friday, April 15, 2016

IRS Withdraws Troubling Provision of Proposed Nondiscrimination Regulations

Yesterday, the IRS released Announcement 2016-16 withdrawing parts of the nondiscrimination regulations it proposed at the end of January. Those proposed regulations had troubled many in the defined benefit industry since their proposal for a number of reasons (more below). From the standpoint of the IRS, the troubling part of the proposal addressed some serious abuses by practitioners and the sponsors they consult to. From the standpoint of practitioners, the proposed regulations took an objective test that has been around for quite a while and essentially changed the rules of the game.

I'm going to have to get a little bit technical here before I bring you back to reality. What the proposed regulations would have done was to make retirement plans with multiple formulas show that each formula applied to reasonable business classifications of employees or to pass a more difficult test.

Under regulations that were finalized in 1993 and then amended for cross-tested plans in the late 90s, a rate group in the testing population must have a coverage ratio at least equal to either

  • 70% if the plan uses the Ratio Percentage Test to pass minimum coverage tests or
  • The midpoint of the safe harbor and unsafe harbor (the midpoint is typically in the 25% to 40% range, but is determined through a somewhat convoluted formula) if the plan uses the Average Benefit Test to satisfy minimum coverage
It is far easier for a rate group to satisfy a lower minimum coverage ratio than a higher one. And, many plans had been designed around satisfying the lower threshold. While the preamble to the proposed regulation said that it was targeting QSERPs, practitioners found that they also were potentially problematic for many plans of small businesses and plans of professional service firms. 

Why would this be troubling? Certainly, among larger corporations, the prevalence of ongoing defined benefit plans has dropped precipitously, but many small businesses and professional service firms have adopted new defined benefit plans (DB) over the last 15 years or so and many of these plans would have found it more difficult or perhaps impossible to pass these proposed rules.

This doesn't mean that DB plans of this sort are out of the woods yet, so to speak. Clearly, the current Treasury Department views that plans of this sort may be abusive in their application of the nondiscrimination regulations, so we could see another effort from the IRS to make the regulations a bit less QSERP-friendly. 

In the meantime, there are some great DB designs that exist for companies that wish to provide meaningful retirement benefits to their rank and file employees. You can learn more about them here.

Tuesday, April 12, 2016

The Quandaries of Being A Retirement Plan Fiduciary

Last week, the Department of Labor issued its final rule on what it means to be a fiduciary and on conflicts of interest. Virtually everyone in the retirement plan industry has been scurrying about to determine what the effect of the rule is. Some, including the US Chamber of Commerce, say it will lead to unnecessary litigation. Others say it will drive unknowledgeable advisers out of the retirement plan business.

If you're interested in the details of that regulation, every large consulting firm, law firm, and recordkeeper either has or will be publishing their take on it. Here, however, I want to address a different issue.

If you sit on the committee that oversees a retirement plan whether its called the Benefits Committee, the Investment Committee, or the Committee for All Things Good Not Evil, by virtue of that role, it is probable that you are a fiduciary. That means that both individually and as a member of that committee, when making decisions related to the plan (not your own account in the plan, but the plan generally), you have a requirement to act in a fiduciary manner and in the best interest of plan participants.

That's not a low bar.

Instead of bringing up situations that arise from the new final regulations (the other articles will present you with all of those that you need), let's instead consider an age old problem. Suppose your company sponsors a defined benefit plan and you are on the committee that oversees the plan. Let's complicate the situation a bit by adding in the following fact pattern:

  • The plan is covered by the PBGC (Title IV of ERISA)
  • The plan is frozen and the committee's minutes show that the intent of the committee is to terminate the plan whenever it becomes well enough funded
  • Your company is subject to US GAAP; in other words, you account for the plan under ASC 715 (previously FAS 87).
  • Your own personal incentive compensation is affected by corporate financial performance measured under US GAAP
  • Over time, you have received a material amount of equity compensation from your employer meaning that you now hold a combination of shares of stock, stock options, and restricted stock in your employer
Your actuary comes to a meeting with your committee and informs you that you have three options related to a funding strategy:
  • Option #1 will keep the ASC 715 pension expense down and will not result in a settlement (that would be a loss currently), but will result in the plan being less well funded
  • Option #2 will produce a settlement loss, but will get the plan closer to termination and leave it currently better funded for remaining plan participants
  • Option #3 will reduce ASC 715 pension expense and get the plan better funded and therefore closer to termination, but will have a material effect on the corporate balance sheet and could cause the company to violate certain loan covenants
You do have a quandary, don't you? Only Option #1 will help you to maximize your incentive pay. In my personal experience, in days gone by, for that particular reason, Option #1 would have gotten some votes. If you vote for Option #1, are you fulfilling your responsibilities as a fiduciary?

I'm not an attorney, so I'm not going to answer that question, but I'm sure you can find many who would be happy to weigh in.

Option #2 looks like it could be better for plan participants. Of course, that depends a little bit on what better means in this context. But, if the committee goes with Option #2, you know that your incentive payout could be smaller. If you vote against Option #2 (another question for the attorneys), are you fulfilling your fiduciary requirements?

And, then there's Option #3. How far do you have to go to fulfill your fiduciary requirements? Do you have to make decisions that are clearly not in the best interest of the company, but that may be in the best interests of plan participants? 

It's tricky, isn't it?

Now, let's consider a different situation that may not affect your personal compensation. Using Strategy #1, your company will pay PBGC premiums equal to about 10% of its free cash flow. Using Strategy #2, those same premiums will be reduced to about 3% of free cash flow. But, your actuary isn't familiar with Strategy #2. And, you do have a really good relationship with him. But, the people who brought you Strategy #2 say you can only implement it by using them.