Retirement Plan Guidance is on EBSA’s Gift List for 2014

The Department of Labor’s Employee Benefits Security Administration (EBSA) recently released an update to its guidance agenda, including a number of priorities that can be expected to affect retirement plans.  Clearly there are some surprises in this updated priorities document and perhaps some reason for concern as well.

The most anxiously awaited EBSA guidance are the regulations defining when an advisor, service provider, or other person may be considered a fiduciary in their dealings with a plan or retirement account.  Of course, it is not just the defining, but the duties and obligations that accompany that role, that will matter.  We were surprised to learn that EBSA has now targeted the month of August, 2014, for issuance of these re-proposed regulations.  The expectation over many months has been “imminent,” based on EBSA comments.  But, in every instance, there has been a delay and a resetting of expectations.   

Perhaps the August 2014 target is an indication that new Secretary of Labor Thomas Perez is not completely comfortable with the expansive dimensions these regulations reportedly will have, as formulated under the guiding hand of Assistant Secretary Phyllis Borzi.  Or, given the widely held belief that Secretary Perez is one of President Obama’s more liberal cabinet members, caution and industry sensitivity may not be the motive at all.  Possibly the new August target is nothing more than a fail-safe reset of expectations intended to avoid the embarrassment of another missed deadline.  Hopefully the delay will result in a workable regulation that corresponds to what the SEC will be doing, that protects retirement plan participants and provides and will temper what many have feared will be regulatory overreach and a potential threat to IRA owners’ continued access to advisory services.

Another item on the guidance plan, with a much closer April, 2014, target date, is “standards for brokerage windows” in individual account type plans, such as 401(k) plans.  A brokerage window within a plan investment suite offers participants what can be virtually limitless investment options.  Readers will recall that Field Assistance Bulletin (FAB) 2012-02R gave us EBSA’s assurance that the very detailed investment disclosures required for a plan’s designated investment alternatives (DIAs) under fee disclosure regulations would not apply to investments chosen under a brokerage window.  For that reason many were surprised to see this on EBSA’s regulatory agenda. 

However, the agency did warn in FAB 2012-02A that it would be unacceptable for a plan to offer only a brokerage window in order to avoid the need for any DIA disclosures.  EBSA cited “…ERISA Section 404(a)’s general statutory fiduciary duties of prudence and loyalty,” noting that “…fiduciaries may have duties under ERISA’s general fiduciary standards apart from those in the [fee disclosure] regulation,” and that the agency would “… determine how best to assure compliance in a practical and cost effective manner, including, if appropriate, through amendments of relevant regulatory provisions.” 

The FAB’s reference to “amendments of relevant regulatory provisions” sounds ominously like we could see a reopening of what most thought was a closed chapter in the fee disclosure drama.  “Brokerage Windows II” is a sequel we might not want to see.  

One item the industry will welcome seeing EBSA revisit is the current regulations that plans must follow when selecting a safe annuity for plan participants or beneficiaries at payout time.  A reasonable safe harbor, one that does not require a plan administrator to be both a psychic and a Harvard economist when selecting a safe annuity, has been sorely needed.  Existing regulations are next to impossible to confidently meet.  This IS good news.

Also worthy of comment is the distant timeline—again, August, 2014—for proposed regulations on including lifetime income projections on participant benefit statements.  Given the detail in EBSA’s advanced notice of proposed rulemaking in May of 2013, and the August, 2013, close of the public comment period, coupled with the urgency EBSA seemed to attach to the issue, this distant timing is a little surprising.  Perhaps the answer lies in the kind and quantity of public comments the agency received on its very complex proposal.  Time will tell.

As each of looks forward to unwrapping something special on Christmas Eve or Christmas Day, it appears we can also look forward to EBSA unveiling some gifts of its own in 2014.

IRS on the Lookout for Rollover, Valuation and Related Abuses

Those who do not take note of rulings by the United States Tax Court may have missed a recent decision that has caused many in the retirement plans community to sit up and take notice. 

The case, Ellis v Commissioner, involved a taxpayer who funded a business start-up with assets rolled over to an IRA from a former employer’s qualified plan, a transaction referred to as a rollover-as-business startup (ROBS).  Unfortunately, in the process of establishing a used car business with the rolled-over funds, causing the business to enter into a real estate rental agreement with related parties, and paying himself for services to the business, the IRS determined that the defendant ran afoul of the prohibited transaction rules.  As a result, the IRA that had funded the used car business start-up was disqualified, deemed distributed, and the defendant became subject to substantial tax and penalty consequences.

We have known for some time that the IRS has been “making a list, and checking it twice,” when it comes to ROBS to inject a little seasonal flavor.  The Service is deeply concerned about transactions that abuse the tax rules in order to avoid legitimate taxation. 

Some feel this U.S. Tax Court ruling is a “shot across the bow,” bearing in mind that it was the Service that first disqualified the defendant’s IRA, which—following appeal—led to the involvement of the Tax Court.  It certainly should serve as a caution to anyone who might consider using accumulated retirement assets to start a business.  The real scrutiny began roughly five years ago with an IRS compliance initiative targeting ROBS arrangements. 

More typical than the IRA rollover example in this Tax Court case, in the ROBS process a taxpayer sets up a corporation, which establishes a qualified plan.  The plan first accepts the rollover, then uses it to purchase stock issued by the founding corporation.  The stock is in the plan, and the rollover cash used to purchase it is used by the corporation (the owner) to fund a business start-up, or perhaps purchase a business franchise. 

Not all such transactions are considered abusive or illegal.  Some of these ROBS arrangements have been approved in the past.  But some, as in Ellis v Commissioner, either cross the line as prohibited transactions, or break ERISA rules for plan operation.  One example of a post-ROBS operational failure is allowing the owner’s account to purchase the corporate stock, an investment that is denied to others who—now or later—may participate in the plan.  Besides the potential discrimination in such a situation, there may also be issues with establishing the value of the corporate stock purchased with the rollover assets.  Often, the amount of the rollover and the value of the stock purchased by the plan are—too coincidentally— virtually the same, even when the corporate entity has yet to do a dime’s worth of business.  That can be seen as a red flag to a reviewer.

The IRS is also interested in IRA and employer plan asset valuation in more general terms.  Valuation is a special concern when an investment is not traded on a public exchange, and is therefore hard to value.  Such investments may include real property, securities options, debt obligations, partnership interests, and others.  Valuation is of particular importance when potentially taxable distributions are taken from retirement arrangements, or when a taxpayer executes a Roth IRA conversion, or an in-plan Roth rollover (IRR) within a 401(k), 403(b) or 457(b) governmental plan.  Like a distribution of pre-tax assets, a Roth conversion or IRR is a taxable event.  If investments are unintentionally or intentionally undervalued, the asset owner may gain, while the U.S. Treasury—and American taxpayers—lose.

One clear manifestation of this asset valuation concern is the DRAFT 2014 Instructions to Forms 1099-R and 5498, released in June.  In these draft instructions the IRS specified that both fair market values reported on Form 5498, IRA Contribution Information, and distributions reported on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, etc., were to identify hard-to-value assets. 

The IRS has since made this significantly more detailed reporting an option for 2014, due possibly to challenges involved in information gathering and systems programming for custodians, trustees, and plan administrators.  But, make no mistake; the IRS intends to collect more detailed information on the presence of such assets in tax-advantaged retirement savings arrangements.  The objective can only be to ensure that such assets are not mis-valued in an attempt to avoid proper taxation.

Like it or not, such initiatives serve notice that the Service intends to close some of the cracks through which they believe questionable transactions may have been falling and serves as a warning that anyone entering into one of these arrangements do so with an eye towards the prohibited transaction rules and IRS concerns.