United States: Qualified Retirement Plans: July 2004 Developments

Cash balance plan scores a court victory. In an action by a former employee against a company, the federal district court in Maryland has determined that the conversion of the employer's traditional pension plan to a cash balance plan did not violate the prohibitions against age discrimination in ERISA. The court found that it was appropriate to use ERISA's rules for individual account plans, and not the rules for traditional pension plans, to measure compliance with ERISA nondiscrimination requirements. The class certification sought by the plaintiff and the plaintiff's age discrimination claims were dismissed. Tootle v. ARINC, Inc., et al., 2004 WL 1285894. The court's holding is consistent with the earlier Eaton v. Onan decision in the southern federal district court of Indiana but inconsistent with the Cooper v. IBM Personal Pension Plan decision in the southern federal district court in Illinois. The future of cash balance plans remains up in the air, but this is a win for their proponents.

The Securities and Exchange Commission is examining payments by mutual fund companies to 401(k) plan promoters and sponsors. The Director of the SEC's Office of Compliance Inspections and Examinations announced the examination program in a press release issued on July 6th. Detailed questionnaires have been received by Putnam Investments and Fidelity Investments, according to their spokespersons. The SEC Director's statement said: "We're looking into payments by funds and their advisers to 401(k) plans, plan consultants, and plan platforms." It is especially important now for 401(k) plan fiduciaries to "follow the money" and know as much as they can about expenses borne by their various investment funds and options, who is being compensated by those funds, and in what amounts.

Final regulations were published on July 22nd relating to establishing "deemed IRAs" as a component of tax-qualified retirement plans. The rules (Treasury Decision 9142) permit qualified plans to incorporate .deemed IRAs.. The deemed IRA may be in the same trust as the qualified plan assets, but the qualified plan and the deemed IRA will remain subject to their own respective statutory requirements. Deemed IRAs are intended to make retirement saving easier for employees. It is not clear, yet, that their administration under these rules will be simple enough to induce many employers to offer deemed IRAs.

Here's a case to remember if you are thinking about a plan amendment customized to affect just one participant―it might be okay. In Glenn Coomer v. Bethesda Hospital, Inc., 370 F3d 499, the Sixth Circuit Court of Appeals held that an employer did not inappropriately discriminate under ERISA when it amended its pension plan to allow a lump sum cash out in excess of $5,000 (the maximum allowed under the Plan) for one former employee but refused to do so a few years later for others who requested a similar opportunity to take lump sums in excess of $5,000. The court said that the employer's actions did not violate Section 510 of ERISA because that section only prohibits adverse action taken because a participant avails himself of an ERISA right or interference with the attainment of any ERISA right to which a participant is otherwise entitled. The court concluded that ERISA Section 510 did not broadly forbid all forms of discrimination. Accordingly, it found that the plan sponsor's amendment of the plan to aid one individual, and its refusal to amend the plan for the benefit of others who are similarly situated, was not prohibited discrimination under Section 510.

Other nondiscrimination concerns may arise if a plan amendment is adopted, for example, that only affects highly compensated employees, although those concerns were not present in this case.

Retiree "lifetime" health benefits may be terminated if they are not "vested," according to the Seventh Circuit. In Vallone v. CNA Fin. Corp., U.S. (7 Cir., 2004), health benefits announced as being provided for the participant's lifetime and included in a voluntary early retirement program were allowed to be canceled by the employer. The court was persuaded to reach this conclusion because the underlying plan language did not say that participants were "vested" in these benefits and it reserved to the employer the right to amend, terminate, or modify the health plan from time to time. The holding is consistent with earlier Seventh Circuit cases. It indicates that, in the Seventh Circuit's interpretation of the law, employers who are careful not to provide for "vesting" of welfare plan benefits in the plan document and who consistently reserve the right to amend, terminate, or modify their welfare plans may retain substantial flexibility to change or cancel those programs for retirees. No employer should take any action based on this brief summary of a complex case. Circuit Court opinions evolve and change over time and may also be affected by subsequent U. S. Supreme Court opinions.

IRS has issued guidance on Health Savings Accounts in the form of 88 Questions and Answers. Health Savings Accounts (HSAs) were created in 2003 to be tax-free savings programs for people to use to pay for health care expenditures. HSAs must be linked with a high deductible health plan" (HDHP) with at least a $1,000 deductible for single and $2,000 deductible for family coverage. The underlying principle is that if health care consumers are forced to make expenditures from their HSAs to pay health care expenses up to these deductible amounts, they will spend their health care dollars more wisely.

A big concern has been whether "first dollar" coverages can be provided along with, or as part of, the HDHP without causing the covered participant to be ineligible for an HSA. Examples of first dollar coverage plans include employee assistance plans, disease management programs, and wellness programs. The new HSA release indicates that, so long as a program does not provide significant benefits in the nature of medical care or treatment, it may be offered along with the HDHP and will not affect a covered participant's eligibility for an HSA. Other topical concerns are addressed in this release that will be of interest if you are considering offering HSAs alongside your HDHP. (Treasury Notice 2004-50).

The IRS focus on executive compensation compliance issues takes shape. In our April 2004 Newsletter we described the IRS. compliance initiative focusing on executive compensation. Now, some of the results of the initial study are in and, as a result of what has been learned, the IRS has announced that it will be closely scrutinizing corporate nonqualified deferred compensation plans in future routine corporate audits. In the compliance initiative a main focus has been on "matching" the employer's deduction for nonqualified deferred compensation with the reporting of the same income on the corporate executives' tax returns. The IRS spokesperson noted that a surprising number of large, sophisticated employers are not complying with the rules on timing of deductions found in Code Section 404(a)(5), i. e., the rule that there should be no deduction for the corporation until the executive takes the deferred compensation into income.

According to the IRS spokesperson, the top three compliance issues are (1) nonqualified deferred compensation; (2) stock- based compensation; and (3) the million dollar cap on deductible compensation under Code Section 162(m). These three areas are expected to become standard areas of investigation in future IRS audits.

You may wish to forward this article to your company's finance and tax accounting area as an early warning of potential audit concerns.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.