Regulatory Considerations, Plan Selection for Businesses and Plan Investment Considerations

Question 1

Employee retirement income security act (ERISA)

Answer 1

• imposes various duties, standards, and prohibitions on plan fiduciaries
• prohibited transaction rules: specify that plan fiduciaries in interest must not engage in certain activities unless there is an available exemption
• can be subject to excise taxes or penalties under IRC

Question 2

Department of Labor (DOL) regulations

Answer 2

• fiduciary: person who renders investment advice for a fee with respect to qualified plan
• investment advice: value, selling, buying, investing securities and has discretionary authority and regularly renders advice per agreement (research doesnt count unless pursuant to mutual agreement)

Question 3

Fiduciary liability issues

Answer 3

Duties with respect to plan must
- solely in interest of participants and beneficiaries
- purpose of providing benefits to them and avoiding expenses
- care, skill, prudence, and diligence a prudent person would
- diversifying investments to minimize risk

Question 4

Potential liabilities for breach of fiduciary duties under ERISA

Answer 4

• prudence standard: based on conduct and not performance of investments
• diversification standard: no specific percentage limit on any one investment

Question 5

Prohibited transactions

Answer 5

• fiduciary cannot engage in transaction they know constitutes a conflict of interest
• conflict of interest: furnishing goods/ service between plan and party of interest or transfer to or use for benefit of a party in interest
• fiduciary cannot deal with assets of plan in own account or receive consideration for own personal account involved in transactions of plan

Question 6

ERISA and other qualified plan regulators

Answer 6

• PBGC: insure the payment of guaranteed benefits. funded with annual premiums, paid by DB sponsors, issues interpretive guidelines on ERISA
• IRC: favorable tax treatment for plans that qualify and denies those committing violations
• ERISA: protects interests of participants
  DOL: enforces ERISA, issues interpretive guidelines on ERISA, issues opinions and exemptions to prohibited transactions

Question 7

Benefits guaranteed by the PBGC

Answer 7

• only guarantees DB and cash balance plans
• when plans lack assets to pay benefits, PBGC guarantees monthly benefit adjusted annually
• only covers nonforfeitable and pension benefits and only for those entitles to benefit or already being paid

Question 8

Defined benefit plan termnations

Answer 8

• may be voluntarily terminated (standard termination) by an employer or involuntarily terminated by PBGC
• voluntary termination: occurs when sufficient assets to fund accrued benefits
• distress termination: occurs when there are insufficient assets to fund benefit
• employer bankruptcy liquidation
• employer is in a bankruptcy reorganization proceeding
• employer can prove to the PBGC that plan termination is necessary to pay debts

Question 9

Owners personal objectives - plan selection

Answer 9

• maximizing the proportion of plan contributions that benefit owners, HCE, or older employees
• maximizing or minimizing ER contributions
• maximizing ER contribution flexibility
• vesting to minimize turnover
• allow employees to make before tax salary deferrals

Question 10

Tax considerations - plan selection

Answer 10

• plans are tax deferred
• if owner is in high bracket they can use plan to pursue active management and in retirement withdrawal money in lower bracket

Question 11

Establishing a qualified plan

Answer 11

• plan document must be executed in tax year
• safe harbor 401k must be before plan year
• standard 401k needs to be adopted before before deferrals can be made
• SIMPLE 401k can be adopted anytime after Jan 1 but before Oct 1

Question 12

Establishing a SIMPLE

Answer 12

• between Jan 1 and Oct 1

Question 13

Establishing a SEP

Answer 13

• after employers fiscal year end
• has until business tax return due date to establish and make contributions

Question 14

Pension protection act of 2006

Answer 14

• allows LTC-annuity combinations
• directs DOL to clarify regulations for including annuities in 401ks
• annuity must meet safest available annuity standards

Question 15

Diversification

Answer 15

• trustees have duty to diversify investments to minimize risk
• DC: publicly traded employer securities must allow participants to diversify after 3 years of service

Question 16

Fiduciary considerations

Answer 16

• fiduciary can be sued to failing to diversify investments

Question 17

Unrelated business taxable income (UBTI)

Answer 17

• if UBTI exceeds 1k the qualified plans UBTI is subject to income tax
• income from LP or dividends from margined account is considered UBTI

Question 18

Life insurance

Answer 18

• LI benefits must be incidental to primary purpose of plan
• Incidental if meets either of 2 tests
  1. aggregate premiums paid for DB is always less than plan benefit percentages (DC use more)
• ordinary LI/ whole LI - 50%
• term LI/ universal LI - 25%
  2. participants DB no more than 100 times expected monthly benefit (DB use more)

Question 19

Using life insurance in a qualified plan

Answer 19

• satisfies need for LI in owner of small business and provides tax deduction to business
• pure insurance protection is taxed to participant at Table 2001 cost
• if DB is payable from proceeds of LI, difference between face value and cash surrender is treated as death proceeds and excluded from income