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Preserve ERISA plans with proactive, voluntary changes


The Employee Retirement Income Security Act of 1974 includes governing rules that are complex and constantly changing. Plan fiduciaries, administrators and managers of a plan face the most penalties due to this act. These sanctions were a significant obstacle to employers contemplating establishing tax-qualified plans as well as welfare benefit plans.

For this reason, the government utilizes penalties and rewards to ensure legal compliance for ERISA plans. The rewards include self-correction programs that can be used if mistakes are made, while the penalties are extreme tax sanctions that are imposed if a sponsor is caught out of compliance.

A tax-qualified plan can become disqualified in many ways. Regardless of why it was disqualified, the plan will lose--retroactively and prospectively--its tax advantages as well as subject the sponsor to penalties that can exceed half the value of the plan's assets. Penalties can include denial of corporate deductions, taxation of pension trusts and halting the ability to roll over individual retirement accounts.

The most common disqualification is a form defect. This occurs when the plan is not updated to reflect changes in tax law, for example GUST and the Economic Growth and Tax Relief Reconciliation Act of 2001. If your plan has not been updated for these laws between 2003 and 2005, it is likely disqualified and should be reviewed. "GUST" refers to the following tax laws: the General Agreement on Tariffs and Trade, the Uruguay Round; the Uniformed Services Employment and Reemployment Rights Act of 1994; the Small Business Job Protection Act of 1996; and the Tax Relief Act of 1997. It also includes the Internal Revenue Service Restructuring and Reform Act of 1998 and the Community Renewal Relief Act.

Another typical disqualification is an operational defect. This occurs when the terms of the plan are in compliance with the law, but the plan is not operated in accordance with its terms. Examples include allowing entry into a plan after six months of service when the plan requires 12 consecutive months for entry, or making late contributions to a 401(k) plan when its terms require timely elective deferrals.

Two other common problems are demographic and employer eligibility defects. A demographic defect occurs when a plan initially satisfies the various nondiscrimination testing rules, but falls out of compliance because of a change in the workforce. Employer eligibility defects occur when an employer adopts a plan that it legally cannot adopt (e.g., a for-profit entity adopts a 403(b) plan).

These defects may be cured under the Employee Plans Compliance Resolution System, which places plan participants in the position they would have been in had the defect not occurred. EPCRS is conditioned on correction by the plan sponsor and provides general guidelines on correction principles and some specific correction methods. These correction programs are available only if an Internal Revenue Service audit has not commenced.

Plan officials and employers that engaged in prohibited transactions may apply to the Department of Labor for relief under the Voluntary Fiduciary Correction program. A prohibited transaction is, in general, a non-arm's-length transaction between an ERISA plan and "parties-in-interest." A prohibited transaction will occur when a service provider to an ERISA-covered plan (also known as a party-in-interest) engages in transactions with the plan that harm the plan's economic interests by, for example, overcharging the plan or the plan receiving below-market rates of return for the risk involved and the plan having its assets dissipated--all as a result of its relationship with the service provider. Applicants must fully correct any prohibited transactions, restore any resulting plan losses with interest and distribute any supplemental benefits owed to eligible participants.

Some of the fiduciary breaches eligible for correction under the VFC program include:

  • Loans to or from parties-in-interest at below-market interest rates.

  • Late payment of participant contributions to pension or welfare plans.

  • Sale and leaseback of property to a sponsoring employer.

  • Purchase or sale of assets between a plan and a party-in-interest or an unrelated party at below-market value.

Given that prohibited transactions can result in up to a 100% excise tax on the amount included in the transaction--plus interest and penalties in addition to significant exposure to litigation--it is usually prudent to consider using the VFC.

Most pension plans, and all welfare benefit plans with more than 100 participants, must file Form 5500 annual with the Labor Department. Failure to do so can result in penalties of more than $1,100 per day. To encourage plan sponsors to submit Form 5500, the federal agency created the Delinquent Filer Voluntary Compliance program, which reduces penalties if Form 5500 is submitted voluntarily before audit.

The government created voluntary compliance programs as a way to provide an incentive to the private sector to bring pension and welfare plans into legal compliance. Voluntary correction programs are attractive because the sanctions are so significant. However, these programs are not available if a plan is under governmental audit. Therefore, it would behoove most employers to engage in a due diligence check of their ERISA plans to determine if all is in good order.

Marcia S. Wagner is president of Wagner Law Group, a Boston firm specializing in ERISA, employee benefits and employment law.