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QDROs, Anti-alienation and non-ERISA plans...


Guest STLGiant
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Guest STLGiant

KKost,

Thank you for your input. I'm fully aware of the fact that public school districts do not pay federal income tax. They are subject to withholding. They can also be held liable for federal income tax that a participant would have had to pay if the 403(B) annuity or custodial account which had contractual failures. Part of what TVC or CAP is all about is paying a sanction to maintain the tax deferred status of 403(B) deferral contributions and earnings and eliminating penalties that would otherwise be charged to an effected participant.

While 403(B) may deal with whether a participant can defer taxes, the employees ONLY have that right if the district will agree to do so. The employees can't dictate as to whether the district will agree to sponsor a 403(B) or a 457 arrangement. There is no law that mandates a district must provide a 403(B).

Several issues discussed in this thread could easily be addressed by making non-Title I 403(B) plans subject to QDRO and other important rules under ERISA.

IMO, non-Title I 403(B) plans should also be subject to ERISA fiduciary and prudence guidelines and some limited notification requirements, (e.g. spousal consent for beneficiary designations to other than a spouse, loan requests, and hardships withdrawals). If one is seeking to protect the rights of spouses, States shouldn't go "halfway" by adopting some of the QDRO rules, they should address ALL the issues that came about with the Retirement Equity Act.

While I concur that no district can hide behind a veil, the problem is the effect of having a distribution under the 403(B) regulations for a QDRO. What is the effect of the plan participant who has a QDRO distribution from his or her account? I'm not worried about the fact that the recipient of the QDRO can roll the proceeds over, I read 571 too and understand that.

However, with respect to the participant who had a distribution from his/her account, is their remaining value of their annuity or account now subject to taxation since the moneys were distributed without a "valid" distributable triggering event (e.g. attaining age 59 1/2, retirement, death, separation of service)? Can or should the participant make additional contributions to their annuity or custodial account, or should they set-up a brand new one? Will the district be penalized for improper withholding if the participant continues to make contributions to an annuity or custodial account that has been subject to a QDRO distribution? Where is the guidance on this?

As to fiduciary rules, if the district, (as the plan sponsor) dictates who can be a vendor, that could make them party to a lawsuit (obviously from a State suit) depending on what sections of ERISA fiduciary and prudence are under State code. In California and Texas a public school district can't deny a vendor. That's funny, a public school district might have to take a vendor with a contractual defect?

What if the plan sponsor was exchanging free services (e.g. Compliance Review) in exchange for just approving the vendors provided by a brokerage firm or just that one vendor? In some instances this occurs by forcing current vendors to pay the brokerage entity a fee to stay on as a vendor--and those that don't pay are not allowed to do any further business with the district's employees. Doesn't that sound like mandating investment selections--like a fiduciary? What about a district that only provides a single vendor, and its only product offered is a fixed annuity? Doesn't that appear to limit the participant's ability to diversify?

As you can see, the law is not the issue, it's the loopholes that are the issue. If one takes the logical fork, one may be in violation of federal or state law AND there is no good roadmap.

As to distribution notices, generally they are provided to a terminated participant at termination of employment. Can you guess how many vendors tell these terminated participants that they can roll the money out of their existing contract and over to somebody other than their current vendor at termination of employment? I can see it now under the new regs, "Gee IRS, we at XYZ Annuity, Insurance or Mutual Fund company didn't know Mr./Mrs. or Ms. Participant left the employ of the district. That's why we didn't send them a notice."

Currently, participants only get a notice of their distributable options when they ask the vendor for a distribution, not at their termination of employment. Wonder why? The vendors want to keep the money on their books, not lose it to a competitor. The veil is the fact that the vendors don't mandate the district provide dates of termination for anyone on their list bills, or if they do, the people selling the products aren't communicating that as a "policy and procedure".

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STL Giant: Last time I looked political subdivisions of states were not subject to income tax under IRC 115. School districts are political subdivsions if established under state law. Under the prinicipal of federalism going back to the 1830's the states/ susbdivisions are soverign entities not subject to federal taxation. I don't know how the IRS can sue a soverign entity exempt from income tax or seize their assets. You will need expert tax counsel to determine if payment of withholding taxes automatically waives the exemption from income taxation.

There never will never be any extension of Title I of ERISA to governments because of the 11th amendment or to church plans (First amendment). The Supreme court has imposed restrictions on the ability of Congress to extend laws to states (ADEA, ADA).

While some states require that school districts take all vendors the school districts protect themselves by having the vendor sign a hold harmless and indemnification agreement in favor of the district and sometimes reqire that a vendor purchase a surety bond. If payments are made to become a vendor (pay to play) then criminal laws have been violated and federal prosecutors routinely send people on an all expenses paid trip to club fed for mail or wire fraud.

By the way under IRC 1041 a transfer of property directly or held in trust pursuant to a divorce is regarded as a tax free gift. The recipient takes the transferor's basis. Also under the 1984 tax act, the transfer of an annuity contract pursuant to a divorce is treated as a tax free event to the recipient, including the recovery of the transferor's basis. This allows tax free division of 403(B) annuities into two contracts. Why do you need a QDRO?

mjb

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Guest STLGiant

MBozek:

Shool districts are held accountable for payroll withholding for compensation of employees working at their district. If the district allows a 403(B) participant to defer more than what they are supposed to (402(g) violation) to an annuity or custodial agreement with contractual defects, the DISTRICT is LIABLE for improper withholding penalties. Since there is no statute of limitations for 403(B) plans (like filing a Schedule P in a qualified plan) indeed the IRS can assess withholding tax and penalties to the district as far back as there are violations. Same holds true for improper withholding due to failed MEA calcs.

In practice the IRS typically will only go back 5 years and then only on those participants who have been sampled and found to be in violation. However, I understand that IRS audits in Charlotte, NC, Minneapolis MN, and in Aurora, CO I heard they went back further than 5 years on the entire census. The audits were 18-24 months in duration.

The IRS can also apply taxation penalties to the participant as well as an excise tax if in a custodial account on those contributions that are in violation of 402(g).

Within an audit cap or TVC settlement, the district typically pays a negotiated sanction so the Service doesn't go after the participants individually. So perhaps it's not tax, but then again it really is!

As to "never" I rarely use this word when it comes to EP/EO. It seems just when you've got your arms around the law, it is changed by Congress. Since my entrance 1978 it's changed a ton, but not so much in the 403(B) area in comparison to 401(a) plans. My previous post comments that "certain" parts of ERISA should be mandated for non-Title I 403(B) plans like QDROs, 404© and notification requirements under 204(h).

As to hold harmless agreements, once you get through the loop-holes of those things, they're not worth the paper they're written on--especially if they come from a vendor. The history of an HHA dates back to a document produced by the law dept of an insurance/annuity provider. No company in their left or right mind would ever issue a document allowing them to be sued. The only HHA worth anything is one signed between the participant and the district. As to surety bonds or errors and ommissions by sales people, all that provides is a legal action for the district to go after a vendor. The Service has already stated in the 403(B) frequently asked Q&As that if there's a problem with the district, they're going after the district, not the vendor, since the district (even in non-Title I plans) is the plan sponsor.

As to the issue of I mentioned about pay to play, it's alive and well in the midwest with at least one very large brokerage firm that has ties to MO state educational associations. I understand something similar exists in IL, and OH. These brokerage companies are pretty big, so they must have somehow "disclaimed" it off in their contract. I agree it's wrong, but it's happening every day.

As to 1041, I was unaware that non-Title I 403(B) individual accounts point to this at all. Fist off, the money is not in a Trust. I was under the impression that non-Title I 403(B) accounts are treated as IRAs with respect to distributions?

I like the two contract idea, I just am unaware of any company doing that. Do you personally know of any who have done so in the 403(B) market or are you just commenting on annuities in general?

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STL Giant: there is a big difference between being audited and penalities being imposed. IRS officials are not anxious to annoy local government officials who have clout in Washington with congressman who control appropriations and these matters are usually settled with nominal penalities being assessed. Also the S/l generally limits the IRS ability to recover taxes against employees to three years.

As for as amending ERISA, I have seen proposals for the last 20 years to apply Title I oF ERISA to public and church plans. For the constitutional reasons cited in my prior post, ERISA type provisions will NEVER be enacted. Besides the cost of enacting these provisons would require too great an expenditure of political capital to be worthwhile.

Hold harmless agreements can protect the employer if properly drafted. All vendor contract start off with exculpation from liability.I have never had a vendor refuse to add a hold harmless agreement that makes them liable for their own acts of negligence (but they will usually not agree to be laible for mistakes caused by the employer, e.g., incorrect compensation.) The contract can provide that the vendor will provide counsel to the employer or pay for all expenses. But the employer has to demand these provisions. If the vendor won't give these assurances then go to another provider.

Disclaimers will not protect parties from criminal charges so there may be there people playing with fire. Around here it is not unusual to see public officials charged with various forms of malfeasence.

Finally a tax free transfer under IRC 1041 applies to property not held in trust if the transfer occurs within 1 year after the marriage ceases. The biggest 403(B) providers will split an annuity contract pursuant to a court order.

mjb

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Guest STLGiant

Thanks M...

For the record, a public school district outside Denver had to pay around $80K in Audit-CAP sanctions. That's pretty big and no the governor, nor MOC was unable to get the Service to back off, since the actual amount the Service could have assessed was a large single digit multiple of the actual amount paid.

The two public school districts in MN and NC paid handsomely too, without any Congressional assistance. In NC, KS and NE it was Universities who also paid 6-digit settlements.

No the Service is not kinder and gentler, and the States aren't doing much to complain, nor are the MOCs doing much to stop the IRS either.

As to the cost of implementing some ERISA provisions on governments, I can see your point on discrimination testing, or tracking separated participants regarding RMDs, but not on specific issues like fiduciary responsibility, nor prudence standards, nor spousal consents for loans, hardships on non-spouse beneficiaries. The vendors have the forms and the vendors could in fact do this (geez, they're doing it now on the 401(k) side).

Hold harmless agreements no matter how well intended just won't work with vendors with respect to MAC calcs, if the participant has the ability to use more than one vendor. Vendors do not share cumulative contribution numbers with their competitors. Privacy Acts that many have adopted further mandate their inability to share this data.

You are absolutely correct that the incorrect includible compensation is typically used, as is the improper service calculation. Many times vendors are unaware of all the compensation paid (over and above contracted amount, like for driving a bus, or coaching or tutoring). Vendors and districts are also unaware of employees working part-time at retail stores offering immediate participation to part-timers and providing great match formulas on 401(k) deferrals. Nobody has taken the time to "teach the teachers" that any deferrals to Sears' 401(k) must be included in their 402(g) calculations when deferring into their district 403(B) programs.

Therefore HHA signed by vendors would be good for contractual defects, since the vendor couldn't be held liable for information unavailable to them, and most HHA address that. Having the participant sign the HHA to the district is an option, but with the lack of teachers in this country and the competition between districts for qualified staff, that HHA might mean the difference in landing a math/science teacher or losing him to the district down the street.

As to the pay to play, the argument I'm hearing is that if a district seeks to have multiple vendors that WILL share cum # info and the like and have one MAC calculation encompasing multiple vendors come with my group, Mr. Superintendent. Your district won't have to pay, we'll get my group of vendors to pay our fees for compliance review. This arrangement has been going on for years! It's like the 12b-1 sharing between some companies and TPA firms...

As to your 1041 issue, I guess then I understand that the annuity is split, participant's spouse gets some subject to rolloever rules AND the participant is o.k. under IRC 414(p)(11) and can continue making contributions to his/her "split" account and not have to start anew.

In closing, this was a great thread. Thanks to everyone who posted! :)

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CCalhoun: your post of 2-6 on civil unions and state qualified plans is perhaps answered by a recent case in Ga. involving Susan Freer. On jan 23rd a Ga appeals court ruled that that civil unions are not marriages and even if they were Ga would not recognize them. If state cts outside Vt reject civil unions as valid marriages then VT dros involving benefits will not be enforced against pension plans in other states. But I thought that the defense of marriage act also allowed a state ct to reject same sex marriages which were legal in another state which would prevent a dro being issued in favor a person who was a partner in a same sex union. Thinking practically would the IRS really disqualify a public plan and cause the taxation of the participants (and anger all of the local public officals, e.g. governor, who would call their congressmen/senators) because the plan complied with a legaly issued ct order? Disqualifiying a public plan would not not be a voter friendly thing to do for a government agency that needs all of the congressonal suport it can get.

mjb

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mbozek,

You are correct that the Defense of Marriage Act permits Georgia, for example, to refuse to treat a Vermont civil union (or even a Dutch same-sex marriage) as not being a marriage, thereby precluding a Georgia court from even issuing a dro with respect to such relationship. However, the issue becomes what happens in, for example, a Vermont court, where state law prohibits treatment of parties to a civil union differently than spouses and thus a court could issue a dro in favor of a party to a same-sex union. Would compliance with such an order not only create unfavorable tax consequences to the employee and/or alternate payee, but risk disqualification of the plan?

As you say, the IRS may have political reasons for not aggressively disqualifying state or local plans that comply with dros in favor of parties to a civil union. However, the politics goes both ways. State and local governments often do not want to get their names in the newspapers for doing something which, even in theory, could disqualify the plan. It is my understanding, for example, that the Vermont law establishing the statewide retirement system currently prohibits distributions pursuant to a dro earlier than when the participant has a distributable event, regardless of whether the alternate payee is an opposite-sex spouse or a party to a civil union. The reasoning was that treating a party to a civil union differently than an opposite-sex spouse would violate Vermont law, while allowing an early distribution to a party to a civil union could disqualify the plan. The solution was not to allow early distributions to anyone.

Employee benefits legal resource site

The opinions of my postings are my own and do not necessarily represent my law firm's position, strategies, or opinions. The contents of my postings are offered for informational purposes only and should not be construed as legal advice. A visit to this board or an exchange of information through this board does not create an attorney-client relationship. You should consult directly with an attorney for individual advice regarding your particular situation. I am not your lawyer under any circumstances.

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Carol: if the benefits under the Vt public plan are paid to the other party of the civil union under an dro that is not a QDRO, (because the non employee is not a spouse under the tax law) isn't the employee taxed on the benefits paid to the non spouse under the assignment of income doctrine? I thought that the purpose of obtaining a QDRO under a non ERISA plan was to prevent such taxation.

mjb

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Yes, the employee would be taxed on the income, unless the other party to the civil union was a dependent within the meaning of section 152. However, this at least is an issue that can often be worked out between the parties (e.g., by giving the alternate payee less in recognition of the fact that the employee will have to pay the tax). The question is whether you can ever get to that point, i.e., will plans be so concerned about potentially jeopardizing their own qualification that they simply will not allow a distribution to an alternate payee who is a party to a civil union until the employee has a distributable event? And in Vermont, which prohibits treating parties to civil unions differently than spouses, does this mean early distribution rights must be taken away from opposite-sex spouses because they cannot be given to parties to civil unions? (And does anyone but me find it ironic that a statute called the "Defense of Marriage Act" may have the effect of taking rights away from opposite-sex married couples?)

Employee benefits legal resource site

The opinions of my postings are my own and do not necessarily represent my law firm's position, strategies, or opinions. The contents of my postings are offered for informational purposes only and should not be construed as legal advice. A visit to this board or an exchange of information through this board does not create an attorney-client relationship. You should consult directly with an attorney for individual advice regarding your particular situation. I am not your lawyer under any circumstances.

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Isn't this issue of revoking early retirement benefit commencement rights a matter to be decided under the equal protection clause of the VT consitituion not ERISA. If the Vt. cts refuse to allow early commencement of retirement benefits by a VT ex- spouse unless the same right is available under a civil union then the ct order would not violate the terms of a plan which permits early commencement of benefits to an ex spouse but does not require it. By the way the defense of marriage act does not require a state that permits civil unions to treat members of such unions to the same rights as married couples. Finally your comments about the impact of the Act to married couples is similar to the outrage I heard from divorced women after REA was enacted because their ex husbands would be entitled to their pension benefits. They were of the opinion that only the husband's pensions should have been subject to division. Equal protection goes both ways.

mjb

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Isn't this issue of revoking early retirement benefit commencement rights a matter to be decided under the equal protection clause of the VT consitituion not ERISA.
There would be, in theory, two ways of complying with the equal protection clause of the VT constitution. The first would be to give early distribution rights to both married couples and parties to civil unions. The second would be to deny such rights to both. It is the Internal Revenue Code's qualification rules, combined with the Defense of Marriage Act, that make the first alternative risky, and therefore in effect mandate that a plan required to comply with the VT constitution must choose the second option if it is to avoid that risk.
If the Vt. cts refuse to allow early commencement of retirement benefits by a VT ex- spouse unless the same right is available under a civil union then the ct order would not violate the terms of a plan which permits early commencement of benefits to an ex spouse but does not require it.
True. Given the current state of the law, that is the only risk-free option. But it means that a governmental plan in VT is in effect prohibited from allowing an early distribution option to married couples that other governmental and private plans are permitted to allow.
By the way the defense of marriage act does not require a state that permits civil unions to treat members of such unions to the same rights as married couples.
Not only does it not require a state that permits civil unions to treat members of such unions to the same rights as married couples, it actually puts barriers (as described above) in the way of any state that on its own wants to treat members of such unions as having the same rights as married couples.
Finally your comments about the impact of the Act to married couples is similar to the outrage I heard from divorced women after REA was enacted because their ex husbands would be entitled to their pension benefits. They were of the opinion that only the husband's pensions should have been subject to division. Equal protection goes both ways.
Hmm, I thought I was arguing that equal protection should go both ways. I believe that the pensions of both husbands and wives should be divisible upon a divorce. I also believe that the pensions of parties to a civil union should be divisible upon a termination of the civil union. In what respect are my "comments about the impact of the Act to married couples ... similar to the outrage I heard from divorced women after REA was enacted because their ex husbands would be entitled to their pension benefits"?

Employee benefits legal resource site

The opinions of my postings are my own and do not necessarily represent my law firm's position, strategies, or opinions. The contents of my postings are offered for informational purposes only and should not be construed as legal advice. A visit to this board or an exchange of information through this board does not create an attorney-client relationship. You should consult directly with an attorney for individual advice regarding your particular situation. I am not your lawyer under any circumstances.

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I have to go back to a research project but I agree with your comments up to a point. The fact that Vt law may take away some benefits available to divorcing spouses in other states because of the enactment of the civil union statute is a consequence that VT legislators should have thought about before they passed such legislation- and it will be thought about by legislators in other states (CT) that are contemplating civil union laws. My comment about REA benefits was intended to make a point that there is a common misconception that equal protection laws must always result in an increase in the rights available to members of excluded groups to the level of rights of the members of the included groups. Allowing spouses to share on an equal basis in pension benefits earned by the employee (by making pension benefits a form of federal community property under ERISA) requires the reduction of the benefits payable to members of existing groups (e.g., married women with pensions) in order to level the playing field. Both methods of extending equal protection are valid.

mjb

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