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

[Guest STLGiant]

It's my understanding that school districts, as quasi-government entities, are exempt from ERISA Title I, but not from Title II.

It is also my understanding that in order for ANY 403(B) annuity contract, or 403(B)(7) custodial account to be a "valid" contract, it must contain ERISA's anti-alienation language.

Finally, it's my understanding that when Congress passed the Retirement Equity Act of 1984, establishing QDROs, the intent was to provide an exception to the anti-alienation provisions of both ERISA and the Code, since the antialienation provision and ERISA's broad preemption provisions conflicted with state laws designed to ensure that individuals satisfy their family support obligations.

So help me with this logic. If the only Code Sections that a district 403(B) plan must adhere to is anti-alienation...

AND

if the concept of QDRO is an exception to anti-alienation

THEN

I can't see how school district 403(B) plans exempt from QDROs?

Second question, if the answer is that the district must adhere to REA QDROs, due to the anti-alienation exception, what else under REA must non-Title I plans adhere to?

I can think of spousal consent on beneficiary designations or loan consent as additional inclusions, since without it, what would stop one spouse from naming a non-spouse beneficiary (let's assume it's not the kids or a trust) or taking a maximum loan from the plan prior to filing for divorce?

Replies welcomed...

[QDROphile]

Start by examining your premises. A valid 403(B) arrangement does not have to comply with ERISA if it is a governmental plan and governmental plans are exempt from section 401(a) (13 ) of the Internal Revenue Code. Section 414 (p) has special provisions for governmental plans. Domestic relations orders could get really interesting under governmental plans, but probably most plans and state laws roughly approximate the federal scheme for QDROs.

[Guest STLGiant]

Thanks QDRO, although I understand what you are saying, it still appears as clear as mud. Tell me, is the valid contract/custodial account rules determined by anti-alienation or by transferability.

If it's the former, then I still don't understand. If it's the latter, then perhaps it's very clear.

BTW, do you know of a source or chart that lists what states have adopted special rules for DROs (i.e. they haven't adopted ERISA QDRO rules) in the event the plan is not subject to Title I?

Thanks!

[QDROphile]

I don't really understand what you mean by the valid contract/custodial account rules. An arrangement is valid if it meets applicable requirements. The requirements are different for governmental plans compared to private employer plans. You can find other threads that discuss whether or not a governmental plan document should include ERISA features or references. You can also find a thread about whether or not a 403(B) plan has to offer annuity options -- answer: it depends. For a 403(B) plan, you start with the requirements of 403(B).

Also, a plan can have features beyond what is required as long as it does not provide what is forbidden. Unless an employer wants a totally custom arrangement, the employer will be limited to what someone else has designed for sale. In these products, you tend to have some common elements, dictated by marketing rather than perfect fit with the buyer. Some products can be made to fit better than others.

As for state law, I am not aware of a list. I would not expect to find one. I am aware of at least one state that has a special statute on domestic relations orders applicable to certain governmental plans. But the same state has its rules for domestic relations orders on a major government plan incorporated into the statute that constitutes the plan. This sort of variability makes analysis and organization of rules very difficult.

[Guest STLGiant]

I appreciate your response.

My understanding of the audit requirements is that while there is no requirements that all 403(B) plans operate in accordance with its terms (as there is no written plan document requirement for many) there is certain Code requirements which MUST be in either the annuity contract or custodail account agreements, whether or not the plan sponsor is subject to ERISA. My understanding is that the annuity contract or custodial account must provide three items so to be "valid", as follows:

1) Non-transferability requirement under 401(g)

2) Direct Rollover Requirements under 1.403(B)-2, Q&A 4; and

3) IRC 402(g) limit under 401(a)(30).

If any of these items are missing, the contract is not adequate for a 403(B) non-ERISA, non-Title I plan (or any other 403(B) arrangement for that matter, I think,)

2) and 3) I understand. 1) is hazy to me. How does non-transferability relate to distributions under a DRO?

[QDROphile]

I think it is great that you are asking fundamental questions. We tend to take too many things for granted. I hope someone can respond for the benefit of all of us. I have never had occasion to get to the level of your question.

[Carol V. Calhoun]

STLGiant, there are actually more requirements for even a non-ERISA 403(B) plan than the ones you mention. (The Code section 415 limit and the age 70½ distribution requirement spring to mind.) However, to focus specifically on your question, the non-transferability requirement is theoretically an issue because it could be interpreted to prohibit transferring a contract (or a portion of one) to a former spouse, for example. However, given that ERISA-covered 403(B) plans are required to comply with qualified domestic relations orders, the transferability requirement obviously could not prohibit compliance with such orders. The issue then becomes how far that exception extends.

I think that most people would assume that a non-ERISA plan could comply with any domestic relations order, not merely with one that would be a qualified domestic relations order under ERISA. (See section 414(p) for comparable rules for qualified plans that are not covered by ERISA.) But what about an order that is not a domestic relations order? For example, suppose that a Vermont court issues an order in favor of a former party to a civil union. Unless the party is a "dependent," such an order would not even be a domestic relations order, much less a qualified domestic relations order, under section 414(p). Can a 403(B) plan nevertheless comply with it?

[Guest STLGiant]

Dear Carol:

Thanks for your input. I concur that 415 and 70.5 distributions are also mandated, yet you open the door for a previous post of mine, if 70.5 is minimum distributions are required, who has the onus on the 204(h) notifications? If the accounts are rolled over, it's the custodian, no issues there. But, what if the accounts are maintained by the participant? Remember, they were set up as a plan of the district, since without the district, one cannot set-up the 403(B) arrangement. Ergo, the onus must fall on the district to notify of a 70.5 distribution if the account is not rolled over to an IRA at separation of service, how could it not be?

Unfortunately, you and I both know that a vendor is not going to provide 70.5 notice on a timely basis, jeez, they seek to keep the assets, not see them leave their coffers! I've seen situations where the vendor never notified the ex-participant, even though they had the DOB! Confusing to say the least.

I guess that in the Vermont court system, one would have to fall back to what is the spirit of the law (REA)? Wasn't the legislative history behind a QDROs, was to "ensure that individuals satisfy their family support obligations".

In that light, I guess one could argue the theoretical importance for the need to obtain a beneficiary designation whereby if the participant is married and the account exceeds $5,000 that the spouse must be the primary beneficiary. In addition, then, couldn't spousal consent also be argued necessary should the participant seek to make the beneficiary other than the spouse, or prior to a participant obtaining a loan or a hardship?

It's kind of like an off ramp to the insane asylum, I'm stuck on the clover leaf with the feeling of chasing my tail.

I can't see how one can protect the rights of women, and yet in the same breath, say it's not applicable if you are a government entity, school district or otherwise, sponsoring a non-Title I 403(B) arrangement.

My problem is that I must support these and other administrative actions, and am hearing from another contributing Benefitslink 403b Board member (not on this thread) that none of this is applicable, since school districts are exempt from ERISA, including the J&S, Spousal Consent, Loan, QDRO and other issues whereby I support what Carol is saying...many are theoretically an issue!

Considering the consulting expense is tax dollars, and in this recession they are tight, and the IRS activity in 403(B) audits, what message should a consultant take to the School Board, "more likely than not"?

STL

:confused:

[Carol V. Calhoun]

Just a comment on the Vermont situation: the issue is that Congress specifically passed the "Defense of Marriage Act," saying that federal law (including the Internal Revenue Code) would not recognize a person of the same sex as a "spouse," even if applicable state or foreign law did. So people who come from abroad and have more than one spouse, a child spouse, a spouse who is a close relative, a person who became a spouse through forcible rape, etc., can have their marriages recognized here if such marriages were valid in their home country. However, federal law prohibits the recognition of a same-sex marriage, even if it was validly contracted in a US state or a foreign country. I'm glad Congress is out there to protect us against the real evils of the world! [Heavy sarcasm, here.]

Given that statute, I'm not sure that a court would treat an order in favor of a former party to a civil union as being to "ensure that individuals satisfy their family support obligations." However, as with so much else in this area, the law is unclear.

[mbozek]

When Congress enacted QDROs in 1984 as an exception from the nonalienation rules of ERISA, governmental and church plans were not subject to compliance with the QDRO provisions of the IRC with one exception: 414(p) (11) permits distributions from government and church plans exempt from ERISA to be treated as made pursuant to a QDRO if they meet the requirements for a QDRO. This allows a division of plan benefits from a government or church plan to be treated as a tax free distribution if (1) the plan permits such division and (2) the dro meeets the requirements for a QDRO.

As far as civil union statutes are concerned there can be no tax free division of the benefits under a QDRO because IRC414(p) limits an alternate payee under a QDRO to a spouse, child or dependent of the participant. Relationships recognized as a a "civil union" or "domestic partnership" are not between spouses under the enaced state laws but are alternative relationships between persons of either the opposite or same sexes. That is why it called a civil union or domestic partnership, not marriage. Persons designated under these relationships are not regarded as legal spouses for QDRO purposes any more than employer provided health benefits are a tax free benefit of domestic partners who receive them because they are not legal dependents under the IRC nor can there be a tax free rollover under an IRA to a domestic partner or a person recognized under a civil union because the recipient is not a spouse under the tax law.

As far as protecting women's rights Congress has based the exemption from ERISA on first amendment grounds (churches) and 11th amendment grounds, federalism, (states). By the way the board member is right -- the only requirements that a government 403(B) plan is subject to are the requirements in Section 403(B) itself. None of the ERISA requirements, e.g., written plan document, apply. IRS audit guidelines list the requirements for govt and church 403(B) plans which are thankfully few.

[Guest STLGiant]

MJB QUERY:

What about ERISA law that has been "cut & pasted" and adopted by States. My overall concern is that while a public school district might be exempt from ERISA on a federal basis, they may indeed have to comply if the State has adopted legislation mimicking portions of ERISA. For example:

Public School Districts are exempt from ERISA Fiduciary rules, ergo a district "could" have only one vendor... I see nothing under 403(B) that dictates providing prudent investments, only investments that meet contractual provision as outlined by the Code. I understand that California and Texas State law provide that no school district (public or private) can limit the right of a participant for having a 403(B) vendor--however, I think a vendor can be limited if the contract or custodial agreement doesn't meet Code requirements.

So, what if that state adopted legislation utilizing ERISA fiduciary laws? Could a district employee-participant sue the district in State court successfully as the district did not provide the employee-participants with prudent invesment choices and provided only one vendor?

Going back to what Carol said in her most recent post, what effect does State law that mimicks ERISA, be it QDROs, Fiduciary guidelines have on non-ERISA 403(B) arrangements sponsored by public schools. Has anyone on the Board looked or reviewed that issue? How are people handling this?

It should be noted that it appears that hospitals, 501©(3) orgs., non-public schools and ERISA electing church schools sponsoring 403(B) arrangements might have a DOL issue if only one vendor was offered.

[Carol V. Calhoun]

mjb,

Actually, there is now one country (the Netherlands) that does not have a separate civil unions statute, but simply allows same-sex couples to marry. Nevertheless, under the Defense of Marriage Act, such marriages are not recognized for ERISA or Internal Revenue Code purposes.

The Vermont statute is a hybrid. Although a Vermont civil union is not a marriage, the Vermont statute provides that

A party to a civil union shall be included in any definition or use of the terms "spouse," ... and other terms that denote the spousal relationship, as those terms are used throughout the law.

Nevertheless, a same-sex spouse is not treated as a spouse for ERISA or Code purposes, due to the Defense of Marriage Act. Even if a state were to allow same-sex couples to marry, such persons would not be treated as married for ERISA or Code purposes.

Also, a domestic relations order applicable to a governmental plan need not meet the requirements for being a QDRO in order to be treated as a QDRO for purposes of taxing the participant and the alternate payee. Any domestic relations order applicable to a governmental plan is treated as though it were a QDRO for this purpose. Code section 414(p).

My concern is not just with regard to the tax effects on individuals. Because my clients are all either employers or plans, I am particularly concerned about the effect on plan qualification. For example, a pension plan is not allowed to distribute benefits until the earlier of retirement or separation from service. A QDRO (in the case of a private plan) or any domestic relations order (in the case of a governmental plan) is an exception to this rule. However, if an order in favor of a domestic partner is not even a domestic relations order, does an otherwise qualified governmental pension plan jeopardize its qualified status by distributing benefits in compliance with it before the participant attains normal retirement date or separates from service?

Incidentally, health coverage to a domestic partner is not taxable if the domestic partner is a dependent of the employee. Similarly, an order in favor of a domestic partner is a domestic relations order, and may even be a QDRO, if the domestic partner is a dependent of the employee. However, the definition of dependency requires, among other things, that (a) the domestic partner is financially dependent on the employee, and (B) the relationship is not in violation of local law. It does not cover a situation in which the employee has not provided at least 50% of the domestic partner's support. This contrasts with health coverage of a spouse, which is nontaxable even if the spouse does not qualify as a dependent, or a domestic relations order in favor of a spouse, which is permissible even if the spouse does not qualify as a dependent.

[Carol V. Calhoun]

STLGiant,

Although the fiduciary standards of ERISA are often "cut and pasted" into state statutes, the penalties for violating those standards are provided by state law, not ERISA. Thus, whether an employee-participant can sue the district in State court successfully would be determined under state law. In some instances, the answer would be yes. In others, the state law might provide different penalties, or might provide governmental immunity to the district. (But see the Walker case, in which governmental immunity was held not to apply to a collectively bargained governmental plan.)

[Guest STLGiant]

Thank you again for the clarifcation!

[mbozek]

STL Giant: Plans exempt from ERISA ares subject to applicable state laws. If a state has adopted ERISA fiduciary provisions, then prudent investment rules will apply to the extent applicable under state law. Note- some states have adopted the ERISA prudent investor rules for asset allocation in place of the old common law rules that a fiduciary could be surchared for a single bad investment regardless of the overall performance of the portfolio.

While anyone can sue anyone else in the good old USA, a plaintiff would have the burden of pleading and proving that the use of one vendor was imprudent . This is very expensive and difficult because expert testimony would be required from a registered investment advisor that the performance of the vendors products was an imprudent investment not related to market conditions. E.g, a mere drop in rates of return is not impudent if the martket conditions have changed. Many small plans subject to ERISA use only one vendor because they do not have enough revenue to make it profitable for multilple vendors. The real issue is whether the participants have sufficient opportunity to diversify their investments, not whether there are duplicate investment choices. Many small plans use one provider because they get bundled services which cover the cost of plan administration for a low cost. There is a trade off between offering multiple providers and low administration cost. There is nothing in ERISA that prohibits an employer from using a single vendor for 403(B) plan investments.

[Guest STLGiant]

Thanks MJB, a few comments.

My one vendor case involves a public school district having just a fixed annuity provider. I can see where having one vendor (a variable annuity or custodial account) could address all the issues of having an sufficient opportunity to diversify, but not with just a fixed annuity.

The administrator in me likes the idea of one vendor having "all the assets" since prior vendor MEAs (pre-2002) would likley have the cumulative contributions figures. The operative word being "likely". As to whether the MEAs issued had the proper definition of includible compensation, or the correct actual years of service is another story in and of itself...

Anyway, as to the issue of the burden of proof on the plaintiff, I'm not so sure that it would be as difficult or as expensive as your post suggests in light of some case law involving suits against insurance company GICs (prior to the issuance of 404©). If the only vendor was a fixed annuity, I think it would be quite easy to prove that a change in the market does not provide sufficient opportunity for a participant to diversify. Again, if the sole vendor product used was a variable annuity or a custodial account, I would concur with your statement.

Finally, as to expert testimony by one or more "experienced" RIAs, well that's not that expensive. Well, at least not in this state. Having grown up in NJ, the cost is probably triple of what it is in MO. Legal fees for a participant going after a big insurance/annuity company? Priceless....

FWIW, while there may be nothing in ERISA prohibiting the use of a single vendor in a 403(B) plan, I think if the sole vendor only offered a fixed annuity; one would be inviting a lawsuit, don't you think? Especially if the state in question, adopted fiduciary or prudency text of federal provisions. Are you aware of any site that illustrates which states have adopted ERISA fiduciary or prudency provisions?

[Carol V. Calhoun]

The National Council on Teacher Retirement ("NCTR") surveyed state retirement systems that serve teachers and found that 36 out of 50 use a prudence rule that is modeled on the ERISA standard. However, I would suspect that the proportion of locally run 403(B) plans that are subject to the ERISA standard is much lower. Such plans often seem to fall into a gap between trust law (which does not apply to them, because they are not structured as trusts) and state pensions law (which may not cover plans of localities at all, or may cover localities only as to their 401(a) plans).

[Harwood]

From Publication 571 "Tax-Sheltered Annuity Programs . . ."

"Qualified Domestic Relations Order. You may be able to roll over tax free all or any part of an eligible rollover distribution from a 403(B) plan that you receive under a qualified domestic relations order (QDRO). If you receive the interest in the 403(B) plan as an employee’s spouse or former spouse under a QDRO, all of the rollover rules apply to you as if you were the employee."

[Guest STLGiant]

Thanks Harwood, however, the original question with respect to QDROs was were non-Title I 403(B) plans, those typically sponsored by public school districts, subject to QDRO rules.

It appears the answer is that non-Title I 403(B) plans are exempt from QDRO regulations. However, depending upon the state where the public school resides, the district could be pulled into QDRO requirements under State law.

What's unanswered is which specific States have laws that mimick ERISA as to recognition of a DRO as a QDRO. Same with respect to fiduciary or prudence rules.

In addition, there is no post addressing if State law mimick ERISA for purposes of providing spousal notice requirements, mandating one's spouse as the primary beneficiary and mandating obtaining spousal consent for ANY distribution (hardship, loan, or distribution based on a triggering event) going to anyone or thing (trust) other than the participant's spouse.

The purpose of the posts is to emphasize that while we may know there are exemptions for government entities (a.k.a. public school districts) from ERISA Title I, there are also directives under Title II as outlined in IRC. However, there are some ERISA regulations that public school districts are normally exempt from that have been adopted as State law. Those State laws can "bring" a public school district into compliance with ERISA regs., not reportable to or mandated the fed, but by the hand of the State....

[Guest kkost]

Going back to your original point - which appears to be what Harwood was trying to do - public school districts don't pay federal income tax. Because of this, their only concern with Title II is ensuring that their employees get a tax benefit from their programs.

Section 403(B) deals with whether the participant can defer tax - these are tax rules, not legislative mandates like those in Title I. If you look at 414(p)(9) and (11), you will see that those rules are merely structured to preserve the tax deferral for divorced spouses who are awarded benefits - not to avoid some substantive prohibition on alienation.

If a state court orders a distributon from a public school plan, there is no ERISA preemption shield that the district can hide behind - the distribution must be made. The only question is whether the recipient can continue the tax deferral.

[mbozek]

STL Giant: Non litigation type persons always under estimate the amount of evidence and proof required to prevail in civil litigation, the financial resources of the defendants and the difficulty of finding competent counsel to take a complex financial case on a contingency fee. Your relaince on the GIC cases is misplaced. Unysis union employees sued the the plan fiducaries for putting 20% of the 401(k) plan assets into Executive life annuities (Exec life became insolvent). After 4 separate courts reviewed the case the final decision was that there was no breach of fiduciary duty because the plans assets had been diversified.

The Plaintiff must do more than just produce an expert who will give an opinion--- the expert must prepare a detailed research report comparing the performance of the funds in the plan with other comparable funds-- This will cost big bucks and will be disputed by the industry experts for the fund/ employer. If the employees scrimp on the costs of the expert testimony they get killed at trial or the case gets tossed out on summary judgment. The will get killed anyway because of the lack of investment advisors who are willing to take on a fund family. Also federal courts will impose monetary sanctions on plaintiffs who file frivilous claims under Rule 11b.

As far as having a single fixed annuity option under a non erisa plan u must look to the applicable state law. I have advised clients that local counsel must be retained to determine whether there is any fiduciary responsibility under the applicable law (e.g., some plans may not be the responsibility of the employer any more than an IRA would be) because the plan does not hold the assets in trust and what is the standard for review. The simpliest anwer is to use a vendor that offers more than one investment option.

Kkost- Since there is no ERISA preemption of state law, most public retirement plans are structured as spendthirft trusts under state law which do not permit the alienation of assets under a divorce decreee. The alternate payee receives a property settlement note from the employee for the amount of the alternate payee's interest in the public retirement plan which will be paid at retirement. The note may be secured by the employee's interest in other property, e.g. ,the marital residence to guarantee payment.

[Carol V. Calhoun]

mbozek,

My experience has been somewhat different from yours with regard to state plans and domestic relations orders. Most of the ones I have seen have some provision (which in many cases resembles the qualified domestic relations rules imposed on nongovernmental plans by ERISA) for honoring domestic relations orders. See, e.g., SC Code §§ 9-18-10(9), § 9-18-20(B)&©.

When advising governmental plans, I typically tell them that if a state's domestic relations law is going to treat the retirement plan assets as part of the marital estate for purposes of determining each spouse's share, it is in the interest of the participant as well as the spouse to allow domestic relations orders. This is because the alternatives impose less flexibility in planning for both parties. Having the participant receive the money, and then turn it over to the spouse, pursuant to a property settlement note requires contact between often hostile parties for many years in the future. Alternative methods (e.g., giving the spouse the marital home in exchange for the participant getting the full retirement benefit) may be impractical if the retirement plan is the largest asset, and may in any event leave the participant with a full retirement benefit but very limited assets to live on currently. Finally, the spouse's withdrawal rights may in many instances be more favorable than the participant's. (A defined benefit plan, for example, cannot pay a participant before normal retirement date or severance of employment, but it can--if state law permits--pay a spouse much earlier than that.) This gives the spouses flexibility at a time when immediate cash needs (for lawyers, and to set up two separate households) may be high.

[Guest kkost]

mbozec: My comments were limited to taxation of distributions to non-participants under 403(B) plans and the lack of a substantive anti-alienation rule under federal law.

[mbozek]

Carol:

You are missing my point. Property settlement notes are used in those states where state law does not allow the state retirement benefits to be divided by a qudo and there are state plans that have spendthrift clauses. The fact that the state pension benefits are included as marital assets does not automatically mean that the spouse can receive a payout of the interest upon divorce. Also a property settlement note can be paid out after divorce on an installment basis to the alternate payee.

Second many insurance companies are willing to do a tax free division of a 403(B) annuity contract under the terms of the divorce decree where the alternate payee receives his or her own annuity contract equal to the amount their interest in the employees annuity. The terms of the APs contract are identical to the employee's contract. This avoids the need to do a QDRO. ( I dont know if mutual funds can be split this way).

[Carol V. Calhoun]

kkost and mbozek,

Will I spoil the fun here if I agree with both of you? It is true that a state or local retirement system has no ERISA preemption, and therefore must comply with a valid domestic relations order. On the other hand, there may be a question is whether a valid domestic relations order can be issued. In the first place, state spendthrift trust law is as much a part of state law as state domestic relations law, so it is necessary to determine whether state spendthrift trust law may preclude a state domestic relations order from being issued with respect to the plan. In the second place, many state plans are embodied in state statutes, and many local plans are adopted pursuant to state enabling legislation. If such a statute provides that the plan is not required to comply with domestic relations orders, again it is necessary to try to reconcile the laws to determine whether a valid domestic relations order can even be issued.

mbozek, I agree that "The fact that the state pension benefits are included as marital assets does not automatically mean that the spouse can receive a payout of the interest upon divorce. " All I was saying is that a state pension plan can provide for a payout to a spouse upon divorce, whereas it in many instances cannot provide for a payout to a participant at that time unless the participant has had some distributable event. Thus, although many would assume that protecting pension assets from a divorcing spouse is always in the interest of the participant, in fact there are many circumstances in which attempts to "protect" pension benefits creates inflexibility for the participant as well as the spouse.

[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".

[mbozek]

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?

[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?

[mbozek]

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.

[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!

[mbozek]

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.

[Carol V. Calhoun]

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.

[mbozek]

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.

[Carol V. Calhoun]

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?)

[mbozek]

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.

[Carol V. Calhoun]

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"?

[mbozek]

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.