Bank CD rates in qualified plans

[Guest TrustMe401k]

Does anyone have ANY reg, PLR, cite, or have any experience with the following:

Small Community bank has 401(K) Plan and uses bank CD as the fixed interest/ guaranteed fund. They are currently paying a much higher rate on the CD in the plan than they pay to anyone who comes in off the street witht he same amount of $.

If anyone has ever heard of anything that we should inform the bank about I would appreicate hearing it.

Thanks!

[Kirk Maldonado]

There is a prohibited transaction issue here, but there is a statutory exceptiont that might apply. Look at IRC Section 4975.

[pjkoehler]

jehmig: See ERISA Sec. 408(B)(4) and DOL Reg. Sec. 2550.408b-4 and IRC Sec. 4975(d)(4) and Treas. Reg. Sec. 54.4975-6(B) regarding the statutory exemption for investments in deposits of banks by a plan covering the bank's own employees

[Guest TrustMe401k]

Thanks for your replies. There seems to be no question that the bank can invest in its own CD due to the PT exemption outlined in the cites listed above.

The regs says that the Plan may invest in this type of instrument "bearing a reasonable rete of interest". Can anyone define reasonable or is this a facts and circumstances issue? The point is that the bank pays 2+% higher on the CD in the Plan than it does for investment of a similar size to its regular customers. Would / could there be a finding that the rate of interest is not reasonable?

Obviously, higher is better than lower (at least for the Plan participants) and there is no discrimination in favor of HCES so maybe I'm being paranoid. Maybe this is a banking regulation issue. Maybe I should take a vacation....

Thanks again!

[pjkoehler]

jehmig: The regs are not very helpful on this issue. While logically, the published CD rate the plan sponsor/bank offers its customers would be a "reasonableness" benchmark, neither the DOL or Treasury regs specifically refer to this as a factor. But, you could argue by analogy in the light of the exemption requirements for participant loans, which require that the note bear a "reasonable rate of interest." That term is defined to mean the rate charged by persons in the business of lending money for loans made under similar circumstances. DOL Reg. Sec. 2550.408b-1(e). Of course, the CD sold to the plan didn't occur within a normal commercial setting. The bank could argue that in determining a reasonable rate, it should be able to increase it's published rate to adjust for the lack of direct marketing and other overhead costs. Whether it can justify the two percentage point differential is a factual question.

I don't think this is good long term practice, especially if the population of NHCEs is steadily decreasing. The bank is probably better advised to allow the CDs to rollover at the bank's then published rates.

[BFree]

You mention that the CD in the plan is of similar size to CDs outside the plan. Have you compared duration or purchase date? For example, a 5-year CD taken out 2 years ago would yield a substantially different rate than a CD taken out today.

[Guest TrustMe401k]

BFree: CD just rolled over last month.

[Guest b2kates]

Regarding the "extra" interest on the CD to the plan. in the early 80s I worked for a law firm which represented many plans. they bundled plan money and invested in CD's. (remember the double digit interest rates). they generally received 1 or 2 points higher than the street from the banks. The bank rationale was that as plan money it would be invested fora long time and if the interest rate was good the funds would like continue to be invested with the bank.

hope this is helpful.