New Regs For Retirement Plans

Greater Hudson Valley Family Health Center Inc. had a “plain vanilla” 403(b) retirement plan for a long time. About a year ago the Newburgh, N.Y.-based medical services nonprofit decided to explore other options as part of a broad benefits overhaul aimed at stemming a high rate of executive turnover.

“We wanted to offer a better retirement plan, but we were wary of shifting regulations,” said Chief Financial Officer Patrick R. Murphy. The organization’s management spoke to its outside auditors who brought in an affiliate with compensation specialists who recommended a 457(b) plan and a 457(f) plan. “It was a complicated procedure because of the many tax and regulatory issues, but overall, we were very impressed with the way they worked with our board to explain the issues and to implement the new plans,” said Murphy.

The organization is exploring enhancements to deferred compensation plans with an outcome-based incentive rewards program. “We’re still examining the issues,” Murphy said. “If it’s feasible, it would be a valuable way to further attract and retain key employees,” he said.

Possible challenges by the Internal Revenue Service (IRS) and new rules being considered by at least one state could threaten existing executive compensation and deferred compensation plans. And, regulators are taking a closer look at so-called excess benefit transactions, or compensation to key employees and others that might be out of line with industry standards.

“There are recently enacted regulations and expected future regulations affecting benefit plans for rank-and-file employees and for highly paid executives,” said Harry Atlas, a Washington, D.C.-based partner in the Employee Benefits and Executive Compensation Group of the law firm Venable LLP. “For example, there are enhanced requirements affecting governance and fiduciary obligations for sponsors of rank-and-file retirement plans, primarily focusing on fees, including new fee-disclosure regulations that require plan sponsors to examine and understand fees and to inform participants about them.”

Atlas said, “there’s also a trend towards automatically enrolling employees in retirement plans, which makes it even more important for employers to select and monitor the default investment funds in their plans in a way that minimizes fiduciary risk,” although automatic enrollment is not the subject of recent regulatory changes.

“We’re likely to see more of that in the future, although employers are currently not required to offer auto-enrollment,” he said.

Changes are also coming to so-called top-hat plans, or plans aimed at highly compensated executives, such as 457(f) deferred compensation arrangements. The plan name refers to the section of the Internal Revenue Code that governs it. Under existing 457(f) regulations, deferred executive compensation is generally treated as taxable income to the recipient once the person is vested, even if they have not received the funds. But until recently, at least, nonprofits have tried to push the envelope through a variety of creative but arguably legal arrangements, such as “renegotiating” vesting dates as they draw near, and relying on post-employment noncompetition provisions to delay vesting.

“But although the IRS has said it will issue rules — that will likely restrict practices regarding vesting — the agency has not yet issued them,” Atlas explained. “Some nonprofits are somewhat frustrated about this, since they’re not sure how far they can go in designing plans in the absence of final guidance.”

During this period of flux, some nonprofits might consider staying with 457(b) top-hat plans, which offer more regulatory certainty. But 457(b) plans have relatively modest annual contribution limits, which do not apply to 457(f) plans.

While Section 457(b) and Section 457(f) plans continue to be attractive, the deferred funds in both are subject to creditor claims, warned Mark Schneiderman, a partner and director of the compensation and human resources practice at the Garden City, N.Y.-based firm CohnReznick Benefits Consultants LLC, an affiliated company of the accounting and advisory firm CohnReznick LLP.

“Nonprofit boards, and the executives who are covered by 457(b) and 457(f) plans, should be aware of this,” he said. “Their flexibility, as compared to other kinds of plans, is appealing, but there is a danger that they could be seized by creditors under certain situations like bankruptcy.”

When it comes to rank-and-file retirement plans, Schneiderman said that nonprofits used to favor 403(b) plans, which are similar to 401(k)s, except they are subject to fewer compliance requirements. Although 403(b) plans are a type of safe harbor in that they are presumed to meet non-discrimination standards with respect to employee contributions, a series of documentation and other regulations issued during the past few years have eroded their attractiveness, and 401(k)s are now favored by many nonprofits, according to Schneiderman.

“403(b)s used to be like the Wild West, but have recently come under more IRS and federal Department of Labor scrutiny,” he explained. “The Internal Revenue Service and the DOL have both recently issued new regulations that formalized documentation rules and compliance requirements. The increased oversight and employer compliance burden has caused more and more nonprofits to move towards using 401(k) plan rather than 403(b) plans and to fund their plans using either pooled mutual funds or group annuity contracts instead of individual annuity contracts.”

“The framework of regulations that not-for-profits face in sponsoring a retirement plan has become vastly more complex over the past decade,” according to Gina Gurgiolo, senior consultant with the Portland, Ore.-based consulting firm Multnomah Group. “Of course, the rules that face other types of plans aren’t getting less complex. The recently effective fee disclosure requirements affect all plans that are subject to the federal Employee Retirement Income Security Act, or ERISA, for example,” she said.

A typical plan structure for a nonprofit entity consists of a 403(b) plan, which might or might not be accompanied by a 401(a) and a 457(b) plan, she added.

“The 403(b) plan is typically used by not-for-profit employers as a vehicle for employee deferrals,” she explained. “Some not-for-profit employers, though, use a 401(k) plan for this purpose. Sometimes the employer contribution, if there is one, is made in the 403(b) or 401(k) plan; and sometimes it is made instead to a 401(a), which typically receives only employer and after-tax employee contributions. Most frequently, the 401(a) plan describes the employer-made contribution and assigns supplemental executive benefits often created through a 457(b) plan for highly compensated employees, she added.

No one should expect the complexity of retirement plan sponsorship to ease in the coming years, she added. “It’s best to expect continued change and to be ready for it,” Gurgiolo said.

Nonprofits should pay attention to the way they compensate key employees, added Schneiderman. “Compliance with excess benefit rules is a significant emerging issue for nonprofits,” he said. Nonprofits that take a few steps might be able to take advantage of a safe harbor, or presumption of reasonableness, he added.

“First, the compensation should be set by a board composed of the independent board of directors,” he counseled. “Then, the board should base its salary decisions on competitive market data that considers factors like geography and the size of the organization. Finally, the board should document its decision-making process on a contemporaneous basis, instead of doing so after the fact.”

At least one state has gone even further, he noted. “New York State issued proposed regulations that would prohibit state funded nonprofit and for-profit service providers from spending more than $199,000 per year on the compensation of directors and many other employees,” Schneiderman said. “The so-called Covered Executives include employees, directors, trustees, managing partners, or officers whose salary and benefits, in whole or in part, are administrative expenses rather than program expenses.”

So administrators are subject to the limits while service providers like doctors, nurses, teachers, aides appear to be exempt from the limits. Employees who are both administrators and service providers are subject to the limits on a pro-rata basis, he added. In light of this and other developments, Schneiderman said it’s important to periodically review plans.