The IRS recently ruled that a 401(k) plan may require mandatory 401(k) contributions to be withheld from eligible employees. compensation, if the employer gives appropriate notice to its employees and the employees have an opportunity to "elect out" of the mandatory contributions.
In Revenue Ruling 98-30, the IRS determined that salary deferral contributions made to a plan that requires mandatory 3% salary deferral (401(k)) contributions from those eligible employees, who did not elect otherwise, would be valid elective contributions.
The plan discussed in the ruling required 3% minimum 401(k) contributions to be withheld from the compensation of all eligible employees, who did not elect otherwise. Employees were immediately eligible, upon hire, to make 401(k) contributions to the plan. Each eligible employee, at the time of hire and annually thereafter, was provided a notice explaining the mandatory 401(k) contributions requirement and was given the opportunity to elect not to make 401(k) contributions or to make 401(k) contributions at a different level, either higher or lower than 3%. An eligible employee could elect at any time not to make 401(k) contributions or to change his or her level of 401(k) contributions.
The focus of the IRS ruling is the employer's notice to its employees of the availability of the election to make or not make 401(k) contributions and the opportunity to make it within a reasonable period before the date on which the cash would be available to the employee.
The IRS also stated in the ruling that its conclusion would be the same if the plan imposed a length of service requirement before an employee became eligible to make 401(k) contributions. Therefore, the ruling is not limited to plans that offer immediate eligibility.
The use of an "elect out" feature in a 401(k) plan may be of interest to employers seeking to boost participation by employees. Since some employees do not participate in a 401(k) plan simply out of "inertia" (i.e., failing to take the time to enroll), some of the increased participation resulting from the mandatory 401(k) contributions may result in long term participation.
Common Issues
Two issues must be kept in mind regarding the mandatory, or "elect out," contributions. First, according to the Department of Labor, unless and until the employees who are making mandatory contributions affirmatively select investment funds, the plan fiduciaries will not receive ERISA Section 404(c) protection for participant direction of investments for the mandatory contribution participants. The plan administrator should strongly urge the participants with mandatory contributions to direct their plan account investments, if the plan fiduciaries rely on the fiduciary protection provided under ERISA Section 404(c).
Second, for California employers, and for employers in other states with similar laws, the requirement that certain withholdings from pay are allowed only with participant consent must be considered. The issue is whether mandatory 401(k) deductions from pay, without participant consent, are valid under such state laws. The Department of Labor, in an Advisory Opinion based on a similar state law in New York, opined that the law was preempted by ERISA. (DOL Op. Ltr. 94-27A, 7/14/94). Although it is likely that a similar result would be obtained if the California law were reviewed by the DOL, this will remain an unresolved issue until tested in court.
Tax Law Changes Require Plan Amendments
The Small Business Job Protection Act of 1996 ("SBJPA"), the Taxpayer Relief Act of 1997 ("TRA"), and the Uniformed Services Employment and Reemployment Rights Act ("USERRA") require amendments to be made to qualified retirement plans. The required amendments are more extensive for those plans that have 401(k) contributions and matching contributions. Defined benefit plans must be amended for changes required under the General Agreements on Tariff and Trade ("GATT").
The amendments involved include revising the definition of highly compensated employees, new ADP and ACP testing rules for 401(k) and matching contributions, small account distribution limits and changes to the age 70 minimum required distribution rules.
In most cases, the SBJPA, USERRA and GATT amendments must be completed no later than the last day of the first plan year that begins on or after January 1, 1999. For calendar year plans, therefore, the
current deadline for amendments generally is December 31, 1999.
TRA amendments should be made by the same date. TRA requires substantially fewer amendments than those required by SBJPA.
Generally, your plan will need to be completely restated if it has four or more amendments currently outstanding. If your plan has fewer than four amendments outstanding, the IRS should accept a freestanding amendment, and a complete plan restatement will not be required.
The Importance of Plan Language Permitting Plan Administrator to Use Discretion in Denying Benefits
An April 1998 opinion from the Ninth Circuit Court of Appeals, which has since been withdrawn for review by the full court, highlights the importance of carefully reviewing the terms of employee benefit plans and insurance policies for appropriate grants of discretion to the Plan Administrator. A denial of long-term disability benefits was subject to de novo review by the Court because the disability insurance policy at issue in that case did not state clearly that the satisfactory written proof of disability required under the policy was written proof satisfactory to the Plan Administrator. Rather than reviewing the Plan Administrator's decision to terminate the long-term disability benefits on an arbitrary and capricious abuse of discretion standard (that makes reversal of such decisions difficult), the Court reviewed the evidence on an objective, de novo standard. This means that the Court looked at the evidence as if it had not been reviewed before, giving no deference to the Plan Administrator's prior decision.
In Kearney v. Standard Insurance Company, Ninth Circuit, No. 96-16539, April 21, 1998, Mr. Kearney, a trial attorney, had a heart attack and bypass surgery. After paying long-term disability benefits for some time, Standard Insurance Company, which was both the insurer and the Plan Administrator, notified Mr. Kearney that the benefits would be terminated because he was able to return to his job. The policy stated that benefits would be paid upon "receipt of satisfactory written proof" that the covered person has become disabled while insured under the policy.
Both Mr. Kearney and Standard Insurance Company obtained determinations from various doctors as to Mr. Kearney's ability to return to work as a trial attorney. The Plan Administrator terminated the disability benefits even though the doctor appointed by the Plan Administrator recommended that the Plan Administrator obtain the results of certain tests, which could establish Mr. Kearney's disability.
The Ninth Circuit stated that a de novo review of the Plan Administrator's decision was required for two reasons. First, the policy language in question did not clearly grant to the Plan Administrator the discretion to determine whether the required "satisfactory written proof" was satisfactory. Second, as Standard Insurance Company was both the Plan Administrator and the source of benefits under the policy, it had a self-interest conflict in making its decision to terminate the long-term disability benefits.
The Ninth Circuit devoted a substantial portion of its decision to the reservation of discretion issue. It determined that in the absence of a clear reservation of discretion for the Plan Administrator to determine whether proof of disability was satisfactory, the written evidence presented must be analyzed on an objective, "reasonable person," standard. Based on this standard, the Court determined that Standard Insurance Company's decision was not reasonable.
In contrast, in a 1996 case, Snow v. Standard Insurance Company, 87 F.3d 327 (9th Cir. 1996), the Ninth Circuit held that the proper standard of review on the disability claim at issue was an "abuse of discretion" standard, under which the Court must give deference to the determination of Standard Insurance Company as the plan fiduciary. In Snow, the insurance contract at issue clearly stated that Standard must be presented with what it considered to be satisfactory written proof of the claimed loss. Therefore, the appropriate reservation of discretion to the fiduciary existed in Snow.
The Kearney case highlights once again the importance of the language in a plan document or an insurance policy in determining the deference a court may give to a Plan Administrator's decision. Plan and policy language should be carefully reviewed for proper reservation of discretion to the Plan Administrator, or other fiduciary, to make decisions and review evidence with respect to a plan.
The Ninth circuit announced in August that this opinion has been withdrawn and that the full bench of the U.S. Court of Appeals would rehear the Kearney case on the grounds that the insurer's conflict of interest may have clouded the denial of benefits.