How to prepare for the annual review of your employee retirement plan

This article appeared in the Journal of Accountancy on November 1, 2017.

Many business owners believe their work is done once they establish an employee retirement plan. They don’t realize how important it is to review the plan annually and reduce any risk of errors, misunderstandings, or breaches of fiduciary duty.

Many employers are unaware of the fact that they as individuals are a fiduciary of their retirement plan and, therefore, are exposed to liability. A 2014 AB Global survey of about 1,000 defined contribution plan sponsors found this was the case for more than one-third of the respondents. The confusion was worse among the sponsors of very small plans (those with less than $1 million in assets), with nearly 50% of the respondents saying they were unaware of their fiduciary role.

The survey highlights the need for business owners, especially small business owners, to take the time to understand their role in the retirement plan hierarchy. They should also review their plans to make sure they are aware of plan features, offerings, fees, and performance, as well as ensuring that all administrators and advisers they hire are providing the agreed-upon services.

A 2015 MassMutual Retirement Services survey of employers sponsoring retirement plans found that most respondents are not regularly reviewing their retirement plans. Of the 565 survey respondents, 57% expressed interest in reviewing their plans with the assistance of their plan adviser at least twice a year, but only 44% do. Only about 25% of the respondents said they review the total amount their employees are saving for retirement to determine if it appears to be accurate and/or adequate.

A good starting point for a review is the plan documents. The retirement plan document (RPD) and the summary plan description (SPD), which is the “plain language” version of the RPD, contain all the necessary information about the plan. They include such items as plan participation eligibility, vesting requirements, compensation components, and investment and disbursement options upon retirement. The business owner should be familiar with its provisions and should ensure that the plan is updated when necessary. Both mandatory (e.g., legislative changes) and discretionary (owner/administrator) revisions to the plan must be reflected in the plan documents.

Just as employers schedule annual employee reviews to discuss goals, evaluate performance, and address any concerns, they should schedule an annual employee retirement plan review to ensure that the plan complies with IRS and Employee Retirement Income Security Act (ERISA) regulations, as well as with the plan documents.

A review also provides the opportunity to evaluate investment performance, reasonableness of fees, and accuracy of compensation calculations and employee data.

If this seems like a great deal of work, it is. That’s why it is common for business owners to employ the services of professionals to assist with the administration and maintenance of their plan. Owners may employ a third-party administrator, a recordkeeper, a financial adviser, a custodian, or an investment manager. The key is to understand the roles and responsibilities of all involved, including the role of the owners themselves, and any potential liability.

The U.S. Department of Labor (DOL) simplifies the process of identifying plan fiduciaries and their responsibilities in its publication Meeting Your Fiduciary Responsibilities, by indicating that anyone “exercising discretion or control over the [retirement] plan” is a fiduciary. Therefore, the act of hiring a plan administrator or custodian makes a business owner a fiduciary.

Since fiduciaries act on behalf of the plan’s participants, it is expected that they observe plan requirements and make decisions that are in the participants’ best financial interest. This responsibility comes with potential liability, as the DOL cautions: “Fiduciaries who do not follow the basic [ERISA] standards of conduct may be personally liable to restore any losses to the plan, or to restore any profits made through improper use of the plan’s assets resulting from their actions.”

Effective performance by plan fiduciaries is essential to the retirement plan’s success. On behalf of plan participants and their beneficiaries, they ensure that selected investments meet plan requirements and that associated fees are reasonable. Most importantly, fiduciaries are legally required to carry out their duties with prudence (see ERISA’s “prudent man standard of care,” ERISA §404(a), 29 U.S.C. §1104(a)). Failure to do so is considered a breach of duty. Such breaches have been the subject of several lawsuits.

In Peabody v. Davis, 636 F.3d 368 (7th Cir. 2011), an employee sued plan trustees for breach of fiduciary duty because plan funds were invested in company stock that steadily declined in value for five consecutive years. The court held in the employee’s favor, citing the trustees’ lack of prudent behavior. The case of Tibble v. Edison International, 135 S. Ct. 1823 (2015), takes the obligation of the fiduciary a step further. The Supreme Court held that plan fiduciaries are not only obligated to select proper investments, they also have an ongoing duty to monitor the performance of those investments.

To adhere to ERISA retirement plan disclosure requirements (29 C.F.R. §2520.104b-1), any time a plan is modified, both the RPD and the SPD must be updated, and employees must be made aware of the update. An updated SPD or, at a minimum, a summary of material modification (SMM) must be provided to plan participants no more than 210 days after the end of the plan year the change was made.

Updates must be provided to employees in plain language so that they are readily understood. In Amara v. CIGNA Corp., 534 F. Supp. 2d 288 (D. Conn. 2008), aff’d, 348 Fed. Appx. 627 (2d Cir. 2009), vacated and remanded on other grounds, 131 S. Ct. 1866 (2011), CIGNA employees challenged their employer’s modification of their retirement plan from a defined benefit plan to a cash balance plan. They claimed that this discretionary modification was not clearly explained in the updated SPD distributed to the employees and that the new plan provided them with less generous benefits. The court ruled in favor of CIGNA’s employees, holding that the descriptions of the plan modifications were incomplete and misleading.

The IRS defines compensation as “any payment made by an employer to an employee for services rendered in the course of the employer’s business.” But in retirement planning, different definitions of compensation are used for different purposes. For example, the compensation definition used to calculate contributions might be different from the one used to ensure compliance with nondiscrimination requirements. Also, no standard formula exists outside of basic earned income to identify which payroll items must be included as compensation for the purpose of calculating retirement benefits. The employer has the option of including or excluding items such as bonuses, commissions, overtime pay, and stock options for certain plan purposes, such as when calculating deferrals or employer matching contributions. Therefore, the IRS recommends that contributions be made based on the correct definition of compensation.

A failure to update or clarify compensation definitions can result in misunderstandings about expected dollar amounts of retirement benefits.

Plan documents must be clear about the monetary distribution options that employees may choose upon retirement. For example, a retiree may choose the payout option of a single life annuity, which means that his benefits will cease when he dies. If he wants his beneficiary to continue to collect a benefit upon his death, he may select a joint and survivor option, which will reduce the monthly benefit received. Another option might be a lump-sum distribution.

Employers must ensure plan participants provide the name and contact information of their designated beneficiaries and remind them to report any changes in beneficiary, perhaps resulting from divorce or death.

Employers should encourage employees to also review their plans annually. Employees should review their investment choices and performance, contact information, birthdate, hire date, selected plan options, marital status, and beneficiaries. Since it is common for plan participants to change employers, current contact information is necessary to enable employers to provide former employees with the benefits they are entitled to. ERISA requires all fiduciaries to take reasonable actions to locate former plan participants, but employees can facilitate this process by providing necessary updates.

A retirement plan review has several facets. This article is not meant to serve as a comprehensive guide, but rather to highlight the importance of a review. The retirement plan documents are a good starting point. The IRS also provides checklists, with links to Fix-It Guides. Of course, business owners can employ others to review their plans, but it is recommended that they be involved in the process, since they are probably plan fiduciaries. Lastly, owners should meet with all individuals with decision-making responsibilities for the retirement plan to discuss plan updates and compliance, review investment selections/performance, determine the impact of regulatory updates, and address participant issues or pending litigation.

About the author
Cynthia Scarinci ([email protected]) is an associate accounting professor at the College of Staten Island’s School of Business and serves on the board of directors of the New York State Society of CPAs.