Individual account plan administrators should consider amendments to their 401(k) and 403(b) plans and summary plan descriptions (SPDs) in order to implement two recent legislative and regulatory items. First, the Department of Labor recently released a final rule requiring plan administrators to provide participants and beneficiaries with certain investment fee and expense information. Plan SPDs will need to be amended in order to comply with these new requirements. Second, legislation was recently enacted authorizing 401(k) and 403(b) plans to allow in-plan Roth conversions. A plan amendment is required to authorize the conversions. The details of these new items are outlined below.
1. Department of Labor Releases Final Rule on Fee Disclosures in Individual Account Plans
On October 14, 2010, the Department of Labor released final regulations detailing new requirements for 403(b) and 401(k) plans that grant participants and beneficiaries the right to direct the investment of all or a portion of assets held in their individual accounts. Under these new regulations, plan fiduciaries must take steps to ensure that plan participants and beneficiaries are informed, on a regular and periodic basis, of plan investment options and related fees and expenses. The regulations permit plan administrators to rely upon information received from investment service providers in making the required disclosures.
These new regulations become effective on December 20, 2010, and will apply to 401(k) and 403(b) plans for plan years beginning on or after November 1, 2011. For most calendar-year plans, this means that the regulations will apply on January 1, 2012.
Plan-Related Information: The regulations specifically require plan administrators to automatically disclose to each participant or beneficiary (i) on or before the date that they can first direct their investments, (ii) annually thereafter, and (iii) upon any change in the disclosed information, certain plan-related information including, but not limited to the following:
- An explanation of the circumstances under which participants and beneficiaries may give investment instructions,
- An explanation of any specified limitations on such instructions, including any restrictions on transfer to or from a designated investment alternative (e.g., restrictions on the transfer of guaranteed investment contracts or company stock);
- An identification of any designated investment managers;
- A description of any "brokerage windows," "self-directed brokerage accounts," or similar plan arrangements that enable participants and beneficiaries to select investment options beyond those designated by the plan;
- A description of or reference to any plan provisions that relates to the exercise of voting, tender, and similar rights appurtenant to an investment in a designated investment alternative, (including any restrictions on such rights), and automatic provision of all materials relating thereto;
- An explanation of any general plan administrative fees and/or expenses for services (e.g., recordkeeping, legal, or accounting expenses) that may be charged by the plan sponsor against the individual accounts of participants or beneficiaries;
- An explanation of any fees and/or expenses for individual account services (e.g., fees for investment advice, plan loan or qualified domestic relations order (QDRO) fees, transfer fees, etc.) that may be charged against the individual accounts of participants or beneficiaries; and
- If applicable, a description of the basis on which such fees and expenses will be allocated to or affect the balance of each individual account (e.g., are the fees allocated on a pro rata or per capita basis?).
In addition, plan administrators must automatically provide participants and beneficiaries with a statement containing the following information on at least a quarterly basis. This information may be included in the quarterly benefit statement currently required under § 105 of ERISA:
- The dollar amount of any administrative or plan-wide fees and expenses that are actually charged during the preceding quarter to the participant's or beneficiary's account for the administrative and/or individual services outlined above;
- A description of the services to which such charges relate; and
- If applicable, an explanation that in addition to the specifically disclosed fees and expenses, some of the plan's administrative expenses were paid from the total annual operating expenses of one or more of the plan's designated investment alternatives (e.g., under a revenue sharing arrangement).
Investment-Related Information: In addition, the regulations require plan administrators to automatically disclose to each participant or beneficiary (i) on or before the date that they can first direct their investments, (ii) annually thereafter, and (iii) upon any change in the disclosed information, certain investment-related information including, but not limited to the following:
- Information on any designated investment alternatives offered under the plan, including the name and type of each investment option;
- For designated investment alternatives that do not have a fixed or stated rate of return (e.g., mutual funds, investment manager-created funds, life-cycle funds, collective investment trusts, separate insurance company accounts, etc.):
- performance data including the average annual total return for the investment for the most recent one-, five-, and ten-year periods;
- comparable benchmark information (from a named broad-based market index) for the most recent one-, five-, and ten-year periods; and
- the total annual operating expenses of the investment (which are automatically deducted from the investment return and not charged to the individual accounts) expressed both as a percentage (i.e., expense ratio) and as a dollar figure for each $1,000 invested;
- For designated investment alternatives that have a fixed or stated rate of return (e.g., guaranteed investment contracts, fixed annuities, etc.):
- the fixed or annual stated return of the investment; and
- the term of the investment;
- A description of any limitations or restrictions relating to a participant's ability to purchase, transfer, or withdraw from any investment option (e.g., round trip, equity wash, or other restrictions);
- Fee and expense information about each investment option, including a description of any shareholder-type fees (i.e., fees charged directly to a participant or beneficiary's account, such as commissions, sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees, and purchase fees that are not otherwise included in the total annual operating expenses of the investment);
- An internet web address sufficiently specific to provide participants with access to additional specified information about any designated investment alternatives; and
- A general glossary of terms to assist participants and beneficiaries in understanding the designated investment alternatives or an internet web address that will provide access to such a glossary.
The rule provides a model chart that may be used to provide the above-described investment return and expense information. If the model chart is used correctly, the regulations explain that the requirement to provide the information in a comparative format will also be met.
Finally, the regulations provide that certain additional investment-related information (e.g., prospectuses, financial statements, etc.) is to be provided to plan participants and beneficiaries upon request.
2. In-Plan Roth Account Conversions Allowed Under 401(k) and 403(b) Plans
On September 27, 2010, the President signed the Small Business Jobs Act (the "Act") into law. Effective immediately, the Act allows in-plan Roth conversions for 401(k) and 403(b) plans. Previously, plan participants could only effect a Roth account conversion by withdrawing amounts from their employer-sponsored plan and then rolling such amounts over into a Roth IRA. Beginning on January 1, 2011, the Act also authorizes governmental 457(f) plan sponsors to add designated Roth accounts to their plans and to allow in-plan Roth conversions.
In order to take advantage of the in-plan Roth conversion option, plan terms must be amended to authorize Roth salary deferrals (if the plan does not already authorize such deferrals) and to specifically authorize in-plan conversions. Conversions are only permitted upon distributable eligible rollover events (e.g., upon the termination of employment, a participant's reaching age 59-1/2, a participant's qualified disability, etc.). Furthermore, the conversion must otherwise meet all of the plan's written rollover requirements. Spousal beneficiaries are eligible for the conversion option as well.
There are several advantages to offering an in-plan Roth account conversion as opposed to requiring participants to take a distribution from their 401(k) or 403(b) account and then roll the amount over into a Roth IRA. Among other things, these include:
- Keeping more money in the employer-sponsored plan, which increases the likelihood of the participant's money remaining in the account for retirement and lowers investment fees for the plan sponsor as a result of economies of scale;
- Retaining ERISA fiduciary protection and oversight over funds held within the plan (as Roth IRAs are not subject to ERISA);
- Potentially increasing the range of investment options that exist (i.e., individual participants will not have access to the full range of plan-offered institutional investment options and will be restricted to retail investment options with respect to their IRA); and
- Lowering investment management fees for participants within the plan (as opposed to being charged retail fees for individual investments made within an IRA).
Plan participants are subject to tax on all pre-tax conversions rolled over or converted into a designated Roth account. However, under current special tax legislation participants may elect to have conversions to a Roth account made in 2010 be taxed 50% in 2011 and 50% in 2012. After 2010, amounts rolled over or converted to a Roth account or Roth IRA will be taxed in the year of the roll over or conversion. The 10% early distribution tax does not apply to Roth rollovers or conversion. Plan sponsors should carefully consider a plan amendment authorizing in-plan Roth conversions prior to December 31, 2010.