Compliance Issues For Retirement Plan Trustees - Part I

Michael S. Melbinger is the lead partner and global head of Winston & Strawn's employee benefits and executive compensation practice group. He can be reached at (312) 558-7588.

Part II of this article appears in the August 2005 issue of The Metropolitan Corporate Counsel.

Congratulations! The financial services company for whom you work has made you responsible for its employee benefit trust business. The good news is that U.S. pension assets are estimated to be $5.5 trillion, and approximately 25 percent of all U.S. equities are held by pension plans. This is quite a responsibility. You can buy that new house now.

The bad news is that five separate federal agencies regulate employee benefit plans and trusts: the U.S. Department of Labor (DOL), the Internal Revenue Service (IRS), the U.S. Securities and Exchange Commission (SEC), the Pension Benefit Guaranty Corporation (PBGC), and the Office of the Comptroller of the Currency (OCC). One federal statute, the Employee Retirement Income Security Act of 1974 (ERISA), is devoted entirely to the regulation of employee benefit plans, trusts, and fiduciaries. (Did we mention that you may now be a fiduciary?) Significant portions of the Internal Revenue Code (Code) and several other federal statutes also apply to employee benefit plans. This is quite a responsibility. You better keep reading.

Compliance with the myriad federal statutes, regulations, and ever-evolving court decisions applicable to retirement benefits is a full-time job. Failure to comply with such authorities is costly because each of the relevant statutes imposes civil and criminal penalties potentially applicable against plan sponsors, administrators, and/or fiduciaries. ERISA also permits aggrieved plan participants to sue the plan and/or its fiduciaries for damages.

Although the complexity of the law and regulations governing employee benefit plans and trusts is burdensome, this complexity creates opportunities for employee benefit professionals. A professional who understands the intricacies of the law and regulations can do more than keep his or her clients out of trouble. This professional can assist the benefit plan client in achieving the following goals:

  • providing cost-efficient benefits to employees;

  • designing state-of-the-art benefit plans for employers;

  • providing benefits that attract, retain, and motivate employees;

  • receiving optimal investment performance on plan assets; and

  • ensuring the receipt of all the information to which the client is entitled and needs to satisfy the legal requirements applicable to the plan.

However, in addition to providing superior client service and innovative design ideas, a bank employee benefit professional also must protect the bank (or trust company) from fiduciary liability under the applicable law. Compliance with the law is a key aspect of providing protection. Anticipating problems and spotting issues that could lead to future problems, however, may distinguish the outstanding trust professional from one who is merely competent.

Each year brings more laws from Congress; more pronouncements, regulations, and rulings from the IRS, the DOL, the OCC, and other agencies; and more significant new cases from the federal courts. These developments make the professional's life more difficult. This article will describe the laws that relate to employee benefit trusts and the federal agencies that administer the laws.

ERISA And The U.S. Department Of Labor

The DOL has the primary authority to enforce the requirements of ERISA. The express purpose of the U.S. Congress in passing ERISA was to protect the interests of participants and beneficiaries in employee benefit plans. Accordingly, ERISA imposes a variety of specific duties and responsibilities on entities and individuals who are fiduciaries with respect to an employee benefit plan.

Fiduciary Duties. ERISA Section 404 requires that a fiduciary discharge its duties with respect to a plan:

  • solely in the interests of participants and beneficiaries;

  • for the exclusive purpose of providing benefits to participants and beneficiaries and defraying the reasonable expenses of administering the plan;

  • with the care, skill, prudence, and diligence under the circumstances then prevailing of a prudent person expert in such matters; and

  • in accordance with the plan documents, insofar as such documents are consistent with ERISA.

If a fiduciary fails to meet ERISA's standard of conduct, the fiduciary is personally liable for any losses resulting from the breach of fiduciary duty. ERISA permits the DOL, the plan administrator, and participants or their beneficiaries to bring an action against the fiduciary. Civil and criminal penalties also may apply.


Who Can Sue: Four types of persons may sue under ERISA: plan participants, plan beneficiaries, plan fiduciaries, and the DOL. ERISA Section 502 provides that such persons may bring the following types of lawsuits:

  • claims related to benefits;

  • claims for breach of fiduciary duty;

  • suits based on violations of ERISA's reporting and disclosure requirements; and

  • suits by the DOL to recover penalties for prohibited transactions and breach of fiduciary duties and to enforce other provisions of ERISA.

ERISA also authorizes participants, beneficiaries, and fiduciaries to bring actions to (i) enjoin any act or practice that violates ERISA or the terms of a plan, or (ii) obtain "other appropriate equitable relief" to redress such violations or enforce ERISA or the terms of a plan. Participants may bring claims based on promissory estoppel (e.g., wrong information in a summary plan description) under this section. The Supreme Court has held that plan participants and beneficiaries can bring claims under ERISA on behalf of themselves for individual relief (as opposed to bringing a claim for the plan).

Retaliation. ERISA also prohibits taking discriminatory or adverse actions against a participant or beneficiary for exercising rights to which he or she is entitled under an ERISA plan and interfering with the attainment of rights protected by ERISA.

Prohibited Transactions. ERISA prohibits a fiduciary from entering into a transaction that it knows or should know is a direct or indirect transaction with a party in interest. ERISA also prohibits a fiduciary from dealing with plan assets for its own benefit or where it has a conflict of interest. Examples of the types of prohibited transactions that have led to litigation with the DOL or the IRS include the following:

  • purchases or sales of assets to related parties;

  • loans or extensions of credit to related parties;

  • directing business to a related party;

  • paying excessive compensation to a fiduciary or related party;

  • the use, transfer, or commingling of plan assets by a fiduciary;

  • transactions in which the fiduciary is on both sides; and

  • the acquisition of employer securities or real property in excess of allowable limits.

The Internal Revenue Code And The IRS

If a retirement plan satisfies the various "qualification" requirements of the Code, it is "qualified" for favorable tax treatment. The Code provides the following favorable tax treatments to qualified plans:

  • The employer's contributions to the plan are immediately deductible.

  • Employees can make before-tax contributions to the plan.

  • Employer and employee contributions allocated to an employee's plan account are not taxable to the employee.

  • Employer and employee contributions accumulate investment earnings in a fully tax-exempt trust.

  • Plan distributions may be eligible for rollover and net realized appreciation treatment for employer securities, thereby further deferring taxation.

  • Benefits are not counted toward determining "excess parachute payments" under code Section 280 G.

IRS Filings. Retirement plan sponsors must file their plans with the IRS for a favorable determination that the plans meet the qualification requirements of the Code. The plan sponsor must make other filings with the IRS to (i) request a favorable determination upon termination of a retirement plan, (ii) request the approval of a change in a plan or trust year, or (iii) notify the IRS in advance of certain mergers, consolidations, or transfers of plan assets or liabilities. Additionally, the retirement plan trustee or other "payors" of designated distributions, including all distributions from qualified retirement plans, P.S. 58 costs, death benefit payments, and distributions from nonqualified retirement plans to beneficiaries of deceased employees, must file Form 1099-R with the IRS.

Reporting Requirements. The Code requires plan administrators to file Annual Report Form 5500 with respect to any retirement and welfare benefit plans. Although banks seldom act as plan administrators with respect to employee benefit plans, the reporting and disclosure requirements generally are relevant to banks in the following respects:

  • Banks are required to provide part of the information necessary for the plan administrator to prepare the required governmental filings.

  • When the bank is the payor of benefit plan amounts, certain reporting responsibilities apply to it directly.

  • Certain information provided in participant disclosures may relate to the bank's role as trustee or investment provider with respect to the plan.

Required Forms of Distribution. The Code mandates specific forms of distribution for defined benefit pension plans and some individual account plans. We sometimes call these mandated forms the "normal form of benefit" under the plans. Most individual account (or defined contribution) plans provide for distribution in a single lump sum. However, the normal form of benefit under a defined benefit (or money purchase) pension plan must be

  • a joint and 50 percent survivor annuity (for a participant who is married at the time his or her benefits are to commence); or

  • a fixed annuity for life (for an unmarried participant).

Other optional forms may be available to the participant, such as a single-life annuity or even a lump sum. However, a married participant may elect such optional forms only with the written consent of his or her spouse.

Consent for Distributions Exceeding $5,000. A retirement plan (or a plan administrator) cannot make (or force) a distribution to a participant prior to age 62 (or the normal retirement age set forth in the plan, if later) if the participant's account balance or accrued benefit has a present value exceeding $5,000. The participant's consent must be in writing. Additionally, automatic distributions in excess of $1,000 must be paid directly to an IRA, if the plan participant fails to direct otherwise. After the participant has attained normal retirement age, the consent requirements no longer apply.

Withholding Requirements Applicable to Distributions. Code Section 3405 requires withholding for federal income taxes at a 20 percent flat rate for any distribution of more than $200, if the distribution is an "eligible rollover distribution" and the participant does not directly roll over to an IRA or another employer plan. Distributions that are not eligible for rollover remain subject to elective withholding (i.e., the payee may "elect out" of withholding).


The plan administrator of a qualified retirement plan is generally responsible for the withholding of federal income tax from a designated distribution and for payment of the withheld tax. The plan administrator may be relieved of liability for federal income tax withholding if it transfers this responsibility to the payor. To transfer the liability, the plan administrator must direct the payor to withhold federal income taxes and give the payor the information necessary to correctly compute the withholding tax liability. The plan administrator must explicitly inform the payor of the information that would be reportable on the Form W-2P or 1099-R or that such information is not applicable to a particular participant, payee, or distribution.

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