By ESOPs, Benefits & Compensation

On behalf of the ESOPs, Benefits & Compensation team, we hope your Summer is off to a great start. In the time of family vacations and out-of-office replies, the pace of employee benefits changes—both large and small—remains steady. As always, please feel free to reach out to a member of our team with any questions on these (or any other) topics.
 
SECURE 2.0 Guidance Issued on Emergency Personal Expense Distributions
 
Continuing to work through the backlog of SECURE 2.0 guidance, the IRS has issued initial guidance on newly created retirement plan “emergency personal expense distributions.” These distribution types, created by SECURE 2.0, allow plan participants to withdraw relatively small amounts to meet unforeseen financial challenges. Largely following the statute and other familiar rules for similar distribution types, the IRS guidance confirms the following: 

• Personal expense distributions are subject to income tax but are not subject to the 10% early withdrawal penalty.
• They may be taken for reasons broader than the typical “hardship” distribution reasons. While the guidance does list certain items as examples, the list is not exclusive, and personal expense distributions may be for any type of unforeseeable or emergency financial reason.
• The employee may self-certify the existence of a personal emergency.
• Distributions are limited to one per year. However, if a participant takes a personal expense distribution, but does not re-contribute the amount distributed or make elective deferrals to the plan, they cannot take another personal expense distribution for three years.
• Distributions can be re-contributed to the plan within three years.
• The maximum amount of a personal expense distribution is $1,000 (and, in some cases, less).
• Plans are not required to offer these types of distributions to participants (i.e., a plan does not have to give participants this choice).

Plan sponsors should weigh the potential benefits and administrative costs of adding these (or any other new) distribution types, especially where the plan already allows hardship distributions or participant loans. Although beneficial in that these distributions are exempt from the 10% tax penalty (whereas hardship distributions are not) and do not have to be repaid (whereas loans do), the added administration of tracking distributions, re-contributions, three-year limitations and restrictions, and other matters, coupled with the small amounts available to begin with, may outweigh the potential advantages of offering them.
 
DOL Tries Again with Fiduciary Rules, with Limited Impact on Plan Sponsors
 
In the latest step of a long-running regulatory saga, the Department of Labor released final rules in late April governing the provision of fiduciary investment advice to retirement plans. If not sooner limited by pending litigation—as prior versions of the same rule have been—a portion of the new investment advice rules would take effect in September of 2024, and another portion in September of 2025.
 
Broadly, the new rules aim to expand the circumstances in which financial professionals who provide investment advice to retirement plans would be held to ERISA’s strict “fiduciary” standard, under which the financial professional would be required to act in the retirement plan investor’s best interest. The new rules—and their accompanying guidance—would require financial professionals to provide prudent recommendations, put the investor’s interest ahead of their own, make extensive disclosures about their recommendations, and abide by certain other administrative rules. The financial institutions employing the financial professionals would also have to impose extensive policies and procedures to avoid conflicts of interest and ensure compliance with the new rules. The new rules also cover certain types of financial professionals, and certain transactions, that currently are not subject to ERISA’s fiduciary rules.

While the impact on certain financial service providers will be significant, plan sponsors and employers will feel less of the burden, and even then, feel it mostly indirectly. For example, plan sponsors may receive additional or more extensive disclosures from their plan advisors regarding the advisor’s ERISA fiduciary status and obligations. Of course, plan sponsors and those responsible for operating employment-based retirement plans already have an obligation to understand and monitor their advisors’ and vendors’ services, but reading and understanding the disclosures and explanations will help sponsors show they are properly overseeing these relationships. Some vendors who may not be acting as ERISA fiduciaries now—and don’t want to be—may limit their service offerings to make sure they are not covered by the new rule. Others may simply be more cautious regarding the extent to which they—or their representatives or call centers—will communicate in a way that could be construed as ERISA-covered investment advice. Again, even if not impacted directly by the new rules, plan sponsors should make reasonable efforts to understand the capacity in which each of their vendors is—and is not—acting and what obligations they owe to the plan and its participants.
 
One helpful item for employers: The DOL made it clear that human resources or other internal employees who answer employees’ general questions about their employer’s retirement plan ordinarily are not fiduciaries under the new rules.  
 
Supreme Court Ruling Risks Upending Decades of IRS and DOL Guidance
 
A late-breaking Supreme Court decision—involving not ERISA, but whether Atlantic herring fishermen can be required to pay the cost of a federally required fishery management observer—could have ripple effects through the entire regulatory structure of ERISA and other federally regulated employee benefits.  In that case, the Supreme Court overruled a 40-year-old case called Chevron, which largely required federal courts to defer to federal agencies’ interpretations of the laws they enforced. In overruling Chevron, federal courts now have much more latitude in deciding whether to follow the regulations and other guidance of federal agencies—including the IRS and DOL—or whether to substitute the court’s own opinion.
 
While on the surface it has little relation to ERISA or employee benefits, the bottom line is that nearly all rules and regulations written by the IRS, DOL, and other governing agencies are no longer as reliable as they have been during the last several decades. This is because Congress, in writing complex benefits laws, often cannot describe every detailed nuance of a law in the legislation itself. As a result, an extraordinarily large portion of federal employee benefits law is written not directly by Congress, but by the federal agencies that implement, oversee, and enforce those laws. Judges will now have a freer hand to disregard these regulations in many instances.
 
While individual employers may not feel any desire to defy existing regulations, legal challenges by other employers, participants, or industry groups will impact them as well. Given the structure of the federal court system, this could result in different legal rules applying in different parts of the country—for example, an IRS regulation governing retirement plans may be upheld in one jurisdiction and struck down, revised, or rendered unenforceable in another. And the outcome can cut both ways—employers or industry groups may successfully overturn rules they feel are too burdensome, but employees or participants who feel that the federal statute provides more protection than an IRS or DOL regulation may challenge the regulation (on which the IRS or DOL has told employers they may rely) and expose employers to legal liability for falling short of the judge’s interpretation of the underlying federal statute.
 
It’s difficult to tell exactly how the dust will settle. Certainly, agencies will still write and enforce rules—and often courts will continue to agree with those rules—but it seems likely the decision will at least generate more courtroom challenges to long-established rules and practices.
 
Two Courts Reach Opposite Results on Use of Plan Forfeitures
 
Speaking of challenges to long-held practices reaching contradictory results, two initial decisions have been issued in lawsuits claiming plan sponsors inappropriately used 401(k) plan forfeitures to reduce their employer contributions instead of using the forfeitures to pay the plan’s administrative expenses, which it charged to plan participants.
 
As a reminder, several similar lawsuits were filed against large plan sponsors. Generally, the plan document allowed the employer to use forfeitures to either pay expenses of the plan or reduce employer contributions. Instead of using the forfeitures to pay plan expenses—expenses charged directly to participants’ accounts—the plan sponsor used the forfeitures to reduce its own contribution requirement. Although the plans at issue appear to allow forfeitures to be used for either reason (both of which are legally permissible), the lawsuits claim that the employer acted improperly by choosing to use the forfeitures to reduce its own contributions (instead of directly benefiting the participants).
 
Two early decisions in those cases were issued within a few weeks of each other, each in California, and each reaching the opposite outcome on the same legal question—one ruling that the claims could move forward because the plan sponsor had put its own interests ahead of those of the plan participants; the other dismissing the same claims as “a swing for the fences” that came up short. Other similar cases are still pending. While it’s probably too early for plans to change their practices based on these few decisions alone, the lawsuits are worth monitoring because they present a simple and discrete legal question and could prohibit a practice currently permitted by the IRS and DOL.

The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2024.