erisa pension plan overpayments: navigating conflicting...
TRANSCRIPT
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Presenting a live 90-minute webinar with interactive Q&A
ERISA Pension Plan Overpayments:
Navigating Conflicting Fiduciary
Obligations and IRS Guidance Preventing or Uncovering Errors Before Distribution,
Restoring Losses and Protecting the Plan's Tax Qualification
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
WEDNESDAY, JULY 8, 2015
Carol Buckmann, Counsel, Osler Hoskin & Harcourt, New York
Arthur A. Marrapese, III, Partner, Employee Benefits Practice Leader, Hodgson Russ,
Buffalo, N.Y.
William H. Woolston, Esq., Covington & Burling, Washington, D.C.
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Overpayments from Qualified Plans
William Woolston
6
Recordkeeping errors (“black box” calculator problems)
Data input mistakes (“fat finger” errors)
Source data errors
Legacy plans, employees, and benefit calculations
Side effect of mergers, acquisitions, and divestitures
Miscommunication between plan administrators, recordkeepers,
and trustees
Diverting from plan document terms (“we’ve always done it this
way”)
How Do Overpayments Happen?
7
Internal control audits
HR or plan administration audits
Corporate audits
Plan service provider audits
Recordkeeper accuracy audits by recordkeeper and company
Trustee audits
Benefit claim process
Analysis of claims can reveal previously unknown errors
Legal compliance reviews
Law Department or outside counsel uncovers discrepancies between plan document, administrative practice, recordkeeping manuals
Government agency audits
Discovery more common in IRS audits, but can happen in DOL audits
Discovering Overpayments
8
Plan qualification jeopardized by overpayments
Tax-qualified plans must be operated in accordance with their
terms
Overpayments mean a participant or beneficiary has received
more than provided for under the terms of the plan
IRS categorizes overpayments as an “operational failure” (i.e., a
failure to operate the plan in accordance with its terms)
If uncorrected, overpayment could result in disqualification
Fewer assets remain in the plan to pay benefits of other
participants and beneficiaries
Litigation
Ineligible rollover distributions
Consequences of Overpayments
9
Overpayments are “operational failures” eligible for correction
under the IRS’s Employee Plans Compliance Resolution System
(“EPCRS”)
EPCRS offers two voluntary programs for correcting overpayments:
Self-Correction Program (or “SCP”)
Voluntary Correction Program (or “VCP”)
Methodology for correcting overpayments is similar irrespective of
which program is used, but VCP has a few significant advantages
over SCP
Correcting Overpayments under IRS Guidance
10
SCP allows plan sponsors to correct overpayments without IRS
involvement
SCP is not available in all cases
Availability hinges upon whether the operational failure is
“significant” or “insignificant”
If the failure is “significant” it can be self-corrected only if the
correction is completed by the last day of the second plan year
following the plan year for which the error occurred
If the failure is “insignificant” it can be self-corrected at any time;
however, whether or not a failure is insignificant is a facts and
circumstances analysis
Self-Correction Program Highlights
11
• IRS does not provide a bright-line “significance” test; factors include:
• Whether other errors occurred during the same period • Multiple errors are aggregated to determine significance
• Percentage of plan assets and contributions involved
• Number of years the error occurred
• Number of participants affected relative to total number of participants
• Number of participants affected as a result of the failure relative to the number of participants who could have been affected by the failure
• Whether correction was made within a reasonable time after discovery
• Reason for the errors (for example, data errors)
• IRS provides example of error affecting 6% of a plan population as insignificant and an error affecting 36% as significant
Self-Correction Program Highlights
12
IRS offers plan sponsors the ability to self-report operational
failures to the IRS and ask the IRS’s blessing on corrections
To access this program, IRS charges a fee that is graded based on
how many participants are in the plan
If the IRS approves the application, a “compliance statement” is
issued that effectively precludes the IRS from later raising the error
as a qualification failure
Protection of compliance statement is contingent upon
completing the corrections
VCP is generally available to all plan sponsors, unless the plan is
under IRS investigation (e.g., subject to open IRS audit)
VCP has another distinct advantage over SCP: The ability to
obtain IRS approval for retroactive plan amendments
Voluntary Correction Program Highlights
13
Key principle of EPCRS is to put the plan and the participant in the
circumstances they would have been had the failure not occurred.
Rev. Proc. 2013-12 § 6.01(1)
EPCRS provides a general framework for correcting overpayments
Plan sponsors have several options available for correcting the
qualification failure related to the overpayment, each with its own
costs and benefits
Recoupment (with or without sponsor restorative contributions)
Default approach under EPCRS
Sponsor restorative contributions and no recoupment
New guidance from IRS “clarifies” that this approach is available
Plan amendment that sanitizes past overpayments by
retroactively making the overpayment amount a plan benefit
Attractive but available only in VCP
Correcting Overpayments: What Are My Options?
14
For many years, IRS guidance has suggested that plans are
obligated to try to recoup overpayments from participants
Under the IRS’s default approach, a plan takes the following steps:
If overpayment is related to ongoing distributions (i.e., annuities
or installments), future payments are reduced to correct amount
The plan must notify the participant the overpayment portion was
not eligible for tax advantages (i.e., tax-free rollover)
Plan is “made whole” for past overpayment(s) by a combination
of recoupment and restorative contributions by the sponsor
The amount owed to the plan is equal to the cumulative overpayment(s), plus
interest at the plan’s “earnings rate” (i.e., the rate of return on plan assets for
the period between the payment date and the correction date)
Recoupment: IRS Default Approach for Correction
15
Plans can offer participants the choice of repaying the overpayment
in a lump sum or installments, or by reducing future payments
The amount recoverable from the recipient is equal to the
cumulative overpayment(s) plus interest at the rate used under
the plan for actuarial equivalence purposes
This amount can differ markedly from the amount owed to the plan
If the overpayment was rolled over into an IRA or another
employer’s plan, the recipient must unwind the rollover to avoid
negative tax consequences
If the plan is unable to recoup the full interest-adjusted
overpayment from the recipient, or if the amount recouped is less
than the amount owed to the plan, the plan sponsor “or another
person” must contribute the difference to the plan
Recoupment: IRS Default Approach for Correction
16
In 2015, IRS issued Rev. Proc. 2015-27, which “clarifies” that
seeking recoupment of overpayments is not required
Instead, plan sponsors may decide to skip recoupment and make a
contribution to the plan that will make it whole
This option could be attractive for plan sponsors, but concerns
remain:
If the recipient rolled the overpayment over into an IRA and does not unwind
the rollover, the recipient could be subject to excise taxes under Code § 4973
Administrative burdens associated with making small, off-cycle plan
contributions
Windfalls to recipients
Litigation exposure for plans that decide to recoup
Guidance also reminds plan sponsors that overpayments may be
corrected by retroactive amendment
IRS Clarifies: Recoupment Not Mandatory
17
Retroactive plan amendments can be used to effectively “erase” the operational failure
Option is available only in VCP
Plan amendment provides for an increase in the benefit payable to the recipient retroactive to the annuity starting date
Result is that the plan is treated as if it always provided the recipient with a benefit that includes the overpayment
Because the plan is treated as if the overpayment was always part of the benefit, there are no rollover problems
Retroactive plan amendments are an attractive option for many plan sponsors, but there are considerations:
Costs associated with VCP filings (filing, legal, and actuarial fees)
May not be efficient to submit a VCP filing for every overpayment
Takes time to resolve VCP filings
Nondiscrimination testing
Windfalls to recipients
Retroactive Plan Amendments and Overpayments
18
EPCRS also requires plans to make changes to administrative
practices to ensure failures do not recur
What can plan sponsors and administrators do?
Regular internal control audits
Regular audits of recordkeepers
Careful implementation of new recordkeeping systems
Diligent change order process
Legal compliance review (periodic and when system changes are
made or proposed)
Preventing Future Overpayments
19
Contact:
William Woolston
Covington & Burling LLP
(202) 662-5844
U.S. Tax (IRS Circular 230):
Any U.S. tax or other legal advice in this communication (including in
any attachment) is not intended and is not written to be used, and it
cannot be used, by any person to (i) avoid penalties under U.S.
federal, state or local tax law, or (ii) promote, market or recommend
to any person any transaction or matter addressed herein.
More Questions?
ERISA Pension Plan Overpayments:
Navigating Conflicting Fiduciary Obligations
and IRS Guidance
By Arthur A. Marrapese, III
Strafford Webinar Presentation July 8, 2015
DEPARTMENT OF LABOR GUIDANCE
The prudent person rule requires a fiduciary to attempt to collect an
overpayment from the participant or beneficiary.
The hardship of a participant or beneficiary resulting from a recovery attempt, or
the cost of collection efforts may be such that it would be prudent for the plan
not to seek recovery.
A plan may be able to secure an award of attorney’s fees where a participant or
beneficiary acts in bad faith. North American Coal Corp. Retirement Savings
Plan v. Roth, 33 EBC 2214 (D.N.Dak. June, 2004).
Advisory Opinions 77-07, 77-08, 77-32A, 77-33, 77-34
21
DEPARTMENT OF LABOR GUIDANCE
If the plan is able to recover the full amount from another person (e.g., the employer, fiduciary, or negligent service provider) the plan need not consider recoupment of the overpayment.
It may be prudent for the plan that made the overpayment to recoup on a time payment basis.
It may be prudent to reduce future benefit payments, in accordance with the provisions of the plan, if other reasonable attempts to collect the erroneous amount have failed.
Terminating a participant’s or beneficiary’s eligibility for benefits under the plan to which the money is owed (or any other plan) until the full amount is repaid would likely violate the exclusive benefit and prudent person rules.
Advisory Opinions 77-07, 77-08, 77-32A, 77-33, 77-34 (cont.)
22
Litigation Issues- Plan Fiduciary and Participant Suits
Carol Buckmann
Overview of Issues
24
Is there a statute of limitations on these claims? If so, what is it? Do ERISA’s 3 year or 6 year limitations periods apply? U.S. Supreme Court in Tibble v. Edison found limitations
period began to run each time allegedly imprudent fund was not replaced.
135 S. Ct. 1823 (2015) This does not necessarily mean that all past
overpayments can be recovered. May be limited to overpayments made during the limitations period.
Must the participant exhaust claims and appeals procedures before challenging benefit reductions?
Can the plan charge interest? Has the plan document reserved the right to reduce
payments to correct overpayments?
Overview of Issues (Cont’d)
25
Has the SPD or benefit statement reserved the right to reduce payments to correct overpayments?
Is a deferential Firestone standard of review available?
What about state law claims, such as for fraud or fraudulent misrepresentation?
ERISA pre-emption
Issues for Fiduciaries Considering Lawsuits to Recover Past Overpayments
26
Is this an isolated mistake or was there a calculation error affecting many retirees?
Can retirees appeal? In 2014, a federal court found that Blue Cross Blue Shield’s recoupment practices failed to comply with ERISA’s notice and appeal requirements and permanently enjoined them. See 2014 WL 1276585 (N.D. III. Mar. 28, 2014)
Does the plan sponsor want to make up for the losses due to overpayments?
Would suit against the retiree be futile? Can the plan be amended to allow overpayments to
continue? Extent to which retiree hardship may be considered. Ability to enter into settlement Venue
Earlier Cases Recognized Right to Recoup
27
Prior to CIGNA, many courts treated mistakes in
benefit payments as correctible recordkeeping errors rather than fiduciary breaches.
See, e.g., Stark v. Mars, 2012 WL 2918410 (S.D. Ohio, July 17, 2012), finding no fiduciary breach for call center mistake based on computer error
In Johnson v. Retirement Program Plan, 2007 WL 649280 (E.D. Tenn, 2007), the court held that a plan subject to ERISA could legally recoup overpayments made to a retiree.
See also, e.g., Wells v. United States Steel & Carnegie Pension Fund, 950 F.2d 125 (6th Cir. 1991)
Also recognized that recoupment may be unavailable under general equity principles if it results in hardship
CIGNA v. AMARA Expands Available Participant Challenges to Recoupment
28
The U.S. Supreme Court stated that traditional equitable remedies are available to participants for fiduciary breach in a claim under Section 502(a)(3) of ERISA (11 U.S.C. Section 1132(a)(3)):
Reformation Estoppel Surcharge
131 S. Ct. 1866 (2011) These claims are being asserted offensively in suits
brought by participants to keep their overpayments, not just as defenses in suits brought by plan sponsors.
CIGNA v. AMARA Expands Available Participant Challenges to Recoupment (Cont’d)
29
Reformation remedy was applied on remand in CIGNA. See the Second Circuit Court of Appeals decision at 775 F.3d 510 (2014), affirming the lower court decision that communications fraudulently misrepresented the plan provisions. Reformation gave participants the higher benefit they thought they were entitled to.
CIGNA v. Amara-Estoppel and Reformation
30
After CIGNA, plaintiff’s lawyers will seek to characterize all overpayments as fiduciary breaches
Plaintiffs in pay status may try to enjoin the plan from reducing benefits on estoppel grounds.
Estoppel traditionally requires detrimental reliance Gabriel v. Alaska Elec. Pension Plan Gabriel never qualified for a vested benefit, but sued for
equitable relief to keep his pension 755 F. 3d 647 (9th Cir. 2014) Estoppel and reformation are not available. The Ninth
Circuit will not apply estoppel when relief would be contrary to clear written plan provisions to preserve actuarial soundness of plans. Remanded for a determination whether surcharge applied.
CIGNA v. Amara-Estoppel and Reformation (Cont’d)
31
Paul v. Detroit Edison Company (2015 U.S. Dist. LEXIS 40061,E.D. Mich, March 2015)
District court decision in which plan sponsor was estopped from correcting pension. Plaintiff repeatedly asked for confirmation that his calculation was correct. Court found that the calculation was so complicated, the retiree could not do the calculation himself.
Can the participant raise the equitable defense of laches?
Laches traditionally required prior knowledge
CIGNA v. AMARA-What About Surcharge?
32
Surcharge remedy is also sought to get fiduciary to contribute to fund to make up losses (extra payments)
Does not traditionally require detrimental reliance. Remand in Gabriel to determine whether
surcharge is available was due to intervening CIGNA v. Amara decision, though decision does not make it seem likely Gabriel will prevail.
Surcharge was traditionally used to require fiduciaries to disgorge profits from their breaches
Not obviously applicable to overpayments where fiduciary did not benefit, but being actively pursued by plaintiff’s counsel.
What About Benefit Estimates?
33
Estimates may be provided years before payments commence, so no recoupment or surcharge may be available.
Benefit statements usually have a statement that future corrections may be made
Recent decision by Court of Appeals for the 7th Circuit re: estimates, Reilly v. Continental Casualty Company, 785 F.3d 261 (2015)
Dealt with a deferred vested participant seeking to rely on estimate given at termination of employment
Court found that plan sponsor didn’t adequately explain the adjustment, but that Reilly nevertheless had to put forth an alternative calculation to prevail.
Couldn’t prevail simply due to sponsor missteps No estoppel claim was raised-what would be
detrimental reliance?
Special Considerations for Public Plans
34
May have their own procedures to be followed before adjusting benefits
In at least one case, participants successfully argued in a class action that state wage withholding law requiring consent had been violated when Portland tried to recoup overpayments from Fire & Police Retirement Fund . See City of Portland, July 26, 2012
Portland settled for 60% of the overpayments, to be recouped from future COLA adjustments and paid plaintiffs’ legal costs.
Settlement was approved by IRS in a VCP compliance statement available online at www. portlandoregon.gov/fpdr/article/454677
Probably no ERISA pre-emption Need to consult statutes and state constitution An act of the legislature may be required to amend plans SS Admin and FERS can take equitable considerations and hardships into
account in determining whether to correct overpayments. Under 5 U.S.C. Section 8470, FERS recovery may not be made if “the
individual is without fault and recovery would be against equity and good conscience.” Under FERS regulations, financial hardship may be taken into account, such as when the beneficiary needs income to meet ordinary living expenses.
Under 42 U.S.C. Section 404(b), Commissioner of the SSA may also take into account physical, mental, educational or linguistic limitations of the recipient
On the Horizon
35
U.S. Supreme Court has granted cert in Montanile v. Board of Trustees, 135 S. Ct. 1700 (2015)
11th Circuit decision is unpublished-593 Fed. Appx. 903, 2014 U.S. App. LEXIS 22438 (2015)
Deals with a welfare (disability) plan, but will impact all ERISA plan recovery claims
Must there be identifiable tracing of assets to a specific sum of money that would be subject of equitable recovery in order for plan to prevail?
Lower courts said plan could impose an equitable lien on tort settlement proceeds even if those monies had been spent.
Will procedures used by SS Administration, FERS or the PBGC be a model for new legislation or regulation dealing with pension overpayments?
Another possible model: PBGC does not demand interest
More Questions?
Contact: Carol Buckmann, Osler, Hoskin & Harcourt LLP
[email protected] 212.991.2581
U.S. Tax (IRS Circular 230):
Any U.S. tax or other legal advice in this communication (including in any attachment) is not intended and is not written to be used, and it cannot be used, by any person to (i) avoid penalties under U.S. federal, state or local tax law, or (ii) promote, market or recommend to any person any transaction or matter addressed herein.
36
ERISA Pension Plan Overpayments:
Navigating Conflicting Fiduciary Obligations
and IRS Guidance
By Arthur A. Marrapese, III
Strafford Webinar Presentation July 8, 2015
EMPLOYER TAX ISSUES
Is the contribution a nonelective contribution or restorative contribution?
A contribution is “restorative” if:
the contribution restores losses resulting from a fiduciary breach for
which there is a reasonable risk of liability; and
similarly situated participants are treated in a uniform fashion.
Nature of Corrective Contribution
38
EMPLOYER TAX ISSUES
If the contribution exceeds the amount of the loss, the excess would be treated
as a nonelective employer contribution.
In virtually all cases, overpayments corrected in accordance with EPCRS would
be considered restorative payments, and not plan contributions.
See Rev. Rul. 2002-45.
Nature of Corrective Contribution
39
EMPLOYER TAX ISSUES
Restorative contributions are deductible as a business expense under IRC §162
if they are in settlement of an actual or potential fiduciary claim to which the
employer is exposed as a fiduciary.
See, for example, PLR 9822043. See also PLR 201440027.
Deductibility of Restorative Contributions
40
PARTICIPANT TAX ISSUES
The plan reduces further payments to the recipient so that the actuarial present
value of the reduction is equal to the overpayment plus interest.
The recipient is taxed on the amount actually received; the amount recovered
via offset is not taxed.
The recipient may not deduct the amounts attributable to the offset as a loss
deduction under IRC §165(a).
Rev. Rul. 2002-84, Situations 1 and 2.
Recoupments Via Offset Against Future Benefits
41
PARTICIPANT TAX ISSUES
If the overpayment and repayment occur in the same tax year, the repayment would simply reduce the taxable amount, and a 1099-R reflecting the actual payment minus the reduced payment would be issued.
If the repayment occurs in a subsequent tax year, the repayment is treated as a loss deduction under IRC §165(a).
If the repayment is $3,000 or less, the repayment is subject to the 2% adjusted gross income threshold for miscellaneous itemized deductions under IRC §67(a).
If the repayment is more than $3,000, the AGI threshold does not apply and the deduction is based on the rules for restoration of a substantial amount held under a claim of right set forth in IRC §1341.
Rev. Rul. 2002-84, Situation 3.
Recoupment Via Repayment
42
PARTICIPANT TAX ISSUES
The overpayment is treated as a taxable distribution followed by an improper
rollover to the IRA. See, e.g., CCA 201313025.
The overpayment is subject to an excise tax of 6%. IRC §4973.
Any portion of any overpayment that remains in the IRA as of the end of a
subsequent taxable year is subject to another 6% excise tax, to the extent the
overpayment exceeds the individual’s IRA contribution limit for the taxable year.
Overpayments Included in Amounts Rolled Into Traditional IRAs
43
PARTICIPANT TAX ISSUES
The following relief is available as part of a VCP submission in appropriate cases:
The IRS will not pursue the excise tax under §4973 if the recipient withdraws the overpayment (adjusted for earnings) and returns that amount to the plan. Rev. Proc. 2013-12, §6.09(5)(a).
If the overpayment was not made pursuant to a distributable event, the plan sponsor must request excise tax relief as part of the VCP submission and provide an explanation supporting the request. Rev. Proc. 2013-12, §6.09(5)(c).
If the failure involves an overpayment that is not made pursuant to a distributable event, the IRS will not pursue the IRC §72(t) penalty (10%) if the recipient returns the improperly distributed amount, adjusted for earnings, to the plan. Rev. Proc. 2013-12, §6.09(6).
Overpayments Included in Amounts Rolled Into Traditional IRAs
44
PARTICIPANT TAX ISSUES
Excess contributions can be corrected by withdrawing them (with earnings) by
the due date (including extensions) of the federal tax return for the tax year for
which the excess contributions were made. IRC §408(d)(4).
Relief may be available if a recipient reasonably relies on erroneous information
the plan was required to provide (e.g., an incorrect 1099-R). IRC §408(d)(5).
Overpayments Included in Amounts Rolled Into Traditional IRAs
45
PLAN DRAFTING CONSIDERATIONS
The plan document and SPD should require repayment plus interest and authorize offset of future payments until the plan is made whole, regardless of when the overpayment occurred.
A person or other party who receives any Plan payment to which he or she is not entitled under the terms of the Plan, must reimburse the Plan for the full amount of the improper payment plus interest. If the person or other party fails to repay the improper payment on or before the 90th day following the day such person or other party receives notice of the amount due, such person or other party shall be liable to the Plan for any and all reasonable and necessary costs incurred by the Plan to enforce its repayment right. The Plan shall have the right to recoup improper payments by reducing, entirely or in part, benefit payments or other payments to which the person or other party is otherwise entitled.
Repayment/Recoupment Provisions
46
PLAN DRAFTING CONSIDERATIONS
The plan document and SPD should contain a forum selection clause.
Are venue selection clauses consistent with ERISA?
A majority of courts that have considered the question have upheld the
validity of venue selection clauses in ERISA-governed plans.
See, for example, Smith v. Aegon Companies Pension Plan, 769 F.3d 922
(6th Cir. 2004) (the Aegon pension plan’s venue selection clause was valid
and enforceable).
Venue Selection Clause
47
PLAN DRAFTING CONSIDERATIONS
The plan document and SPD should contain a carefully worded provision designed to defend an estoppel claim:
No person is entitled to any benefit under the Plan except and to the extent expressly provided under the terms and conditions of the Plan. For example, the fact that payments have been made from the Plan in connection with any claim for benefits does not establish the validity of the claim; provide any right to have such benefits continue for any period of time; or prevent the Plan from recovering the benefits paid to the extent that the Administrator determines that there was no right to payment of the benefits under the Plan. No person who claims a right to benefits under the Plan may base that claim on any oral or written statement made by any person. The provisions of the Plan govern over any inconsistent benefit information given to a person, orally or in writing, regardless of the source.
No Estoppel of Plan
48