Employee Benefits & Executive Compensation Blog

The View from Proskauer on Developments in the World of Employee Benefits, Executive Compensation & ERISA Litigation

Best Practices in Administering Benefit Claims #5 – Establishing (and Following) a Good Claims Process

This week we discuss the importance of establishing good claims procedures and the benefits of following those procedures.

A plan’s claims procedures should be spelled out clearly in both the plan document and the summary plan description (where the two documents are not one in the same).  In addition to setting all of the applicable deadlines for submitting claims and appeals (as we discussed last week), the procedures should inform claimants of:  optional levels of appeal or review (if any); procedures for designating an authorized representative; the requirement to exhaust the plan’s claims procedures before commencing an action; and their right to review documents relevant to the claim decision.  Good claims procedures also will confer final, decision-making authority on one or more people, or a committee.  Importantly, the claims procedures must be made known to all participants because, of course, without knowledge of what the claims procedures are, a participant cannot reasonably be expected to utilize them.

The claims process, contrary to what may be intuitive to many, is not generally viewed by the courts to be an adversarial process—at least not at the beginning stages.  That is because plan fiduciaries—such as those responsible for deciding claims and appeals—owe a fiduciary duty of loyalty to participants.  Now, that is certainly not to say that claims decisions must always be in the participant’s favor.  It does mean, however, that participants must be given an opportunity to present their position on why they believe they are entitled to benefits and that the plan fiduciary should consider and evaluate all of their arguments at the claim and appeal stages.  The fiduciary should give careful consideration to the evaluation of a participant’s claims and arguments, particularly since the participant is generally entitled to all documents that are considered by the claims fiduciary in making its decision—even if the documents are not relied upon in reaching the decision.

There are many benefits to making sure the claims fiduciary follows the plan’s claims procedures.  For instance, a court (or arbitrator) will require a claimant to first exhaust the plan’s administrative process before s/he brings an action for benefits under ERISA section 502(a).  And, if after exhausting the claims procedures, the participant pursues a claim for benefits in court (or arbitration), the judge (or arbitrator) is required to defer to the claims fiduciary’s decision unless it was arbitrary and capricious.  Unlike giving the claim a fresh review, the arbitrary and capricious standard of review is highly deferential to the plan fiduciary’s decision.  Furthermore, the participant generally will not be entitled to discovery in litigation (or arbitration) outside of the administrative record.  This has the added benefit of reducing litigation (or arbitration) costs.

Next week, we’ll discuss the mechanics of benefit claim administration, including dealing with the fiduciary exception to attorney-client privilege.

You can find our previously published best practices here:

Best Practices in Administering Benefit Claims #4 – Know (and Understand) the Law: Full and Fair Review

This week in our blog series on best practices in administering benefit claims, we discuss the importance of knowing and, importantly, understanding the laws governing benefit claim administration.

Section 503 of ERISA sets forth the general guidelines for a plan’s claims and appeal procedures.  It requires that a plan provide adequate written notice of the denial of a claim by a participant or beneficiary (or authorized representative).  The notice has to set forth the specific reasons for the denial and be “written in a manner calculated to be understood by the participant.”  ERISA also requires that a plan provide a participant whose claim has been denied the opportunity for a “full and fair review by the appropriate named fiduciary.”  The U.S. Department of Labor’s implementing regulations elaborate on the ERISA claims procedures requirements in much more detail and, in particular, concern the time, notification, and content requirements for each phase of the claims process.

  • What is the timing for an initial claim decision? The regulations provide specific timing requirements for deciding an initial claim; generally speaking, a decision regarding a claim must be rendered within 90 days of receipt of the claim regardless of whether the claim was complete.  That period can be extended in the case of “special circumstances” provided the claimant is notified of the extension before the expiration of the initial period.  In some cases (g., urgent care, pre-service, and post-service claims under a group health plan), the period may be shorter than 90 days.
  • What information must an adverse claim decision include? If the claims fiduciary determines that the claim should be denied (in whole or in part), that adverse determination has to include the specific reasons for determination, information needed to perfect the claim, references to relevant plan provisions, a statement of the claimant’s right to relevant documents, a description of the plan’s appeal procedures and time limits, and a statement of the claimant’s right to bring suit under ERISA following an adverse benefit determination on appeal.  Additional information may be required when dealing with a group health plan or a plan providing disability benefits.
  • What is the timing for decision on appeal? A claimant should be given at least 60 days (or 180 days for group health plans) to appeal following receipt of an adverse benefit determination notice.  In connection with their appeals, claimants should be given the opportunity to submit comments and other documentation related to the claim, and to request any documents, records, and information relevant to the claim.
  • Who decides the appeal and what information must an adverse appeal decision include? The same person or group may generally decide the claim and appeal other than for group health plans where the decision-maker on the appeal must be different from the decision-maker on the claim.  In all cases, the fiduciary responsible for the decision on appeal may not give deference to the initial claim decision and should take into account everything submitted in connection with appeal to make its own decision.  If there is an adverse benefit determination on appeal, the notice must contain much of the same information as the initial adverse claim decision.
  • Special rules for group health plans. There are a number of special rules for group health plans, including those noted above and, in certain instances, an external review requirement.  These requirements go well-beyond the scope of this blog.

ERISA’s claims regulations weave a complex web of rules for a plan’s claims and appeal procedures.  Care should be taken to (1) review and understand the regulations, and (2) properly document the claims procedures in the plan document and summary plan description.

Next week, we’ll discuss the importance of a good claims process and a participant’s obligation to exhaust the claims procedures before commencing an action for benefits.

You can find our previously published best practices here:

Guide to DOL’s New “Notice and Access” Proposal for Electronic Delivery

On October 23, 2019, the Department of Labor published a new proposed regulation that paves the way for “notice and access” electronic delivery of certain disclosures for retirement plans.  The proposal is welcome news for plan sponsors and administrators who have been frustrated by the existing “opt-in” regime for electronic disclosure.  But the proposal is limited in scope—it covers only notices related to retirement plans, leaving health and welfare plans for another day—and it imposes significant obligations for sponsors and administrators who wish to have safe harbor protection under the proposed regulation.

DOL has requested comments on the proposal and additional issues related to required disclosures.  Comments are due by November 22, 2019.  The following are important points about the proposal:

  • Limited scope: the proposal covers only retirement (“pension”) plans, not health or other welfare plans. The safe harbor does not apply to health or other welfare benefit plan disclosures.  DOL indicated in the preamble that it is considering whether to expand the proposed safe harbor to include welfare plans.
  • Opt-out regime: the proposal includes a safe harbor for plan sponsors and administrators to furnish notices on a website, unless participants affirmatively request paper disclosure. To take advantage of the safe harbor, two notices will be required.  First, the proposal requires that an initial paper notice be sent to each person intended to be covered by the safe harbor; the paper notice must explain the documents that will be furnished electronically, the right to request paper copies free of charge, and how to opt out of electronic delivery (either for certain documents or globally).  After the initial paper notice is furnished, participants would have to be notified electronically each time a document is posted on the website (unless the document falls under the “consolidated” notice rule, explained below).  The proposal requires that the electronic notice include a website address directing participants to the posted document.
  • Consolidated notice: exception to requirement to send a separate electronic notice for each document posted online. Although the safe harbor generally requires a separate electronic notice be sent each time a document is posted, the proposed regulation permits one “consolidated” notice covering all of the following documents: summary plan description (SPD), summary of material modifications (SMM), summary annual report (SAR), annual funding notice, section 404a-5 investment-related disclosure, notice about default investment alternatives (QDIA notice), and pension benefit statement. The consolidated electronic notice must be furnished annually.
  • Retention required: documents posted on the website must remain posted until they are updated, changed, or become obsolete. Documents posted under the proposed safe harbor would have to be maintained on the website until superseded. In addition, documents posted on the website would have to be searchable electronically.
  • Existing safe harbor not affected: the proposal is to have a new safe harbor that is in addition to (not a replacement for) the existing safe harbor for participants who opt in and employees who have computers at their desks. There is a general obligation to furnish ERISA-required documents by a method “reasonably calculated to ensure actual receipt.”  An existing DOL safe harbor provides that this obligation may be satisfied by electronic delivery only if the participant has work-related computer access (such as a computer at their desk) or the participant affirmatively consents to receive notices electronically; that safe harbor has detailed requirements for the consent to be valid.  The proposed regulation offers an additional safe harbor for delivery of ERISA-required notices, but it does not replace or supersede the existing DOL safe harbor.
  • Comments requested: DOL requests comments on the proposal and an assortment of questions about disclosure more generally. In addition to its general request for comments in response to the proposed regulation, DOL asked for feedback on 21 separate topics related to disclosure, such as:
    • Whether any ERISA-required disclosures have become obsolete (due to the passage of time or technology);
    • Whether more personalized disclosures would enhance participant engagement;
    • Whether cybersecurity risk assessments and security measures related to plan disclosures should be incorporated into the regulation; and
    • Whether and to what extent plans should share the “substantial” cost savings from electronic distribution of documents with participants.

Employers who have struggled with seemingly endless disclosure obligations that are not widely read should welcome the opportunity to submit comments.

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The proposed regulation will become effective 60 days after the final rule is published in the Federal Register, with no option to rely on the proposed regulation before it is finalized.

New HRA Regulations Part 5 – More on the Employer Shared Responsibility Mandate

On September 30th, the IRS issued proposed regulations that establish safe harbors for compliance with the employer mandate in the context of individual coverage health reimbursement arrangements (or “ICHRAs”).  These proposed regulations are important for employers that choose to offer ICHRAs and want to be sure they comply with the employer shared responsibility mandate requirements under the Affordable Care Act (“ACA”).

The issues being clarified in the proposed regulations stem from prior guidance that we explained in our blog series on the final health reimbursement arrangement (HRA) regulations issued by the Departments of Labor, Health and Human Services, and Treasury (the “Departments”) in June 2019.  That guidance established basic parameters for how the new ICHRAs would interact with the ACA employer shared responsibility mandate.  However, that earlier guidance needed to be fleshed out based on industry feedback and experience.  The September 30th proposed regulations (which also cover nondiscrimination issues that will be summarized in a subsequent blog) provide that additional guidance.

The key stumbling block to ACA compliance in this area is in determining whether the ICHRA coverage provided is “affordable” for ACA purposes.  This is an extraordinarily complex undertaking.  To help solve that problem, therefore, the proposed regulations include several safe harbor methods of compliance, such as a location-based safe harbor, a lookback safe harbor and a general affordability safe harbor.  Before we explain these safe harbor rules, let’s step back and understand why affordability matters for ACA purposes.

ACA Employer Mandate:  Why Affordability Matters

The ACA’s employer mandate, codified under Section 4980H of the Internal Revenue Code (“Section 4980H”) generally requires (subject to stiff penalties) that applicable large employers (“ALEs,” generally employers that employ more than 50 full-time employees on a controlled-group basis) offer eligible employer-sponsored health coverage to at least 95% of their full-time employees and their dependent children.  Even if an employer satisfies the 95% requirement, though, a smaller penalty under Section 4980H(b) could still be assessed if the coverage offered is either not “affordable” or does not have minimum value. So it is important to know whether coverage is “affordable” in order to mitigate or avoid ACA penalties.

Here’s where it gets complicated.  Affordability for purposes of the employer mandate is tied to the same formula used for determining an individual’s premium tax credit eligibility on the ACA Marketplace. In that context, affordability is determined based on whether the cost of the second lowest cost silver plan available to the individual on the ACA Marketplace is less than 9.5% (adjusted for inflation) of his or her household income.  In the group health plan context, the relevant comparator is the employee portion of the self-only premium for the lowest cost minimum value coverage option offered by the employer to the employee.

Determining the coverage option to use for affordability purposes is easy enough in the group health plan environment, but using household income as a measure of affordability is a problem because employers typically do not have that information. Therefore, in prior ACA guidance, the IRS established three affordability safe harbors for employers—the W-2 safe harbor, the rate of pay safe harbor, and the federal poverty line safe harbor.

The problem is that these general safe harbors alone cannot solve the affordability conundrum related to ICHRAs.  With IRS Notice 2018-88, the IRS began laying the groundwork for future regulations by outlining some basic parameters for compliance with the ACA mandate.  For example, Notice 2018-88 provided that ICHRAs are minimum essential coverage and an affordable ICHRA will be deemed to have minimum value. But even with those basic rules, affordability was viewed as a real challenge and additional guidance was necessary.

Applying Affordability to ICHRAs

The proposed regulations reiterate the position in IRS Notice 2018-88 and state that affordability for purposes of Section 4980H(b) involves a similar methodology to that used for calculating premium tax credit eligibility.  For an ICHRA to be affordable in a given month, an “employee’s required HRA contribution” (or the difference the monthly HRA contribution for self-only coverage and the lowest cost silver-level plan available on the Marketplace) must not exceed 1/12 of (a) the employee’s household income for the taxable year multiplied by (b) the “required contribution percentage” (currently set at 9.86%).

For employers, particularly those with a large, national workforce, applying this formula would be extremely difficult.  That is because the “required HRA contribution” is based in part on the lowest cost silver-level plan available on the Marketplace within the relevant rating area.  That cost varies on an individual-basis depending on age and place of residence.  To help employers apply these rules, the proposed regulations propose the following safe harbors for affordability purposes:

  • Location Safe Harbor. Under the location safe harbor for determining affordability, the proposed regulations would allow ALEs to measure affordability against the lowest cost silver-level plan available in the area where an employee’s primary site of employment is located. For purposes of this safe harbor, an employee’s primary site of employment is the location at which the employer reasonably expects the employee to perform services on the first day of the plan year (or, on the first day the ICHRA takes effect). In some cases (g., when an employee works remotely and cannot be required to report to a particular worksite), the ALE will be required to consider an employee’s place of residence. Employers with multiple worksite locations would still be required to determine affordability for Section 4980H purposes separately for each area.
  • Lookback Safe Harbor. Employers typically determine the employee cost-share for coverage in the fall of each year (i.e., the open enrollment period for calendar year plans). However, at that time, the premiums for individual market coverage in the following year are typically not yet available.  As such, for measuring affordability, the proposed regulations offer a safe harbor through which ALEs with a calendar plan year may use the monthly premium for the lowest cost silver plan in January of the prior calendar year. A similar safe harbor is also available to ALEs with non-calendar plan years; however, the applicable lookback date is the January of the current calendar year, as opposed to the January of the prior year.
  • General Affordability Safe Harbors. As discussed above, whether an ICHRA is considered affordable is partially based on the relationship between the employee’s required HRA contribution and the employee’s household income for the taxable year. Because an employer offering an ICHRA will generally not know an employee’s household income, the proposed regulations provide that ALEs offering ICHRAs are permitted to use the three general affordability safe harbors established previously by the IRS (e., the W-2 safe harbor, the rate of pay safe harbor, and the federal poverty line safe harbor).

What about other safe harbors?

The Treasury Department declined to provide an age-based safe harbor, noting that it was limited in its ability to materially deviate from the premium tax credit rules.  Nevertheless, the proposed regulations did offer some simplifications to help employers through this problem.  First, although affordability is determined on a monthly basis, an employee’s age at the start of the plan year (or the date on which the employee becomes eligible to participate) can be used for the duration of the plan year.  Second, if within an age band, there is variation among the lowest cost silver plan for different ages in that band, the lowest cost silver plan for that entire age band can be used for all ages in the age band.  Employers would still need to make adjustments based on location, however.  Finally, the Treasury Department noted that employers could always simplify the process by using the premium applicable to the lowest cost silver plan available to the oldest employee for all employees within the applicable location.  This simplification, however, would generally require a higher benefits spend than necessary.

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These proposed regulations make an effort to ease the burden on employers with respect to the affordability calculus for ICHRAs.  To some degree, the proposed safe harbors will be helpful for ICHRA sponsors.  Even with these safe harbors, though, the administrative burden in determining affordability may be significant, particularly for employers with a widespread employee base.  ALEs that are considering adopting ICHRAs should consult with benefit advisors and counsel when designing the plan and assessing affordability.

New Jersey Individual Mandate Requires State Filings in March 2020

The Affordable Care Act’s individual mandate (i.e., the requirement that most individuals obtain adequate health insurance or pay a penalty) is dead.  A side effect of the ACA mandate’s demise is that states are beginning to step-in and pass their own versions of the individual mandate.  Massachusetts, of course, has long had an individual mandate in place for its residents.  Since the ACA mandate’s repeal, California, the District of Columbia, New Jersey, Rhode Island, and Vermont have passed individual mandates.  Several other states are also considering enacting individual mandates.  As these state laws become more prevalent, employers and plan sponsors need to consider whether these states have reporting requirements similar to the ACA’s requirements under Sections 6055 and 6056 of the Internal Revenue Code.  This blog highlights the filing requirement in New Jersey, under which forms must be filed with the state by March 31, 2020.

Similar to the repealed ACA individual mandate, New Jersey requires its residents to obtain minimum essential health coverage (subject to various exemptions) or pay a penalty.  To assist the state in verifying enrollment information provided by taxpayers, employers and plan sponsors (whether or not domiciled in New Jersey) providing coverage to New Jersey residents will need to submit to the state the same forms required under Sections 6055 of 6056 of the Internal Revenue Code (i.e., Forms 1094/5-B and 1094/5-C).  The forms must be submitted electronically through the Division of Revenue and Enterprise Services’ MFT SecureTransport service, which is the same system for processing W-2 forms.

Currently, the existing IRS Forms 1094/5-B and 1094/5-C contain the information New Jersey needs to verify enrollment, and therefore, New Jersey is willing to accept those forms.  However, New Jersey notes that if the IRS changes the forms, it is possible that the state will develop its own forms.  This is an important point, because as of the date of this blog, the IRS has not issued draft Forms 1094/5-B or 1094/5-C for 2019.  Given that 2019 is the first year without the ACA’s individual mandate, it is possible that the IRS is developing significantly revised forms (and, hence, the delay).

Employers and plan sponsors providing coverage to New Jersey residents should consider contacting their reporting vendors to ensure that the vendors have the capability to submit forms to the state.  Employers and plan sponsors that handle reporting on their own should start working now to make sure current file submission programming is compatible with New Jersey’s filing system.  In a more perfect world, the IRS forms will continue to request enrollment information so that states with individual mandates can “piggy-back” on those forms.  If that is not the case, the rising tide of state individual mandates could because an administrative headache for employers and plan sponsors.

Best Practices in Administering Benefit Claims #3 – Dealing with Benefit Assignments

Our blog series on best practices in administering benefit claims has thus far stressed the importance of knowing and reading the plan document and summary plan description.  This week, we take a look at a plan term that has been the subject of frequent dispute in health and welfare benefits claim litigation—interpretation of plan provisions prohibiting a participant’s right to assign benefits to healthcare providers.

Out-of-network medical providers commonly require patients to sign documents that purport to assign their rights to plan benefits to the provider.  If this assignment works (if it’s valid), it would allow the medical provider to “step into the shoes” of the patient and challenge the amount a plan pays to the provider.  This would give the provider direct rights against the plan, including through a plan administrative claim and, if necessary, litigation.

Under ERISA, group health plans are allowed to prohibit benefit assignments and, for a variety of reasons, many plans do so.  With a valid anti-assignment provision, plans have successfully defeated claims brought by out-of-network providers seeking additional plan reimbursements.

Anti-assignment provisions must be drafted carefully and clearly so they will accurately reflect the plan sponsor’s intentions.  Some of the issues to consider include:  Will the plan prohibit all benefit assignments? Will it prohibit only the assignment of payment of benefits?  Will it only prohibit the provider from commencing action in court?  Will it require that providers and participants get the plan administrator’s consent before the assignment is valid?  Plan sponsors generally have wide latitude to limit, or prohibit altogether, the assignment of benefits.

In considering anti-assignment provisions, there are two other points to remember:

First, ERISA allows participants to designate authorized representatives to act on their behalf through the claims process.  This could mean that a provider, an attorney, or any other individual could be appointed to act on behalf of the participant.  Unlike a properly designated assignee, however, an authorized representative does not step into the shoes of the participant and does not acquire rights independent of the participant.  A plan may provide for reasonable procedures that participants must follow in designating authorized representatives, which may facilitate benefit claim administration.

Second, many health plans will have “direct payment” provisions whereby the plan will pay out-of-network benefits directly to a provider as a convenience to the participant.  A properly drafted anti-assignment clause will distinguish between a permissible direct payment arrangement from a prohibited assignment of benefits.  This is an important and difficult provision to draft, and counsel should be consulted on this point.

Next week, we’ll discuss the importance of knowing and understanding the applicable law and regulations on benefit claim and appeal procedures.

Proskauer to Speak at the 65th Annual International Foundation’s Annual Employee Benefits Conference

Proskauer’s Employee Benefits and Executive Compensation Group will be attending and speaking at the 65th Annual Employee Benefits Conference hosted by the International Foundation of Employee Benefit Plans. Robert Projansky, Neal Schelberg and Anthony Cacace will be leading conversations around hot topics in the industry.  We welcome you to join any of our presentations, we look forward to seeing you!

When: Sunday, October 20th – Wednesday October 23rd, pre-conference beginning on Saturday, October 19

Where: The San Diego Convention Center, 111 W Harbor Drive, San Diego, CA 92101

 

Saturday, October 19 – Pre-conference

Time Topic Presenter
8:00 am – 12:00 pm Trustee Responsibility and Legal Environment Robert Projansky

 

Monday, October 21

Time Topic Presenter
9:15 – 10:30 am Fiduciary Refresher Neal Schelberg
1:15 – 2:30 pm Fiduciary Dilemmas Robert Projansky
1:15 – 2:30 pm Tensions in the Boardroom: Issues Confronting Trustees Who Are in Disagreement Anthony Cacace
2:45 – 4:00 pm Working With Your A-Team (for Trustees) Robert Projansky

 

Tuesday, October 22

Time Topic Presenter
7:30 – 8:45 am Working With Your A-Team (for Trustees) Robert Projansky
1:15 – 2:30 pm Fiduciary Dilemmas Robert Projansky
1:15 – 2:30 pm Tensions in the Boardroom: Issues Confronting Trustees Who Are in Disagreement Anthony Cacace

Best Practices in Administering Benefit Claims #2 – Know (and Read) Your SPD

Last week, we kicked off our blog series on the fundamentals of benefit claim administration with an explanation of how important it is to know and read your plan document.  The plan document is the legally binding contract that describes each participant’s rights and benefits under the plan. It also guides the legal obligations and protections for the plan administrator and other plan fiduciaries responsible for plan administration. This week, in part two, we review the importance of the summary plan description. 

Many plan documents are accompanied by a separate summary plan description.  Under ERISA, a summary plan description is precisely what it sounds like—an easy to understand summary of the plan document.  Applicable ERISA regulations explain the specific types of information that must be included in the summary plan description, depending on the type of plan in question.  Case law also has, from time to time, imposed requirements to include additional information.  Separately, based on years of experience, we, as practitioners, have developed recommended language or SPD terms that help clarify plan terms and provide protection against misrepresentations or misunderstandings.  Plan sponsors and fiduciaries are well-advised to periodically read their summary plan descriptions to ensure that they comply with all available guidance, are consistent with the plan documents, and have not inadvertently omitted required information.  Although the plan document, not the summary description, is supposed to “rule” in court, inconsistencies and inadvertent omissions have given rise to costly, unnecessary litigation.  A little bit of effort now, may avoid a large, costly headache later on.

Is it possible that a plan and summary plan description can be one and the same document?  Yes. This is found particularly in the context of health plans or other “welfare benefit plans” under ERISA.  Practitioners regularly discuss with clients questions of format and presentation as part of an overall compliance review.

Finally, remember, a good summary plan description doesn’t do anyone any good if it is not timely and appropriately distributed to plan participants. There are various ways to distribute a summary plan description, including through electronic means.  ERISA regulations should be considered carefully in deciding how to proceed.

Stop by next week when we discuss authorized representatives and assignments.

Best Practices in Administering Benefit Claims #1 – Know (and Read) Your Plan Document

Our ERISA Practice Center blog posts often discuss many complex, and sometimes esoteric, substantive and procedural ERISA issues, as well as related agency guidance and case law.  In this new ten-part blog series, however, we take a step away from the complex and esoteric in order to review some of the fundamentals of benefit claim administration. To that end, we want to share with you our top ten best practices for benefit claim administration.  Let’s dive right into our first best practice:  Know (and read) your plan document.

Know your plan document?  Read your plan document?  Seems simple enough.  Sometimes, however, some of the simplest things can prove to be the most difficult.  ERISA requires every employee benefit plan to be in writing.  The plan document is at the core of ERISA and provides the foundation for the benefits to which participants and beneficiaries are (and are not) entitled.  Plan sponsors and fiduciaries are well-advised to review their plan documents periodically.  Make sure the plan terms are consistent with the plan sponsor’s and plan administrator’s understanding.  This is particularly true when it comes to plan amendments and restatements. Given the number of hands potentially involved in the adoption and implementation of plan amendments and restatements, it is important to make sure nothing has “slipped through the cracks.”  In addition, a periodic review of the plan document can help you find those plan terms that may be ambiguous or have unintended consequences.  Use this review as an opportunity to clarify ambiguous terms to help mitigate risks of litigation.  In short, a relatively small amount of effort now to know and read your plan document may save an enormous amount of effort (and money) later.

Come see us again next week where we’ll take a look at the importance of other plan-related documents.

Final Hardship Distribution Regulations, Part Three: New Disaster Relief and Expanded Sources Available for Hardship Distributions

The IRS recently released final regulations making a number of changes to the rules applicable to hardship distributions from 401(k) and 403(b) plans.  Concluding our three-part series on the final regulations, this blog entry will focus on the following changes to the hardship distribution rules: (1) modifications to the list of safe harbor expenses that qualify for hardship distributions, and (2) additional contribution sources that are now available for hardship distributions.

Modifications to Safe Harbor Expenses: Distributions made for certain “safe harbor” hardship expenses are deemed to be made on account of an immediate and heavy financial need.  The final regulations modify this list of safe harbor expenses as follows:

  • Casualty loss: Employees may receive hardship distributions for expenses to repair damage to a principal residence if the expenses qualify for any type of casualty loss deduction under Code Section 165. As a result of the 2018 Tax Cuts and Jobs Act (TCJA), through 2025, the Section 165 casualty loss deduction by its terms is not available unless the loss is due to a federally-declared disaster.  To avoid this unintended limitation on available hardship distributions, the final regulations modify the casualty loss safe harbor so that it covers casualty loss expenses regardless of whether the damage resulted from a federally-declared disaster.

The revised casualty loss definition may be applied on or after January 1, 2018.  So, if a plan made casualty loss hardship distributions in 2018 without regard to the TCJA changes discussed above, the plan may be amended to apply the revised casualty loss definition effective January 1, 2018.  That way, the plan provisions will conform to the plan’s operations.

  • FEMA-designated disaster: The final regulations add a new “FEMA-designated disaster” safe harbor expense category. Under this new category, hardship distributions may be made for expenses and losses incurred by an employee on account of a FEMA-designated disaster, provided that the employee’s principal residence or principal place of employment at the time of disaster is in the FEMA-designated disaster zone.

Note that prior disaster relief issued by the IRS extended the relief to expenses incurred by an employee’s dependents or qualifying relatives.  The new regulatory safe harbor is narrower in that it only applies to expenses incurred by the employee.  In the regulatory preamble, the IRS indicated that it does not anticipate issuing disaster relief by individualized notice in the future. As a result, plan sponsors cannot necessarily rely on extended deadlines to adopt disaster relief provisions.

Pending further guidance from the IRS, plan sponsors that wish to incorporate the FEMA-designated disaster safe harbor category into a plan’s hardship distribution provisions would need to do so by the end of the plan year in which the amendment is first effective.  Like the revised casualty loss definition, the new FEMA-designated disaster category may be applied on or after January 1, 2018.

  • Primary beneficiary: Incorporating prior guidance issued by the IRS in Notice 2007-7, the final regulations clarify that hardship distributions for qualifying medical, educational, and funeral expenses may be made for expenses incurred by a participant’s “primary beneficiary” (someone named as a beneficiary and who has an unconditional right, upon the employee’s death, to all or part of the employee’s plan account).

Expanded Sources for Hardship Distributions: Expanding the current contribution sources that may be distributed on account of hardship, the final regulations provide that sources available for hardship distributions from 401(k) plans include earnings on elective deferrals, qualified non-elective contributions (QNECs), qualified matching contributions (QMACs), and earnings on QNECs and QMACs, regardless of when contributed or earned.  Plan sponsors are not required to expand the available sources and may continue to limit the amounts available for hardship distributions consistent with the prior rules.

  • Special note for 403(b) plans: Earnings on pre-tax deferrals made to a 403(b) plan continue to be ineligible for hardship distributions. However, QNECs and QMACs in a 403(b) plan that are not held in a custodial account would be eligible for hardship distributions. QNECs and QMACs in a 403(b) plan that are held in a custodial account continue to be ineligible for hardship distributions.

Reminder – Plan Amendment/Operational Changes Required: As summarized in our prior blog entry, individually-designed 401(k) plans that currently permit hardship distributions will likely need to be amended to reflect the final regulations by December 31, 2021.  The amendment deadline for pre-approved 401(k) plans is more complicated and depends on several factors; however, generally, the deadline to make changes for the final regulations would likely be the employer’s tax filing deadline (plus extensions) for 2020.  The amendment deadline for 403(b) plans is similarly complicated.  Although the general remedial amendment deadline for 403(b) plans is March 31, 2020, as a result of recently-released Rev. Proc. 2019-39, both individually-designed and pre-approved 403(b) plans will likely have additional time to adopt plan amendments relating to the final regulations.

In addition to monitoring the plan amendment deadlines summarized above, plan sponsors should also be aware that if a plan currently imposes a six-month suspension of contributions following a hardship distribution, the suspension must be eliminated for hardship distributions on or after January 1, 2020.

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You can read more about the final hardship distribution regulations in our prior blog posts in this series, including a summary of the key changes to the hardship distribution rules, as well as important implementation considerations for plan sponsors.

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