Important Considerations for Balance Forward Retirement Plans

The recent volatility in the financial markets has prompted increased attention to the possibility and appropriateness of daily valued defined contribution retirement plans performing interim valuations prior to making participant distributions. This issue was on the minds of plan sponsors and fiduciaries during the volatile market activity of 2008 and 2011.

With the recent dramatic decline and volatility in the financial markets, many plan sponsors and fiduciaries (and their third-party service providers) are asking whether they should conduct an interim valuation of plan assets in a balance forward defined contribution plan. The issue raised for balance forward plans in volatile markets is that participants who are eligible for distributions as of a valuation date that precedes a period of significant market decline may opt to take distributions as of the earlier effective date that preceded the downturn. As a result, the participant receives, what some may consider, an inflated payout potentially to the detriment of the plan at large. Notions of “fairness" aside, this question raises both fiduciary and tax issues and no matter what the plan fiduciary decides to do, someone is likely to be unhappy. Of course, if significant amounts are involved, the decision to re-value (or not to re-value) could result in litigation.

Plan fiduciaries responsible for making decisions about plan valuations and distributions will want to review their plan documents carefully and consider the following with their legal counsel.

Plan Documents

The plan documents may allow the employer, the trustee, or some other fiduciary to conduct an interim valuation, i.e., an additional valuation which the plan terms do not require. The authority to conduct an interim valuation may be most impactful for a plan with a single annual valuation date but might also be useful for plans valued quarterly.

The Anti-Cutback Rule

Assuming a plan permits an interim valuation, another consideration is whether such valuation constitutes a prohibited cutback of benefits under Section 411(d)(6) of the Internal Revenue Code (the “Code”). The valuation date under a plan is a “right or feature," it is not a protected benefit.¹ Therefore, where a participant has previously terminated employment and has requested his or her distribution, the participant does not have a protected benefit as to any particular valuation date. Thus, the plan fiduciary would not violate the anti-cutback rule by conducting an otherwise permissible interim valuation. However, the conclusion is likely different for a plan that does not permit interim valuations, the participant has already terminated, and the employer wishes to amend the plan to permit an interim valuation. Under those circumstance plan fiduciaries should proceed with great caution and talk to legal counsel before taking such action.

Additional Fiduciary Considerations

Under ERISA, the fiduciary must operate the plan in the best interest of the participants and beneficiaries. That means all the participants. Sometimes, as in the case of a big market swing, the interest of the departed participants will be diametrically opposed to that of the remaining participants. The fiduciary is faced with the choice of whose ox to gore; of course, if the fiduciary revalues the assets, the outgoing participants will share the loss with those who remain behind. No doubt, the outgoing participants who are fixated on their most recent account statement will be upset.

What has been the prior practice for the plan where the market has gyrated wildly up or down? That certainly will be raised if there is a dispute. There is not necessarily one correct answer here. What if only one departed participant with a relatively small percentage of the overall plan assets is impacted? What if it is many participants or a large part of the overall plan is being distributed? In at least one extreme instance, a court sided with the fiduciary who revalued the assets where the outgoing participant had 92% of the overall plan assets. If the fiduciary did not re-value, there would not have been any assets left in the plan (in fact the plan would have still “owed" more money to the departed participant). Not all cases will be that obvious, so once again we reiterate that a plan fiduciary should consult with legal counsel before deciding to revalue (or not to re-value) plan assets.

Participant Communications

Those charged with communicating with participants about their account balance should use caution. Distribution notices and other communications reflecting account balances should be clear that any balance shown is only as of the date indicated and that this balance may not be what a participant will receive. Plan officials should use similar care in verbal communications with participants regarding their account balance.

Other Actions to Consider

A plan fiduciary should also consider:

· Amending the plan (avoiding any cut-back violations) to provide for more frequent mandatory valuations, balancing any increase in cost associated therewith; or

· Adopting a reasonable written policy which calls for interim valuations where there has been market fluctuation, up or down, greater than a pre-determined percentage since the last valuation. The policy could be tied to an index such as the S&P 500, as a benchmark. Such a policy may help defeat a fiduciary breach claim based on the exercise of discretion in a particular case.

THIS MATERIAL IS FOR GENERAL EDUCATIONAL AND INFORMATIONAL PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL, INVESTMENT OR TAX ADVICE. YOU SHOULD CONSULT WITH YOUR OWN LEGAL, INVESTMENT OR TAX PROFESSIONALS REGARDING YOUR SPECIFIC ISSUES AND CIRCUMSTANCES.