A. Introduction

The field of employee benefits is one which applies to banks with or without trust departments. Employee benefit plans are vehicles for which the benefits promised by an employer are funded, administered, and provided to eligible employees or members. Individual Retirement Accounts (IRAs) established by individuals under certain provisions of the tax laws are also covered in this section.

Employee benefit plans represent a diverse field. Plans vary according to the types of benefits provided, the manner in which plan assets are administered, and the manner in which benefit amounts are provided to the employees/participants and their beneficiaries. Every bank offers various types of employee benefits to its employees and their beneficiaries. As such, portions of the material in this section of the manual are relevant to every bank supervised by the FDIC.

Bank trust departments may manage the bank's own employee benefit plan(s) for its own employees. The trust department may perform the same services for the bank's parent holding company and affiliates. In addition, the trust department may service employee benefit plans sponsored by outside corporations, unions, individuals, and government entities.

B. Scope of Bank Activity

C. Types of Benefits

One way of describing various types of employee benefit plans is to reference the types of benefits the plan provides. In general, there are two types of benefits: retirement and welfare.

Retirement plan benefits generally arise when an employee is qualified to retire, and often provide benefits to the employee's spouse and dependents. Some retirement plans involve the deferral of income for periods extending to the termination of employment, or beyond. Such plans usually cover key members of management. Retirement plans involve a number of different types of plans and funding arrangements. Although trust departments are generally more active in the retirement benefits field, examiners need to be aware of the general requirements for welfare benefit plans as well.

The term welfare benefits is used to describe non-retirement benefits. Welfare benefits may involve health and life insurance, scholarships and education assistance, day care centers, apprentice programs, prepaid legal services, vacation and sick-leave programs, and all other non-retirement benefits.

A second, and more common way of generically describing various types of employee benefit plans involves the method used to determine how assets are contributed to the plan. In this regard, there are two main types of pension plans: defined benefit and defined contribution plans.

Most plans operated by private employers are offered, at least in part, because contributions to the plan are tax deductible to the plan sponsor. In order to be tax deductible, an employee benefit pension plan must meet certain minimum standards and have certain provisions required by the Internal Revenue Service (IRS). As the tax laws and regulations tend to change often, the specific requirements, eligibility, conditions, and thresholds also are subject to change.

D.1. Defined Benefit Plans
A defined benefit plan is one which establishes a formula to define what the participant (employee) is entitled to receive. The formula is usually based on longevity and/or income. Most traditional pension plans use this approach, which often provides greater benefits the longer the employee stays with the plan sponsor. Employees/participants are entitled to the percentage of the benefits established under the plan. This entitlement is termed "vesting."

D.1.a. Defined Benefit Pension Plans
In this approach, the benefit payment is defined. The participant is entitled to whatever amount the formula results in, and has a claim against all of the plan's assets for payment of the vested benefit. The plan sponsor (employer or union) is responsible for ensuring that sufficient assets are in the plan to pay those defined benefits. The most common type of defined benefit plan is the traditional pension plan.

Pension plan benefits are generally paid out in the form of a life annuity beginning at the participant's normal retirement date. Other methods of paying benefits are installment payments and lump sum distributions, with options sometimes given to the participant. The Pension Benefit Guarantee Corporation (PBGC) insures the benefits of private defined benefit plans to the extent provided in Title IV of ERISA.

In private plans, it is common for retirement benefits payable under the pension plan to be set in conjunction with Social Security benefits. Benefits calculated in this manner are said to be integrated with Social Security retirement benefits. IRS regulations governing the integration of Social Security benefits are complex and designed to prevent discrimination in favor of highly paid employees.

Defined benefit plans are more expensive to administer and operate than defined contribution plans. Defined benefit plans involve projecting a host of variables to estimate the amount of benefits payable upon retirement and the amount of assets that must be contributed today to fund those benefits in the future. Actuaries are required to perform the projections. Due to the extra costs involved, defined benefit plans have become less popular, with many defined benefit plans terminated and replaced by defined contribution plans.

D.1.b. Cash Balance Plans
Another form of defined benefit plan is the "cash balance" plan. Cash balance plans are similar to traditional defined benefit pension plans in that: (a) they guarantee a specific benefit upon retirement which is not dependent upon the plan's investment performance; (b) retirement benefits are payable as an annuity with surviving spouse protection; (c) employers must follow minimum funding policies under ERISA, and (d) basic plan benefits are guaranteed by the PBGC up to limits set by law.

In recent years, this type of plan has become increasingly popular. Most of these plans have emerged as conversions from overfunded traditional defined benefit pension plans. Following conversion, plan assets remain intact. And employers cannot remove overfunded assets unless the plan has been terminated and full benefits under the terminated plan have been funded. Despite this protection, some conversions by high profile employers have attracted media attention. The focus of much of the attention, and controversy, surrounds diminished benefits for employees with long years of service. Unless employers take explicit steps to protect older employees with long company service, conversions from traditional pension plans (whose benefits are largely determined by years of service and final average pay) into cash balance plans, may impact these employees negatively.

Cash balance plans differ from traditional defined benefit plans in that they define benefits in terms of a stated "account balance," as opposed to a specific monthly benefit for life under traditional defined benefit pension plans. In this form of plan, employers credit a participant's account each year with a "pay credit" (typically based on a percentage of compensation) plus an "interest credit" (either a fixed rate, or a rate which is linked to an index, such as the one year treasury bill rate). When a participant retires under a cash balance plan, he or she is entitled to the balance of his or her vested benefit (similar to a defined contribution plan), which may be taken as an annuity or in a lump sum. This is opposed to retirements under traditional defined benefit pension plans, where retirees are entitled to lifetime monthly annuities based upon years of service and pay.

A transition device, called "wearaway," is sometimes offered to employees with long service when traditional defined benefit pension plans are converted to cash balance plans. Wearaway provides employees the option of receiving the greater of their frozen benefit under the phased out pension plan formula, or their total benefit under the cash balance formula. Employees near early retirement age may accrue little or nothing for a prolonged period under a cash balance plan until the phased out plan benefit is worn away. This is because the value of the traditional pension plan benefit may be far greater than future accruals under the cash balance plan. Furthermore, beginning balances under the cash balance plan may be set lower than the present value of the phased out plan's accrued benefit. This serves to worsen the wearaway effect. Some employers temper the adverse conversion impact on long service employees by: (a) "grandfathering" them under the older plan's benefit formula, (b) providing higher "pay credits," (c) setting their opening balances higher, or (d) permitting employees to choose between benefit formulas under the old or new plans.

Employer accruals under a typical cash balance plan remain relatively level, increasing only slightly toward the end of an employee's career. Employer accruals under a traditional defined benefit pension plan begin relatively low, but increase sharply as an employee approaches retirement. This tends to make cash balance plans less costly to fund and operate than traditional defined benefit pension plans. Unlike traditional pension plans, cash balance plans also typically eliminate early retirement options but permit participants to receive retirement benefits in a lump sum, which can be rolled over into an IRA or another employer's plan.

D.2. Defined Contribution Plans
A defined contribution plan is one which establishes a formula defining how much the plan sponsor will contribute to the plan. The formula may be based on the sponsor's profitability, on the amount of the participant's earnings, or on any number of other factors or combinations. In some plans, the sponsor determines the amount of contribution on a discretionary basis.

Profit sharing, employee stock ownership, thrift 401(k) and 403(b), Simplified Employee Pension (SEP)-IRA, Salary Reduction SEP (SARSEP), Savings Incentive Match Plan for Employees (SIMPLE), and other types of commonly encountered plans use the defined contribution approach. As with defined benefit plans, plan participants are entitled to their vested percentage of the benefits, as established under the plan.

In this approach, the contribution is defined; the benefit payment is not. The benefit amount is dependent on both the amount contributed and the success of the investment results. Under this approach, the participant is entitled only to the amount in his or her account, based on the varying amounts contributed and the investment return. The participant has a claim only on the assets of his or her account in the plan; there is no claim against all of the plan assets belonging to other plan participants. The PBGC does not insure the benefits of defined contribution plans.

In general, there are five basic types of plans or formulas for defined contribution plans: profit sharing, money purchase pension, target benefit, stock bonus, and employee stock ownership.

D.2.a. Profit Sharing Plans
A profit sharing plan is a qualified defined contribution plan which is also an Individual account plan. These plans are subject to ERISA. Plan assets are often invested wholly in the employer's stock. ERISA diversification requirements are not generally violated so long as the plan or trust instrument allows no more than 10% of the plan's assets to be invested in employer securities, except as provided in Section 407(a) of ERISA. Such plans are believed to foster productivity on the part of employees, who will own part of the company.

There are two types of profit sharing plans: current or deferred plans. In a current profit sharing plan, profits are paid directly to employees in cash, check, or stock as soon as profits are determined. Deferred profit sharing plans are more common. Deferred profit sharing plans are defined contribution plans operating under a written plan and qualified under the Internal Revenue Code (IRC) where the employer provides retirement benefits.

The employer's contribution to the plan each year can be either purely discretionary (nothing at all, if the employer wishes) or based on some type of predefined formula. If a formula is used, it typically relates the contribution to the employer's profits. The term profit sharing plan implies that an employer must have profits before any contributions are made to the plan. However, this requirement was eliminated under the Tax Reform Act of 1986. Contributions to profit sharing plans are not required to be based on an employer's profits according to Section 401(a)(27)(A) of the IRC.

The plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants. In addition, the plan must provide a predetermined formula for distributing the fund accumulated under the plan after a fixed number of years; attainment of a stated age; or upon the prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment.

Generally, contributions are allocated to participants in proportion to their compensation with subsequent allocations reflecting future contributions adjusted by the investment experience of the plan. Plan benefits consist of the amount accumulated in each participant's account including: (1) employer contributions,   (2) forfeitures from other employee's accounts, and (3) interest and capital gains. Many plans permit participants to borrow against their vested interest in the plan.

D.2.b. Money Purchase Pension Plans
A Money Purchase Pension Plan (MPPP) is a defined contribution plan which is also an Individual account plan. Employer contributions are usually determined based upon a percentage of compensation for specific Individuals. As with the profit sharing plan, benefits for each participant are derived from the amounts contributed to each Individual account. Unlike a profit sharing plan, forfeitures are not added to participants' accounts but are used to reduce the employer's contributions.

Money purchase pension plans differ from profit sharing plans in a number of ways:

• MPPPs must state a definite formula or approach for employer contributions; contributions may not be determined annually by the employer;

• MPPPs are subject to minimum funding requirements of the IRC;

• MPPPs must provide for a life annuity as a distribution option;

• MPPPs have different deduction limitations under the IRC than profit sharing plans; and

• MPPPs distributions are not permitted before retirement age, death, disability, or termination of either the plan or employment.
  

D.2.c. Target Benefit Plans
Target benefit plans are intended to provide a target benefit to each participant upon retirement. Employer contributions to each participant's account are established through a defined benefit formula. The amount of the contribution is determined by an actuary. The plan does not guarantee that the target benefit will be paid at retirement; its only obligation is to pay whatever can be provided by the amount in the participant's account depending on the actual investment results achieved by the fund. A life annuity must be one distribution option for the employee.

Target benefit plans are hybrids of a money purchase plan and a defined benefit plan. Target benefit plans are Individual account plans because contributions are allocated to each participant's Individual account.

D.2.d. Stock Bonus Plans
Stock bonus plans are identical to profit sharing plans and are usually established to permit employees to share in the ownership of the business and/or to reward meritorious service. Contributions, as with profit sharing plans, are not necessarily based upon profits and the benefits are distributable in cash or stock of the employer.

Generally, the plan must allow the participant to demand that the benefit be distributed in employer securities. If employer stock is not traded on an established market, the employee must have the right to require the employer to repurchase the stock under a fair market value formula.

D.2.e. Employee Stock Ownership Plans (ESOPs)
The information presented under this section will apply to both ESOPs sponsored by the bank for its own employees, and ESOPs found in the bank's trust department which are sponsored by different employers. In addition to the material presented under this heading, examiners should also refer to the following:  
(1) ESOP Plans - Employer Securities Investments - Prudence; (2) ESOP Plans - Employer Securities Investments - Valuation; and (3) ESOPs Loans to Plans - Section 408 Statutory Exemption. The pertinent areas related to ESOPs are noted below:

• ESOPs, In General
  
• Leveraged ESOPs
  
• Advantages and Disadvantages of ESOPs

D.2.e.(1). ESOPs, In General
An ESOP is an Individual account plan that is either a qualified stock bonus plan or a combination qualified stock bonus and qualified money purchase plan. ESOPs provide separate accounts for each participant. Benefits are based solely on amounts contributed to each Individual account including attributable income, expenses, gains and losses, and allocated forfeitures of other participants' accounts. ESOPs are defined in Section 407(d)(6) of ERISA, Department of Labor (DOL) ERISA Regulation 2550.407d-6, and Section 4975(e)(7) of the IRC. See Appendix E.

Congress has provided a number of tax incentives to encourage the formation and continuation of ESOPs. ESOPs operate primarily under IRS requirements but are also subject to certain ERISA provisions. Since tax incentives impact government revenues, the rules under which ESOPs operate are subject to change by Congress and implementing IRS regulations. Some ESOPs which reflect various statutory or regulatory approaches have special names: Tax Reform Act Stock Ownership Plans (TRASOPs), Payroll-deduction Stock Ownership Plans (PAYSOPs), etc.

Most ESOPs invest solely in the employer's stock. Since many companies are either closely-held or have a very limited market for their stock, valuing the stock can prove problematic and provide opportunities for abuse. The value of the employer's stock greatly impacts the employee's eventual benefits.

In reviewing the administration of an ESOP's investments, the examiner must be cognizant of the following facts pertaining to ESOPs. ESOPs:

• Are not exempt from ERISA's prudence and exclusive benefit rules; but
  
• Are exempt from ERISA's diversification rule; and
  
• May be exempt from prohibited transactions (purchases and sales of employer securities from the employer and/or parties in interest) if certain conditions are met. In general, refer to ERISA Section 408(e) and DOL ERISA Regulation 2550.408e. See Appendix E. Three main conditions for exemption require:
  • Not more than adequate consideration may be paid by the plan (see Definitions, ERISA 3(18);
    
  • No direct or indirect commissions may be paid; and
    
  • The investment meets the prudence requirement of Section 404(a) of ERISA.

As tax-qualified plans, ESOPs must follow applicable IRS requirements, in addition to ERISA provisions. Except as otherwise indicated below, IRS Regulation 54.4975-11 (see Appendix E) establishes most of the following operational requirements for ESOPs. An ESOP must:

• Be formally designated as an ESOP in the plan document.

• Be designed to invest primarily in qualifying employer securities. For leveraged ESOPs, investments are restricted to the employer's common stock or convertible preferred stock; stock rights, warrants, and options are not considered in the definition. For non-leveraged ESOPs, the definition also includes marketable bonds, debentures, notes, and similar marketable debt instruments of the employer.

The types of qualifying employer securities are covered by IRS Regulation 54.4975-12. DOL ERISA Regulation 2550.407d-5 defines the term qualifying. See Appendix E.

• Value employer securities in accordance with both IRS and ERISA requirements. The valuations affect purchases and sales of employer securities, market-value reporting on the Annual Report (Form 5500), allocations to participants' accounts, and distributions to participants.

ERISA Section 408(e)(1) and DOL ERISA Regulation 2550.408e require that transactions for employer securities involve no more than adequate consideration. This term is defined in ERISA Section 3(18).

Section (d)(5) of IRS Regulation 54.4975-11 requires certain steps when valuing employer securities by an ESOP. For securities traded on securities exchanges, the quoted prices may be used. If the stock is publicly traded, no appraisal is necessary. But if it is traded infrequently, an appraisal may still be needed. In general, employer securities which are not readily tradable on an established securities market must be valued by an independent appraiser.

• Valuations must be made in good faith and based on all relevant factors:
  
  • In any transaction between the ESOP and a disqualified person, the value of the securities must be determined as of the date of the transaction. In such transactions, an independent appraisal, by itself, does not automatically equal good faith.
    
  • For all other transactions, values must be determined as of the most recent valuation date under the plan. In such transactions, an independent appraisal will generally be deemed to be a good faith determination of value.
    

• Include a put option. IRC Section 401(a)(23) also states that, to be qualified, a stock bonus plan must include a put option for securities that are not publicly traded.

With a put option, an employee who is entitled to a distribution from an ESOP has the option of requiring the employer to repurchase employer securities from the employee's Individual account in the plan. If the securities are not readily tradable on an established market, the securities must be valued at a reasonable fair market value. Through this arrangement, the employee receives a cash distribution instead of an in-kind distribution of illiquid securities.

• Include a suspense account for which assets are added to and maintained.
  

In addition, an ESOP must (1) pass voting rights through to participants for those shares allocated to Individual accounts according to Security and Exchange Commission (SEC) Regulation 240.14c-7 and (2) meet stringent nondiscrimination tests as to employee participation according to IRS regulations.

ESOPs can acquire assets through: (1) an outright gift of cash or newly issued common stock to the plan, (2) a thrift arrangement under which employees contribute money (PAYSOPs), (3) a profit-sharing arrangement where the employer's annual contribution is a percentage of profits, or (4) a money purchase arrangement where a percentage of compensation is contributed each year irrespective of profits. Most ESOPs; however, obtain initial funding through loans and are termed leveraged ESOPs. Loans to ESOP plans must comply with IRS and Labor Department requirements. Refer to the Leveraged ESOPs caption below.

D.2.e.(2). Leveraged ESOPs
Since a majority of ESOPs are leveraged, the examiner needs to understand the concept of a leverage ESOP and the conditions that apply. A corporation creates an ESOP, alone or in addition to (sometimes referred to as piggyback) another qualified retirement plan. The ESOP applies for a loan. The lender is usually an independent third party, but it could be anyone, including a party in interest such as the plan sponsor or the bank.

A number of conditions apply to such loans when the loan is with or guaranteed by a party in interest. The ESOP loan should be primarily for the benefit of participants and beneficiaries. Demand loans are not permitted and the loan must be payable over a set period. Terms of the loan must be, at the time it is made, at least as favorable to the ESOP as those of a comparable loan negotiated at an arm's-length basis by independent parties. No more than a reasonable rate of interest may be charged. While the loan may be unsecured, most ESOP loans are secured. If collateral is given by the plan to a party in interest, it may consist only of qualifying employer securities.

Leveraged financing may operate in two different ways. In the first way, the company gives the lender a written guaranty promising that the ESOP will repay the loan and that, each year, the employer will contribute to the ESOP sufficient funds to permit the ESOP to make its annual repayment of the loan. In the second way, the company borrows money from a bank and lends the money to the ESOP under terms identical to those negotiated between the company and the bank (mirror loan). After one of the financing options is chosen, the ESOP takes the loan proceeds and purchases qualifying employer securities at a reasonable price. Purchases must meet the conditions of ERISA Section 408(e) to avoid violating prohibited transaction rules.

Company contributions to the ESOP, which are tax-deductible under IRC Section 404, are used to pay off the loan. The employer's entire plan contribution (used to pay back the loan) is deductible within the limits of the IRC. If the employer borrowed the money directly, only the interest paid on the loan, and not repayment of the principal, would be deductible. The payments release a proportionate amount of securities from the loan's collateral. The securities, which were held in a suspense account by the plan, can be allocated among the plan participants as portions of the loan are paid off.

D.2.e.(3). Advantages and Disadvantages of an ESOP
There are a number of factors that influence the decision to sponsor an ESOP. Many of the considerations are tax-oriented. The plan sponsor, participating employees, and other parties all derive various advantages and disadvantages from the operation of an ESOP.

Employer Considerations
The employer's advantages include the fact that ESOPs are believed to foster productivity on the part of employees who will own part of the company. An ESOP may also provide a means of raising capital internally without resorting to outside financing, which may be more expensive. If leverage for the ESOP is necessary, the lender may offer a lower interest rate to the plan since interest received on the loan may be non-taxable to the lender (see Lenders to ESOPs). In addition, an ESOP may be used to convert a public company to a private one or to resist an unwanted takeover. An ESOP used for such a purpose is subject to, among other things, the fiduciary responsibility and prohibited transaction provisions of Title I of ERISA, Protection of Employee Benefit Rights

Operating an ESOP also offers the employer a number of tax advantages. Tax deductions are available for stock or cash contributions to the plan, cash dividends paid to plan participants, and dividends used to repay the loan. Particularly noteworthy is that the employer's entire plan contribution (used to pay back the loan) is deductible within IRC Section 404 limits.

Disadvantages for the employer involve the dilution of ownership and/or control, and the difficulties and costs inherent in arriving at recurring fair market valuations for thinly-traded securities.

Employee Considerations
The primary consideration for most employees is that contributions made by the employer and accumulated earnings are tax-deferred. In addition, taxes on stock appreciation, when the stock is distributed, may be deferred by rolling the distribution over into an Individual Retirement Account (IRA). The fact that ESOPs offer employees a stake in the employer corporation through stock ownership has meant, in some situations, that employees have been able to save their jobs by purchasing a company or production facility which was scheduled for closure.

One significant disadvantage is that the employee bears all investment risk. In addition, the employee's investment is concentrated in one company's stock performance and valuations for the employer stock may be difficult to achieve. If the outlook for the employer's industry or for the employer itself is poor, the employee's retirement benefits may be threatened. Ownership of marginal or poorly managed companies, or those in declining industries, is of little value to employees and no foundation for careful retirement planning. As with any defined contribution plan, the employee's benefits are not insured by the PBGC.

When employees own stock in the employer, they exercise a certain amount of control over the employer. However, their influence may be limited as most ESOPs do not own a majority of the company's stock. Only shares allocated to Individual accounts have voting rights. And, the allocation of stock to Individual employees' accounts is a slow process in leveraged ESOPs. Voting rights are fully passed through only in publicly traded companies; in non publicly traded companies, only certain issues are voted on by participants. In a number of instances where an ESOP was formed to permit employees to purchase a facility from the employer, the employees owned a majority of the stock but management controlled voting authority. In effect, the employees may have little or no say in how the company they own is managed or operated.

To qualify for tax credit under IRC Section 409, ESOPs are required to pass the following voting rights on to Individual accounts holding allocated shares. IRC Section 409(e)(2) requires plans holding registered employer securities to permit plan participants to direct the plan on how to vote allocated securities. Where plans hold non-registered securities, IRC Sections 409(e)(3) and (5) require plans to permit plan participants to direct the plan on how to vote allocated securities with respect to corporate matters, such as: mergers, consolidations, recapitalization, reclassification, liquidation, dissolution, sale of substantially all assets of a business, or similar transactions. IRC Section 409(e) is located in Appendix E.

Lenders to ESOPs
Tax laws provide incentives for lenders to grant loans to ESOPs. Under IRC Section 133, 50% of the interest the lender earns from an ESOP loan is non-taxable income when certain conditions are met:

• The ESOP owns at least 50% of each class of the outstanding stock of the corporation issuing the stock (or 50% of all outstanding stock) immediately after the acquisition (there are some limited additional provisions for isolated situations);
  
• The term of the loan isn't for more than 15 years; and
  
• The participants can direct the plan how to vote the shares allocated to their Individual accounts and acquired with the exempt loan.

These loans carry normal credit risk to the lender; plan sponsors in weak financial condition may involve more than normal credit risk. If the employer is unable to make its contributions to the ESOP, the plan will be unable to repay the lender. If the lender exercises its rights as a secured lender (the employer stock collateral pledged by the ESOP and the employer guarantee), it may wind up owning and operating the company.

Company Shareholder Considerations
Generally, if an ESOP exists, shareholders of the employer have a ready market for their stock. In addition, if a shareholder sells his or her employer stock to the ESOP, any unrealized gain may be deferred. The shareholder may elect not to recognize the gain on the sale of stock to the ESOP if qualified replacement property is purchased within the replacement period. Refer to IRC Section 1042 regarding the Sales of Stock to Employee Stock Ownership Plans or Certain Cooperatives.

D.2.f. Thrift and Savings Plans
A thrift or savings plan is a defined contribution plan which is also a type of Individual account plan. These plans are employer sponsored and employee participation is normally voluntary. The plans permit the employee to make contributions, usually established as a percentage of pay. Employers normally make matching or partially matching contributions.

In many thrift and savings plans, employees can direct their plan assets into several pre-selected investment vehicles. Many corporate plans include employer stock as one of the investment options for these plans. An advantage to a plan where the employee decides how to invest funds in his or her plan account is that there is a reduced fiduciary liability for both the plan sponsor and any bank trustee. Self-directed thrift plans must generally comply with the requirements of DOL ERISA Regulation 2550.404c-1. This is discussed further in subsection H.5.c.(6), Individual Account (Section 404(c)) Plans.

Most thrift and savings plans are tax-qualified. Section 401(k) of the IRC, which originally was added in 1978, permits employers to establish tax-qualified cash or deferred profit sharing or stock bonus plans. Under such plans, taxes on amounts contributed by both the employer and the employee, as well as accumulated earnings are deferred. With a salary reduction-type arrangement, the employees receive less current cash income and pay correspondingly lower Federal income taxes. Essentially, what a salary reduction plan accomplishes is to permit employees to provide for their own retirement with pre-tax dollars, rather than after-tax dollars.

To qualify for the mentioned tax benefits, the IRS requires the plan document to cover a number of specific areas. Among these are nondiscrimination in eligibility for the plan, and provisions to assure that executives and highly-paid employees do not receive preferential treatment. Vesting, withdrawals, participant loans, distribution of benefits, and other requirements must be met. The IRS rules governing these matters are complex and are primarily a concern for the plan sponsor, not a bank fiduciary.

D.2.g. Welfare Benefit Plans
The more common types of employee welfare benefit plans and the related benefits include:

• Health Plans which provide for hospital expenses, diagnostic X-ray and laboratory fees, surgical and medical fees, medicine and drugs, major medical insurance, accidental death and dismemberment, and life insurance benefits. Such plans may also provide for dental care, visual care, psychiatric care, and preventive medical examinations.
  
• Disability Plans which normally provide benefits during periods of inability to work because of physical incapacity from illness or injury.

• Vacation and Holiday Plans which provide cash benefits to cover time off for vacation purposes.

• Apprenticeship, Educational, and Similar Plans which provide funds for retraining Individuals in the event of termination of a job in a particular industry, provide an opportunity to expand skills to improve job performance, or take on new responsibilities within or outside of the company.

• Multiple Employer Welfare Arrangements (MEWAs) which permit a pooling of employer contributions to purchase health insurance for their employees at favorable rates. Problems can arise because some suppliers offer attractively priced but unfunded "insurance-like" products without complying with state insurance laws. These suppliers claim their products are employee benefit "plans" and are, therefore, preempted from state insurance laws by ERISA. In doing so, they attempt to avoid state regulation and insurance reserve requirements. The following rules apply: (1) when a MEWA is covered by ERISA and fully insured (which rarely happens), state insurance laws may apply to the extent they provide specified levels of reserves and contributions to pay future benefits; (2) when a MEWA is covered by ERISA and not fully insured, any state insurance law "not inconsistent" with ERISA may also apply; (3) when a MEWA is not covered by ERISA, no preemption can be claimed. Refer to subsection L, Compliance with State Laws for additional comment on state law and MEWAs. [The term MEWA is defined for purposes of Title I of ERISA in Section 3(40)(A); section 514(b)(6) of ERISA addresses the issue of presumption with respect to MEWAs.]

Most single employer welfare plans are either insured plans or unfunded plans. The insured plans typically provide medical and/or life insurance. The unfunded benefit plans most common for single employers are vacation and sick leave plans. The establishment of a single trust, to which contributions are made and from which benefits are paid, normally involves multiple employer plans. Occasionally larger corporations may provide medical and life benefits on a self-insured basis. In these instances, a trust to which annual contributions are made may be established.

Since welfare benefits are normally included in group insurance programs, an examiner will infrequently encounter a trust department acting as trustee of a welfare benefit plan. However, trusteed welfare benefit plans are subject to the various provisions of ERISA in the same manner as pension benefit plans. Thus, when encountered in trust departments there must be a plan and trust document which defines the manner of contribution, provides the basis for payment of benefits, and describes the manner in which such plan funds are to be invested.

D.3. Abandonned Plans

The Abandoned Plan Program facilitates the termination of, and distribution of benefits from, individual account pension plans that have been abandoned by their sponsoring employers. The program was established pursuant to three final regulations and a related class exemption and is administered by Employee Benefits Security Administration national and regional offices.

Significant business events, such as bankruptcies, mergers, acquisitions, and other similar transactions affecting the status of an employer, too often result in employers, particularly small employers, abandoning their individual account pension plans (e.g., 401(k) plans). When this happens, custodians such as banks, insurers, mutual fund companies, etc. are left holding the assets of these abandoned plans but do not have the authority to terminate such plans and make benefit distributions – even in response to participant demands. In these situations, participants and beneficiaries have great difficulty accessing the benefits they have earned. In response, the Labor Department’s Employee Benefits Security Administration (EBSA) has developed rules to facilitate a voluntary, safe and efficient process for winding up the affairs of abandoned individual account plans so that benefit distributions are made to participants and beneficiaries. Information about the program is available under the Abandoned Plan Program section of EBSA’s Web site at www.dol.gov/ebsa.

Overview of Regulations

The regulations, 29 CFR Parts 2550 and 2578, establish standards for determining when a plan is abandoned, simplified procedures for winding up the plan and distributing benefits to participants and beneficiaries, and provide guidance on who may initiate and carry out the winding-up process.

Plan Abandonment

A plan generally will be considered abandoned if no contributions to or distributions from the plan have been made for a period of at least 12 consecutive months and, following reasonable efforts to locate the plan sponsor, it is determined that the sponsor no longer exists, cannot be located, or is unable to maintain the plan.

Determinations of Abandonment

Only a qualified termination administrator (QTA) may determine whether a plan is abandoned under the regulations. To be a QTA, an entity must hold the plan’s assets and be eligible as a trustee or issuer of an individual retirement plan under the Internal Revenue Code (e.g., bank, trust company, mutual fund family, or insurance company).

Termination and Winding-Up Process

The regulations establish specific procedures that QTAs must follow, including:

• Notifying EBSA prior to, and after, terminating and winding up a plan.
• Locating and updating plan records.
• Calculating benefits payable to participants and beneficiaries.
• Notifying participants and beneficiaries of the termination, their rights and options.
• Distributing benefits to participants and beneficiaries.
• Filing a summary terminal report.

A QTA is not required to amend a plan to accommodate the termination.

The regulations include model notices that the QTA may use.

Distribution Safe Harbor for Missing Participants

The regulations establish a fiduciary safe harbor for distributions from terminating individual account plans (whether or not abandoned) on behalf of missing participants.

In most cases, the account of a missing participant will be transferred directly to an individual retirement plan. In some cases, accounts of $1,000 or less may be distributed to a bank account or state unclaimed property fund on behalf of the missing participant.

Fiduciary Liability

QTAs that follow the regulations will be considered generally to have satisfied the prudence requirements of ERISA with respect to winding-up activities.

A QTA does not have an obligation to conduct an inquiry or review to determine whether or what breaches of fiduciary responsibility may have occurred with respect to a plan prior to becoming the QTA for such plan.

A QTA is not required to collect delinquent contributions on behalf of the plan, provided that the QTA informs EBSA of known delinquencies.

Since more than one entity may be holding assets of a plan, the regulations provide a safe harbor for other asset custodians who cooperate with the QTA.

Annual Reporting Relief

The regulations provide annual reporting relief, under which QTAs are not responsible for filing a Form 5500 Annual Report on behalf of an abandoned plan, either in the terminating year or any previous plan years; but the QTA must complete and file a summary terminal report at the end of the winding-up process.

Instructions on how to file the terminal report will be available under the Abandoned Plan Program section of EBSA’s Web site at www.dol.gov/ebsa.

Class Exemption

Accompanying the regulations is a class exemption, PTE 2006-06 (116KB PDF file - PDF Help), that provides conditional relief from ERISA’s prohibited transaction restrictions.

The exemption would cover transactions where the QTA selects and pays itself:

• For services rendered prior to becoming a QTA.
• To provide services in connection with terminating and winding up an abandoned plan.
• For distributions from abandoned plans to IRAs or other accounts maintained by the QTA resulting from a participant’s failure to provide direction.

D.4. Health Savings Accounts (HSAs)

Health Savings Accounts (HSAs) were created on December 8, 2003 under Title XII of the Medicare Prescription Drug, Improvement and Modernization Act of 2003," (MPDIMA of 2003) and updated under Title III of the Tax Relief and Health Care Act of 2006 (TRHCA of 2006).

In general, HSAs are tax-exempt trusts or custodial accounts created exclusively to pay for the qualified medical expenses of the account holder and his or her spouse and dependents. Individuals with a high deductible health plan (and no other health plan other than a plan that provides certain permitted coverage) may establish an HSA. However, individuals who may be claimed as a dependent on another person’s tax return are not eligible to open an HSA. HSAs provide tax-favored treatment for current medical expenses as well as the ability to save on a tax-favored basis for future medical expenses. Within limits, contributions to an HSA made by or on behalf of an eligible individual are deductible by the individual. Where the establishment of an HSA is voluntary on the part of an employee, and the employer does not influence or limit the investment or use of HSA funds, the HSA does not constitute "employee welfare benefit plans" for purposes of Title I of ERISA. Individuals may make tax deductible contributions to the HSA even if they do not itemize deductions; the individual’s employer can make contributions that are not taxed to either the employer or the employee; and, employers sponsoring cafeteria plans can allow employees to contribute untaxed salary through salary reduction. Individuals age 55 and older are also allowed to make additional catch-up contributions to their HSAs. Furthermore, certain credits on behalf of the individual by plan sponsors are permissible and not viewed as a prohibited transaction under ERISA or the Code. Amounts contributed to an HSA belong to the account holder and are portable. Earnings on HSAs are not taxable, and can grow tax-free through investment earnings. Unlike amounts in Flexible Spending Arrangements that are forfeited if not used by the end of the year, unused funds remain available for use in later years. Distributions from an HSA for qualified medical expenses are not includible in gross income. However, distributions from an HSA which are not used for qualified medical expenses are includible in gross income and subject to an additional 10 percent tax. The additional tax does not apply if the distribution is made after death, disability, or the individual attains the age of 65. After an individual has attained age 65 and becomes enrolled in Medicare benefits, contributions cannot be made to an HSA.

A high deductible health plan is a health plan that, for 2007, has a deductible that is at least $1,100 for self-only coverage or $2,200 for family coverage and that has an out-of-pocket expense limit that is no more than $5,500 in the case of self-only coverage, and $11,000 in the case of family coverage. Out-of-pocket expenses include deductibles, co-payments, and other amounts (other than premiums) that the individual must pay for covered benefits under the plan. A plan is not a high deductible health plan if substantially all of the coverage is for permitted coverage or coverage that may be provided by permitted insurance. A plan does not fail to be a high deductible health plan by reason of failing to have a deductible for preventive care.

Permitted insurance is: (1) insurance if substantially all of the coverage provided under such insurance relates to (a) liabilities incurred under worker’s compensation law, (b) tort liabilities, (c) liabilities relating to ownership or use of property (e.g., auto insurance), or (d) such other similar liabilities as the Secretary of Treasury may prescribe by regulations; (2) insurance for a specified disease or illness; and (3) insurance that provides a fixed payment for hospitalization.

Permitted coverage is coverage (whether provided through insurance or otherwise) for accidents, disability, dental care, vision care, or long-term care.

Health flexible spending arrangement (“FSAs”) and health reimbursement arrangements (“HRAs”) are health plans that constitute other coverage under the HSA rules. An individual who is covered by a high deductible health plan and a health FSA, or HRA, is generally not eligible to make contributions to an HSA. An individual is eligible to make contributions to an HSA if the health FSA or HRA is: (1) a limited purpose health F