UPDATE
Financial Institution
Tax-Favored Savings Accounts
QUALIFIED RETIREMENT PLANS n INDIVIDUAL RETIREMENT ACCOUNTS n 403( b) PLANS n 457 PLANS
529 PLANS n COVERDELL EDUCATION SAVINGS ACCOUNTS n ARCHER MEDICAL SAVINGS ACCOUNTS
NOVEMBER 2002
With this issue, Kirkpatrick & Lockhart LLP is launching the periodic publication of the Financial Institution
Tax-Favored Savings Accounts Update. The Update will focus on legal issues of interest to financial institutions
that offer their customers investment opportunities through tax-favored savings accounts such as qualified
retirement plans, individual retirement accounts, 403(b) plans, 457 plans, 529 qualified tuition programs,
Coverdell education savings accounts and Archer medical savings accounts. In each issue, we plan to highlight
topics that reflect the variety of roles that financial institutions serve with respect to tax-favored savings
accounts, including recordkeeper, trustee or custodian, and document sponsor. If you wish to be included on
the mailing list for this publication, please send your e-mail address to Joanne Cowden at jcowden@kl.com.
Department of Labor Publishes Regulations Concerning
Advance Notice of Blackout Periods
The Department of Labor (DOL) has published
regulations obligating administrators of defined
contribution retirement plans to provide plan
participants and beneficiaries (and the issuer of any
employer securities held by the plan) advance notice
of any investment, loan or distribution “blackout
period.” (67 Federal Register 64765 (October 21, 2002)).
Blackout periods are relatively common in connection
with changes in plan investment alternatives in
participant-directed investment plans, changes in plan
recordkeepers and plan mergers and acquisitions, but
they can arise in other circumstances as well.
Contents
The regulations generally provide that the “plan
administrator” of an individual account plan (which is
defined to exclude plans with only one participant) must
notify affected plan participants and beneficiaries at least
30 and no more than 60 days in advance of a blackout
period that will result in a suspension, restriction or
limitation of the rights of plan participants or beneficiaries
to direct or diversify assets credited to their accounts,
to obtain loans from the plan, or to obtain distributions
from the plan for a period of more than three consecutive
business days. The regulations do not apply to blackout
periods related to the administration of qualified domestic
relations orders or to blackout periods resulting from the
application of federal securities laws.
Department of Labor Publishes Regulations
Concerning Advance Notice of Blackout Periods .................. 1
Year-End Model IRA Document
Deadline is Approaching ........................................................ 3
Year-End Prototype Qualified Plan Deadline Extended ...... 4
DOL Addresses “Float” Earned by
Plan Service Providers ............................................................. 4
Tax Court Decision Describes Alternative Method
for Acquiring Private Company Stock by Individual
Retirement Account ................................................................ 5
Individuals May Use New Required Minimum
Distribution Tables to Calculate Substantially
Equal Periodic Payments Under Code Section 72(t) ............. 6
The regulations, adopted as interim final rules,
implement the provisions of the Sarbanes-Oxley Act of
2002 (SOA) that directed the DOL to issue regulatory
guidance on defined contribution plan blackout periods.
The regulations will become effective for blackout periods
beginning on or after January 26, 2003.
Kirkpatrick & Lockhart LLP
The 30-day advance notice deadline does not apply in
the following situations:
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Where a postponement of the blackout period to
accommodate the 30-day advance notice requirement
would result in a fiduciary violation of the Employee
Retirement Income Security Act of 1974 (e.g.,
continued investment in the securities subject to
the blackout would be imprudent).
Where commencement of the blackout period is due to
events that were unforeseeable or circumstances that
are beyond the control of the plan administrator (e.g., a
recordkeeper’s computer failure).
Where the blackout period applies only to
participants or beneficiaries in connection with a
merger, acquisition or divestiture, or similar
transaction involving either the plan or the plan
sponsor, and occurs solely in connection with
individuals becoming or ceasing to be participants
or beneficiaries under the plan as a result of the
transaction.
In each of these cases, notice must nevertheless be
provided as soon as reasonably possible under the
circumstances. An administrator that wishes to avail
itself of the fiduciary and unforeseeable circumstance
exceptions to the 30-day rule must sign and date a
written determination of the circumstances giving rise
to the exception.
The 30-day advance notice deadline also does not apply
during the period beginning January 26, 2003 (the effective
date of the regulations), and ending February 25, 2003.
For blackout periods beginning during this period,
administrators are only obligated to deliver the notice as
soon as reasonably possible.
Although at least one notice must generally be
delivered between 30 and 60 days prior to a blackout
period, the regulations do not prohibit the delivery of
multiple notices or additional notices more than 60 days
or less than 30 days before the blackout period.
The required notice must be provided in writing to plan
participants and beneficiaries who are affected by the
blackout period. The notice may be furnished in any
manner otherwise permitted under the DOL’s general
disclosure rules, including electronically. Notices that
are furnished by first-class mail will be deemed to have
been provided on the date of mailing.
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If the plan holds employer securities, the notice must
also be provided to the issuer of the employer securities
(which, in many cases, will also be the plan
administrator). Notice delivered to the issuer’s agent
for service of legal process (or other person designated
in writing by the issuer) will be considered notice to
the issuer. The purpose of the administrator ’s
obligation to notify the issuer of a blackout period is to
enable the issuer to meet the obligation separately
imposed on the issuer by the SOA to notify its directors
and executive officers and the Securities and Exchange
Commission of certain plan-related blackout periods. In
this regard, the issuer’s directors and executive officers
are prohibited by the SOA from trading in certain employer
securities during plan-related blackout periods applicable
to employer securities.
The DOL has prescribed a number of specific rules
regarding the required content of the notice to affected
participants and beneficiaries. These specific content
rules are generally beyond the scope of this article.
However, it is worth noting that the notice must specify
the expected beginning and ending dates of the
blackout period and must designate an individual
responsible for answering questions about the blackout
period. In the event of any change in the beginning
and ending dates of the blackout period, a supplemental
notice must be distributed as soon as reasonably
possible.
The DOL has published a model notice that
administrators may use to satisfy their notice
obligations.
The notice to the issuer need not contain all of the
information contained in the notice to affected
participants and beneficiaries; however, the notice
provided to affected participants and beneficiaries will
be considered sufficient for this purpose.
Under regulations separately issued by the DOL, the
DOL may assess a civil penalty of up to $100 per day from
the date of the plan administrator’s failure or refusal to
provide notice to a participant or beneficiary. The DOL
emphasizes that the administrator is personally liable for
the payment of these penalties and that the penalties may
not be paid by the plan.
KIRKPATRICK & LOCKHART LLP FINANCIAL INSTITUTION UPDATE
Year-End Model IRA Document Deadline is Approaching
In Revenue Procedure 2002-10 (January 28, 2002), the
Internal Revenue Service (IRS) published procedures
for updating individual retirement account documents
to reflect the provisions of the Economic Growth and
Tax Relief Reconciliation Act of 2001 (EGTRRA).
Under Revenue Procedure 2002-10, an individual whose
individual retirement account is established using a model
trust or custodial agreement published by the IRS, and
who wishes to take advantage of the EGTRRA
amendments to the Internal Revenue Code for 2002 (e.g.,
the $500 catch-up contribution for individuals age 50 or
older by December 31, 2002 and the higher $3,000 regular
contribution limit) must adopt an EGTRRA-updated
revised model trust or custodial agreement by December
31, 2002.
The IRS issued the following EGTRRA-updated
individual retirement account trust and custodial
agreements earlier this year:
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Form 5305 (Traditional Individual Retirement Trust
Account)
Form 5305-A (Traditional Individual Retirement
Custodial Account)
Form 5305-R (Roth Individual Retirement Trust
Account)
Form 5305-RA (Roth Individual Retirement Custodial
Account)
Form 5305-RB (Roth Individual Retirement Annuity
Endorsement)
Form 5305-S (SIMPLE Individual Retirement Trust
Account)
Form 5305-SA (SIMPLE Individual Retirement
Custodial Account)
In addition, employers that have established a SIMPLE
plan or Simplified Employee Pension plan (SEP) using
a model plan published by the Internal Revenue Service
and that wish to take advantage of the EGTRRA
amendments to the Internal Revenue Code for 2002
must adopt an EGTRRA-updated model plan by
December 31, 2002.
The IRS issued the following EGTRRA-updated model
plans earlier this year:
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Form 5304-SIMPLE (Savings Incentive Match Plan
for Employees of Small Employers (SIMPLE)—Not
for Use With a Designated Financial Institution)
Form 5305-SIMPLE (Savings Incentive Match Plan
for Employees of Small Employers (SIMPLE)—for
Use With a Designated Financial Institution)
Form 5305-SEP (Simplified Employee Pension—
Individual Accounts Contribution Agreement)
Form 5305A-SEP (Salary Reduction Simplified
Employee Pension—Individual Accounts
Contribution Agreement)
Trustees and custodians of individual retirement accounts
will need to ensure that employers and individual retirement
account owners that use the IRS’s model agreements and
plans comply with the December 31, 2002 deadline.
Note: Use of the pre-EGTRRA model documents to
establish a new individual retirement account, SIMPLE
or SEP is not permitted after October 1, 2002.
Individual retirement account owners whose individual
retirement accounts are established using prototype trust
and custodial agreements (rather than the IRS model
agreements) will need to adopt the appropriate EGTRRAupdated model form by December 31, 2002, or an EGTRRAupdated prototype within 180 days after the IRS issues an
opinion letter to the sponsor of the prototype. Employers
whose SIMPLE and SEP plans are established using
prototype plan documents will need to adopt the prototype
sponsor’s EGTRRA-updated prototype within 180 days
after the IRS issues an opinion letter to the sponsor of the
prototype. Sponsors of prototype plans and agreements
are required to submit EGTRRA-updated prototypes to
the IRS by December 31, 2002.
Kirkpatrick & Lockhart LLP
Year-End Prototype Qualified Plan Deadline Extended
In Revenue Procedure 2002-73 (effective December 9,
2002), the Internal Revenue Service has extended the
deadline by which adopters of master, prototype or
volume submitter plans must amend their plans to
comply with the requirements of the Uruguay Round
Agreements Act, the Uniformed Services Employment
and Reemployment Rights Act of 1994, the Small
Business Job Protection Act of 1996, the Taxpayer
Relief Act of 1997, the Internal Revenue Service
Restructuring and Reform Act of 1998 and the
Community Renewal Tax Relief Act of 2000 (the socalled “GUST” amendments).
Prior to the release of Revenue Procedure 2002-73,
employers that had adopted pre-GUST master,
prototype or volume submitter plans or that had
certified their intent to adopt a GUST-restated master,
prototype or volume submitter plan by the GUST
deadline applicable to individually designed qualified
retirement plans (generally, the later of the last day of
the first plan year beginning after January 1, 2001 or
February 28, 2002) were required to adopt a GUSTrestated master, prototype or volume submitter plan by
the later of December 31, 2002 or the last day of the 12th
month following the date the Internal Revenue Service
issues a favorable opinion letter to the sponsor of the
master, prototype or volume submitter plan.
Revenue Procedure 2002-73 extends this deadline to
the later of September 30, 2003 or the last day of the 12th
month following the date the Internal Revenue Service
issues a favorable opinion letter to the sponsor of the
master, prototype or volume submitter plan.
DOL Addresses “Float” Earned by Plan Service Providers
In a recent Field Assistance Bulletin to its field
enforcement personnel, the Department of Labor (DOL)
addressed the controversial topic of “float” earned by
a bank trustee or other service provider to an employee
benefit plan. “Float” is the return on uninvested cash
balances that typically arises when a plan service
provider can invest that cash for its own account
pending investment by, or distribution from, the plan.
Although continuing to recognize that float may be a
permissible form of compensation to employee benefit
plan service providers, Field Assistance Bulletin
(“FAB”) 2002-3 describes the obligations of plan
fiduciaries and service providers to ensure that float
arrangements are reasonable and do not involve
prohibited transactions.
The DOL first addressed the float issue in a 1994
advisory opinion and then in a follow-up letter to the
American Bankers Association. In those letters, the
DOL took the position that a bank or other plan service
provider may retain float on uninvested funds as part
of its compensation. In FAB 2002-3, the DOL notes,
however, that subsequent field investigations have
shown “a variety of methods by which plan fiduciaries
are informed of, and or approve, the practice of plan
service providers retaining float as part of their overall
compensation,” and that “there is little or no disclosure
of specific information regarding compensation earned
in the form of float.” Accordingly, the FAB describes
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certain minimum criteria for float arrangements. In
particular, FAB 2002-3 states that a plan fiduciary
authorizing a float arrangement must:
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Review “comparable” service providers and
arrangements to determine whether other providers
keep float rather than credit it to the plan.
Review and understand the circumstances under
which float may be earned and, among other things,
ensure that service agreements include appropriate
“time limits” for the retention of funds on which
float may be earned.
Evaluate float as part of the provider ’s “total
compensation.” This includes, in the DOL’s view,
requesting and reviewing “the rates the provider
generally expects to earn” on float.
Similarly, FAB 2002-3 also indicates that a service
provider who receives compensation that includes float
must:
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Disclose the “specific circumstances” under which
float will be earned.
Establish, disclose, and adhere to “specific time
frames” within which cash balances will be invested
for the plan’s benefit.
In the case of float on plan distributions, disclose
when the float period begins and ends as well as the
KIRKPATRICK & LOCKHART LLP FINANCIAL INSTITUTION UPDATE
time frames for mailing and other administrative
practices that might affect the float period.
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Disclose the “rate of the float” or the specific manner
in which the rate will be determined.
Thus, FAB 2002-3 provides further insight into the
DOL’s views as to the required elements of arrangements
with plan service providers where float is a part of the
compensation earned by the service providers.
Tax Court Decision Describes Alternative Method for Acquiring
Private Company Stock by Individual Retirement Account
A recent decision by the United States Tax Court, Ancira
v. Commissioner, 119 T. C. (Sept. 24, 2002), approves
an unusual method by which an individual retirement
account (IRA) can invest in the stock of a private
company. For a variety of reasons, many IRA trustees
and custodians do not permit investments in private
company stock. Among the objections to such
investments for IRAs are the difficulties in making the
purchase, the illiquidity of the investment and the need
to maintain custody of share certificates.
Some commentary in the popular press has described
the acquisition method in Ancira as one that IRA
owners may use to overcome IRA trustee or custodian
objections to private company stock investments.
However, we find Ancira, although of interest, likely to
be of limited utility to IRA owners. Nevertheless, in
light of the attention received by Ancira in the popular
press, we anticipate that the Ancira decision is likely
to be the source of inquiries from IRA owners and that,
therefore, IRA trustees and custodians should at least
be aware of it.
In Ancira, the owner of a self-directed IRA wished to
purchase the stock of a private company. Because of
the mechanical difficulties associated with the
acquisition of private company stock, the custodian of
the IRA would not directly acquire the stock. Instead,
by arrangement with the IRA custodian and the private
company, the IRA owner invested in the private
company by completing a distribution form that
instructed the custodian to issue a check drawn on the
account and payable to the private company. The IRA
owner then delivered the check to the company and
instructed the company to issue the shares in the name
of his IRA.
The custodian characterized the transaction as a
distribution and filed a Form 1099-R to report the
distribution to the Internal Revenue Service (IRS). The
IRA owner did not report this amount on his federal income
tax return. In litigation that resulted from an IRS audit of
the IRA owner’s return, the IRS took the position that the
amount paid to purchase the shares was a taxable
distribution from the IRA.
The Tax Court rejected the position of the IRS and
characterized the purchase of the private company
shares as an investment by the IRA rather than a
distribution in part because the IRA owner had no right
under state law to negotiate the check, and instead,
acted as a mere conduit for the investment.
Although Ancira has been billed as enabling IRA
owners to invest in private companies where the trustee
or custodian would not otherwise permit such an
investment, it remains to be seen whether IRA trustees
or custodians will in fact adopt this approach. True,
the Ancira method can facilitate the making of the
investment. However, the method does nothing to
address concerns an IRA trustee or custodian may have
that the investment is illiquid and thus may be difficult
to value or that physical custody of the share
certificates representing the investment will be needed.
Notably, in Ancira, the share certificates were delivered
to the custodian only after the IRS had issued a notice
of deficiency to the IRA owner. The Tax Court observed
that this failure did not change the result.
Notwithstanding the Tax Court’s observation, we
believe it is not good practice for IRA trustees and
custodians to allow stock certificates representing
private company stock investments to be routinely held
outside the custody of the trustee or custodian (or the
agent of the trustee or custodian).
Kirkpatrick & Lockhart LLP
Individuals May Use New Required Minimum Distribution
Tables to Calculate Substantially Equal Periodic Payments
Under Code Section 72(t)
Section 72(t) of the Internal Revenue Code imposes a
10% excise tax on certain distributions from individual
retirement accounts and qualified retirement plans prior
to age 59-1/2. The excise tax does not apply if the
distribution is one of a series of substantially equal
periodic payments (not less frequently than annually)
made for the life (or life expectancy) of the account owner
or plan participant or the joint lives (or joint life
expectancy) of the account owner or plan participant
and his or her beneficiary. If a series of substantially
equal periodic payments that is otherwise exempt from
the 10% excise tax is substantially modified within the
five-year period beginning on the date of the first
payment, the 10% excise tax is retroactively applied to
the prior payments.
payments) may, at any time, change to the 2002 required
minimum distribution method without triggering the
retroactive 10% excise tax. The Revenue Ruling provides
that an individual that uses the 2002 required minimum
distribution method may use either the uniform life
expectancy, the single life expectancy or the joint and
last survivor life expectancy tables in the 2002 required
minimum distribution rules (using, in the case of the
joint and last survivor expectancy table, the age of the
individual’s beneficiary).
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FOR MORE INFORMATION regarding the items described in this
update, or other issues concerning financial institution tax-favored savings
accounts, please contact Michael Hart or Catherine Bardsley at the
e-mail address or telephone number listed below:
In 1989 (Notice 89-25), the Internal Revenue Service (IRS)
specified three methods of distribution that could be
used to comply with the substantially equal periodic
payment exception. One of those methods permitted
distributions to be calculated on the same basis as
required minimum distributions for individuals age
70-1/2 or older. Earlier this year, the IRS published final
regulations that, in many cases, changed the method for
calculating required minimum distributions for
individuals age 70-1/2 or older and thereby substantially
reduced, in many cases, the amount that is required to
be distributed.
Our Financial Institution Tax-Favored Savings Accounts practice is part of our
Employee Benefit Plans/ERISA practice. If you would like more information about
our Employee Benefit Plans/ERISA practice, please contact one of the attorneys
listed below:
Individuals who were receiving a series of substantially
equal periodic payments using the pre-2002 required
minimum distribution method are, in many cases,
receiving distributions that are larger than the
distributions they would receive under the 2002 required
minimum distribution rules. However, changing the
method of calculation would, arguably, cause a
substantial modification in the payment stream, thereby
triggering the retroactive 10% excise tax.
MICHAEL A. HART
412.355.6211
mhart@kl.com
Boston
Stephen E. Moore
617.951.9191
smoore@kl.com
Los Angeles
William P. Wade
310.552.5071
wwade@kl.com
New York
David E. Morse
212.536.3998
dmorse@kl.com
Pittsburgh
William T. Cullen
J. Richard Lauver
Charles R. Smith
Richard E. Wood
Linda B. Beckman
Douglas J. Ellis
Michael A. Hart
412.355.8600
412.355.6454
412.355.6536
412.355.8676
412.355.6528
412.355.8375
412.355.6211
wcullen@kl.com
rlauver@kl.com
csmith@kl.com
rwood@kl.com
lbeckman@kl.com
dellis@kl.com
mhart@kl.com
San Francisco Laurence A. Goldberg 415.249.1043
Kathleen M. Meagher 415.249.1045
Katherine L. Aizawa 415.249.1044
lgoldberg@kl.com
kmeagher@kl.com
kaizawa@kl.com
Washington
william.schmidt@kl.com
cbardsley@kl.com
eberger@kl.com
William A. Schmidt 202.778.9373
Catherine S. Bardsley 202.778.9289
Eric Berger
202.778.9473
In Revenue Ruling 2002-62, the IRS has concluded that
an individual who commenced receiving distributions
prior to January 1, 2003, using the pre-2002 method for
calculating the amount of annual distributions (or any
other method for calculating substantially equal periodic
BOSTON
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HARRISBURG
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LOS ANGELES
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MIAMI
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CATHERINE BARDSLEY
202.778.9289
cbardsley@kl.com
NEWARK
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Kirkpatrick & Lockhart LLP
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This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein
should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
© 2002 KIRKPATRICK & LOCKHART LLP.
ALL RIGHTS RESERVED.