September 1996 Vol. I, No.1
ERISA, EMPLOYEE BENEFITS AND EXECUTIVE COMPENSATION NEWSLETTER

TABLE OF CONTENTS (read left to right).

 I. PENSION SIMPLIFICATION

A. Nondiscrimination Rules

1. Family Aggregation

2. Repeal of Section 415(e) Combined Limit

3. Simplified HCE Definition

4. Simplified Testing

5. New Section 401(k) Safe Harbor

 B. Distribution Rules

1. Excess Distribution Tax Suspended

2. In Service Distribution at Age 70.5 Not Required

3. QJSA Notice Rules Eased

4. Taxation of Lump Sums

5. Exclusion for Employer-Provided Death Benefits Repealed

 C. Miscellaneous

1. Deadline for Plan Amendments

2. Higher Penalties for Reporting and Disclosure Breaches

3. Prohibited Transaction Tax Increased

4. Employer-Provided Educational Assistance

5. The SIMPLE Retirement Account

6. Spousal IRAs

 II. TAX-EXEMPT PLAN SPONSORS

A. Tax-Exempt Organizations Eligible for 40l(k)Plans

B. Section 403(b) Changes

C. Section 457(b) Plans

 III. HEALTH REFORM ACT

A. Health Care Access and Portability

1. Portability

2. Pre-Existing Conditions Exclusions

3. Nondiscrimination

4. Effective Date

B. Medical Savings Account

C. Increase in Self Employeds' Health Deduction

D. Long-Term Care Tax Treatment

E. COBRA Modifications

F. Corporate-Owned Life Insurance

G. Nontaxable Accelerated Death Benefits

IV. MISCELLANEOUS

A. Leased Employees

B. Safe Haven Rule for Employee/Independent Contractors

C. Employee Contributions Must Be Deposited 15 Days After Month Received

D. Repeal of State Source Taxation of Retirement Income

E. IRS Issues Proposed Rules on Loans to Plan Participants

F. Guidance to Plan Sponsors on Participant Investment Education

   

I. PENSION SIMPLIFICATION

President Clinton has signed into law a legislative reform of significance to employee benefit plan sponsors and service providers. The Small Business Job Protection Act of 1996 (the "Act") which was signed on August 20, 1996, contains many long-awaited pension simplification measures. The Act modified many current rules for discrimination testing, benefits limits and distributions from qualified retirement plans. On the other hand, penalties for prohibited transactions and failures to satisfy reporting requirements were significantly increased.

 

A. NONDISCRIMINATION RULES

1. Family Aggregation. The Act repeals the family aggregation rules applied in determining whether an employee is highly compensated and whether compensation taken into account under a plan exceeds the limit imposed under Internal Revenue Code (the "Code") Section 401(a)(17) (i.e., the $150,000 limit). The repeal is effective for plan years beginning after 1996.

Example: Jones Corporation maintains a money purchase pension plan which provides for a 20% of compensation contribution. Mr. Jones owns 100% of Jones Corporation and his wife works at the corporation. Both Mr. and Mrs. Jones earn in excess of $150,000. Prior to the change in law, the money purchase pension plan allocation for both Mr. and Mrs. Jones was limited to $30,000. After the repeal of the family aggregation rules, Mr. and Mrs. Jones may individually receive an allocation of $30,000 on their behalf under the plan.

2. Repeal of Section 415(e) Combined Limit. Under current law, Code Section 415(e) imposes a combined limit on the aggregate benefits an individual may receive from defined contribution and defined benefit plans maintained by the same employer. Perhaps the most welcomed provision of the Act repeals the combined limit, although the repeal is delayed until the first year beginning after 1999. This change will greatly simplify compliance testing for employers who maintain defined contribution and defined benefit plans that cover the same employees. In addition, it will permit significantly greater benefits to be provided from tax-qualified plans.

3. Simplified HCE Definition. Most qualified plan nondiscrimination rules are based on comparisons between highly compensated employees ("HCEs") and nonhighly compensated employees. However, the definition of HCE under current law is quite cumbersome and based on different levels of compensation, status as an officer and ownership of the employer.

Under the new law, for plan years beginning after December 31, 1996, an individual is an HCE only if he or she is a five-percent owner of the employer or earned compensation from the employer in the preceding year in excess of $80,000 (indexed for inflation). A plan may elect to limit HCEs to individuals among the top 20 percent of employees ranked by compensation.

4. Simplified Testing. The 401(k) nondiscrimination test, generally referred to as the actual deferral percentage ("ADP") test, is based on the average salary reduction amounts deferred by all highly compensated employees as compared to the average salary reduction amounts deferred by all nonhighly compensated employees. These averages are based on current year deferrals, which cannot be known until the end of the year. At the end of the year, the plan sponsor must scramble to determine the average deferrals, and if a violation of the rules exists, quickly distribute appropriate amounts to bring the plan back into compliance with the rules. Similar rules apply for employer matching and employee after-tax contributions under Code section 401(m). This test is generally referred to as the actual contribution percentage ("ACP") test.

The new law permits an employer to perform 401(k) nondiscrimination testing for any plan year beginning after 1996 using contribution and compensation information from the previous year for nonhighly compensated employees. (Current year contributions and compensation must be used for HCES, even though the HCEs are identified on the basis of the preceding year.) The change allows an employer to know in advance the maximum amount which may be contributed for a plan year by HCES, thereby minimizing the need for corrective action after the end of the plan year.

5. New Section 401(k) Safe Harbors. The Act establishes a new safe harbor for nondiscrimination testing, though the change does not take effect until plan years beginning after 1998. The 401(k) nondiscrimination test, or the ADP test, will be deemed satisfied if the employer makes nonelective contributions at least equal to three percent of compensation on behalf of each nonhighly compensated employee eligible to participate in the 401(k) plan. Alternatively, the employer may make matching contributions equal to 100 percent of each nonhighly compensated participant's salary deferrals up to three percent of the participant's compensation, plus 50 percent of the participant's salary deferrals in excess of three percent of compensation up to five percent of compensation.

The contributions made by an employer to satisfy the safe harbor must: (1) be fully and immediately vested, (2) be subject to the same restrictions on distributions as are salary reduction amounts (i.e., they may not be distributed prior to the participant's termination of employment, attainment of age 59.5, disability, death or financial hardship), and (3) not be "integrated" with Social Security. Also, the employer must provide advance written notice of the arrangement to each eligible employee.

The Act also provides a safe harbor for satisfying the matching or ACP test. That test will be deemed satisfied with respect to matching contributions if: (1) one of the ADP safe harbors is met, (2) salary reduction amounts and/or after-tax contributions in excess of six percent of compensation are not matched, (3) the rate of match does not increase as the rate of salary reduction increases, and (4) the rate of match for any HCE for any level of salary reduction is not higher than the rate applicable to any nonhighly compensated employee. In any event, the ACP test still must be satisfied with respect to after-tax contributions.

Whether an employer will use the safe harbor method of satisfying the ADP and/or ACP tests will likely depend on whether the costs of providing fully vested contributions at the prescribed levels are less than the costs involved in performing the nondiscrimination tests. In addition, an employer must address employee relations concerns regarding the distribution of excess contributions or other corrective action if the safe harbors are not used.

B. DISTRIBUTION RULES

1. Excess Distribution Tax Suspended. Code Section 4980A imposes a 15 percent excise tax on an individual to the extent that he or she receives distributions from qualified plans and/or IRAs during any year that, in the aggregate, exceed $150,000 (indexed for inflation) or, for a distribution for which special lump-sum tax treatment is elected, $750,000 (indexed for inflation). The Act provides that distributions received in 1997, 1998 or 1999 will not be subject to this excise tax.

The suspension of the excise tax provides planning opportunities for individuals over age 59.5 with large interests under qualified plans and/or IRAs. Note also that the 15 percent estate tax imposed under Code Section 4980A on excess accumulations under retirement plans and IRAs is not suspended. Thus, estates and non-spousal beneficiaries of decedents who die during the period of the suspension will continue to be subject to the accumulation tax.

Note that whether to take distributions from tax-favored plans during this time period requires sophisticated financial analysis. For some individuals, the ability to accumulate tax-deferred earnings on the amounts in retirement accounts may outweigh the financial advantage of escaping the excise tax.

2. In Service Distribution at Age 70.5 Not Required. Under current law, minimum distributions from tax-favored retirement plans, including individual retirement accounts, must begin by April 1 of the calendar year following the year the individual attains age 70.5 regardless of whether the individual is working or retired.

Beginning in 1997, qualified plan participants, other than five-percent owners, are not required to begin receiving distributions until April 1 of the year following the later of the year: (1) the employee retires, or (2) the employee reaches age 70.5. A defined benefit plan participant who continues to work after age 70.5 and does not begin to receive benefits must receive an actuarial increase in his or her benefit to reflect delayed commencement. IRA holders and five-percent owners continue to be subject to the rule that distributions must begin by April 1 of the calendar year following the year the individual attains age 70.5.

3. QJSA Notice Rules Eased. Currently, a qualified plan participant must receive notice of qualified joint and survivor annuity ("QJSA") rights at least 30 days, but no more than 90 days, before his or her annuity starting date, although temporary regulations permit waiver of the 30-day minimum period. Effective for plan years beginning after 1996, the new law codifies the 30-day waiver rule and further provides that notice may be given after the annuity starting date, so long as the participant has a 30-day election period thereafter or waives the 30-day period.

4. Taxation of Lump Sums. Effective for taxable years beginning after 1999, the Act repeals five-year forward averaging for lump-sum distributions from qualified plans. The Act preserves, however, the Tax Reform Act of 1986 grandfather rules for ten-year forward averaging and capital gains treatment (which allows individuals to treat amounts attributable to pre- 1974 contributions as capital gain), both of which are generally available to individuals who attained age 50 by January 1, 1986.

5. Exclusion for Employer-Provided Death Benefits Repealed. The Act repeals the $5,000 exclusion for employer-provided death benefits for deaths occurring after August 20, 1996.

C. MISCELLANEOUS

1. Deadline for Plan Amendments. Since the IRS permits incorporation of technical rules by reference in only limited situations, plan sponsors are required to amend their plans in order to implement these new rules. Plan amendments do not have to be made until the first day of the first plan year beginning after December 31, 1997 if the plan is operated in compliance with the Code as amended by the Act and the amendment is given retroactive effect.

2. Higher Penalties for Reporting and Disclosure Breaches. For reports required to be filed with the IRS after 1996, the Act significantly increases a plan sponsor's penalty exposure for failure to file a Form 5500 or a Form 1099-R, or to provide the tax notice required under Code Section 402(f). Both daily penalties and caps are raised substantially. In addition, the penalty for failure to file a Fon-n 5498 (to report contributions made to an IRA), which under current law is unlimited, will be capped at $100,000.

3. Prohibited Transaction Tax Increased. Disqualified persons, such as plan sponsors and their affiliates, fiduciaries, and service providers, generally are prohibited from buying or selling property or providing services to a qualified retirement plan absent a specific exemption from such "prohibited transactions." A two-tiered tax is imposed on any such prohibited transaction, payable by the disqualified person. Under prior law, a first-tier tax of 5 percent of the amount involved in the transaction was imposed, increased to 100 percent, if the prohibited transaction was not corrected.

The first tier tax on prohibited transactions has been increased from 5 to 10 percent, effective with respect to prohibited transactions occurring after August 20, 1996.

4. Employer-Provided Educational Assistance. The Act retroactively extends the $5,250 annual exclusion for employer-provided educational assistance (which expired December 31, 1994), except that expenses for any graduate course generally are excludable only if the course began before June 30, 1996. Prospectively, the exclusion applies to expenses relating to undergraduate courses that begin before June 1, 1997. The IRS is to provide expedited procedures for refunds of any overpayment of taxes paid on excludable amounts since January 1, 1995.

5. The SIMPLE Retirement Account. The Act creates a new type of savings plan for small employers called the "SIMPLE Retirement Account", which takes the place of SARSEPs. Employers with 100 or fewer employees who sponsor no other qualified retirement plan may establish these accounts for their employees beginning in 1997. Generally, employees earning $5,000 or more per year are considered to be eligible to participate, and eligible employees may make salary reduction contributions up to $6,000 each year. The employer must either: (1) contribute two percent of compensation for all eligible employees, or (2) match 100 percent of employees' contributions, up to three percent of compensation (with a limited ability to reduce the level of matching contributions). The accounts can be funded through IRAs or a 401 (k) plan and are not subject to ADP or top-heavy testing. Also, if IRAs are used, simplified reporting and disclosure rules apply.

6. Spousal IRAs. Beginning in 1997, the maximum tax-deductible IRA contribution a married couple with only one working spouse can make in any year is increased from $2,250 to $4,000.

 

II. TAX-EXEMPT PLAN SPONSORS

The Act contains several provisions of significance to plans of tax-exempt entities and state and local governments.

A. TAX-EXEMPT ORGANIZATIONS ELIGIBLE FOR 401(k) PLANS

Currently, tax-exempt entities and state and local governments are prohibited from establishing 401(k) plans. Effective for plan years beginning after December 31, 1996, tax-exempt organizations will be allowed to maintain such plans. The prohibition generally will remain in effect for state and local governments.

B. SECTION 403(b) CHANGES

The Act makes two significant changes with respect to tax-sheltered annuity plans (i.e., "Section 403(b) plans"). First, the Act overrides the rule that restricts an individual from entering into more than one 403(b) salary reduction agreement per year. Beginning in 1996, the rules regarding the frequency and revocation of such agreements and the compensation to which the agreements may apply are the same as those applicable to 401(k)plans. Second, a403(b) contract must provide that elective deferrals will not exceed the annual limit on elective deferrals (the so-called "402(g) limit"), effective for years beginning after 1995. Existing contracts must be modified by November 19, 1996.

C. SECTION 457(b) PLANS

The Act makes a number of changes with respect to certain deferred compensation plans of state and local governments and tax-exempt entities ("Section 457(b) Plans"). First, effective for years after 1996, the Act revises Section 457 by: (1) permitting certain in-service distributions of accounts that do not exceed $3,500, (2) permitting an election to defer the commencement of distributions after amounts are made available for distribution, but before they are distributed, and (3) providing for indexing of the dollar limit on deferrals (currently, $7,500). Secondly, solely with respect to plans of state and local governments, the new law imposes a requirement that all amounts deferred under a Section 457 Plan be held in a trust, custodial account or annuity contract, effective immediately for plans established after August 20, 1996, but not until January 1, 1999 for existing plans.

III. HEALTH REFORM ACT

The primary goal of the Health Insurance Portability and Accountability Act (the "Health Reform Act"), which was signed on August 21, 1996, is to improve access to health care for both employers and employees. Other significant provisions of the Health Reform Act permit limited establishment of IRA-like Medical Savings Accounts, provide new rules for the tax treatment of long-term care, modify the rules for corporate-owned life insurance, and revise certain COBRA continuation rules. The Health Reform Act also increases the health insurance deduction for self-employed individuals from 30 percent to 40 percent in 1997, with additional increases phased-in until the deduction reaches 80 percent in 2006.

A. HEALTH CARE ACCESS AND PORTABILITY

1. Portability. Politicians have stated the health care reforms would "enable you to take your health coverage with you when you leave your job." In fact, the new law does not provide such a broad sweep. However, the new law does restrict the scope and applicability of pre-existing condition exclusions, and outlaws differences in coverage based on a person's health problems.

2. Pre-Existing Condition Exclusions. A plan may exclude coverage for a new employce's pre-existing conditions for no more than 12 months, and the exclusion may only apply to health conditions that existed in the six months before the individual was first eligible for plan coverage. The 12-month maximum exclusion period is reduced for each month that a new participant had prior health coverage in effect and for waiting periods prior to eligibility. Coverage before a 63-day break can be disregarded. In other words, someone leaving a job where he or she had coverage for at least 12 months would have no pre-existing condition exclusion, as long as that earlier coverage had not been allowed to lapse for more than 63 days.

However, even for individuals who had previous health coverage, plans could elect to apply a pre-existing condition exclusion for categories of coverage that the prior plan did not include. For example, if the prior plan did not include prescription drug coverage, the new plan may exclude drug coverage for pre-existing conditions for 12 months.

Plans may also exclude coverage for pre-existing conditions for up to 18 months for those who enroll after the point at which they are first eligible to do so. Plans must offer special enrollment opportunities for people whose need or eligibility for health coverage changes because of birth, death, marriage, divorce, etc., or because of a job loss that causes the individual to lose other coverage.

No pre-existing condition exclusion can be applied to maternity coverage, or to newborn or newly adopted children who are promptly enrolled in the plan. The law also bans limits or exclusions of coverage based on genetic testing.

3. Nondiscrimination. Plans will not be allowed to exclude an individual or terminate or limit his or her coverage based on the person's past, current or expected health status. Although insurance companies may charge extra for covering people with health problems, to the extent allowed by state law, employee benefit plans may not require higher contributions from individual participants based on their health or use of health care.

4. Effective Date. These requirements are generally effective for plan years beginning after June 30, 1997. For collectively bargained plans, the effective date is, in general, delayed to the first plan year beginning after June 30, 1997.

B. MEDICAL SAVINGS ACCOUNT

Congress has authorized a four-year pilot program for testing whether "Medical Savings Accounts" ("MSAs") are effective at helping control health care costs without undue drain on Federal tax revenue. Beginning in 1997, MSAs, which will be subject to rules similar to those for IRAs, will be available for contributions by employers with fewer than 50 employees or by their employees. The legislation establishes a mechanism to assure that no more than 750,000 MSAs are created as part of the pilot program. To be eligible to contribute (or to have contributions made by the employer), the employee or self-employed person must be covered only for "high deductible" health care coverage (i.e., catastrophic coverage). A high deductible health care plan is one with a deductible in the range between $1,500 and $2,250 for individual coverage and between $3,000 and $4,000 for family coverage and that provides a maximum on out-of-pocket expenses (including deductibles) of $3,000 (individual coverage) and $5,500 (family coverage).

MSAs are designed to function much like IRAs. Each year the account holder will be able to contribute and deduct up to 65 percent of the deductible under the catastrophic health plan (75 percent, for family coverage). Employer contributions to employees' accounts, up to the same annual limits, will not be taxed to the employee, but an employee cannot contribute to an MSA if the employer contributes in that same year. An employer that contributes to any employee's MSA must make a comparable contribution (same dollar amount or same percentage of the deductible) to the MSAs of all employees covered by high deductible plans sponsored by that employer, or pay a 35 percent excise tax on the contributions that it does make. MSAs cannot be offered through cafeteria plans.

Unused MSA balances may be carried forward to be used in future years, with interest accruing on a tax-exempt basis. There will be no tax on amounts withdrawn from an MSA if the funds are used to meet health care expenses (including long-term care), but not if they are spent for insurance premiums or plan contributions. Withdrawals not spent on health care would be taxable, and there will be an extra 15 percent tax on taxable amounts withdrawn before death, disability or the date the account holder becomes eligible for Medicare (currently, age 65).

C. INCREASE IN SELF EMPLOYEDS' HEALTH DEDUCTION

Current law permits self employed individuals to deduct 30 percent of health insurance premiums covering themselves and their families. The new law increases this deduction to 40 percent in 1997, 45 percent in 1998 through 2002, 50 percent in 2003, 60 percent in 2004, 70 percent in 2005, and 80 percent in 2006 and thereafter.

D. LONG-TERM CARE TAX TREATMENT

Expenses for long-term care and long-term care insurance will generally be treated like expenses for health care and health insurance. Thus, individuals will be able to deduct amounts they spend for long-term care in excess of 7.5 percent of their adjusted gross income, and will not be taxed on employer payments for insured long-term care coverage. Long-term care coverage cannot be offered through cafeteria plans. To qualify for the special tax treatment, the insurance must be non-surrenderable and guaranteed renewable, among other things. These new rules are generally effective as of January 1, 1997, with transition rules for existing long-term care contracts.

E. COBRA MODIFICATIONS

The new law makes several technical changes in the COBRA rules to: (1) clarify that a child bom or adopted while an individual is on COBRA can be added to that coverage immediately; (2) allow extended COBRA eligibility for a qualified beneficiary who becomes disabled within 60 days after the qualifying event; and (3) coordinate the new limits on pre-existing condition exclusions with the COBRA rules regarding duplicate coverage. In addition, a pension technical correction passed as part of the Minimum Wage Bill clarifies that the total period of COBRA eligibility, in the case of a qualifying event that follows the employee's becoming entitled to Medicare, is no more than 36 months.

F. CORPORATE-OWNED LIFE INSURANCE

The Health Reform Act phases out interest deductions for COLI policies in 1996 through 1998, and disallows such deductions starting in 1999. Interest deductions for policies purchased on or before June 20, 1986, and for policies on a limited number of key employees, are excepted but are subject to an interest rate cap starting in 1996. Certain transition rules also apply.

G. NONTAXABLE ACCELERATED DEATH BENEFITS

Life insurance benefits received by beneficiaries as a result of an individual's death are nontaxable. However, for many terminally ill individuals, near bankruptcy from a long illness, the cash value of their life insurance or the death benefits expected from that insurance policy may be the only asset available for current expenses of the individual and his or her family.

Effective January 1, 1997, accelerated death benefits to terminally or chronically ill individuals will not be included in gross income. This income exemption will apply whether the proceeds are paid from life insurance contracts or through a "viatical settlement," i.e., the sale or assignment of the insurance contract to a person regularly engaged in such trade or business.

IV. MISCELLANEOUS

A. LEASED EMPLOYEES

Congress has replaced the current "historically performed" test under the leased employee rules, which is generally considered to be overly broad, with a new "primary direction or control" test that is designed to eliminate the uncertainty created by the current test. Under the new test, an individual will not be considered a leased employee unless the individual's services are performed under the primary direction or control of the service recipient. Primary direction or control is determined under a facts and circumstances test and generally means that the service recipient exercises the majority of direction and control over the individual.

B. SAFE HAVEN RULE FOR EMPLOYEE/INDEPENDENT CONTRACTORS MODIFIED

The Small Business Act clarifies and modifies Section 530 of the Revenue Act of 1978, a safe haven which generally allows a taxpayer to treat a worker as not being an employee for employment tax purposes, regardless of the worker's actual status under the common-law test, unless the taxpayer has no reasonable basis for the treatment. The modified rules generally apply to periods after 1996.

C. EMPLOYEE CONTRIBUTIONS MUST BE DEPOSITED 15 DAYS AFTER MONTH RECEIVED

The Department of Labor has issued final regulations, effective February 3, 1997, significantly reducing the maximum period during which participant contributions to pension plans may be treated as non-plan assets. The rules regarding welfare benefit plans, such as health plans, remain unchanged. Under the 1988 prior regulations, employers generally had a maximum of 90 days after receipt of pension plan contributions before the contributions became plan assets. Under the final regulations, however, contributions become plan assets and must therefore be paid to the plan on the earliest date that they can reasonably be segregated from the employer's general assets, but in no event later than the 15th business day of the month following the month in which the contributions were withheld or received by the employer.

D.REPEAL OF STATE SOURCE TAXATION OF RETIREMENT INCOME

President Clinton signed P.L. 104-95 into law on January 10, 1996. This law prohibits states from imposing an income tax on retirement income of individuals who are no longer residents of those states. "Retirement income" is defined broadly to include any income from qualified plans, simplified employee pensions, qualified annuity plans, tax-sheltered annuities under Code Section 403(b), individual retirement accounts, deferred compensation plans under Code Section 457, and other plans. Nonqualified deferred compensation plans are also treated as providing "retirement income" where the income received by the taxpayer from such plans is part of a series of substantially equal periodic payments made for the life or life expectancy of the taxpayer (or joint life expectancies of the taxpayer and his or her designed recipient), or for a period of not less than 10 years. However, lump sum payments from non-qualified deferred compensation plans may still be subject to state income taxes in the source state even though the participant no longer lives there.

E. IRS ISSUES PROPOSED RULES ON LOANS TO PLAN PARTICIPANTS

The IRS has issued proposed rules regarding loans from qualified plans. The proposed rules provide that, if the amount of the loan exceeds the maximum limit (eg., it exceeds $50,000), only the excess amount (rather than the entire loan) is a deemed distribution. However, if a loan repayment is not made when due, the outstanding loan balance (not just the missed payment) is a deemed distribution. While a participant is on an unpaid leave of absence, a special exception exists with respect to the requirement that loans be repaid in substantially level installments at least quarterly. This exception permits loan repayments to be suspended during the leave of absence. However, the loan must still be repaid in full by the latest date permitted by law, which is generally five years after the loan is made.

F. GUIDANCE TO PLAN SPONSORS ON PARTICIPANT INVESTMENT EDUCATION

Under ERISA, a plan sponsor is considered a fiduciary, and, thus, subject to potential fiduciary liability to the extent the plan sponsor renders investment advice to a participant. This provision is particularly meaningful in the context of plans that have participant-directed accounts, the most prevalent being 401 (k) plans. Participants in these plans desire sufficient investment-related infon-nation so they can make informed investment decisions. However, plan sponsors face a dilemma: they desire to avoid possible fiduciary liability due to the provision of investment advice, yet want to give participants the tools to maximize their investment return. In recognition of this conflict, the Department of Labor issued an Interpretive Bulletin that provides safe harbors for plan sponsors who wish to furnish investment-related information to participants without subjecting themselves to potential liability for rendering investment advice.

The Department has delineated four safe harbors. The first safe harbor relates to plan information. Under this safe harbor, plan sponsors may provide information regarding the benefits of plan administration, the benefits of increasing contributions, the impact of preretirement withdrawals on retirement income, the terms of the plan, the operation of the plan, and information describing investment alternatives under the plan. However, plan information must not contain any reference to the appropriateness of any individual investment option for a particular participant.

The second safe harbor relates to general financial and investment information. For example, information may be provided about the historic differences in rates of return between different asset classes, the effects of inflation, estimating future retirement income needs, determining investment time horizons, and assessing risk tolerance. To meet this safe harbor, the information must not have a direct relationship to investment alternatives available to participants.

The third safe harbor relates to asset allocation models. Providing a participant with models of asset allocation portfolios of hypothetical individuals will not constitute investment advice, so long as several requirements are met. The models must be based on generally accepted investment theories and all material facts and assumptions on which such models are based must accompany the models. The models must also be accompanied by a statement that, in applying a particular model to his or her own situation, the participant should consider his or her other assets, income, and investments in addition to his or her interest in the plan.

The fourth safe harbor relates to interactive investment materials. Questionnaires, worksheets, interactive software, and other similar materials for use by participants to estimate their future retirement needs and the impact of different asset allocations on retirement income will not be considered investment advice if the following requirements are met: (1) the materials are based on generally accepted investment theories; (2) there is an objective correlation between the asset allocations generated by the interactive material and the data supplied by the participant; (3) all material facts and assumptions upon which the interactive material is based are provided; (4) where an asset allocation generated by the model identifies a specific investment alternative under the plan, note must be made if there are other investment alternatives under the plan with similar risk and return characteristics; and (5) the materials must be accompanied by a statement indicating that the participant should consider his or her other assets, income, and investments in addition to his or her own interest in the plan.