McKay Hochman Company, Inc.

Given the steep drop in the stock market since last August, must a balance forward plan make an interim valuation before processing a distribution based on the prior valuation (done on June 30, 2008, or December 31, 2007)?

Plan Issues in Uncertain Economic Times
The state of the economy always has an impact on certain retirement plan issues. Here are some issues that are particularly critical right now.

Fiduciary Responsibility and the Interim Revaluing of a Balance Forward Plan
The steep decline in the stock market that began in September 2008 has resulted in a significant drop in the value of retirement plan assets. This is a particular problem for balance forward plans, and we have received many calls about whether a special valuation is called for given the present economic climate. While our plan document empowers a plan administrator to require a special plan valuation, this places the administrator in conflict with former employees who may have statements showing significantly higher account balances as of the plan’s usual valuation date and who will want to realize those balances regardless of the fact that the value of the plan’s assets has plummeted in the interim.

A Twofold Responsibility. ERISA requires plan fiduciaries to operate a qualified plan in the best interest of all of its participants and beneficiaries and to administer the plan at reasonable cost. However, when significant decreases (or increases) in the plan’s market value occur, participants with a distributable event (including a severance of employment or an in-service distribution) have an inherent conflict with participants with no distributable event. The fiduciary has both a legal and moral obligation to decide what is best for all participants, so ideally, all participants should share in the losses (or gains) incurred by a balance forward plan. Thus, those with a distributable event should not be paid an overvalued balance to the detriment of the remaining plan participants (assuming there are no other facts that may dictate a contrary result).

Special Valuations. In unsettled economic times such as those we are experiencing now, the question as to whether it is permissible to pay a distribution request based on an annual or even a semiannual valuation becomes critical, especially when a significant amount of time has elapsed since the last valuation. However, many issues must be evaluated before the decision to go forward with a special valuation is made. Let’s look at an example to demonstrate the issues involved.

If the plan paid $500,000 when the value of the entire plan has dropped 20% in a matter of weeks, would the other participants be negatively impacted? Yes. Does the fiduciary of the plan have a responsibility to protect the benefits of the participants? Yes.

The fiduciary in this example has a rather clear requirement to weigh whether an interim valuation is necessary before paying participant A1. Keep in mind that if a fiduciary overpays one participant at the expense of the others, the fiduciary has breached his/her fiduciary duties (and is personally responsible for making the plan whole). Additionally, the participant made the election using 20/20 hindsight. Would they want to stay with the June 30th valuation if the market was up 20% instead of down? Most of the elections in the plan document relating to the timing of distributions only allow for payment after the next valuation date or the close of the plan year so that participants cannot take advantage of market timing. A different answer may apply if the participant had elected the distribution prior to June 30th, but the values only now became available. In that case it is not as clear that a special valuation should be done. The participant made their request before they knew what the distribution amount would be.

Is the employer required to have a special valuation performed? Unlike the first example, this is a tough call for an employer because the expense of the special valuation significantly outweighs the “overpayment.” In such an instance, most employers would most likely believe it wrong to charge the plan $3,500 just to save $676.

Is the employer nonetheless required to have a special valuation performed and possibly cover the expense out of its general assets? There is no clear guidance; however, it is not likely. Again, the employer may want to look at the terms of the plan to see if distribution can or should be delayed until after the close of the plan year and calculate the distribution amount on the updated valuation. In any event since the distribution amount is less than 1% of the fund balance, even a distribution at the end of October would be made without a special valuation considering the cost.

Legal Issues. Unfortunately, the employer is unlikely to please everyone in either of these situations; and some employees may threaten a lawsuit. Instead of one employee in Example 1, assume there were 10 employees who wanted withdrawals totaling $500,000. And of those 10 employees, one was the employer’s spouse, whose account represented $100,000 of the $500,000. While this may cause the owner personal aggravation, a special valuation would still be the safest course. This is because an overpayment to a highly compensated employee and relative has the potential of violating both ERISA fiduciary and Internal Revenue Code nondiscrimination standards. The negative effect of the special valuation could be eased by allowing the individuals who have requested distributions to cancel their request once they find out what the revalued amounts would be.

It is very important to remember that if a fiduciary is found to have breached his or her fiduciary duties, the fiduciary is personally liable for the loss to the plan and for the payment of any applicable penalties.

Employer Options. Employers may want to consider amending their plan to have more frequent valuations or changing distribution options. Alternatively, employers might consider adopting an administrative policy that requires interim valuations when there has been a market change, up or down, of a set percentage (using a standard market index). This may help to avoid lawsuits over time.

Employers may take the additional step of adding a warning to benefit statements stating that the account balance reflected on the statement is only as of the date indicated and may not be the balance on the date of distribution due to market changes.

Many other fact sets could be created, but the basics of the concepts in play are covered here. Hopefully, values will go back up as dramatically and as quickly as they declined — but we know that may not happen.

Note that although this article discusses the impact of market volatility on balance forward plans, daily valued plans are not totally free of market risk. Employers may wish to tighten procedures for processing distribution requests to clearly define the date upon which a final distribution amount is determined and to avoid serious “hang time” between when a distribution is requested and when the distribution check is cut.

To learn more, call 973-492-1880 or e-mail info@mhco.com.