Defined contribution plan sponsors in the 401(k) and 403(b) plan markets should not expect relief from the Internal Revenue Service anytime soon.
No relief is coming for their service providers either, as cash-strapped charities, hospitals and universities, seek ways to spread the pain of hefty fines and sanctions for compliance violations in their 403(b) plans. Many sponsors of voluntary salary reduction plans maintain a hands-off distance from plan administration and will demand some recompense from the vendors managing their plans, consultants say.
A concerted and "vigorous" examination program of 403(b) plans will continue, said an IRS official, who noted the 2-year-old program already has netted millions of dollars in fines and sanctions for the agency as it uncovered unexpectedly high instances of non-compliance. The 403(b) audits also will shift from large institutions to include small- and midsized plans.
The IRS issued new 403(b) plan audit guidelines and introduced a tax-sheltered annuity voluntary correction program at the end of April. Consultants and benefits lawyers are divided about the potential success of the program.
The IRS also has said it will embark on a new 401(k) compliance study in January and conduct examinations of 550 randomly selected plans. The intent of the study is to gather information about plan compliance with an eye toward possible regulation changes, but any violations discovered will be subject to normal fines and sanctions, said Mark J. Warshawsky, senior economist, in the IRS office of the assistant commissioner for employee plans and exempt organizations, Washington.
"The purpose of the program is to apply a new study technique and to methodically gather data from a statistically valid, randomly selected sample of plans of all sizes. The idea is to try to find out where problems areas are, to create a national database of information," said Mr. Warshawsky.
There are three motivations behind the study, said Mr. Warshawsky: a concern that individuals are not participating in 401(k) plans; that there is significant pre-retirement leakage from the 401(k) plan system; and that participants are overly conservative in their investment selections. The examinations will focus on compliance issues related to plan eligibility, distributions from the plan in the form of loans, hardship withdrawals and termination rollovers. The exams also will check for prohibited transactions and the accuracy of investment valuations.
The study is expected to be completed in September 1997, with results released in 1998.
While consultants can't predict what the 401(k) examinations will yield, they agree the 403(b) audits have turned that world upside-down.
Not-for-profit organizations are reeling from a comprehensive examination program that started as a means to check the tax-exempt status of such institutions and quickly moved into audits of 403(b) retirement plans. The fines on 30 settled cases have averaged $1 million each.
"The history of 403(b) plans is that there has been no enforcement and little guidance from the IRS, despite what they may say," said Rhonda Davis, a consultant in the Boston office of Hewitt Associates Inc. "403(b) plans are light years more complicated than 401(k) plans, coupled with a lack of enforcement."
One IRS official, who preferred to remain unidentified, said part of the problem is that employers have disconnected themselves from the management of the voluntary salary reduction plans they sponsor that are not covered by the Employee Retirement Income Security Act.
To avoid becoming subject to ERISA with this type of 403(b) plan, non-profit employers have to distance themselves from plan management, leaving plan administration to vendors who individually solicit employees.
Overall, the examination program for non-profit institutions has 86 ongoing audits. Each of the 30 closed audits has resulted in some action against the organization, ranging from recalculations of income to sanctions, with one organization receiving a $100 million tax payment assessment.
The IRS will not identify the organizations it has audited nor will it separate 403(b) sanction payments from those for other types of tax code violations.
Press reports indicate the University of Wisconsin, the University of Nebraska and the University of Michigan all have been audited. Many large hospitals reportedly have been audited as well.
Among many identified problems, 403(b) plans have been most often caught over matters relating to contributions by individuals that exceed maximum exclusion allowances and violation of eligibility requirements.
"The future is going to be bleak for many smaller non-profits - the smaller charities and universities and health care operators who don't have the financial or human resources to deal with massive fines," said Thomas Bieniek, senior vice president of Fidelity Investments Tax-Exempt Services Co., Boston. "It may very well affect their future viability to survive at all," he added.
The effect of the crackdown has been a new era for 403(b) sponsors.
Sponsors are beginning to scrutinize their vendors with the same degree of due diligence used by 401(k) sponsors, said Peter J. Gulia, vice president and counsel at The Copeland Cos., East Brunswick, N.J., a service provider that specializes in the health care market.
Whether many employers who detect violations will voluntarily identify themselves to the IRS is a big question. The new voluntary program runs through October 1996 and allows an employer to correct the defects found and to pay a negotiated settlement no higher than 40% of its tax liability, in addition to an upfront compliance fee, rather than 100% of liability if the plan were subject to an IRS audit.
Fidelity's Mr. Bieniek said the 403(b) program is not as attractive as other IRS voluntary compliance programs because of the higher level of possible sanctions.
Hewitt's Ms. Davis suggested many organizations will be looking at their vendors for help in dealing with both internal audits and assessed fines and sanctions.
"I think that a key to those plans that come forward voluntarily will be indemnification agreements they hold with their vendors," Mr. Davis said. "Those sponsors who know their vendor will make good on mistakes they make will be among the first to step forward."