401(k) Fiduciary Toolkit. Sponsored by ishares. Prepared by The Wagner Law Group. Due Diligence. Due Diligence Review of Existing 401(k) Plans

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1 401(k) Fiduciary Toolkit Sponsored by ishares Prepared by The Wagner Law Group Due Diligence Due Diligence Review of Existing 401(k) Plans

2 IMPORTANT INFORMATION The Wagner Law Group has prepared this guide. BlackRock does not represent that this information is accurate and complete, and it should not be relied upon as such. This guide is intended for financial advisors who provide advisory services to 401(k) plans in a fiduciary capacity under the Employee Retirement Income Security Act of 1974, as amended (ERISA). This guide is intended for general informational purposes only, and it does not constitute legal, tax or investment advice on the part of The Wagner Law Group or BlackRock. BlackRock is not affiliated with The Wagner Law Group. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor. For Financial Professional Use only Not for Public Distribution SY-9/10

3 ishares 3 Before signing on to be a Fiduciary on a 401(k) plan, consider a due diligence review of the existing plan s operations. Not only will you demonstrate your value to new clients through your in-depth knowledge of their plan, but you ll help protect yourself from potential co-fiduciary liability. Whether you re providing investment-only service or proposing a bundled solution to the sponsor, this guide, prepared by The Wagner Law Group, provides insight into a plan s state of compliance with the tax-qualification requirements under Title II of ERISA. For more information, visit our Fiduciary Resource Center at To learn how to use ishares ETFs in 401(k) plans, call the Retirement Plan Sales Team at

4 4 Due Diligence Executive Summary Financial advisors should consider due diligence document reviews of new 401(k) plan clients. Reviews can help an advisor give prudent advice based on the particular needs of the plan. They can also help advisors demonstrate their value to new clients and provide protection against potential co-fiduciary liability for plan compliance problems. Reviews can be conducted strategically, based on the following checklist of relevant items: 1. Plan Documentation Request a copy of the plan document, trust agreement, and the IRS determination letter (or the IRS opinion letter in the case of a prototype plan document). If the client s 401(k) plan is actually a plan resulting from the merger of multiple plans, ask for background information on the plan merger. Have the plan document and required amendments been executed? If not, there may be a plan document failure and the sponsor should be advised to follow up with the document provider or counsel. Inform the sponsor that it should keep its plan documentation in a centralized file location, and encourage the sponsor to work diligently with the plan document provider. 2. investment Review Documents Request a copy of the Investment Policy Statement (IPS), investment meeting minutes, and any other documentation in support of investment-related fiduciary decisions by the sponsor. If the sponsor does not currently maintain any such documentation, it could mean that the sponsor is unaware of its fiduciary obligations. Be sure to educate the sponsor. When working on investment menu changes, ensure investment recommendations are made in accordance with the plan s existing or newly adopted IPS. If the IPS does not address fees, discuss changing the IPS with the client. 3. Participant Disclosures Request a sample enrollment kit from the plan s existing recordkeeper, including the Summary Plan Description (SPD) and investment menu and fee disclosures. Also request copies of the annual notice if the plan is a 401(k) safe harbor plan or has an automatic enrollment feature. If the investment menu and fee disclosures are defective or stale, coordinate with the sponsor to ensure such information is provided properly to participants in the future. If annual notices

5 ishares 5 are not being distributed in the case of a plan with a 401(k) safe harbor design or automatic enrollment, the sponsor should be advised to follow up with the recordkeeper or counsel to address compliance issues. Use the SPD to become familiar with an existing 401(k) plan s design, especially for participant enrollment meetings in connection with the rollout of a new 401(k) plan menu or the transition to a new platform. 4. Form 5500 and Summary Annual Reports (SARs) Request copies of the Form 5500 filings for the two most recent plan years and the most recent SAR, which is the summary notice to participants of the plan s Form 5500 filing. If the sponsor is unable to locate these documents, follow up with the sponsor on its Form 5500 filing and SAR disclosure obligations. If Schedule H indicates a disclaimer of opinion has been issued by the plan s accountant, ask the sponsor about any problems uncovered by the accountant. Review Form 5500 Item 6 or 7 for basic demographic information about the plan, and Schedule H/I for information regarding the plan s assets and flows. For 2009 and future plan years, review Schedule C for enhanced disclosure of plan fees. If participant headcount has decreased significantly, ask the sponsor if a partial termination has occurred. Also review Schedule H/I to confirm the plan s fidelity bond and verify this coverage. 5. Plan Testing Records Request minimum coverage test, Actual Deferral Percentage (ADP)/Actual Contribution Percentage (ACP) tests and top-heavy test. If unavailable, confirm plan design satisfies the test(s) automatically. If the sponsor is unable to produce plan testing records, the sponsor should be advised to follow up with its provider or counsel to demonstrate testing compliance for current and past years. If the plan is struggling with ADP/ACP testing, discuss possible strategies for increasing deferrals by non-highly compensated employees (e.g., investment meetings, automatic enrollment, enhanced match, safe harbor design). In addition to reviewing these matters, advisors should consider having a brief discussion with the plan s ongoing recordkeeper to confirm the IRS contribution and compensation limits are being observed properly.

6 6 Due Diligence Introduction When a financial advisor is hired by a plan sponsor to advise its 401(k) plan, the advisor s recommendations and investment guidance must be provided with care. In many arrangements, advisors agree to serve their plan clients as fiduciaries under ERISA. Accordingly, any investment advice provided to the sponsor or plan participants must be prudent and in accordance with the fiduciary standards of care under ERISA. Naturally, in order to provide prudent investment recommendations, the advisor must consider the particular circumstances and needs of the plan. This guide is intended for use by advisors when they are taking over a new 401(k) plan client. If an advisor intends to provide investment only services to a new 401(k) plan client through an unbundled arrangement, the advisor can use this guide to become more familiar with the existing plan s particular circumstances before recommending any changes to the plan s investment menu. Similarly, if the advisor is proposing a bundled solution to the sponsor, requiring a transition to a platform for both investments and administrative services, the advisor can use this guide to learn more about the plan before providing advice on the transition to the new 401(k) platform. The guide is also a helpful checklist for advisors to use to maintain good practices and procedures for their existing plan clients. Essential Value of Due Diligence Document Reviews Before providing any fiduciary advice, financial advisors should consider exercising due diligence by researching their new 401(k) plan clients to obtain as much relevant information as possible about the plan and its participants. In addition to providing the necessary context for the advice, a due diligence review can protect the advisor from potential legal liability. In his or her capacity as a plan fiduciary, a financial advisor may be held responsible for the actions of a co-fiduciary, including the 401(k) plan sponsor. Under ERISA, a co-fiduciary can be held responsible for a sponsor s breach of its duties if the co-fiduciary (1) knowingly participates in the sponsor s breach, (2) enables the breach to occur, or (3) has knowledge of the sponsor s breach and fails to make a reasonable effort to remedy the breach. 1 The U.S. Supreme Court has also held that even non-fiduciary service providers that knowingly participate in a fiduciary s breach can be held liable for that breach under ERISA ERISA 405(a) and (c) and 29 CFR , FR Harris Trust & Savings Bank v. Salomon Smith Barney Inc., 530 U.S. 238 (2000).

7 ishares 7 Documents Requested for Due Diligence Review A due diligence review generally involves requesting and evaluating the 401(k) plan s key documents and records. Retirement plans are tightly regulated under ERISA and the Internal Revenue Code (IRC), which require a plan sponsor to maintain various types of plan documentation as well as regulatory filings, participant disclosures and plan testing records. An advisor can use these materials to gain valuable insights into a new plan client which, in turn, will help the advisor give prudent advice to both the plan sponsor and plan participants. A proper review does not need to be a laborious or time-consuming effort, and financial advisors should not attempt to read and understand all of the technical information included in these materials. Instead, if an advisor knows what to look for, the requested documents can be reviewed strategically. The sections below summarize the key documents and information advisors should request, and also provide tips on how these materials may be reviewed. Plan Documentation ERISA requires a 401(k) plan sponsor to establish and maintain a written plan document which memorializes the terms of the plan. The assets of a plan must also be maintained in a trust, requiring trust provisions that are reflected in a stand-alone agreement or incorporated into the plan document. Plan fiduciaries are subject to a duty of obedience under ERISA and they are responsible for operating the plan in accordance with these documents. In addition, the plan document must be timely amended to comply with changes in federal tax law and ERISA. In accordance with IRS procedures, a restated plan document must be submitted to the IRS periodically for a determination letter approving the form of the plan. Many small plans (e.g., less than 100 employees) will use IRS pre-approved plan documents, known as prototype or volume submitter plans. These plan documents customarily have an adoption agreement and a base document. The plan sponsor must check the boxes in the adoption agreement, indicating which plan features are applicable, before executing it. The base document includes plan definitions and various plan provisions relating to the adoption agreement, but the base document itself generally does not need to be executed. Pre-approved plans by their nature have an IRS opinion letter approving their form.

8 8 Due Diligence A failure to maintain an up-to-date plan document can result in disqualification of the plan. The IRS will customarily impose tax penalties on the plan sponsor, rather than actually disqualify the plan, to avoid hurting plan participants. Given the potential severity of the penalties for plan document failures, sponsors should make every effort to maintain their plan documentation and execute any required interim amendments on a timely basis. If the plan is the result of a merger of multiple plans, the sponsor should maintain records of all relevant plan documentation, including the historical plan document, trust agreement and IRS determination/opinion letters for each merged plan. For the post-merger plan to remain tax-qualified, the optional forms of benefit under the merged plans must be preserved in accordance with IRS requirements. 3 For example, if one of the merged plans allows participants to take in-service withdrawals, this benefit option must be preserved and cannot be eliminated in connection with the plan merger. INFO REQUEST Request a copy of the plan document and the trust agreement (which may be incorporated into the plan document). Also request a copy of the IRS determination letter (or the IRS opinion letter in the case of a prototype plan document). If the client s 401(k) plan is actually a plan resulting from the merger of multiple plans, ask for background information on the plan merger and confirm that optional forms were protected. Have the plan document and required interim amendments been executed? If not, there may be a plan document failure and the sponsor should contact the document provider or counsel. If the plan is the result of a merger of multiple plans, confirm with the sponsor or the plan s recordkeeper that the optional forms of benefit from each merged plan have been properly preserved. Inform the sponsor that it should maintain signed originals of the current and historical plan documents and IRS determination/opinion letters in a centralized file location. If the sponsor is transitioning to a new plan document, encourage the sponsor to work diligently with the document provider. 3. See IRC Section 411(d)(6), the related Treasury regulations and the IRS pronouncements thereunder.

9 ishares 9 Investment Review Documents The U.S. Department of Labor (DOL) strongly encourages plan sponsors to adopt an investment policy statement (IPS), which is a written statement that provides the plan s investment fiduciaries with guidelines for investment management decisions. 4 The DOL has made it clear that, in enforcing ERISA, it will not judge fiduciaries on the results they achieve, but on the processes they follow. Accordingly, it is a common best practice for plan fiduciaries to meet at reasonable intervals (e.g., annually) in order to conduct investment reviews of their 401(k) plans on an ongoing basis. These meetings are customarily documented with minutes, and the reviews are conducted in accordance with a written IPS. Due to the heightened scrutiny of plan fees by regulators and the courts, it is an evolving best practice to include guidelines in the IPS for reviewing the fees and expenses charged by the plan s investment funds. If a plan has absolutely no documentation of any investment review, the sponsor may be placing itself and any other co-fiduciaries at serious risk. A 401(k) plan sponsor has a fiduciary duty to monitor the plan s investment line-up, in order to ensure each investment choice in the plan menu is a prudent investment option. 5 This duty extends to the initial selection of any investment option as well as the ongoing decision to continue or change such option. Compliance with this duty to monitor also necessitates proper documentation. 6 Without any documentation of investment reviews, the plan s fiduciaries may be viewed as having failed to properly monitor the plan s investments in breach of their duties under ERISA. In the event of such breach, the plan fiduciaries could be personally liable for any losses incurred as a result of participants investing in imprudent investment alternatives. 7 In light of these substantial liability risks, plan sponsors should take their duty to monitor the 401(k) plan s investment menu seriously and maintain proper documentation (e.g., IPS, investment meeting minutes). INFO REQUEST Request a copy of the IPS, the minutes of any fiduciary investment meetings, and any other documentation in support of investment-related and fee-related fiduciary decisions by the sponsor. If the sponsor does not currently maintain any such documentation, it could mean that the sponsor is not taking its investment duties seriously and may be unaware of its fiduciary obligations. Be sure to educate the sponsor, so that it understands the value of meeting regularly to review the plan s menu in accordance with a written IPS. 4. DOL Interpretive Bulletin 08-2, Interpretive Bulletin Relating to the Exercise of Shareholder Rights and Written Statements of Investment Policy, Including Proxy Voting Policies or Guidelines, 29 CFR Preamble to DOL regulations under ERISA Section 404(c), 57 Fed. Reg (Oct. 13, 1992). 6. DOL Interpretive Bulletin Section 409(a) of ERISA.

10 10 Due Diligence When working with a new 401(k) plan client on investment menu changes, make sure investment recommendations are made in accordance with the plan s existing IPS. If the IPS does not address the review of investment fees, discuss changing the IPS with the client. If transitioning to a new IPS, ensure the client has accepted and adopted it before recommending any changes to the investment menu. Participant Disclosures The Summary Plan Description (SPD) is the primary disclosure document for informing participants about their plan and how it operates. It must be provided to participants automatically within 90 days after becoming covered by the plan. A Summary of Material Modification (SMM) describes material changes to the plan, and it must be distributed within 210 days after the end of the applicable plan year. The SPD and any SMMs are typically included in the enrollment kit for new participants. An updated SPD has to be re-distributed to participants every five years (or ten years if there have been no plan changes requiring an updated SPD). Participants also customarily receive disclosures concerning the plan s investment menu in accordance with Section 404(c) of ERISA. To comply with this requirement, many 401(k) plans include summary investment information in the enrollment kits for new participants (e.g., investment brochure, fund fact cards). Prospectuses and summary prospectuses are typically also included in these kits or mailed separately following the participant s initial investment in a fund. By complying with ERISA Section 404(c), plan sponsors are shielded from liability for participants investment losses. So long as the sponsor maintains a prudent menu of investment options, participants alone are held responsible for their investment allocation decisions. In addition to protecting the sponsor from claims relating to investment losses, in certain 401(k) fee litigation cases, the court has held that Section 404(c) also provides a defense against claims that one or more of the plan s investment funds charged excessive fees. 8 Given the value of complying with ERISA Section 404(c), sponsors should consider working with their recordkeepers to ensure participants receive the necessary investment disclosures. If the plan is a 401(k) safe harbor plan, participants must receive an annual 401(k) safe harbor notice at least 30 days (and not more than 90 days) before the beginning of each plan year. In exchange for making a matching or profit-sharing contribution that meets the safe harbor and providing the annual notice, the sponsor of the safe harbor plan does not have to comply with the annual ADP/ACP test (as discussed in Plan Testing Records below) See, e.g., Hecker v. Deere & Co. (7th Cir. Feb. 12, 2009). 9. IRC Section 401(k)(12) establishes the safe harbor requirement for a matching contribution or a profit-sharing contribution. The matching contribution must be at least as favorable as a 100% match on the first 3% of pay deferred and a 50% match on the next 2% of pay deferred. The profit-sharing contribution must be at least 3% of pay. In either case, the employer contribution must be fully and immediately vested.

11 ishares 11 If the 401(k) plan has an automatic enrollment feature, the employer is immune from state laws that ban payroll deductions without the written consent of employees, so long as it provides annual notice to participants and meets other applicable conditions. 10 Additional information must be included in these annual notices if the plan is intended to meet the requirements of a qualified automatic contribution arrangement (QACA) enabling the sponsor to skip the ADP/ACP test, or an eligible automatic contribution arrangement (EACA) enabling participants to make withdrawals within a short period after automatic enrollment. 11 If the automatic contributions are invested in a default option that satisfies the conditions of a qualified default investment alternative (QDIA), participants (and not the plan sponsor) are held responsible for their passive decision to invest in the QDIA, so long as the sponsor also includes information about the QDIA in the annual notice. 12 Under IRS rules, the annual notice must be provided at least 30 days (and not more than 90 days) before the beginning of each plan year. INFO REQUEST Request a sample enrollment kit from the plan s existing recordkeeper. If not included in the enrollment kit, request a copy of the plan s SPD (including any SMMs) and any disclosures concerning the investment menu and fees. Also request copies of the annual notice(s) if the plan is a 401(k) safe harbor plan, has an automatic enrollment feature, or has a QDIA. If the investment menu and fee disclosures are defective or stale, it could mean that participants have not been receiving appropriate information about the plan s investment options. Educate the sponsor on the importance of providing such information to participants, and coordinate with the sponsor to ensure proper information is provided in the future. If the plan is a 401(k) safe harbor plan or has an automatic enrollment feature, but the sponsor is unable to locate a copy of the requisite annual notice, it could mean that the notice is not being provided to participants. If so, advise the sponsor to follow up with the recordkeeper or counsel on the implications of a notice failure and to confirm that timely notice will be provided in the future. Advisors can use the SPD to quickly familiarize themselves with an existing 401(k) plan s design and features. When conducting enrollment meetings in connection with the rollout of a new 401(k) plan menu or the transition to a new platform, advisors should anticipate questions about basic plan operation from participants. 10. Section 514(e)(3) of ERISA. 11. IRC Section 401(k)(13) establishes the QACA safe harbor requirement for a matching contribution or profit-sharing contribution in the case of a 401(k) plan with an automatic enrollment feature. IRC Section 414(w) establishes the requirements for EACA withdrawal rights. 12. Section 404(c)(5) of ERISA.

12 12 Due Diligence Form 5500 and Summary Annual Reports The Form 5500, Annual Return/Report of Employee Benefit Plan, is the annual information return that must be filed on behalf of employee benefit plans with the DOL, which has an information sharing arrangement with the IRS. The return requires the plan sponsor to provide basic plan information, and it is due at the end of the seventh month following the close of the plan year. A 2½ month extension is available by filing a Form Thus, for plans with a calendar plan year, the extended filing deadline is October 15. Item 6 or 7 of the Form 5500 has basic demographic information about the plan s participant population. 13 When reviewing this information, advisors should be mindful of the IRS s partial termination rule. As a condition of tax-qualification, a plan must fully vest all affected participants in the event of a partial termination, which generally occurs when an employer-initiated action results in a significant decrease in plan participation (e.g., reduction in force). Although all relevant facts and circumstances should be considered, a partial termination is presumed once the number of active participants with an employer-initiated severance during a plan year exceeds 20% of all active participants. 14 With respect to large plans (with 100 participants or more), Schedule H of the Form 5500 provides basic financial information about the plan s assets. Large plans generally must include audited financial statements as attachments to the Form 5500, which must include the opinion of an independent qualified public accountant. Small plans (with less than 100 participants) generally do not need to include audited financial statements with their Form 5500 filings, and they are subject to simplified financial reporting on Schedule I. Beginning with plan year 2010, small plans will have the alternative option of filing a Form 5500-SF and reporting this financial information directly in Part III of this Form, rather than filing a Form 5500 with Schedule I. Item 4e of Schedule H (or Schedule I in the case of a small plan) asks the sponsor to confirm that the plan is covered by a fidelity bond. Under Section 412 of ERISA, the sponsor is required to purchase and maintain a fidelity bond on behalf of the plan. Generally, the sponsor and any other person who handles funds or other property of the plan must be bonded. The fidelity bond must cover at least 10% of the amount handled by the bonded individual. The bond may not be for less than $1,000 and need not exceed $500,000 ($1,000,000 in the case of a plan holding employer securities). A financial advisor who does not have discretionary control over plan assets generally does not need to be bonded. Sponsors should make sure their coverage is adequate, especially in light of the ease with which regulators can determine whether a plan is adequately bonded. 13. The format of Form 5500 has changed slightly over the years. Basic demographic information is reported in Item 6 of the Form 5500 for plan years 2009 and 2010, but it is reported in Item 7 of the Form 5500 for prior plan years. 14. IRS Revenue Ruling

13 ishares 13 Failing to file the complete Form 5500 can be a very costly mistake for sponsors. For each day the filing is late or incomplete, the DOL may impose a penalty of up to $1,100 per day. The IRS may impose a separate penalty of $25 per day up to a maximum of $15,000. Fortunately, the DOL s Delinquent Filer Voluntary Compliance Program (DFVC) allows a sponsor to make late filings at a reduced penalty. However, a sponsor cannot take advantage of the DFVC once it is under DOL investigation for failing to file a Form The Summary Annual Report (SAR) is a summary notice of the plan s Form 5500 filing, which must be distributed annually to participants within nine months after the end of the plan year (or two months after the extended filing deadline for the Form 5500). The SAR itself is rather brief, including basic financial information about the plan and a statement that more information is available on the Form The SAR notice requirement applies to all 401(k) plans, and there is no exception for small plans. As a practical matter, poor plan administration can lead to the failure to deliver the required SARs to participants, but penalties (of up to $110 per day) are only triggered if the plan sponsor fails to provide a SAR within 30 days of a written request by a participant. Plan sponsors have a duty to provide SARs to participants, and they should make every effort to meet this fiduciary requirement, especially since it is an easy obligation to satisfy with the assistance of the plan s providers. INFO REQUEST Request a copy of the Form 5500 filings for the two most recent plan years, and a copy of the most recent SAR. If the sponsor is unable to locate the Form 5500 filings and the SAR, it could mean that the plan s administrative service provider is not preparing them. In this situation, consider advising the sponsor to contact its provider or counsel to address any delinquent Form 5500 filings and to confirm that Form 5500 filings and SARs will be prepared properly in the future. If Part III of Schedule H (for large plans with 100 participants or more) indicates that a disclaimer of opinion has been issued by the plan s accountant, it may mean the accountant was unable to complete a successful audit of the plan s financial statements. Be sure to follow up with the sponsor to determine if a problem was uncovered by the accountant.

14 14 Due Diligence Review Form 5500 Item 6 or 7 and Schedule H (or Schedule I in the case of a small plan) to get a general sense of the size and growth of the participant population as well as the flows into the plan trust. If participant headcount has decreased significantly during a plan year, ask the sponsor if it has researched the possibility of a partial termination with its recordkeeper or counsel. Beginning with plan year 2009, Schedule C to the Form 5500 must include enhanced fee disclosures, including information concerning any indirect payments from the plan s funds and fund managers to the plan s service providers. Review Item 4e of Schedule H (or Schedule I in the case of a small plan) to see if the plan has reported that it is covered by a fidelity bond, and consider asking for a copy of the bond or otherwise confirming that the sponsor maintains appropriate bond coverage. Plan Testing Records 401(k) plans are designed to encourage workers, especially middle- and lower-income employees, to save for their own retirement. So that plans do not disproportionately favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs), the IRS has established three sets of tests which a 401(k) plan must pass in order to prove that it is not a discriminatory arrangement improperly benefiting too many HCEs. First, a 401(k) plan must pass an annual minimum coverage test. This test assesses whether a sufficient number of the NHCEs employed by the sponsor are eligible to make or receive contributions under the plan, factoring in the comparative number of employed HCEs who are eligible. A plan would undoubtedly fail the minimum coverage test if it only allowed top-level employees to participate and excluded all rank-and-file employees. The test takes into account all employees of the sponsor as well as any other employees of the sponsor s controlled group. The sponsor s controlled group includes companies that are affiliated with the sponsor due to overlapping ownership interests. For example, the sponsor s controlled group may include a parent corporation that owns and controls the sponsor as well as subsidiary corporations owned by the sponsor corporation. The minimum coverage test is automatically passed if all employees of the sponsor s controlled group are eligible under the plan, and

15 ishares 15 a formal test is not required under these circumstances. On the other hand, if the plan only covers the sponsor s employees and excludes all other employees of the controlled group, the minimum coverage test must be performed to demonstrate compliance with these rules. Second, the plan must satisfy the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests each year. The ADP test determines whether the average deferral rate of all NHCEs eligible to contribute to the plan is sufficient in comparison to the average deferral rate of all eligible HCEs. A plan fails the ADP test if the eligible NHCEs fail to contribute at a high enough rate. Similarly, the ACP test compares the average match rate of eligible NHCEs against the average match rate of eligible HCEs. If a 401(k) plan fails the ADP/ACP tests, generally the excess contributions for HCE participants must be reversed or the NHCE participants must receive a supplemental 401(k) contribution. The plan is deemed to pass the ADP/ACP tests automatically if the sponsor makes a safe harbor match or profit-sharing contribution in accordance with IRS rules. 15 Third, the plan must satisfy the top-heavy test. A plan is deemed to be top heavy if the account balances of key employees exceed 60% of the value of all accounts under the plan. Key employees generally include officers earning more than $160,000 (for 2010) and certain owner-employees. For any year in which a plan is deemed to be top heavy, all non-key employees generally must receive a 3% minimum employer contribution. Passing the various tests described above is a tax-qualification requirement for all 401(k) plans. A failure to comply with these rules will result in plan disqualification, although it is much more likely that the IRS would instead impose tax penalties on the plan sponsor rather than pursue actual disqualification of the plan. INFO REQUEST Request a copy of the minimum coverage, ADP/ACP and top-heavy tests. If any tests are not performed, request confirmation from the plan s recordkeeper that testing is not necessary because the plan s design automatically satisfies the applicable rules. If the sponsor is unable to produce the relevant plan testing records, it could mean that the plan s recordkeeper is not performing the relevant test. In this situation, consider advising the sponsor to contact its provider or counsel to demonstrate testing compliance for current and past years. 15. IRC Section 401(k)(12) establishes the safe harbor requirement for a matching contribution or a profit-sharing contribution. IRC Section 401(k)(13) establishes an alternative safe harbor for a matching contribution or profit-sharing contribution if the plan has an automatic enrollment feature.

16 16 Due Diligence If the sponsor is a member of a controlled group of corporations, coordinate with the plan s recordkeeper to ensure all employees of the controlled group are being taken into account for purposes of the minimum coverage test, especially if the plan limits participation to employees of some, but not all, members of the controlled group. If the plan is having problems passing the ADP/ACP tests, discuss potential solutions with the sponsor. The sponsor could encourage NHCE participants to increase their savings rate by arranging investment meetings with the advisor. The sponsor could also consider enhancing the match for NHCEs, adopting a safe harbor employer contribution which eliminates the need to run the ADP/ACP tests, or utilizing automatic enrollment.

17 ishares 17 Checking in with the Plan s Ongoing Recordkeeper In addition to reviewing these documents and information, advisors should consider having a brief discussion with the plan s ongoing recordkeeper to confirm the various IRS contribution and compensation limits are being observed properly. The IRS imposes annual limits on elective deferrals ($16,500 for 2010) and catch-up contributions ($5,500 for 2010), as well as the maximum annual compensation that may be considered under the plan ($245,000 for 2010). The discussion should serve as a quick spot check on prospective plan operation, serving as a simple way to round out the due diligence review of the new plan client. Conclusion Financial advisors should conduct a due diligence review of their new 401(k) plan clients documents and records for a variety of reasons. The important information that can be drawn from these materials will help the advisor make prudent recommendations that are tailored to the specific needs of the client. It will also give the advisor an opportunity to check the plan s current condition in terms of regulatory compliance. A due diligence review can protect advisors from potential co-fiduciary liability with respect to plan compliance problems, and it can also help advisors reinforce their new (and existing) client relationships by demonstrating the value of their services and their expertise.

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