A new survey conducted by Newport Group and PLANSPONSOR shows a dramatic increase in the use of nonqualified deferred compensation (NQDC) plans to retain and attract executives.  Of 350 organizations offering NQDC plans, 42% said that was the reason for offering them.  This is up from 26% in the 2020 survey.  The survey also found a dramatic increase in the number of small and mid-sized companies offering NQDC plans.  In 2020 only 50% of those surveyed offered NQDC plans but that number is now 80%.

The limitations on the amounts that can be contributed to a qualified plan under Internal Revenue Code (Code) section 415 ($66,000 in a defined contribution plan for 2023); the limit on the amount of compensation that can be considered  in a qualified plan ($330,000 in 2023) under Code section 401(a)(17); and the limit on elective deferrals into a 401(k) plan ($22,500 if under 50, $30,000 with catch-up for 2023) under Code section 402(g) all limit how much a well-paid executive can save for retirement.  Therefore NQDC plans can be used to allow them to save more to have a larger percentage of replacement income at retirement.

The deadlines for amending many retirement plans for recent changes in the law under the CARES Act and SECURE Act have been extended to December 31, 2025 (governmental qualified or 457(b) plans or a 403(b) plan for public school employees deadline is generally within 90 days after the legislative body with authority to amend the plan closes the third regular legislative session that begins after Dec. 31, 2023).  IRS Notice 2022-33 first extended the deadlines for many, but not all, provisions in both Acts.  See Notice 2022-33 Does Not Extend Deadline For Adopting Amendments to Plans for All CARES Act Provisions: Loan and In-Service Withdrawal Provisions Excluded.   Additionally, Notice 2022-45 extended the deadline for amendments for loan and in-service withdrawal provisions to the same date.  However, importantly, these Notices do not extend the deadline for 457(b) plans sponsored by tax exempt organizations.  Thus, those plans must be amended by December 31, 2022 if on a calendar year. 

Tax Exempt Organization 457(b) Plans Are Different.  Internal Revenue Code (Code) Section 457 governs the taxation of unfunded deferred compensation plans of state or local governments or tax exempt organizations.  Generally, Code section 457(b) provides that benefits of an eligible deferred compensation plan are not taxable to the participant until received and sets forth the requirements to be an eligible deferred compensation plans.  The requirements are different depending on whether the employer is a state or local governmental entity or a tax exempt organization.  Governmental 457(b) plans are similar to 401(k) plans.  For example, the assets must be held in a trust for the exclusive benefit of participants.  However, the assets of a 457(b) plan sponsored by a tax exempt organization must remain the employers and subject to its creditors.  Thus, to avoid violating ERISA, the tax exempt organization 457(b) plan must be a “top hat” plan for a select group of management and highly compensated employees.

Required Minimum Distributions Amendment.  The SECURE Act increased the age when participants must begin taking required minimum distributions (RMDs) from age 70 1/2 to age 72.  Section 457(b) plans are subject to the RMD rules.  Therefore, 457(b) plans of tax exempt organizations must be amended by the end of the year for the changes to these rules unless the IRS issues another Notice extending the deadline.  Time is running out for the IRS to pass such an extension.  Therefore, tax exempt organizations should be taking steps now to amend their 457(b) plans.

 

On September 29, the House of Representatives passed the Mental Health Matters Act (Act) which included the provisions of another bill previously introduced, the Employee and Retiree Access to Justice Act (ERAJA).  While the Act principally deals with health plans and expanding access to mental health and substance abuse services, ERAJA amends ERISA in two important ways that will lead to much more ERISA retirement plan litigation.

Arbitration.  ERAJA would invalidate and render unenforceable any arbitration provisions, class action waivers, and representation waivers for the purposes of  claims brought under ERISA Section 502 as well as common law claims.   There is an exception if particular rules (including a paper notice written to be understood by an average participant and 45-day waiting period) are followed.  Agreeing to arbitration also cannot be a condition for participation under a plan.

Standard of Review.  ERAJA would also legislatively remove the ability of plans to give the plan administrator discretion in deciding claims and having the administrator’s decision be given deference by a reviewing court that has been the law since the 1989 Supreme Court decision of Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989).  Under that case, when the plan document gives the administrator discretion in deciding benefit claims, a reviewing court should not overturn the decision of the administrator unless it determines the administrator acted arbitrary and capricious.   ERAJA would require all courts to use a “De Novo” standard when reviewing the decision, not giving any deference to the administrator.  Multiemployer plans would not be subject to this change.

While ERAJA is just a bill that would have to pass the Senate and be signed by the President before becoming law, if it were to be enacted it would dramatically change the landscape of ERISA litigation.  It would no doubt increase ERISA litigation and act as even more of a deterrent for employers to adopt private retirement plans.

There has been much press coverage on how the Inflation Reduction Act provides billions in funding for IRS enforcement.  Some stories say that the IRS will be hiring 87,000 new agents to audit taxpayers over the next 10 years.  This is disputed but there is no doubt that there is $80 billion in funding to the IRS under the Act. Of this over $46 million is allocated to enforcement.  However, enforcement means a number of things other than just hiring agents to audit, it can also include hiring customer service agents, IT personnel and upgrading technology.  Secretary Treasury Yellen has stated that taxpayers making less than $400,000 a year should not see an increase in the rate of auditing activity. 

This debate centers generally around individual taxpayers.  However, since 2010 the IRS has seen its budget cut by 20%.  The number of employees has decreased by 16,000 employees and its enforcement agents decreased by 30%. See, What The New $80 Billion for the IRS Really Means for Your Taxes. Therefore, the agency needs the funding.  However, businesses and employers should be aware of the upcoming increase in enforcement and ensure they can withstand an audit.  In particular benefits plans should perform self-audits to see if there are document or operational failures that might be self-corrected or corrected under EPCRS or the Voluntary Closing Agreement program.  Likewise, there is significant reason to believe that there may be an enforcement initiative for nonqualified deferred compensation plans.  These are addressed respectively below.  

Qualified Plans.

Over the past few years there has been a lot of  legislation affecting plans due to the Covid-19 Pandemic.  On top of that, pre-approved plans were required to be restated for changes in the law to a certain point.  The way qualified plans work is that the IRS gives employers time after changes in the law are effective to adopt the written provisions into the plan document.  However, the plan must be operated in accordance with the new provisions upon the effective date regardless if the plan has been amended or not.  Therefore, there is ample opportunity for disconnects causing failures.  Below is a list of some items that should be reviewed.

  1. Ensure plans  have been timely restated.  For example, preapproved defined contribution plans were required to be restated by July 31, 2022.
  2. Ensure plans are properly operated.  For example, if the employer has adopted increased loan amounts for Covid-19 and/or distributions for Covid-19 hardships that the plan is properly operating these provisions with proper employee notices, etc.
  3. Ensure that any interim amendments required to be adopted are done so by their effective date.  While the deadline for adopting amendments for many changes has been extended not all have been. See Notice 2022-23 Does Not Extend Deadline For Adopting Amendments to Plans for All CARES Act Provisions: Loan and In-Service Withdrawal Provisions Excluded.
  4.  Ensure that elective deferrals are timely deposited.
  5.  Ensure Forms 5500 are timely filed
  6. Ensure that Required Minimum Distributions (RMDs) are being properly distributed by the applicable age 70 1/2 or 72.  Document if the plan suspended RMDs in 2020 due to Covid-19.
  7. Review the basic plan operation to ensure it is operating smoothly, participants are entering timely, getting employer contributions timely, etc.

These are but some of the issues that should be considered in a self-audit to ensure the plan is ready for an audit.

Nonqualified Deferred Compensation (NQDC)  Plans.

Last year the IRS revised its Nonqualified Deferred Compensation Audit Technique Guide effective June 1, 2021.  This document explains to auditing agents what issues they should be looking for when auditing nonqualified plans.  The guidelines breakdown the issues to the following three.

  1. When are deferred amounts includible in employee’s gross income?
  2. When are deferred amounts deductible by the employer?
  3. When are deferred amounts considered for employment tax purposes?

The new guidelines have a more detailed emphasis on Code section 409A and how it significantly changed the rules governing NQDC Plans including the fact that plans must be in writing.  The guidelines list of series of questions agents should ask to discover the possible plans of the employer.  For example:

Does the employer have any plans, agreements, or arrangements for employees that supplement or replace lost or restricted qualified retirement benefits?;

Do employees have individual employment agreements?;

Do employees have any salary or bonus deferral agreements?;

Does the employer have any insurance policy or annuity plan designed to provide retirement or severance benefits for executives?;

Are there any board of director’s minutes or compensation committee resolutions involving executive compensation?; and

Is there any other written communication between the employer and employees that sets forth “benefits”, “perks”, “savings, “severance plans”, or “retirement arrangements”

Employers would be prudent to self-audit their records to identify all possible arrangements and confirm their compliance with Code section 409A and other principles of law such as the Constructive Receipt and Economic Benefit doctrines.  Also as a result of the Pandemic many Executives may have renegotiated their employment arrangements or even taken severance.  These arrangements should be confirmed to be compliant with Code section 409A, as well.

The fact that the IRS updated its Audit Technique Guide could be a signal that it plans more examination activity in this area.

Conclusion.

The additional funding for enforcement to the IRS under the Inflation Reduction Act will no doubt lead to more examinations.  The benefits area is ripe for increased enforcement activity.  Employers should be proactive to ensure their plans and operations are in good shape not only because they might be audited by the IRS but because it is the prudent thing to do.  A compliance failure may not only affect the tax effects of a plan but can also lead to a claim by a participant.  Additionally, while the pandemic is not over, businesses have learned how to deal with it and it should no longer be an excuse for neglecting plans.

We are always available to help review plans for compliance.

On August 26, 2022, Governor Newsome signed legislation that amends the statute governing CalSavers, California’s mandatory payroll reduction IRA savings plan to lower the threshold number of employees required to subject a California employer to the law from five to one on December 31, 2025.  Currently, employers with five or more employees that do not offer a retirement plan to their employees, must register for CalSavers and withhold and pay over to CalSavers a percentage of pay from those employee’s that enroll in CalSavers.  Under the new law, the threshold drops from five or more employees to one or more employees.  This change will allow employees of employers with one to four employees that do not offer a retirement plan, to save for retirement through CalSavers.

Excluded from participation in CalSavers are sole proprietorships, self-employed individuals, and other business entities that only employ the owners of the business.

What It Means.

Effected small businesses must decide upon a compliance strategy.  On the one hand, they can just register with CalSavers when the new threshold becomes effective.  This is the simplest compliance strategy with minimal administration.

However, between now and then they should consider whether adopting a private retirement plan, such as a 401(k) plan that will exempt them from CalSavers, may be more advantageous.  CalSavers operates Roth-IRAs on behalf of the enrolled employees.  The maximum amount that can be saved in an IRA is $6,000 annually, those over age 50 can save another $1,000.  On the other hand, an employee can save $20,500 in a 401(k) plan and those over age 50 can save another $6,500 for a total of $27,000.    Safe harbor plans, requiring an employer contribution, can allow owners to save the maximum without having to worry about discrimination testing.  Also, private retirement plans can have minimum age and service requirements before employees participate in the plan.  They can also reward loyalty by providing employer contributions are  subject to a vesting schedule whereby employees will forfeit some benefit if they don’t stay with the employer long enough.  Private plans can also allow employees to borrow against their account balance which can’t be done with a CalSavers account.  Finally, there is a federal tax credit for employers that adopt private retirement plans.

All California employers, not just those with between one and four employees, should consider whether a private plan can be designed to better meet their goals than the state run CalSavers.  Those with under 5 employees, in particular, have time to meet with retirement plan professionals to discuss private plan designs that may be a better option before being subject to CalSavers.  This author recommends they take advantage of the time to do so.

On August 3, 2022, the IRS issued Notice 2022-33 which extended the deadline for Employers to adopt certain amendments to their qualified plans, 403(b) plans, and governmental plans, resulting from recent legislation including the  Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), and the Bipartisan American Miners Act of 2019 (Miners Act).  The Notice gives Employers until December 31, 2025 to adopt the amendments retroactively to the provision’s effective date.  Governmental plans generally have longer.   Without the extension, the amendments for non-governmental plans would have been due by the last day of the first plan year beginning on or after January 1, 2022 (December 31, 2022 for calendar year plans).  The deadline was generally December 31, 2024 for governmental plans.  Despite when the plan amendments are due to be adopted, plans must be operated in accordance with the new provisions by their effective date, even if not yet in the plan document!

CARES Act Provisions.

Notice 2022-33 does not extend the deadline under the CARES Act for adopting plan amendments reflecting special COVID-related relief for qualified individuals involving loans and in-service withdrawals.  The Act allowed plans to offer such individuals the ability to take COVID-related in-service withdrawals,  increased the maximum limit on plan loans to $100,000 or 100% of the vested account balance, allowed for the temporary suspension of loan repayments and an additional period for loan repayment after such suspension. Plan amendments adopting these provisions must still be made by the end of the first plan year beginning on or after Jan. 1, 2022 (Dec. 31, 2022 for calendar year plans).

The CARES Act provision permitting the waiver of RMDs for defined contribution plans for 2020 is eligible for the extended adoption date.

SECURE Act Provisions.

The provisions of the SECURE Act that qualify for the extended deadline include:

  • The increase in the age for commencing required minimum distributions (RMDs) from 70½ to 72;
  • The modification of the rules for RMDs to beneficiaries under defined contribution plans;
  • The requirement that 401(k) plans permit long term part-time employees (those that complete at least 500 hours of service during each of three consecutive years beginning January 1, 2021) to have the opportunity to make elective deferrals to the plan;
  • Permitting a plan to allow penalty-free withdrawals for qualified birth or adoption distributions up to $5,000; and
  • The increase in the maximum automatic enrollment safe harbor contribution from 10 percent to 15 percent of eligible pay.

Miners Act Provision.

The Miners Act permitted a reduction in the minimum age for in-service distributions from defined benefit plans from age 62 to age 59½ to align it with defined contribution plans.  This provision need not be adopted until December 31, 2025.

Conclusion.

The extension gives the IRS more time to issue guidance on these changes in the law and maybe even model amendments.  In general, it is a welcome extension.  However, it would be nice if all the CARES Act provisions were extended.  However, we may get some additional retirement plan provisions in legislation before the end of the year (e.g., SECURE 2.0).  If enacted that legislation is also likely going to require amendments that could be tied to the December 31, 2025 deadline.

On July 26, Democratic Senators Dick Durbin, Elizabeth Warren, and Tina Smith sent a letter to Fidelity Investments CEO, Abigail Johnson, asking why Fidelity would allow plan sponsors to offer Bitcoin as an investment for plan participants.  The Senators said, “it seems ill-advised for one of the leading names in the world of finance to endorse the use of such a volatile, illiqud and speculative asset in 401(k) plans.”

After citing how difficult it is for many Americans to save for retirement and many are likely to outlive their savings, the Senators said, “it begs the question: when saving for retirement is already a challenge for so many Americans, why would Fidelity allow those who can save to be exposed to an untested, highly volatile asset like Bitcoin?”  The letter goes on to state, “What appears to be certain is many are unaware of the potential risks and financial dangers posed by digital assets like Bitcoin”.

The letter then cites the recent fall of Bitcoin’s value by more than two-thirds off its peak in November of 2021 and said that Fidelity’s decision is “immensely troubling.”  It pointed out that Fidelity’s limit of only allowing participants to invest 20% of their account in Bitcoin and pointing out the risks on its Website, Fidelity acknowledges it is well aware of the dangers associated with investng in Bitcoin and digital assets yet decided to offer the investment anyway.

The Senators conclude stating there are many other  ways Americans can invest in Bitcoin and the “cryptocurrency casino” but through a retirement plan is. . . “a bridge to far.  Retirement accounts must be held to a higher standard, one that Bitcoin and other unregulated digital assets fail to meet.  This asset class is unwieldy, immensely complex, unregulated, and highly volatile.  Working families’ retirement accounts are no place to experiment with unregulated asset classes that have yet to demonstrate their value over time.”

The Senators then request a response.  It will be interesting to see if they get one and what it says.  This author is in full agreement with the Senators.  See, Why Would Anyone Invest In Crypto Through A Retirement Plan?.  Of course, this all comes while ForUsAll Inc., one of the first providers to begin offering cryptocurrency funds via brokerage windows in retirement plans, has sued the Department of Labor maintaining its latest guidance on cryptocurrency (Compliance Assistance Release No.  2022-01) is unlawful.  See, Crypto Provider Fights Back Against DOL Warning Guidance.  The Department of Labor has not yet filed its answer in that suit.  Stay tuned.

On June 2, ForUsAll Inc.  filed suit against the United States Department of Labor (DOL) in federal district court in D. C., over its latest soft guidance issued in March on the use of cryptocurrency investments (Crypto) in plans.  Compliance Assistance Release No. 2022-01)   Last June, ForUsAll Inc. became one of the first providers to begin offering Crypto funds via brokerage windows in retirement plans.  See, “Why Would Anyone Invest In Crypto Through A Retirement Plan?”.  The lawsuit maintains that the DOL’s guidance was arbitrary and capricious and exceeded its regulatory authority by: inventing a new standard of care, “extreme care” for fiduciaries considering adding Crypto as a plan option; announced a new fiduciary obligation to monitor Crypto in brokerage windows; and threatened to open investigations of plan fiduciaries that offer Crypto.  It also alleged that the DOL  failed to follow the proper steps for issuing guidance under the Administrative Procedures Act, requiring a chance for public comment.  The suit asks the court to vacate and set aside the guidance and enjoin the DOL from attempting to enforce it.

Other Criticism.

Since the DOL issued its guidance, industry groups including the American Bankers Association, the American Benefits Council and others have criticized it and requested it be withdrawn.  However, many employee benefits practitioners don’t believe Crypto in plans is a good idea.  Meanwhile EBSA still doesn’t have a confirmed head as the Senate narrowly failed to confirm Lisa Gomez on June 8.  However her nomination is still alive because Majority Leader Chuck Schumer, D-New York, voted against the nomination, allowing him to bring it to the floor again in the future.

Crypto Still Risky.

While the lawsuit could rescind the DOL guidance, it’s this author’s opinion that Crypto is still a very risky investment for retirement assets for the reasons expressed in the guidance and my prior blog article.  Brokerage windows may be a less risky way for fiduciaries to offer Crypto to participants who demand it, but that doesn’t make it a good idea.  Under the current climate, fiduciaries should carefully consider whether to offer Crypto and carefully document their decision in case they are questioned by the DOL.  Stay tuned as we will continue to monitor the progress of the suit and guidance in this developing area.

A California employer with 5 or more employees that does not provide a retirement plan must register with CalSavers, the state’s mandated payroll deduction IRA program by June 30, 2022.  Additionally, a bill has passed the California Senate, SB 1126, and is being considered by the Assembly that would lower the threshold number of employees to 1 non-owner employee.  I have written extensively on CalSavers.  See for example:   “CalSavers Is Here To Stay As Supreme Court Refuses To Hear ERISA Challenge”;  “Inflation Adjusted Plan Limits Reiterate Advantages of Employer Plan Over CalSAVERS; Supremes May Accept Preemption Challenge”;  “Ninth Circuit Holds CalSavers Is Not Preempted By ERISA. . . 6/30 Deadline Approaching”; etc.  This blog article will discuss a couple of nightmare scenarios of the effect of the mandated CalSavers on employers.

Take Care Of Your Qualified Plan.   An employer that maintains a qualified retirement plan such as a pension, profit sharing or 401(k) plan for its employees is exempt from registering for CalSavers.  Likewise, maintaining a SEP-IRA or SIMPLE plan also exempts the employer.  So an employer maintaining one of these plans doesn’t have to worry about CalSavers, or does it?  Employers maintaining such plans are exempt from registering for CalSavers.  On the other hand, employers that don’t maintain another plan and don’t register for CalSavers are subject to penalties.  The penalties are $250 per employee and will be levied in partnership with the California Franchise Tax Board.  Once receiving the first notice of penalties, if the employer doesn’t comply within 90 days the penalty increases another $500 (for at total of $750) per employee.  CalSavers has indicated that it is serious about levying such penalties.  See CalSavers Begins Assessing Penalties-Threshold Number Of Employees Drops To 5 on June 30.

The CalSavers law says nothing about the terms of the retirement plan maintained by the employer that exempts it from registering.  For example, a profit sharing plan can have contributions in the complete discretion of the employer.  Presumably, the employer can contribute in the first plan year and then not contribute for subsequent years but it would still be exempt from registering for CalSavers.  However, failing to contribute for 3 or more  years could cause the IRS to maintain that the plan is not a qualified plan because it was not intended to be permanent as evidenced by the lack of contributions.

I often help clients in correcting failures in the required plan provisions or operation of their qualified plans, such as 401(k) plans.  Failures can be anything from failing to timely amend the plan for required changes in the law for a number of years to failing to include otherwise eligible employees.  I have helped employers restore the qualified status of their plan through the Employee Plans Correction Resolution System (EPCRS) or, when the failure is not eligible for EPCRS through a Voluntary Closing Agreement.  However, sometimes the failure is so egregious that the IRS will not enter into a closing agreement or the amount involved in correcting the plan is prohibitive for the employer to do it.

Imagine this worst case scenario.  In 2012, an individual with a significant account balance in the 401(k) plan of his former employer wishes to purchase his own business but doesn’t have enough wealth outside his retirement plan.  Searching the Internet he finds “ROBS R US.com”, a provider that helps people use the technique the IRS has named “Rollover for Business Startup” or ROBS.  Under this technique he incorporates a C corporation, has it establish a 401(k) plan, rolls over his account balance from his former employer’s plan and directs the investment of his account into employer stock of the new corporation.  The corporation now has capital, and purchases an existing business with more than 5 employees.   However, the owner never tells any of the employees about the plan, never makes any employer contributions to the plan, never values the stock in the plan, doesn’t file Forms 5500, and never amends the plan.  Essentially, once the corporation is capitalized, the owner forgets about the plan.   In 2023, the IRS audits the plan and determines that the corporation’s total disregard for the law means it will disqualify the plan and it is not eligible for the Audit Closing Agreement Program under EPCRS.  Therefore, the employer loses tax deductions for the past three years, and the owner will be taxed on the value of the stock.

That is certainly, bad enough.  However, since the employer didn’t maintain a qualified plan, it was required to register for CalSavers and failed to do so, now it is subject to penalties.

Misclassified Workers.

Another nightmare scenario involves misclassified workers.  Even though it is very difficult to be an independent contractor in California as a result of AB 5, it still happens. See California Rideshare Companies At The Intersection Of AB5 and Proposition 22So imagine an employer has 3 full time employees and a 25 person sales force classified as independent contractors.    The employer does not provide its workers a retirement plan and does not register with CalSavers.  The employer operates this way from 2021 to 2025 when it is audited by both the IRS and California that determine the sales force should be classified as employees.  Now the employer has 28 employees and has been subject to CalSavers since 2021.  It would be subject to penalties.

It’s important to note that had the employer adopted a 401(k) plan for the 3 full time employees, it wouldn’t have such penalties  and also would likely not have to cover the misclassified sales force retroactively.  The plan document probably contains “Microsoft” language that says if an independent contractor is reclassified as an employee by a government agency, they will not be retroactively eligible to participate in the plan.   This language was approved by the United States Court of Appeals for the Ninth Circuit in the case of Vizcaino v. Microsoft, 120 F.3d 1006 (9th Cir. 1997).  Therefore, the 401(k) plan would not lose its qualified status provided it covered the salesforce prospectively.

Conclusion.

These situations demonstrate how noncompliance with one law can trigger a prior obligation to comply with CalSavers.  It is unclear how CalSavers will handle penalties in these situations.  However, the CalSavers penalties could be an add-on cost to an already bad situation for the employer.

I’ll admit I don’t completely understand Cryptocurrencies or “Crypto” for short.  And without wanting to sound immodest, I’m not unintelligent or inexperienced in the world of investments or employee benefits, business, or the law.  Therefore, I will not try to explain it or how it works in this brief blog articles, there are plenty of other articles you can find on the Internet that do that.  I do know that there are over 17,000 Cryptos.  I also know that Crypto is not actual currency, at least not in the United States (Bitcoin, the first and largest Crypto is now the official currency of El Salvador).  That means it is not legal tender for all debts in the U.S. like cash.  I also know that it is quite volatile subject to large changes in its value.

Recently, there has been a big push in the media to encourage Americans to invest in Crypto.  In fact, a commercial starring Matt Damon premiered during the Super Bowl promoting Crypto.com.  Also, providers and plan sponsors are beginning to offer Crypto as an investment on the menu in participant directed 401(k) plans.  Last month, the nation’s largest record keeper, Fidelity Investments, announced it will have a product ready in coming months allowing 401(k) participants to direct up to 20% of their account to be invested in Crypto should the sponsoring employer add it to the available menu.  Fidelity will begin with Bitcoin but plans to add other Cryptos in the future.  Last June, a smaller provider ForUsAll Inc. began offering over 50 different Cryptos via brokerage windows in plans.  An April Investopedia survey showed that 28% of millenials expect to invest in Crypto to support themselves in retirement.  It is reported that 52 million Americans already invest in Crypto.

Prudence Generally Means Conservative.  I’ve had many occasion to advise clients on the legal aspects of riskier plan designs and investments.  For example, often when clients want to establish a ROBS plan, I have advised of the risks and many have changed their mind.  ROBS stands for Roll Over for Business Start-Up which is a term coined by the IRS to describe a technique to establish a C corporation that adopts a 401(k) plan permitting participant investment in employer  stock.  The principal owner then rolls over substantial assets from a prior employer plan or IRA, and purchases the C corporation stock to capitalize the business.  The term was coined in an internal IRS Memorandum describing all the ways these technically legal designs can be challenged on audit.  Beyond the risks identified in the Memorandum, I advise clients on the fact that they are gambling their hard earned retirement assets on a new business venture.  If the business fails they lose their retirement fund.  There is a reason retirement investing tends to favor conservative less risky strategies with steady growth over time.

The same can be said for such speculative and unregulated investments such as Crypto.  Do you really want to put your retirement money at that much risk?

The DOL’s Position.  In March the U.S. Department of Labor issued Compliance Assistance Release No. 2022-01 titled 401(k) Plan Investments in “Cryptocurrencies”.  In it the DOL cautions plan fiduciaries to exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plan’s investment menu for plan participants.  The guidance states that at this early stage in the history of cryptocurrencies, the DOL has “serious concerns about the prudence of a fiduciary’s decision to expose a 401(k) plan’s participants to direct investments in cryptocurrencies” or other products whose value is tied to cryptocurrencies. These investments “present significant risks and challenges to participants’ retirement accounts, including significant risks of fraud, theft, and loss. . .” and cites several reasons including: Crypto’s speculative nature, difficulty for participants to make informed decisions, valuation concerns, lack of but evolving regulatory environment and the fact that losing a password could mean losing the entire investment.  The guidance concludes that EBSA is launching an investigative program aimed at plans that offer Crypto investments as part of its menu or through brokerage accounts and that fiduciaries of such plans can expect to be questioned on how offering such investments meet their fiduciary duties of prudence and loyalty in light of the risks.

Proof in the Pudding.  On May 12, 2022, the market saw $200 billion in wealth in Crypto lost overnight.  Bitcoin has lost 50% of its value since the Superbowl ad ran.  Again, I don’t completely understand Crypto but I’ve read that the free-fall in Crypto has been largely tied to the failure of a particular Crypto ironically called a “stablecoin” known as TerraUSD or UST, which is supposed to be pegged one-to-one with the U.S. dollar.  However, it somehow lost its peg and is now worth about 14 cents on the dollar.  Worse yet another Crypto called Luna is a token closely related to UST and is now worth zero.  Again, I don’t completely understand it, but I understand that it is quite volatile and Cryptos have experienced significant losses as a result.  So it begs the question:

Why would anyone want to invest in Crypto through a retirement plan?  More importantly, why would a fiduciary allow it as an option?  Given the current environment, I couldn’t call it a legally prudent investment.