Consider the PEP, a New SECURE Act 401(k) Option

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What is a PEP?

A PEP or Pooled Employer Plan is a new way, created by the SECURE Act, for unrelated employers to collectively participate in a defined contribution plan which is professionally run, and because of economies of scale, could charge lower fees than “traditional” plans. This arrangement is a type of multiple employer plan, or MEP – that is, a type of plan covering employees of more than one employer. The PEP option will first be available in 2021.

While PEPs aren’t the right fit for every plan sponsor, they promise to be a major development in the pension plan market. We are expecting to learn more details in future guidance from the IRS and Department of Labor (DOL).

What is New About PEPs?

PEPs are intended to facilitate the adoption of 401(k) plans by small employers by permitting them to offload much, but not all, of their fiduciary responsibilities to professionals and to benefit from pooled investments.  

The PEP option also solves two problems that had discouraged participation in MEPs under prior law:

1. Unrelated employers that did not have a business nexus and that participated in a MEP were required to file separate 5500s. Adopting employers also were required to have separate, independent audits by a CPA if the employer’s portion of the plan had 100 or more participants.  A PEP is now permitted to file a combined Form 5500 and to conduct one combined audit. PEPs are also eligible for additional streamlined reporting rules.  

2. PEPs and MEPs covering employers with a business nexus (closed MEPs) are entitled to relief from the “one bad apple” rule that was previously a concern for adopters of pre-SECURE Act pooled plans. This rule puts all participating employers at risk of plan disqualification if one employer in the plan has a qualification violation, even if the other employers had no responsibility for the violation. (The IRS has also proposed its own regulatory relief from the “one bad apple” rule for defined contribution MEPs, including those that would not be PEPs.)

Who Can Sponsor a PEP?
Financial services companies, insurers, plan recordkeepers, and investment advisers are expected to be interested in becoming sponsors of PEPs covering their clients. Under the new rules, the person running a PEP is called a “pooled plan provider,” or “PPP.” A recordkeeper could, for example, offer a PEP as an option for all plans for which it provides recordkeeping services.

The SECURE Act imposes no conditions on who may be a PPP. Even an individual appears to be eligible to be a PPP.  However, PPPs will be required to register with the IRS and DOL and we do not know if future guidance will impose additional registration requirements. The Internal Revenue Code already creates a special status for certified PEO providers who register with the IRS. By analogy to this similar situation, we could expect the requirements to include providing audited financial statements and evidence of prior competence.  PPPs might also be required to satisfy financial capital or net worth requirements.

PEPs may even be established for IRA accounts, for example by a bank offering IRAs. This appears to be a new potential market for multiple employer arrangements.  

What Are Other Requirements for PPPs?

A PPP must acknowledge that it is a “named fiduciary” as defined in section 402 of ERISA, as well as the plan administrator under Section 3(16) of ERISA. The PPP must satisfy requirements for administration to be issued by the Department of Labor and must maintain ERISA bonding coverage for the entire plan. In addition, the PPP will:

  • Engage a trustee responsible for collecting contributions. The trustee must be a bank or trust company or other approved custodian for IRAs and cannot be an individual.

  • Either directly or through another entity it has hired, such as an investment manager described in section 3(38) of ERISA, select the investment menu to be available under the plan.

  • Fulfill reporting and disclosure obligations on behalf of the participating employers.

  • Make sure that fees are reasonable, as the plan will not be a PEP if it charges excessive fees.

Which Responsibilities Are Retained by the Employers?

Employers will still be responsible for prudently selecting the PPP and other vendors. If an investment manager as defined in Section 3(38) of ERISA is not retained to select investments, the employer will also be responsible for investments. Therefore, an employer without a 3(38) investment manager may wish to retain an investment adviser as co-fiduciary for this purpose.

Conflicts Issues

It is hoped that the DOL will also issue guidance on how to manage the potential conflicts that arise when the PPP also offers proprietary investments to the adopting employers. Guidance on the potential conflicts arising from the provision of multiple services to PEP employers by the PPP and entities affiliated with the PPP would also be helpful.

Looking to the Future

This kind of “open” MEP for employers that are not affiliated in some way, which some are calling a PEP-MEP, is predicted to become an attractive plan alternative for many businesses. While it is still too early to understand all of the details of how PEPs will work, the pension community has been eager to have these provisions enacted. For the first time, we have statutory provisions limiting the fiduciary responsibility of employers who participate in a qualifying PEP and combined reporting, both of which provide advantages over current open MEP products. Current sponsors of open MEPs will undoubtedly be interested in this new and improved version.  In addition, PEPs could be a way for current plan service providers to expand their businesses by providing more extensive services to their current and prospective clients. It is not too early to begin considering the PEP 401(k) option.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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