IRS Determination Letter Process and January 2011 Submission Presentation to the FCERA Board of Retirement December 15, 2010 Laurie S. DuChateau Reed Smith LLP

2 What is a Tax-Qualified Plan?  Definite written program setting forth all provisions essential for Internal Revenue Code (“IRC”) qualification  Written document that details how the plan will operate in conformity with IRC Section 401(a); and  The plan must be operated in accordance with its terms  In 1988 FCERA plan was determined by the IRS to be tax-qualified

3 Advantages of Maintaining Qualified Plan Status  Employer contributions not currently taxable to members  Plan earnings and income are not currently taxable to members  Favorable tax treatment available for distributions (e.g., rollover treatment)  No employment taxes paid on contributions or distributions

4 Advantages of Maintaining Qualified Plan Status (cont’d)  Eligible “picked-up” employee contributions treated as pre-tax contributions  Grandfathering and transitional rules apply  Favorable benefit limits

5 What is a Determination Letter?  The IRS’s opinion that the plan terms conform to the tax-qualification requirements in the IRC  IRS bound by the determination  Plan currently has an IRS determination letter issued May 6, 1988

6 Advantages to Obtaining a Determination Letter  Protection from retroactive disqualification of plan for plan term deficiencies upon plan audit  Binding opinion of the IRS as to the qualified status of the plan  Full access to IRS program - Employee Plans Compliance Resolution System (“EPCRS”)

7 Advantages to Obtaining a Determination Letter (cont’d)  Evidence of qualification to provide to third parties including other plans accepting member’s rollover distributions or investment transaction partners  May avoid foreign tax withholdings in some countries  Members may have additional protection in the event of personal bankruptcy

8 Disadvantages to Obtaining a Determination Letter  Financial costs  IRS filing fee $1,000  Legal Fees  EPCRS filing fee of up to $25,000  Diversion of staff time  Disclosure of deficiencies to IRS may result in a loss of control addressing such issues

9 Determination Letter Filing Process  File under IRS Cycle E which ends on January 31, 2011  Next scheduled filing is Cycle C (February 1, 2013 – January 31, 2014)  Filing off-cycle may result in delayed processing of the request and loss of remedial amendment period  IRS filing fee $1,000  EPCRS filing fee up to $25,000

10 EPCRS  IRS program available for self correction of plan document and operational failures  If plan not under IRS audit, plan may present deficiencies to IRS, pay required filing fee and correct deficiencies

11 EPCRS (cont’d)  Upon approval by IRS, a compliance letter is issued by IRS  Compliance letter is binding on IRS and cannot, upon audit, penalize plan for corrected issues subject to the compliance letter

12 Proposed 2010 Internal Revenue Code Compliance Policy  Plan must be established and maintained by an employer or employers as a government defined benefit plan (IRC § 401(a)(1)  Proposed compliance policy supplements the plan by incorporating the IRC required provisions as needed  Proposed compliance policy clarifies IRC required provisions as may be necessary  Changes may eventually be included in CERL

13 Exclusive Benefits – No Reversion – IRC § 401(a)(2)  Plan must be operated for the exclusive benefit of its members  Change clarifies current intention of plan

14 Vesting – IRC § 401(a)(17)  Plan subject to pre-ERISA vesting requirements  To the extent funded plan must provide 100% vesting upon termination of the plan or complete discontinuance of contributions  Vesting would also be required for accrued benefits upon a member’s attainment of normal retirement age  Change clarifies required vesting provisions

15 Forfeitures – IRC § 401(a)(8)  Forfeitures of benefits may only be used to reduce future employer contributions  Change clarifies existing plan terms  Proposal to update CERL for this provision to be proposed by SACRS

16 Required Distributions – IRC § 401(a)(9)  Benefits must be distributed, or begin to be distributed, by the required beginning date (RBD)  RBD is April 1 of calendar year following the later of the calendar year in which:  the member attains age 70-1/2; or  separates from service

17 Required Distributions – IRC § 401(a)(9) (cont’d)  Benefits must be distributed over member’s life expectancy or life expectancies of member and designated beneficiary  Benefits must meet the incidental benefit rule which requires certain minimum distributions to ensure that the benefit is primarily a retirement benefit  Change clarifies CERL provisions

18 Compensation Limits – IRC § 401(a)(17)  The plan must limit the compensation used to calculate benefits to $200,000 (as adjusted for inflation - $245,000 for 2011)  Additional clarifying language included

19 Compensation Limits – IRC § 401(a)(17) (cont’d)  Members who first joined plan prior to July 1, 1996 are grandfathered  Grandfathering based on plan provisions in effect on July 1, 1993  No compensation limit for grandfathered members

20 Rollovers – IRC § 401(a)(31)(A)  The plan must provide for tax-free rollovers of distributions out of the plan by members and beneficiaries  Notice requirements must be satisfied  Changes provide technical clarification

21 Rollovers – IRC § 401(a)(31)(A) (cont’d)  Distributions from the Plan may be rolled over into:  401(k) qualified plans  403(b) plans  governmental 457(b) plans, and  IRAs, including after 2009 Roth IRAs

22 Rollovers – IRC § 401(a)(31)(A) (cont’d)  Beginning in 2010, the plan must extend to non-spouse beneficiaries rollover rights to inherited IRAs

23 Qualified Domestic Relations Orders (“QDROs”) – IRC § 414(p)  Permits favorable income tax treatment for allocation of member benefits made pursuant to a domestic relations order  A domestic relations order will be treated as a QDRO if it meets the Code definition  Spouse or former spouse receiving distribution under QDRO is taxed upon distribution, not member  Provides criteria for making determination

24 Military Benefits (Heart Act and USERRA) – IRC § 414(u) and IRC § 401(a)(37)  USERRA - Uniformed Services Employment and Re-employment Rights Act of 1994  Contributions, benefits and service credit with respect to qualified military service must meet the requirements of USERRA  HEART Act – Heroes Earnings Assistance and Relief Act of 2008

25 Military Benefits (Heart Act and USERRA) – IRC § 414(u) and IRC § 401(a)(37) (cont’d)  Survivors of member who dies while performing qualified military service are entitled to same benefits as provided if the member had been reemployed and terminated employment on account of his/her death  Accruals during period of qualified military service are not required

26 Limits on Contributions – IRC § 415  Defined benefit plan benefits limited to the IRC “dollar limit” of $160,000 (as adjusted for inflation – $195,000 for 2011)  Testing based on straight life annuity beginning at age 62  Police/fire fighters with 15 or more years of service have more favorable limits  Benefits may be subject to other adjustment for testing purposes

27 Limits on Contributions – IRC § 415 (cont’d)  Benefits in excess of dollar limit payable from the replacement benefit plan  Annual additions to a defined contribution plan and post-tax employee contributions to a defined benefit plan cannot exceed the “annual additions” to plan

28 Limits on Contributions – IRC § 415 (cont’d)  Annual addition – the lesser of  100% of compensation or  $40,000 (adjusted for inflation by the IRS - $49,000 for 2011)  Limits are modified for permissive service credit purchases in a defined benefit plan (IRC § 415(n))  Special rules apply to restoration of withdrawals (IRC § 415(k)(3))

29 Limits on Contributions – IRC § 415 (cont’d)  Pick-ups of members’ mandatory contributions will be tested under IRC § 415(b) (IRC § 414(h))  Rollovers and transfers are not subject to these limits

30 Picked-Up Employee Contributions – IRC § 414(h)  Employers under a governmental plan may “pick-up” employee contributions to the plan  Pick-up is the pre-tax treatment of the contributions  Pick-up contributions available for permissive service credit  IRS guidance has restricted the ability to pick-up voluntary employee contributions, including service purchases (Rev. Rul )

31 Picked-Up Employee Contributions – IRC § 414(h) (cont’d)  One time irrevocable pick-up election  If service purchase pick-ups are eliminated, a member may purchase the service using post-tax contributions, rollovers, and transfers

32 Prohibited Transactions – IRC § 503 (b)  The plan may not engage in “prohibited transactions”  Limited exceptions apply to prohibited transaction rules  Prohibited transactions involve transactions between the plan and related parties such as the County

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