Plan Overdraft Services

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.  

A recent call with an advisor in Hawaii is representative of a common inquiry related prohibited transactions. The advisor asked: “A bank serves as the trustee of my client’s retirement plan. It offers overdraft protection services to the plan. Wouldn’t that be an extension of credit to a plan and, therefore, considered a prohibited transaction?” 

Highlights of Discussion 

A bank's provision of overdraft protection services to a qualified retirement plan may be exempt from the prohibited transaction rules, provided the bank complies with the requirements of Department of Labor Advisory Opinion (DOL AO) 2003-02A and Prohibited Transaction Class Exemption 80-26 (PTE 80-26).

Overdrafts in a plan may occur as the result of securities transactions or check clearings. The covering of overdrafts in these scenarios represents the lending of funds from a depository institution (e.g., a bank or other financial institution) to an ERISA plan. Under the rules of the Employee Retirement Income Security Act of 1974 (ERISA), the depository institution is considered a “party in interest” either because it is a fiduciary to the plan (e.g., bank-owned deposits in the plan or a provider of trustee services to the plan). ERISA Secs. 406(a)(1)(B), 406(a)(1)(D) and 406(b)(2) prohibit interest free loans and other extensions of credit from parties in interest to employee benefit plans.    The Department of Labor (DOL) recognized that most plan overdrafts are short-lived and not abusive. As a result, the DOL provided relief for such transactions in PTE 80-26. PTE 80-26 covers loans or other extensions of credit used for the payment of ordinary operating expenses of the plan, or for a period of no more than three days for a purpose incidental to the ordinary operation of the plan. In order to qualify for the PTE, the overdraft coverage arrangement with the plan must meet the following requirements.  

• The financial institution may not charge the plan interest or any other fee, and the plan does not get a discount for payments made in cash; 

• The proceeds of the loan or extension of credit are used only for 1) the payment of ordinary operating expenses of the plan, including the payment of benefits in accordance with the terms of the plan and periodic premiums under an insurance or annuity contract, or 2) for a period of no more than three business days, for a purpose incidental to the ordinary operation of the plan; 

• The loan or extension of credit must be unsecured;  

• The loan or extension of credit may not be made, directly or indirectly, by an employee benefit plan. 

 The DOL provided further clarification on the topic in an advisory opinion issued February 10, 2003, which specifically discusses the provision of overdraft protection services in connection with securities and other financial market transactions. In DOL AO 2003-02A, the DOL opined that, under certain circumstances, the extension of an overdraft to a plan in connection with the settlement of a securities or other financial market transaction would satisfy the requirements for the exemptions provided in ERISA Sections 408(b)(2) and 408(b)(6).  

Conclusion

The covering of overdrafts in a qualified retirement plan by a financial institution that occur as the result of securities transactions or check clearings could be a prohibited transaction. Fortunately, the DOL has provided relief in PTE 80-26 and AO 2003-02A.  

Since 2002, contributions to 457(b) plans no longer reduce the amount of deferrals to other salary deferral plans, such as 401(k) plans. A participant’s 457(b) contributions need only be combined with contributions to other 457(b) plans when applying the annual contribution limit. Therefore, contributions to a 457(b) plan are not aggregated with deferrals an individual makes to other types of deferral plans. Consequently, an individual who participates in both a 457(b) plan and one or more other deferral-type plans, such as a 403(b), 401(k), salary reduction simplified employee pension plan, or savings incentive match plan for employees has two separate annual deferral limits.  

Another consideration when an individual participates in more than one plan is the annual additions limit under IRC Sec. 415(c),1 which typically limits plan contributions (employer plus employee contributions for the person) for a limitation year 2 made on behalf of an individual to all plans maintained by the same employer. It this situation, the annual additions limit is of no concern for two reasons:  1) there are two separate, unrelated employers; and 2) contributions to 457(b) plans are not included in a person’s annual additions [see 1.415(c)-1(a)(2)].  

Conclusion

IRS rules would allow a person who participates in a 457(b) plan and a 401(k) plan to contribute the maximum amount in both plans. However, it is important to work with a financial and/or tax professional to help determine the optimal amount based on the participant’s unique situation.