Month: April 2019

On April 19, 2019, the IRS issued guidance expanding the circumstances under which plan sponsors can make corrections for certain plan failures under the Employee Plans Compliance Resolution System (EPCRS) without seeking IRS approval. This is welcome relief since filing under the Voluntary Correction Program (VCP) can be costly, especially for small employers.

What changed?

The new guidance expands the corrections that can be made under the Self-Correction Program (SCP) by permitting corrections for certain plan loan, operational and plan document failures which could previously only be made by filing an application under the VCP. Since the IRS User Fees on the VCP Filings increased substantially last year, filing a VCP Application can be a costly process.

Plan Loan Failures

Plan loan failures are common and often occur when an employer fails to withhold loan payments from an employee’s paycheck. If the payments are not caught up within a specific time frame (known as the “cure period”), the loan is defaulted and the outstanding loan balance is taxed to the participant.

Previously, if the mistake was found after the expiration of the plan’s cure period, the only way to make the correction (and avoid taxation to the participant) was to file under VCP. This could be quite costly, since the VCP filing fees are based on plan assets (and not the failure itself). For example, if a plan sponsor needed to make corrections for three participants and the plan had $1,000,000 in assets, the VCP filing fee would be $3,000 (not including service provider fees to prepare the filing).

Under the updated procedures, a plan sponsor is permitted to make the correction for a loan that has gone into default under SCP assuming certain conditions are satisfied. The correction methods, however, remain unchanged. In general, a defaulted loan can be corrected by (1) having the participant make a lump-sum payment for the late loan payments, including accrued interest; (2) reamortizing the outstanding loan balance, including accrued interest, over the remaining term of the loan; or (3) a combination of both methods.

Note: In order to correct a defaulted loan (under SCP or VCP), the maximum 5-year repayment term (or longer period in the case of a home loan) must not have expired.

The new procedures also provide additional correction options for other types of plan loan failures.

Operational Failures

An “operational failure” is simply defined as a failure to follow the terms of the plan document. Many plan mistakes fall within this category. While most operational failures were previously eligible to be corrected under SCP (assuming the timing and general requirements were satisfied), there were only limited and specific circumstances under which corrections could be made by amending a plan retroactively to conform its terms to the plan’s prior operations.

For example, if plan operationally allowed all participants to make Roth contributions (without amending the plan to permit Roth contributions), a VCP filing would have been required to amend the plan retroactively to correct the mistake. Under the new guidance, this generally could be done under SCP.

These changes should give plan sponsors much greater flexibility in making necessary plan corrections, since the rules have been relaxed for retroactive amendments used to correct operational failures. This doesn’t mean that any operational failure can be made by retroactive amendment under SCP, though. The IRS did impose specific restrictions, but this is still a huge win!

Plan Document Failures

Plan document failures happen when a plan contains a provision (or provisions) that, at face value, is not permissible under the Code or regulations. They also happen when a plan fails to adopt a required plan amendment (or document restatement). Previously, such corrections could only be made under VCP. Under the updated guidance, plan sponsors are now permitted to make the necessary corrections under SCP provided the corrections are made within a specific time frame and other conditions can be met.

The Bottom Line

Mistakes happen; the rules governing retirement plans are complex. This new guidance is great news for plan sponsors, making it much easier for them to work with their plan service providers to correct certain failures without a costly VCP filing.

To have questions answered about these new rules, please contact us.

If your client has a traditional 401(k) plan that failed the 2019 ADP/ACP testing, it may be the perfect time to discuss the option of adding a safe harbor provision to the plan.  The following provides a general overview of the rules applicable to safe harbor 401(k) plans.

What is a Safe Harbor 401(k) plan?

A safe harbor 401(k) plan is a type of retirement plan that is exempt from certain testing requirements. Specifically, a safe harbor plan is generally exempt from ADP/ACP testing enabling the plan’s highly compensated employees to maximize 401(k) deferrals/Roth contributions without limitation. Safe harbor plans may also be exempt from top-heavy requirements if certain conditions are met.

What are the contribution requirements?

The plan must make either a safe harbor non-elective contribution or safe harbor matching contribution. These contributions cannot be subject to allocation conditions, e.g. employment on the last day of the plan year and/or 1,000 hours, and must be:

• 100% vested
• Subject to the same distribution restrictions as 401(k) contributions

What is a safe harbor non-elective contribution?

A safe harbor non-elective contribution is similar to a profit sharing contribution and must be made on behalf of all eligible employees, with limited exceptions. The contribution must be, at a minimum, 3% of eligible plan compensation regardless of whether the employee elects to defer or is employed on the last day of the plan year. The SECURE Act of 2019 made changes to this plan design that allow a Plan Sponsor to add this provision at any time during the Plan Year, or even after the end of the Plan Year up until the due date of their tax return. Adding the provision after the 11^th month of the Plan Year would require a 4% contribution rather than 3%, but that can drop back down to 3% for future years.

What is the formula for safe harbor matching contributions?

Unlike the safe harbor non-elective, the safe harbor matching contribution can only be added at the beginning of a Plan Year.

There are two basic formulas that may be used:

• 100% on the first 3% of salary deferred, plus 50% on the next 2% of salary deferred (maximum of 4% match)
• 100% on at least the first 4% of salary deferred, but no more that 6% of salary deferred

Are there other requirements?

Yes, but only for the safe harbor matching contribution; before the beginning of each plan year the employer must provide all eligible employees with a notice meeting specific requirements. The notice must also be provided to employees before they become eligible to participant in the plan on an ongoing basis throughout the year.

Can a plan make matching contributions in addition to safe harbor matching contributions?

Yes, however, depending upon the matching formula, ACP testing may be required.

If the plan allows for after-tax (non-Roth) contributions, is the plan still exempt from ACP testing?

No; voluntary after-tax contributions are always subject to ACP testing.

For additional matching contributions to be exempt from ACP testing, what conditions must be satisfied?

• Discretionary matching contributions may not exceed 4% of compensation
• Deferrals in excess of 6% may not be matched
• The rate of match may not increase as deferrals increase
• The plan may not impose allocation conditions on additional matching contributions

In order for the plan to be exempt from the top-heavy rules, what conditions must be satisfied?

• No contributions may be allocated to participants for the plan year other than 401(k), Roth and safe harbor contributions
• Forfeitures may not be allocated to participant accounts for the plan year
• The plan may not have dual eligibility requirements, e.g. immediate eligibility for 401(k) and a one-year wait for safe harbor contributions

Can a safe harbor plan include an automatic enrollment feature?

Yes; as a matter a fact, a safe harbor plan can be designed in such a way that if it includes an automatic enrollment feature with an automatic escalation feature, the plan can take advantage of a lesser safe harbor matching contribution formula and a 2-year cliff vesting schedule.

Can a safe harbor plan provide profit sharing contributions?

Absolutely! The plan can provide for discretionary (or fixed) profit sharing contributions in addition to safe harbor contributions and can include any allowable allocation formula, such as an integrated or cross-tested formula. This just means the plan will not be exempt from the top-heavy rules in years in which the employer elects to make a profit sharing contribution.

When can a plan adopt safe harbor provisions?

An existing 401(k) plan can only adopt a Safe harbor Matching Contribution feature effective as of the beginning of a plan year. Different rules apply to profit sharing only and new plans.

How can I learn more?

If you would like to learn more about safe harbor plans, please contact us. We would be happy to assist you with determining whether this type of design would be a good fit for any of your retirement plan clients.

 

When a participant terminates employment, what happens to their loan balance?

Most plans provide that the loan becomes payable in full upon termination of employment. If the loan is not repaid within a specified amount of time, the loan is “offset”. What this means is the outstanding loan balance is treated as being distributed from the plan to the participant.

A plan can, however, permit a participant to continue to make regularly scheduled loan payments after termination employment, so you will want to check the plan document and loan policy to determine which provisions apply.

Is a loan that has been offset taxed?

A loan that has been offset (which is an actual distribution) is taxable to the participant. Further, it is subject to the 10% early withdrawal penalty unless an exception applies.

To avoid taxation, a participant can rollover the dollar amount of the loan balance that was offset to an IRA or other qualified plan (assuming the plan accepts such rollovers).

How long does a participant have to complete the rollover?

Effective January 1, 2018, a participant has until the extended due date of his or her individual income tax return (for the year the loan was offset) to complete the rollover.

It is important to note this extended rollover period only applies to the loan offset amount; the normal 60-day rollover window applies to any cash distributions.

Is the loan offset amount subject to 20% federal withholding?

It depends. If the participant receives a cash distribution, the outstanding loan balance is included when determining the 20% withholding requirement. If the participant doesn’t take a cash distribution, then withholding would not apply.

Can a participant rollover their actual loan balance to another employer’s plan?

Possibly. Assuming the loan has not been offset, it would be permissible to rollover the loan itself from one plan to another if permitted under the terms of both plans. However, this is not a very common feature.

What if a plan is terminated?

Generally, the rules described above also apply when a plan is terminated.

How can I learn more?

If you would like to learn more about these rules, please contact us.