Mid-Year Amendments for Safe Harbor Plans

For many years the IRS did not permit mid-year changes to Safe Harbor 401(k) plans except under very limited circumstances. In 2016, the IRS issued Notice 2016-16 relaxing the rules providing sponsors of Safe Harbor 401(k) plans with much greater flexibility throughout the year. The guidance does contain a short list of changes that are specifically prohibited, but many changes are permissible provided certain conditions are satisfied.

Which changes are permissible?

In general, most changes that would be permissible mid-year in a traditional 401(k) plan can be made in a Safe Harbor plan as long as the necessary requirements are met.

What are the requirements for amending a Safe Harbor plan mid-year?

If a permissible amendment results in a change to the information provided in the Safe Harbor notice, an updated notice must be provided within a reasonable period prior to the effective date of the change. For this purpose, the IRS considers the timing requirement to be satisfied if the updated notice is provided at least 30 (but no more than 90) days prior to the change.

In situations where it is not practical to provide the notice prior to effective date of the change (e.g. the plan is being amended retroactively as the first day of the plan year to provide for an additional match), the updated Safe Harbor notice must be provided as soon as possible but no later than 30 days after the date the amendment is adopted.

In either case, participants must also be provided the opportunity to change their deferral elections for a reasonable period of time following receipt of the updated Safe Harbor notice.

What if the change does not impact the information provided in the Safe Harbor notice?

If the change does not impact the information required to be provided in the Safe Harbor notice, there is no requirement to provide an updated notice or to provide participants with an opportunity to make changes to their deferral elections.

Keep in mind, however, the plan would generally be required to provide participants with either a Summary of Material Modifications or an updated Summary Plan Description.

Which changes are specifically prohibited mid-year?

  • Any change that would reduce the number of participants who are currently eligible to receive Safe Harbor contributions
  • Changing the type of Safe Harbor plan (e.g. changing from a traditional Safe Harbor plan to a qualified automatic contribution arrangement)
  • Increasing the number of years required to become vested in Safe Harbor contributions under a qualified automatic contribution arrangement
  • A mid-year change to add or modify the formula used to calculate matching contributions (or related plan compensation) or a mid-year change to permit discretionary matching contributions, unless certain additional conditions are satisfied

 

What are the conditions for making changes to matching contributions?

In order to increase Safe Harbor matching contributions (or to add or modify a fixed or discretionary matching contribution), the amendment must be adopted at least 3 months prior to the plan year, must be retroactive as of the first day of the plan year, and, the necessary notice and deferral opportunity requirements must be met.

Can a plan change from a Safe Harbor match to a 3% Safe Harbor nonelective contribution mid-year?

No. This is not permissible under the notice or regulations. This type of change could only be made as of the first day of the following plan year.

Did the IRS provide any example of permissible amendments?

Yes. IRS Notice 2016-16 provides several examples of permissible amendments including the following:

  • An amendment to increase the Safe Harbor nonelective contribution from 3% to 4% for future contributions
  • An amendment made prior to 3 months before the end of the plan year to increase the Safe Harbor matching contribution from 4% to 5% and to change the period for calculating match from a payroll period to plan year basis retroactively
  • An amendment to add an age 59 ½ in-service distribution feature

Can a plan be amended to reduce or suspend Safe Harbor contributions mid-year?

It depends. This is addressed under the Safe Harbor regulations. A Safe Harbor plan may only be amended mid-year to reduce or suspend Safe Harbor contributions if (1) the employer is operating at an “economic loss”, or (2) the annual Safe Harbor notice included a statement indicating that the plan could be amended to remove or suspend Safe Harbor contributions during the plan year. Additional procedural requirements must also be satisfied, and the plan essentially reverts to a traditional 401(k) plan for the plan year.

Can a Safe Harbor plan be terminated mid-year?

Yes. This is also addressed under the regulations. In general, Safe Harbor contributions must be made through the date the plan is terminated, and other conditions must be satisfied. Unless the plan termination is due to a “substantial business hardship”, or as a result of a company merger or acquisition transaction, the plan would lose its Safe Harbor status for the final plan year (i.e. the plan would be subject to ADP/ACP testing, top heavy requirements, etc.)

What changes can only be made as of the beginning of a plan year?

While many changes can be made mid-year, certain changes can only be made as of the first day of the following plan year, and the amendment must be adopted prior to the first day of the plan year. Examples of such amendments include:

  • Adding a Safe Harbor provision to an existing traditional 401(k) plan
  • Changing the plan’s Safe Harbor formula from a Safe Harbor nonelective contribution to a Safe Harbor match

How can I learn more?

Please call EJReynolds at 954.431.1774 or visit ejreynoldsinc.com

Deadline Approaching to adopt a Safe Harbor 401(k) Plan for 2019!

Have you been talking with prospective clients about adopting a new 401(k) plan? Even in today’s  environment, many businesses are thriving and want to secure deductions for the 2019 Tax Year. If so, the deadline for adopting a safe harbor 401(k) plan for 2019 is fast approaching, so it would be a great time to schedule a follow-up conversation!

Safe harbor 401(k) plans are attractive for many employers (especially small employers) because they provide relief from certain plan testing requirements. Specifically, a safe harbor plan is generally exempt from ADP/ACP testing enabling the plan’s highly compensated employees to maximize elective deferrals, i.e. 401(k) deferrals/Roth contributions, without limitation. Safe harbor plans may also be exempt from the top-heavy requirements if certain conditions are met.

What is the deadline for adopting a safe harbor 401(k) plan?

No. There are no restrictions (other than the normal limits) placed on the amounts that can be deferred during this three-month period. As a result, owners, key employees and any other participants would still have time to make elective deferrals of $19,000 (plus $6,000 for participants age 50 or older). This, of course, assumes they will have enough compensation to do so within this time period.

Are there limits on the amounts that can be deferred?

No. There are no restrictions (other than the normal limits) placed on the amounts that can be deferred during this three-month period. As a result, owners, key employees and any other participants would still have time to make elective deferrals of $19,000 (plus $6,000 for participants age 50 or older). This, of course, assumes they will have enough compensation to do so within this time period.

What are the contribution requirements?

The plan must make either a safe harbor matching or safe harbor nonelective contribution.

The basic safe harbor matching contribution formula is 100% on the first 3% of deferrals, plus 50% on the next 2% (maximum of 4% match). Alternatively, an enhanced safe harbor matching formula can be used, which is most commonly 100% on the first 4% of deferrals.

Safe harbor nonelective contributions must be at least 3% of each participant’s compensation, regardless of whether they elect to make deferrals.

Note that safe harbor contributions (match or nonelective) must be 100% vested, subject to the same distribution restrictions as elective deferrals, and cannot be subject to any allocation conditions, e.g. employment on the last day of the plan year.

Tax credit available for Small Employers

As an incentive to establish a new 401(k) plan, small employers (generally, businesses with no more than 100 employees) may be eligible to receive a tax credit of up to $500 (per year, for the first three years) to help defray the costs associated with establishing and maintaining a plan.

Which design is best?

One-size does not fit all. It really depends on the goals of the employer and demographics of the workforce. The good news is that we can assist you in determining what will work best for your clients after considering their unique needs! Please contact us to learn more.

If you would like to learn more about these rules, please contact us and we will be happy to assist you.

Is Auto-Enrollment right for your company or organization?

Since the Pension Protection Act of 2006 (PPA), Automatic Enrollment features in 401(k) and 403(b) plans have increased in popularity for large and small employers alike. PPA added fiduciary protection for Plan Sponsors, as well as safeguards for employees with requirements for advanced notices and default investments. But what exactly is an Automatic Enrollment feature? Is it appropriate for your plan design? First, let’s look at the requirements, then we’ll look at the pros and cons. With the right knowledge and information, you can determine if the Automatic Enrollment feature is right for you.

Educating Participants and Auto-Enrollment Options

The basic tenet of an Automatic Enrollment feature is this; Employees do not participant in the 401(k) plan mainly because of apathy and lack of education. They don’t know how much to contribute, and they don’t know where to invest their funds. An Automatic Enrollment feature takes that decision away from the employee; the employee is automatically enrolled in the 401(k) or 403(b) plan at a default level and their contributions are invested in a default investment fund unless the employee proactively says no.

There are three types of automatic options to consider: Automatic Contribution Arrangement (ACA), Eligible Automatic Contribution Arrangement (EACA), and Qualified Automatic Contribution Arrangement (QACA).

Here’s a quick overview of each:

ACA – The most flexible design, where there is no minimum contribution rate or required auto-escalation. There is also no required employer contribution.  This design can be added to a plan at any time.

EACA – This design is like an ACA where there is no minimum contribution rate or required auto-escalation. There is also no required employer contribution.  However, an EACA must be in place as of the first day of a Plan year. Also, employees may have up to 90 days to request to receive the return of their employee deferrals, without incurring the tax penalty.

QACA – The least flexible design, where there is a minimum contribution rate, the employer must provide a specific matching contribution, and participants must be fully vested in this match within two years of service.  The QACA generally must be in place the entire year.  If done correctly, this design will automatically satisfy certain non-discrimination testing.  Also, employees may have up to 90 days to request to receive the return of their employee deferrals, without incurring the tax penalty.

Benefits and Drawbacks of Auto-Enrollment

The automatic enrollment feature isn’t a one size fits all and it isn’t the best choice for all companies and organizations, so look at these pros and cons before moving forward.

Benefits of auto-enrollment:

  • Employees will be more likely to participate, and contributions will increase – This can help when it is hard to get employees to take part in the enrollment process.
  • Employers may provide an automatic escalation feature where employees increase their contribution rate each year.
  • Employees will defer paying income tax on their contributions.
  • Employees are more likely to meet their retirement goals by participating immediately when they become eligible, rather than potentially waiting until later in their career.
  • Auto-enrollment may help the nondiscrimination testing results, while the QACA plan will exempt a plan from certain nondiscrimination testing requirements.

Possible drawbacks of auto-enrollment:

  • Setting the auto-enrollment contribution rate lower than a participant would have elected may negatively impact employee retirement savings goals, while setting it too high may cause employees to fully opt-out of the plan, negatively impacting both employee savings and overall participation.
  • Employees may become disengaged and wrongly believe their needed retirement savings will be taken care of with auto-enrollment. The defaulted investment option may not be appropriate for the employee based on their specific situation. As Plan Sponsors, companies should continue to provide retirement education programs to their employees through their plan’s investment advisor to address this potential pitfall.
  • There may be some added administrative time to incorporate and explain the automatic enrollment feature to employees, including the notice requirements for both the default or increasing deferral rate and the default investment option chosen by the employer.
  • Employer matching contributions may increase with increased employee participation.
  • Payroll integration is a must! Missing the first deduction for a newly eligible employee or missing the automatic increase deadline for a plan offering auto-increase features, can result in penalties to the employer, and a required contribution equal to 25% of the missed deferral plus the full match that should have been contributed.
  • Small balances – since newly eligible participants are default enrolled, their initial account balances may reduce the average account balance of the plan overall. Some investment platforms may charge higher fees for plans with lower average account balances, so make sure to check with yours.

Still not sure if auto-enrollment is right for your organization?

While there is no blanket answer, we can help you understand how implementing an auto-enrollment feature might affect your company or organization – Contact us today!

The 10 most frequently asked questions about Fidelity Bond Coverage

  1. What is a fidelity bond?

A fidelity bond is a special type of insurance that protects plan participants from the risk of loss due to acts of fraud or dishonesty by plan officials.

  1. Is a fidelity bond required for my plan?

Generally, yes. With limited exceptions, all qualified plans (i.e. 401(k) plans, profit sharing plans, ESOPs, certain 403(b) plans, etc.) are required by law to be covered by a fidelity bond.

 

  1. Which types of plans are not required to have a fidelity bond?

Plans that are exempt from certain provisions of ERISA are not required to be covered by a fidelity bond. These plans include “one-participant” plans (i.e. plans that only cover the owner of a business (or the owner and his or her spouse), or only the partners of a partnership (or the partners and their spouses)), governmental plans, most plans sponsored by churches, and 403(b) plans that meet certain requirements.

 

  1. Who must be covered by the fidelity bond?

The plan must be the named insured; however, each person who “handles” plan assets must be covered by the bond. A person is considered to “handle” plan assets if his or her responsibilities are such that plan participants could incur a loss if he or she were to commit an act of fraud or dishonesty with respect to the plan.

 

  1. How is the amount of required coverage determined?

In general, the fidelity bond must be equal to at least 10% of plan assets as the beginning of each plan year, subject to a minimum bond amount of $1,000 and a maximum of $500,000 ($1,000,000 for plans that hold employer securities).

 

Note: Plans that hold more than 5% of Plan assets in “non-qualifying assets” (e.g. limited partnerships, third-party notes, collectables, real estate, mortgages, etc.) are subject to additional requirements.

 

  1. Can the plan be covered under the company’s general policy?

Yes; this is permissible provided that all of the necessary conditions are satisfied. For example, the plan must be a named insured, and the policy may not have a deductible (at least with respect to the portion of the policy covering the plan).

 

  1. Can a fidelity bond cover more than one plan?

Yes; each plan must be a named insured and assets under each plan as of the beginning of the plan year must be considered when determining the required coverage amount.

 

  1. Is a fidelity bond the same thing as fiduciary insurance?

No; fiduciary insurance provides protection for fiduciaries individually (rather than plan participants) in the event a legal claim is made against a plan fiduciary for a breach (or alleged breach) of their fiduciary responsibilities.

 

  1. Can the cost for the fidelity bond be paid for from plan assets?

Yes; the plan can pay for the fidelity bond assuming the plan permits for payment of plan expenses (which most do).

 

  1. Is there a penalty or fine if a plan doesn’t have coverage?

There isn’t a specific penalty or fine under the regulations; however, the amount of the bond must be reported on the plan’s Form 5500 each year which is filed with the Department of Labor (DOL).

 

If the plan is not covered by a fidelity bond, or if coverage not sufficient, this could certainly raise a “red-flag” and prompt an unwanted plan audit by the DOL or Internal Revenue Service.

 

If you would like to learn more about these rules, please contact us and we will be happy to assist you.

 

 

The 11 most asked In-Service Distribution questions

An in-service withdrawal occurs when an employee takes a distribution from a qualified, employer-sponsored retirement plan, such as a 401(k) account, without leaving the employ of their company.  Read the 11 FAQs below to ensure you are informed on these distributions next time you are asked.

  1. When can a participant receive a distribution from a retirement plan while still working?

It depends. A plan may (but is not required to) allow participants to receive in-service distributions. In addition, certain conditions must be satisfied which are set forth under the Internal Revenue Code and regulations.

  1. Are the rules different depending upon the type of contributions?

Yes. Elective deferrals (i.e. 401(k) and Roth contributions) can only be distributed while a participant is still working under limited circumstances. The following in-service distributions are permissible, if provided for under the plan document:

  • Hardship distributions
  • Distributions on or after the date a participant has attained age 59 ½
  • Qualified reservist distributions
  • Distributions after a participant has become disabled (as defined under the terms of the plan)

Safe harbor nonelective and matching contributions may only be distributed upon reaching age 59 ½, hardship or disability. This also holds true for QNEC and QMAC account balances.

Profit sharing and employer matching contribution account balances may be distributed upon attainment of a stated aged (which may be less than age 59 ½), after the contributions have accumulated (or “aged”) in the plan for at least 2 years, after an employee has been a plan participant for at least 5 years, or upon a stated event.

Rollover and voluntary after-tax (non-Roth) contribution account balances may be distributed at any time.

Different rules apply to pension plan balances, which generally may not be distributed to an active employee prior to attainment of age 62.

  1. Are in-service distributions eligible for rollover?

Generally, yes. With the exception of hardship distributions, any of the in-service distributions described above are eligible for rollover.

  1. Are in-service distributions subject to the additional 10% income tax for early withdrawals?

Yes. Unless the participant has attained age 59 ½, the taxable portion of the distribution is generally subject to the additional 10% income tax. There are exceptions to this rule if the participant is disabled (as defined under the Internal Revenue Code) or if the distribution is a qualified reservist distribution.

  1. What qualifies as a “hardship” distribution?

The regulations provide “safe harbor” rules, which most plans follow. Under these rules, hardship distributions may be made for the following reasons:

  • To prevent foreclosure or eviction from a participant’s principle residence
  • To purchase a participant’s principal residence (excluding mortgage payments)
  • To pay for post-secondary education for a participant, his spouse, children or dependents for the next 12 months
  • To pay for unreimbursed medical expenses that would otherwise be deductible (without consideration to the deduction limit) for a participant, his spouse, children or dependents
  • To pay for funeral expenses for a participant’s deceased parent, spouse, child or dependent
  • To pay for expenses necessary to repair a participant’s principle residence as a result of a casualty
  • Expenses incurred as a result of a natural disaster in a federally declared disaster area
  • Medical, post-secondary educational, and funeral expenses for a participant’s primary beneficiary
  1. Are in-service distributions from Roth accounts taxable?

It depends. Roth contributions are not taxed when distributed, but the related earnings may be unless the distribution is a “qualified distribution”. In general, a distribution is a qualified distribution only if the distribution is being made on account of death, disability or attainment of age 59 ½ and the participant has had a Roth account under the plan for at least 5 years.

Distributions that are rolled over to a Roth IRA are not taxable.

  1. What are “Qualified Reservist” distributions?

A plan can allow participants who have been called to active duty for a period of more than 179 days (or indefinitely) to receive a distribution of their elective deferrals.

  1. Are distributions from voluntary after-tax accounts taxable?

Like Roth contribution account balances, the after-tax contribution portion of the account is not taxable but the related earnings are unless the distribution is rolled over to a traditional IRA. If rolled over to a Roth IRA, the related earnings are taxed.

  1. If a plan allows in-service distributions, can the provisions be removed?

A plan can remove a hardship distribution feature at any time; it is not a protected benefit. The other types of in-service distribution options discussed above are protected under the law. What this means is that any of these provisions may be removed prospectively; however, the participant account balances as of the effective date of the change must continue to be eligible for in-service distribution under the plan’s prior provisions.

  1. If an employee terminates and then is rehired, can he still receive a “termination” distribution?

No. After an employee has been rehired, he or she is no longer eligible to receive a termination distribution and would have to qualify for an in-service distribution under the terms of the plan.

  1. What happens if a plan issues an in-service distribution to a participant who doesn’t qualify to receive one under the terms of the plan?

The bottom line is that the plan sponsor must take corrective actions; this is plan qualification issue. The good news is the IRS provides methods for correcting such mistakes under their Employee Plans Compliance Resolution System (EPCRS). Generally, the employer must take steps to have the participant return the funds to the plan, along with related earnings, but there are other options as well.

To learn more about in-service distributions, please contact us and we will be happy to assist you.

What does it mean to be top-heavy?

In general, a plan is considered to be top-heavy when more than 60% of plan assets are attributable to “key employees” as of the “determination date”. Top-heavy plans are subject to certain minimum contribution and vesting requirements.

Who is a key employee?

A key employee is an employee who at any time during the plan year: (1) owned more than 5% of the company, (2) owned more than 1% of the company and had compensation in excess of $150,000, or (3) was an officer of the company with compensation in excess of a specified dollar amount ($180,000 for 2019). Note that stock attribution rules apply when determining ownership for this purpose.

What is the determination date?

For the first plan year, the determination date is the last day of the plan year. For subsequent years, the determination date is the last day of the prior plan year. Note that top-heavy status is measured annually and may change from year to year.

How is top-heavy status calculated?

The top-heavy ratio is calculated by comparing the account balances of key employees to non-key employees, after making certain adjustments. First, certain participant balances are excluded (i.e. rollover account balances from unrelated employers; account balances of terminated participants who did not work for the company during the year; and account balances of former key employees). Next, certain amounts are added back (i.e. distributions made on account of termination, death or retirement if the participant worked for the company during the year; and in-service distributions made within the 5-year period ending on the last day of the plan year).

 What are the minimum contribution requirements for top-heavy plans?

Generally, the employer must make a contribution on behalf of all non-key participants who were employed on the last day of the plan year equal to the lesser of 3% or the highest contribution rate of any key employee. Certain contributions count towards satisfying the top-heavy minimum requirement (e.g. employer matching contributions, profit sharing contributions, and forfeiture allocations). If a participant has already received an amount sufficient to satisfy the top-heavy minimum, no additional contributions must be made on their behalf.

Caution: Plans that allow for immediate entry for 401(k)/Roth purposes but have a longer eligibility period for employer contributions are still required to make top-heavy minimums for non-key participants who were only eligible for the 401(k)/Roth portion of the plan.

How is the highest contribution rate for key employees determined?

All contributions (other than rollover contributions) are considered when calculating the contribution rates for key employees. This means that 401(k) deferrals and Roth contributions are included.

What are the minimum vesting requirements?

Top-heavy plans must use either a 3-year cliff or 6-year graded vesting schedule. This requirement has little impact since most plans use vesting schedules that meet or exceed these standards.

Are safe harbor 401(k) plans exempt?

Safe harbor plans are generally not required to make top-heavy minimums if all non-highly compensated employees are eligible for the safe harbor contribution, and the employer makes no contributions to the plan other than (1) safe harbor matching contributions, (2) additional matching contributions that satisfy the safe harbor rules, or (3) safe harbor nonelective contributions.

Caution: Forfeiture allocations can trigger top-heavy minimums in safe harbor plans.

What happens if the employer doesn’t fund top-heavy minimums?

Failure to make top-heavy minimums is an operational failure that can jeopardize the qualified status of the plan. As a result, any “missed” top-heavy minimums must be funded along with related earnings.

If you have any questions regarding the top-heavy rules or would like to learn more, please contact us.

 

Most Common Mistake: Failure of Timely 401(k) Deposits

One of the most common mistakes made by 401(k) plan sponsors is failure to deposit participant contributions (i.e. 401(k) deferrals/Roth contributions) and loan payments in a timely manner. Having said that, it is worthwhile reviewing the rules and consequences of making late deposits.

What are the rules?

In general, the Department of Labor (DOL) requires that participant contributions and loan payments be deposited as soon as the amounts can be reasonably segregated from the general assets of the employer.  This is because the amounts are considered to become plan assets at this point in time. Under examinations, the DOL also reviews deposits for consistency to determine whether contributions were funded in a timely manner.

Safe Harbor for Sponsors of Small Plans

Under the regulations, there is a “safe harbor” for sponsors of small plans (generally, plans with less than 100 participants). Under this rule, participant contributions and loan payments will be deemed to have been funded in a timely manner provided that the contributions are deposited within seven business days following the date in which the amounts were withheld.

Sponsors of Large Plans

Since the 7-business day rule does not apply to large plans, these plan sponsors must abide by the general rule of making the deposits as soon as the amounts withheld can be reasonably segregated from the general assets of the employer. As a result, we generally recommend these employers make deposits within three business days on a consistent basis.

What are the consequences of making late deposits?

The employer has engaged in a prohibited transaction with the plan because the employer had “use” of plan assets.

  • The late deposit must be reported on Form 5500
  • The employer must pay a 15% excise tax on the amount involved by filing Form 5330
  • Participants must be credited with lost earnings (the DOL has an online calculator that may be used for this purpose in certain situations)

Is the employer required to file under the DOL’s Voluntary Fiduciary Correction Program (VFCP)?

No. Filing under VFCP is not required. Nevertheless, employers may want to file under this program to obtain relief from the DOL for penalties that may otherwise be imposed and agreement not to investigate the plan fiduciaries for failure to deposit the amounts in a timely manner.

If you have any questions regarding the deposit rules or would like to learn more, please contact us.

IRS Expands Self-Correction Programs

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.

Should your clients add a Safe Harbor 401(k) provision?

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 11th 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.

 

Loans and Termination of Employment

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.