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Mid-Year Changes to Safe-Harbor 401(k) Plans

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“What changes, if any, can an employer make to a safe harbor 401(k) plan during the plan year, while maintaining safe harbor status?”

ERISA consultants at the Retirement Learning Center 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 plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Washington D.C. is representative of a common inquiry related to making changes to a safe harbor 401(k) plan.

Highlights of Discussion

Sponsors of safe harbor 401(k) plans[1] have a limited ability to alter their plans mid-year without jeopardizing their safe harbor status. Any change must be one the IRS views as “permissible” and, oftentimes, employees must receive notification and have a new deferral election opportunity.

Notice 2016-16 provides that a mid-year change to a safe harbor plan or to a plan’s safe harbor notice does not violate the safe harbor rules merely because it is a mid-year change, if the

  • Plan satisfies the notice and election opportunity conditions, if applicable, and
  • Change is not a prohibited mid-year change as listed in Notice 2016-16.Permissible Changes
  • According to the notice, permissible mid-year changes include
  1. Increasing future safe harbor non-elective contributions from 3% to 4% for all eligible employees;
  2. Certain increases to matching contributions adopted at least three months before the end of the plan year;[2]
  3. Adding an age-59 ½, in-service withdrawal feature;
  4. Changing the plan’s default investment fund;
  5. Altering the plan rules on arbitration of disputes;
  6. Shifting the plan entry date for employees who meet the plan’s minimum age and service eligibility requirements from monthly to quarterly; and
  7. Adopting mid-year amendments required by applicable law (for example, newly effective laws).

Changes 1-4 require an updated notice and an additional election period as explained next.

Notice Requirements

When required, sponsors must provide an updated safe harbor notice that describes the mid-year change and its effective date within a reasonable period before the effective date of the change. Providing the notice 30-90 days before the effective date is deemed reasonable. If is it not possible for the plan sponsor to distribute the updated safe harbor notice before the effective date of the change, it must provide the notice as soon as practicable, but not later then 30 days after the date the changes is adopted.

Election Requirement

When required, sponsors must give each notified employee a reasonable period of time to change his or her cash or deferral election after receipt and before the effective date of the change. A 30-day election period is deemed reasonable. However, if it is not possible to provide the election opportunity before the effective date of the change (e.g., retroactive plan amendment), then the election opportunity must begin as soon as practicable after the notice date, but not later than 30 days after the date the change is adopted.

EXAMPLE Plan M:

  • Traditional 401(k) matching safe harbor plan
  • Operated on a calendar year
  • Match is calculated on a per payroll-period basis
  • A mid-year amendment is made August 31, 2018, to 1) increase the safe harbor matching contribution from 4% to 5%; and 2) change from a payroll-period match to a full-plan-year match
  • Both changes are retroactively effective to January 1, 2018

Due to the retroactive effective date of the change, the sponsor cannot provide an updated notice and give an additional election opportunity to employees prior to the January 1, 2018, effective date. On September 3, 2018, the first date that an updated notice and additional election opportunity can practicably be provided, the sponsor distributes an updated notice that describes the increased contribution percentage and gives an additional 30-day election period starting September 3, 2018. The mid-year change is a permissible change, and notice and election requirements are met.

Conclusion

Sponsors of safe harbor plans often wonder if they can make changes to their plans mid year. The answer is yes, provided any change is of the permissible variety, and notice and election requirements are met.

 

[1] IRC §§ 401(k)(12) or 401(k)(13) and/or 401(m)(11) or 401(m)(12), and 403(b) plans that apply the IRC § 401(m) safe harbor rules pursuant to IRC § 403(b)(12).

[2] Adopted at least three months before the end of the plan year, made retroactively effective, revocation of payroll period allocation, and new notice and election period apply.

© Copyright 2024 Retirement Learning Center, all rights reserved
IRA
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Active Plan Participant and IRA Contributions

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“Active participation in an employer’s retirement plan can affect whether an IRA contribution made by the participant is deductible on the tax return. What does ‘active participation’ mean?”

ERISA consultants at the Retirement Learning Center 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 plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Minnesota is representative of a common inquiry involving a taxpayer’s ability to make a deductible IRA contribution. 

Highlights of Discussion

For purposes of the IRA deduction rules, an individual shall be an “active participant” for a taxable year if either the individual or the individual’s spouse actively participates during any part of the year in a(n)[1]

  • Qualified plan described in Internal Revenue Code Section [IRC §401(a)], such as a defined benefit, profit sharing, 401(k) or stock bonus plan;
  • Qualified annuity plan described in IRC §403(a);
  • Simplified employee pension (SEP) plan under IRC §408(k);
  • Savings incentive match plan for employees (SIMPLE) IRA under IRC §408(p);
  • Governmental plan established for its employees by the federal, state or local government, or by an agency or instrumentality thereof (other than a plan described in IRC §457);
  • IRC §403(b) plan, either annuity or custodial account; or
  • Trust created before June 25, 1959, as described in IRC §501(c)(18).

When an individual is considered active depends on the type of employer-sponsored plan.

Profit Sharing or Stock Bonus Plan:   During the participant’s taxable year, if he or she receives a contribution or forfeiture allocation, he or she is an active participant for the taxable year.

Voluntary or Mandatory Employee Contributions: During the participant’s taxable year, if he or she makes voluntary or mandatory employee contributions to a plan, he or she is an active participant for the taxable year.

Defined Benefit Plan: For the plan year ending with or within the individual’s taxable year, if an individual is not excluded under the eligibility provisions of the plan, he or she is an active participant for that taxable year.

Money Purchase Pension Plan: For the plan year ending with or within the individual’s taxable year, if the plan must allocate an employer contribution to an individual’s account he or she is an active participant for the taxable year.

Refer to IRS Notice 87-16 for specific examples of active participation.

As a quick check, Box 13 on an individual’s IRS Form W-2 should contain a check in the “Retirement plan” box if the person is an active participant for the taxable year.

 

Form W-2 Box 13 Retirement Plan Checkbox Decision Chart

Type of Plan Conditions Check Retirement Plan Box?
Defined benefit plan (for example, a traditional pension plan) Employee qualifies for employer funding into the plan, due to age/years of service—even though the employee may not be vested or ever collect benefits Yes
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee is eligible to contribute but does not elect to contribute any money in this tax year No
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee is eligible to contribute and elects to contribute money in this tax year Yes
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee is eligible to contribute but does not elect to contribute any money in this tax year, but the employer does contribute funds Yes
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee contributed in past years but not during the current tax year under report No (even if the account value grows due to gains in the investments)
Profit-sharing plan Plan includes a grace period after the close of the plan year when profit sharing can be added to the participant’s account Yes

 

If a person is an active participant, he or she must apply income thresholds to determine whether an IRA contribution is deductible or not. Please refer to the following chart

IRA Contribution Deductibility

 

Conclusion

Participating in certain employer-sponsored retirement plans can affect an individual’s ability to deduct a traditional IRA contribution on an individual’s tax return for the year. The IRS Form W-2 should indicate active participation in an employer-sponsored retirement plan. When in doubt, taxpayers should check with their employers.

 

 

[1]  IRS Notice 87-16

 

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415(m) Plans

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“What is a 415(m) plan?”

ERISA consultants at the Retirement Learning Center 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 plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Ohio is representative of a common inquiry involving plan types. 

Highlights of Discussion

A 415(m) plan is a type of nonqualified deferred compensation plan offered by public employers (e.g., state and local governments and their agencies, including public schools, colleges and universities). The technical title for these plans is “qualified governmental excess benefit arrangement” under Internal Revenue Code Section [IRC § 415(m)].

415(m) excess benefit plans are generally used to allow eligible public employees to set aside contributions over and above the contribution/benefit limits of IRC §415 that apply to qualified plans. The sponsoring institution owns the assets but the employees have a vested interest in the benefits. In the event of employer bankruptcy, assets are subject to the claims of the employer’s creditors.

Although, a 415(m) plan is a type of nonqualified deferred compensation plan, it is not subject to the IRC §409A rules for income inclusion for such plans. It is treated as if it were a nonqualified plan of a for-profit corporation.

For participant taxation purposes, pre-IRC §409A rules apply, specifically, those found under IRC Sec. 83 (related to the value of transferred property for the performance of services); IRC Sec. 451 (pertaining to the constructive receipt of income; and the Economic Benefit Doctrine (where taxation occurs in the year that assets are unconditionally and irrevocably paid into a fund or trust to be used for the employee’s sole benefit).

Conclusion

In addition to having a type of qualified plan available to them, employees in the public sector may also have access to 415(m) excess benefit plans, which allow them to set aside amounts over the usual plan limits.

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Beware of Dull Tools in Retirement Planning

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By W. Andrew Larson, CPC, Retirement Learning Center

Retirement planning is complex, emotional and can be a time sucker. Deciding on the vision of what retirement will look like requires a commitment to time and honest reflection.

We as an industry have deployed a veritable host of tools to support individuals and couples in the retirement planning process

Have the plethora of tools created misconceptions in minds of consumers? Obviously, we need to encourage practical retirement planning. Maybe we have tried to make it too simple in an effort to get more people engaged in retirement planning. We have encouraged people to use tools. In fact, the entire “robo advisor” industry has sprung up advocating tool use. And the easier the tool the better–right?

Consumers seem to implicitly trust tools and their output. I have been surprised at the level of trust placed in retirement planning tools. There seems an almost magical quality about a friendly and colorful retirement planning widget. It’s so simple. Just enter the right data, select the right retirement age and rate of return and *POOF* we are on our way to a happy and blissful retirement. We are in awe of the fancy print outs, and colored graphs and charts. They look so good, they must be accurate.

I met a couple who, to reward themselves for being “on-track” in their retirement planning (according to their retirement planning widget), purchased an airplane!

Their trust in the tool may have been misplaced.

Maybe we need to take a step back and help consumers understand the limitations of virtually all retirement planning tools. Let’s discuss frankly an aspect, and limitation, of every retirement planning tool ever developed. At the core of every retirement planning tool are one or more life expectancy tables or algorithms. Enter your age and the software tells you how long you have to live—on average. Couples enter their information and we have their joint life expectancy! Let the planning begin.

Why should we be concerned about the accuracy of life expectancy tables? Are the tables really that inaccurate? The short answer is life expectancy tables are accurate and inaccurate; the accuracy is based on the timeframe and number of individuals involved. The use of longer time frames and more people to develop the tables equates to greater accuracy. Fewer people and/or shorter time frames mean less accuracy. Actuarial tables were never intended to forecast individual outcomes. Let’s explore this seeming paradox.

Life insurance companies engage actuaries to develop life expectancy tables in order to set premiums for insurance and annuity products. For this purpose, life expectancy tables are well suited. The tables tell you, on average, how long a group of people are expected to live. Obviously, some will live longer than the average and others will not. Insurance companies use the tables to price their products, realizing that, in the long term, the numbers will end up close to the average.

But, the concern is using a tool—the life expectancy table—which is designed to predict average life expectancy of a group to calculate the life span of an individual.

The tables are not accurate in predicting a specific individual’s lifespan. In fact, an individual tool is accurate about five percent of the time. Five percent!

Let’s review again why life expectancy tables are so inaccurate on an individual basis. Let’s say the life expectancy table tells us the group’s average life span for a 62-year-old is 20 years (age 82). An average life expectancy of 20 years at age 62 clearly doesn’t mean the group lives exactly 23 years longer (to age 82). Some will die before that age and some will live beyond age 82.  In reality, only about five percent of current 62-year-olds will die on or about age 82; about half of the group will die sooner and about half the group will die later. Remember, the 20 year life expectancy is an average figure and varies due to many factors including current age, gender, race, and geographic location. Any retirement planning software is an approximate tool. The life expectancy calculations are, by their nature, inaccurate on an individual basis.

What are the solutions? In my view, awareness is the first step. Understanding the inherent limitation of life expectancy calculations is necessary in order to prevent excess dependence on a tool with limited accuracy. One solution is to consider the use of alternative tables. For example, David Blanchett, head of retirement research at Morningstar Investment Management, has proposed using annuity purchase tables (which are more conservative) to more accurately project life expectancy and plan accordingly (“How To Better Estimate Life Expectancy,” Investment News, February 12. 2015).

Perhaps we need to slow down the planning process to make sure individuals are aware of the inherent limitations of the tools they may use, and foster the understanding of what a life expectancy table is and how it works. Life expectancy tables tell us on average how long a group of people can be expected to live.

Perhaps we should ask our clients if they understand how the tools work. Maybe we should ask them about the appropriateness of specific tools. Maybe we should discuss the tools’ limitations. Again, I am not against tools, not at all. In fact, I have helped build and develop planning tools. But I believe we have an obligation to help clients understand the proper use and limitations of planning tools.

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414(h) “Pick Up” Plans

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“What is a “414 pick-up” plan?”

ERISA consultants at the Retirement Learning Center 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 plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Texas is representative of a common inquiry involving plan types.

Highlights of Discussion

A 414 pick-up plan is a type of governmental plan[1] where mandatory designated employee (after-tax) contributions are treated as employer contributions as long as the employing unit formally “picks up” the contributions.[2] When picked up, the employing unit treats the amounts as employer contributions for federal income tax purposes and does not include these amounts in the participating employees’ current gross income. Such amounts remain tax deferred until later distributed.

IRS Revenue Ruling 2006-43 defines what the employing unit must do in order to formally pick up the contributions. It must

  1. Specify that the employee contributions are being paid by the employer. In order to accomplish this, an authorized person of the employing unit must take formal action to ensure the contributions will be paid by the employing unit in lieu of employee contributions. The action can only apply prospectively and must be evidenced by a written document (e.g., minutes of a meeting, a resolution, or an ordinance).
  2. Not permit a participating employee as of the pick-up date to have a right to make a cash or deferred election with respect to the contributions. For example, participating employees may not opt out of the pick-up, or receive the contributed amounts directly instead of having them paid by the employing unit to the plan.

Further details of these requirements, including how they are treated for Social Security and Medicare tax purposes, are contained in Revenue Ruling 2006-43 and the IRS’ summary of pick up plans.

Conclusion

IRC §414(h)(2) provides that for any plan established by a governmental unit, where the contributions of employing units are designated employee contributions, the employer–through written authorization–may pick up the contributions, and treat the amounts as employer contributions for federal tax purposes. As employer contributions, such amounts are not included in the taxable income of plan participants until later distributed from the plan.

[1] An IRC §401(a) qualified plan established by a State government or political subdivision thereof, or by any agency or instrumentality of the foregoing. Governmental pick-up contributions also apply to certain plans established and maintained by Indian tribal governments.

[2] IRC §414(h) plan

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