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SECURE Act Increases Late Filing Penalties

“What are the new higher penalties under the SECURE Act for companies that fail to timely file 401(k) plan reports and notices?”

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 a financial advisor from Massachusetts is representative of a common inquiry related to penalties for late plan filings.

Highlights of the Discussion

The Further Consolidated Appropriations Act, 2020 included provisions from the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) that materially increased penalties for plan sponsors that fail to file certain reports and notices in a timely manner. The following penalties apply to filings and notices required to be provided after December 31, 2019.

 

Form or Notice Penalty Assessed for Late Filings after 12/31/2019 Pre-SECURE Act Penalties
Failing to timely file Form 5500[1] Up to $250 per day, not to exceed $150,000 per plan year $25 a day, not to exceed $15,000 per plan year
Failing to timely file Form 5310-A Up to $250 per day, not to exceed $150,000 per plan year $25 a day, not $15,000 per plan year
Failing to file Form 8955-SSA Up to a daily penalty of $10 per participant, not to exceed $50,000 A daily penalty of $1 per participant, not to exceed $5,000
Failing to file Form 5330 The lessor of $435 or 100% of the amount of tax due The lesser of $330 or 100% of the amount due
Failing to file Form 990-T The lessor of $435 or 100% of the amount of tax due The lesser of $330 or 100% of the amount due
Failing to provide income tax withholding notices up to $100 for each failure, not to exceed $50,000 for the calendar year $10 for each failure, not to exceed $5,000

 

Conclusion

Beginning in 2020, plan sponsors face much stiffer IRS penalties for not complying with plan reporting requirements as a result of law changes.

[1] The SECURE Act did not change the DOL’s penalty of up to $2,194 per day for a late Form 5500 filing.

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Returning Contributions under a Mistake of Fact

My client made an excess contribution to his 401(k) plan. A provision in his plan document states, ‘Any contribution made by the Employer because of a mistake of fact must be returned to the Employer within one year of the contribution.’  When can a plan sponsor take back a contribution made to a plan based on a mistake of fact? 

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 a financial advisor from California is representative of a common inquiry related to plan errors.

Highlights of the Discussion

The circumstances under which a contribution can be returned timely to a plan sponsor are limited under ERISA Sec. 403(c)(2):

  1. The contribution was made because of a mistake of fact provided it is returned to the employer within one year;[1]
  2. The contribution was made on the condition that the plan is qualified and it is subsequently determined that the plan did not qualify; or
  3. The contribution was made on the condition that it was deductible.

Rev. Rul. 91-4,[2] provides that a qualified pension plan may contain a provision authorizing return of employer contributions made because of a “mistake of fact” as provided in section 403(c)(2)(A) of ERISA.

Focusing on the meaning of mistake of fact, neither the Internal Revenue Code nor ERISA (or regulations there under) define “mistake of fact” for purposes of qualified retirement plans. Through private letter rulings the IRS has revealed it views this exception as “fairly limited.” Consider the following excerpt from IRS Private Letter Ruling (PLR) 9144041:

“Mistake of fact is fairly limited. In general, a misplaced decimal point, an incorrectly written check, or an error in doing a calculation are examples of situations that could be construed as constituting a mistake of fact. What an employer presumed or assumed is not a mistake of fact.”

Plan sponsors have attempted to zero in on the meaning of mistake of fact through the request of private letter rulings. For example, in PLR 201424032, the IRS concluded that an excess contribution made to the plan based on the incorrect asset value was made because of a mistake of fact. An “erroneous actuarial computation” was a mistake of fact in PLR 201228055. A “mistaken belief about the number of participants and beneficiaries” in the plan constituted a mistake of fact in PLR 201839010.

Before correcting an excess contribution to a retirement plan, plan officials should consider all available correction methods, including those outlined in the IRS’s Employee Plans Compliance Resolution System found in Revenue Procedure 2019-19.

Conclusion

While it may be permissible to return an excess employer contribution as a result of a mistake of fact, bear in mind, such mistakes are very narrowly defined by the IRS.

[1] Within six months for a multiemployer plan

[2] Revenue Ruling 91-4 Internal Revenue Service 1991-1 C. B. 57

Section 401.-Qualified Pension, Profit-sharing and Stock Bonus Plans

26 CFR 1.401-2: Impossibility of diversion under the trust instrument.

Reversions; remedial amendments. Circumstances under which reversions of employer contributions to a quali­fied plan are discussed. Rev. Rul. 77-200 superseded and Rev. Rul. 60-276 obsoleted.

Rev. Rul. 91-4

PURPOSE

The purpose of this revenue ruling is to obsolete Rev. Rul. 60-276, 1960-1 C.B. 150, and to supersede Rev. Rul. 77-200, 1977-1 C.B. 98, for reversions occurring on or after December 22, 1987, the date of enact­ment of section 9343 of the Omnibus Budget Reconciliation Act of 1987 (“OBRA 87”), Pub. L. 100-203.

ISSUE

Under what circumstances may a qualified pension, profit-sharing or stock bonus plan permit reversion of employer contributions?

FACTS

A plan permits reversion of em­ployer contributions under the condi­tions described in section 403(c)(2) of the Employee Retirement Income Se­curity Act of 1974 (“ERISA”), Pub. L. 93-406, as amended by section 9343(c) of OBRA 87.

LAW AND ANALYSIS

Section 401(a)(2) of the Internal Revenue Code of 1986 generally re­quires a trust instrument forming part of a pension, profit-sharing or stock bonus plan to prohibit the diversion of corpus or income for purposes other than the exclusive benefit of the employees or their beneficiaries. Sec­tion 403(c)(1) of ERISA contains a similar prohibition against diversion of the assets of a plan.

Section 403(c)(2) of ERISA, for which there is no parallel provision in the Internal Revenue Code, generally provided, prior to its amendment by OBRA 87, that the general prohibi­tion against diversion does not pre­clude the return of a contribution made by an employer to a plan if: (1) the contribution is made by reason of a mistake of fact (section 403(c)(2)(A); (2) the contribution is conditioned on qualification of the plan under the Internal Revenue Code and the plan does not so qualify (section 403(c)(2)(B)); or (3) the con­tribution is conditioned on its deduct­ibility under section 404 of the Code (section 403(c)(2)(C)). The return to the employer of the amount involved must generally be made within one year of the mistaken payment of the contribution, the date of denial of qualification, or disallowance of the deduction.In Rev. Rul. 60-276, the Service held that a provision permitting the reversion of the entire assets of a plan on the failure of the plan to qualify initially under the Code would be allowed. In Rev. Rul. 77-200, the Service held that plan language pro­viding for the return of employer contributions under the circumstances specified in section 403(c)(2)(A) and (C) of ERISA could also be included in a plan intended to qualify under the Internal Revenue Code.

The Tax Court, in Calfee, Halter, & Griswold v. Commissioner, 88 T.C. 641 (1987), held that a plan may qualify under section 401(a) of the Code if it permits reversions under pre-OBRA 87 section 403(c)(2)(B) of ERISA, even if such reversions are not limited to initial qualification of a plan. In reaching this conclusion, the Tax Court assumed that the standards and guidelines in Title I of ERISA were applicable in interpreting the Code.In enacting section 9343 of OBRA 87, Congress legislatively overturned the holding in Calfee, Halter, & Gris­wold. It amended section 403(c)(2)(B) of ERISA to provide for the return of employer contributions under that section only if: (1) the return of the contribution is conditioned on initial qualification of the plan; (2) the plan received an adverse determination with respect to its initial qualification; and (3) the application for determina­tion is made within the time pre­scribed by law for filing the employ­er’s return for the taxable year in which such plan was adopted, or such later date as the Secretary of the Treasury may prescribe. Section 9343 also provided that, except to the ex­tent provided by the Code or the Secretary of the Treasury, Titles I and IV of ERISA are not applicable to interpreting the Code. Both amendments were effective on the date of enactment of OBRA 87, De­cember 22, 1987.

Section 1.401(b)-1 of the Income Tax Regulations provides a remedial amendment period for disqualifying provisions. Any such section 401(b) remedial amendment period is a later date as the Secretary may prescribe for filing the application for determi­nation.

HOLDING

Pursuant to this revenue ruling, language providing for a return of contributions in the circumstances specified in section 403(c)(2)(A), (B) and (C) of ERISA, as amended by OBRA 87, may be included in a plan intended to qualify under the Internal Revenue Code. Thus, plans that are amended to include such language will not fail to satisfy section 401(a)(2) of the Code solely as the result of such an amendment. For example, a plan provision permitting the reversion of the entire assets of the plan on the failure of the plan to qualify initially under the Internal Revenue Code will be allowed only under the circumstances described in section 403(c)(2)(B) of ERISA.The determination of whether a reversion due to a mistake of fact or the disallowance of a deduction with respect to a contribution that was conditioned on its deductibility is made under circumstances specified in section 403(c)(2)(A) and (C) of ERISA, and therefore will not ad­versely affect the qualification of an existing plan, will continue to be made on a case by case basis. In general, such reversions will be per­missible only if the surrounding facts and circumstances indicate that the contribution of the amount that sub­sequently reverts to the employer is attributable to a good faith mistake of fact, or in the case of the disallow­ance of the deduction, a good faith mistake in determining the deductibil­ity of the contribution. A reversion under such circumstances will not be treated as a forfeiture in violation of section 411 (a) of the Code, even if the resulting adjustment is made to the account of a participant that is partly or entirely non-forfeitable.

The maximum amount that may be returned to the employer in the case of a mistake of fact or the disallow­ance of a deduction is the excess of (1) the amount contributed, over, as relevant, (2) (A) the amount that would have been contributed had no mistake of fact occurred, or (B) the amount that would have been con­tributed had the contribution been limited to the amount that is deduct­ible after any disallowance by the Service. Earnings attributable to the excess contribution may not be re­turned to the employer, but losses attributable thereto must reduce the amount to be so returned. Further­more, if the withdrawal of the amount attributable to the mistaken or nondeductible contribution would cause the balance of the individual account of any participant to be reduced to less than the balance which would have been in the account had the mistaken or nondeductible amount not been contributed, then the amount to be returned to the employer must be limited so as to avoid such reduction. In the case of a reversion due to initial disqualifica­tion of a plan, the entire assets of the plan attributable to employer contri­butions may be returned to the em­ployer.

EFFECTIVE DATEPlans have until the end of the section 401(b) remedial amendment period to be amended retroactively to conform with OBRA 87. Operation of a plan in a manner inconsistent with section 403(c)(2)(B) of ERISA, as amended by section 9343 of OBRA 87, on or after December 22, 1987, the effective date of section 9343, will cause the plan to fail to satisfy sec­tion 401 (a) of the Code.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 60-276 is obsoleted. Rev. Rul. 77-200 is superseded for rever­sions of employer contributions ocurring on or after the date of enact­ment of section 9343 of OBRA 87.

 

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SECURE RMDs

“I have a client who has a 401(k) plan and an IRA. She turned age 70½ in 2019. How do the changes to required minimum distribution (RMD) rules affect her?”

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 a financial advisor from Minnesota is representative of a common inquiry related to required minimum distributions.

Highlights of the Discussion

The short answer is that she is unaffected by the increase in the age at which RMDs must begin as a result of recent law changes. The increase in the RMD age (from 70 ½ to 72) as enacted under provisions from the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) is effective for individuals turning 70 ½ after December 31, 2019. (See Sec. 114 on page 623 of Further Consolidated Appropriations Act, 2020.)

Because your client turned 70 ½ in 2019, as an IRA owner, her required beginning date (RBD) for taking her first RMD remains April 1, 2020. Her RBD for the RMD due from her 401(k) plan is subject to the specific provisions of the plan, and would be April 1, 2020, if her plan does not include the special language that allows certain participants to delay their RBD until April 1 following the year they retire. The delayed RBD provision that some plans offer allows still-working participants who do not own more than five percent of the business to delay their RBD until April 1 of the year following their retirement.

Keep in mind that a 50 percent penalty tax could apply if a person fails to take his or her RMD on a timely basis.

Conclusion

The new rule that delays a person’s RBD until April 1 following the year he or she turns age 72 applies to distributions required to be made after December 31, 2019, with respect to individuals who attain age 70 ½ after such date.

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Oops … How to fix switched contributions

“My client initially elected to make designated Roth contributions to her 401(k) plan and a few years later switched her election to pre-tax elective deferrals. We just discovered the employer is still treating her deferrals as designated Roth contributions. Is there a way to retroactively treat these amounts as pre-tax salary deferrals?”

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 a financial advisor from Massachusetts is representative of a common inquiry related to designated Roth contributions in 401(k) plans.

Highlights of the Discussion

Yes, there is a way of correcting the situation where an employer has failed to make the correct type of salary deferral to a 401(k) plan (i.e., pre-tax/designated Roth, or vice versa) based on the participant’s deferral election. It will require some correcting of IRS tax forms and the employer’s participation in the IRS’s Employee Plans Compliance Resolution System (EPCRS) program. Please refer to Fixing Common Mistakes-Correcting a Roth Contribution Failure and Revenue Procedure 2019-19.  

Generally speaking, an employer in this situation can correct the error by executing three steps.

Step 1: Transfer deferrals

The employer transfers the erroneously deposited deferrals, adjusted for earnings, from the designated Roth account to the pre-tax salary deferral account. The employer must ensure the information on IRS Form W-2, Wage and Tax Statement, for the participant is correct (i.e., reflecting the correct contribution type). That may involve the employer filing a corrected Form W-2 with the IRS showing the previously misidentified designated Roth contributions as pre-tax salary deferrals.

Step 2: Follow EPCRS or Audit CAP

Since the error represents an operational failure on the plan sponsor’s part, the sponsor should follow plan correction procedures outlined in the IRS’s EPCRS program. Depending on the circumstances, it may be possible for the employer to self-correct the error, without penalty or a formal filing with the IRS. Otherwise, a sponsor can file with the IRS under the IRS’s Voluntary Correction Program (VCP). If the error was discovered during an IRS audit, the only corrective option is to follow the Audit Closing Agreement Program (Audit CAP).

Step 3: Establish avoidance procedures

Part of correcting a plan error is to ensure that the error will not happen again. Plan sponsors should create, document and follow new policies and procedures that will prevent future failures such as these.

Conclusion

The IRS has identified the misclassification of employee salary deferrals as designated Roth contributions and vice versa by plan sponsors as a common plan mistake. Fortunately, there is a relatively painless IRS process to remedy the situation.

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Does your plan need IRS Form 8822-B?

“When filing her Form 5500 report, my client was told she needed to file IRS Form 8822-B for her 401(k) plan. What does this form report?”

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 a financial advisor from Tennessee is representative of a common inquiry related to plan reporting.

Highlights of the Discussion

If your client had a change of address for her business or a change in the “responsible party” (i.e., the representative of the company who received the business’s official Employer Identification Number), [1]  she is required to file IRS Form 8822-B, Change of Address or Responsible Party—Business. Form 8822-B notifies the IRS of a change to a business’s mailing address, location or responsible party. Also, if an organization had not previously identified a specific person as its responsible party, filing Form 8822-B is advisable. When there’s been a change, it’s important to have Form 8822-B in place for any future mailings or correspondence the business may receive from the IRS.

The requirement to file Form 8822-B took effect in 2014, following the release of final regulations (Treasury Regulation 301.6109).  Affected businesses must file the form within 60 days of the change that is being reported. A business files the form with either the IRS office in Cincinnati, OH or Ogden, UT, depending on the firm’s old business address.  While there is no formal penalty for failing to file Form 8822-B or late filings of the form, there is a risk that important IRS notices could be misdirected to the wrong address or sent to the attention of the wrong individual. The form specifically references its connection to certain employment, excise, income and other business returns (e.g., Forms 720, 940, 941, 990, 1041, 1065, 1120, etc.) and employee plan returns such as the Form 5500 series of returns.

Conclusion

Plan sponsors may not have been aware of the importance of IRS Form 8822-B. Filing such form, when required, can only be beneficial.

[1] IRS Publication 1635: Employer Identification Number

 

 

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DC Plan Amendments and Accrued Benefits

“My client wants to amend his 401(k) plan to add a last day requirement to receive a profit sharing contribution for the current plan year. Right now the contribution is discretionary and there is no service or last day requirement to receive the contribution. Can he make that change before year end?”

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 a financial advisor from Tennessee is representative of a common inquiry related to plan amendments.

Highlights of the Discussion

The IRS has taken the position that the right to receive a contribution under a defined contribution plan’s existing allocation formula is protected once the participant has satisfied the plan’s allocation conditions [Technical Advice Memorandum (TAM) 9735001].[1] If participants in the plan have already accrued a right to receive an allocation (a “protected allocable share”)—even though the contribution may be discretionary—the contribution cannot be taken away.

A plan amendment cannot decrease the accrued benefit of any plan participant [IRC § 411(d)(6)(A)]. These anti-cutback rules only protect benefits that accrue prior to the amendment [Treas. Reg. § 1.411(d)-3(b)].

In the question at hand, since there are no requirements to receive the profit sharing contribution, anyone who has completed an hour of service for the year has accrued a right to any profit sharing allocation the sponsor may or may not make for the year.

In contrast, let’s say the plan had a 1,000 hour of service requirement to receive a discretionary profit sharing contribution and the plan sponsor wanted to add a last day requirement. In that case, the plan sponsor could amend the plan to add the last day up to the point that someone completes 1,000 hours of service—which could be mid-year, based on 2,080 hours worked in a full year.

Similarly, suppose the plan required 501 hours of service to receive a contribution. The sponsor would only be able to change the allocation method up until the date on which the first participant works his/her 501st hour for the year. After that point, changing the method would eliminate a right the participant has already earned according to TAM 9735001.

Of course, a plan sponsor has the right to amend the plan’s contribution formulas on a prospective basis.

Conclusion

It’s always very important to check the plan document for contribution eligibility requirements. A plan amendment cannot decrease the accrued benefit of any plan participant. The right to receive a contribution under a defined contribution plan’s existing allocation formula is protected once the participant has a protected allocable share of the contribution.

[1] Technical Advice Memorandum Number: 9735001

Internal Revenue Service

February 20, 1997

SIN# 411.03-00

INTERNAL REVENUE SERVICE

NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

ISSUE

Whether §411(d)(6) is violated by a retroactive amendment of an allocation formula under a discretionary profit-sharing plan adopted after the end of the plan year, but before the due date for the employer’s return for the corresponding taxable year, resulting in lower allocations for some participants than the allocations they would have received under the allocation formula in the plan during the plan year.

FACTS

The Employer maintains the Plan, a discretionary profit-sharing plan. Section 2.1 of the Plan defines “account balance” as the aggregate balance of a participant’s account as of a determination date. Section 2.12 defines “determination date” as the last day of the preceding plan year. Section 2.35 defines “plan year” as the calendar year.

Section 5.3 of the Plan provides that the amount of the contribution to the Plan for each plan year shall be paid to the trustees, either in a single payment or in installments, not later than the last day of the period provided by the relevant provisions of the Code and other applicable laws for the payment of a deductible contribution for the taxable year in which the plan year ends. Any payment made prior to the end of the plan year on account of the contribution for such plan year shall be held by the trustees in a suspense account until the end of such plan year.

Article VI of the Plan deals with accounts and allocations. Section 6.3 provides that the contribution to the Plan (including forfeitures occurring during the plan year) for any plan year shall be deemed to have been made as of the last day of such plan year and shall be allocated to the trust fund and apportioned among and credited to the accounts of those participants who are employed on said date, in the ratio that each participant’s compensation bears to the aggregate compensation of all such participants.

Section 6.6 of the Plan provides, in relevant part, that on each valuation date the amount which shall be credited to the account of each participant shall be (i) the account balance on the preceding valuation date, plus (ii) the participant’s allocated portion of the contributions (and, if applicable, forfeitures) made with respect to the plan year ending on the current valuation date, plus or minus (iii) the participant’s pro rata share of the increase or decrease since the preceding valuation date in the fair market value of the trust fund. Section 2.45 defines “valuation date” as the anniversary date and, if applicable, the date of termination of employment of a participant where there has occurred a twenty percent or more decrease in the value of the trust fund since the last valuation date and distribution is to be made to the participant prior to the next valuation date. Section 2.3 defines “anniversary date” as December 31 of each year.

The Plan contained a definite pre-determined allocation formula during the 1992 plan year (“existing formula”). Relying on § 404(a)(6), the Employer made its contribution for the 1992 plan year on or about January 7, 1993 (“1992 contribution”), but the contribution was not immediately allocated among participants.

On March 15, 1993, the Employer adopted an amendment to the Plan that added a new allocation formula (“new formula”). The effective date of this amendment was January 1, 1992. Under the new formula some participants received larger allocable shares of the 1992 contribution, and the remaining participants received smaller allocable shares of the 1992 contribution, compared with their allocable shares under the existing formula. On June 23, 1993, the 1992 contribution was allocated to participants’ accounts under the new formula. Thus, the March 15, 1993 plan amendment reduced the amounts allocated to the accounts of some participants, compared with the amounts that would have been allocated under the existing formula. The reduced allocations in turn resulted in decreased account balances for those participants.

LAW

Section 401(a) prescribes the qualification requirements for a trust forming part of a stock bonus, pension, or profit-sharing plan. Under §1.401-1(b)(1)(ii), a profit-sharing plan must provide a definite predetermined formula for allocating plan contributions among participants. Under §1.401-1(c), qualified status must be maintained throughout the trust’s entire taxable year.

Section 411(d)(6)(A) generally provides that a plan will not be treated as satisfying §411 if the accrued benefit of a participant is decreased by a plan amendment. Under §411(a)(7)(A)(ii) and §1.411(a)-7(a)(2), in the case of a defined contribution plan, “accrued benefit” mean the balance of the employee’s account held under the plan.

Under §1.411(d)-4, A-1(a), §411(d)(6) protected benefits, to the extent they have accrued, are subject to the protection of §411(d)(6) and, where applicable, the definitely determinable requirement of §401(a). Accordingly, such benefit cannot be reduced, eliminated or made subject to employer discretion, except to the extent permitted by regulation.

Section 1.411(d)-4, A-1(d), lists examples of benefits that are not §411(d)(6)-protected. The list includes “(8) the allocation dates for contributions, forfeitures, and earnings, the time for making contributions (but not the conditions for receiving an allocation of contributions or forfeitures for a plan year after such conditions have been satisfied), . . . .” The parenthetical language in §1.411(d)-4, A-1(d)(8), indicates that, once the conditions for receiving an allocation have been met, a plan amendment that adds further conditions would violate §411(d)(6).

Section 404(a)(6) allows a contribution made after the end of the employer’s taxable year, but before the due date of the employer’s return, to be treated as made on the last day of the preceding taxable year if the contribution is made on account of the preceding year. Rev. Rul. 76-28, 1976-1 C.B. 106 and Rev. Rul. 90-105, 1990-2 C.B. 69 provide that a contribution made after the close of an employer’s taxable year will be deemed to have been made on account of the preceding taxable year under § 404(a)(6) if, among other conditions, the contribution is treated by the plan in the same manner as the plan would treat a contribution actually received on the last day of the preceding taxable year.

Section 411(d)(6) was added to the Internal Revenue Code under Title II of the Employee Retirement Income Security Act of 1974 (“ERISA”). Title I of ERISA provides an identical provision to §411(d)(6) at §204(g), which was enacted at the same time and has been interpreted in participants’ suits challenging employer plan amendments. Several ERISA §204(g) cases involve plan amendments that were retroactively effective and that changed the valuation date used in determining the account balance of a terminated employee under the plan. In Pratt v. Petroleum Production Management, Inc. Employee Savings Plan & Trust , 920 F.2d 651 (10th Cir. 1990), and Kay v. Thrift and Profit Sharing Plan for Employees of Boyertown Casket Co. , 780 F.Supp. 1447 (E.D. Pa. 1991) the courts addressed such plan amendments.

In Pratt , the petitioner separated from service at a time when the plan provided that a separated participant was to receive his vested interest in his account valued as of the next preceding valuation date, which was defined as the last day of the plan year. However, before Pratt received his distribution and subsequent to the applicable valuation date (as defined under the terms of the plan when he separated, i.e., prior to the adoption of the amendment) a plan amendment was adopted that permitted interim valuation dates as necessary to account for a material change in the value of trust assets. Stocks that were a part of Pratt’s account had seriously declined in value in the time period between the original valuation date and Pratt’s separation date (and the new interim valuation date under the amended plan). The district court granted Pratt relief on the basis of both ERISA §204(g) and under ERISA §502(a), breach of contract. On review, the appellate court noted that a participant’s accrued benefit in an account-type plan consists of the participant’s account balance. The appellate court looked to the terms of the plan prior to the adoption of the amendment when Pratt separated to ascertain his vested rights and how his account balance should be valued. The appellate court affirmed the district court’s decision, stating that the retroactive amendment, under these circumstances, reduced Pratt’s accrued benefit. Thus, the amendment was precluded by ERISA §204(g).

Kay differs from Pratt in that the retroactive amendment made on December 22, 1987, changing the valuation date from September 30, 1987 (as defined under the terms of the plan when Kay separated from service) to October 30, 1987, was made before the September 30, 1987 valuation was completed. Citing Pratt , the court held that the plan administrator was required to determine the value of Kay’s accrued benefits in accordance with the terms of the plan at the time of Kay’s termination, and that retroactive application of the amendment permitting interim valuation dates violated §204(g) of ERISA. The effect of this holding is that Kay’s ERISA-protected accrued benefit was his account balance determined as of the original valuation date, even though the valuation of his account as of that date had not actually been made at the time the plan was amended.

ANALYSIS

In the case of a defined contribution plan, an employee’s accrued benefit is the balance of the employee’s account held under the plan. With respect to the employer’s contributions, it could therefore be argued that §411(d)(6) protection applies only to amounts actually credited to the participant’s account. However, the accrued benefit includes amounts to which the participant is entitled under the terms of the plan, even though the bookkeeping process of crediting those amounts to the participant’s account has not actually occurred.

Prior to the adoption of the March 15, 1993 amendment, the account balance under the terms of the Plan was the aggregate balance of the participant’s account as of December 31, 1992. The Plan provided that, as of December 31, 1992, the participant’s account was to be credited with the participant’s allocated portion of the contribution for the 1992 plan year. The Plan provided for the 1992 contribution to be apportioned among and credited to the accounts of the participants employed on December 31, 1992, and specified the formula, that is, the existing formula, under which the 1992 contribution was to be allocated among participants’ accounts. Under the terms of the plan, each participant became entitled to his or her allocable share of the 1992 contribution as of December 31, 1992, determined under the existing formula (“protected allocable share”).

For purposes of §411(d)(6), each participant’s protected allocable share of the 1992 contribution under the existing formula became part of the participant’s account balance, and thus part of the accrued benefit, as of December 31, 1992, even though the bookkeeping process of determining account balances did not actually occur on that day. Thus, the March 15, 1993 retroactive amendment of the formula under which the 1992 contribution was allocated, reducing the protected allocable shares of the 1992 contribution of some participants, resulted in a reduction of those participants’ accrued benefits and violated §411(d)(6).

Under §1.411(d)-4, A-1(d)(8), the conditions for receiving an allocation of contributions or forfeitures for a plan year are subject to § 411(d)(6) after such conditions have been satisfied. That is, once a participant has satisfied the conditions for receiving an allocation, the participant’s right to an allocation becomes §411(d)(6)-protected, and a plan amendment cannot add further conditions. In this case, amendment of the allocation formula after the end of the 1992 plan year, when participants had satisfied the conditions for receiving an allocation, is analogous to a change in the conditions for receiving an allocation in violation of §411(d)(6).

The Employer argues that, in the case of a discretionary profit-sharing plan, the employer has no obligation to make a contribution; therefore, participants do not accrue benefits under the plan until a contribution is actually made. We note that, in this case, the contribution had in fact been made at the time of the March 15, 1993 plan amendment. Moreover, as described above, under the terms of the plan, a participant became entitled to his allocable share of any contribution for 1992 as of December 31, 1992. Where a contribution is in fact made for 1992, the participant’s protected allocable share of that contribution is determined as of December 31, 1992, under the existing formula.

The Employer also refers to §404(a)(6), which allows an employer to make a contribution after the end of the plan year. Section 404(a)(6) is irrelevant in determining when a participant’s right to an allocation becomes §411(d)(6)-protected. The sole effect of § 404(a)(6) is to deem a payment to have been made on the last day of the preceding plan year for deduction purposes. The employer’s exercise of the right to make a contribution after the end of the plan year cannot be used to circumvent §411(d)(6) protection that attaches as of the end of the plan year.

CONCLUSION

Pursuant to the terms of the Plan, each participant’s protected allocable share of the 1992 contribution under the existing formula became part of the participant’s account balance, and for purposes of §411(d)(6), part of the accrued benefit as of December 31, 1992. Therefore, the March 15, 1993 retroactive amendment of the formula under which the 1992 contribution was allocated, reducing the protected allocable shares of the 1992 contribution of some participants, resulted in a reduction of those participants’ accrued benefits and violated §411(d)(6).

 

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A tale of two 457(b) plans

“Are there differences between 457(b) plans for tax-exempt entities and governmental entities and, if so, what are the differences?”

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 a financial advisor from Wisconsin is representative of a common inquiry related to 457 plans.

Highlights of the Discussion

A plan established under IRC §457(b) allows employees of eligible sponsoring employers to set aside a portion of their income on a tax-deferred basis for receipt and taxation at a later date (similar to a 401(k) or 403(b) plan). You may sometimes hear them referred to as “eligible deferred compensation plans” because they follow the rules of subsection (b) under IRC §457 as opposed to “ineligible” plans as defined under IRC §457(f).

Two types of employers can establish 457(b) plans:  1) state or local governmental entities; or 2) tax-exempt organizations pursuant to IRC §501. While there are some similarities between a governmental 457(b) plan and a tax-exempt 457(b) plan, there are some very important differences, including, but not limited to, funded status, plan loans, catch-up contributions, when amounts are taxable, and eligibility for roll over to another plan.

The IRS has compiled this handy comparison chart (recreated below) to help those who work with or participate in 457(b) plans understand in more detail the similarities and differences between plan operations for the two types of employers that sponsor them.

  Tax-Exempt 457(b) plan Governmental 457(b) plan
Eligible employer IRC §501 tax-exempt employer that isn’t a state or local government (or political subdivision, instrumentality, agency) State or local government or political subdivision or instrumentality or agency
Written plan document required? Yes Yes
Eligible participants Limited to select group of management or highly compensated employees Employees or independent contractors who perform services for the employer may participate
Coverage; nondiscrimination testing No No
Salary reduction contributions (employee elective deferrals) permitted? Yes Yes
Ability to designate all or portion of salary reduction contribution as a Roth contribution No Yes
Employer contributions permitted? Yes Yes
Salary reduction contribution limit, in general Lesser of applicable dollar limit ($19,000 in 2019) or 100% of participant’s includible compensation Lesser of applicable dollar limit ($19,000 in 2019) or 100% of participant’s includible compensation
Increased salary reduction limit for final 3 years before attaining normal retirement age Lesser of:

  • 2 x applicable dollar limit ($38,000 in 2019) or
  • applicable dollar limit plus sum of unused deferrals in prior years (only if deferrals made were less than the applicable deferral limits (Note: age 50 catch up contributions not allowed; no coordination needed))
Lesser of:

  • 2 x applicable dollar limit ($38,000 in 2019) or
  • applicable dollar limit plus sum of unused deferrals in prior years (to the extent that deferrals made were less than the applicable limits on deferrals; age 50 catch up contributions aren’t counted for this purpose)

Note: Can’t use the increased limit if using age 50 catch up contributions. Therefore, in years when an employee is eligible to take advantage of both, the employee can use the higher of the two increases to the limit.

Salary reduction contribution limits- Age 50 catch-up contributions (for individuals who are age 50 or over at the end of the taxable year) Not permitted Salary reduction dollar limit increased by $6,000 (up to a total of $25,000 in 2019)

Note: See above. Can’t use in years that a participant is taking advantage of the increased limit during the final 3 years before attaining normal retirement age.

Timing of election to make salary reduction contribution Before the first day of the month in which the compensation is paid or made available Before the first day of the month in which the compensation is paid or made available
Total contribution limits (both salary reduction and employer contributions) Same as limit for salary reduction contributions. So, any employer contribution limits the amount of salary reduction contribution an employee can make (and vice versa) Same as limit for salary reduction contributions. So, any employer contribution limits the amount of salary reduction contribution an employee can make (and vice versa)
Correcting excess elective deferrals Distribute excess (plus allocable income) by April 15 following the close of the taxable year of excess deferral Distribute excess (plus allocable income) as soon as administratively practicable after the plan determines that the amount is an excess deferral
Contributions to trust? No Yes
Participant loans permitted? No Yes
Hardship distributions permitted? Yes, if both:
1. the distribution is required as a result of an unforeseeable emergency, for example, illness, accident, natural disaster, other extraordinary and unforeseeable circumstances arising from events beyond the participant’s (or beneficiary’s) control
2. the participant exhausted other sources of financing and the amount distributed is necessary to satisfy the emergency need  (and tax liability arising from distribution)
Yes, if both:
1. the distribution is required as a result of an unforeseeable emergency, for example, illness, accident, natural disaster, other extraordinary and unforeseeable circumstances arising from events beyond the participant’s (or beneficiary’s) control and
2. the participant exhausted other sources of financing and the amount distributed is necessary to satisfy the emergency need (and tax liability arising from distribution)
Automatic Enrollment permitted? No Yes
Taxation Earlier of when made available or distribution Distribution
Distributable events
  • Attainment of age 70 ½
  • Severance from employment
  • Unforeseeable emergency (see above)
  • Plan termination
  • Qualified domestic relations order
  • Small account distribution (not to exceed $5,000)
  • Attainment of age 70 ½
  • Severance from employment
  • Unforeseeable emergency (see above)
  • Plan termination
  • Qualified domestic relations order
  • Small account distribution  ($5,000 or less)
  • Permissible Eligible Automatic Contribution Arrangement (EACA) withdrawals
Required minimum distributions under Internal Revenue Code Section 401(a)(9) Yes Yes
Rollovers to other eligible retirement plans (401(k), 403(b), governmental 457(b), IRAs) No Yes
Availability of statutory period to correct plan for failure to meet applicable requirements No Yes, until 1st day of the plan year beginning more than 180 days after notification by the IRS
Availability of IRS correction programs including the Employee Plans Compliance Resolution System (EPCRS) under Revenue Procedure 2019-19 Generally, not available to correct failures for an unfunded plan benefiting selected management or highly compensated employees. May consider closing agreement proposals when nonhighly compensated are erroneously impacted. Can apply for a closing agreement with a proposal to correct failures. Proposal is evaluated according to EPCRS standards.

 

Conclusion

While there are some similarities between governmental 457(b) plans and a tax-exempt 457(b) plans, there are some very important differences of which to be aware.

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Reclassified Workers

“I have a client who is converting his 401(k) plan from one TPA to another and switching plan documents. In the switch, we discovered the original plan references ‘reclassified employees.’ Can you shed some light as to the relevance of this reference?”  

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 a financial advisor from Massachusetts is representative of a common inquiry related to employee classifications for plan purposes.

Highlights of the Discussion

Worker classification is a high priority for the IRS because it affects whether an employer must withhold income taxes and pay Social Security, Medicare and unemployment taxes on wages paid to an employee. Worker classification also affects whether a participant will be considered eligible to participate in a qualified retirement plan sponsored by an employer.

For example, businesses normally do not have to withhold or pay any taxes on payments to workers classified as independent contractors. The earnings of a person working as an independent contractor are subject to self-employment tax and are, generally, reported on a Form 1099-MISC, Miscellaneous Income. Because they do not meet the definition of eligible employee for retirement plan purposes, independent contracts are excluded from participation in any retirement plan sponsored by their employer. An independent contractor would have the ability to establish his or her own retirement plan based on his or her self-employment earnings.

In the past decade, the IRS has undertaken a series of employment tax audit initiatives focused on worker classification issues—especially on employers who have treated workers as independent contractors when they should have been treated as common law employees. (See IRS Topic No. 762 Independent Contractor vs. Employee.) Since 2011, the IRS has sponsored a Voluntary Classification Settlement Program (VCSP) that provides an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from federal employment taxes. To participate in this voluntary program, the taxpayer must meet certain eligibility requirements and apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.

For retirement plan purposes, whether an employer will have to retroactively cover workers who have been reclassified as common-law employees will depend on the plan document language. Some plans only require employers to cover reclassified employees prospectively as of the date the IRS makes a formal determination as to the individual’s employee status. Other plans allow the employer to elect or may mandate retroactive coverage of reclassified employees. Consequently, plan sponsors should review their plan documents for language that addresses reclassified employees to determine their proper treatment. Should an employer discover that it has prevented otherwise eligible employees from participating in the plan, a prudent course of action would be to consider the correction provisions of the IRS’s Employee Plans Compliance Resolution System  for exclusion of an otherwise eligible employee.

Conclusion

Not only do reclassified employees affect payroll departments, they also can impact retirement plan operations. Therefore, plan sponsors have an obligation to properly categorize workers, and treat such workers for plan purposes according to the terms of their plan documents.

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Purchasing Service Credits in a Defined Benefit Plan

“My client has a job with the government. She is asking me about purchasing service credits in her retirement plan. Can you explain what she might be talking about?”

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 a financial advisor from Minnesota is representative of a common inquiry related to governmental plans.

Highlights of the Discussion

Generally, service credit is credit for work performed for which your client may earn a benefit under a defined benefit pension plan. Many states allow their public employees to purchase permissive service credits for previous years of service which, otherwise, would not count in the pension. It commonly happens when an employee terminates governmental employment prior to vesting, but later becomes employed in another governmental position [IRC §415(n)]. In order to purchase the service credit, the employee must make a voluntary additional contribution, in an amount determined under such governmental plan, which does not exceed the amount necessary to fund the benefit attributable to such service credit [IRC §415(n)(3)(A)(iii)].

Whether a governmental worker may purchase service credits depends on the particular retirement system. If he or she is eligible, then the retirement system determines the cost of the purchase. The plan usually limits the number of years of service credit that a participant may purchase. The retirement system usually provides different payment options, which may include the following:

  • A lump-sum payment for the full cost;
  • Payroll deductions over a period of time; and
  • Direct rollovers or trustee-to-trustee transfers of amounts from a qualified plan (including a 401(k) plan, a 403(b) plan or state or local government 457 plan).[1]

Conclusion

Because the ability to purchase service credits in a governmental defined benefit plan is dependent on the particular retirement system, reviewing specific plan documentation and forms is essential to determine if the option is available, what payment methods may be used and how to request the purchase.

[1] The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) broaden the third option to permit funds from 403(b) and 457 plans to be transferred on a pretax basis to purchase service credit, or to repay prior cash-outs of benefits, in governmental defined benefit plans. Previously, these transfers were only allowed from qualified plans, such as 401(k) plans.

 

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