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What is a 414(k) Plan?

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“My client emailed me asking about a ‘414(k) plan.” Is that a new type of plan—or  was that a typo?’ 

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 and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Nevada focused on plan design.

Highlights of the Discussion

While it may have been a typo, there is such a thing as a 414(k) plan—or more precisely—a 414(k) account.  A 414(k) account [created pursuant to IRC Sec. 414(k)] is a separate account within a defined benefit (DB) plan that is derived from employer contributions and, for the most part, is treated as a defined contribution (DC) plan [IRC Sec. 414(k)].

The 414(k) separate account balance is treated as a DC plan for purposes of satisfying the minimum participation and vesting standards, maximum contribution limitations, nondiscrimination tests for matching and after-tax contributions, and treatment of after-tax contributions as a separate contract [IRC Sec. 414(k)(1) and (2)]. To create a 414(k) account, the plan document provisions describing this separate account must contain language similar to the language of other DC plans.

Generally, contributions to a 414(k) account are in addition to the contributions that fund the DB plan’s basic retirement benefits and are used to enhance retirement benefits. The 414(k) separate account is credited with actual trust earnings. Under the individual account rules of IRC Sec. 414(i), 414(k) separate account benefits are based solely on the amounts contributed to the account and any income, expenses, gains, losses, or forfeitures that may be allocated to the participant’s account. 414(k) accounts may be appealing because they could allow participant direction of assets.

Certain transfers from the DB portion of the plan to the 414(k) separate account are prohibited: Sponsors cannot transfer

  • Excess earnings from the DB portion of the plan to the 414(k) separate account;
  • Assets from the DB plan to the 414(k) account; or
  • Excess DB assets to fund matching contributions in the 414(k) account.

Transferring a distribution from the DB portion of the plan to the 414(k) account is also questionable.

Conclusion

Not a new type of plan, a 414(k) account is a separate account within a DB plan derived from employer contributions and, for the most part, treated as a DC plan. The plan document must contain language to support this arrangement.

 

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Deadline for Setting Up a SIMPLE IRA Plan

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Did SECURE Acts 1.0 and/or 2.0 Change the Deadline for Setting Up a SIMPLE IRA Plan?

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

A recent call with an advisor in New Mexico is representative of an inquiry involving a savings incentive match plan for employees (SIMPLE) IRA plan.

Highlights of the Discussion

The short answer is no. While SECURE Acts 1.0 and/or 2.0 have given us a multitude of retirement plan changes, they did not affect the deadline for setting up a SIMPLE IRA plan. The general deadline for establishing a SIMPLE IRA plan for a given year is still October 1 of the year.  For example, the deadline for an eligible business owner to set up a SIMPLE IRA plan for 2023 is October 1, 2023.

There are two exceptions to the general rule as follow (See IRS Notice 98-4, Q&A K-1).

  1. If the business comes into existence after October 1 of the year the SIMPLE IRA plan is desired, then the new business owner may still set up a SIMPLE IRA plan for the year, provided he or she does so as soon as administratively feasible after the start of the new business.
  2. If a business has previously maintained a SIMPLE IRA plan, then it may only set up a new SIMPLE IRA plan effective on January 1 of the following year (e.g., set up the plan in 2023 with an effective date of January 1, 2024).

Businesses that are eligible to establish SIMPLE IRA plans are those that

  1. Do not maintain any other qualified retirement plans; and
  2. Have 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding year [IRC §408(p)(2)(c)(i) and IRS Notice 98-4, Q&A B4 ].

However, an employer can use less restrictive participation requirements if it so desires.

(Note that SECURE Act 2.0, beginning in 2024, will allow employers to replace their SIMPLE IRA plans mid-year with an “eligible 401(k) replacement plan.” See a prior Case of the Week  “A SIMPLE Switch” for more information.)

The basic steps for establishing a SIMPLE IRA plan are

  1. Execute a written plan document (either a government Form 5304-SIMPLE or Form 5305-SIMPLE, or a prototype plan document from a mutual fund company, insurance company, bank or other qualified institution);
  2. Provide notice to employees; and
  3. Ensure each participant sets up a SIMPLE IRA to receive contributions.

Employees who are eligible to participate in a SIMPLE IRA plan are those who received at least $5,000 in compensation from the employer during any two preceding years and are reasonably expected to receive at least $5,000 in compensation during the current year.

Conclusion

Business owners who are interested in establishing SIMPLE IRA plans must be aware of the deadline to do so, and the additional steps involved to ensure a successful set up.

 

 

© Copyright 2023 Retirement Learning Center, all rights reserved
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Automatic enrollment and governmental 457(b) plans

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My client maintains a governmental 457(b) plan. The plan’s recordkeeper told us they cannot add an auto enrollment provision to the plan because state law prohibits it. Is that true?”

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 and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Pennsylvania focused on governmental 457(b) plans and automatic enrollment.

Highlights of Discussion

Note:  For general informational purposes only. For specific guidance, seek legal advice.

For governmental 457(b) plans in Pennsylvania, that is true, unless it is a collectively bargained plan. Based on our reading of Pennsylvania state law, automatic enrollment is not allowed unless authorized by an employees’ written authorization or pursuant to a collective bargaining agreement (34 Pa. Code §9.1).

Generally, automatic enrollment is available for governmental 457(b) plans, but state law will dictate whether a particular state will allow it. The issue revolves around having written authorization to withhold amounts from an employee’s pay.

Automatic enrollment was universally authorized in the private sector more than a decade ago through the Pension Protection Act of 2006. However, public sector defined contribution plans were not included in the legislation. For public sector plans, each state is responsible for determining whether it will allow automatic enrollment, and many states have laws preventing its establishment.

According to the National Association of Governmental Defined Contribution Administrators (NAGDA), nine states allow automatic enrollment, 25 states do not allow automatic enrollment and 16 states allow “some” automatic enrollment. For example, Texas is a state that is reported to allows some automatic enrollment. Texas law states: “Employees participating in the state plan are automatically enrolled. However, public employees of other political subdivisions are subject to wage deferral laws that prevent the implementation of automatic enrollment,” (Tex. Labor Code Ann. §61.018, §609.5025, § 609.007).

Conclusion
Whether a governmental 457(b) plan can include an automatic enrollment feature depends on state law. For specific questions on a particular state, seek legal guidance from a professional who is well-versed in that state’s statutes.

© Copyright 2023 Retirement Learning Center, all rights reserved
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Can My Client Still Set Up a 401(k) Plan for 2022?

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“I’m a wealth advisor working with sole proprietor who wants to set up a 401(k) plan for 2022. Is that still possible and could she make salary deferrals for 2022?”

Highlights of the Discussion

Because this question deals with specific tax information, business owners and other taxpayers should always seek the guidance of their tax professionals for advice on their specific situations. What follows is general information based on IRS guidance and does not represent tax or legal advice and is for informational purposes only.

With respect to setting up a plan for 2022, the short answer is, yes, provided your client has an extension to file her 2022 tax return. However, she could only make an employer contribution for herself—not employee salary deferrals for 2022. Here’s why.

Under the SECURE Act 1.0, for 2020 and later tax years, a business has until its tax filing deadline, plus extensions for a particular tax year to set up a plan. The plan establishment deadline is tied to the type of business entity and its associated tax filing deadline. Please see a prior Case of the Week, “Plan Establishment and Compensation,” for more detailed information.

For example, a sole proprietorship [or limited liability corporation (LLC) taxed as sole proprietorship] would have an extended plan establishment deadline of October 15, 2023, to set up a plan for 2022. That means your client could set up a 401(k) plan up until that date if she has a tax filing extension.

Regarding the ability to make retro-active employee salary deferrals, unfortunately, it is too late for your client to make salary deferrals for 2022. The change that allows sole proprietors or single member LLCs to make retroactive first-year elective deferrals under Section 317 of SECURE Act 2.0 takes effect for plan years beginning after December 29, 2022. Consequently, if she sets up a 401(k) plan now, she could only make salary deferrals on a prospective basis.

Conclusion
SECURE Acts 1.0 and 2.0 have made favorable changes to plan establishment and funding rules, including the ability to make retroactive first-year elective deferrals for certain unincorporated business owners beginning for the 2023 plan year. Before jumping into a plan, be aware there are lots of details that investors should discuss with their tax and legal advisors.

 

© Copyright 2023 Retirement Learning Center, all rights reserved
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Chapter 7 vs. Chapter 11 Bankruptcy and Considerations for Retirement Plans

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“I know of several businesses that have filed either Chapter 7 or Chapter 11 bankruptcies in my area. Are the considerations for an employer’s retirement plan different based on whether the bankruptcy is categorized as a Chapter 7 or 11?”

Highlights of the Discussion
If a firm is filing for bankruptcy, the considerations regarding the business’s retirement plans will differ based on the type of bankruptcy. Generally, there are two types of bankruptcy filings, based on which chapter of the Bankruptcy Code applies: Chapter 7 (liquidation) or Chapter 11 (reorganization).
Regardless of the type of bankruptcy, participants’ qualified plan assets are fully protected from the general creditors of the business under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 and the Employee Retirement Income Security Act of 1974.

In a Chapter 7 liquidation bankruptcy filing, the bankrupt business typically liquidates it assets to pay its creditors and ceases to exist. In cases like this, the bankrupt business usually terminates its retirement plans and pays out the assets to participants.
In a Chapter 11 reorganization bankruptcy filing, the bankrupt business receives protection from the court while it works to restructure its financial affairs so that the business can continue to exist. In cases like these, the effect of the reorganization on a business’s retirement plans could vary from no affect at all to plan termination.

If the bankrupt business maintains a defined benefit plan, it must notify the Pension Benefit Guaranty Corporation (PBGC—the governmental agency that insures private sector defined benefit plans) of the bankruptcy filing—either Chapter 7 or Chapter 11. The PBGC, however, does not automatically take over the defined benefit plan. The PBGC’s goal is to work with the business to help it preserve its plan if at all possible.

The PBGC will only assume the responsibility for paying benefits to participants of a private employer’s defined benefit plan following either a distress-initiated plan termination (where the employer determines it is financially unable to support the plan further), or a PBGC-initiated plan termination (where the PBGC determines the employer cannot fulfill its financial responsibilities to the plan).
For more in depth coverage of the topic and participant considerations, please see this Department of Labor participant fact sheet on employer bankruptcy.

Conclusion
When a business files for bankruptcy, there will be unique considerations with respect to the business’s retirement plan depending on the type of filing (Chapter 7 or 11). Participants assets are always protected from a bankrupt employer’s creditors, but whether the plan continues depends on the situation.

© Copyright 2023 Retirement Learning Center, all rights reserved
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UPDATE: Proxy voting on securities held in qualified plans

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“Who or what entity is responsible for proxy voting on securities held in a qualified retirement 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 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 Texas is representative of a common inquiry related to stock or securities held in an employer-sponsored retirement plan.

Highlights of the Discussion

The first place to look for the answer as to who/what entity has voting rights for securities held in a qualified retirement plan is in the language of the governing plan document. For example, there generally will be a section entitled “Voting Rights” or “Voting.” The responsible party likely will be either 1) the plan participant or 2) another plan fiduciary (such as the trustee or investment manager).

In plans where investments are participant-directed, a plan participant has the responsibility to direct the trustee as to the manner in which any voting rights should be exercised, assuming the plan participant timely received all notices, prospectuses, financial statements and proxy solicitation. When participants fail to give instructions, the plan document should address who or what entity assumes the voting responsibility. For example, many plan documents will specify the plan trustee as the entity to vote in lieu of receiving participant instructions. Alternatively, the plan may specify another fiduciary such as an investment manager.

In circumstances where a plan fiduciary has been given proxy voting responsibility under the terms of the plan, responsible individuals must turn to Department of Labor (DOL) regulations for guidance. On December 1, 2022, the DOL published final regulations dealing with environmental, social, and corporate governance (ESG) investing and proxy voting entitled, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.” The new rules took effect January 30, 2023, while certain provisions related to proxy voting will not apply until December 1, 2023.

The final rule amends the prior regulation to be clear that plan fiduciaries should vote proxies as part of the process of managing a plan’s investments, unless they determine that voting proxies may not be in the plan’s best interest. Plan fiduciaries should not be indifferent to the exercise of shareholder rights.

The final rule amends the prior regulation to remove the two ‘‘safe harbor’’ examples for proxy voting policies because the DOL believes these safe harbors do not adequately safeguard the interests of plans and their participants and beneficiaries. What remains is the requirement to prudently manage shareholder rights to enhance the value of plan assets or protect plan assets from risk.

The final rule eliminates the prior rule’s specific monitoring obligations related to the use of investment managers or proxy voting firms. Consequently, the statutory obligations of prudence and loyalty apply to monitoring the work of service providers.

The final rule removes from the past regulation a specific requirement to maintain records on proxy voting activities and other exercises of shareholder rights. The replaced provision was widely perceived as treating proxy voting and other exercises of shareholder rights differently from other fiduciary activities and, in that respect, had the potential to create a misperception that proxy voting and other exercises of shareholder rights are disfavored or carry greater fiduciary obligations than other fiduciary activities.

In the end, the long-standing standards of prudence and loyalty should prevail with respect to proxy voting. Plan fiduciaries should vote proxies as part of the process of managing a plan’s investments, unless they determine that voting proxies may not be in the plan’s best interest.

Conclusion

For guidance on the individual or entity responsible for the voting of proxies for securities held in a qualified retirement plan—turn to the governing plan documents. The authority for proxy voting should be addressed in the plan document and the process and procedures should comply with DOL regulations that emphasize prudence and loyalty.

 

© Copyright 2023 Retirement Learning Center, all rights reserved
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204(h) Notice

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“My client is merging his firm with another firm, and they will be combining the companies’ defined benefit plans. Some participants will experience a reduction in benefits. Is there any kind of notice to participants that applies in this situation.”

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

A recent call with an advisor in Nebraska is representative of a common inquiry related to reducing plan benefits.

Highlights of Discussion

If a plan amendment or other employer action (e.g., merger or acquisition) reduces future benefit accruals for participants and/or beneficiaries in a defined benefit, target benefit or money purchase pension plan, the plan sponsor must provide a special notice to the affected individuals under Sections 204(h) of ERISA and 4980F(e) of the Internal Revenue Code (IRC). This special notice (a.k.a., the “204(h) Notice”) must be given to plan participants, beneficiaries and each employee organization that will experience a “significant” reduction.

Significant is determined based on the reasonable expectations and the relevant facts and circumstances. For a defined benefit plan, it is a comparison of the retirement-age benefit after the amendment to the retirement-age benefit prior to the amendment. For a defined contribution plan, it is a comparison of the amounts to be allocated after the amendment to what would have been allocated prior to the amendment.

The notice must state the specific provisions of the amendment causing a reduction in future accruals and its effective date. However, the notice need not explain how the individual benefit of each participant or alternate payee will be affected by the amendment. The notice should be written so it is understandable by the average plan participant and must provide sufficient information to allow a participant or beneficiary to understand the impact of the reduction.

Timing of the 204(h) Notice is important and depends on the type of change. The timing rules are complicated, but, generally, plan sponsors must provide the notice at least

-45 days before the effective date of benefit reduction;

-30 days after the amendment for an early retirement subsidy in a merger or acquisition, and

-15 days for other mergers or if a small plan (fewer than 100 participants) is involved.

(See  Treas. Reg. §54.4980F-1(b), Q&A-9(a) for more details on the timing of notices.)

Failure to provide the notice could result in an excise tax of $100 for each day of noncompliance.

Conclusion

Plan sponsors must provide a 204(h) notice when a plan amendment or other employer action (e.g., merger or acquisition) reduces future benefit accruals for participants and/or beneficiaries in a defined benefit, target benefit or money purchase pension plan. There are content and timing rules associated with the notice. A penalty for failing to provide the notice could apply.

© Copyright 2023 Retirement Learning Center, all rights reserved
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Updating the Plan Administrator

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“In an M&A situation, where the acquiring organization does not assume the seller’s retirement plan, what is something that the selling company often overlooks with respect to its retirement plan?”

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

A recent call with an advisor in Minnesota is representative of a common inquiry related to company acquisitions and mergers (M&As).

Highlights of Discussion

M&A scenarios are notorious for treating retirement plans as an after-thought. Because little thought is given to plans in these situations, a great deal of confusion, many missteps and fiduciary risk arise. That said, failing to update the Plan Administrator—the person or entity that is authorized with plan service providers to make decisions related to the retirement plan—is a common oversight.

RLC consulted on a case where Company A purchased Company B in an asset sale and Company A did not take on Company B’s 401(k) plan. The person who had been identified as Company B’s Plan Administrator and signed the Forms 5500 no longer held that role after the acquisition. Months went by and the Plan Administrator role was not filled. That meant that the plan was in limbo, and the level of participant frustration was escalating, along with risk of Department of Labor involvement.

Until a new Plan Administrator was formally appointed and the proper documentation provided, the plan recordkeeper would not/could not make any decisions or take any actions with respect to the plan (for fear of fiduciary liability). The owners of Company B should have anticipated that after the sale, a new Plan Administrator would need to be appointed. Once the new Plan Administrator was officially installed, the plan was put on a course for payout and termination.

Conclusion

Little thought—if any—is given to retirement plans in M&A scenarios. Something as simple and common as failing to update the plan decision-maker (Plan Administrator) with service providers can render a plan dead-in-the-water.

© Copyright 2023 Retirement Learning Center, all rights reserved
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ESOP Rebalancing

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“One of my clients with an Employee Stock Ownership Plan (ESOP) asked about a true up provision in his plan. What is an ESOP true up provision?”

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

A recent call with an advisor in Illinois is representative of a common inquiry related to an ESOP.

Highlights of Discussion

I believe what your client is referred to is a “rebalancing” provision in the ESOP. Rebalancing is the periodic mandatory transfer of employer securities among participant accounts, resulting in all participants having the same proportion of employer stock to other investments as in the ESOP trust as a whole (see this 2010 IRS Memorandum for more details). For example, if the ESOP was invested 70 percent in employer stock and 30 percent in other investments, after rebalancing, each participant’s ESOP account would be invested 70 percent in stock and 30 percent in other investments.

Rebalancing usually happens at the end of the plan year and does not affect the face value of an ESOP participant’s account balance. According to the IRS’s, Listing of Required Modifications for ESOPs, “rebalancing, which treats all participant accounts the same, will not raise issues of current or effective availability and is generally acceptable.” Rebalancing is different than “reshuffling,” which will be covered in a future Case of the Week.

For an ESOP to be able to perform rebalancing it

  • Must hold cash and
  • The plan document must include an annual rebalancing provision.

An example of where rebalancing may come into play might be in a mature ESOP that has allocated all of its shares to its employees and begun contributing cash into the accounts of new employees. Without rebalancing, the new ESOP participants would not be shareholders in the ESOP.

Conclusion

Rebalancing is the mandatory transfer of employer securities into and out of the accounts of ESOP participants, usually on an annual basis, designed to result in all participant accounts having the same proportion of employer securities. In order to rebalance, the plan document must have specific language permitting rebalancing.

© Copyright 2023 Retirement Learning Center, all rights reserved
Governance
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Plan Termination and the Principle of Permanency

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“I have a client who set up a cash balance plan a few years ago and now wants to terminate the plan. Is that OK? Or does the IRS require a sponsor to maintain its qualified plan for a certain number of years?”

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

A recent call with an advisor in Illinois is representative of a common inquiry related to plan termination and the principle of permanency.

Highlights of Discussion

It depends on the reason your client is ending the plan. The IRS has an expectation of plan permanency. “The term ‘plan’ implies a permanent, as distinguished from a temporary, program,” Treasury Regulation 1.401-1(b)(2). However, a plan sponsor reserves the right to change or terminate the plan, and discontinue contributions, but if this happens within a few years after plan establishment, the plan sponsor must document as evidence a valid business reason for terminating the plan. Without documentation of the business necessity, upon examination the IRS will presume the plan was not intended to be a permanent program from its inception. A potential consequence could be the IRS would deem the plan was never qualified and revoke its tax-favored status—making the plan’s assets immediately taxable to participants, and any tax deductions taken by the employer null and void.

What is “a few years?” The IRS gave more insight into the time requirement for plan permanency in Revenue Ruling 72-239, stating a plan that has been in existence for over 10 years can be terminated without a business necessity.

In Revenue Ruling 69-25 the IRS elaborated on what constitutes a “business necessity.” Business necessity, in this context, means adverse business conditions, not within the control of the employer, under which it is not possible to continue the plan, including bankruptcy or insolvency, and discontinuance of the business, along with merger or acquisition of the plan sponsor, provided the merger or acquisition was not foreseeable at the time the plan was created.

IRS examiners are instructed to look for evidence of plan permanency. The IRS’s Employee Plans Guidelines for Plan Terminations at 7.12.1.3 outline the steps examiners must take to evaluate plan permanency, including checking Forms 5310, Application for Determination Upon Termination to determine how long the plan has been in existence, the reason for termination and, if terminated due to adverse business reasons, an explanation detailing the conditions that require the sponsor to end the plan. The examination steps in the Internal Revenue Manual also list the valid business reasons that demonstrate “necessity” for plan termination purposes.

As a fiduciary liability mitigation strategy, a plan sponsor should thoroughly document any decision to terminate its retirement plan, and the reasons for terminating, being mindful of the need for documentation of a valid business reason if termination occurs within a few years after the plan’s initial adoption.

Conclusion

Business owners who have established or who may be contemplating establishing a qualified retirement plan must be aware that the IRS expects the arrangement will be a permanent one. And, although plan sponsors reserve the right to terminate their qualified retirement plans, the IRS views “business necessity” as the only legitimate reason for plan abandonment within the first few years of establishment.

© Copyright 2023 Retirement Learning Center, all rights reserved