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Nongovernmental 457(b) plans and rollovers … the two don’t mix

My client works for a nonprofit hospital that has a 457(b) plan. Another advisor told him he could take a distribution from the plan and roll it over to an IRA within 60 days. Is that correct—I’m suspicious?

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 New York is representative of a common inquiry related to 457 plans and rollovers.

Highlights of the Discussion

No—that is not correct; a nongovernmental 457(b) plan (e.g., a plan maintained by a nonprofit hospital) is not an eligible plan for rollover purposes, only eligible plans of governmental entities are eligible plans for rollover purposes [IRC Sec. 457(e)(1)(A) and not subsection (B), which refers to tax-exempt entities]. Therefore, nongovernmental 457(b) plan distributions are not eligible for rollover. For a handy rollover guide, see the IRS’s Rollover Chart.

For nongovernmental 457(b) plans, the only way to defer taxes would be through a direct transfer to another 457(b) plan of a tax-exempt entity [Treas. Reg. 1.457-10(b)]. A 457(b) plan of a tax-exempt entity may provide for transfers of amounts deferred by a participant to another eligible plan of a tax-exempt entity if

  • The transferor plan provides for transfers;
  • The receiving plan provides for the receipt of transfers;
  • The participant or beneficiary whose amounts deferred are being transferred will have an amount deferred immediately after the transfer at least equal to the amount deferred with respect to that participant or beneficiary immediately before the transfer; and
  • In the case of a transfer for a participant, the participant has had a severance from employment with the transferring employer and is performing services for the entity maintaining the receiving plan.

Aside from the ability to rollover distributed assets, there are many other differences between 457(b) plans maintained by governmental entities versus those maintained by tax-exempt entities. The IRS has a helpful online chart that highlights the key differences.

Conclusion

Nongovernmental 457(b) plan distributions are not eligible for rollover. In some cases, amounts could be transferred to another tax-exempt 457(b) plan if certain conditions

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State and Local Plans for Public Employees—Are They Protected?

An advisor asked: I know private-sector qualified plans are protected under federal law (ERISA) but state and local plans for public employees are not. Are there any protections for state plans?

Highlights of the Discussion
There is no comprehensive federal law that protects state and local governmental plans for public employees, and the Pension Benefit Guaranty Corporation (PBGC) does not insure such plans. That said, all 50 states have some form of protection for public pensions. The National Conference on Public Employee Retirement Systems (NCPERS) has a state-by state rundown of coverage. According to the U.S. Census Bureau, over 5,000 public sector retirement systems exist in the U.S.

The creation of public plans and the rules that govern them emanate from the entity that has “authority” over the pension, which could be the state constitution, the legislature, case law or a combination thereof. These rules vary significantly by state not only with respect to the source of protection, but who is entitled to protection and the plan features that are protected.

Public plans also are subject to state laws governing open meetings and open records rules, anti-conflict of interest rules, codes of ethics, the investment of trust assets, and common-law trust provisions. Further, the Governmental Accounting Standards Board (GASB) has some say in the operation of public pensions. GASB is an independent, nonprofit organization that sets financial accounting and reporting standards for state and local governments. GASB is the source of generally accepted accounting principles (GAAP) used by state and local governments in the United States. While GASB has no enforcement authority, public employee pension plans typically follow GASB rules in order to obtain unmodified opinions from their auditors (e.g., Statements 67, 68 and 75). Adhering to GASB standards is also an important consideration for the bond rating agencies.

There are also nonprofit organizations that work for the protection of public pensions, such as NCPERS, The National Public Pension Coalition, the National Association of State Retirement Administrators, as well as others.

Conclusion
While federal involvement is limited, all 50 states have some form of protection for their public pensions. Significant differences exist among the plans. Working with these plans requires expertise in both pension law and investment theories.

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Long-Term Part-Time Employees and Liberal Plan Entry

My client is concerned about the Long-Term Part-Time Employee (LTPTE) rules. His plan allows employees to enter the plan as of the first of the month following their date of hire, without an hour of service requirement. How do the LTPTE rules apply in his case?

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 Indiana is representative of a common inquiry related to long-term part-time employees.

Highlights of the Discussion
The short answer is—they do not apply. Here’s why. Under the LTPTE rules for 2024, employees who had at 500-999 hours of service in 2021, 2022 and 2023 (i.e., three consecutive years) and reached age 21, would have become eligible to defer into the company’s 401(k) plan in 2024. Pre-2021 service is ignored in this case. For 2025, the years of service requirement is reduced to two years. Therefore, an employee with at least 500-999 hours of service in 2023 and 2024, and who is age 21 would become eligible for deferrals in 2025. Pre-2023 service is ignored for this purpose.

If a plan has immediate eligibility (no hour of service requirement) or the eligibility requirements are more liberal than the LTPTE eligibility requirements, then the LTPTE rules are not applicable (REG–104194–23). Since the plan’s eligibility provisions, in this case, allow employees to enter the plan as of the first of the month following their date of hire without any hour of service requirement, the LTPTE rules do not apply as the eligibility rules are more liberal than the LTPTE requirements.

Conclusion
In 2024, we saw the first LTPTEs become eligible to participate in 401(k) plans. Plans that have more liberal eligibility requirements than those outlined under the LTPTE rules are not subject to the LTPTE rules.

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Suspending Social Security retirement benefits

My client who is 68 heard that he could suspend his Social Security retirement benefit and earn delayed retirement credits. Is that true and, if so, what are the details?

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 Oklahoma is representative of a common inquiry related to Social Security benefits.

Highlights of the Discussion
Suspending Social Security benefits is an important tax question for which your client should seek professional tax advice based on his personal situation. Based on guidance available on the Social Security’s website (www.ssa.gov), since your client has reached full retirement age, but is not yet age 70, it appears he can ask the Social Security Administration (SSA) to suspend his retirement benefit payments. By doing this, he will earn delayed retirement credits for each month his benefits are suspended, which will result in a higher benefit payment when he resumes them.

If your client makes the decision to suspend benefit payments after consulting with a financial advisor, he can make a request to suspend payments by calling the SSA or sending a written request. The SSA will suspend benefit payments beginning the month after an individual makes the request. If your client suspends benefit payments, they will automatically start again the month he reaches age 70—or sooner if he requests they restart prior to age 70.

There are several factors to consider when contemplating a suspension of retiree benefits, including, but not limited to, the following.

  1. If a retiree voluntarily suspends his/her retirement benefit and he/she has others who receive benefits on their record, the others will not be able to receive benefits for the same period that the retiree’s benefits are suspended. An exception applies for divorced spouses.
  2. If a retiree voluntarily suspends his/her retirement benefit, any benefits he/she receives on someone else’s record will also be suspended.
  3. Medicare Part B premiums cannot be deducted from suspended benefits. Therefore, a person who suspends his/her retirement benefit will be billed for such premiums.

Conclusion
The rules related to suspending Social Security retiree benefits are complex. It is possible to earn delayed retirement credits by suspending benefits, but other issues such as the availability of family benefits and Medicare considerations may come into play when making the decision. Anyone contemplating a suspension of retiree benefits should seek expert advice from a tax and/or legal advisor.

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SIMPLE IRA Plan Termination and Two-Year Rollover Rule

“One of my clients terminated his SIMPLE IRA plan at the end of 2023 and established a 401(k) plan beginning 2024. He’s worried about the two-year waiting period for distributing assets held in the now terminated SIMPLE IRA plan. Is there any leeway with the waiting period for a terminated 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 a financial advisor in Ohio is representative of a common inquiry involving a savings incentive match plan for employees SIMPLE IRA plan.

Highlights of Discussion
Yes, there is, and we just received more clarification on this issue in IRS Notice 2024-02. You are aware that a distribution from a SIMPLE IRA within the first two years of an individual’s participation in the SIMPLE IRA plan, potentially, is subject to a 25 percent early distribution penalty tax unless the amount is being moved to another SIMPLE IRA plan or a penalty exception applies.

Section 332(b) of the SECURE Act 2.0 adds Internal Revenue Code (IRC) Sec. 72(t)(6)(B) to the IRC and amends IRC Sec. 408(d)(3)(G). Under the addition and amendment, if an employer terminates a SIMPLE IRA plan and establishes a 401(k) plan [or 403(b)] plan that limits distributions (as described next), then the two-year waiting period on rollovers from the terminated SIMPLE IRA to the 401(k) [or 403(b)] does not apply, provided the rollover contribution is subject to the receiving plan’s distribution restrictions (Q&A G4 of Notice 2024-02).

In the case of a 401(k) plan, distributions must be limited to those triggers listed in IRC Sec. 401(k)(2)(B):
• Severance from employment,
• Death,
• Disability,
• Plan termination,
• Attainment of age 59½,
• Hardship,
• As a qualified reservist distribution,
• For certain lifetime income investments and
• As qualified long-term care distributions.

Further, amounts may not be distributable by reason of the completion of a stated period of participation or the lapse of a fixed number of years (e.g., no in-service distributions prior to age 59 ½). Be sure to check the 401(k) plan document for its treatment of rollover contributions. Some plans allow distributions of rollover amounts at any time.

For 403(b) plans, rollover contributions from the terminated SIMPLE IRA plan must be limited to those triggers listed in IRC Sec. 403(b)(11), which are similar to those listed above.

Conclusion
Under SECURE Act 2.0, with clarification by Notice 2024-02, if an employer terminates a SIMPLE IRA plan and establishes a 401(k) plan [or 403(b)] plan that limits distributions as prescribed, then the two-year waiting period on rollovers from the terminated SIMPLE IRA to the 401(k) [or 403(b)] does not apply, provided the rollover contribution is subject to the receiving plan’s distribution restrictions. An in-service distribution provision before age 59 ½ would not align with the necessary distribution restrictions for the waiver.

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Reducing PBGC Premium Costs

“One of my plan sponsor clients with a defined benefit plan asked me about ways to reduce the Pension Benefit Guaranty Corporation (PBGC) premiums the company pays. Do you have any ideas to help save on costs?”

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 in Illinois is representative of a common inquiry involving PBGC premiums.

Highlights of Discussion
The 2024 PBGC premium rate per participant is $101 and could be even higher for underfunded plans. Therefore, decreasing the participant count in a plan can help reduce PBGC premiums.

After reviewing the plan details, RLC’s consultants noted the plan had many former employees with small benefit amounts and a number of retirees taking benefits. Several strategies are available that can reduce the number of participants and thus the PBGC premium costs, including the following.

First, SECURE Act 2.0 has increased the cash-out amount limit from $5,000 to $7,000, and this feature would allow the plan sponsor to require separated participants with benefits under this threshold to take distributions. (See a prior Case of the Week New Cash Out Limit-Mandatory or Not?) This tactic removes the former participants from the plan and, consequently, the number of participants for which PBCG premiums are due. To illustrate how this is applied, reducing the participant count by 10 could reflect $1,010 in savings (10 x $101) in premiums. The PBGC premium rates are also indexed each year, so savings for future years would be higher.

Next, for participants currently taking benefits, a “lift out” strategy could be used whereby an insurance carrier essentially buys these participants out of the plan and the carrier takes on the obligation to pay benefits. Once the transaction is completed the participants are no longer in the plan and PBGC premium savings are realized.

Conclusion
Depending on the circumstances of the plan, there may be ways for defined benefit plan sponsors to reduce their PBGC premiums, including utilizing enhanced cash-out provisions and lift-out strategies. Of course, one must ensure the language of the governing plan document allows for such actions.

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New Cash Out Limit—Mandatory or Not?

“SECURE Act 2.0 increased the plan cash-out limit to $7,000. Are plans required to apply the new limit?”

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 in Utah is representative of a common inquiry involving plan cash outs.

Highlights of Discussion
This is a great question because there are several areas of confusion related to plan cash-out provisions. The following addresses the dollar thresholds associated with cash-outs or “mandatory distributions.”

First, qualified retirement plans are not required to have cash-out provisions at all. Internal Revenue Code (IRC) sections 411(a)(11) and 417(e) permit—but do not require—qualified plans to include provisions allowing for the immediate distribution of a separated participant’s vested benefit without the participant’s consent where the present value of the benefit is less than the statutory limit.

Plan sponsors can elect to add a provision to their plans to cash out small, vested benefit amounts up to the statutory limit when a participant terminates. These mandatory distributions can be paid out without the consent of the participant or his/her spouse, if applicable. The statutory limit in recent years has been up to $5,000, but Section 304 of the SECURE Act 2.0 increased the statutory limit to $7,000, effective for 2024 and later years.

Each plan has the option to set its own cash-out threshold within the prescribed limit (anywhere from $0 to $7,000 for 2024 and later years).The threshold must be written into the plan document. So, if a plan has a cash-out provision, the threshold could be any amount up to $7,000. Moreover, the anti-cutback rules do not apply to amendments adding or changing a plan’s cash-out threshold [Treas. Reg. §1.411(d)-4, Q&A-2(b)(2)(v)].

Plans with a cash-out level of less than $1,000 can issue a check for the amount to the participant. Plans that have a cash-out threshold of between $1,000 and the statutory maximum (now $7,000) must automatically roll over the distribution to an IRA established for the former employee, if the former employee does not make an affirmative election to have the amount paid in a direct rollover to an eligible retirement plan or to receive the distribution directly. Notice requirements apply. For additional information please see Notice 2005-5.

Conclusion
Qualified plans are not required to have cash-out provisions, but if they do, the details must be specified in the plan document. Each plan has the option to set its own cash-out threshold within the prescribed limit (anywhere from $0 to $7,000 for 2024 and later years).

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Year-End Tax Reminders

A recent call with a financial advisor in Pennsylvania is representative of a common inquiry involving year-end tax-related deadlines. The advisor asked: “Of what year-end tax deadlines should I remind my clients?”

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.

Highlights of the Discussion
There are several December 31, 2023, deadlines of which employers, retirement plan participants, IRA owners and other savers should be aware. The list below includes several but is by no means exhaustive. And—because December 31 falls on a Sunday this year, conservatively these actions should be completed by Friday December 29th to ensure they are completed no later than December 31st. 1

  • 2023 Roth conversion: In order for a taxpayer to consider either a Roth IRA or Roth 401(k) in-plan conversion for 2023 tax purposes, he or she must complete the conversion no later than December 31, 2023. (Don’t confuse the 2023 conversion deadline with the deadline for making a 2023 Roth IRA contribution, which is April 15, 2024.)
  • 2023 Qualified Charitable IRA Distribution: No later than December 31st, IRA owners and beneficiaries age 70½ or over can transfer up to $100,000 from their IRAs to an eligible charity, and exclude the amount from gross income. The excluded amount also can be used to satisfy any required minimum distributions that are due from their IRAs for 2023. New for 2023 and for later years, a QCD also can include a one-time gift of up to $50,000 (adjusted for inflation) to a charitable remainder unitrust, a charitable remainder annuity trust, or a charitable gift annuity. See a prior Case of the Week “There’s More to Love About QCDs” for other enhancements to QCDs as a result of SECURE Act 2.0.
  • 2023 Required minimum distributions for second or subsequent distribution years: Plan participants and IRA owners who have begun their required minimum distributions must take their second or subsequent years’ RMDs no later than December 31, 2023—or, potentially, face a 25% penalty on the amount not taken.
  • Discretionary Plan Amendments: Plan sponsors with calendar-year plans that made discretionary operational changes to their retirement plans during the year must generally amend their plan documents to reflect such changes no later than December 31, 2023.
  • Deferral Election: Though not a requirement, plan participants will want to make sure their employee salary deferral elections are properly set for the beginning of 2024.
  • Beneficiary Audits: Although there is no prescribed deadline, plan participants and IRA owners should make it a habit to review their beneficiary elections at least annual to ensure they are up to date.
  • 529 Plan Contribution: Although contribution rules vary by states, many states have a contribution deadline of the end of the calendar year (December 31) to qualify for a 529 education savings plan tax deduction on their tax returns for the tax year.

Conclusion
Before the New Year’s Eve celebration begins, individuals should check with their tax advisors to see if December 31, 2023, marks the deadline for important 2023 tax-related actions like those listed above. Happy Holidays!

1 When a particular act is tied to a prescribed IRS filing deadline there is an exception. In that circumstance, if the due date falls on a Saturday, Sunday, or legal holiday, then the due date is the next business day (IRC Sec. 7503).

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New Annual Reminder Notice for Unenrolled Participants

“The recordkeeper for my client’s retirement plan announced that it would be incorporating a new notice into its plan notice distribution process as a result of SECURE 2.0. What is the “Unenrolled Participant Annual Reminder Notice?”

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 a plan notices.

Highlights of the Discussion
Some employees, although they may meet their retirement plan’s eligibility requirements to participate, choose not to. Prior to SECURE 2.0 (Public Law 117-328), plan sponsors were required to continue to provide these otherwise eligible but nonparticipants with all the same IRS and DOL plan notices as required for active participants. This task is often completed by a plan’s recordkeeper. Effective for 2023 and later years, SECURE 2.0 allows for a simpler way to satisfy plan notice requirements for these nonparticipants.

Pursuant to section 320 of SECURE 2.0, after the initial year of eligibility, sponsors of defined contribution, 401(k) and 403(b) plans may choose to give an otherwise eligible employee that elects not to participate a single “Unenrolled Participant Annual Reminder Notice” for a year in lieu of myriad other DOL and IRS notices typically required. Under the rule, the plan must provide

  1. An annual reminder notice of the employee’s eligibility to participate in the plan and any applicable election deadlines, and
  2. Any otherwise required document requested at any time by the otherwise eligible employee.

During the initial year of eligibility, all participants must receive all required notices related to initial eligibility, including the plan’s Summary Plan Description (SPD).

Beginning in 2024, it is possible that an eligible, nonparticipant who received the Unenrolled Participant Annual Reminder Notice timely (within a reasonable period before the beginning of the plan year) will no longer receive the following, unless requested:

• SPD
• Summary of Material Modifications (SMM)
• Safe Harbor, EACA and QACA notices
• Fund Changes
• Annual Participant Fee Disclosure
• Summary Annual Report

Depending on the plan’s recordkeeper, plan sponsors may see a reduction in their mailing volume and associated fees for the above-listed notices. Plan sponsors and their advisors should understand how their recordkeepers will be addressing this issue and be prepared to answer participant questions should they arise.

In its request for information (RFI) in August of 2023, the DOL inquired what additional guidance plan administrators may need to implement this simplified disclosure process, including whether the notice should include additional information and whether a model notice would be helpful. The DOL also asked whether it should provide additional criteria for determining if participants are unenrolled. Comments were due October 10, 2023, and we are still awaiting the outcome.

Conclusion
Effective for 2023 and later years, SECURE 2.0 allows for a simpler way to satisfy plan notice requirements for otherwise eligible participants who choose NOT to participate by providing a single Unenrolled Participant Annual Reminder Notice. Plan sponsors and their advisors should understand how their recordkeepers will be addressing this issue and be prepared to answer participant questions should they arise.

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Special Notice Requirements for 401(k) Discretionary Matching Contributions

“Can you explain the special written disclosure rules that apply to certain 401(k) plans that use a discretionary matching contribution formula?”

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 a discretionary matching contribution in a 401(k) plan.

Highlights of the Discussion

Sponsors using pre-approved plan documents for their 401(k) plans that apply a discretionary matching contribution formula must satisfy special notice requirements in years a match is provided. This requirement came about as a result of the Cycle 3 Restatement in 2022.

For businesses that elect to apply a fully discretionary matching contribution formula (i.e., where the rate or period of the matching contribution is not pre-selected) in their pre-approved plans, the IRS has made it clear that such plans still must satisfy the “definitely determinable benefits” requirement of Treasury Regulation Section 1.401-1(b)(1)(I). According to the regulation, a plan must provide a definite predetermined formula for allocating the contributions made to the plan. Consequently, any pre-approved document with discretionary matching contributions will have to have language that complies with the definitely determinable mandate, and adopting employers will have to

1. Provide the plan administrator or trustee written instructions no later than the date on which the discretionary match is made to the plan describing

  • How the discretionary match formula will be allocated to participants (e.g., a uniform percentage of elective deferrals or a flat dollar amount),
  • The computation period(s) to which the discretionary matching formula applies; and, if applicable,
  • A description of each business location or business classification subject to separate discretionary match formulas.

2. Provide a summary of these instructions to plan participants who receive an allocation of the discretionary match no later than 60 days following the date on which the last discretionary match is made to the plan for the plan year.

Example:

ABC Inc., has a calendar year, pre-approved 401(k) plan with a completely discretionary matching formula. For the 2023 plan year, ABC has decided to make a fully discretionary matching contribution on April 1, 2024. In this case, if ABC carries through with its intended matching contribution, the deadline to notify the plan administrator is April 1, 2024, and then the deadline to provide the participant communication is May 30, 2024.

Note that these requirements do not apply to pre-approved 403(b) plans as they are subject to a separate pre-approval process (Cycle 2) (See Q&A 11 of Q&As for 2nd Cycle Preapproved 403(b) Plan Providers).

As part of a prudent governance process, plan sponsors should work with their pre-approved document providers and recordkeepers to review their procedures surrounding their plans’ matching contributions to ensure compliance with these requirements. Some pre-approved document providers have sample communication language available for plan sponsors who give discretionary matching contributions.

Conclusion

Employers that use a pre-approved 401(k) plan and give discretionary matching contributions must satisfy additional administrator and participant communication requirements to satisfy the definitely determinable benefit requirement of treasury regulations.

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