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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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Hybrid retirement plans

“Is ‘hybrid’ just another name for a cash balance defined benefit 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 from Colorado is representative of a common inquiry related to hybrid plans.

Highlights of the Discussion

Sort of—a cash balance plan is a type of hybrid defined benefit plan; a pension equity plan is another type of hybrid plan. The term hybrid applies to a category of defined benefit plan that uses a lump-sum based formula to determine the guaranteed benefit (rather than a formula based on years of service and compensation as is the case with most traditional defined benefit plans). A participant must refer to plan documentation to determine which type he or she may have.

Functionally, hybrid plans combine elements of traditional defined benefit plans and defined contribution plans. Hybrid plans specify contributions to an account (or balance) like a defined contribution plan, but guarantee final benefits like a defined benefit plan. Such plans grow throughout an employee’s career and allow employees to see that growth through an account balance. There are basically two types of hybrid plans: cash balance and pension equity. The account for each participant in a hybrid plan is theoretical, and is not actually funded by employer contributions. The employer contributes to the plan as a whole (covering all eligible workers in the plan) to ensure that sufficient funds will be available to pay all benefits.

Cash balance plans were the first type of hybrid plan, emerging in the late 1980s.[1] Under a cash balance plan an employee’s hypothetical account balance is determined by reference to theoretical annual allocations based on a certain percentage of the employee’s compensation for the year and hypothetical earnings on the account. In a typical cash balance plan, a participant’s account is credited each year with a pay credit (such as 5 percent of compensation from his or her employer) and an interest credit (either a fixed rate or a variable rate that is linked to an index such as the one-year Treasury bill rate).

Another common type of hybrid plan is a pension equity plan or PEP. While pension equity plans and cash balance plans share methods of accumulating value, a major difference is the earnings used to determine the benefit. Cash balance plans specify a credit each year, based on that year’s earnings, whereas pension equity plans apply credits to final earnings (IRS Notice 2016-67).

While traditional defined benefit plans specify the primary form of distribution as an annuity (with lump sums sometimes given as a optional form of benefit), hybrid plans specify the primary form of distribution as a lump sum, which can be converted to an annuity (see Treasury Regulation 1.411(a)(13)–1). Pursuant to Revenue Procedure 2019-20, the IRS provides a limited expansion of IRS’s determination letter program for individually designed retirement plans to allow reviews of hybrid plans, as well as merged plans.

The Bureau of Labor Statistics has put together the following comparison table showing the similarities and differences between cash balance and pension equity plans.

table

Conclusion

The term hybrid plan refers to a category of defined benefit plans that uses a lump-sum based formula to determine guaranteed retirement benefits. Cash balance and pension equity plans are the two most common types of hybrid plans. The provisions of the governing plan document will specify which type of hybrid plan a participant may have.

[1] Bureau of Labor Statistics

 

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Where, oh where, have my retirement benefits gone?

“I have a client who has worked in the banking industry for decades and has changed jobs numerous times. Many of his former employers have merged with other institutions or no longer exist. He is not currently receiving any retirement benefits from these past employers, but feels certain he should be. How can he locate his lost retirement plan benefits?”

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 Jersey is representative of a common inquiry related to locating lost retirement plan benefits.

Highlights of the Discussion

Given the frequency with which the average U.S. worker changes jobs throughout his or her career (i.e., 12 times)[1], and the merger and acquisition activity in the past decades, it should not be surprising that some workers have lost track of their retirement plan assets. The Employee Retirement Income Security Act of 1974 (ERISA) requires plan sponsors to make efforts to find missing plan participants.[2]

Former participants can take matters into their own hands and search for retirement benefits to which they believe they are entitled. Below is a list of options for locating lost retirement plan assets. There may be other resources as well.

  1. Contact former employer(s) directly if they still exist. Check old tax forms, Forms W-2 and other employment-related documents.
  2. Contact the plan’s recordkeeper or third-party administrator (TPA). This information likely appears on an old plan statement, if available.
  3. Search the Department of Labor’s (DOL’s) Form 5500 database of filings (Form 5500/5500-SF Filing Search) for plan administrator contact information. Many qualified retirement plans are required to file this annual plan report with the IRS and DOL. Using the employer’s tax identification number may be helpful in locating employers and plans that have been merged or changed names.
  4. Try the DOL’s searchable database of abandoned plans, which contains information on retirement plans that have been forsaken by their sponsors.
  5. The Pension Benefit Guaranty Corporation (PBGC) has two ways to assist in benefits searches. First, search the PBGC’s database for unclaimed defined benefit plan pensions. Searchers can also try to locate a plan by whether it is insured or trusteed by the PBGC. Second, search the PBGC’s list of missing participants. As of January 1, 2018, terminating defined contribution plans have the option of transferring missing participants’ benefits to the PBGC for eventual distribution.[3]
  6. Every state has some type of unclaimed property program. Plan sponsors who have failed to locate missing participants or beneficiaries may have escheated the retirement plan assets to their respective state programs. The National Association of Unclaimed Property Administrators is a not-for-profit organization that maintains a database of state programs to help individual’s find missing property.
  7. Searchers could check with The National Registry of Unclaimed Retirement Benefits to see if a former employer has listed a particular person as a missing participant. The registry is a nationwide, secure database listing of retirement plan account balances that have been left unclaimed.
  8. Watch for a notice from the Social Security Administration (SSA): Potential Private Retirement Plan Benefit Information. It is a reminder about private employer retirement benefits that an individual may have earned, also called “deferred vested benefits.” The IRS provides the information to the SSA. It comes from the plan administrators of the private retirement plans in which workers participated.
  9. The nonprofit organization Pension Help America may be able to link searchers with local and regional governmental offices to help locate retirement plan assets and/or solve other benefit issues.

Conclusion

Individuals who have lost track of their retirement plan benefits for whatever reason have several federal, state, regional and local resources available to help them find the retirement benefits to which they are entitled.

[1] https://www.bls.gov/news.release/pdf/nlsoy.pdf

[2] https://www.irs.gov/retirement-plans/missing-participants-or-beneficiaries

 

[3] https://www.pbgc.gov/prac/missing-p-defined-contribution

 

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Deadlines to deposit elective deferrals

“I get confused by the various deposit deadlines for employee salary deferrals. Can you summarize them for me, please?” 

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 North Carolina is representative of a common inquiry related to depositing employee salary deferrals.  

Highlights of the Discussion

The following table summarizes the Department of Labor’s (DOL’s) deferral deposit deadlines for various plan types.

Plan Type Deadline Citation
Small 401(k) Plan

A plan with fewer than 100 participants

 

Safe Harbor Rule: The plan sponsor has seven business days following the day on which such amounts were withheld to deposit them to the plan. DOL Reg. 2510-3-102(a)(2)

 

Large 401(k) Plan

A plan with 100 or more participants

The plan sponsor must deposit deferrals as soon as they can be reasonably segregated from the employer’s assets, but not later than 15 business days following the month the deferrals are withheld from the participants’ pay. DOL Reg. 2510-3-102(a)(1) and (b)(1)

 

Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) IRA Deferrals must be deposited within 30 days after the end of the month in which the amounts would otherwise have been payable to the employee. DOL Reg. 2510.3-102(b)(2)

 

Salary Reduction Simplified Employee Pension (SAR-SEP)

An IRA-based plan with 25 or fewer employees.

Safe Harbor Rule: The plan sponsor has seven business days following the day on which such amounts were withheld to deposit them to the plan. DOL Reg. 2510-3-102(a)(2)

 

Conclusion

The DOL’s top compliance concern is the timely deposit of employee salary deferrals to their respective plans. Plan sponsors and service providers must ensure policies and procedures are in place to ensure deferral deposit deadlines are met.

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Rollovers to Qualified Retirement Plans

“My client changed jobs and was hoping to move at least a portion of his prior 401(k) plan balance to his new employer’s 401(k) plan? When he inquired about the rollover with the new employer, he was told that the plan cannot accept his rollover. I thought all qualified retirement plans had to offer rollovers. What could be the issue here?”  

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 rollovers to qualified retirement plans.

Highlights of the Discussion

Some qualified plan distributions simply are not eligible for rollover (e.g., required minimum distributions, excess contributions, substantially equal periodic payments, etc.).[1]  But, in this case, I think the new employer may be refusing the rollover because its plan does not accept some or all rollover amounts—period.

While is it true that pursuant to Internal Revenue Code Section (IRC §) 401(a)(31) the IRS requires qualified plans to offer distribution recipients a direct rollover option of their eligible rollover distributions of $200 or more to an eligible retirement plan, it imposes no such requirement that an eligible retirement plan accept rollovers. Thus, a plan can refuse to accept rollovers if the language of the governing plan document does not address the ability of the plan to receive eligible rollover distributions. Even if a plan accepts rollovers of eligible amounts, a plan could limit the circumstances under which it will accept rollovers. For example, a plan could limit the types of plans from which it will accept a rollover or limit the types of assets it will accept in a rollover (See Treasury Regulation Section 1.401(a)(31)-1, Q&A 13). Plan administrators must apply their policies regarding the acceptance of rollovers in a nondiscriminatory and uniform manner to all participants.

Statistically speaking, 97 percent of all qualified retirement plans accept some types of rollovers.[2] That number declines based on the size of the receiving plan. It is more likely that a plan will limit the sources of rollover contributions. For example, 66 percent of all plans surveyed accept rollovers from IRAs; 46 percent accept rollovers from defined benefit pension plans; and 40 percent accept rollovers from governmental 457(b) plans.[3]

Some plans will limit when they will accept rollover contributions. For example, some plans make new hires wait until they satisfy the eligibility requirements to make deferrals before being eligible to bring in a rollover contribution.

The best guidance is to have your client confirm with the new plan administrator—perhaps through the HR Department—whether or not rollovers are allowed according to the plan document, and, if so, what type of contributions the plan will accept and when.

The IRS has a number of helpful links on its website covering rollover information; here are a few:

Conclusion

A plan can refuse to accept or limit rollovers coming in depending on the language of the governing plan document. When in doubt—check the plan document provisions regarding rollovers. Plan administrators must apply their policies regarding the acceptance (or nonacceptance) of rollovers in a nondiscriminatory and uniform manner to all participants.

[1] Treas. Reg.§ 1.402(c)-2(Q&A 3 and 4)

 

[2] Plan Sponsor Council of America, 61st Annual Survey, 2018

[3] Ibid

 

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