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Hierarchy of Payroll Deductions

An advisor asked, “I’ve run across the client situation where an individual’s paycheck is too small to handle all the mandatory deductions or withholdings (e.g., payroll taxes, health insurance premiums, FSA contributions, life insurance, garnishments for child support and taxes, repayment of qualified loans, union dues, elective deferrals to a 401(k) plan, etc.) Is there a hierarchy of deductions that a payroll department should follow?

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 withholding on payroll.

Highlights of the Discussion

First, check to see if the employer or payroll processor have a written policy. With respect to 401(k) salary deferrals, you could check the governing plan documents to see if there is a written policy (although few plans contain such information).

If no policy exists, it is best to put one in place. ERISA does not prescribe a hierarchy of withholding, neither is one specified in federal tax law. For guidance, it would be prudent to discuss the issue with a tax attorney. For reference, here’s one example of withholding order that applies to Federal civilian employees issued by the United States Office of Personnel Management.

Generally, payroll deductions are either mandatory or optional. Mandatory deductions would include those identified under federal, state, and local law. An employer is legally obligated to collect this money and remit it to the proper authority. Optional deductions, on the other hand, are voluntary, and an employee must provide written authorization to have such amounts withheld from a paycheck.  Notice that 401(k) salary deferrals are akin to Thrift Savings Plan deferrals and, therefore,  are considered “optional.”

Conclusion

If an employer does not have a policy regarding the hierarchy of payroll withholdings, a best practice is to put one in place with the help of a tax advisor, and apply it consistently.

 

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Is Congress Closing the Backdoor to Roth IRAs?

An advisor asked: “Is Congress Closing the Backdoor to Roth IRAs?”

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 Roth conversions.

Highlights of the Discussion
Potentially, yes, as well as restricting other Roth conversion strategies. As part of the tentative measures to help fund the proposed $3.5 trillion budget reconciliation package (a.k.a., Build Back Better Act ), the House Ways and Means Committee has suggested, among other tactics, restricting “back-door Roth IRAs,” a popular tax-reduction strategy where individuals convert traditional IRA and/or retirement plan assets to Roth IRAs. If enacted as proposed, after-tax IRA and after-tax 401(k) plan conversions would be eliminated after 12/31/2021. For amounts other-than after-tax (i.e., pretax assets), traditional IRA and plan conversions for taxpayers who earn over the following taxable income thresholds would cease after 12/31/2031:

• Single taxpayers (or taxpayers married filing separately) with AGI over $400,000,
• Married taxpayers filing jointly with AGI over $450,000, and
• Heads of households with AGI over $425,000 (all indexed for inflation).

The buildup of Roth assets can be a source of tax-free income later if certain conditions are met. Ending Roth conversions using after-tax contributions in a defined contribution plan or IRA, and restricting Roth conversions of pre-tax plan or IRA assets would materially limit many taxpayers’ ability to accumulate Roth assets in a tax-free or tax-reduced manner.
You won’t find the phrase backdoor Roth IRA in the Internal Revenue Code or Treasury regulations. Nor is it a specific product, but the industry has known about the phenomena for years. A backdoor Roth IRA is merely a series of transactions or steps an individual can take to have a Roth IRA—regardless of income level. While initially poorly understood and lacking clear IRS guidance, so called “back-door Roth IRAs” have been legitimized over the years by the IRS.

The ability to make a 2021 Roth IRA contribution is phased out and eliminated for single tax filers with income between $125,000-$140,000; and for joint tax filers with income between $198,000-$208,000. Consequently, if a person earns too much, he or she cannot make a Roth IRA contribution directly (i.e., through the front door). But many can still take another route—by converting traditional IRA or qualified retirement plan assets, a transaction that has become known as the backdoor Roth IRA.

Congress repealed any income limitations for Roth IRA conversions in 2010. Consequently, regardless of income level, anyone could fund a Roth IRA through a conversion. For example, if a person exceeds the income limitation for contributions to a Roth IRA, he or she could contribute amounts (deductible or nondeductible) to a traditional IRA based on earned income and, shortly thereafter, convert the contribution from the traditional IRA to a Roth IRA. Similarly, a person with a 401(k)-plan account balance could convert eligible plan assets either in-plan to a designated Roth account (if one exists) or out-of-plan to a Roth IRA through a plan distribution. Assets that are taxable at the point of conversion would be included in the individual’s taxable income for the year. Going forward, earnings would accumulate tax-deferred and, potentially, would be tax-free upon distribution from the Roth IRA. Under the authority of IRS Notice 2014-54, a qualified plan participant can rollover pre-tax assets to a traditional IRA for a tax-free rollover and direct any after-tax assets to a Roth IRA for a tax-free Roth conversion.

Conclusion
Plan participants and IRA owners need to be aware that as part of the 2021 budget reconciliation process, the ability to convert assets to Roth assets may be sunsetting. If revenue-generating provisions of the Build Back Better Act are enacted as currently proposed, Roth conversions of after-tax IRA and after-tax 401(k) plan assets would be eliminated after 12/31/2021; and Roth conversions of pre-tax IRA and plan assets would cease after 12/31/2031.

Click here for an RLC webinar on the proposed changes.

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Cybersecurity and DOL Document Requests

An advisor asked: “I understand the Department of Labor (DOL) is already checking the cybersecurity procedures of plans that are currently under audit. Do you have any insight into what the DOL’s auditors are requesting from plan sponsors with respect to cybersecurity policies?”

Highlights of the Discussion

Yes, we have a little insight. The DOL’s “Cybersecurity Document Requests” that we have seen, which have been given to at least some plans under audit, reveal the DOL has been asking for quite an extensive list of documentation, as represented below. Moreover, the DOL has noted that plan administrators should be aware that they may need to consult not only with the sponsor of the plan, but with the service providers of the plan to obtain all the documents requested, and if they are unable to produce the requested documents the plan administrator must specify the reasons why the documents are unavailable.

1. All policies, procedures, or guidelines relating to

• Data governance, classification and disposal.
• The implementation of access controls and identity management, including any use of multi-factor authentication.
• The processes for business continuity, disaster recovery, and incident response.
• The assessment of security risks.
• Data privacy.
• Management of vendors and third-party service providers, including notification protocols for cybersecurity events and the use of data for any purpose other than the direct performance of their duties.
• Cybersecurity awareness training.
• Encryption to protect all sensitive information transmitted, stored, or in transit.

2. All documents and communications relating to any past cybersecurity incidents.
3. All security risk assessment reports.
4. All security control audit reports, audit files, penetration test reports and supporting documents, and any other third-party cybersecurity analyses.
5. All documents and communications describing security reviews and independent security assessments of the assets or data of the plan stored in a cloud or managed by service providers.
6. All documents describing any secure system development life cycle (SDLC) program, including penetration testing, code review, and architecture analysis.
7. All documents describing security technical controls, including firewalls, antivirus software, and data backup.
8. All documents and communications from service providers relating to their cybersecurity capabilities and procedures.
9. All documents and communications from service providers regarding policies and procedures for collecting, storing, archiving, deleting, anonymizing, warehousing, and sharing data.
10. All documents and communications describing the permitted uses of data by the sponsor of the Plan or by any service providers of the Plan, including, but not limited to, all uses of data for the direct or indirect purpose of cross-selling or marketing products and services.

Most recently, the DOL on April 14, 2021, issued three cybersecurity directives nationwide for retirement plans:

Tips for Hiring a Service Provider: This piece helps plan sponsors and fiduciaries prudently select a service provider with strong cybersecurity practices and monitor their activities, as ERISA requires.
Cybersecurity Program Best Practices: This piece assists plan fiduciaries and record-keepers in their responsibilities to manage cybersecurity risks by following these 12 steps.
Online Security Tips: This piece offers plan participants and beneficiaries who check their accounts online basic rules to reduce the risk of fraud or loss.

For more details, please see RLC’s previous Case of the Week: Cybersecurity and Retirement Plans-What’s the Latest?

Conclusion
The industry is still waiting for definitive cybersecurity rules for retirement plan administration. In the meantime, the best that concerned parties can do is make a good faith effort to adopt cybersecurity policies, following the series of guidelines, suggestions and best practices issued by the DOL, and document, document, document.

 

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Failed Rollovers

An advisor asked:

“One of my clients took a distribution from his 401(k) plan and timely rolled it over to an IRA. All good—except that the IRA rollover contained an amount which should have been my client’s required minimum distribution (RMD) for the year. What happens to the RMD in the IRA?”

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 an invalid qualified-plan-to-IRA rollover.

Highlights of the Discussion

A rollover to an IRA could be a failed or invalid rollover under several circumstances, including if the rollover

  • Includes an RMD;
  • Is made after the 60-day time limit without a valid waiver or extension;
  • Violates the one-per-12-month IRA-to-IRA rollover rule (NA in this case since coming from a plan);
  • Does not meet the definition of an eligible rollover distribution.

Generally, the IRA owner has a few of options to correct the error pursuant to IRC Sec. 219(f)(6). Your client should seek the guidance of a professional tax advisor for his specific situation. Generally, under current rules,

  1. The IRA owner could leave the ineligible rollover amount in the IRA because the IRS deems such invalid rollovers to be regular IRA contributions for the year. (Of course, the individual, otherwise, would have to be eligible to make a regular IRA contribution for the year and the IRA administrator would need to correct the IRS reporting to reflect a regular IRA contribution).
  2. IRS Notice 87-16 allows an IRA owner to remove any current-year IRA contribution that is an eligible contribution without penalty by following the rules for removing excess contributions with net income attributable (NIA). These contributions must be removed by the tax return due date (including any extensions).
  3. If all or a portion of the invalid rollover amount exceeds the IRA owner’s regular contribution limit, the remaining rollover amount is treated as an excess contribution and will be subject to the six percent penalty tax if not timely removed (i.e., generally, October 15 of the year following the year the excess was created).
  4. Any remaining excess that is carried over in the IRA in subsequent years continues to be treated as a regular IRA contribution until the excess amount is eventually used up or removed.

Conclusion

When an invalid rollover contribution is made to an IRA during the year, the invalid rollover amount is deemed to be a regular IRA contribution for that taxable year. What happens next depends on whether the amount is an eligible contribution or an excess contribution.

See IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs) for more guidance.

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LLC Plan Establishment Deadline

An advisor asked,

“I’m working with a limited liability company (LLC) that is interested in setting up a retirement plan.  What is the LLC’s deadline for establishing a 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 Texas is representative of a common inquiry related to setting up qualified retirement plans.

Highlights of the Discussion

Because this question deals with specific tax information, business owners should always seek the guidance of a tax professional for advice on their specific situations.  What follows is general information.

The short answer is it depends on whether the LLC is taxed as a corporation, a partnership or a sole proprietorship. For federal tax purposes, the IRS, typically, treats an LLC as a partnership that must file IRS Form 1065, U.S. Return of Partnership Income for the business.[1] There are exceptions to this rule, so a client should be encouraged to determine the exact nature of the business’s tax structure with a tax advisor. For example, a domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832, Entity Classification Election and elects to be treated as a corporation. A single-member LLC may choose to be taxed as either a corporation or as a sole proprietorship.

Once the LLC’s tax-filing status is determined, then we turn to the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which gave businesses more time to set up plans for a particular tax year. Prior to the SECURE Act, a business that wanted a qualified retirement plan (e.g., 401(k), profit sharing, money purchase pension, defined benefit pension plan, etc.) for a particular tax year had to establish it by the last day of the business’s tax year. For example, a calendar year business had to sign documents to set up the plan by December 31 of the tax year in order to be able to contribute to and take a deduction for contributions.

Under the SECURE Act, 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 as illustrated below.

Tax Status Standard Filing Deadline Extended Filing Deadline
S-Corporation (or LLC taxed as S-Corp) March 15 September 15
Partnership (or LLC taxed as a partnership) March 15 September 15
C-Corporation (or LLC taxed as C-Corp) April 15 October 15
Sole Proprietorship (or LLC taxed as sole prop) April 15 October 15

[Note: Simplified employee pension (SEP) plans have historically followed the above schedule; and special set-up rules apply for safe harbor 401(k) plans.]

EXAMPLE:  The Limited is an LLC taxed as a partnership. Its standard tax filing deadline is March 15th of the year following the tax year in question. For the 2020 tax year, The Limited timely filed IRS Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns.  Consequently, it has an extended tax filing deadline of September 15, 2021, for its 2020 tax year. The owners of The Limited decide in August of 2021 they would like to set up a 401(k)/profit sharing plan for the business for 2020 and later years. The Limited has until September 15, 2021, to execute plan documents to set up the plan, effective for 2020. While The Limited would be able to make a profit sharing contribution on behalf of participants for 2020, participants can only make pre-tax employee salary deferrals and designated Roth contributions prospectively—meaning after they execute valid salary deferral elections for compensation yet to be received in 2021.

Conclusion

For many reasons, including determining the deadline to establish a qualified retirement plan, it is important to ascertain the federal tax-filing status of an LLC business. Under the SECURE Act, for 2020 and later tax years, a business has until its tax filing deadline, plus extensions to set up a plan.

 

[1] LLC Filing as a Corporation or Partnership

 

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Asset or Stock Sale—Which Could Trigger a Plan Distribution?

An advisor asked:  “Between an asset and stock sale of a company, which transaction could trigger a plan distribution for participants?”

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 San Diego, CA is representative of a common inquiry involving company mergers and acquisitions and what happens to the retirement plans of the involved entities.

Highlights of the Discussion

That is somewhat of a trick question because there is a “general” answer and then there is the “facts and circumstances” answer. Let’s take a look at both answers.

Generally, in a “stock-for-stock” sale, the buyer acquires everything (i.e., “lock, stock and barrel”), including any retirement plans. Consequently, the acquired employees would not incur a severance from employment and, therefore, would not have a distribution triggering event as the buyer would, most likely, assume responsibility for the seller’s plan. In that case, the buyer could choose to merge the acquired company’s plan into its own plan (if one existed) or maintain the plans separately.

Generally, in an asset sale, the acquiring employer would not acquire or continue the seller’s plan, resulting in termination of the seller’s plan and a distribution triggering event for its participants.

However, taking a general approach to complicated transactions like stock and asset sales can land one in hot water. The most prudent approach is for the entities involved to specifically address what will happen to the retirement plans as part of the M&A negotiations.

For example, based on the facts and circumstances of the M&A transaction, it is possible, in a stock transaction, that the merger agreement could specify that the seller terminate its retirement plan. Plan termination would need to be completed prior to the closing date of the merger. If the plan is terminated in a manner compliant with requirements for plan termination, the participants of the seller’s plan would have a distribution triggering event.

Similarly, based on the facts and circumstances of the situation, the merger agreement could specify that the buyer will assume sponsorship of the seller’s plan after the asset sale is complete and, therefore, forestall a distribution triggering event.

Plan assessment tools are helpful in M&A situations. For example, the Retirement Learning Center offers a service called the Plan Forensic Analysis, which is a comprehensive assessment of retirement plans and their provisions, used most often to compare two or more plans involved in an M&A scenario. Such a review is helpful for advisors and their plan sponsor clients to identify potential issues and options as part of the M&A process so there are no surprises (e.g., what will happen to the plans, how do we deal with protected benefits and/or who is responsible for plan corrections).

Conclusion

Generally speaking, a stock sale will not result in a retirement plan distribution opportunity for participants, while an asset sale will, unless the merger agreement specifies otherwise. The most prudent approach to handling retirement plans in an M&A scenario is to address the plans head on as part of the transaction negotiations, use plan assessment and comparison tools, and document decisions.

 

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UPDATE: Who is an Independent Contractor?

An advisor asked, “Who is considered an ‘independent contractor,’ and should he or she be included in the retirement plan of the employer who contracts for his or her services?”

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 involving independent contractors and retirement plan eligibility.

Highlights of the Discussion

  • This is a very timely question because the Department of Labor (DOL) has gone back and forth regarding its final definition of independent contractor in 2020 and 2021. Because determining the correct worker status is an important tax question it is advisable to seek the help of a qualified tax professional. What follows is a general explanation of the DOL’s independent contractor rules for educational purposes only as they stand to date.
  • First, a little background. Historically, the industry has looked to the Fair Labor Standards Act of 1938 (FLSA), court rulings and informal guidance from the DOL and IRS to help define who is an independent contractor (and not an employee).
  • The U.S. Supreme Court on several occasions has ruled that there is no single rule or test for determining whether an individual is an independent contractor or an employee for purposes of the FLSA. The Court has held that it is the total activity or situation that controls. Among the factors which the Court has considered significant are
  1. The extent to which the services rendered are an integral part of the principal’s business.
  2. The permanency of the relationship.
  3. The amount of the alleged contractor’s investment in facilities and equipment.
  4. The nature and degree of control by the principal.
  5. The alleged contractor’s opportunities for profit and loss.
  6. The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
  7. The degree of independent business organization and operation.
  • In September 2020, during the Trump administration, the DOL issued proposed regulations that would have provided an “economic reality” test to determine a worker’s status as an independent contractor. On January 6, 2021, the DOL issued a final rule clarifying the standard for employee versus independent contractor based on the economic reality test. The effective date of the final rule was March 8, 2021. However, on February 5, 2021, at the start of the Biden administration, the DOL published a proposal to delay the independent contractor rule’s effective date until May 7, 2021. On March 4, 2021, after considering approximately 1,500 comments received in response to that proposal, the DOL published a final rule delaying the effective date of the independent contractor rule to May 7, 2021. Then, on May 5, 2021, after reviewing approximately 1,000 comments it received, the DOL withdrew the independent contractor final rule. The end result—the DOL’s most recent independent contractor rule never took effect.
  • Consequently, it is “back to the future;” the DOL’s longstanding prior guidance addressing the distinction between employees and independent contractors under the FLSA remains in effect (see Fact Sheet 13: Employment Relationship Under the Fair Labor Standards Act (FLSA).
  • The IRS has some helpful online information as well on determining worker status at Independent Contractor (Self-Employed) or Employee?
  • In a nutshell, the determination of whether a person who provides services to a business is considered an employee or independent contractor is based on the degree of “control or direction” provided by the business to the worker and is dependent upon the facts and circumstances of each case. Generally, an individual is an independent contractor if the business for which he/she performs services, does not control the means or methods used by the worker to accomplish the promised result. It is important for the business owner to look at the entire relationship with the worker, consider the degree of his or her right to direct and control the worker’s actions and, finally, to document each of the factors the business owner uses to arrive at the determination.
  • As an alternative, a person or entity can ask the IRS to make a formal determination on a worker’s status by filing IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The filing takes at least six months to process.
  • With respect to retirement plan participation, a person who meets the definition of an independent contractor is not an employee of the business for which he or she provides services and, therefore, would not be eligible to participate in the business’s retirement plan.
  • However, an independent contractor could contribute to his or her own retirement plan based on his or her self-employment income.

Conclusion

Determining whether a worker is an employee or independent contractor for tax purposes as well as retirement plan coverage purposes can be tricky.  In 2020 and 2021, the DOL floated regulations which were later withdrawn, that included an “economic reality” test, to determine a worker’s status. The DOL’s longstanding prior guidance addressing the distinction between employees and independent contractors under the FLSA remains in effect Fact Sheet 13: Employment Relationship Under the Fair Labor Standards Act (FLSA).

 

 

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Pooled Plan Providers to Date by State

An advisor asked:  “Do you have any statistics around how many Pooled Plan Providers (PPPs) for Pooled Employer Plans (PEPs) have registered with the Department of Labor (DOL), and where they are located?”    

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 Pooled Plan Providers.

Highlights of the Discussion

Yes, we do have some statistics based on a tool on the DOL’s website that shows PPP filings. As of August 3, 2021, the number of PPPs that have registered with the DOL to be able to offer PEPs is 117.* Keep in mind that number will continue to change. Registering with the IRS and DOL is one of the requirements for a firm to become a PPP of a PEP.  Below is a summary of the number of PPPs by state.

Pooled Plan Providers by State*

AR 1
AZ 3
CA 4
CO 1
CT 3
FL 42
GA 2
IL 6
IA 2
KS 1
MD 1
MA 3
MI 1
MN 6
MS 2
NB 1
NV 1
NJ 4
NY 9
OH 1
PA 6
SD 2
TN 1
TX 8
UT 4
VA 1
WA 1
TOTAL 117

*(As of 08.04.2021. States without registrants omitted.)

The most likely entities to serve as PPPs include financial institutions, such as banks and insurance companies, record keepers, large broker/dealers, registered investment advisor firms, payroll providers and local chambers of commerce.

To encourage more businesses to sponsor workplace retirement plans, Congress created PEPs, available for adoption starting in 2021 through registered PPPs. PEPs are new plan structures created by a segment of the Further Consolidated Appropriations Act of 2020 also known as the Setting Every Community Up for Retirement Enhancement (SECURE) Act. These new plan arrangements allow two or more completely unrelated employers to participate in a single retirement plan administered through a registered PPP. Each employer has the fiduciary duty to prudently select and monitor the PPP and other fiduciaries of the PEP.

The idea behind PEPs is that employers would be more inclined to offer retirement benefits if they could band together to reduce the burdens and costs of plan maintenance. And, to sweeten the deal, the special plan startup tax credits in the SECURE Act allow eligible employers to receive up to $5,000 in tax credits for the first three years and offer an additional $500 tax credit for adding an automatic enrollment feature that can be used with PEPs.

Conclusion

PEPs became available for adoption starting in 2021 through registered PPPs. Thanks to a tool on the DOL’s website, the industry can stay up to date on PPP registrants.

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Fully Discretionary Match Meets Definitely Determinable Benefit Rule

An advisor asked:  “I read recently in a TPA’s annual letter that there is a new mandate to provide a written disclosure of the match formula in years where a plan makes a discretionary match. Can you provide some 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 California is representative of a common inquiry related to a discretionary matching contribution in a 401(k) plan.

Highlights of the Discussion

Sponsors of 401(k) plans that utilize pre-approved plan documents are facing an IRS-mandated, cyclical restatement process (“Cycle 3 Restatement”). Every six years, plan providers must update their 401(k) documents for recent law and regulatory changes and file them with the IRS for pre-approval (or re-approval). In turn, employers who use these documents must adopt an updated pre-approved plan, in this case, no later than July 31, 2022 (IRS Announcement 2020-07).

There are new requirements with this restatement 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. With respect to these fully discretionary matching contributions, the IRS made it clear to document providers that their documents must satisfy the “definitely determinable benefits” requirement of Treasury Regulation Section 1.401-1(b)(1)(i), which states 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 include 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.
  1. 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.

The first year for which this communication is required is the plan year following the year the employer signs the restatement.

Example:

ABC, Inc., restates its calendar year 401(k) plan in 2021—even though it could wait until as late as July 31, 2022. Based on this timing, the communication is first due for the 2022 plan year.  If ABC Inc., completes making the 2022 matching contribution April 1, 2023, then the deadline to provide the participant communication is May 30, 2023.

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 new requirements. Some pre-approved document providers have sample communication language available for plan sponsors who give discretionary matching contributions.

Conclusion

Pre-approved defined contribution plans are in a restatement cycle that must be completed by July 31, 2022. Employers that use a pre-approved plan and give a fully discretionary matching contribution must satisfy additional participant communication requirements to satisfy the definitely determinable benefit requirement of treasury regulations.

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Foreign Corporations and Controlled Groups

An advisor asked: “I just discovered that two U.S. companies that I work with are owned by a common parent company that is foreign. Should I be concerned?”    

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 Pennsylvania is representative of a common inquiry related to a controlled group of employers.

Highlights of the Discussion

It is possible that because of the common parent company (despite being a foreign entity), the two U.S. subsidiaries could be part of a controlled group of businesses, which would impact the operation of their retirement plans. It would be prudent for the owners of the companies to seek a legal determination on controlled group status.

Under Internal Revenue Code Section (IRC §) 414(b) a controlled group of businesses exists when any two or more entities are connected through common ownership in a parent-subsidiary, a brother-sister, or a combination of the two controlled groups. For this purpose, entities could be foreign. The code section references the definition of controlled group that appears in IRC §1563(a) alone (and not subsection (b), which would have allowed the exclusion of foreign corporations). Tax court case Fujinon Optical, Inc., v. Commissioner, 76 T.C. 499 (1981) and others support the finding that U.S. businesses related only through a common foreign parent could be a single employer for purposes of IRC §414(b).

It is important to determine whether a group of businesses is a “controlled group” because the IRS requires that all employees of companies in a controlled group be treated as employed by a single employer for qualification requirements of IRC §§ 401 (general qualifications), 408(k) (simplified employee pension or SEP plans), 408(p) (saving incentive match plan for employees or SIMPLE plans], 410 (minimum participation standards), 411 (minimum vesting standards), 415 (limits on benefits and contributions), and 416 (top-heavy determination).

Conclusion

The IRS’s controlled group rules pull in foreign entities with common ownership in U.S. businesses. This may catch some U.S. subsidiaries off guard. Controlled group status has several ramifications for the involved businesses’ retirement plans. Because an accurate controlled group determination is critical, businesses should seek guidance from their legal advisors.

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