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401(k) Plans: Time To Restate And Perhaps Revise


The Internal Revenue Service maintains procedures designed to assist plan sponsors in preserving the tax qualified status of their retirement plans. With respect to prototype and volume submitter plans, the IRS procedures require that such plans be restated every six years. Under the current cycle, such plans must be restated no later than April 30, 2016. As a result, the majority of plan sponsors should review their qualified plans within the upcoming months, if they have not already done so, and make decisions regarding plan provisions.

The upcoming April 30, 2016 deadline for the restatement of prototype and volume submitter documents provides not only the occasion for plan sponsors to update their plans in accordance with legal requirements, but also an opportunity to consider possible changes to their plans’ provisions. This article sets forth some considerations for plan sponsors when presented with updated prototype documents by their plan document vendors. These considerations represent common trends and best practices and are not intended to be an exhaustive list of the changes a plan sponsor might consider.

Automatic Enrollment and Escalation

Automatic enrollment is a popular development in the 401(k) industry. Through automatic enrollment, new or current participants may be treated as having enrolled at an established contribution percentage. The participant must be provided a notice describing the terms of the automatic enrollment feature and offered the option to change the automatic percentage or elect no contribution at all. If the automatic enrollment feature is designed to be an “Eligible Automatic Contribution Arrangement”, participants may be offered the option to withdraw the amounts automatically deferred from their pay within the first 90 days after the date of the first contribution. In addition, a plan may include a “Qualified Automatic Contribution Arrangement” or “QACA” and, in so doing, avoid the 401(k) nondiscrimination testing provided certain requirements are met. This form of automatic enrollment requires an initial 3% automatic deferral rate, and automatic escalation of the default rate for each of the following three years.

More recently, plans have trended toward providing automatic escalation regardless of whether the plan is intended to comply with the QACA requirements. Automatic escalation can further serve to assist participants with accumulating retirement savings by “smoothing” the increase over time to a meaningful contribution rate. Regardless of the form of automatic enrollment chosen, automatic enrollment, through the power of inertia, can significantly increase participant retirement savings.

Vesting Revisited

Over the past several years, plan sponsors have generally shortened their plans’ vesting periods. The law permits plans to either provide for a graduated vesting schedule for employer contributions of not more than six years or no vesting for three years, with all employer contributions being vested at the end of the three-year period. One reason plans have trended toward shorter vesting schedules is to offer benefits consistent with competitors and attract talented employees. Another reason is that many plans are “safe-harbor” plans. A safe-harbor plan avoids non-discrimination testing and the potential limitation of the amount that highly compensated employees and owners can contribute provided that the plan meets the safe-harbor employer contribution requirements. Safe-harbor employer contributions must be fully vested.

The trade-off for shorter vesting schedules, or no vesting schedule, is that employers lose the benefit of forfeitures. When a participant who is not fully vested terminates employment, his or her non-vested account balance is credited to a forfeiture account. Forfeiture amounts are generally allocated to the remaining active participants or used to pay plan expenses that would otherwise be paid by the employer or charged directly to participant accounts. Forfeitures are also commonly used to offset the employer’s contribution to the plan. There are limitations on the extent to which an employer can lengthen the vesting schedule with respect to current participants. However, there is no prohibition on changing the vesting schedule for new participants.

How About Safe-Harbor?

Since the last prototype restatement cycle, there have been several significant trends with respect to plan contributions. One major trend is the continued proliferation of safe-harbor 401(k) plans. Safe-harbor 401(k) plans offer employers a free pass on the non-discrimination requirements. In translation, this simply means that business owners and highly-compensated employees can contribute up to the maximum contribution dollar limit ($18,000 for 2015 and $24,000 for participants age 50 or older under a plan’s “catch-up” provision) without the threat of having the amount of contribution limited to a lesser amount or returned to them. The trade-off is that eligible non-highly compensated employees must receive either a fully vested employer contribution of three percent of their compensation or a fully vested matching contribution not less than 100% of the first three percent they contribute plus 50% of the next two percent they contribute. Safe-harbor plans are very popular and any employer that has problems with the non-discrimination tests should very seriously consider a safe-harbor 401(k) design.

Roth Continues to Expand

Roth contributions can be very appealing due to the fact that although employee contributions are made on an after-tax basis, such amounts and the earnings attributable to Roth contributions are not taxed upon distribution. In order for a distribution to be a “qualified Roth distribution,” certain requirements must be met including the requirement that the participant maintain a Roth account for a minimum of five years.

Employers may also include an in-plan Roth rollover or conversion provision. Under such a provision, a participant may elect to convert pre-tax accounts, whether or not currently distributable, to Roth accounts. Of course, the participant is required to recognize income on the converted amount. However, future earnings on the converted amount will be distributed tax-free provided the Roth requirements are met. Through IRS guidance, the conversion rules were expanded to allow the conversion of amounts attributable to pretax contributions to be converted to Roth amounts regardless of whether the participant is eligible to receive a distribution of such amounts.

Plan Governance and Fiduciary Practices

The restatement process is also a good time to review your plan’s governance and fiduciary practices. The Department of Labor (the “DOL”) has significantly increased its plan audit activity in recent years. As part of its review process, the DOL is examining fiduciary committees and asking for copies of committee bylaws and/or charters, meeting minutes, information relating to monitoring plan vendors and evidence of fiduciary training to name a few. The DOL will examine whether plan fiduciaries understand and have reviewed the fees paid by the plan. It is highly recommended that plans of all sizes have a committee in place that meets regularly and conducts itself in a manner that satisfies the high expectations of the DOL.

Reconsider and Confirm or Revise

Plan sponsors have grown accustomed to periodic plan updates and restatement cycles. But too often the restatement process is a rubber-stamp ceremony, with little discussion surrounding the existing plan provisions. During this restatement cycle, plan sponsors should take the time and give thought to their plan’s terms and provisions and discuss optional provisions with their advisors. This is also a good time to review your plan’s governance and fiduciary practices. The restatement process can serve as an opportunity for plan sponsors to reconsider existing plan provisions and operation and implement new features that align with their goals and needs and the goals and needs of their employees.

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When Bad Things Happen To Good Plans: IRS Enhances Plan Correction Methods

Corrective Action

The Employee Plans Compliance Resolution System (“EPCRS”) is a program offered by the IRS that allows plan sponsors to correct retirement plan compliance violations on a voluntary basis. Plan sponsors whose plans experience operational errors or mistakes can avail themselves of EPCRS and pay a penalty that is a fraction of the penalty that would otherwise be assessed if the defect is discovered under an IRS audit. In some cases, if the defect qualifies for self-correction without IRS approval, the sanction or penalty can be entirely avoided.

EPCRS continues to improve as a very beneficial tool for plan sponsors who desire to maintain legal compliance in a complex regulatory environment. Most recently, the IRS published two new Revenue Procedures, which serve to further entice plan sponsors to utilize EPCRS by expanding the program and lowering the cost of certain corrections. The opportunity to correct certain defects in accordance with the Revenue Procedures is available immediately. This article provides a brief summary of the more pertinent enhancements to EPCRS offered by the Revenue Procedures.

Employee Elective Deferral (401(k)) Contributions

A common plan error is the failure on the part of the plan sponsor to accurately honor the salary deferral election of eligible employees in a 401(k) plan. Before the issuance of the Revenue Procedures, the permitted corrective measure under EPCRS was for the plan sponsor to contribute 50% of the amount that should have been contributed and the full matching contribution that would have been contributed if the participant’s election had been followed. These corrective contributions were adjusted for earnings.

The justification by the IRS for requiring the 50% contribution in lieu of the elective deferral is that even though the participant received the cash amount that should have been deferred, the participant was deprived of the tax deferred savings opportunity. Recognizing that the 50% could be considered a “wind-fall” for the participant, the Revenue Procedures provide that if the correct deferral amount begins not later than the first payroll after a three month period after the failure first occurred, only the corrective matching contribution is required. If the correction is made after three months, the corrective percentage for missed deferrals is 25% rather than 50%. In order to be eligible for the lower 25% correction percentage, the following conditions apply:

  • The participant election must be followed not later than the first payroll after the second year following the year the failure occurred or, if the plan sponsor is notified by the employee, the first payroll made after the month of the notification;
  • The corrective contribution must be made before the last day of the second plan year after the year of the failure and, in no case, after the plan or plan sponsor is under examination by the IRS; and
  • Corrective contributions for missed matching contributions are made in accordance with existing EPCRS rules and all corrective contributions are adjusted for earnings.

Regardless of whether the correction is made within the first 3 months or the second year following the initial failure, notice of the failure must be provided to the employee no later than 45 days after the date the correct deferrals begin.

Automatic Enrollment/Contributions

Recognizing that automatic enrollment errors are common, the Revenue Procedures provide significant relief with respect to the available correction method for failure by a plan sponsor to implement a plan’s automatic contribution feature. The Revenue Procedures provide that where the failure to implement a plan’s automatic contribution feature does not extend beyond 9½ months after the end of the plan year during which the failure occurs, no corrective contribution is required to be made by the plan sponsor if:

  • The correct deferrals begin no later than the end of the 9½ month period after the end of the plan year in which the failure first occurred or the first payroll date after the end of the month the plan sponsor is notified of the failure by the affected employee;
  • Notice of the failure is provided to the affected employee no later than 45 days after the date the correct deferral amount begins; and
  • Corrective contributions for missed matching contributions are made in accordance with the existing EPCRS rules and all corrective contributions are adjusted for earnings.

Other Revisions

The Revenue Procedures include several other revisions to the correction methods including an extended period to correct excess annual additions, reduced sanctions for required minimum distribution and participant loan violations under certain conditions, clarification regarding the plan sponsor’s duty to collect excess distributions, a new permitted method for calculating lost earnings in some situations and a variety of procedural changes.


The revisions to EPCRS by the recently released Revenue Procedures provide an impetus to plan sponsors to utilize the IRS voluntary correction program and to make the corrections sooner rather than later. By catching errors within the stated timeframes, plan sponsors can significantly reduce the cost of correction. The regulatory environment surrounding retirement plans is vast and complex; however, when errors occur, prompt correction can serve to significantly reduce and eliminate further costs and financial exposure. If you have questions regarding the IRS plan correction program, please feel free to contact one of our employee benefits lawyers or your McGrath North attorney.

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