The Comparison of 457(b) Plans, 401(k) Plans, 403(b) Plans, and Deemed IRAs chart has now been updated to reflect recent developments, including:
The attractiveness of a 457(b) plan as compared with a 403(b) plan or a 401(k) plan may vary greatly depending on the circumstances. Read more
The 2019 supplement to the Fourth Edition of the Governmental Plans Answer Book has now been published.
The 2019 Supplement to Governmental Plans Answer Book gives subscribers the most relevant, current, and practice-oriented answers to the issues faced daily by plan administrators, attorneys, actuaries, consultants, accountants, and other pension professionals as they navigate the requirements and procedures involved in administering their plans. The 2019 Supplement to Governmental Plans Answer Book examines the following significant changes and case law in this area and includes:
For more information on this book, written by Carol V. Calhoun, Cynthia L. Moore, and Keith Brainard, you can use the following links:
With the IRS cutting back on determination letters for individually designed plans, more and more employers are switching to pre-approved plans. An article recently published in the Lexis Practice Advisor discusses practical considerations involved with such plans. Topics include:
Go to: Pre-approved Plan Designs and Favored Regulatory Status | General Advantages and Disadvantages of Pre-approved Plans | Types and Requirements of Pre-Approved Plans | Limitations on Plans That May Be Pre-approved | Pre-approved Plan Providers | Implementing Pre-Approved Plans | Obtaining IRS Opinion Letters
This practice note describes the requirements for implementing pre-approved plans and advantages, disadvantages, and best practices concerning the implementation and legal review of pre-approved plans. A pre-approved plan document can be used for most types of plans qualified under section 401(a) of the Internal Revenue I.R.C. (I.R.C.) (qualified plans). Tax-sheltered annuities or custodial accounts described in I.R.C. § 403(b) (403(b) plans) can also take the form of pre-approved plans, but the procedures are rather different and are described in a different practice note. See Pre-approved 403(b) Plans.
This practice note discusses the following topics:
For information on the extent to which pre-approved plan documents may be used for various types of retirement plans, see Pre-approved Plan Eligibility Checklist.
Pre-approved plans are retirement plans that an entity (Provider) creates for adoption by a number of unrelated employers. In contrast, individually designed plans are retirement plans that an employer sponsor or a law firm creates usually for exclusive use by the employer sponsor (and members of its controlled group).
Pre-approved plans fall into one of two categories: standardized and non-standardized plans. In both cases, the plan’s Provider submits the plan document to the Internal Revenue Service (IRS) to review and opine on whether the written form of the plan satisfies the legal requirements for qualified status. After the IRS pre-approves the plan, the Provider offers the plan to employers to adopt.
Regulatory agencies favor pre-approved plans because they:
The favored status of pre-approved plans has increased over time. Most recently, the IRS generally restricted the ability of individually designed plans to obtain favorable determination letters except upon the plan’s establishment or termination. I.R.S. Announcement 2015-19, 2015-2 C.B. 157; I.R.S. Rev. Proc. 2016-37, 2016-2 C.B. 136. By eliminating an individually designed plan’s ability to receive interim approval of the plan’s form, federal regulators have tacitly endorsed pre-approved plans as the model for future plan implementations. See, also, I.R.S. Notice 2016-03, 2016-1 C.B. 278; I.R.S. Rev. Proc. 2016-37, 2016-2 C.B. 136, Section 18 (extending the deadline for adoption of pre-approved plans in certain instances in recognition of the abolition of the remedial amendment program for individually designed plans).
Use of a pre-approved plan has advantages both for the adopting employer and for the plan Provider over adoption of an individually designed plan. However, you should weigh these advantages against the disadvantages and limitations applicable to the various pre-approved plan types. Advantages, disadvantages, and certain other concerns from the perspective of the employer are discussed in the sections that follow. Also discussed are the advantages for the plan Provider.
For employers, the major advantages of a pre-approved plan are simplicity, cost, and assurances of IRS approval. An employer can adopt a pre-approved plan merely by selecting among available options (any of which will satisfy IRS requirements), having the documents approved by the board of directors or other person(s) having authority, and signing. Thus, the employer saves the cost of having a plan drafted and obtaining an IRS determination letter on its qualification.
As mentioned above, because pre-approved plans are submitted for IRS approval prior to their adoption by an employer, they are to a certain extent set in form. Nevertheless, they still allow adopting employers to make certain customization decisions. For example, the employer will decide whether to allow plan loans or provide for matching contributions, and how long a vesting schedule to provide. After the adopting employer makes these elections electronically, software systems generate the documents required for the plan.
The sponsor of a new individually designed plan must apply for a determination letter in which the IRS opines on the plan’s qualified status (in form). In addition, under the revised determination letter program, such sponsor can no longer get IRS assurances on the plan between inception and termination. However, a pre-approved plan Provider gets an IRS opinion letter on the pre-approved plan, and the adopting employer can generally rely on this letter. Moreover, the Provider can get a new letter on the pre-approved plan every six years, to reflect changes in the plan and changes in applicable statutes, regulations, and other guidance.
A pre-approved plan is often part of “one-stop shopping” for the employer. The plan Provider or an affiliate may also be providing investment choices under the plan, third party administrative services, etc. This saves the employer from having to find different vendors for each of the functions under the plan. Particularly for a small employer, the simplicity of a pre-approved plan is often what enables the employer to adopt a plan at all without undue expense and use of employer personnel.
The major disadvantage of a pre-approved plan is that it limits the employer’s flexibility for design options. Following are examples as to why an employer might generally prefer to sponsor its own (individually designed) plan over a pre-approved plan:
The difficulties discussed above are most often a concern to larger employers who may want to adopt more complex plans or to handle investments in-house, and who have greater costs associated with their large numbers of plan participants. However, a smaller employer that wants to maximize benefits for the owners may also prefer an individually designed plan.
Two major cost-related considerations for employers are (1) whether the employer intends to purchase bundled and/or additional services (one-stop shopping) and (2) the extent to which legal review of a pre-approved plan may be necessary.
First, to the extent an employer chooses a pre-approved plan for the purpose of one-stop shopping, the plan may be less effective than anticipated. Employers must consider the following:
Even without legal review, an adopting employer has assurances that a pre-approved plan meets qualification requirements. However, this does not eliminate the need for legal review. Some issues that may come to light in connection with a legal review (apart from documentary qualification issues) include:
For Providers of pre-approved plans, the use of pre-approved plans is primarily a marketing decision. An investment company, payroll provider, insurance company, or third-party administrator may sponsor a pre-approved plan so that it can sell its services by providing the employer with a quick and inexpensive way to get the plan set up. If the sponsor had to provide an individually designed plan for each employer, the up-front cost would make the transaction less profitable to the sponsor.
Law firms may provide pre-approved plans for use by their clients as a plan that has received legal review, but is less costly than an individually designed plan and can receive IRS assurances on its status.
In some respects, the rules for standardized and non-standardized plans are similar. Both are plans that are designed by a Provider for use by adopting employers (per adoption agreements). Both types of plans must include a procedure for Providers to amend a plan on behalf of an adopting employer. Rev. Proc. 2017-41, 2017–29 I.R.B. 92, Section 5.03. In addition, pre-approved plans are subject to the following requirements:
In some pre-approved plans, each employer that adopts the plan uses a single funding medium (for example, a trust or custodial account document) as all other employers who adopt the same plan. In others, each employer who adopts the plan has a separate funding medium.
There are two subsets of pre-approved plans: standardized and non-standardized. I.R.S. Rev. Proc. 2017-41. The difference between them is the method by which they comply with the rules preventing discrimination in favor of highly compensated employees.
A standardized pre-approved plan is designed so that it is impossible by its terms for it to violate any of the tests of I.R.C. § 401(a)(4) and (5) (relating to discrimination in benefits), and I.R.C. § 410(b) (relating to discrimination in plan coverage). Together, these rules constitute the I.R.C.’s non-discrimination rules. (An employer must still ensure that 401(k) contributions meet the actual deferral percentage (ADP) test of I.R.C. § 401(k)(3) and that employer matching contributions and employee after-tax contributions meet the actual contribution percentage (ACP) test of I.R.C. § 401(m).) A non-standardized plan requires the employer to monitor the plan to ensure that, as applied to its employees, the plan satisfies the I.R.C.’s non-discrimination rules.
A pre-approved plan can consist of a single plan document, or a basic plan document plus an adoption agreement. A pre-approved plan must also have a trust or custodial agreement, separate from the plan document(s). However, the IRS will no longer rule on whether a trust agreement for a pre-approved plan is tax-exempt under I.R.C. § 501(a).
In the case of a pre-approved plan that consists of a basic plan document plus an adoption agreement, the basic plan document provides all provisions that could possibly apply to the plan, while the adoption agreement permits the employer to select among such provisions. For example, the basic plan document for a profit-sharing plan might provide for 401(k) contributions, matching contributions, and/or contributions that are the same percentage of compensation for all employees. The adoption agreement could allow an employer to choose to have the plan provide for only contributions that are the same percentage of compensation for all employees, only 401(k) contributions, only 401(k) and matching contributions, or all three types of contributions.
A single plan document can be structured so as to have alternative versions of certain provisions, so that a particular employer’s plan can omit provisions inapplicable to that employer.
An adopting employer cannot vary the provisions of a pre-approved plan at all, beyond the options provided in the single plan document or the adoption agreement, except:
Rev. Proc. 2017-41, Section 8.03.
To ensure that it meets the I.R.C.’s non-discrimination rules for any employer that adopts it, a standardized plan is limited in the options it can provide. For a qualified plan:
I.R.S. Rev. Proc. 2017–41, Section 5.16.
A non-standardized plan does not contain the above provisions that ensure that the plan will meet the I.R.C.’s non-discrimination rules, except that such plan:
Rev. Proc. 2017-41, Section 5.15. If a non-standardized plan permits non-safe-harbor hardship distributions, such distributions must be subject to nondiscriminatory and objective criteria contained in the plan. Rev. Proc. 2017-41, Section 6.03(14).
Thus, except in the case of a governmental or nonelecting church plan, inappropriate selections regarding coverage or benefits can cause a non-standardized plan to lose the protection of IRS pre-approval. However, pre-approval still provides assurances that the plan will meet IRS requirements other than the Non-discrimination Rules.
Not all types of plans eligible for qualified status can be pre-approved. The IRS sets forth certain types which are allowed, and excludes plans with certain features, as described below. I.R.S. Rev. Proc. 2017-41.
Pre-approved plans can include plans qualified under Internal Revenue I.R.C. (I.R.C.) § 401(a) or 403(a) (qualified plans), including plans that permit employee pretax salary deferral contributions (also known as (401(k) contributions or elective deferrals).
Most pre-approved qualified plans are profit-sharing plans. To the extent that they provide 401(k) contributions, they are known as 401(k) plans. However, most other types of qualified plans can also be pre-approved. Qualified plans eligible for the pre-approved form include:
Certain types of qualified plans cannot be pre-approved plans:
Rev. Proc. 2017-41, Section 6.03.
Pre-approved plans can include governmental plans and church plans that have not elected to be covered by ERISA (non-electing church plans). However, because such plans are exempt from ERISA and from many of the I.R.C. qualification requirements, but are subject to special requirements under state law, the plan documents used for governmental plans and nonelecting church plans must be separate from each other, and also separate from the documents used for ERISA-covered plans. Rev. Proc. 2017-41, Section 9.06.
The IRS provides different procedural requirements to apply for an opinion letter, depending on whether the plan is or is not a “mass submitter” plan as described below. Mass submitters usually have reduced procedural requirements and get expedited treatment from the IRS, because of the high volume of Providers they represent, and the number of identical or near-identical plans they submit to the IRS. This makes it easier and more efficient for review purposes. “Substantially identical” plans may receive expedited review, even if they are not mass submitter plans.
Provider. A Provider of a pre-approved plan must be a U.S. business that has at least 15 employer-clients that it reasonably expects to adopt the sponsor’s lead basic plan document. A sponsor that meets the 15 employer-clients requirement can request opinion letters for a number of additional basic plan documents and adoption agreements provided it has at least 30 employer-clients in the aggregate, each of which is reasonably expected to adopt at least one of the Provider’s basic plan documents. Although there is no specific deadline for having the 15 or 30 employer-clients adopt the plan, the IRS reserves the right at any time to request from the Provider a list of the employers that have adopted or are expected to adopt the Provider’s pre-approved plans, including the employers’ business addresses and employer identification numbers.
Providers must make reasonable and diligent efforts to ensure that adopting employers of the Provider’s plan have actually received and are aware of all plan amendments.
Mass submitter. A “mass submitter” is a U.S. business that submits opinion letter applications on behalf of at least 30 unaffiliated Providers that have “word-for-word identical” basic plan documents to the mass submitter’s lead plan. In addition, if the mass submitter has additional plans, it can submit applications regardless of the number of Providers for the mass submitter’s other plan(s).
Mass submitters who have met the “30 Provider” requirement can submit additional applications for Providers with identical plans and Providers that have “minor modifications” to the mass submitter’s plan. The IRS will review submissions with respect to minor modifications on an expedited basis and opinion letters will be issued to the Provider as soon as possible.
Mass submitters usually have reduced procedural requirements and get expedited treatment from the IRS, because of the high volume of Providers they represent, and the number of identical or near-identical plans they submit to the IRS. This makes it easier and more efficient for review purposes.
All of these terms have specific meanings. For example, the term “word-for-word identical plan” includes a “flexible” plan. This feature permits the prototype’s Provider to remove certain sections of a mass submitter’s plan because they do not apply or because the financial institution offering the plan does not offer the provision. If the prototype’s Provider does not offer loans, for example, then the section in the plan and the adoption agreement that refers to loans is removed and generally replaced with “reserved.” Plans can have as many as six administrative flexible provisions and six investment flexible provisions.
A “minor modification” is a minor change to an otherwise word-for-word identical plan of the mass submitter that does not require an in-depth technical review. For example, a change from five-year 100% vesting to three-year 100% vesting is a minor modification. On the other hand, a change in the method of accrual of benefits in a defined benefit plan would not be considered a minor modification. A minor modification must be submitted by the mass submitter on behalf of the Provider that will adopt the modified plan.
At minimum, implementing a pre-approved plan requires multiple documents. For a plan taking the form of a basic plan document plus an adoption agreement, it requires a:
Alternatively, the plan can take the form of a single plan document plus a trust or custodial account document.
For either type of plan, the following additional documents are also required:
The plan Provider will also need to provide each adopting employer with a copy of the opinion letter applicable to the pre-approved plan.
Additional requirements for these documents are provided below.
A Provider’s document system will generate the basic plan document or specimen plan, and a copy of the opinion letter by which the IRS approved the written form of the plan. (See below regarding IRS approval.) Neither document allows for customization, but both are essential to the plan.
A basic plan document reflects the regulatory requirements for all plans that are covered by the pre-approved plan document, even if all the features discussed in the basic plan document are not elected in the adoption agreement. For example, a basic plan document may incorporate both profit sharing and 401(k) plan statutory requirements, even a specific employer elects in the adoption agreement to provide only profit sharing features but not 401(k) features. Essentially, the basic plan document reflects all the regulatory basis for every possible election in the adoption agreement.
Alternatively, a plan can elect to use a single plan document that incorporates only those features that a specific adopting employer elects. In the case of a plan with this form, all references to the adoption agreement below should be read as referring to the single plan document.
All document systems require certain information about the employer adopting the plan, the plan itself, and the document being generated. General information includes:
After drafting the adoption agreement or the single plan document, the system user must register the document in the Provider’s system. Registration enables the Provider to notify adopting employers when plan revisions are required by law, or simply to adopt such revisions itself. Without such automated “upkeep” of implemented plans, the plan’s pre-approval can essentially expire for failure to have updated the plan as laws, regulations, or other guidance changes.
Often, companies that provide plan document systems also offer plan administration and plan reporting systems. Such systems work together, culling data from one system for use in the others. For example, the information provided to the document system about the adopting employer will be reflected in the plan’s annual tax return. Such shared information includes:
Since the same information has multiple applications, there is inherent risk that erroneous information may compromise related plan service systems. In practice, such risks may be minimized before the plan goes into operation—via diligent review by Providers, plan administrators, and adopting employers.
Every plan must define when an employee will become eligible to participate. The selection of eligibility and service provisions, including eligibility exclusions, is often a function of the demographics of the employer’s workforce (provided the selected eligibility and service requirements adhere to I.R.C. requirements, and ERISA requirements in the case of an ERISA plan, and are applied consistently). For additional information on coverage and minimum participation requirements see ERISA § 202 (29 U.S.C. § 1052); I.R.C. § 410; 26 C.F.R. § 1.401(a)(26)-6(b). Governmental and church plans are exempt from statutory eligibility and participation rules, but plan documents for them must still specify what eligibility and participation rules will apply.
An employer may exclude from the definition of “eligible employee” any employee who:
I.R.C. §§ 401(a)(26)(B) and 410(b); 26 C.F.R. §§ 1.401(a)(26)-6(b) and 1.410(b)-6.
However, the employer may elect in the adoption agreement to include nonresident aliens and collectively bargained employees described above, provided the inclusion is consistently applied. 26 C.F.R. §§ 1.401(a)(26)-6(a) and 1.410(b)-6(b)(3).
In a non-standardized plan, an employer may choose to exclude certain classifications of employees based upon the plan’s design. Such “design-based” exclusions include:
Some large employers sponsor different plans for different employment classifications, i.e., hourly, salaried, commissioned salespeople, collectively bargained employees and partners/owners. Employees may also be excluded on the basis of being employed by a separate line of business (as defined in I.R.C. § 414(r)) for the purpose of nondiscrimination testing under I.R.C. § 410(b)(6)(C).
Employers often permit their entire full-time workforce to participate after satisfying the plan’s age and/or service requirements – but may wish to exclude part-time employees. Part-time employees cannot be excluded based solely on their part-time status: if they satisfy the plan’s service requirements they must be permitted to enter the plan. I.R.C. § 410(a). Conversely, the adoption agreement may allow exclusions based on other criteria that may also apply to part-time employees (such as ineligibility for employer-paid health and welfare benefits).
ERISA covered plans reference YOS to determine much about an employee’s rights in a plan. YOS serves many purposes, including as:
In a non-ERISA plan, service can be based on years of employment, years of participation, or other creditable years of service as defined in the plan document.
To apply service requirements consistently, the plan must also define the terms used to calculate plan service, including:
Each type of contribution permitted in a plan can be subject to uniform or varied eligibility requirements. Examples of varied eligibility requirements include:
After satisfying the plan’s eligibility requirements, the eligible employee becomes a plan participant on the plan’s “entry date.” Like eligibility requirements, entry date can vary for different types of contributions. Entry dates may be:
For more information about participation requirements generally, see I.R.C. §§ 401(a)(26), 410(a) and 410(b); for 401(k) plans see I.R.C. § 401(k)(2).
ERISA and I.R.C. compliance is often date-driven. Dates that are crucial to plan administration (but of little interest to employers and participants) include:
Because these dates impact plan administration, the employee benefits practitioner is advised to consult with the plan administrator, the third-party plan administrator (if any) and/or the plan’s actuary to determine an appropriate dates and periods.
The dates of greatest interest to employers and participants involve retirement. Except in the case of a governmental plan, “normal retirement age” (NRA) although not a calendar date, must be elected in the plan. A pre-approved can, for example, provide NRA options of:
Whatever NRA is selected must be applied consistently. Additional information about retirement ages can be found at 26 C.F.R. § 1.401(a)-1(b); ERISA § 3(24) (29 U.S.C. § 1002(24)); I.R.S. Notice 2012-29, 2012-1 C.B. 872.
The normal retirement date (NRD) is the date on which a participant who has terminated employment can begin taking unreduced retirement distributions. In some instances, the plan will also permit in-service distributions beginning on NRD, or permit a participant to delay distributions beyond NRD until they are mandated (soon after the later of termination of employment or turning age 70½). Except in the case of a governmental plan, the adoption agreement must designate the NRD because rights and obligations toll from that date. The employer designates the plan’s NRD by reference to the NRA:
A plan may, but is not required, to permit an “early retirement age” (ERA) – and corresponding “early retirement date (ERD),” at which an employee who has terminated employment can receive actuarially reduced benefits. If selected by the employer, ERA can be:
For large employers, ERA/ERD may be used to promote succession, or to provide early retirement windows when a company finds itself top-heavy with senior employees. Early retirement benefits are relatively rare among small employers, and if permitted, are typically in plans that cover few employees other than the business owner and his immediate family.
Some plans elect to provide retirement benefits in the event the participant becomes disabled before attaining retirement age. If so, the adoption agreement must define “disability” that permits payment of benefits before ERA or NRA is attained. Disability retirement options include:
Compensation is among the most complex topics under ERISA and the I.R.C. Like service provisions, compensation is a concept used for several plan purposes, including:
In a non-standardized plan, compensation can also be variously defined. Nevertheless, a non-standardized plan must give the adopting employer the option to select total compensation as the compensation to be used in determining allocations or benefits. The differences between types of compensation are subtle when read, but significant in application. The adoption agreement should designate a compensation definition that is appropriate to how compensation is paid to plan participants. Optional compensation definitions include:
The compensation definition can be further modified by applying certain exclusions from compensation. Generally, employee deferrals to other plans sponsored by the employer can be excluded from the definition of compensation. Possible exclusions include deferrals to:
In a non-standardized plan an employer can also choose to exclude types of pay from the plan’s definitions of compensation, including overtime, commissions, discretionary bonuses, bonuses, taxable employee benefits, compensation in excess of a specified dollar amount, and a designated exclusion that does not discriminate in favor of HCEs. Other possible inclusions/exclusions can be selected for salary paid in the first few weeks of the next limitation year; for salary continuation during military leave or for disabled participants; or for post-severance compensation.
The adoption agreement must also designate the “computation period” for compensation, for each purpose to which the compensation definitions apply. Computation periods can be an entire plan year; the plan’s limitation year; the calendar year ending with or within the plan year; a pay period, monthly, bi-monthly, quarterly, semi-annually, bi-weekly, or weekly; or a 12-month period ending on a designated date.
As with any administrative provisions, the employee benefits practitioner should consult the plan administrator before selecting compensation definitions.
For a further discussion on permissible definitions of plan compensation, see Compensation Definition Rules for Qualified Retirement Plans.
For a defined contribution plan, the adoption agreement must specify the type of contributions allowed. For example, in a 401(k) plan, there might be any or all of elective deferrals, matching contributions, and profit-sharing, Roth contributions, employee after-tax contributions, deemed IRA contributions. The employer’s contribution may be required at a specified rate under the terms of the plan, or may be determined by the employer each year. Safe harbor contributions may be provided in order to ensure than a 401(k) plan satisfies the ADP and ACP tests. Elective deferrals may be limited to the statutory limitations that apply to elective deferrals under I.R.C. §§ 402(g), 415, 401(k)(3) and 416, or the plan may permit catch-up contributions to the extent permitted by law. (401(k) plans permit catch-ups under I.R.C. § 414(v)). The plan must set forth special contribution rules in case the plan becomes top-heavy.
A defined contribution plan must also specify how contributions are allocated. For example, are profit-sharing contributions allocated strictly in proportion to compensation, or are they coordinated with Social Security under the I.R.C. § 401(l) permitted disparity rules? Are matching contributions allocated in proportion to all employee contributions, or do they match just elective deferrals? Are there maximum limits on the contributions that will be matched?
A defined benefit plan (including a cash balance plan) must specify the benefit formula to be applied. For example, a defined benefit plan might provide that the benefit is X% of final average compensation times years of service. The rate of contributions would then not be specified under the plan, but determined based on actuarial computations of what contributions were necessary to fund the benefits.
“Vesting” refers to the extent to which portions of employer-funded contributions become nonforfeitable over time. Most often, a designated percentage becomes vested in each year of the stated vesting period. The unvested portion of employer contributions can be forfeited, i.e., removed from the participant’s account balance, if the participant terminates employment before satisfying the vesting schedule (although certain service reinstatement rules can prevent forfeiture). In contrast, employee-funded contributions are always fully vested and can never be forfeited by the participant.
If the plan provides employer contributions, the adoption agreement must specify their vesting periods. A plan can designate a single vesting schedule for all employer-funded contributions, or individual vesting schedules for each type of employer contribution. ERISA and the I.R.C. limit the time over which employer contributions can vest. For an ERISA plan, the longest permissible graded vesting period is six years. Cliff vesting cannot require more than three vesting YOS. For additional information on minimum vesting requirements, see I.R.C. § 411(a)(2); 26 C.F.R. § 1.411(a)(1); 26 C.F.R. §§ 1.411(a)-3T.
Permissible vesting schedules in an ERISA plan include:
Top-heavy contributions to an ERISA plan are subject to special vesting requirements. Foremost, the vesting schedule for top-heavy contributions must be at least as favorable as the vesting schedule for other employer contributions. In practice, plans that provide a vesting schedule for non-safe harbor employer contributions often designate the same vesting schedule for top-heavy contributions.
Certain contributions are also subject to statutory vesting schedules. For example:
For a governmental plan, the IRS provides a safer harbor for vesting at least as favorable as the following schedule:
The plan’s selected vesting schedule notwithstanding, the employer can choose whether to “accelerate” vesting upon a participant’s attainment of early retirement age, death, or disability. The employer can also choose to count a participant’s time of disability toward their vesting service (as though s/he was still employed). Like all adoption agreement provisions, however, the administrator must apply vesting acceleration on an equal and nondiscriminatory basis.
After a corporate merger, acquisition or spin-off, an employer may require a new plan or amendment of its existing plan, to provide plan coverage to employees of the entity that was the subject of the corporate transaction. For example, an employer that acquires another business can cover the acquired employees in the employer’s existing plan, or may sponsor a new plan for the acquired company. If the acquired company has a pre-existing plan, the employer may become the sponsor of the acquired plan, may sponsor a new plan for the affected employees, or may merge the prior plan into an existing plan.
ERISA’s provisions relating to mergers and acquisitions exceed the scope of this note. But in relevant part, affected employees may not lose the benefits allocated to them under a prior employer’s plan: each affected participant is entitled to receive a benefit after a corporate transaction that is at least equal to the benefit the participant would have received before the transaction. I.R.C. §§ 401(a)(12) and 414(l); 26 C.F.R. §§ 1.401(a)-12, 1.414(l)-1. For additional information on ERISA’s requirements regarding retirement plans involved in mergers & acquisitions, see Retirement Plan Issues in Corporate Transactions.
When implementing (or amending) a pre-approved plan that will cover acquired employees, the adoption agreement must indicate:
In summary, old money must vest at least as quickly as it would under the prior plan, but new money can vest at the existing plan’s schedule, whether slower or faster than the former plan’s vesting schedule.
Similarly, if two plans merge and assets are transferred from the acquired plan into a new or existing plan, the transferred assets must continue to vest at the same or faster rate as they would have under the former plan. The adoption agreement will require you to designate each account type that is the source of transferred assets, i.e., non-elective contribution account or matching contribution account, and the vesting schedule that applied to the transferred assets.
An account balance in an ERISA plan that becomes forfeitable is not immediately forfeited: the participant must attain a designated number of years of “breaks in service” before the balance is deducted from the participant’s employer contribution account. If the participant returns to service before the maximum break in service is completed, then the participant’s account balance attributed to unvested employer contributions can be reinstated. (But compare employer contributions that are fully and immediately vested, which can never be forfeited.)
In order to permit forfeitures, an adoption agreement must indicate the service rules that apply to forfeitures, including how breaks in service are counted (by incorporating HOS and YOS – both of which are defined in “Service Requirements and Entry Date” above under “Eligibility Requirements”). The most typical break in service and reemployment provisions are:
Some plans (more typically defined benefit plans) apply a “rule of parity” that allows a plan to disregard YOS completed before a break in service, if the number of consecutive one-year breaks equals or exceeds the greater of five, or the participant’s years of service before the break began. In contrast, although relatively rare, employers can choose to count all service toward vesting, including service completed after a break in service, regardless of the length of the break in service.
Governmental plans are not subject to statutory rules regarding forfeitures, but must nevertheless specify what forfeiture rules are being used.
Forfeitures are the result of a participant’s failure to complete the plan’s vesting schedule. For example, if a plan has three-year cliff vesting, employer contributions will vest when the participant completes three years of service, but if the participant terminates employment after two years, the account balances become forfeitable.
The adoption agreement must reflect the plan’s rules for how forfeitures will be deducted from participants’ accounts. A plan can permit forfeitures to occur at:
Consult the trustee (or trust custodian charged with valuing account balances) before electing these provisions. For additional information on forfeitures, see I.R.C. §§ 411(a)(6).
Forfeited assets cannot revert to the employer; therefore the adoption agreement must detail when and how forfeitures of employer contribution accounts will be applied in the plan. Once forfeited, unvested employer non-elective and matching contributions can be used by the employer to:
Plans must permit distribution of benefits (if requested by the participant or beneficiary) as the result of retirement, termination of employment or death. If elected in the adoption agreement, a plan may treat a participant’s full disability (as defined in the plan) as a distribution event.
In all cases, the adoption agreement must designate the forms of distribution permitted by the plan. Options include:
For additional information on permitted distribution types, see I.R.C. §§ 401(a)(15), 401(a)(11), 411(d)(6). More varied distribution types are permitted in governmental and nonelecting church plans, which are not subject to those I.R.C. sections.
If permitted by the employer’s election (and if later elected by the participant) a plan can provide joint and survivor annuities, which pay for the life of the participant, and at participant’s pre-death election, continue payments to a designated beneficiary a fixed proportion of the annuity contract value for a specified period.
Pre-approved plans may permit various annuity options, and those provided in support of annuity products often provide extensive ones. In a defined benefit plan, the normal form of benefits must be a qualified joint and survivor annuity for the participant and spouse if the participant is married, and otherwise a life annuity for the participant. A preretirement survivor annuity in favor of the spouse must also be provided if the participant dies before termination of employment. If a married participant wants to elect a different form of benefits, the election is possible only if the spouse consents.
Depending on the annuity options provided by the pre-approved plan’s provider, the adoption agreement may require decisions on:
For additional information on statutory annuity requirements, see I.R.C. §§ 401(a)(11), 417; 26 C.F.R. § 1.401(a)(20).
Plans are not required, but may in some circumstances permit, participants to access portions of their account balances while still employed by the adopting employer. For participants, the availability of in-service distributions is a double-edged sword: they calm employees’ fears that money saved for retirement will be inaccessible until retirement, but removing assets and losing investment income reduces retirement readiness. Notably, although a plan can permit premature distributions (taken before the plan’s earliest retirement date) a 10% penalty tax will be deducted from the premature distribution.
Once elected, the ability to remove in-service distributions is limited. The availability of in-service distributions are “protected benefits”: once provided, they must always be available for account balances that exist before the removal of the protected benefit. Although subsequent allocations are not subject to an eliminated protected benefit, the plan will incur additional administration costs to administer a protected benefit for portions of participants’ account balances. See I.R.C. § 411(d)(6) for additional information on protected benefits.
In-service distributions can be provided only if the adoption agreement provides for them. Distributions of employee deferrals under a 401(k) plan can be permitted only on or after a participant’s attaining an age specified by the employer that is no earlier than 59½, or upon hardship (see below).
The adoption agreement may also apply non-age requirements to access account balances that would be used for in-service distributions. Additional requirements can include:
In a defined benefit plan, in-service distributions can be permitted only upon attainment of the earlier of age 62 or normal retirement age under the plan. Various rules limit the normal retirement age that can be specified for this purpose.
The adoption agreement must also specify the accounts from which in-service distributions can be deducted. If elected, in-service distributions of 401(k) elective deferrals can be made from accounts holding:
For additional information on in-service distributions, see I.R.C. §§ 401(k)(2)(B)(i)(III), 401(k)(10).
For a 401(k) plan, another permissible in-service distribution is the hardship distribution. Hardships distributions must be granted on the basis of immediate and heavy financial need, which must be defined in the plan. The single plan document or adoption agreement must designate the accounts from which hardships can be paid. Like in-service distributions, the availability of hardships is a protected benefit. Hardship distributions are also subject to the 10% premature distribution penalty.
Most pre-approved plans define “hardship” as meeting the “safe harbor hardship” standards of 26 C.F.R. § 1.401(k)-1(d)(2)(iv). If a safe harbor hardship is elected in the single plan document or adoption agreement, the safe harbor’s “deemed hardship” criteria cannot be changed, and any distribution paid on this basis will be deemed necessary to satisfy the participant’s immediate and heavy financial need. Safe harbor distributions can be used to pay:
In addition, before obtaining a safe harbor hardship, a participant must have obtained all other distributions and plan loans that are available under the plan and must have ceased elective deferrals and voluntary employee contributions for six months.
Although atypical in a pre-approved plan, in lieu of the safe harbor standards, an employer can define its own non-safe harbor criteria for hardship distributions. However, a unique definition must be consistently applied, and the employer should expect the plan’s review, approval and recordkeeping processes to invite stricter scrutiny in a financial or agency audit of the plan. See I.R.C. § 401(k)(2)(B)(i)(IV) for additional information on hardship distributions.
Although not technically an in-service distribution, a defined contribution plan can permit plan loans that enable participants to access their account balances before terminating employment. Plan loans are paid from the participant’s accounts, and must be repaid with interest. Plan loans that have not been repaid are deducted from the participant’s accounts; there is no premature distribution penalty associated with plan loans. For a plan covered by ERISA, married participants must provide their spouse’s consent to obtain plan loans.
If plan loans are permitted, the adoption agreement must specify the number, frequency, minimum and maximum amounts permitted, applicable interest rate and default provisions relating to plan loans. For information on plan loans see I.R.C. § 72(p)(2).
Besides statutory and design options, the adoption agreement must specify how plan asset and trust or custodial account provisions will apply. These include:
Other documents required to generate a pre-approved plan may also require some additional information.
If plan assets are held in trust (as opposed to an annuity contract), either the basic plan document or a separate trust agreement must set forth the trust provisions. The trust agreement enumerates ERISA’s fiduciary requirements that apply to trustees’ management of plan assets. “Named trustees” are generally employees of the adopting employer, who exercise some discretion in the administration of the plan. Most typical in pre-approved plans, named trustees select the plan investments that a participant can apply to his individual accounts. Conversely, some pre-approved plans require trustees to make all investment decisions for the plan’s aggregated accounts. For additional information on trust requirements, see ERISA § 403 (29 U.S.C. § 1103).
In either case, the trust agreement must specify the names of the plan’s trustees, and since circumstances (such as retirement) cause trustees to change, the trust agreement will require periodic amendment.
In brief, the SPD describes the plan’s benefits and participant rights in “plain English” intended to be understood by the average plan participant, including eligibility, contributions, vesting/forfeiture, distributions, where to get additional information about the plan.
Choices elected in the adoption agreement will also be captured in the system-generated SPD. However, additional plan policies may need to be completed to enable the document system to generate a complete (and ERISA compliant, in the case of an ERISA plan) SPD. Additional policies that would impact the SPD include the plan’s:
Detailed information about ERISA’s requirements for SPDs is located at ERISA § 102 (29 U.S.C. § 1022); 29 C.F.R. § 2520.102-3. While non-ERISA plans are not subject to statutory or regulatory requirements for SPDs, they will nevertheless typically provide a plan summary to inform employees of the essential plan terms.
The corporate resolution is the instrument with which the employer adopts the plan and approves the plan documents. The information required for the resolution is usually captured from the employer’s general information that was entered into the adoption agreement.
However, some situations will require either unique or multiple resolutions. Besides allowing you to select certain routine resolutions (i.e., appointing and/or removing a plan trustee), the resolution module should allow you to draft unique resolutions that are not pre-programmed as a module option (such as allocating contributions to specified ineligible employees to correct cross-testing failures under 26 C.F.R. § 1.401(a)(4)-11(g)).
Many plan provisions that can be elected by the employer also require special disclosures to plan participants. For example, SHNE and SHM contributions, as well as automatic deferral contributions, each require the administrator to provide annual notice to participants. Certain events, such as plan mergers, cause a transfer of investments between investment platforms and a “blackout period” during which participants cannot access their accounts or change their investments. The plan administrator must provide detailed blackout notices to participants and beneficiaries well before the blackout begins.
Some document systems generate such participant notices but only after you provide relevant event-specific information. When the notice relates to plan features, the relevant information is captured from the adoption agreement. But when a notice relates to an event that isn’t a plan feature – such as a plan merger – additional information is required to generate a compliant notice.
The IRS issues opinion letters on pre-approved plans. The opinion letter explains the:
The IRS announces the date by which employers must adopt pre-approved plans for each six-year cycle.
For instructions on how to apply for an opinion letter, see Pre-Approved Plan Submission Procedures. For a detailed discussion on determination letter applications (including information on how to apply), see Determination Letter Application Procedures.
If a mass submitter files on behalf of a flexible plan, it must bracket and identify the optional provisions when submitting such plan, and must also provide the IRS a written representation describing the choices available to Providers and the coordination of optional provisions. Thus, such a representation must indicate whether a Provider’s plan may contain only one of a certain group of optional provisions, may contain only a specific combination of provisions, or may exclude the provisions entirely. Similarly, if the inclusion (or deletion) of a specific optional provision in a Provider’s plan will automatically result in the inclusion (or deletion) of any other optional provision, this must be set forth in the mass submitter’s representation.
Adopting employers that have made minor modifications to the terms of the pre-approved plan may request a determination letter using Form 5307. Examples of minor changes include: changing the effective date of a provision, adopting IRS model or sample amendments, the adoption of an interim or discretionary amendment in accordance with Revenue Procedure 2007-44, or the adoption of amendments to obtain reliance for §§ 415 and 416 given the required aggregation of plans. Adopting employers that have not made any changes to the terms of the pre-approved plan (except to select among options under the plan) should not submit Form 5307. These employers may rely on the opinion letter issued for the plan.
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The IRS maintains pre-approved plan programs (1) for retirement plans described in I.R.C. § 401(a) (qualified plans), and (2) for annuity contracts or custodial accounts described in I.R.C. § 403(b) (403(b) plans). A new chart shows what types of plans are and are not eligible to use the pre-approved plan program.
Use this checklist to determine which retirement plans can use pre-approved plan documents to satisfy the requirements for preferential tax treatment under the Internal Revenue Code (I.R.C.). The IRS maintains pre-approved plan programs (1) pursuant to Rev. Proc. 2017-41, 2017–29 I.R.B. 92, for retirement plans described in I.R.C. § 401(a) (qualified plans), and (2) pursuant to Rev. Proc. 2013–22, 2013–18 I.R.B. 985, as modified by Rev. Proc. 2014–28, 2014–16 I.R.B. 944, for annuity contracts or custodial accounts described in I.R.C. § 403(b) (403(b) plans). The programs available for pre-approved plans are different depending on the type of plan and the type of employer. Read more.
The IRS has now issued a series of forms to enable federal, state, and local governments to assess their compliance with federal tax statutes, and has set forth some common errors found in examining such employers. Several of the forms relate to employee benefits issues, and may be of assistance to governments trying to ensure that they comply with all legal requirements.
The forms are as follows:
For use by Federal, State and Local Government Entities
For use by State and Local Government Entities Only
