When the IRS announced that it would virtually eliminate the determination letter program for individually designed retirement plans, many practitioners moved through the classic Kübler-Ross five stages of grief (see the picture at the right). Some have yet to finish. In Announcement 2016-32, the IRS requested comments on how these plans can maintain compliance going forward since determination letters are no longer available.
As a general rule, the IRS used to deny plans the ability to incorporate tax code provisions by reference (rather than reciting them wholesale in the plan), except for a very short list available here. The IRS is asking if there are additional provisions that would also be appropriate to incorporate by reference. This would avoid the need to reproduce these provisions wholesale and run the risk of a minor foot fault if the language did not line up. It would also help avoid the need to update plans for law changes, in some cases.
Additionally, much to the anger of many practitioners, the IRS has historically sometimes required a plan to include provisions that were not applicable to the plan. For example, there are special diversification requirements for plans that hold publicly-traded employer stock, yet the IRS has required them even for private companies. One wonders if the IRS actually observed numerous situations where privately held corporations became public companies and then failed to amend those of their plans that held employer stock. What a scourge on the individually designed plan world this must have been! The IRS would like to know if there are other provisions that could possibly be avoided and the likelihood that the plan sponsor will actually amend the plan when the provision becomes applicable. While there may be a few of these provisions out there, there likely aren’t enough to make a significant difference in the length of individual designed plans or to stem the tide of faulty individually designed plans.
For those employers who still want the comfort of an IRS letter of some kind, they could bargain with a company that offers a pre-approved plan. However, there are challenges to switching to a pre-approved prototype or volume submitter plan, and the IRS wants to know about them. For example, employers with unique plan designs or multiple different benefit formulas may not be able to fit under a particular pre-approved form. Under the rules applicable to those plans, too much variation from the pre-approved form destroys the ability to rely on the letter and turns the plan into an individually designed plan (which can’t then get a determination letter).
What might depress practitioners most is that the above areas are the only ones the IRS came up with as possibilities. For example, it would make sense to let plans apply for a determination letter when there is a plan merger. The IRS has historically requested the documents of plans that were merged into a plan under determination letter review. Without allowing this, the IRS will end up not reviewing a plan until it is terminated. At that time, the Service may be asking for plans that were merged from 20 or more years ago. That level of recordkeeping would be prohibitive for some plan sponsors. Additionally, if the IRS found an error at that time, it could be extremely difficult to fix. Therefore, allowing a complete review of the plan when it is a party to a plan merger would be highly valuable. Additionally, since plans will be permitted to obtain a determination letter on initial adoption, a limited determination approval process might be available to review amendments to the already approved plan rather than the entire plan again.
The Service will accept comments in writing on or before December 15. Service employees responsible to draft the rules may also read this post, so feel free to leave your comments below.
As retirement plan professionals know, certain distributions from plans and IRAs to taxpayers can be rolled over to another plan or IRA within 60 days. Of course, sometimes 60 days is just not enough and the IRS recognizes that, having permitted a seemingly innumerable number of private letter rulings granting extensions. These often occur where a financial advisor gave bad advice or made some kind of mistake or where some tragedy worthy of a blues or country song (or worse) befell the taxpayer that made it impossible to complete the rollover in 60 days.
The IRS has had a small cottage industry the last decade or so of granting private letter rulings extending the 60-day period for these rollovers. But now, they’ve decided to let plans and IRAs just take the taxpayer’s word for it.
Under a new revenue procedure, taxpayers can now self-certify as to the reason that they need more time. Now, taxpayers can’t just certify for any reason. They have to have missed the 60-day period because of one or more of the following reasons:
- An error on the part of the financial institution receiving the rollover or making the distribution
- The distribution was made in the form of a check and the check was misplaced and never cashed (“I put the check where I knew I’d remember it. It was right next to my keys.”)
- The distribution was deposited into and remained in an account that the taxpayer mistakenly thought was a retirement plan or IRA (“but this email said that it was an eligible plan and the money would also help the deposed prince of Nigeria…”)
- The taxpayer’s primary residence was severely damaged (but not a vacation home, it seems)
- A member of the taxpayer’s family died
- The taxpayer or a member of his or her family was seriously ill
- The taxpayer was incarcerated
- Restrictions were imposed by a foreign country (does not include mandates from the deposed prince of Nigeria)
- A postal error occurred (“I told them to address it to Santa Claus at the North Pole…”)
- The distribution was made on account of a tax levy, but the proceeds of the levy were returned
- The financial institution making the distribution delayed providing information that the receiving plan or IRA needed to complete the rollover, despite the taxpayer’s reasonable efforts to obtain the information (e.g., phone calls, emails, bad reviews on Yelp maybe?)
There are other conditions too. The taxpayer has to make the contribution as soon as practicable once the identified impediment is no longer holding up the process. A contribution within 30 days after the issue is resolved is treated as meeting this requirement.
The good news for plans and IRA custodians is that they can rely on the certification unless they have actual knowledge that the excuse is not real. So they don’t have to have the same lie detector skills as parents or teachers.
Of course, the IRS also reserves the right to verify this on audit. We are left to wonder how some of these will be verified. For example, how does the IRS plan to prove that the taxpayer didn’t misplace a check? Nonetheless, if the IRS finds that the self-certification was inappropriate, taxpayers will be subject to additional taxes and penalties.
It’s worth noting that some “explanations” still don’t fly, even under this broad relief. Ignorance of the law is still no excuse (“I didn’t know I only had 60 days.”). Also, an inability to count to 60 properly is not going to be enough to get someone off the hook.
The IRS plans to modify the Form 5498 (which reports IRA contributions) to report any contributions received after the 60-day deadline, which will help let the IRS know whom to audit.
For employers, this ruling may result in some questions from their third party administrators. Most rollovers to qualified plans are likely made in direct trustee-to-trustee transfers, which are not a part of this ruling. Because of that, the questions are likely to be few, but there could be some. For example, if an employee comes forward with a self-certification that does not clearly fit into the list, but is close, the TPA may request that the plan administrator (which may be the employer or someone there) make a decision about whether the certification is sufficient. Practically, however, certifications outside this specific list should not be accepted.
The IRS has provided other resources on this issue as well which are available at the links below:
– IRS Webpage – Accepting Late Rollover Contributions
As we previously reported, the IRS had said last year that determination letter program for retirement plans would largely be going away. Rev. Proc. 2016-37 includes information with respect to the future of the determination letter program. As highlighted in a recent IRS webcast, a noteworthy development is that “subject to IRS resources” that post-initial determination letters may be available after 2017 in specified circumstances:
(1) significant law changes,
(2) new plan designs, and
(3) Plan types that can’t convert to a pre-approved format.
Number 3 means complex plans that do not fit on a pre-approved document may, ‘subject to IRS resources’ as published annually, be able to be submitted for a ruling under the determination letter program. Therefore, complex individually designed plans may still have hope that the IRS will continue to rule on their qualified status.
There were two other key points in the webcast. First, the IRS will publish a “required amendments” list and that employers will have until the end of the second calendar year after the date the list is published to amend their plans. Second, there will also be an operational compliance list issued annually that will be accessible on the IRS website, not published. The purpose of the operational list is to focus on the operation of the plan prior to the date of adoption of the amendment. These lists will include information that is prospective only and will not include information from prior annual lists.
The Department of Labor (DOL), along with several other federal agencies, recently released adjusted penalty amounts for various violations. The amounts had not been adjusted since 2003, so there was some catching up to do, as required by legislation passed late last year.
These new penalty amounts apply to penalties assessed after August 1, 2016 for violations that occurred after November 2, 2015 (which was when the legislation was passed). Therefore, while the penalty amounts aren’t effective yet, they will be very soon and they will apply to violations that may have already occurred. Additionally, per the legislation, these amounts will be subject to annual adjustment going forward, so they will keep going up.
- For a failure to file a 5500, the penalty will be $2,063 per day (up from $1,100).
- If you don’t provide documents and information requested by the DOL, the penalty will be $147 per day (up from $110), up to a maximum penalty of $1,472 per request (up from $1,100).
- A failure to provide reports to certain former participants or failure to maintain records to determine their benefits is now $28 per employee (up from $10).
Pension and Retirement
- A failure to provide a blackout notice will be subject to a $131 per day penalty (up from $100).
- A failure to provide participants a notice of benefit restrictions under an underfunded pension plan under 436 of the tax code will cost $1,632 per day (up from $1,000).
- A payment in violation of those restrictions will be $15,909 per distribution (up from $10,000).
- A failure of a multiemployer plan to provide plan documents and other information or to provide an estimate of withdrawal liability will be $1,632 per day (up from $1,000).
- A failure to provide notice of an automatic contribution arrangement required under Section 514(e)(3) of ERISA will also be $1,632 per day (also up from $1,000).
Health and Welfare
- Employers who fail to give employees their required CHIP notices will be subject to a $110 per day penalty ($100, currently).
- Failing to give State Medicaid & CHIP agencies information on an employee’s health coverage will also cost $110 per day (again, up from $100).
- Health plan violations of the Genetic Information Nondiscrimination Act will also go up to $110 per day from $100. Additionally, the following minimums and maximums for GINA violations also go up:
- minimum penalty for de minimis failures not corrected prior to receiving a notice from DOL: $2,745 (formerly $2,500)
- minimum penalty for GINA failures that are not de minimis and are not corrected prior to receiving a notice from the DOL: $16,473 (up from $15,000)
- cap on unintentional GINA failures: $549,095 (up from $500,000)
- Failure to provide the Affordable Care Act’s Summary of Benefits and Coverage is now $1,087 per failure (up from $1000).
The above penalty amounts are usually maximums (the penalties are “up to” those amounts), which means the DOL has the discretion to assess a smaller penalty. Employers and plans should be mindful of these and the other penalty increases described in the fact sheet. These increased penalties give the DOL additional incentive to pursue violations and assess penalties. They also give the DOL greater negotiating leverage in any investigation. For these reasons, it pays to be aware of the various compliance obligations (and any associated timing requirements) and make sure your plans’ operations are consistent with those obligations.
Typically, when a participant receives annuity payments from a defined benefit pension plan where he or she has a basis in the benefit (what Code Section 72 calls an “investment in the contract”), a portion of the payment is treated as a recovery of that basis. Therefore, it is not taxable to the participant. That portion is determined under the rules of Code Section 72. The most common way in which an employee has basis in his or her benefit is by making after-tax contributions. Currently, this is more common in governmental defined benefit plans than other plans.
However, it was not clear how these basis recovery rules worked in the context of phased retirement distributions. The IRS recently issued Notice 2016-39 to address the treatment of payments made by a qualified defined benefit pension plan to an employee during phased retirement. Phased retirement is the period during which an employee begins to take distributions of a portion of his or her retirement benefits from a plan while continuing to work on a part-time basis. During these periods, it may be difficult for the plan to do the typical calculation under Code Section 72. Additionally, the employee may be continuing to accrue additional benefits, which would further complicate the calculation.
The Notice provides that if certain conditions are met, the payments will not be considered amounts received as an annuity for purposes of Code Section. This means that, if the employee made after-tax contributions to the plan or otherwise has a basis in his or her benefit, then a portion of the payment will be treated as basis recovery and will be excluded from income using the calculation rules under Code Section 72(e)(8) described in the Notice.
According to the Notice, any payments received by an employee from an applicable plan will not be treated as received from an annuity if all the following conditions are met:
- The employee begins to receive a portion of his or her retirement benefits when he or she enters phased retirement and begins part-time employment;
- The employee will not begin receiving his or her full retirement benefits until ceasing employment and commencing full retirement at an indeterminate future date. For this purpose, a date is “indeterminate” as long as it can be changed. Since the employee and employer can always agree to a later date, nearly every date will be indeterminate for this purpose;
- The plan’s obligations to the employee are based in part on the employee’s continued part-time employment, which impacts both the duration of the phased retirement benefits and the amount of additional retirement benefits the employee accrues during the phased retirement period. In other words, the plan only pays phased retirement benefits as long as the employee is part-time and the employee’s part-time status affects the employee’s ability to accrue benefits under the plan (although the Notice does not appear to say how it affects the accrued benefit); and
- Under the terms of the plan, the employee cannot make an election as to the form of the phased retirement benefit to be paid during phased retirement. Instead, the employee must elect a distribution option at full retirement that applies to the employee’s entire retirement benefit, including the portion that commenced as phased retirement benefits. In other words, the employee’s benefit at full retirement must be reduced by the actuarial equivalent of the amount received during phased retirement.
Any amounts that are not received as an annuity will be subject to the special basis recovery rules in the Notice. Specifically, the amount excludible from the employee’s gross income will be a portion of each payment, calculated by multiplying the amount of the payment by the ratio of the employee’s investment in the contract (i.e., the employee’s basis) to the present value of the employee’s accrued benefit. The Notice provides that the basis recovery fraction may be fixed at the time payments begin under a phased retirement program. This avoids the need to redo the calculation as the employee makes additional contributions to the plan.
The IRS also issued Revenue Procedure 2016-36, which provides that this Notice will not apply to amounts received from a non-qualified contract.
The United States Department of Labor recently issued a Final Rule updating the Fair Labor Standards Act (the “FLSA”) that includes an increase in the standard salary level and that will take effect December 1, 2016. Under the FLSA, certain employees may be exempted from overtime pay for working more than 40 hours per week if their job duties primarily involve executive, administrative, or professional duties and their salary is equal to or greater than the required salary levels.
Among other changes made by the Final Rule, the threshold salary levels have been dramatically increased and will continue to be automatically updated every three years in the future. Prior to the Final Rule, the standard salary level was $455/week or $23,660/year. As of December 1, 2016, the standard salary level will be $913/week or $47,476/year. Highly compensated employees are subject to a less stringent job duties test than lower compensated employees; the salary threshold for highly compensated employees was $100,000 and will increase to $134,004.
The Final Rule also revises prior FLSA regulations by permitting up to ten percent (10%) of the salary thresholds to be met with nondiscretionary bonuses and incentive compensation (including commissions).
Employers may face many other decisions in addition to whether to increase pay or limit overtime hours as a result of the Final Rule. Many employers offer certain benefits, like long-term disability or paid time off, to employees on the basis of whether the employee is exempt or non-exempt under the FLSA. As employees’ classifications change, their benefits will change accordingly unless employers decide to make corresponding changes to benefits eligibility.
Employers will also need to revisit their retirement plans to confirm whether overtime pay is eligible for employer contributions, including matching contributions; if so, employers should plan ahead for increased contributions. Further, if overtime pay is excluded, employers should be aware of potential nondiscrimination testing issues (as a result of non-highly compensated employees becoming newly eligible for and receiving overtime pay).
Finally, increased overtime costs may require employers to reduce other employee benefits or require greater employee contributions for such benefits to stay on budget for the year. Regardless of its exact impact on your business, the Final Rule is sure to require some changes. Start planning now; December 1st will be here before you know it!
One might be led to believe that the current administration is in favor of expanding retirement savings opportunities. After all, the DOL has somewhat apologetically subverted ERISA to allow the States to sponsor employer-based savings plans. And the President’s recently proposed budget endeavors to provide a national retirement savings program. (See page 135 of the General Explanations of the Administration’s Fiscal Year 2017 Revenue Proposals) So why then would the IRS reverse two decades of regulation that favors cross-tested plans in small businesses, an action that might cause many small employers to terminate their qualified plans or amend them to reduce the employer contribution to employee’s accounts?
Some background may be in order. Cross-tested defined contribution plans are allowed to test equivalent benefit accrual rate (EBAR) groups separately using the ratio percentage test or the average benefits test. Unlike testing for coverage, application of the average benefits test here does not include testing for a reasonable business classification. This has permitted cross-tested plans to create small rate groups each of which meets the modified average benefits test and permits greater relative nonelective contribution (NEC) amounts for HCEs. Typically, the average benefits test for cross-testing finds that the EBARs for HCEs are the same or less than the EBARs for NHCEs. Notwithstanding this EBAR comparison, this allows for a sizeable difference in nonelective contribution allocation rates that benefit the HCEs who are often older and certainly more highly compensated. To take advantage of this otherwise seeming-to-discriminate structure, the plan must provide a gateway NEC of at least 5% of compensation for all eligible NHCEs, a rather generous employer minimum contribution. This trade-off was seen as a fair differentiation that would allow small business owners the opportunity to “skew” contribution allocation rates in their favor while at the same time providing their employees with a meaningful account addition. This has led to adoption of thousands of cross-tested plans benefitting many NHCEs around the country.
The proposed rule upends the trade-off. By adding the reasonable business classification requirement to the average benefits test for cross-testing purposes (and, of course, leaving the gateway contribution in place), the IRS, in proposed regulation §1.401(a)(4)-13, will force many cross-tested plans to use the ratio percentage test at a far greater cost since the small rate group approach will be eliminated. That will require an increase in the EBARs for the NHCEs in order for a larger rate group to pass the ratio percentage test if the EBAR for the specified HCE is static. That will require a greater NEC for NHCEs, an increased cost that many small businesses simply cannot afford or will not want to contribute for other business reasons (like the high cost of health insurance). And the average benefits test will not be palatable since small rate groups that often include only one NHCE will not be based on a reasonable business classification. A reasonable business classification is based on “all the facts and circumstances . . ., is reasonable and is established under objective business criteria that identify the category of employees who benefit under the plan. Reasonable classifications generally include specified job categories, nature of compensation (i.e., salaried or hourly), geographic location, and similar bona fide business criteria. An enumeration of employees by name or other specific criteria having substantially the same effect as enumeration by name is not considered a reasonable classification.” Treas. Reg. §1.410(b)-4(b). Of course, a “facts and circumstances” test often presents an unknown, one that small businesses are not likely to embrace.
So, why, after all these years, would the IRS change the rule to make it more expensive to sponsor a cross-tested plan, possibly causing many small employers to amend their plans to eliminate NECs or even terminate their plans? The answer may lie in looking at who most adopts these plans. Although there are no available statistics, it is commonly understood that many, possibly the majority of, cross-tested plans have been adopted by professional practices including those dastardly doctors and lawyers, seemingly high earners that the IRS may believe want nothing more than to take advantage of their employees. If the rule is finalized, the affect will likely be a reduction in the size of employer contributions to the accounts of those NHCEs fortunate enough to be participants in cross-tested plans. The impact of the new rule would seem to be contrary to the policy goal of expanding coverage for NHCEs. When looking at annual contribution limits under current law and the President’s goal of limiting the size of a tax-favored account (see the Proposal beginning on page 167 of the General Explanations of the Administration’s Fiscal Year 2017 Revenue Proposals) that would prevent the doctors and lawyers from getting a perceived too large a share of the tax advantage, it doesn’t seem to make policy sense to disrupt a plan structure that provides the gateway contribution for NHCEs.
Update: If you want to contact Treasury or your Congressional representative to tell them what you think of this change, you can go to http://savemyplan.org/.
The Department of Labor (“DOL”) has recently implemented an initiative to investigate the manner in which defined benefit plans of large employers comply with the required minimum distribution rules set forth in Section 401(a)(9) of the Internal Revenue Code (“Code”). The initiative is focused on the extent to which large employers have processes in place to (i) locate missing plan participants, (ii) inform deferred vested participants that a benefit is payable, and (iii) commence benefit payments in a timely fashion by each participant’s “required beginning date” (generally, the April 1 following the later of the calendar year in which the participant reaches age 70½ or the calendar year in which the participant terminates employment).
In light of the DOL’s audit initiative, employers will want to assure that they have procedures in place to (i) locate missing plan participants, (ii) inform terminated vested participants regarding their right to elect benefits, and (iii) commence benefit payments on or before each participant’s required beginning date. In addition, employers will want to confirm that such procedures are consistently followed in practice, and that documentary evidence regarding compliance is being maintained and preserved. For example, employers will want to retain evidence of all certified mailings to terminated vested participants and lost participants, as well as efforts made through locator services to locate lost participants.
Outside of audit concerns, implementing and consistently following such procedures may help to minimize the risk that participants will be faced with excise taxes for not having their required minimum distributions timely distributed. Under Section 4974 of the Code, any participant who is not paid his or her required minimum distribution for a given year may be liable for an excise tax equal to 50% of amount that should have been paid out as a required minimum distribution for the year. Although this excise tax has been around for quite some time, it may be (unwelcome) news to participants who are past their required beginning dates. If, after implementing procedures, it is determined that there are participants who are delinquent on their required minimum distributions, an employer may be able to correct these missed distributions through the IRS’s Employee Plans Compliance Resolution System (“EPRCS”) and have the excise tax waived by the IRS.
A few weeks ago, the President released his proposed budget for the fiscal year 2017. As usual, it is dense. However, the President has suggested some changes to employee benefits that are worth noting. While they are unlikely to get too much traction in an election year, it is useful to keep them in mind as various bills wind their way through Congress to see what the President might support.
- Auto-IRAs. Stop us if you’ve heard this one before. The proposal would require every employer with more than 10 employees that does not offer a retirement plan to automatically enroll workers in an IRA. No employer contribution would be required and, of course, individuals could choose not to contribute. (In case you’ve forgotten, we’ve seen this before.)
- Tax Credits for Retirement Plans. Employers with 100 or fewer employees who “offer” an auto-IRA (note the euphemistic phrasing in light of the first proposal) would be eligible for a tax credit up to $4,500. The existing startup credit for new retirement plans would also be tripled. Small employers who have a plan, but add automatic enrollment would also be eligible for a $1,500 tax credit.
- Change in Eligibility for Part-Timers. The budget would require part-time workers who work 500 hours per year for three consecutive years to be made eligible for a retirement plan.
- Spending Money to Help Save Money. The President proposes to set aside $6.5 million to encourage State-based retirement plans for private sector workers.
- Opening Up MEPs. To help level the playing field with the State-run plans, the budget proposes to remove the requirement that employers have a common bond to participate in a multiple employer plan (MEP). This is a proposal that has already been floated by Sen. Orrin Hatch, so there’s some possibility that, even in an election year, this might get passed (probably, if not mostly, because it would be hard for anyone to have a vote for open MEPs used against them on the campaign trail given that so few outside the retirement space even know what they are).
- More Leakage For Long-Term Unemployed. The budget also proposes to allow long-term unemployed individuals to withdraw up to $50,000 per year for two years from tax-favored accounts. This proposal, if implemented, would be interesting to study empirically. Obviously, it would lead to more leakage from retirement plans, but would people be more apt to contribute knowing that they could withdraw if they really needed to do so?
- Double-tax of Retirement Benefits? In what appears to be a repeat of a prior proposal, page 50 of the budget summary states that the value of “Other Tax Preferences” (not specified) would be limited to 28 percent. This would seem to describe the President’s proposal from prior years that to the tax benefit of retirement plan contributions (among other items). However, such a proposal is, in our view, counter-intuitive given the other proposals to expand retirement access.
- Cadillac Tax Would Get a Tune-Up. The ACA tax on high-cost coverage would change the thresholds that determine when the tax applies. Currently, there is one threshold for self-only coverage and another for coverage other than self-only coverage. The budget would propose to change the thresholds to the higher of those amounts or the average premium for a gold plan in the ACA Marketplace in each state. This is designed to help address geographic variations in the cost of coverage. There is also a mention in the summary of making it easier for employers with flexible spending arrangements to calculate the tax, but it is not clear what form that would take.
- Miscellaneous. In the budget tables, there are also a few benefits items, such as:
- Expanding and simplifying the small employer tax credit for employer contributions to health insurance (page 148).
- Simplifying the required minimum distribution rules (page 152).
- Taxing carried interests / profits interests as ordinary income (page 153).
- Requiring non-spousal beneficiaries of deceased IRA owners and retirement plan participants to take inherited distributions over no more than five years (page 153).
- Capping the total accrual of tax-favored retirement benefits (which seems like another repeat of prior proposals – page 153).
- Limiting Roth conversions to pre-tax dollars (page 153).
- Eliminating the deduction for dividends on stock in ESOPs of publicly-traded companies (page 153).
- Repealing the exclusion of net unrealized appreciation for certain distributions of employer securities from qualified retirement plans (page 153).
A summary of these changes from the Administration is available here (along with a few other items). More on the overall budget is available here. Do you have additional details, other information, or a point of view on these proposals? Post it in the comments!
On January 29, 2016, the Internal Revenue Service issued guidance on mid-year changes to safe harbor plans under Internal Revenue Code Sections 401(k), and 401(m). Notice 2016-16 significantly expands the permissible mid-year changes available to sponsors of safe harbor plans under prior guidance.
The Notice provides guidance on mid-year changes to a safe harbor plan or to a plan’s safe harbor notice content that do not violate the safe harbor rules on account of being mid-year changes. For purposes of this Notice, a mid-year change is one that is either effective on a day other than the first of the plan year or one that is effective on the first of the plan year but adopted after that date.
This expansion, of course, comes with a few requirements. Simply put, Notice 2016-16 requires that any changes must meet applicable notice and election opportunities and must not be on the list of prohibited mid-year changes.
Notice and Election Requirements
Not all mid-year changes require an employer to provide an updated safe harbor notice and election opportunity. Mid-year changes that do not alter required safe harbor notice content (even if the information is provided in a plan’s safe harbor notice) do not require any additional notice. Similarly, if the pre-plan year annual safe harbor notice included the required information about the mid-year change and its effective date, then no additional notice is required.
Any mid-year change that does alter a plan’s required safe harbor notice content requires both (1) an updated safe harbor notice that describes the change and its effective date and (2) a reasonable opportunity for the employees to change their cash or deferred and/or any after-tax employee contribution elections.
The updated notice must be provided within a reasonable period before the effective date, based on the facts and circumstances. Providing the notice between 30 and 90 days prior to the effective date is deemed reasonable. If notice prior to the effective date is impracticable, such as notice for retroactive changes, then providing notice as soon a practicable, and no later than 30 days after the change is adopted, is deemed reasonable.
A reasonable opportunity to change a cash or deferred election exists if an election period of 30 days is provided to employees. This election period must be provided prior to the effective date if practicable and, if not, as soon as practicable after the updated notice is provided (but not later than 30 days after the change is adopted).
Prohibited Mid-Year Changes
Notice 2016-16 explicitly prohibits three types of changes, and permits a fourth only if it meets additional requirements. These prohibited mid-year changes are:
- Increasing the number of years of service required to vest in safe harbor contributions under a qualified automatic contribution arrangement.
- Reducing or narrowing the group of employees eligible to receive safe harbor contributions. This prohibition does not limit an employer’s ability to make otherwise permissible changes under eligibility service crediting rules or entry data rules with respect to employees who are not eligible to receive safe harbor contributions as of the effective date or the date of adoption.
- Changing the type of safe harbor plan (for example, changing from a traditional 401(k) safe harbor plan to a qualified automatic contribution arrangement).
- Modifying or adding a formula used to determine matching contributions if the change increases the amount of such contributions or permitting discretionary matching contributions. However, this prohibition does not apply if, at least three months prior to the end of the plan year, the change is adopted and the required updated notice and election opportunity (described above) are met and the change is made retroactively effective for the entire plan year.
Additional Changes that are Not Provided Relief Under Notice 2016-16
Despite only prohibiting four specific types of changes, the IRS makes it clear that not all other possible changes are permitted. Certain mid-year changes will violate the safe harbor plan rules unless applicable regulatory conditions are satisfied, including adopting a short plan year, changing a plan year, adopting safe harbor plan status, reducing or suspending safe harbor contributions and changing from a safe harbor plan to a non-safe harbor plan. In addition to those examples, the IRS cautions that other laws may affect the permissibility of mid-year changes including anti-cutback restrictions, nondiscrimination restrictions, and anti-abuse provisions.
It is likely that additional guidance on mid-year changes to safe harbor plans may be published later this year. The IRS has requested comments on whether additional guidance is needed, particularly for mid-year changes of plan sponsors involved in mergers and acquisitions.
This Notice is effective for mid-year changes made on and after January 29, 2016. The Notice also applies to 403(b) plans that apply the 401(m) safe harbor rules.