IRS Rules that Encourage Adoption of Pre-approved Plans
Last year, the Internal Revenue Service (IRS) announced that it was ending its existing determination letter program. Effective January 1, 2017, the staggered remedial amendment cycle for individually designed retirement plans will end; however, a plan sponsor still would be able to obtain a determination letter with respect to initial qualification and qualification upon plan termination. The IRS has stated that there may be other limited circumstances announced in the future for which a determination letter may be received.
Notice 2016-3 provides additional guidance in connection with these changes and further encouragement for plan sponsors to move from individually designed plans to pre-approved plans.
- Controlled Group and Affiliated Service Cycle A Elections: Under the old rules, a controlled group and affiliated service groups which maintain more than one tax-qualified retirement plan were permitted to elect to submit their determination letter applications together during the Cycle A submission cycle. Those groups still will be permitted to submit their applications during the final Cycle A submission cycle (ending January 31, 2017) if they had made the election to submit their applications as a group by January 31, 2012, which was the end of the last Cycle A submission cycle. As a result, controlled and affiliated service groups cannot make the election now in order to obtain one final determination letter under the last Cycle A submission cycle.
- Determination Letter Expiration Dates Disregarded: Under the previous determination letter program, determination letters received by plan sponsors included expiration dates after which the determination letter could no longer be relied on. The expiration dates included in determination letters issued prior to January 4, 2016, are no longer operative. Future guidance will clarify the extent to which an employer may rely on a determination letter after a subsequent change in law or plan amendment.
- Extension of Deadline to Adopt Pre-Approved Defined Contribution Plans: Notice 2016-3 extended the deadline to adopt a pre-approved plan until April 30, 2017, for a plan sponsor which has not adopted a pre-approved plan before January 1, 2016.
These changes have the practical effect of encouraging plan sponsors that maintain individually designed plans to transition to volume pre-approved plans:
- Any adopter of a pre-approved plan is on the same remedial amendment cycle. That remedial amendment cycle is every six years; the current cycle is now ending April 30, 2016. An employer which is a member of a controlled group or an affiliated service group and which utilizes a pre-approved plan will be on the same remedial amendment cycle without having to make any election to be on the same filing deadline. As noted above, old rules applicable to individually designed plans required the group to make an election to be on the same remedial amendment cycle.
- An adopter of a pre-approved plan may rely on its opinion letter, which is like having a determination. Unless the rules change for pre-approved plans, the expiration of reliance on that letter will correspond to the six year amendment cycle for pre-approved plans.
- The extension to adopt a pre-approved plan for a first time adopter until April 30, 2017, was specifically designed to encourage plan sponsors to convert individually designed plans into pre-approved plans.
Revenue Procedure 2016-6 released early this year provides the rules for applying for and receiving a determination letter. That Revenue Procedure set forth the limited circumstances under which an employer that has adopted a pre-approved plan may apply for a determination letter. Those limited circumstances include:
- slightly modifying the pre-approved plan’s language for coordinating 415 limitations and top heavy requirements among multiple sponsored plans;
- adopting a normal retirement age of less than age 62;
- whether there has been a partial termination of the plan, the employer is a member of an affiliated service group or the employer is a recipient of services of leased employees;
- whether the plan is a multiple employer plan; and
- when the employer is required to obtain a determination letter to comply with published procedures of the Service (for example, in conjunction with a request for a minimum funding waiver).
The point is that these albeit limited circumstances for a determination letter nonetheless allow for seeking some “blessing” from the IRS with respect to the pre-approved plan document and certain factual situations that is not available to an adopter of an individually designed plan. This additionally encourages adoption of a pre-approved plan.
Is the elimination of the determination letter program and the push to encourage adopting pre-approved plans a bad policy? That is hard to say definitively. The IRS has allowed much more flexibility in pre-approved plan provisions over the years, e.g. allowing for disparate allocations that must pass cross-testing to demonstrate non-discrimination. Many plans, even those of very large employers, have a rather ordinary design and a pre-approved plan can accommodate the plan design and deliver the intended benefits. However, there are plans that have complicated designs, often due to “legacy” benefit issues, and the pre-approved plan just will not deliver the intended benefits without extensive modification, which results in losing that pre-approved status. The employer which must have the individually designed plan will be taking on risk; that employer will be exposed to the IRS in an audit reviewing and then disagreeing with the provisions of the document. A non-compliant document exposes the employer to a retroactive disqualification of that plan. The recourse for correction practically may be limited to seeking approval from the IRS under its correction program, which is a less than satisfying process given the group alleging the document error is the same group determining the correction. That process simply feels like an opportunity for the IRS to assess additional penalties, unless the employer is willing to go to court, which is a long and expensive process in which the courts tend to defer to the holdings of the IRS.
Right now, how much exposure an employer sponsoring an individually designed plan has and the best course of action to manage that document risk is unknown. We all await further IRS guidance.
Should you have any questions concerning retirement plans, please contact Eastman & Smith.
Disclaimer: The article in this publication has been prepared by Eastman & Smith Ltd. for informational purposes only and should not be considered legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney/client relationship.