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Insight 3 Issues Companies With 401(k) Plans Must Have On Their Radar

By John C. Hughes,

401(k) plans have many moving parts, and there are constant changes in the laws and regulations that govern these plans – your plans. As such, companies that maintain 401(k) plans must be continually vigilant.

Contrary to popular belief (and marketing), it is not a “turn key” proposition. The investment and insurance companies that hold your plan’s money do not guarantee that they will properly address the complex and ever-changing legalities of your plan (see page 1 of your contract with those service providers). In fact, it seems that recordkeepers sometimes bully their employer clients into doing things their way, instead of the legally compliant way and in the best interest of the client employer. This article briefly addresses three issues for employers’ attention.

IRS Form 5500 – Deadline Fast Approaching

We are in the heart of IRS Form 5500 season. Most plans must file Form 5500 by July 31 (or October 15 if an extension is properly obtained). It is important to carefully review Form 5500 to ensure it is properly completed and does not unnecessarily raise red flags. The company signs under penalty of perjury that the information reported is complete and accurate. Additionally, Form 5500 plays a prominent role in the IRS’s and Department of Labor’s decisions regarding which plans to investigate. Finally, the penalties for late, missing, or incomplete filings could be as high as $2,194 per day. Certainly, an argument to be avoided.

Key Takeaway: Carefully review the draft Form 5500 with counsel and ensure it is filed on time.

Updated IRS Guidance Regarding Plan Failures

Retirement plans are granted a special tax status under the Internal Revenue Code that benefits the employer and the plan participants. If the rules are not followed, the favorable tax status is jeopardized, and the employer is potentially subject to fines and costs associated with making corrections.

Plan failures (referred to as “qualification” failures) are excessively common. The failures are generally of two varieties: (1) the plan document is flawed because it is not timely adopted in the first place and/or updated for changes in the law (or those documents are misplaced/discarded), and (2) plan operations deviate from what the plan document says.

It is in every employer’s best interest to identify and fix qualification failures sooner rather than later. This is mostly because it is the right thing to do, but also because it will avoid potentially substantial liabilities in the form of costly corrections and monetary penalties imposed by the IRS (known as “Audit CAP” sanctions).

The IRS maintains a program for fixing problems so that employers may maintain a plan’s favorable tax status and avoid fines (and more costly corrections). The IRS recently updated this program. The update is set forth in IRS Revenue Procedure 2019-19. This article will not focus on the technical details of the update. Suffice it to say that the IRS has its eye on these issues, and there is a right way and a wrong way to address plan failures for which you may incur liability to the government and/or the plan participants (your employees).

Examples of common plan qualification failures include:

  • Incorrect implementation of automatic enrollment or automatic escalation features.
  • Failure to implement employee elections
  • Excess matching contributions
  • Failure to properly or timely amend a plan
  • Failure to implement a plan amendment
  • Improper consideration of, or failure to consider, related employers.

Some failures may be corrected without IRS involvement (“self-corrections”), while others must be submitted formally to the IRS by way of a “VCP” application.

Key Takeaway: Failures happen. Find them and correct them consistent with the IRS’s correction program.

Hardship Distributions – Changes in the Law

Plans are permitted (but not required) to allow for distributions toemployees on account of financial hardship. There are detailed laws and regulations that set forth the circumstances under which hardship distributions may be made. The Bipartisan Budget Act of 2018 made changes to those laws, and directed the Secretary of Treasury to change the regulations governing hardship distributions.

The changes in the law generally make it easier to obtain a hardship distribution, and allow employers to:

  • Eliminate the 6-month suspension on an employee’s ability to make 401(k) contributions after taking a hardship
  • Eliminate the need for an employee to take a plan loan before taking a hardship
  • Allow for the distribution of earnings on 401(k) contributions when taking a hardship.

The changes generally may be implemented now. Some may or may not be required to be implemented later; some are optional, some are not. Most recordkeepers and document providers have asked employers to implement the above three practices. An actual written plan amendment will not be required until later (pending expected IRS guidance; although, some document providers have already put amendments in place).

In the meantime, it is important for employers to:

  • Understand what you have agreed to.
  • Make sure it is consistent with your objectives.
  • Make sure it is happening
  • Be on the lookout for the written amendment (and make sure it is timely adopted)
  • Be sure your communications to employees on this issue are made and are accurate.

I have had clients:

  • Not desire the operational changes recommended by recordkeepers and document providers (and/or have had those changes implemented on a somewhat subtle unilateral basis).
  • Adopt plan amendments, but ignore them and do things differently and/or not advise the employees of the changes.
  • Ignore the issue altogether (which might be ok for now, but perhaps not, depending on what your plan says and what is happening in fact).

Key Takeaway: Understand how your plan is handling hardship distributions in response to recent changes in the law.

Please contact myself or Cydni Waldner for assistance with any of the foregoing, or with any other benefit plan related questions or comments

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