August 2015 Newsletter - The IRS is Back with Some Brand New Corrections

Let's face it. Finding out that the IRS wants to poke around is not going to be the highlight of anyone's day. Voluntarily admitting a mistake to the IRS and asking for forgiveness is probably even lower on the wish list! So hearing about new voluntary corrections from our friends at the Service might seem like a waste of time.

Not so fast! Believe it or not, the division of the IRS responsible for qualified retirement plans actually does not want to find problems and hand out sanctions. Their goal is to help preserve tax-favored retirement benefits that exist within retirement plans. Of course, if someone doesn't play by the rules, they shouldn't then be able to claim the same benefits as someone who does satisfy the various requirements.

That is where the various voluntary correction programs come into play. The IRS recognizes that there are a lot of moving parts involved in the proper care and feeding of a retirement plan. More than 20 years ago, they created the first iteration of a program that allowed companies to voluntarily get their plans back on track, provide participants with any missed benefits and avoid most, if not all, of the penalties the IRS might otherwise assess. Over the last two decades, the IRS has continued to evolve, update and consolidate these programs to make them more accessible and meet the needs of an evolving business climate.

That evolution continued earlier this year when the IRS expanded the correction options for situations when participants are not signed up to make 401(k) deferrals when they are supposed to be. The Service also finalized a pilot program for certain single-participant plans that file their Forms 5500-EZ after the deadline. Let's take a look.

Missed 401(k) Deferrals

The "Old" Rules

For the last several years, the "standard" correction for not timely enrolling an employee in the 401(k) plan has been a five-step process:

  1. Determine how much the employee would have deferred—referred to as the missed deferral opportunity;
  2. Calculate a corrective qualified nonelective contribution equal to 50% of the missed deferral opportunity;
  3. Calculate the related matching contribution using 100% of the missed deferral opportunity;
  4. Adjust the qualified nonelective contribution and match for investment gains; and
  5. Deposit the sum of steps 2, 3 and 4 into the participant's account in the plan.

Prior to 2008, the qualified nonelective contribution in step #2 was required to be 100% of the missed deferral opportunity, so the reduction to 50% was a welcome change.

The IRS provides guidelines for determining how much the employee would have deferred. For example, if an employee enrolled but the enrollment was never implemented, the missed deferral opportunity is based on the actual enrollment. If the employee wasn't given the opportunity to enroll, the missed deferral opportunity is equal to the average of the employee's group (either highly compensated or non-highly compensated). There are several other parameters for different situations, but we will spare you those gory details here.

Fortunately, this correction methodology is still completely acceptable. In a Revenue Procedure published in the spring of this year, the IRS provided a couple of new options for correcting missed deferral opportunities, one for automatic enrollment plans and one for traditional 401(k) plans.

Before getting into some of the details, it is helpful to note that the new options only apply to the calculation of the qualified nonelective contribution (step #2, above). Any missed match must still be corrected as noted in step #3, i.e., applying the match formula to the full amount the participant would have deferred if timely enrolled.

It is also worth noting that unless the plan's investments suffered a loss for the time period in question, corrective contributions must always be adjusted to compensate for lost investment earnings.

New Option for Traditional Enrollment 401(k) Plans

For traditional plans that require participants to make an affirmative deferral election, the new option creates a rolling three-month correction window. In a nutshell, if the participant in question is properly enrolled and has deferrals withheld no later than three months following the initial failure, then no qualified nonelective contribution is required. If correct deferrals begin after more than three months but less than two years, the qualified nonelective contribution is reduced to 25%.

There are a couple of small strings attached. The first string is that if the missed employee catches the problem earlier than three months after the initial failure, the company must implement the correct deferrals no later than the first pay period of the month after the employee brings it to the company's attention. In other words, the company can't sit back and say, "Bummer, but we can wait up to three months before we do something about it." Seems like that would have been obvious, but they probably have to plan for that one person who tries to get snarky.

The second string is that the company must provide written notice of the failure to all affected participants. More on that later.

New Option for Automatic Enrollment 401(k) Plans

Ever since Congress passed the Pension Protection Act of 2006, automatic enrollment has become an increasingly popular concept. One of the challenges in getting it from concept to implementation has been the fact that it is easy for new hires to fall through the cracks, especially in plans that have eligibility requirements that extend beyond a month or two after date of hire. And it has been a pain in the neck to go through the corrective calculations every time it happens.

In response to that concern, the IRS also created a new correction for automatic enrollment plans. As long as the failure to automatically enroll a participant on a timely basis is caught and correct deferrals withheld no later than 9½ months after the close of the plan year of the failure, then no qualified nonelective contribution is required. In addition, if the participant did not make an investment election, the lost earnings calculation for the match can be determined using the plan's qualified default investment alternative.

The same strings are attached. Specifically, the correct deferrals must begin earlier if the participant in question brings it to the company's attention, and the company must provide written notice to the impacted participants.

The Notice

It seems like every new rule in the last 10 years has been accompanied by a notice, and this change is no exception. Fortunately, this notice is relatively straightforward. In order to take advantage of either of the new options, the sponsor must provide a notice to all impacted participants no later than 45 days following the date correct deferrals begin that provides:

  • General information about the failure;
  • A statement that correct deferrals are now being withheld;
  • A statement that corrective matching contributions (if the plan provides for one) have been made;
  • An explanation that the participant may increase deferrals to make up for those that were missed; and
  • Plan contact information.

Is There a Catch?

Some may wonder why a company wouldn't take advantage of the new correction options. I mean both of them are less expensive than the standard 50% qualified nonelective contribution. There are several reasons that come to mind, both related to the notice. First, some companies may be reluctant to provide to employees a written statement of an error involving payroll and retirement accounts, especially in a case of already strained employee relations.

The second relates to the timing of the notice. If a company catches the failure and starts withholding the correct deferrals but doesn't provide the notice within 45 days, they are no longer eligible for the reduced qualified nonelective contribution and must revert to the 50% level.

Late Filing of Form 5500-EZ

Most retirement plans are required to file a Form 5500 each year, and the deadline is the end of the 7th month following the close of the plan year (July 31st for calendar year plans). The deadline can be extended by 2½ months (to October 15th for calendar year plans) by filing Form 5558. Hefty penalties could apply ($1,100 per day to the Department of Labor and up to $15,000 to the IRS) for failure to file timely.

For many years, the Department of Labor has had a delinquent filer program that allowed late/non-filers to get caught up and pay a very reduced fee, as low as $750 in some cases. However, that program only applies to companies that must file a Form 5500-SF or Form 5500.

Plans that cover only the owner or partners of a business and their spouses do not normally file one of these forms. Instead they file Form 5500-EZ. If an EZ filer happened to be late, the only option has been to write a so-called "reasonable cause" letter to the IRS to ask them to accept the late filing and forego any fines.

In 2014, the IRS created a pilot program that formally addresses late filing of Form 5500-EZ. After running that program for a year and soliciting feedback from the community, the Service finalized the program earlier this year.

Under the permanent program an EZ filer, as described above, can submit delinquent returns for a plan and pay a reduced penalty of $500 per delinquent filing, up to a maximum of $1,500 per plan if more than three years of returns are submitted. The returns that are submitted must be the forms that applied for the year in question. There are certain limited exceptions that allow use of the current version of the Form 5500-EZ.

In addition, the submission must include a completed Form 14704, attached to the front of the oldest delinquent return in the package, along with a check payable to the United States Treasury for the reduced penalty amount.

The Revenue Procedure that described the correction program makes it clear that EZ filers still have the option to submit a reasonable cause letter in lieu of using the program. However, the IRS also makes it clear that if the reasonable cause is not accepted, the plan will no longer be eligible to use the delinquent filer program and will be assessed the otherwise applicable penalties. If past experiences with government agencies are any indication, they tend to be much less accepting of reasonable causes once there is a formal correction program available, so proceed along that route with caution.


Unfortunately, retirement plans are complicated and have many moving parts that can lead to the occasional OOPS! Fortunately, the IRS continues to provide newer and easier ways to correct many of the more common oversights that can occur without breaking the bank in the process. If you think there might be a mistake lurking in a dark corner of your plan, let your team of service providers know so that they can help you fix it voluntarily rather than after the IRS finds it.

This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.

© 2015 Benefit Insights, Inc. All rights reserved.

June 2014 Newsletter - Ready or Not, Here it Comes... the PPA Plan Restatement

Ready or Not, Here it Comes...the PPA Plan Restatement

June 2014 Newsletter

It's time again to participate in that never ending ritual of qualified retirement plan restatements. As legislation affecting retirement plans is enacted, the Internal Revenue Service (IRS) requires all plan sponsors to restate or "rewrite" their plans to conform to current law.

For pre-approved plans, these required restatements take place on a regular six-year cycle. The current cycle of defined contribution plan restatements is being referred to as the "PPA restatement" after the Pension Protection Act (PPA).

If you sponsor a 401(k) or other type of defined contribution retirement plan for your employees and use a pre-approved type of plan, you will be required to restate the plan within the next two years. Failure to complete this restatement before the deadline of April 30, 2016, could result in the disqualification of your plan and result in possible taxation for participants and your loss of deductions and penalties.

In addition, an interim amendment to the plan may be required by the end of the year to comply with IRS guidance released in April regarding same gender marriages.


After tax legislation is enacted, the law is analyzed by the IRS to determine how it will affect qualified plans in actual operation. This analysis usually takes years, and practitioners may be left to operate their plans on a "good faith" basis during this period.

In other words, plans are required to be operated in the best possible way based on the prevailing understanding of the current law even though official regulations and/or guidance has yet to be issued. As a result, many plan sponsors have adopted "good faith" interim amendments to bring their plans into temporary compliance with PPA, other laws and new guidance issued by the IRS pending this restatement period.

PPA was a sweeping piece of legislation enacted in 2006 which made major changes in the tax laws relating to retirement plans. It is the largest piece of legislation included in the plan restatement. The restatement takes the language from the prior Economic Growth and Tax Relief Reconciliation Act (EGTRRA) restatement document and includes any new laws added by Congress and any guidance issued by the IRS through the fall of 2010 including:

  • The Pension Protection Act (PPA)
  • The final Section 415 regulations
  • The Heroes Earnings Assistance and Relief Tax Act (HEART)
  • The Worker, Retiree, and Employer Recovery Act (WRERA)
  • The Katrina Emergency Tax Relief Act of 2005 (KETRA)
  • The GULF Opportunity Zone Act of 2005 (GOZone)

Types of Plan Documents

All qualified plans are required to have a written plan document. The plan document can take various forms:

  • Individually Designed Plan Document: This type of plan document is custom designed by an attorney exclusively for an individual employer to meet its specific needs. An individually designed plan offers the greatest degree of flexibility possible.
  • Pre-Approved Plan Document:  There are two types of pre-approved plan documents—volume submitter plans and prototype plans. Volume submitter plans generally offer more flexibility than prototype plans but not as much as individually designed plans. Pre-approved plan documents are available for most types of plans including 401(k), profit sharing, new comparability and defined benefit plans.

Restatement Cycles

More than 80% of all plans use prototype or volume submitter pre-approved documents. Currently, we are in the second six-year cycle for defined contribution plans. Most pre-approved plan documents have now been rewritten and approved by the IRS. Beginning on May 1, 2014, the window for restating documents opened. The IRS provides a period of two years for all employers who use a pre-approved plan to finish the restatement.

Pre-approved defined benefit plans are on a different six-year restatement cycle than defined contribution plans. Individually designed plans are on a five-year cycle and must be restated every five years.

IRS Letters

In order to receive a measure of assurance that an individually designed plan document is in full compliance, the plan document may be voluntarily submitted to the IRS to receive a determination that its terms and conditions satisfy all applicable IRS tax-qualification requirements (referred to as a "determination letter").

With pre-approved plans, the IRS has already reviewed the plan language and determined that it meets the requirements for tax qualification. The IRS issues an "opinion letter" for prototype plans and an "advisory letter" for volume submitter plans to the plan document provider who files with the IRS for pre-approval of the plan. As long as an employer does not modify the pre-approved provisions, the employer will have reliance on the opinion or advisory letter issued to the plan document provider.

During the last restatement cycle, any employer could ask the IRS for a determination letter on a pre-approved plan. Effective last year, the IRS will no longer issue an opinion or advisory letter to employers who adopt prototype or volume submitter documents with no changes. These plan sponsors are entitled to rely on the opinion or advisory letter as if they had a determination letter of their own.

If an employer adopts a volume submitter plan document which has minor modifications, a determination letter may be requested with a simplified filing. If the modifications are not minor, the IRS will consider the plan to be individually designed and will require a more complex determination letter application. If a prototype plan document is modified, it is considered an individually designed plan. If the pre-approved plan has been modified for unique circumstances, a determination may be desirable but never required.

Protected Benefits

Special care must be taken to ensure one plan document does not blindly replace another plan document. For example, if a prototype plan is used to restate an individually designed plan, there are special issues to consider such as ensuring certain benefits, called "protected benefits," are not accidentally eliminated or reduced. Protected benefits include forms of distributions (such as lump sum and annuities) and timing of distributions (such as early retirement provisions).

Restatement Process

The restated plan document will incorporate all of the changes that were made in your document between the last restatement and this restatement. An inventory of all amendments and their effective dates will need to be compiled so these changes can be accurately reflected in the new document. In addition, now is an ideal time to make any plan design changes that you may have been contemplating which can be incorporated into the restated document.

After the document is completed, it should be thoroughly reviewed. The IRS is very strict when it comes to following the plan document. If your plan document does not reflect the operation of your plan, you may have a serious issue that could affect the qualification of your plan. Any issues discovered during the restatement process should be addressed as soon as possible.

In addition to the plan document, you may need to have a new summary plan description (SPD) drafted which describes the terms of the plan in a manner designed to be understood by an average plan participant. The SPD will need to be distributed to all participants in the plan.

Most corporate attorneys consider the adoption of a plan or the restatement of a plan to be an important action which should be ratified by the board of directors or managing partners in the case of a partnership. As such, you should document the restatement with the board of director's minutes, consent resolution or similar written acknowledgement.

In most cases, the resolution instructs the president or other officer to execute any documents necessary to accomplish the restatement. Finally, an authorized officer of the plan sponsor should sign the restatement. If a new trust agreement is also included with the document, the trustees should sign as well.

Because a large number of plans need to be restated within the two-year period, not all restatements will be started right away.

Same Gender Marriage Interim Amendments

On June 26, 2013, in United States v. Windsor, the Supreme Court invalidated Section 3 of the Defense of Marriage Act (DOMA) which limited marriage to opposite sex couples for purposes of federal law (including retirement plan administration).

On September 16, 2013, the IRS issued a ruling holding that same-sex marriages legally entered into in any state recognizing such marriages (referred to as the "state of celebration") would be recognized for federal tax purposes. The ruling also held that the state of celebration would control for federal tax purposes, even if the couple lives in a state that does not recognize the marriage.

The IRS recently issued a notice that provides information on interim plan amendments that may be required to comply with the Supreme Court decision. In general, if the language in the plan document does not comply with the Windsor decision, the plan must be amended by December 31, 2014. In any case, the plan must comply in operation with the new rules beginning on June 26, 2013, the date of the Supreme Court decision.

The need to amend the plan will depend on the definition of marriage in the document. Some documents may define marriage as marriage between a man and a woman, some plans may refer to the DOMA definition and some may define marriage as marriage under "applicable law." The first two definitions will need an amendment, the last may not.


Millions of employees rely on their employers to provide retirement benefits. Part of the responsibility for providing those benefits is maintaining the plan in accordance with current tax laws. A plan must be operated in accordance with all laws and regulations and the plan documentation must reflect the laws currently in effect.

The IRS may disqualify a plan that does not comply with the plan restatement requirements, which could result in taxation for the participants and loss of deductions and penalties for the employer.

We are committed to providing the support, attention and professional expertise needed throughout this restatement period to make it a positive experience for all.

This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.

© 2014 Benefit Insights, Inc. All rights reserved.

April 2014 Newsletter - The Continuing Evolution of the Safe Harbor 401(k) Plan

The Continuing Evolution of the Safe Harbor 401(k) Plan

April 2014 Newsletter


The safe harbor 401(k) plan roared onto the scene in 1998 as a new design that allowed company owners and other highly compensated employees to maximize their salary deferrals even when other employees contributed at relatively low levels. Over the last 16 years, these plans have continued to evolve through a series of new laws and IRS pronouncements.


In general, 401(k) plans are subject to annual testing designed to make sure highly compensated employees, or HCEs (those who own more than 5% of the company or earn more than $115,000, indexed for inflation), do not benefit too much more than non-HCEs. If there is too much of a spread between the groups, HCEs must either be refunded a portion of their contributions or the company must contribute additional amounts for non-HCEs. This test is referred to as the actual deferral percentage (ADP) test.

There is also the so-called top-heavy determination that requires the company to make a minimum contribution of up to 3% of pay to employees if certain owners and officers hold more than 60% of the total plan account balances.

Safe harbor 401(k) plans are exempt from the ADP test as long as they meet additional requirements which include agreeing to make a minimum company contribution and providing employees a notice each year that explains the safe harbor provisions. Safe harbor plans are also automatically considered not top heavy as long as the only allocations to participant accounts are employee deferrals and safe harbor contributions.

The company contribution must generally be immediately vested, although plans that also include automatic enrollment for deferrals may be able to apply a two year vesting schedule. The contributions can be either a fixed matching contribution (safe harbor match) on behalf of only those who defer or a fixed profit-sharing-type contribution (safe harbor nonelective) that is made on behalf of all eligible participants.

Tried it but didn't like it

What happens when a plan sponsor has a safe harbor 401(k) plan but no longer wants it? The general rule is that safe harbor features must remain in effect for a full 12-month plan year, so a calendar year plan could amend to remove those features any January 1st. One exception is for plans that are being completely terminated and allows for the elimination of the safe harbor provisions concurrent with that termination.

There was also a provision that allowed for the mid-year elimination of a safe harbor matching contribution as long as the match was funded through the date of elimination and the plan passed the normal tests for the year; however, there was no corresponding "out" for those that used the safe harbor nonelective contribution...until the recent recession.

The IRS recognized that the economic downturn meant that some companies could no longer afford the mandatory contribution, so they proposed new rules in 2009 allowing for the mid-year elimination of a safe harbor nonelective contribution. But, unlike the match, the new rules were only available for companies that could demonstrate a substantial business hardship as defined by IRS rules.

While this was welcome relief, the IRS received feedback that the rules should be the same for both types of safe harbor contributions. In late 2013, the Service finalized the regulations to provide the requested consistency. Under these new rules, a company can eliminate either a safe harbor matching or safe harbor nonelective contribution mid-year, if:

  • They are operating at an economic loss (an easier standard to meet than the "substantial business hardship" standard from the 2009 regulations); or
  • The safe harbor notice provided to employees before the start of the year specifically notes the possibility that the contribution might be suspended during the year.

In both scenarios, the plan must still pass the ADP test and comply with the top-heavy requirements, but at least there is now a uniform set of requirements that is easy to understand.

What is the moral to this story? Sponsors of safe harbor plans should consider whether it makes sense to include the "possibility of suspension" language in all safe harbor notices going forward, even if there are no current discussions of eliminating the contribution. Even if never used, including that language preserves the ability to amend the plan to reduce or eliminate the safe harbor contribution should unforeseen circumstances arise.

Tried it, like it, but want to make a few changes

here are many reasons an employer might want to tweak its plan. Maybe the goal is to make it easier for new employees to join; maybe it is to allow plan loans; or maybe the company wants to change the way it allocates profit sharing contributions. These changes can usually be easily accomplished by simply amending the plan. While safe harbor plans can be amended just like any other, there are restrictions on the timing.

Back in 2007, the IRS published an announcement saying that it is acceptable for safe harbor plans to adopt mid-year plan amendments to add a Roth deferral option or to permit hardship distributions, as long as the plan sponsor provided a supplemental safe harbor notice to describe the change.

It was initially thought that these were just examples of allowable amendments that made a plan more generous to employees. However, the IRS later clarified that because of the rule requiring safe harbor plans to remain in effect for a full 12-month plan year (described above), adding Roth and/or hardship provisions are the only changes that can be made to a safe harbor plan once the year has started. In other words, any other type of change can only be made at the beginning of the next plan year, no matter how much more generous the change might be to participants.

What is the moral to this story? Towards the end of each year, it is important to consider what changes might be warranted or preferred in the subsequent year so that amendments can be prepared and signed timely. In addition, since plan provisions must generally be incorporated in the annual safe harbor notice, confirming any plan changes prior to the December 1st notice deadline for calendar year plans (30 days before the start of the plan year) is strongly recommended. careful when and how you use them

When a participant who is partially vested terminates employment and takes a distribution, the non-vested portion of his or her account that stays behind is called a forfeiture. Most plans specify that such amounts can be used in one of three ways:

  • Pay allowable plan expenses;
  • Offset any company contributions; or
  • Allocate to remaining participants as additional contributions.

Forfeited amounts must be used each year and cannot be carried from one year to the next. If the forfeitures are not used for one of the first two options listed above, then they must be allocated as additional contributions.

For a safe harbor plan, the option that probably comes to mind is to use the forfeitures to fund the safe harbor contributions. Although that would be an easy solution, unfortunately, the IRS does not permit the use of forfeitures for this purpose. The reason is that safe harbor contributions must be fully vested at the time they are deposited. Since forfeitures arise from non-vested contribution sources, such as non-safe-harbor match or profit sharing, they couldn't possibly meet that requirement.

That leads to another challenge. If forfeitures cannot be used to pay for the safe harbor contribution and there are not enough plan expenses to absorb them, the only other choice is to allocate them as additional contributions.

However, if the accumulated forfeitures are not "discovered" until a future year, the only option is to allocate them as profit sharing contributions. This risks the loss of the plan's exemption from the top-heavy rules since there would be an allocation to participant accounts other than deferrals and safe harbor contributions.

What is the moral to this story? If your plan has accumulated accounts that are subject to vesting, it is important to monitor forfeiture activity on an ongoing basis. That allows any forfeited amounts to be applied to fees as soon as possible.

Oops! Forgot to provide the safe harbor notice!

Retirement plans have many moving parts, and business owners and managers often have quite a few competing demands on their time beyond managing the company 401(k) plan. The result? Accidents will happen despite everyone's best intentions.

The IRS does have a correction program for such accidents. It is called the Employee Plans Compliance Resolution System (EPCRS), and it includes sample corrections for some of the more common oversights that arise. One oversight it does not address is how to correct a situation when an employer either does not provide a safe harbor notice at all or provides it after the deadline.

In its recent e-newsletter, Retirement News for Employers, the IRS provided some rather pragmatic guidance on addressing this issue. The newsletter does indicate that if the lack of notice meant that a participant was deprived of his or her ability to defer, the employer likely needs to make corrective contributions to make up for the missed opportunity. However, if employees were otherwise provided with adequate information about the plan and were given ample opportunity to take advantage of all its features, the IRS suggests that the oversight can be treated as an administrative error and that the plan sponsor must revise its procedures to make sure future notices are provided timely.

What's the moral to this story? EPCRS can generally only be used to self-correct if the plan sponsor had existing policies and procedures in place that were designed to prevent the failure being corrected, and the newsletter's reference to revising procedures is further confirmation that there must have been a procedure there in the first place. As a result, it is highly recommended that employers confirm they have internal controls in place in order to preserve the ability to self-correct if accidents happen.


As you can see, the safe harbor 401(k) plan continues to evolve. There are certainly many advantages to this design and there are additional restrictions as well. If you have a safe harbor plan or are thinking of adding the feature, the moral to this story is that working with an experienced provider who can help you plan ahead is a great way to build in added flexibility.

This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.

© 2014 Benefit Insights, Inc. All rights reserved.

February 2014 Newsletter - Boomerang Employees: Rehires and Retirement Plans

Boomerang Employees: Rehires and Retirement Plans

February 2014 Newsletter

Boomerang Employees

A boomerang employee (as we will use that name in this article) is, quite simply, one who leaves and then comes back to work…a rehire. As is so often the case, the retirement plan rules related to rehires are quite different than those that apply to other areas of employment and benefits. Whether rehiring a former employee is a rare occurrence or part of your regular course of business, it is important to understand how these rules work.

First Things First

The first step in this analysis is to determine whether the worker is truly a rehire. You may be thinking that it is pretty obvious, but there can be some ambiguity about whether there was a termination in the first place. If there wasn't, there can be no rehire. Let's consider several scenarios.

Leave of Absence

There are many reasons an employee may take a leave of absence, and there are several other laws, including the Family and Medical Leave Act and the Uniformed Services Employment and Reemployment Rights Act, that may confer special employment rights on those who are covered. As a result and depending on the specifics, a leave of absence may not be a termination of employment; therefore, when the employee returns to work, he or she is not truly a rehire.

Inconsistent Work Schedule

Some employees may have inconsistent work schedules, working more hours one month and very few or no hours in another. This may be more prevalent in industries such as retail sales or hospitality. There are several other fairly common arrangements that fall into this category:

  • “Per Diem” Employees: work a day here and there on an as-needed basis (often in healthcare-related fields);
  • Interns: consistently work during each school break but do not work at all while school is in session;
  • Seasonal Employees: return to work at the same general time each year, e.g. grounds keepers at a golf course, but do not work in the off-season.

Are these employees terminated during each gap in their work schedule or are they continuously employed but not on the schedule? Again, answering that question is a critical first step in determining whether the rehire rules apply.


Another variation is when an employee transfers from one division, location or subsidiary to another. When the transfer is within the same “employer,” it is not a termination and a rehire, it is continuous employment…even if the divisions or locations have separate payrolls or financial reporting structures. The same is true for transfers of employment classification such as a union employee who discontinues his or her union membership and is reclassified as a non-union employee.

You may be wondering why there are quotes around the word employer. The reason is that there are complex rules that require multiple companies with certain overlap in ownership or business operations to be treated as a single employer for retirement plan purposes. An employee who transfers from one such company to another within the same group is again treated as continuously employed.

Rules of the Road

Once the above determination has been made, there are two general rules we must review. They are known as the rule of parity and the one-year holdout rule.

Rule of Parity

The rule of parity establishes the requirements that allow an employee's pre-termination service to be permanently disregarded upon rehire. In short, the employee in question must have been:

  • A participant in the plan prior to termination;
  • 0% vested at the time of termination; and
  • Terminated long enough to incur five consecutive breaks in service.

All three requirements must be met. The first is straightforward; however, keep in mind that someone is a participant if they are eligible for the plan even if they have not chosen to contribute.

The vesting requirement is a bit trickier and depends on the employee's actual account. Since salary deferrals must be fully vested at all times, any employee who has made 401(k) deferrals does not meet the vesting requirement. In other words, there are no circumstances that would allow the company to ignore pre-termination service regardless of how much time has passed between termination and rehire.

If the employee has never deferred or the plan doesn't allow deferrals, we turn our attention to company contributions. It is obvious whether a person has vesting credit if a contribution has been made, but what about an employee who is vested but has no account balance? For example, how would we treat an employee who has worked for the company for two years and is 20% vested but the company has not made any contributions during that time frame? The employee is 20% vested in an account with nothing in it.

The rules are somewhat open to interpretation on this point but seem to suggest that such an employee would be treated as 0% vested in applying the rule of parity. Others argue that such an interpretation seems contrary to the intent of the law. Should this situation arise, it is a good idea to seek assistance from an experienced consultant and to make sure that whatever interpretation is adopted is applied consistently.

Breaks in Service

That brings us to five breaks in service. As a general rule, a break in service is a plan year during which an employee works fewer than 501 hours of service. A couple of quick examples may help here.

Arthur terminates employment on January 31, 2014, having worked 100 hours year to date. Assuming he isn't rehired before then, he would experience his first break in service at the end of 2014 and his fifth at the end of 2018.

Penelope terminates employment on May 31, 2014, having worked 800 hours year to date. Since she completed at least 501 hours of service prior to termination, she does not have a break in service for 2014. That means her first break is in 2015 and her fifth is in 2019.

For plans that use the elapsed time method of counting service, the fifth break in service occurs when the employee has been terminated for 60 consecutive months.

One-Year Holdout Rule

This rule is much simpler in many ways and allows a company to temporarily ignore a rehire's pre-termination service. Under the one-year holdout rule, once an employee incurs a single break in service, pre-termination service is ignored until he or she completes one year of service following rehire. Then all pre-break service is immediately reinstated retroactive to the date of rehire. A break in service is measured the same way as described above for the rule of parity, and a year of service generally means a 12-month period in which the employee works at least 1,000 hours.

Putting the Rules into Play

The above analysis is the hard part. If you've made it this far, putting those results into play is much easier. There are two main reasons that we care about all of these rules: to determine eligibility and vesting. Let's take a look at how the results apply to both of these important determinations.


An employee who didn't meet the plan eligibility requirements before terminating is the most straightforward—he or she must complete those requirements irrespective of breaks in service, etc. Someone who was a participant prior to termination rejoins the plan immediately on rehire unless either the rule of parity or one-year holdout rule applies.

A participant who satisfies all three requirements under the rule of parity is treated as a new hire as of the reemployment date and must satisfy the plan's eligibility requirements that are currently in place in the same manner as any other new employee. Keep in mind that it is somewhat unusual in a 401(k) plan for an individual to meet all of the rule of parity requirements, so proceed with caution and double-check your findings if it looks like a former participant will be treated as a new hire.

The one-year holdout rule can present some unique challenges since it provides retroactive credit for pre-termination service. Another example will help to illustrate.

Harold is a former participant who is rehired for 20 hours per week on December 1, 2013. Under the one-year holdout rule, he completes one year of service after his rehire on November 30, 2014, and his pre-termination service is reinstated retroactively to his rehire date, making him eligible for the plan in 2013.

If the company made a contribution for 2013, Harold is eligible to share in it even though the company could not have known it at the time they made the deposit. The company is obligated to make a 2013 contribution for Harold, but they would have to deduct it on their 2014 tax return.

Keep in mind, however, that other plan rules continue to apply. So, if the plan has a separate provision requiring a participant to work at least 1,000 hours in a plan year to share in a contribution, Harold would not receive a 2013 contribution since he would have only completed 80 hours of service from the December 1st reentry date through the end of the year.

Another quirk of the one-year holdout rule is whether and how it can be applied to a 401(k) plan. A 401(k) plan, by its nature, requires a participant to make a deferral election before the pay becomes available. By the time a participant retroactively reenters the plan under the one-year holdout rule, he or she has already been paid for a year making it impossible to defer. That could be interpreted as a violation of the terms of the plan. As a result, it is unusual for 401(k) plans to apply the one-year holdout rule.


Both the rule of parity and the one-year holdout rule are applied in a similar manner for vesting. There is, however, one very important difference related to the one-year holdout rule: the computation period for determining one year of service can be different for eligibility than for vesting. Specifically, it is counted from rehire date for eligibility, but the vesting computation period in many plans is always the plan year. So, using the above example, although Harold is rehired on December 1, 2013, he will not complete 1,000 hours by the end of the plan year (December 31, 2013) and would reset the clock on January 1, 2014. That means he would not be given retroactive credit for vesting until December 31, 2014, one month later than when his service was recognized for eligibility.


Dealing with boomerang employees can be challenging on many fronts. Establishing a procedure to review employment history will help meet those challenges with regard to the retirement plan. Both the rule of parity and one-year holdout rule are optional provisions, so it is critical to check your plan document. When questions arise, a call to an experienced TPA or consultant at the beginning will go a long way to preventing even more daunting challenges down the road.

This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.

© 2014 Benefit Insights, Inc. All rights reserved.

October 2013 Newsletter - How Do You Spell Relief? E-P-C-R-S

How Do You Spell Relief? E-P-C-R-S


Retirement plans are complicated beasts. The Pension Protection Act of 2006 was more than 1,000 pages long; one of the main reference books that retirement plan professionals use is more than 7,000 pages long; and there are countless other sets of rules and regulations that add tens of thousands more pages. All those pages mean a lot of moving parts, and all those moving parts mean that sooner or later, something is going to fall through the cracks no matter how much attention to detail is paid.

Fortunately, the IRS recognizes that honest mistakes sometimes happen, and they have established a program that allows for correction of those mistakes. It is called the Employee Plans Compliance Resolution System or EPCRS.

A Brief History

The IRS established the first correction program back in 1991. Over the next several years, it created several other programs for different types of plans and errors. Finally in 1998, all of the various programs were consolidated into EPCRS. Since then, the IRS has updated the program nine times, adding new corrections and adjusting methodologies along the way. Not only does this 20+ year history show the IRS commitment to voluntary correction, but it has also resulted in a mature program that provides many practical solutions.

Overview of EPCRS

The program is divided into three main parts—the Self Correction Program (SCP), the Voluntary Correction Program (VCP) and the Audit Closing Agreement Program (Audit CAP). SCP allows plan sponsors to correct certain types of mistakes on their own without seeking formal approval from the IRS, while VCP requires other types of corrections to be submitted to the IRS for its review and approval. In other words, these first two components are focused on helping plan sponsors identify and fix errors before the IRS gets involved.

Audit CAP, on the other hand, deals with the correction of mistakes once the plan is under IRS audit. Since it is preferable to address any issues before the IRS comes knocking, the remainder of this article will focus on SCP and VCP.

General Principles

Before getting into some of the specifics of how SCP and VCP work, it is helpful to understand some of the general principals of EPCRS. Essentially, the program is designed to place plan participants in the position they would have been in had the error in question not occurred in the first place. This may involve making additional contributions, revising compliance testing or reversing improper payouts.

EPCRS does include a number of sample corrections; however, it also offers the flexibility to craft custom fixes in unique situations or when one of the samples is not practical. One question that comes up from time to time is what to do about errors that go back multiple years. Although it can be inconvenient, EPCRS does require that full correction be made, including errors that may go back multiple years.

Types of Failures

EPCRS defines the following four broad categories of failures:

Operational Failures: By far the most common category, an operational failure is simply a failure to follow the terms specified in the plan documents. In other words, it is an error to operate the plan in a manner that is in any way inconsistent with its provisions, even if you are being more generous.

Plan Document Failures: This type of failure occurs when a plan document does not include certain mandatory language and often arises when a plan sponsor does not timely update its plan document after a law change.

Employer Eligibility Failures: When a company sponsors a type of plan it is not permitted to have, an employer eligibility failure occurs. An example of this would be a for-profit company sponsoring a 403(b) plan since those plans can only be sponsored by certain tax exempt organizations and public schools.

Demographic Failures: Last but not least is the failure to satisfy certain nondiscrimination tests such as the minimum coverage test.

The type of failure is an important factor in determining which part of EPCRS can be used. For example, SCP only allows for the correction of operational failures. All other failures must be corrected using VCP.

Self Correction Program

As discussed above, SCP allows plan sponsors to correct certain operational failures on their own, without submitting anything to the IRS for approval. For operational failures that are insignificant, there is an unlimited time frame for using SCP, even if the plan is being audited.

Significant failures, however, can only be corrected via SCP within two years following the year of the failure. In other words, a significant operational failure that occurs in 2013 would have to be corrected no later than December 31, 2015. If not corrected by that date, SCP is no longer available, leaving VCP as the only option. There are also limitations on when SCP can be used to correct significant failures once the plan is under IRS audit.

You are probably wondering who gets to make the call on significance. The answer is the IRS; however, they do provide some factors to consider. These include such items as the number of participants affected by the failure, the amount of plan assets/contributions involved relative to total plan assets and whether other failures occurred.

Although there is no formal approval process, it is strongly recommended that any SCP corrections be well-documented so there is clear proof in the event of a subsequent IRS audit.

Voluntary Correction Program

VCP allows for the correction of all types of errors at any time but, as we will discuss in this section, it includes a formal process for requesting IRS approval. One advantage is that while there is a properly submitted request pending, the failure in question becomes off limits if the plan is selected for audit. However, if the IRS audits the plan before the request is submitted, the plan can no longer use VCP.

Although the VCP process is usually straightforward, it can be a lengthy process and there are some traps for the inexperienced. Even the streamlined version of VCP requires a great deal of supporting documentation. Basically, the VCP package must include several IRS forms that require a narrative description of the failure(s) that occurred as well as the steps that have been taken to correct them.

If the correction requires calculations, the package should include, at a minimum, a description of the calculations, and sometimes the IRS will request a detailed participant-by-participant breakdown to confirm that all have been made whole.

Other items that must generally be included are copies of the plan document, any amendments, applicable nondiscrimination test results and the most recently filed Form 5500.

The IRS charges a fee to review the VCP application, based on the number of participants reported on Form 5500.

Number of Participants Fee

20 or fewer$750

21 - 50$1,000

51 - 100$2,500

101 - 500$5,000

501 - 1,000$8,000

1,001 - 5,000$15,000

5,001 - 10,000$20,000

Over 10,000$25,000

On receipt of the application, fee payment and supporting documentation, the proposed correction is assigned to an agent for review, which may include requests for clarification or additional information. Once the review is complete, the IRS issues a compliance statement indicating its acceptance of the correction. Sometimes, the review process is as short as three or four months but, other times, it can take a year or more, depending on the complexity of the situation and IRS workload.

Sample Corrections for Common Failures

Exclusion of Eligible Employee from making 401(k) Contributions

Every now and then, a plan sponsor may overlook an employee who has met plan eligibility requirements or may forget to implement a deferral election. The correction is for the employer to make a contribution on the employee's behalf to compensate him or her for the missed deferral opportunity. To the extent there was a matching contribution, that amount must be made up as well.

The first step is to determine the missed deferral opportunity based on the type of plan and the circumstances involved.

DescriptionMissed Deferral Opportunity (MDO)

Election not implementedActual amount of election

Traditional 401(k) PlanAverage of group, i.e., HCE or NHCE*

403(b) Plan3% or amount subject to 100% match

Catch-Up50% of limit

Safe Harbor Match3% or amount subject to 100% match

Safe Harbor Nonelective3%

Qualified Automatic Contribution ArrangementBased on escalation schedule

*Highly Compensated Employee or Non-Highly Compensated Employee

The second step is to calculate the corrective contribution based on the missed deferral opportunity from step #1 and the type of deferrals in question.


Pre-Tax Deferral50% of MDOQNEC*

Roth Deferral50% of MDOQNEC*

After-Tax Contribution40% of MDOQNEC*

MatchMatch formula x MDONonelective

*Qualified Nonelective Contribution

The contribution along with an additional amount to compensate for lost investment gains are then deposited into the participant's account in the plan.

If the error is insignificant or is discovered and corrected within two years, the correction can be made using SCP. On the other hand, if the error is significant and is beyond the two-year correction window, the details of the correction should be submitted to the IRS for approval under VCP.

Failure to Timely Update Plan Document for Law Changes

When Congress passes new laws that impact the retirement plan rules or the IRS/DOL update regulations, it is usually necessary to amend plan documents to reflect those changes, and there are specific time frames in which those amendments must be adopted. Occasionally, a plan will miss the deadline, causing a plan document failure.

Since SCP can only be used to correct operational failures, this failure must be corrected via VCP. The plan sponsor simply adopts the required amendment and submits it to the IRS along with copies of any related plan documents. Depending on the nature of the missed amendment(s), the plan sponsor may be eligible for a reduced user fee of $375 rather than the fee based on the number of plan participants.


EPCRS is an invaluable tool for correcting plan failures before the IRS finds them. Although many plan corrections appear straightforward, it is important to work with an experienced professional when going through the plan correction process to make sure that fixing one error doesn't accidentally create another. With more than 20 years and 33,000 corrections under its belt, EPCRS will continue to evolve to allow plan sponsors to bring their plans back into compliance.

This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.

© 2013 Benefit Insights, Inc. All rights reserved.

August 2013 Newsletter - Cross-Testing: The Right Tool for Many Jobs

Benefit Insights®

August 2013 Newsletter

Cross-Testing: The Right Tool for Many Jobs

In this issue:

As the national economy continues its recovery, more and more businesses are beginning to see their financial situations improve to near pre-recession levels. Companies that have not thought about making profit sharing contributions for years are starting to consider their options.

Just as the economy as a whole or the circumstances of a particular company change over time, companies should review their retirement plans to make sure the design changes with them.

Companies that find themselves on solid footing may find themselves thinking of making employer contributions to their retirement plans. Whether the goal is to maximize benefits to the owners, reward employees, reduce tax liability or some combination of all of these, the cross-tested plan design is one worth considering.


Although there are a number of ways a company may choose to divide a profit sharing contribution among the employees, there are three methods that are commonly used.

Salary Proportional (a/k/a Pro Rata):  This method divides the contribution based on the proportion that each individual participant's compensation bears to the total compensation of all eligible participants. It results in each person receiving a uniform percentage of his or her pay.

Integrated (a/k/a Permitted Disparity):  This method considers that employees whose pay exceeds the taxable wage base do not receive social security benefits on their total compensation and allows those people to receive a larger profit sharing contribution to help equalize the benefit.

Cross-Tested (a/k/a New Comparability):  This method allows employees to be divided into groups based on valid business classifications, i.e., owners and employees, and provides different levels of contribution to each group.

The first two methods are relatively straightforward and are considered to be "safe harbor" allocation methods, meaning that they automatically satisfy certain nondiscrimination requirements. However, with ease and safe harbor status often comes limited flexibility.

The cross-tested method, on the other hand, provides a great deal of flexibility but also comes with a few more rules to follow and must undergo additional testing to ensure it complies with the nondiscrimination rules. For companies that are willing to accept a little more complexity, new comparability plans can be used to meet a number of business goals.

The General Concept

Cross-tested designs generally rely on the time value of money to allow companies to maximize benefits to the owners who may have spent the earlier parts of their careers reinvesting everything into growing the business. Since they are closer to retirement, it takes a larger contribution to fund an equivalent benefit than it does for someone who is just entering the workforce.

A simple example may help to illustrate. A company has two participants in its plan—the owner (age 55) and an employee (age 35)—and it wants to provide a retirement benefit of $100,000 to each one at age 65. Assuming there are no investment gains, the owner would need a contribution of $10,000 per year for 10 years to reach the target benefit, while an annual contribution of $3,333 would get the employee to the goal.

Once you factor in an assumed interest rate, the spread gets even greater. The actual calculations and tests are much more involved, but this is the general concept.

Unlike a defined benefit plan in which the company would have to commit to making those contributions each and every year, in a cross-tested profit sharing plan, the company has the discretion to contribute more or less or nothing at all each year.

The Ground Rules

There are several additional rules that apply to cross-tested plans.

Contribution Groups

As noted above, the plan must define the employee groups that are used to allocate contributions. In the early days of this design, many plans would specify groups based on company ownership, officer status, division, office location, etc. Some often-seen combinations were owners and employees; partners, associates and non-lawyers; doctors, nurses and staff; etc.

More recently it has become common for plans to specify that each participant makes up his or her own group, providing maximum flexibility in making contributions. While a law firm could still decide to contribute the same amount for all non-lawyers, it could decide to contribute more or less for certain employees as long as all of the other testing requirements are met.

Contribution Gateway

To ensure that rank-and-file employees receive enough of a benefit relative to the highly compensated employees or HCEs (generally the owners and those earning more than $115,000 per year), the company must provide a minimum gateway contribution to the non-HCEs. This is kind of like the cover charge to get into the cross-testing club. In other words, it does not guarantee the plan will pass the other nondiscrimination tests.

The amount of the gateway contribution is the lower of 5% of compensation or one-third of the highest percentage allocated to any HCE. For example, if the highest HCE allocation is 9% of pay, the gateway contribution to the non-HCEs is 3%. Once the highest HCE contribution reaches 15%, however, the gateway is capped at 5%.

For 401(k) plans that make a flat 3% of pay contribution to meet the safe harbor rules, that safe harbor contribution actually counts toward the gateway requirement if the company also decides to make a cross-tested profit sharing contribution. In other words, assuming all other tests are met, it may be possible for the sponsor of a safe harbor 401(k) plan to contribute an additional 6% of pay on behalf of the owners (bringing the total to 9%) without having to contribute anything more for the employees.

Average Benefits Test

This is another nondiscrimination test the plan must pass. Essentially, all of the contributions made on behalf of each employee (in some cases, including 401(k) deferrals) are added together and converted to a benefit at the plan's retirement age using several factors taken from IRS tables. The average benefit of the non-HCEs is then compared to the average benefit of the HCEs to make sure they are within the appropriate range of each other.

Some plans will pass the test giving only the gateway contribution to the employees and providing the maximum to the owners. Other plans will need to provide additional contributions to some or all of their non-HCE participants in order to increase the average benefit to a passing level.

Since this test is based on the demographics of the workforce, the results are likely to change each year depending on the degree to which the demographic composition fluctuates. Using a small medical practice as an example, the addition of a new physician who is much younger than the other doctors and maybe some of the longer-term staff could cause a plan that was once passing with ease to fail.

Another common cause for extreme demographic shifts is when the child of an owner comes to work for the company. Since children are generally attributed their parent's ownership, they will be considered HCEs even though their actual pay might be very low. Companies anticipating such changes should speak to their TPAs ahead of time to determine the impact to the average benefits test and consider any design modifications that might avoid a problem.

Practical Uses for Cross-Testing

We have already discussed using this design as a means of maximizing the benefits for owners or certain key individuals; however, there are other situations when cross-testing can come in handy.

Rewarding Employees

With the improving economy, some companies are also beginning to pay employee bonuses again. But, along with the cost of the bonus itself comes additional payroll taxes. By using a cross-tested plan design, a company could make individualized profit sharing contributions to certain employees without incurring the cost of the payroll taxes.

Not only does this option eliminate the extra payroll cost, it also helps to address increasing concerns of employee retirement readiness that are becoming more prevalent among companies. Recognizing that a bonus is meant to be a reward, and many employees appreciate cash in hand more than a contribution, some companies will split the "bonus" amount, contributing half to the plan and paying out the other half in cash.

Reimbursing Surrender Charges or Market Value Adjustments

From time-to-time when a company removes certain investment options from the menu, that change can trigger a surrender charge to all those invested in the option being eliminated. This most often occurs in conjunction with a change in service providers. Some companies facing this situation do not want their participants to be harmed as a result of the change and would like to "reimburse" them by contributing to the plan.

The challenge is that these types of charges are usually assessed proportionately based on account balance; however, the money the company deposits as a reimbursement must be allocated as a contribution. Plans that provide for pro rata or integrated allocations would have to allocate the reimbursement accordingly. By amending the plan to provide for a cross-tested allocation with each participant in his or her group, the company could target the contribution to those impacted by the surrender charge.

It might not be possible to make everyone whole, but this option can sometimes get very close. For example, to the extent any HCEs share in the allocation, it could trigger the gateway requirement for all non-HCEs (including those not affected), so it may be necessary to find another way to compensate HCEs. In addition, some people who share in the surrender charge will be former employees, and contributions can only be allocated to those who are participants during the year of the contribution. While not a perfect solution, it can be a step in the right direction.


A well-designed cross-tested plan can be a very effective tool for satisfying a variety of company objectives, but it also comes with a few more moving parts. As a result, it is even more important to work with a knowledgeable TPA or consultant who will ask the right questions to understand your goals and design a plan tailored to meet them.

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This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.

© 2013 Benefit Insights, Inc. All rights reserved.