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June 25, 2009

Why You Need To Update Your 401(k) Documents

Jerry Kalish

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Summary

There are many tax advantages you enjoy by participating in your company’s retirement plan; and this goes if you own your own company, too.

There are many tax advantages you enjoy by participating in your company’s retirement plan; and this goes if you own your own company, too. In order to enjoy them, you of course must comply with federal rules governing qualified retirement plans. And one of those rules requires that the plan be in writing and amended in a timely fashion in order to reflect changes to its provisions as well as changes in the tax laws.

In some cases, these changes may be handled with "snap-on" amendments. In other cases, however, the plan must be rewritten because of the number and complexity of the changes in the law--referred to as a "restatement," or, more simply, a "re-do." And that time is now.

WHY NOW?

In June 2001, a major piece of tax legislation was passed. The new law, the Economic Growth and Tax Reconciliation and Relief Act, or EGTRRA, made significant changes to the Internal Revenue Code as it affected retirement plans.

Because it was eight years ago, many people may have forgotten about its impact on retirement plans. But EGTRRA actually made dramatic enhancements: permitting employees to save more in employer plans and IRAs; easing portability among various plans; and providing significant administrative and fiduciary relief to employers who sponsor retirement plans. EGTRRA also included measures like the Saver's Credit, which benefits low-income savers, and catch-up contributions, which permit older workers to save more under the plans.

Until recently, employers only had to adopt interim amendments to conform to EGTRRA. But now, the IRS requires that all employers amend and restate their written documents to incorporate the changes made by EGTRRA.

Specifically, the IRS issued a Revenue Procedure that implemented a formal (and complicated) system, under which all plan documents are required to be restated by specific dates. The dates depend upon the type of plan document and the employer EIN. I am discussing the "redo" or restatement relating to pre-approved plans, including 401(k) and profit-sharing plans, since such plans account for roughly 94% of all qualified retirement plans.

These pre-approved defined-contribution plans generally need to be redone by April 30, 2010. But from a practical standpoint, it could be sooner.

Why sooner? It's because another tax law, the Pension Protection Act (or PPA), had not been enacted when pre-approved EGTRRA documents were submitted to the IRS for review (the PPA passed in 2006), meaning that the IRS did not include the changes made by the PPA into the EGTRRA restatement process.

Thus, each employer will be required to adopt a separate PPA amendment by the end of the plan year beginning in 2009. So for cost and efficiency purposes, it might be best to handle EGTRRA and the PPA at the same time.

WHAT DOES THE IRS REQUIRE?

Generally, you will need to craft:

1. A restated Plan Document.
2. A Resolution adopting the restated Document.
3. A separate Trust Document (in some cases).
4. An Adoption Agreement (for prototype documents).
5. A restated Summary Plan Description that must be distributed to all participants and beneficiaries.

WHAT YOU SHOULD KEEP IN MIND

* Take special care not to eliminate or reduce "protected benefits”. These include lump-sums distributions and annuities, as well as the timing of distributions, such as an early retirement provision.

* Consider submitting the plan to the IRS for a favorable "determination letter" that applies specifically to the employer's plan. Employers with pre-approved plans automatically have assurance that the plan language satisfies the IRS requirements, assuming no changes are made to what was approved. However, based on an employer’s individual circumstances, it may be desirable to apply for a determination letter covering periods prior to the effective date of the restatement.

* The cost of restating a plan will vary, depending on the type of plan. This cost to restate the plan for IRS compliance may be paid from the plan's assets if the plan document permits.

* Thoroughly review the plan to make sure that it still meets the needs of the employer and the employees. This could be an opportunity to make plan design changes as part of the restatement process.

WHAT HAPPENS IF YOU MISS THE DEADLINE?

It can be a serious matter if you miss the deadline: the IRS can disqualify the plan, meaning it would lose its tax-favored status:

* You would lose the deductibility of employer contributions to the plan;
* Your employees’ vested account balances would become immediately taxable; and
* The trust would lose its tax-exempt status and become a taxable trust.

Bad stuff, in other words. Disqualification can be avoided by using an IRS correction program, which involves paying a sanction and submitting an updated plan--an option you should be thankful exists but which you should avoid resorting to.

IN SUMMING UP...
It is the plan fiduciary's responsibility to ensure that the plan is updated and signed by the deadline. The restatement process can be time-consuming, and should be properly planned to absolutely ensure that the deadline is met. This means starting in 2009.

This article is being provided for general informational purposes only and should not be considered tax or legal advice. Employers should discuss their individual circumstances with their advisors.


Jerry Kalish is founder and President of National Benefit Services, Inc., a Chicago-based employee benefit consulting and administrative firm that serves private-held companies, publicly traded companies, and public sector employers. He blogs at The Retirement Plan Blog and can be reached at jerry@nationalbenefit.com.


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