A qualified retirement plan can provide many benefits to employees as well as the sponsoring employer. Employees are ultimately provided with income to help sustain their lifestyle in their post-retirement years. Employers are given a tax deduction for contributions made to the plan, which helps them provide a valuable fringe benefit and boost employee morale.
In 1974 Congress passed the Employee Retirement Income Security Act (ERISA), which provided much needed protection for workers’ retirement benefits. That law, as well as applicable sections of the Internal Revenue Code (IRC), established a host of administrative rules which must be followed in order for a plan to maintain its qualified status and avoid excise taxes and fiduciary penalties. Following is a summary of the ongoing compliance requirements for qualified plans.
Nondiscrimination Testing
One of the basic requirements of a qualified plan is that it not discriminate in favor of employees who are considered “highly compensated employees” (HCEs). HCEs are employees who own more than 5% of the employer in the current year or the previous year (including family attribution rules) or who earned more than $90,000 in the previous year.
Coverage Requirements
The first area of possible discrimination involves the coverage requirements of IRC section 410(b). This comes into play where a plan is established for only a portion of the employer’s staff and not the entire company. Testing is done on an annual basis to insure that the percentage of the company’s non-HCEs covered under the plan is at least 70% of the percentage of the company’s HCEs that are covered. Alternatively, the plan can pass a more complicated “average benefits test” which illustrates that the benefits provided do not discriminate in favor of the HCEs.
Employer Contributions
Money purchase pension plans and profit sharing plans contain a formula for allocating employer contributions, although in profit sharing plans contributions are often discretionary (optional) from year to year. Such contribution allocations must not violate nondiscrimination rules. While the formula established under the plan generally must prohibit discrimination, certain facts and circumstances need to be considered each year. For example, a plan may require employment on the last day of the plan year to be eligible to share in the contribution, as well as completion of up to 1,000 hours of service. But if a significant number of employees who worked over 500 hours are eliminated from the allocation because of these rules, the plan may be considered discriminatory. This could result in having to include some of the otherwise ineligible participants in the allocation.
401(k) Plans
Plans that allow salary deferrals, matching contributions and/or other employee contributions must test these contributions for discrimination at the end of each plan year (except safe-harbor 401(k) plans). The ADP (actual deferral percentage) and ACP (actual contribution percentage) tests compare contributions made on behalf of the HCEs with contributions made on behalf of the non-HCEs. Generally, the HCEs are allowed an average percentage that is somewhat larger than the average for the non-HCEs. The differential varies depending upon the non-HCE contribution level.
Plans that don’t pass the ADP and/or ACP test usually satisfy the test(s) through corrective distributions, although other methods are available such as making additional employer contributions. A failed test must be corrected within 12 months of the end of the plan year. However, corrective distributions made more than 2½ months after the plan year-end will be subject to a 10% excise tax.
Contribution and Benefit Limitations
IRC section 415 provides the maximum benefit and annual additions limitations for each participant. For plan years beginning in 2004, the maximum annual retirement benefit that can be provided in a defined benefit pension plan is $165,000. In defined contribution plans, the maximum annual additions (i.e., total contribution and forfeiture allocations) is the lesser of 100% of a participant’s compensation or $41,000. For benefit and contribution calculation purposes, the maximum compensation that can be utilized is $205,000.
The maximum salary deferral for 2004 is $13,000. If permitted by the plan, those age 50 and older can defer an additional $3,000 as a catch-up contribution (even if it causes the annual additions to exceed $41,000). In Simple 401(k) plans, the maximum deferral is $9,000, and the catch-up limit is $1,500.
The plan administrator must make sure that these limits are not exceeded. Excess annual additions must be distributed to the participant, reallocated or transferred to a suspense account, in accordance with the plan provisions. Excess deferrals must be distributed by April 15th following the calendar year of the excess. Since the deferral limit includes all plans in which an employee participated during the calendar year, it is the employee’s responsibility, if he participated in salary deferral plans of more than one employer, to notify such employers of any excess.
Top Heavy Testing
Each retirement plan must perform an annual test to determine if it is “top heavy.” A plan is considered top heavy if key employees (generally owners and highly paid officers) have more than 60% of the total account balances (defined contribution plans) or present value of accrued benefits (defined benefit plans) of all plan participants. The determination date for the calculation of top heavy status is the last day of the previous plan year.
If a plan is determined to be top heavy, the employer must provide certain minimum contributions or benefits, and meet one of the enhanced vesting schedules.
Reporting Requirements
Form 5500 Annual Report
Most plan sponsors must file an annual report, Form 5500, with the Department of Labor by the end of the 7th month following the plan year-end. The deadline may be extended an additional 2½ months by filing an extension. Where the owner of the company is the only participant, the plan is exempt from filing a Form 5500 until total assets of all plans of the employer exceed $100,000.
Plans with 100 or more participants at the beginning of the year (“large plans”) are required to attach an accountant’s audit report to the Form 5500. An exception applies for plans with no more than 120 participants that were able to file as a small plan the previous year. Small plans are only exempt from the audit requirement if 95% of the assets are “qualifying plan assets” or if a fidelity bond is purchased for non-qualifying assets and a notice requirement is satisfied in the summary annual report (see below). Qualifying plan assets include assets held or issued by a registered investment company or financial institution, qualifying employer securities, participant loans and participant-directed investments.
ERISA requires plan fiduciaries to obtain a surety bond for at least 10% of the value of plan assets. The amount of the bond in force must be reported on Form 5500.
Form 1099-R
Distributions from qualified plans are required to be reported to the IRS on Form 1099-R with a copy furnished to the participant. This is true even if the distribution is nontaxable, as in the case of a direct rollover to an IRA or other qualified plan. Form 1099-R must also be filed for a defaulted loan treated as a distribution. The deadline for furnishing the participant’s copy is January 31st following the calendar year of distribution.
PBGC Premiums
Defined benefit plans that are subject to the federal government’s PBGC (Pension Benefit Guaranty Corporation) insurance program must pay the required annual premium accompanied by the appropriate PBGC forms. The deadline varies depending upon the size of the plan and its funding status.
Participant Notifications
Certain information must be provided to participants throughout the year. Here is a list of the necessary notifications:
Summary Annual Report: A summary of Form 5500 must be provided to each participant within two months of the 5500 filing deadline (including extensions).
Summary Plan Description (SPD): This document which summarizes the plan provisions should be provided to new participants within 90 days of their plan entry date. The SPD should be updated every five years if the plan has been amended, or every ten years if no amendments have been adopted.
Summary of Material Modifications: When a plan amendment results in a material modification of one or more plan provisions, an explanation of the amendment must be provided to participants within 210 days of the end of the plan year in which the amendment was adopted.
Benefit Statements: Most plans provide benefit statements to participants at least once a year and, if not, are required to do so upon request. Pension plans must automatically provide a benefit statement when a participant terminates employment or has experienced a one-year break in service within 180 days of the close of the plan year in which such termination or service break occurred.
Safe-Harbor Notice: 401(k) plan sponsors who elected to make safe-harbor contributions to avoid ADP and ACP testing must give out a safe-harbor notice within a reasonable time before the start of the plan year. A notice distributed between 30 and 90 days before the first day of the plan year will automatically be considered timely.
Distribution Forms: Participants who are entitled to a distribution of their benefits should be provided with appropriate distribution forms as well as tax and rollover information. Plans that contain annuity distribution options must also furnish a notice explaining spousal rights and comparing equivalent values of optional forms of benefits.
Qualified Pre-Retirement Survivor Annuity (QPSA) Forms: Plans that offer annuity distribution options must provide a written explanation of the QPSA and a waiver form to each participant between the ages of 32 and 35. Where the QPSA first becomes available after age 35 (as with participants hired after that age), the materials must be provided within one year of applicability. Participants who terminate employment before age 35 should be notified within one year of separation.
Investment Information: Many plans today, particularly 401(k) plans, allow participants to direct the investments in their accounts. In order for plan fiduciaries to limit their liability for poor investment results in such accounts, ERISA section 404(c) requires that participants be given the opportunity to exercise control over their accounts. Consequently, they must be furnished with sufficient information about the investments available to them under the plan. Prospectuses and other reports about available investments must be provided on a regular basis (and upon request), and statements showing account balances and activity should be provided at least once every three months.
Blackout Notice: When investment direction, loans or distributions will be unavailable to participants, as in the case of the transfer of plan assets from one custodian to another, a blackout notice must be provided between 30 and 60 days before the blackout period begins.
Conclusion
There are numerous administrative procedures and reporting requirements that must be followed throughout the year to keep a qualified retirement plan in compliance with ERISA and the Internal Revenue Code. Failure to comply can result in fines, excise taxes and even plan disqualification. A properly administered plan can be a valuable fringe benefit for employers and employees.
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.
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Spring will arrive soon, promising new growth and a fresh beginning. It could also be the perfect time to do some spring cleaning for your plan. Let’s look at some areas that you might consider reviewing to ensure your retirement plan is operating efficiently.
Document your processes and procedures to make certain that plan tasks can be handled in case of any absences during an enrollment or pay period. Having a backup in place can prevent errors and delays that could lead to penalties.
Make sure to have a process in place to notify all new enrollments of their eligibility, regardless of whether the plan has automatic enrollment. Depending on the timing for plan entry, including the plan enrollment paperwork with the new hire paperwork could make entry easier for you. Please reach out with any questions regarding when an employee enters the plan.
Deposits of employee deferrals and loan repayments must be submitted to the plan as soon as possible to avoid penalties and corrections. For plans with less than 100 participants, a safe harbor rule allows deposits to be made within seven business days. For larger plans, the expectation is that the money will be deposited more quickly. Depositing these funds on the pay date will avoid the possibility of being late.
Monitoring deferral contribution limits during the calendar year will avoid refunds after year end. Make sure that your payroll is set up to stop deferrals once the limit is reached, including any catch-up contributions for those who have reached age 50.
To keep the plan in compliance, employer contributions must be deposited timely. Due dates are impacted by the type of contributions, required status and tax deductibility. If you have questions on when to deposit your employer contribution or even whether to make an employer contribution, please contact us.
Most plans must be covered by a fidelity bond. The minimum coverage is 10% of plan assets (rounded up to the next $1,000) and the maximum coverage is $500,000. Additional requirements apply to plans with employer securities or non-publicly traded assets. If your fidelity bond is insufficient, now is the time to raise the coverage. Inflation clauses that increase the bond amount as the plan assets increase can ensure that your bond coverage is always adequate. Contact us or your insurance provider if you don’t have a fidelity bond.
Another area to review is communication with participants. Helping your employees understand and trust the plan can increase their contributions. Be sure that your procedures include distributing any plan-related communications—including required participant notices.
Distributions also involve communication, including some of the aforementioned notices. Discussing distribution options with terminated participants, possibly as part of an exit interview, can help to reduce risk of lost participants. We’ll provide instruction on distributions for force-out distributions for small balances, testing corrections and required minimum distributions.
Your plan document is the legal source on how the plan should be administered; operating within its parameters is critical. It’s always worth taking time to review the plan document to ensure that you fully understand and are following its provisions. We’ll cover more details about the plan document later in this newsletter. We’re here to support you in keeping your plan in compliance. Please feel free to reach out with any questions.
Addressing the Challenge of Uncashed Distribution Checks
Uncashed distribution checks present a persistent and often overlooked challenge for retirement plan sponsors. Despite the best efforts of plan administrators, some participants fail to cash their distribution checks, leading to administrative burdens, fiduciary concerns and potential compliance issues. A recent publication by Retirement Management Services (RMS) sheds light on this issue and offers practical guidance for employers seeking to manage and mitigate the risks associated with uncashed checks.
Uncashed checks can arise for various reasons. Participants may have moved without updating their contact information, may not recognize the check as legitimate or may simply forget to deposit it. Regardless of the cause, the responsibility for addressing these uncashed funds ultimately falls on the plan sponsor. This creates a fiduciary obligation to act in the best interest of the participant while ensuring compliance with IRS and Department of Labor (DOL) regulations.
Sponsors are encouraged to maintain up-to-date contact information for all plan participants and to follow up promptly when checks remain uncashed. This may involve sending reminder letters, making phone calls or using certified mail to confirm receipt. In some cases, plan sponsors may also consider using electronic payment methods to reduce the likelihood of checks going uncashed in the first place.
The IRS and DOL have issued guidance on how to handle these situations, including the use of forfeiture accounts and escheatment to state unclaimed property programs. However, these options come with their own set of rules and potential pitfalls. For example, using a forfeiture account may require the plan document to explicitly allow for such treatment. Escheatment laws, which allow the government to assume control of unclaimed property, vary by state. As such, plan sponsors must carefully evaluate their options and consult with legal or compliance experts as needed.
Another important consideration is the documentation of all the efforts made to contact participants and resolve uncashed checks. Maintaining a clear audit trail can help demonstrate fiduciary prudence and protect the plan sponsor in the event of an audit or legal challenge. It is extremely important to have a written policy in place that outlines the steps to be taken when a check remains uncashed beyond a certain period.
By taking a proactive, well-documented and compliant approach, employers can fulfill their fiduciary duties, reduce administrative burdens and ensure that participants receive the benefits they are entitled to.
Source: Retirement Management Services – “Uncashed Distribution Checks” https://www.consultrms.com/Resources/59/Plan-Sponsor-Tips-and-Help/212/Uncashed-Distribution-Checks
Divorce and the Retirement Plan
When a participant in a qualified retirement plan undergoes a divorce, the participant’s account balance may be an asset that is split with the former spouse. As the plan exists for the exclusive benefit of its participants, a court order is required to transfer the participant’s benefits to the ex-spouse. Once approved by the plan administrator, this court order is called a Qualified Domestic Relations Order (QDRO).
The QDRO is a judgment, decree or order that must be issued by a state authority (usually a court). It can be part of the divorce settlement or it may be a separate document. Because of the serious nature of separating the participant’s account balance, the QDRO is more than just an agreement made by both parties — it must also be signed by a judge.
A QDRO will describe how to divide the participant’s account balance between the participant and the ex-spouse, referred to as the alternate payee. In some cases, a set dollar amount will be allocated; in others, a percentage of the account may be designated. In the latter case, the amount assigned to the alternate payee represents the given percentage of the participant’s total vested account balance as of a specified valuation date. This percentage will apply to all sources — such as deferrals, matching or profit sharing — unless specified by the QDRO. Any interest and investment gains/losses that accrue between this valuation date and the date the funds are separated into an account for the alternate payee are often factored into this final calculation. If the participant has outstanding loans, the QDRO will usually indicate how the loans are handled.
Contributions such as deferrals and employer matching made after the valuation date are credited to the participant’s account. Earnings and losses are applied to the account balances. Once the division is complete, the alternate payee’s portion (either dollars or shares) is transferred to an account in the alternate payee’s name.
If the plan allows, the alternate payee may be paid out in a cash or rollover distribution. Not all plan documents allow the alternate payee to receive a distribution before reaching normal retirement age, so it’s important to follow the terms of the plan. In addition, the QDRO cannot violate the provisions of the plan document by requiring a plan to provide an alternate payee or participant with any type or form of benefit not otherwise provided under the plan.
Although the most common situation for a QDRO is a divorce, it can be issued in other situations, such as to a dependent in the case of child support. If the alternate payee is a minor child or legally incompetent, the order can also require payment to the individual with legal responsibility for the alternate payee. If a participant or their attorney provides you with a copy of a divorce decree that references the plan or a QDRO, please contact us immediately, and we will work with you to ensure it meets the requirements of the plan.
Important note for defined benefit plans: For 2025 plan years, PBGC premiums are due one month earlier than usual, specifically on the 15th day of the ninth month after the beginning of the plan year. For calendar year plans, this means the premium is due on September 15, 2025, instead of the usual October 15. This accelerated deadline is due to a provision in the Bipartisan Budget Act of 2015.
Upcoming Compliance Deadlines for Calendar-Year Plans
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