A qualified retirement plan (hereinafter a "Plan") must satisfy the requirements of the Internal Revenue Code ("IRC") in form and in operation. In other words, the documents establishing and governing the Plan must satisfy the IRC requirements and the Plan must be operated in a manner that complies with the IRC requirements. Many plan sponsors confirm a Plan's compliance with the form requirements by obtaining a determination letter from the Internal Revenue Service ("IRS") through the IRS Determination Letter Program.
Based on the form of the documents used to establish the Plan, Plans are generally classified as "individually designed plans" or "pre-approved plans" (consisting of master and prototype plans and/or volume submitter plans).
The Plan documents for "pre-approved plans" often consist of a standardized document or a standardized document with an adoption agreement (which incorporates the provisions dealing with the plan sponsor, eligible employees, contributions, benefits, etc.). In contrast, the plan document for an individually designed plan is typically drafted to incorporate provisions that are individually designed for the Plan (which gives rise to the name individually designed plan).
Individually designed plans and pre-approved plans are treated differently under the existing IRS Determination Letter Program. Generally, the plan sponsor of an individually designed plan requests a determination letter every five years. In contrast, the sponsor or professional maintaining a pre-approved plan (collectively "Sponsor/Mass Submitter") requests a ruling (commonly referred to as an opinion letter) every six years. In the case of a pre-approved plan, the individual employer utilizing the plan document may also apply for a determination letter for the Plan as adopted by the employer (i.e., the qualified status of the Plan incorporating all of the options elected by the employer).
Under the existing IRS Determination Letter Program, the plan sponsor of an individually designed plan and the Sponsor/Mass Submitter of a pre-approved plan have certain timelines in which to adopt interim amendments required by changes to the IRC, to adopt plan design or discretionary amendments, or to correct a defective interim amendment (sometimes referred to as the "remedial amendment period"). In summary, for individually designed plans, the existing IRS Determination Program provides a procedure, whereby every five years, the plan sponsor can confirm that the Plan complies with the IRC form requirements, and subject to certain limitations, can correct a defect in the form of the Plan.
Beginning January 1, 2017, the IRS Determination Letter Program for individually designed plans will be significantly curtailed. See Revenue Procedure 2016-37 (June 24, 2016). Effective January 1, 2017, the staggered five-year remedial amendment cycle for individually designed plans will be eliminated and, beginning on that date, the IRS will no longer accept determination letter applications based on the five-year amendment cycle.
Effective June 1, 2017, a sponsor of an individually designed plan will only be permitted to submit a determination letter application for:
- the initial plan qualification upon adoption of the Plan;
- for qualification upon the termination of the Plan; and
- in other circumstances announced by the IRS in published guidance in the Internal Revenue Bulletin.
For 2017, other than a carryover of certain five-year cycle plans, the IRS will only be accepting determination letter applications for initial plan qualification and qualification of a terminated Plan.
Effective January 1, 2017, the interim amendment procedures will also be revised. Under the new procedures, the IRS expects to publish annually a Required Amendments List that will generally apply to changes in qualification requirements that become effective on or after January 1, 2016. It is expected that the plan sponsor will be required to adopt amendments listed in the Required Amendments List by the end of the second calendar year after the year in which the Required Amendments List is issued (unless an alternative date is set forth in the Required Amendments List). Further, the remedial amendment period for correcting a defective discretionary amendment will be the end of the second calendar year after the year in which the amendment becomes effective or is adopted, whichever is later (i.e., similar to the remedial amendment period for required amendments).
The New IRS Determination Letter Program will give rise to uncertainty as to an individually design plan's continued compliance with the IRC form requirements. Under the existing program, a plan sponsor can confirm the Plan's status every five years by obtaining a determination letter. During the period between the determination letters, a Plan's compliance with the IRC form requirements can be determined by reviewing the plan document, the interim amendments and the Cumulative List of Changes in Plan Qualification Requirements (as published in the Internal Revenue Bulletin).
Under the New IRS Determination Letter Program, an individually designed plan could obtain an initial determination letter upon adoption and there can be a 20 or 30-year period during which the plan is in existence with no assurance that all of the qualifying required interim amendments have been adopted. Likewise, upon the adoption of a discretionary amendment, there is no procedure whereby a plan sponsor can obtain assurance that a discretionary amendment has not caused the Plan to violate the IRC form requirements.
Many third-party administrators provide pre-approved plan documents to plan sponsors for little or no cost, which has resulted in a migration away from individually designed plans to pre-approved plans. Further, the IRS has expanded the pre-approved plan program to cover additional types of plans (such as certain ESOPs and cash balance plans). As such, there are fewer individually designed plans and the proposed changes to the IRS Determination Letter Program will have little or no impact on the majority of Plans.
In addition, the employee benefits community has raised concerns about the New IRS Determination Letter Program. Hopefully, the IRS will modify the program to address these concerns. In any event, employers who utilize an individually designed plan document which can be converted to a pre-approved plan document should consider converting to a pre-approved document.
However, this is not an option for some plan sponsors. A number of types of Plans do not qualify for opinion letters issued through the IRS pre-approved program. These non-qualifying Plans include but are not limited to:
- church plans
- stock bonus plans other than ESOPs
- governmental plans
- ESOPs that are a combination of a stock bonus plan and a money purchase plan
- statutory hybrid plans with certain benefit formulas (including offset arrangements)
- multiemployer plans
- non-safe harbor target benefit plans
- defined benefit plans with employee contributions
- union plans
- 401(k) plans that do not utilize the hardship distribution safe harbors
Sponsors of these non-qualifying Plans and sponsors of Plans with provisions that cause the Plan to be characterized as an individually designed plan will need to take steps to assure the Plan's continued compliance with the IRC's form requirements. At a minimum, plan sponsors will need to review and adjust their plan document retention procedures. In addition, the plan sponsor will likely need to develop a procedure or process to have the plan document's compliance with the IRC form requirements reviewed at regular intervals. In many cases, given that determination letters are commonly referred to in the footnotes of the Plan's audited financials, the regular review of the Plan's document for compliance with the IRC form requirements may end up being incorporated into the Plan's annual financial audit and tax return (Form 5500) process.
In summary, the New Determination Letter Program will result in uncertainty as to an individually designed plan's continued compliance with the IRC form requirements. Plan sponsors of individually designed plans will need to work with their advisors to develop procedures to ensure the Plan's continued compliance with the IRC form requirements.