Correcting Administrative Errors in DC Plans. Jane Armstrong, Esq., Phelps Dunbar LLP
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1 Correcting Administrative Errors in DC Plans Jane Armstrong, Esq., Phelps Dunbar LLP
2 Jane Armstrong, Esq., Partner, Phelps Dunbar, LLP Jane Armstrong is a partner at Phelps Dunbar LLP, a regional law firm that is headquartered in New Orleans. She has practiced exclusively in the areas of employee benefits and executive compensation for over 30 years. Jane has been listed in all editions of the Best Lawyers in America and "Louisiana Super Lawyers," and is listed in Chambers U.S.A. as a leading practitioner in the employee benefits field. She is a frequent speaker and author on retirement plan issues. Jane graduated from Vanderbilt University School of Law, where she was elected to the Order of the Coif.
3 Common Correction Programs Rev. Proc (1/22/2013) Employee Plans Compliance Resolution System (EPCRS) Effective as of April 1, 2013 Generally provides for correction of qualification failures DFVCP Delinquent Filer Voluntary Compliance Program Department of Labor (DOL) program to voluntarily correct late or missed Form 5500 filings VFCP Voluntary Fiduciary Correction Program DOL program to voluntarily correct 19 common transactions that may constitute a fiduciary breach or prohibited transaction
4 EPCRS Three Types of Correction Self-Correction (SCP) No filing, no fee, no compliance statement, no reliance Voluntary Correction (VCP) Filing, fee, compliance statement issued, reliance Correction on Audit (Audit Cap) Penalty imposed, closing/compliance statement issued, reliance
5 EPCRS Four Types of Errors/Failures Plan Document Failure: Plan provision (or omission) that violates Code Section 401(a) Demographic Failure: Failure to satisfy Code Section 401(a)(4) or (a)(26) or 410(b) Operational Failure: Failure to follow plan s terms Employer Eligibility Failure: Employer not eligible to maintain cash or deferred arrangement
6 Generally Applicable Principles for Correction Full correction generally required: All affected participants and beneficiaries All years, whether or not closed Restore plan to position but for failure Correction appropriate and reasonable Keep plan assets in plan
7 Generally Applicable Principles for Correction Full correction generally required: Consistent with the Code (don t violate another Code provision) Consistent with plan s terms in effect when failure occurred (for allocations and distributions) May vary from plan year to plan year, but consistent within a single plan year New employer contributions forfeitures may be used only if plan permits (allocations)
8 Full Correction Principles Exceptions: If correction made through another program, EPCRS not required Reasonable estimates permitted if actual data unavailable or use would not make a material difference Distribution is $75 or less and direct cost of distribution more Overpayment is $100 or less Lost participants cannot be found after reasonable efforts
9 Generally Applicable Approved Correction Methods Eligible employer failures (correct under VCP) Cease contributions Hold assets in trust Distribute when otherwise eligible Failure to obtain spousal consent Notify and obtain consent If consent cannot be obtained: Spouse entitled to survivor s portion of QJSA; must be provided if spouse makes claim Alternative: offer choice between consent to actual distribution, QJSA or single sum
10 Generally Applicable Approved Correction Methods Excess amounts Includes deferrals in excess of plan limits, 415 excess, 402(g) excess, 401(a)(17) excess Correct: If employee deferral, distribute with notice (not eligible for rollover) Otherwise, reduce account balance and place in unallocated account Report (1099-R) in year of distribution Participant loan failures (72(p) violations) If deemed distribution, may request that 1099-R (deemed distribution) be reported in year of correction Non-compliant plans (loans) cannot be corrected after maximum loan term expires
11 Generally Applicable Approved Correction Methods Participant loan failures (72(p) violations) If plan includes 72(p) language, correct by: Repayment (single-sum) of arrears Reamortize outstanding balance and interest Overpayments Reasonable steps to collect Allocate to unallocated account
12 Tax and Similar issues Generally excise taxes not waived, but: Non-deductible contributions, IRS may waive Excess contributions or excess aggregate contributions, IRS may waive RMD failure, must request waiver in submission Overpayments, IRS may impose 10% penalty tax under Code Section 72(t)
13 Key Terms Under examination Sponsor received notice of examination (employee plans) Sponsor received notice of referral to employee plans Ongoing employee plans examination Notice of failure during determination letter request Favorable letter Individual determination letter Opinion letter or notification letter for preapproved plans; sponsor has adopted without substantial modification
14 Key Terms Unallocated account separate account used to offset employer contributions; employer cannot contribute (except deferrals) until account is allocated Earnings If self-directed, actual or highest rate of any fund (if most NHCEs) If not self-directed, plan s rate Includes losses Applies to allocations and distributions Practices and Procedures May be written or unwritten Need not relate to failure
15 SCP PROCEDURES
16 Specific Rules for SCP FOUR STEPS: Determine if plan is eligible Determine if failure is insignificant/significant Must be operational Correct Document the correction (business record)
17 Specific Rules for SCP - Eligible Plans Available for: Qualified plans 403(b) SEPS and Simple IRAs (insignificant failures only) Cannot be under examination, except that insignificant failures may be corrected or correction in process may be completed Must have favorable letter Must maintain practices and procedures
18 Specific Rules for SCP - Failures Eligible for Correction Identify failure period (usually by plan year) Identify operational failure Determine whether failures are insignificant or significant Number of failures occurring within same period; Number of periods in which failures occurred; % of plan assets involved; % of total participants involved; Number of participants affected when compared to number that could have been affected; Whether correction made within a reasonable time after discovery; Reason for failure
19 Specific Rules for SCP - Correction of Significant Failures Significant failures: Must correct using method prescribed in Must be corrected or substantially corrected with correction period Correction period ends on last day of second plan year following plan year in which failure occurred Failures of ADP/ACP third year Assets acquired in merger or acquisition, last day of first plan year beginning after transaction Substantially corrected if: Correction initiated during correction period and completed within 120 days after end of period; or Correction completed for 65% of affected participants during period and then diligently complete
20 Specific Rules for SCP - Correction by Plan Amendment Retroactive amendment may be used to conform plan s terms to actual operation Limited to (App. B, Sec. 2.07): Code Section 401(a)(17) failures - amend to provide for additional allocation Hardship and loans amend to permit Early inclusion of otherwise eligible employee amend entry conditions; limit to affected employees if primarily NHCEs, subject to Code Section 401(a)(4) Correction must be consistent with App. B Submit amendment with on-cycle determination letter request and mark as SCP
21 Specific Rules for SCP Correction Documentation Written business record Include the following: Describe operational failure(s) Establish/describe procedures and any changes made to prevent reoccurrence Retain favorable letter Whether failure considered significant/insignificant (if insignificant, summarize factors considered)
22 Specific Rules for SCP Correction Documentation Business record to include the following: Describe correction, including: List of participants and specific allocations (distributions) made Steps taken to locate missing participants Earnings calculations When completed Attach documentary evidence of correction Any special circumstances (e.g., transferred assets) Signed and dated by (or accepted) by administrator
23 VCP PROCEDURES
24 Specific Rules for VCP Determine eligible plan Cannot be under examination Identify failures; may be operational, document, demographic Determine proposed correction method(s) Prepare written VCP submission Form 8950 (application) required
25 Specific Rules for VCP Pay filing fee Form 8951 (fee) required Compliance statement issued Complete correction (implement within 150 days of compliance statement) Verification of correction to IRS
26 Specific Rules for VCP Form 8950 Complete description of failures, years and number of affected employees Explanation of why (how) failures arose Description of correction method(s) Method to calculate earnings Calculations for each affected employee Method to locate lost participants New procedures implemented to avoid reoccurrence
27 Specific Rules for VCP Form 8950 Request relief from 10% tax on early distributions Request relief from deemed distribution (participant loans) Represent: Not under examination Not party to abusive transaction Signed by sponsor (POA not acceptable) Penalty of perjury statement
28 Specific Rules for VCP Form 8951 Number of Participants Fee 20 or less $ to 50 $1, to 100 $2, to 500 $5, to 1,000 $8,000 1,001 to 5,000 $15,000
29 Specific Rules for VCP Form 8951 Special (reduced) fees: Failure to make MRD - $500 (if 50 or fewer participants) Non-amender and correct within one year following remedial amendment period 50% reduction Non-amender failure to timely adopt optional or interim amendments - $375
30 AUDIT CAP
31 Audit CAP Applies: qualification failure during examination (includes determination letter request) Sanction imposed: Negotiated from maximum payment amount, except for nonamender failures (scheduled amount) Maximum payment amount determined under Rev. Roc Factors considered: Steps taken by sponsor Extent to which correction in process Number and type of affected employees Number of NHCEs Type of failure Reason for failure
32 CORRECTIONS
33 Appendices A and B Appendices A and B provide reasonable and appropriate correction methods for specified failures and appropriate earnings adjustments Appendices A and B are not exclusive; other corrections may be acceptable
34 Operational Error Appendices A and B Failures and Corrections Failure Failure to provide topheavy minimum Failure to satisfy ADP/ACP (Appendix A) Failure to satisfy ADP/ACP (Appendix B) Correction Contribute, including earnings Contribute QNEC to NHCEs Make for all eligible NHCEs Same % of compensation Need not match QNEC Must satisfy ACP Alternative is one-to-one (distribute excess to HCEs and contribute same amount to NHCEs as QNEC)
35 Operational Error Appendices A and B Failures and Corrections FAILURE Failure to timely distribute deferrals in excess of 402(g) limit Exclusion of eligible employee profit sharing (Appendix A) Exclusion of eligible employee profit sharing (Appendix B) CORRECTION Distribute Report in year of distribution and in year of deferral Distribution included in ADP for HCEs, but not NHCEs Excess match forfeited Make contributions Recalculate and reallocate contribution, by debiting accounts (discretionary contribution) If accounts of NHCEs primarily debited, no adjustment for earnings required (reallocate principle only) or may calculate earnings using lowest rate of return
36 Operational Error Appendices A and B Failures and Corrections FAILURE Exclusion deferral opportunity (nonsafeharbor) Exclusion deferral opportunity (safeharbor match) Exclusion deferral opportunity (safeharbor 3% nonelective) CORRECTION Contribute 50% of missed deferrals Calculate using HCE/NHCE rate of deferral Contribute any missed match Contribute 50% of missed deferrals Calculate as greater of 3% or rate of deferrals matched at 100% Contribute match Contribute 50% of missed deferrals Calculate as 3% of compensation in first year, use plan terms for subsequent years Contribute non-elective
37 Operational Error Appendices A and B Failures and Corrections FAILURE Exclusion of eligible employee catch up Failure to implement employee deferral election Partial year exclusion/failure to implement (Appendix B) CORRECTION Make 50% of catch-up contributions Contribute 50% of missed deferrals Calculate using employee s election Contribute match as QNEC May prorate compensation to determine contribution If exclusion less than 3 months, no correction for missed deferrals
38 Operational Error Appendices Failures and Corrections FAILURE Failure to timely pay RMD Failure to obtain spousal consent Failure to comply with Code Section 415 (excess annual addition) CORRECTION Calculate and distribute May request waiver of excise tax Participant obtains informed consent or receives QJS or single-sum PV If consent cannot be obtained, pay QJS, but reduce participant s portion by amounts previously paid; cannot reduce survivor s benefit Reduce account by excess If employer contribution, allocate to other employees or allocate to unallocated account Distribute deferrals
39 Operational Error Appendices A and B Failures and Corrections FAILURE Vesting failure Appendix B) CORRECTION Allocate or distribute If amount allocated as additional employer contribution, may reduce account balances
40 SUMMARY OF ELIGIBILITY CONDITIONS
41 EPCRS Eligibility (Plans, Failures, Conditions) Plan Document Failures Operational Defects Qualified Plans 403(b) SCP VCP AUDIT CAP Not Available Available Available Available Available Available Available (significant/ insignificant) Available (significant/ insignificant) Available Available Available Available
42 EPCRS Eligibility (Plans, Failures, Conditions) SEPs SIMPLE IRAs Plan Under Examination SCP VCP AUDIT CAP Available (insignificant only) Available (insignificant only) Available to correct insignificant operational failures; Significant failures substantially completed Available Available Available Available Not Available Available
43 EPCRS Eligibility (Plans, Failures, Conditions) Favorable Letter Established Practices and Procedures Using Plan Amendment to Correct SCP VCP AUDIT CAP Required or SEP/Simple maintained on IRS Form Plan must maintain Limited use permitted (Sec. 2.07) Not required Not required Permitted Not required Not required Permitted
44 EPCRS Eligibility (Plans, Failures, Conditions) Employer Eligibility Failure After Plan Termination Egregious Failures SCP VCP AUDIT CAP Not available Available Not available Available Not available Available (extra fees) Available Available Available
45 COMMON FAILURES APPROPRIATE CORRECTION PROGRAM
46 Selecting Correction Program Common Error ERROR Late or missed 5500 filing Late or missed deposit of deferrals or participant loan repayments Participant loan failures Failure to timely amend (document error) Operational error Fiduciary breach/prohibited transaction DFVCP VFCP CORRECT USING EPCRS VFCP (with EPCRS for certain failures) EPCRS EPCRS VFCP
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