Maintaining your 403(b) plan s tax-favored status under EPCRS

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1 Maintaining your 403(b) plan s tax-favored status under EPCRS Managing a retirement plan involves navigating the often complex legal requirements associated with 403(b) plans. Even the most diligent plan sponsors may experience compliance errors. And, failure to comply can lead to serious consequences, including plan disqualification and the loss of past and future tax benefits. The good news is that the Employee Plans Compliance Resolution System (EPCRS) can help plan sponsors bring their plans back into compliance. EPCRS is an IRS correction program developed to provide plan sponsors with guidelines and options to correct a range of errors in their retirement plans. Please note this fact sheet does not address DOL ERISA fiduciary failures. To stay current with tax law changes, the IRS updates the correction rules governing EPCRS every few years by issuing new Revenue Procedures. The most recent comprehensive update was Revenue Procedure generally effective as of April The IRS recently modified Revenue Procedure by issuing Revenue Procedures and All of this guidance offers a correction program for 403(b) compliance failures taking into account the requirements of the final 403(b) regulations. Understanding what constitutes a plan failure is a necessary step to maintain a compliant plan. The type of failure then determines how a plan sponsor may correct an error through EPCRS. The following fact sheet is intended to help you understand and navigate the correction process, but you should consult with your legal counsel before pursuing any corrective actions. Plan qualification failures The manner in which sponsors must correct plan errors depends on the type of failure in question. Section 403(b) plan failures fall under four distinct categories. Operational failures generally occur when a plan sponsor fails to operate the plan according to the terms of the plan document. For example, offering loans to employees when the written plan document doesn t allow for them would constitute an operational failure. Plan document failures take place when a plan sponsor did not adopt a written 403(b) plan document by 12/31/09. Such a failure also occurs when a plan document has a provision (or absence of a plan provision) that violates the requirements governing 403(b) plans. Demographic failures apply to plans that fail to meet or correct coverage and nondiscrimination requirements. Employer eligibility failures occur when plan sponsors don t meet the eligibility requirements to establish a 403(b) plan. Only certain tax-exempt employers such as public schools or section 501(c)(3) organizations are eligible to sponsor a 403(b) plan. These 403(b) Failure definitions are for errors occurring after For errors occurring prior to 2009, plan sponsors must use correction methods and definitions in Revenue Procedure

2 Significant vs. insignificant operational failures Determining the classification of an operational failure is based on the facts and circumstances surrounding the error. You should work closely with your legal counsel to make this determination. Some of the factors to consider in this decision include: whether other failures occurred percentage of plan assets and contributions involved number of years the failure occurred relative number of participants involved whether correction was made within a reasonable period following discovery reason for failure It is important to note that significant operational failures must be corrected within two years of the end of the plan year in which the failure occurred. You should also note that significant failures typically cannot be self-corrected during an IRS audit. Only failures deemed insignificant can be corrected using the SCP method, after the two-year period, even if the plan or employer is undergoing an IRS audit. IRS VCP submission kit Plan sponsors who missed the deadline for adopting a written plan can obtain a VCP submission kit on the IRS website. This kit provides step-by-step instructions for filing a VCP compliance statement. EPCRS correction options Under Revenue Procedure , plan sponsors may choose from three correction methods to address plan errors, depending on the type of failure. Each method has different procedures and requirements to correct errors and maintain the plan s tax-deferred status under the IRS. 1. Self-correction program (SCP) SCP is a method available to correct insignificant and certain significant operational failure violations (See Significant vs. Insignificant Operational Failures ) without filing and obtaining the IRS approval. As part of the process, the implementation of new administrative procedures may be necessary to prevent future errors. SCP eligibility: To be eligible for self-correction, your plan must meet certain requirements: Established compliance procedures: Your plan must have established compliance procedures in place. Employer determination of correction: You must work closely with your legal counsel to determine whether you are eligible for self-correction, and if so, you must choose the most appropriate correction method. Vendor cooperation: It is your responsibility as a plan sponsor to notify all plan vendors of existing failures and secure their cooperation in implementing corrections. 2. Voluntary correction program (VCP) The VCP is available for operational errors that can t be corrected using the SCP method. This includes plan amendments not permitted under SCP, or significant errors not corrected within the required two-year period. VCP can also be used to address plan document failures, demographic failures and employer eligibility failure. To make a correction under VCP, the plan sponsor must make a submission to the IRS, complete forms 8950 and 8951 and identify existing mistakes. VCP submissions should include the proposed administrative procedures that the employer will use to correct a plan failure and prevent future mistakes. The plan sponsor also agrees to pay a fee, based on the total number of plan participants, that ranges between $750 and $25,000 (See VCP compliance fee schedule ). The IRS, in turn, will issue a compliance statement addressing the failure and the approved correction methods that the plan sponsor is required to make within 150 days. Please note that for plan sponsors who missed the 12/31/09 deadline for timely adopting a written plan, they may notify the IRS of errors using a VCP submission kit (See IRS VCP submission kit ). VCP compliance fee schedule Number of plan participants Fee 20 or less $ $1, $2, $5, ,000 $8,000 1,001-5,000 $15,000 5,001-10,000 $20,000 More than 10,000 $25,000 Source: IRS, Maintaining your 403(b) plan s tax-favored status under EPCRS 2

3 VCP fee for required minimum distribution (RMD) and loan failures In Revenue Procedure , the IRS released modifications to Revenue Procedure The IRS amended the rules for determining the VCP fee for required minimum distribution (RMD) and loan failures. The filing fee for RMD failures was changed to $500 for less than 150 RMD failures and $1,500 if 151 to 300 participants were affected. For loan failures, the current procedures provide that the normal VCP fee is reduced by 50%. The IRS modified this to create a sliding scale based on the number of loan failures, not upon the size of the plan. 3. Audit closing agreement program (Audit Cap) In some cases, qualification failures may be identified during an IRS plan audit, not by the plan sponsor. Under the Audit Cap program, the plan sponsor agrees to correct the violation, pay a sanction based on the amount of tax benefits preserved and sign a closing agreement with the IRS. Sanctions are intended to bear a reasonable relationship to the nature, extent and severity of the failure, and are significantly less than the penalties associated with noncompliance. If qualification failures are discovered by the IRS, it is important to seek the advice of ERISA legal counsel. Remedial amendment period If you established a plan document prior to December 31, 2009, you can correct any document defects incorrect provisions or lack of provisions in the plan document within the remedial amendment period outlined in Announcement without a VCP filing. Defects can be corrected until you have adopted a preapproved 403(b) plan. Next steps EPCRS allows plan sponsors to proactively address plan defects using the self-correction method, if appropriate, or by written submission under the VCP. Employers who conduct periodic compliance reviews and use EPCRS to correct errors can avoid the penalties associated with qualification failures discovered during an IRS audit. Maintaining your 403(b) plan s tax-favored status under EPCRS 3

4 By protecting your plan s tax benefits, you are helping fulfill your fiduciary obligations. You are also ensuring your employees have access to a tax-advantaged plan that can improve their retirement readiness. These correction rules are very complex. Before implementing a corrective action program, you should always seek the advice of appropriate legal counsel for guidance. TIAA-CREF does not provide legal advice. Guide to fixing common 403(b) failures In order to proceed under EPCRS, plan sponsors must first identify their plan s failure and determine the necessary corrective actions. The following exhibit presents some of the most common plan failures and corrective actions outlined in EPCRS. Plan document failure: written plan not adopted by 12/31/09 Universal availability failure Exclusion of eligible employees from making 403(b) elective deferrals Exclusion of eligible employees from employer contributions Contributions in excess of 415(c) limit (maximum employee and employer contributions) Deferrals in excess of the 402(g) limit (employee maximum elective deferrals) Identify the failure(s) and submit an IRS filing with proposed corrective measures and pay a fee. With the VCP process completed, the IRS will treat the written plan as if it had been adopted timely and the tax-favored status of the 403(b) plan will be restored. Provide improperly excluded employees or those not given proper notice of eligibility with the opportunity to make salary deferrals. Corrective contributions are needed to compensate employees for missed deferral periods. If the employee was not provided the opportunity to elect and make elective deferrals to a non-safe harbor 403(b) plan, the employer must make a qualified non-elective contribution (QNEC) to the plan on behalf of the employee. Missed deferrals are assumed to be equal to the greater of 3% of compensation or the maximum deferral percentage for which the plan sponsor provides a matching contribution rate. That rate must be at least as favorable as 100% of the elective deferral made by the employee. Employers with noncontributory plans can make a contribution, adjusted for earnings, on behalf of the excluded employee. Those with matching plans can make a qualified non-elective contribution equal to 50% of the employee s missed deferral, plus matching contribution based on the missed deferral. Distribute excess employee contributions and earnings to affected employee(s) or transfer to a 403(c) account (a taxable account). Place excess employer contributions and earnings in unallocated plan account used to reduce future employer contributions. Distribute excess employee deferrals and earnings by April 15 of the year following the year the excess deferral is made. Excess deferrals are taxed in the year of deferral and earnings are taxed in the year of distribution. If excess is not distributed by April 15, then excess deferral (plus earnings) is taxable in year of distribution and excess contribution is also taxable in year of contribution (taxed twice). VCP If excess deferrals are not distributed by April 15, then correction may be eligible. Maintaining your 403(b) plan s tax-favored status under EPCRS 4

5 Contributions in excess of 401(a)(17) compensation limit (limit used for nondiscrimination testing purposes) Incorrect definition of compensation used Hardship or loans not allowed in the plan document, but operationally allowed Loans in excess of IRC Section 72 Limits Hardship distributions not administered correctly Overpayments Correct with a plan amendment to increase contribution rates or reduce affected participants account balances and place amounts in unallocated account. Adjust account balances to comply with plan definition or make a retroactive amendment to the plan document (VCP). If plan does not permit hardship withdrawals, it may be amended retroactively. If plan does not allow for loans, add loans to plan on nondiscriminatory basis and add a retroactive plan amendment. Instruct employee(s) to make corrective repayment of excess loan amount to the plan. If participant lacks adequate hardship documentation, correction may be made by requesting participants to repay amounts, plus earnings. An overpayment occurs when a payment to a participant or beneficiary exceeds the amount payable under the plan or exceeds a limitation provided in the Code or regulations. This can mean two things: 1. A payment was made to a participant or beneficiary who did not meet a legal or plan distributable event; or 2. The participant or beneficiary met a distributable event, but the plan sponsor paid out more than the plan allowed. To correct an overpayment, the plan sponsor should take reasonable steps to have the participant or beneficiary return the overpayment (adjusted for earnings) to the plan. The participant or beneficiary must be notified that the overpaid amount is not eligible to be rolled over. However, depending upon the nature of the overpayment, the employer or another party may contribute the amount of the overpayment, with earnings, to the plan in lieu of seeking recoupment from plan participants and beneficiaries. The amount repaid by the employer or another party would be contributed to the plan s unallocated account and it would be used to reduce future employer contributions. Alternatively, a retroactive amendment may be a permissible correction, if otherwise consistent with the rules for retroactive amendments under EPCRS. To correct a premature distribution, the amount repaid by the participant or beneficiary must be reallocated to a participant s account. There is an exception for a payment related solely to a premature distribution of the participant s vested benefit that was determined in accordance with the plan terms. In that case, it does not have to be returned by the employer (or another party) if not repaid by the participant or beneficiary. Adjusted account balances may be eligible. SCP may be used for a retroactive plan amendment if loans or hardship withdrawals are not permitted. Use VCP for loan repayment. VCP may be required if plan lacks adequate policies and procedures. Maintaining your 403(b) plan s tax-favored status under EPCRS 5

6 Employer eligibility Automatic contribution arrangements Missed employee elective deferrals (for plans with and without auto-enrollment) safe harbor Only 501(c)(3) and public educational organizations are eligible to sponsor 403(b) plans. If not eligible, stop contributions and maintain rules on deferred accounts. Under Revenue Procedure , if a plan sponsor s failure to implement an automatic contribution feature or an affirmative election of an eligible employee who is subject to an automatic contribution feature is detected within 9½ months after the year of the failure, no corrective QNEC is required for the missed deferral opportunity. However, the following conditions apply: 1. The affected eligible employee must be enrolled within the 9½-month period (or earlier if the affected employee notifies the employer of the mistake). 2. Notice of the failure must be given to the affected eligible employee no later than 45 days after the date on which correct deferrals begin. The notice must contain certain information as enumerated in IRS Revenue Procedure Corrective contributions to make up for any missed matching contributions must be made in accordance with timing requirements under SCP for significant operational failures and must be adjusted for earnings. This safe harbor has a sunset provision and only applies to errors beginning on or before December 31, However, the IRS could extend it in the future. Corrected within three months: Corrective contributions are not required for missed employee elective deferrals if the following applies: The correct deferrals begin by the first payment of compensation made on or after the earlier of: three months after the failure first began for the affected employee, or the last day of the month after the month the affected eligible employee first notified the plan sponsor. VCP SCP (subject to significant operational failures timing requirements) SCP Maintaining your 403(b) plan s tax-favored status under EPCRS 6

7 Corrected after three months (up to last day of the second plan year): A 25% corrective QNEC contribution for missed employee elective deferral failures are required if the period of failure exceeds three months, but correct deferrals begin by the first payment of compensation made on or after the earlier of: the last day of the second plan year after the plan year in which the failure first began for the affected employee, or the last day of the month after the month the affected eligible employee first notified the plan sponsor. For the missed elective deferral safe harbors to apply, employers must: Notify affected employees about the correction within 45 days after the corrected deferrals begin. The notice must contain certain information as enumerated in IRS Revenue Procedure Provide makeup contributions for the entire missed match and adjust the makeup contributions for earnings. SCP (subject to significant operational failures timing requirements) Please note: TIAA-CREF cannot provide legal advice. Please consult your ERISA legal counsel regarding your ERISA fiduciary obligations, including the establishment and documentation of investment review procedures. TIAA-CREF Individual & Institutional Services, LLC, Teachers Personal Investors Services, Inc., and Nuveen Securities, LLC, Members FINRA and SIPC, distribute securities products. FOR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR USE WITH OR DISTRIBUTION TO THE PUBLIC Teachers Insurance and Annuity Association of America-College Retirement Equities Fund (TIAA-CREF), 730 Third Avenue, New York, NY C _ A15031 (07/15)