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IRS targets the suspension of deferrals after hardship distributions 335
The hardship distribution provisions of 401(k) plans permit participants to receive a distribution of their salary deferrals sufficient to meet certain an unforeseen, immediate and heavy financial hardship. Most plans are written to simplify the determination of what constitutes a heavy financial by need by following certain safe-harbors in regulations. Without these safe harbors, the employer would be required to establish and apply nondiscriminatory and objective standards for reviewing detailed information on the employee’s financial need and current condition. That requires knowing more about the employee than most HR departments want to know. These safe harbors permit hardship distributions by limiting the types of hardships for which payments can be made, and allow the plan administrator to rely on employee representations made to support their requested hardship.
These safe harbors also restrict the ability of the participant to continue making salary deferrals after the hardship distribution. Plans must impose a six-month suspension of deferrals on the participant receiving a hardship distribution. According to the IRS, failure to impose this suspension is a very common compliance error of 401(k) plans. Most compliance failures can be corrected under the IRS’ Employee Plans Compliance Resolution System (EPCRS). Unfortunately, EPCRS does not specify the appropriate correction for failure to impose the six-month deferral suspension. Instead, the IRS has pointed to the general EPCRS rule that a sponsor’s correction approach must restore the plan and an affected participant to the same position as they would have been in had the failure not occurred.
Last year, the IRS hosted a phone forum to discuss various EPCRS issues. The program presented three options to address a failure to suspend a participant’s deferrals after a hardship distribution. Option 1 is to return the improper deferrals, adjusted for earnings, to the participant. According to the program materials, this clearly complies with the EPCRS general rule. Option 2 is to suspend the participant’s deferrals for a six-month period going forward. According to the materials, this "possibly” meets the EPCRS requirement and most corrections will involve a loss of certain matching contributions. The IRS noted in the discussion that the employer cannot allow the matching contributions to offset future matching contributions when deferrals begin again. That is, the matching contributions for the six-months after the suspension period – something the IRS calls "going-forward” period – may not be the same as those made during the six-month period in which the deferrals should have been suspended. In addition, the participant could terminate employment before the end of the six-month going forward period. The materials do not discuss what the plan sponsor should do in either eventuality, but the implication is that either scenario means that the sponsor has not complied with the EPCRS general rule unless the match is forfeited. The third alternative, which is not acceptable, is doing nothing other than revise the relevant administrative procedures for hardships going forward. This third option does not satisfy any correction procedure under EPCRS requirements because the failure has not been corrected.
Reprinted with permission from 401(k) Advisor
The Latest Q&As from TPAs
A client has terminated employment and converted his (distributed) pre-tax 401(k) account to a Roth IRA.
1. Can the employee withdraw the entire amount immediately after the conversion?
2. If so, would the employee have gotten out of the 10% penalty in doing so?
2. No (sorry). Section 408A(d)(3)(F) provides that any distribution from a Roth IRA that is allocable to the taxable amount of a rollover to the Roth IRA made within the preceding 5 taxable years is treated as includible in gross income for purposes of applying the 10% additional tax under § 72(t).
Plan in which there are four participants, all partners. The contribution for 2010 was made prior to the plan year-end assuming that their compensations would exceed the 245,000 limit. After their tax return was prepared, their compensations were less than expected. So, the contribution made in 2010, exceeded the deduction limit. Can the excess be returned to the employer as a mistake of fact?
No. The amount contributed was based on an assumption. The partnership contributed too much because the assumption was too high, not because of an incorrect fact. There is no mistake of fact here, so the amount cannot be returned to the employer as based on a mistake of fact.
Neither the Code nor ERISA (or regulations there under) define "mistake of fact" for purposes of qualified retirement plans. Regulation 1.83-2 does define the term, though: "The mistake of fact exception in § 1.83-2(f) is narrow in its scope. A mistake of fact is an unconscious ignorance of a fact that is material to the transaction".
5-person profit sharing plan is top heavy for 2011 based on 2010 account balances. However, there will be no contributions in the Profit Sharing Plan in 2011. Instead, a Cash Balance Plan will be added in 2011. Starting in 2012, it will become a typical PS/CB cross tested combo plan(s). There will be no 401(k) (or any other) contribution made to the PS plan for 2011. To satisfy 2011 top heavy provisions for the non-key, may I provide only the 2% top heavy in the CB Plan (and 0% in the PS plan).
Yes. A 2% accrual in the DB plan will satisfy top heavy, even if there is a contribution to the PS plan for 2011. Regulation section 1.416-1, M-12A provides "Since the defined benefit minimums are generally more valuable, if each employee covered under both a top-heavy defined benefit plan and a top-heavy defined contribution plan receives the defined benefit minimum, the defined benefit and defined contribution minimums will be satisfied."
Employer has a 401(k) plan that has been in effect for several years and has a top paid group election. Cash balance plan was started after 401(k) was top paid group and does NOT make a top paid group election. Both plans has a calendar plan year for 2010. In doing coverage and nondiscrimination testing for 2010, do we apply the top paid group election or not?
Unclear, but the answer appears to be no. Notice 97-45, Section VI(1) provides that the top paid group election must apply to all plans of the employer "in order to be effective". Since it doesn't, it isn't. What is less clear is whether and how this affects the 401(k) plan document; the plan will not be following the document as far as the top paid group election. There is not specific guidance on this; I'd say a retroactive amendment is needed. Because the amendment is required for compliance, the amendment can be adopted not later than the due date of the employer's tax return.
Revenue Procedure 2000-40 states that a plan with both a change in the enrolled actuary and a change in the actuarial consulting firm is considered to be a change in method. The following is with regard to automatic approval for a change in funding methods:
Situation 1: A TPA firm receives new business from a client who moves his or her plan to this new firm for administration purposes.
Situation 2: A TPA firm acquires new plan as a result of purchasing another TPA firm. Subsequently, the valuation software used to produce the valuations is different between the two years of administration.
When attempting to match the most recently filed return are there specific guidelines for how close the new administrator must come to the previous administrator's valuation results? What are options if the prior TPA firm made mistakes, such as omitting a limit, that significantly alters the valuation results?
For plan years beginning on or after January 1, 2009, automatic approval is provided for a change in funding method if the following conditions are satisfied:
(1) There has been a change both in the enrolled actuary for the plan and in the business organization providing actuarial services to the plan;
(2) The new method is substantially the same as the method used by the prior enrolled actuary and is consistent with the description of the method contained in the prior actuarial valuation report or prior Schedule SB of Form 5500;
(3) The funding target and target normal cost..., as determined for the prior plan year by the new enrolled actuary (using the actuarial assumptions of the prior enrolled actuary), are both within 5% of those values as determined by the prior enrolled actuary; and
(4) For plan years beginning on or after January 1, 2011, the actuarial value of plan assets, as determined for the prior plan year by the new enrolled actuary (using the actuarial assumptions of the prior enrolled actuary), is within 5% of the value as determined by the prior enrolled actuary. (Announcement 2010-3)
My understanding is that you MAY have a DB Plan in addition to a SEP (but the SEP must be set up using a prototype or individually designed SEP- not 5305-SEP).
Assuming the SEP is on a prototype and a DB Plan is set up in 2011:
Is cross testing allowed?
No; SEPs cannot be cross tested.
If NOT a PBGC case, are you limited to the 6% in the SEP? i.e. can I contribute $49,000 in the SEP and the maximum contribution in the DB Plan?
Yes. (Code Section (404(h)(3))
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