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On November 15, 2013, the Internal Revenue Service (“IRS”) issued final regulations regarding how a plan sponsor is permitted to exit a safe harbor 401(k) feature in the middle of the current plan year (“Final Regulations”). These rules both clarified and supplemented the existing operational rules regarding safe harbor 401(k) matching and non-elective (commonly referred to as “profit sharing”) “full year” contribution requirements.

Background

As you may know, one design feature available to a sponsor of a 401(k) plan is a “safe harbor employer contribution” component. The main advantage to such a feature is that it generally permits a plan sponsor to avoid the application of the “actual deferral percentage” (“ADP”) and “actual contribution percentage” (“ACP”) tests that serve to limit the amount of elective deferral and matching contributions that may be made by or the behalf of “highly compensated employees”. In addition, in certain circumstances, proper employment of a safe harbor 401(k) feature can avoid the application and/or impact of the “top-heavy” test which restricts the amount of total plan assets that may accrue within the trust of a plan for the benefit of certain “key employees”. However, the advantages of a safe harbor 401(k) feature come at a cost.

In order to gain the advantage of avoiding the ADP, ACP and top-heavy tests (“Tests”), a plan sponsor who elects to employ a safe harbor 401(k) feature must satisfy several requirements which include, but are not limited to, both employer contribution and administrative aspects. The most noteworthy of these requirements involve a 100% fully vested employer contribution of up to four (4) percent of each eligible employee’s compensation (in the case of a safe harbor matching contribution) and an annual participant notification requirement. Most plan sponsors understand those two obligations from the outset of their election to “go safe harbor”. However, many plan sponsors are less aware of the restrictions that apply to the ability of a plan sponsor to exit their 401(k) plan’s safe harbor design feature; particularly if the desire to eliminate the feature occurs in the middle of the current plan year. The remainder of this article discusses both the prior and new IRS guidance on how to exit a 401(k) safe harbor contribution feature “mid-year”.

Prior Guidance

Prior to the issuance of the Final Regulations, a plan sponsor could fully terminate a safe harbor plan midyear or eliminate a safe harbor matching contribution feature mid-year for any reason if the plan at issue provided advance notification of the elimination of the feature, funded the safe harbor contribution through the effective date of its elimination and applied the Tests in relation to the full plan year.

However, plan sponsors were only permitted to exit a safe harbor non-elective contribution feature mid-year if such sponsor satisfied the criteria set forth above and experienced a “substantial business hardship” as defined under the Internal Revenue Code. For this purpose, a substantial business hardship required a finding that: (i) the plan sponsor was operating at an economic loss, (ii) substantial unemployment or underemployment existed in the plan sponsor’s trade or business, (iii) sales and profits of the plan sponsor’s industry were depressed or declining, and (iv) it was reasonable to expect that the plan would only be continued if relief was granted. As one might anticipate, the satisfaction of all four of the substantial business hardship criteria set forth above severely limited the ability of any plan sponsor to exit mid-year from a safe harbor non-elective contribution feature. In addition, the effective impact of the rules was to require not just a business hardship on the part of the individual plan sponsor but a finding that the entire industry within which such plan sponsor operated was experiencing a substantial hardship. Many practitioners believed that requiring a hardship on the part of the entire industry was unnecessary and too restrictive. Based on the form of the Final Regulations, the IRS agreed.

Final Regulations

As noted above, the manner by which a safe harbor 401(k) contribution could be eliminated mid-year under the old guidance depended upon whether the safe harbor 401(k) contribution at issue was a safe harbor match or a safe harbor non-elective contribution. However, there did not seem to be any justification for such a distinction. Therefore, it should be no surprise that the Final Regulations provide identical rules for the mid-year elimination of either a safe harbor match or a safe harbor non-elective contribution feature.

Under the Final Regulations, there are two circumstances under which a plan sponsor may stop a safe harbor contribution requirement:

1. the plan sponsor is operating at an economic loss; or
2. the plan sponsor included specific language in the annual safe harbor notice explaining that the plan may be amended during the plan year to eliminate the safe harbor contribution feature.

The first item listed above reflects the elimination of three (3) of the four (4) criteria that were previously required in order to satisfy the economic hardship component necessary under the prior guidance with regard to the mid-year elimination of a safe harbor non-elective feature. Obviously, this will make it easier for a plan with a safe harbor non-elective component to qualify for this type of relief but more difficult for a plan with a safe harbor match which did not previously have to satisfy any such requirement. Notwithstanding, the second item’s grant of an ability to every plan sponsor to include “magic” language within its safe harbor notice that permits a plan sponsor to accomplish the same safe harbor elimination goal is much more permissive. Therefore, presumably, such language will become standard “boilerplate” language included within all future safe harbor participant notices prepared not only by Legacy Retirement Solutions but by all plan service providers.

If the plan sponsor meets one of the circumstances that permit the mid-year elimination of a safe harbor contribution, it then must satisfy several administrative requirements in order to effectuate that intent.

Specifically:

1. all eligible employees must be provided with a supplemental notice that informs them about such elimination including its effective date and how to change their deferral elections;
2. the elimination of the safe harbor contribution must be effective no earlier than the later of the date the amendment is adopted or 30 days after all eligible employees are provided with the supplemental notice referenced above;
3. all eligible employees must be granted a reasonable opportunity(including a reasonable period after receipt of the supplemental notice) to change their deferral elections before the elimination of the safe harbor contribution;
4. the plan must be amended to provide that the Tests will be satisfied for the entire plan year in which the elimination occurs; and
5. the plan sponsor must fund the safe harbor contribution through the effective date of the amendment that eliminates it.

With regard to the mid-year elimination of a safe harbor 401(k) match features, the above referenced changes are effective for plan years beginning on or after January 1, 2015. However, with regard to safe harbor 401(k) non-elective features, the Final Regulations are technically effective retroactively to May 18, 2009 but, practically, are effective immediately.

For more information about this issue please contact our marketing department at 484-483-1044 or your administrator at Legacy.

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On December 11, 2013, the Internal Revenue Service (“IRS”) issued Notice 2013-74 (“Notice”) which provided anxiously awaited guidance on “in-plan Roth rollovers”. The following summarizes the new guidance and how it impacts the in-plan Roth rollover rules that existed prior to the release of this new guidance.

Background

An in-plan Roth rollover is a plan provision that a plan sponsor may voluntarily elect to employ which allows a participant of a properly designed 401(k), 403(b) or governmental 457(b) plan to “convert” certain pre-tax amounts held in the plan to an after-tax Roth account maintained within the same plan. Thus, a participant’s decision to exercise this provision results in a taxable rollover “distribution” to a Roth account. In connection with this “account conversion”, the participant is required to pay income tax in the year of the conversion on the converted amount. Then, as a result of the Roth treatment of such converted amounts, related earnings will not be subject to income tax when distributed from the plan if certain other requirements are satisfied.

The Small Business Jobs Act of 2010 (“SBJA”) was the first legislation that authorized in-plan Roth rollovers. However, the authorization granted under SBJA was limited to amounts that might otherwise be distributable under the terms of the plan. This limitation was significant because it essentially restricted the exercise of this provision to participants who usually already had the ability to move such amounts via a tax-free “eligible rollover distribution” from the plan at issue to an “individual retirement account” (“IRA”). Once such amounts were rolled to an IRA, it could then be converted to Roth monies. Thus, it is reasonable to argue that the in-plan Roth rollover authorization provided under SBJA had little to no practical impact on the ability of a participant to convert pre-tax amounts to Roth amounts.

In response to this limitation (and the additional tax revenue that Congress anticipated would result from a more permissive Roth conversion policy), the American Taxpayer Relief Act of 2012 (“ATRA”) expanded the availability of in-plan Roth rollovers to all pre-tax amounts held in 401(k), 403(b) and governmental 457(b) plans regardless of whether such amounts are otherwise distributable. By not requiring that any amount eligible for conversion must also be otherwise distributable from the Plan, ATRA provided a real opportunity for the conversion of pre-tax amounts to Roth monies that did not previously exist for eligible plan participants.

ATRA was signed into law on January 2, 2013. However, the welcome expansion of in-plan Roth rollovers under ATRA was limited by the fact that additional operational guidance from the IRS was necessary before such transactions could be effectuated. The Notice is intended to supply that necessary guidance.

New IRS Guidance

The IRS first provided guidance on in-plan Roth rollovers authorized under SBJA in 2010 within Notice 2010-84. The Notice confirms that the earlier guidance under Notice 2010-84, including the requirement that amounts eligible for in-plan Roth rollovers must be vested, continues to apply to all in-plan Roth rollovers with certain exceptions. For example, the Notice explains that two requirements under the earlier guidance—that a plan must provide a 402 (f) notice to a participant making an in-plan Roth rollover and that an in-plan Roth rollover may be accomplished by an in- plan Roth 60-day roll over—apply only to in-plan Roth rollovers of otherwise distributable amounts.

In addition to confirmation that the majority of the in-plan Roth rollover rules established under Notice 2010-84 continue to apply to the expansion of such rules, the Notice provides several rules that apply only to amounts not otherwise distributable from a plan. First, it confirms that amounts eligible to be rolled over into a designated Roth account include elective deferral contributions under 401(k) and 403(b) plans, matching and profit sharing contributions and deferrals made to governmental 457(b) plans. The Notice also indicates that amounts not otherwise distributable that are converted to a Roth account remain subject to the same distribution restrictions that were applicable to such amounts before the in-plan Roth rollover occurred. Therefore, if a participant (who has not had a severance from employment) makes an in-plan Roth rollover from a pre-tax deferral account prior to age 59 ½, that rollover amount cannot be distributed to the participant prior to the participant’s attainment of age 59 ½ or the occurrence of another event that permits a pre-tax deferral account to be distributed under the terms of the plan.

The Notice continues by clarifying that, for in-plan Roth rollovers of amounts not otherwise distributable, taxes are not required or permitted to be withheld from the rollover amount. Consequently, participants should be aware that they will be required to pay income tax in the year of the conversion on the full amount transferred without actually receiving a distribution from the plan to help satisfy the resulting tax liability. Thus, participants should consider increasing their tax withholding through payroll or making estimated tax payments to avoid an underpayment penalty.

The last aspect of the Notice discussed within this article involves the deadline for amending a plan to provide for in-plan Roth rollovers. A plan amendment providing for in-plan Roth rollovers of amounts not otherwise distributable qualifies as a “discretionary amendment”. Discretionary amendments generally must be adopted no later than the last day of the first plan year in which such amendment is effective. However, the Notice extends the deadline for adopting plan amendments for in-plan Roth rollovers to “the later of the last day of the first plan year in which the amendment is effective or December 31, 2014.” Therefore, a calendar-year plan could permit in-plan Roth rollovers of non-distributable amounts during the 2013 plan year as long as a plan amendment is formally adopted which authorizes such transaction by no later than December 31, 2014.

Please be advised that this article is intended as an informative summary of the new guidance but does not intend, or pretend, to be an exhaustive discussion of every aspect of the new guidance. Therefore, before you decide to either implement in-plan Roth rollovers in your plan as a plan sponsor or exercise your ability as a participant to convert such amounts within the plan you participate in, please consult with your professional retirement plan service provider and your personal tax advisor to make sure that you understand the full impact of any such decision. For more information about this issue please contact our marketing department at 484-483-1044 or your administrator at Legacy.

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Background

Recently, the U.S. Supreme Court struck down Section 3 of the Defense of Marriage Act (“DOMA”) as an unconstitutional violation of the 5th Amendment’s guarantee of equal protection under the law. Section 3 of DOMA defined “marriage” and “spouse” for purposes of Federal law as limited to a legal union between one man and one woman as husband and wife. The elimination of Section 3 of DOMA extends certain marriage rights to same-sex couples under many Federal laws. As a result, guidance from a number of Federal regulatory agencies will be necessary in order to fully integrate the DOMA decision. Although the impact of this decision is much broader than just the world of tax-qualified retirement plans, the remainder of this article focuses exclusively on the retirement plan impact of the decision.

In this regard, on August 29, 2013, the Internal Revenue Service (“IRS”) released Revenue Ruling 2013-17 and certain Frequently Asked Questions (collectively referred to as “the Guidance”) which begin to explain the proper treatment of same-sex spouses under certain employment benefits plans and arrangements. The Guidance becomes effective as of September 16, 2013. However, within the Guidance, the IRS indicated that future guidance will also be issued in order to discuss certain unaddressed issues as well as the potential for the retroactive application of the Guidance. This additional guidance is expected to include consideration of the need for retroactive plan amendments to conform the terms of a plan to its operation in accordance with the new rules.

Rules

In essence, the Guidance establishes that same-sex marriages lawfully performed in any U.S. state, the District of Columbia, or a foreign country are valid as marriages under Federal tax law, regardless of where the couple reside. In addition, for Federal tax purposes, the Guidance indicates that the terms “spouse,” “husband and wife,” “husband”, “wife” and “marriage” include reference to a lawful same-sex marriage as defined above. Finally, the IRS clearly indicated that registered domestic partnerships, civil unions or other relationships formalized under state law as something other than marriage are not treated as marriage for Federal tax purposes, whether between same-sex or opposite sex individuals. Notwithstanding, in the case of a same-sex couple participating in an unrecognized domestic partnership, civil union, etc., such couple could secure prospective Federal recognition of their relationship by obtaining a valid marriage license from a state or country that recognizes same-sex marriage.

Impact
In practice, the Guidance will generally require Plan Sponsors to treat same-sex spouses equal to opposite-sex spouses for Federal tax purposes, so long as the couple was legally married in a state or other locale that recognizes same-sex marriage.

The following example is derived directly from the Guidance. A qualified defined contribution plan provides that a participant’s account must be paid to the participant’s spouse upon the participant’s death unless the spouse consents in writing to a different beneficiary. Such plan does not provide for any annuity forms of distribution. In that case, in the context of a lawfully performed same-sex marriage, the plan must pay the death benefit to the same-sex surviving spouse of any deceased participant. However, the plan would not be required to provide this death benefit to a surviving registered domestic partner of a deceased participant.

Action Items
First, Plan Sponsors should verify that any of its employees who are participants in a same-sex marriage were “legally” married as that term is considered under the Guidance. This includes confirmation that the relationship truly is a marriage and not a registered domestic partnership, civil union or other relationship formalized under state law as something other than marriage.

Second, Plan Sponsors must be on the alert for future regulatory guidance on retirement plan administration in relation to same-sex spouses. As indicated above, the IRS has stated that it intends to release such guidance. However, it is likely that other regulatory agencies will also release pronouncements on the issue.

Finally, the fact that additional guidance is expected on this issue emphasizes that the full impact of the Supreme Court’s DOMA actions are not yet established and that this entire issue remains in a state of flux. Therefore, be sure to check with your retirement plan service professionals when same-sex spousal retirement benefit questions arise.