Retirement News for Employers

IRS explains how to correct a failure to follow retirement plan terms
Retirement News for Employers

Mike Habib, EA

In its Retirement News for Employers, IRS has explained how to correct the common retirement plan mistake of failing to follow the plan terms in its operation. IRS clarified when a plan amendment can be used to correct this mistake via the Employee Plans Compliance Resolution System’s (EPCRS) Self-Correction Program (SCP).

In general, the failure to follow the plan’s terms may be corrected by:

(1) the plan fixing what was done in the plan’s operation by correcting the mistake to match the plan’s terms; or
(2) the employer retroactively amending the plan so that the plan’s provisions match the way the plan was operated.

Generally, SCP is only available if correction is made using the first approach, said IRS. However, SCP may be used to correct an operational failure by amending the plan to match the terms of the plan to the plan’s prior operations for only the three operational failures listed in Rev Proc 2006-27, 2006-22 IRB 945, Appendix B, Sec 2.07 (see RIA Pension and Benefits Week Newsletter 5/15/2006). According to IRS, those three operational failures are:

o Maximum compensation ( Code Sec. 401(a)(17) ) failures. A defined contribution plan that allocates contributions or forfeitures based on a participant’s compensation that exceeds the Code Sec. 401(a)(17) limit may be corrected by amending the plan. The affected participant’s allocation rate, after taking into account only compensation up to the Code Sec. 401(a)(17) limit, must be recalculated, and extra amounts must also be contributed to the other employees.
o Hardship distribution and plan loan failures. The operational failure of making hardship distributions or plan loans to employees under a plan that does not allow them may be corrected by retroactively amending the plan to provide for the hardship distributions or plan loans that were already given. The retroactive plan amendment is permissible provided that: the plan loans or hardship distributions were mostly made to individuals who were not highly compensated employees; loans were made according to the limits in Code Sec. 72(p); and for a 401(k) plan, hardship distributions complied with the Code Sec. 401(k) rules relating to hardship distributions.
o Early inclusion of otherwise eligible employee failures. The operational failure of including an otherwise eligible employee in the plan too early may be corrected by retroactively amending the plan. This would apply to an employee who either (i) has not completed the plan’s minimum age or service requirements, or (ii) has completed the plan’s minimum age or service requirements, but became a participant in the plan earlier than the plan entry date. The amendment, permitting the ineligible employee’s inclusion, serves to reflect the plan’s actual operations. To be entitled to make this retroactive amendment, employees affected by the amendment should be mainly nonhighly compensated employees.

A plan that corrects a failure using SCP must submit, within the plan’s remedial amendment period described in Rev Proc 2007-44, a determination letter application on the corrective amendments, identifying the amendments separately in the application.

The failure to operate the plan in accordance with its terms can be prevented by ensuring that all of the parties involved with plan administration are familiar with the plan’s terms, said IRS. Also, periodic plan reviews should be performed.

Mike Habib, EA