Recent Developments Affecting Qualified Retirement Plans

This update summarizes several recent developments that may affect the administration of 401(k) plans and other qualified retirement plans.

Contents:

• Model Special Tax Notice: Downloadable File
• Revised Special Tax Notice Regarding Plan Payments
• Paperless Plan Administration
• Additional Guidance on 401(k)/401(m) Safe Harbors
• Negative Elections in 401(k) Plans
• Timing of Plan Amendments and Resubmissions

REVISED SPECIAL TAX NOTICE REGARDING PLAN PAYMENTS

Earlier this month, the IRS published a revised model .Special Tax Notice. that is to be provided by the plan administrator to participants prior to the payment of a distribution from a retirement plan that is eligible for a rollover. The Special Tax Notice explains a participant.s distribution options and the tax consequences. Because the Special Tax Notice must describe current law, the new model should be used immediately.

Changes to the Notice. The Special Tax Notice has been revised to clarify that rollovers can only be made to traditional IRAs, and not to Roth, Education, or Simple IRAs. The Notice also reflects changes in the law that made certain hardship distributions from a 401(k) plan ineligible for rollover, eliminated the five-year income tax averaging option for lump sum distributions, and added an exception to the 10% early withdrawal penalty tax for payments made pursuant to a federal tax levy. The Special Tax Notice also reflects the change in the beginning date for required minimum distributions to the later of age 70= or termination of employment in the case of participants other than 5% owners or their relatives.

Customization of the Notice. As before, the Special Tax Notice should be customized to include the name of the Plan and the Plan Administrator. In addition, irrelevant information may be omitted. For example, information on employer securities may be omitted if the Plan does not hold such securities. Also, the beginning date for required minimum distributions should reflect the rule used by the Plan.

Distribution and Timing of the Notice. As a general rule, the Special Tax Notice must be provided to a participant between 30 and 90 days prior to the payment of an eligible rollover distribution. However, pursuant to IRS regulations, a participant may totally or partially waive the 30-day period (depending on the type of plan involved). In addition, under the regulations, the Special Tax Notice may be provided more than 90 days prior to the distribution (for example, in an SPD) if a summary of the Special Tax Notice is provided to the participant within the 30 to 90 day period prior to the distribution. The summary and/or the notice also may be provided to the participant by electronic media such as e-mail, internet or voice response, provided certain standards are met.

PAPERLESS PLAN ADMINISTRATION

Last week, the IRS finalized its proposed regulations permitting delivery of the Special Tax Notice, as well as notices of the right to defer distributions and notices of the right to elect voluntary tax withholding, through electronic media. These regulations also permit the Special Tax Notice and deferral notices to be provided more than 90 days prior to a distribution if a summary of the notice is provided within 90 days of the distribution. The final regulations clarify the requirements for the content of the summaries, but otherwise closely follow the proposed regulations. (See our January 26, 1999 newsletter for a description of these regulations.)

ADDITIONAL GUIDANCE ON 401(K)/401(M) SAFE HARBORS

.Safe harbor. methods for avoiding the actual deferral percentage (ADP) and actual contribution percentage (ACP) nondiscrimination tests under Code Sections 401(k) and 401(m) first became available for plan years beginning in 1999. (See our December 2, 1998 newsletter for a description of the safe harbors.) In January of 2000, the IRS released additional guidance on safe harbor plans that expands the options available to meet the 401(k) safe harbor, eliminates the requirement of a year-end .top-up. for plans using safe harbor matching contributions, and makes numerous other technical clarifications. In addition, the IRS extended until May 1, 2000 the notice deadline for plans adopting safe harbors for the first time this year.

Flexibility to Adopt a 401(k) Safe Harbor Nonelective Contribution. To take advantage of the safe harbors, a plan generally must contain a description of the safe harbor contributions prior to the beginning of the plan year in which the safe harbor will be used. However, the IRS significantly relaxed this requirement for plans that decide to satisfy the 401(k) safe harbor by using a nonelective contribution of 3% or more of a participant.s compensation.

The IRS now permits the employer to decide each year whether a safe harbor nonelective contribution will be made for that year. If the employer decides to make a contribution, the employer must amend the plan at least 30 days prior to the end of the plan year to specify the amount of the safe harbor contribution for that year. The contribution must otherwise meet the requirements for a nonelective safe harbor contribution in the IRS. earlier guidance (e.g., the contribution must be fully vested, it may not be subject to last day or 1,000 service requirements, and it may not be distributed prior to separation from service, death, disability, or attainment of age 59=).

This new option provides plans with the flexibility to take a .wait and see. approach with respect to testing. However, it still requires some advance planning. Plans must generally provide notice of the possible contribution within 30 to 90 days prior to the beginning of the plan year for which the safe harbor may be adopted. Thus, to keep the option open for a safe harbor nonelective contribution in 2001 to a calendar year plan, participants would have to be notified of that possibility by December 1, 2000, and the plan would have to be amended to provide for the contribution by December 1, 2001. (For the year 2000 only, a special transition rule permits plans adopting the nonelective safe harbor for the first time this year to issue the notice any time prior to May 1, 2000 and adopt the plan amendment by December 1, 2000.)

Elimination of the .Top-Up. Requirement. Reversing its prior position, the IRS now permits safe harbor matching contributions to be made on a basis that is more frequent than the plan year (e.g., pay-period by pay-period, monthly, or quarterly) without the requirement to make an additional .top-up. contribution at year-end based on the employee.s contributions for the entire plan year. Plans taking advantage of this option must make safe harbor contributions no later than the last day of the quarter of the plan year following the quarter in which the employee contribution is made, starting with plan year quarters beginning after May 1, 2000.

Adding Safe Harbor Contributions to an Existing Profit Sharing Plan. Creating an exception to the rule that an existing plan must satisfy the safe harbor requirements for the entire plan year, the IRS stated that an existing profit sharing plan that does not have a 401(k) feature may add a new 401(k) provision that satisfies the 401(k) and/or 401(m) safe harbor requirements at any time prior to the last three months of the plan year (i.e., by September 30 in the case of a calendar year plan).

Other Guidance. The IRS also provided further guidance on the content and delivery of safe harbor notices and the application of the safe harbor rules to employee after-tax contributions.

NEGATIVE ELECTIONS IN 401(K) PLANS

In 1998, the IRS gave the green light to 401(k) plan designs that automatically enroll newly eligible participants for salary reduction contributions unless the participant specifically elects not to contribute (commonly called .negative elections.). This subject was covered in our newsletter dated June 26, 1998. In Revenue Ruling 2000-8, the IRS has now expanded that concept to include automatic enrollment of existing participants as well.

Under the plan design described in the Ruling, participants who were contributing nothing in the prior year, or who had elected to contribute less than 3% of pay, were automatically increased to a 3% of pay salary reduction effective on January 1st. At the beginning of a .reasonable period. ending on the January 1 effective date, each participant was given a notice that explained the new automatic enrollment process, advised the participant of the right to file an election not to contribute or to contribute a different percent of pay, and explained the process for making and changing elections. (The IRS did not explain what a .reasonable period. would be.) Annually thereafter, each participant would be notified of his or her current salary reduction percent and the process for changing that percent.

This type of negative election process can be particularly attractive for 401(k) plans that are having problems passing the nondiscrimination tests because of a large number of low or non-contributors. It allows the employer to put inertia to work for the plan, rather than against it. However, it is essential that the process allow any participant who does not want to make the automatic contribution an adequate opportunity to decline before deductions start from the participant.s paycheck.

TIMING OF PLAN AMENDMENTS AND RESUBMISSIONS

Currently, the .remedial amendment period. for revising plans to comply with changes in the law adopted in 1996, 1997 and 1998 and submitting those revisions to the IRS for new determination letters ends for most plans on the last day of the plan year beginning in 2000 (i.e., December 31, 2000 for calendar year plans). Although the IRS has not made any formal announcement, it is becoming apparent that this deadline is not likely to be extended again.

We are proceeding on the assumption that this is now the final deadline, and will be contacting our clients this year to begin the amendment and resubmission process.

Downloadable Files