There are several tools that can be used to correct or fix governmental plan problems.
First, some classification. Practically all the retirement plans we discuss are “tax-advantaged” in one form or another. However, within this group, there are three main subgroups: tax-qualified plans subject to Internal Revenue Code section 401(a), eligible deferred compensation plans subject to IRC section 457(b) and tax-sheltered annuities subject to IRC section 403(b). Although the tax-qualification rules applicable to governmental plans are far less stringent than those applicable to private sector plans, there still are many rules and requirements that must be followed (e.g., contribution limits, deferral limits, distribution restrictions, pick-up rules, etc.). Governmental 457(b) plans have a special rule that generally gives their sponsors more time to fix most compliance problems.
If a 401(a), 457(b) or 403(b) plan is not maintained and administered in accordance with the terms of the plan document, or the applicable statutory and regulatory guidance, it can lose its tax-favored status, investment earnings would be taxed, vested account balances or accrued benefits could become taxable, and any tax-free rollover opportunities would be lost.
For decades, the IRS has offered sponsors of various tax-advantaged plans the opportunity to fix or correct a wide variety of plan failures through the Employee Plans Compliance Resolution System. In turn, EPCRS outlines a range of plan problems, possible corrections and correction principles available to address many, if not most, situations. Many of the less extensive and recently discovered problems can be unilaterally “self-corrected” by the plan sponsor, without any involvement by the IRS, using the Self-Correction Program. Other, more involved, problems can only be corrected under EPCRS through application to the Voluntary Compliance Program. These submissions must be made to the IRS and can take months, or even years, with concomitant costs.
The key to qualifying for SCP is to constantly be on the lookout for plan operational failures (i.e., the failure to follow the plan’s terms) or plan document failures (i.e., a plan provision that violates the tax-qualification rules, or a plan adopted by an ineligible employer). Many, if not most, operational failures can be self-corrected under SCP if they are discovered early and corrected within a few plan years following the failure. A limited number of document failures (i.e., problems with the plan’s terms as opposed to its operation) can also be self-corrected under SCP. It should be possible to find and identify many, if not most, of these problems – particularly in defined contribution plans — using a simple plan checkup.
A few examples of the kinds of problems that may be subject to self-correction would include:
- inadvertently leaving eligible participants out of a plan or including ineligible participants,
- allocating too much or too little to participant accounts,
- contributing excessive amounts to certain participant accounts or
- failing to adopt an interim amendment provided by your recordkeeper.
VCP is available for more serious and extensive problems, such as the ongoing operation of an improperly structured money purchase pension plan with an “opt-in” feature or the maintenance of a regular 401(k) or 403(b) plan by an entity that is not eligible to have one.
The IRS is relatively sympathetic when it comes to problems that have occurred with respect to a governmental plan. Often, the IRS will work with the plan sponsor and its counsel to come up with correction options that will have a less adverse impact on the sponsor and its employees. These more favorable corrections will not be available if the failures are detected by the IRS as part of an audit — as opposed to a voluntary correction.
If you are aware of document or operational problems with your 401(a), 403(b) or 457(b) plan, it is best to discuss them immediately with your employee benefits counsel. If caught early, many problems can be fixed relatively easily and without IRS involvement.
Jeff Chang is a partner at Best Best & Krieger LLP. He has four decades of experience skillfully evaluating benefit and retirement plan compliance to achieve maximum outcomes for public agency clients throughout California. He can be reached at firstname.lastname@example.org or (916) 329-3685.