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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
The IRS has issued proposed regulations that will afford sponsors of 401(k), 403(b), and 457(b) plans flexibility in implementing qualified automatic contribution arrangements (QACAs). The proposed rules allow for variations in the elective deferral percentage and provide for a deemed timing rule that will allow for satisfaction of the annual notice requirement.
The proposed rules also provide guidance with respect to permissible withdrawals of default contributions under eligible automatic contribution arrangements (EACAs). The regulations would confirm that the amount of the distribution would be limited to an employee’s account balance adjusted for gains and losses, and reduced by generally applicable fees.
The regulations are proposed to be effective for plan years beginning on or after January 1, 2008. However, the proposed regulations may be relied upon pending the issuance of final rules.
Effective for plan years beginning after 2007, 401(k) plan sponsors that implement automatic enrollment provisions will be further able to comply with the ADP and ACP nondiscrimination tests by making specific contributions under qualified automatic contribution arrangements (QACAs). Similar to 401(k) safe harbor plans, a QACA offers an additional safe harbor for compliance with the nondiscrimination tests to employers maintaining an eligible automatic enrollment arrangement that provides for a minimum automatic employee contribution and a minimum employer matching or nonelective contribution. However, unlike safe harbor 401(k) plans, which offer immediate vesting, employees would not vest in the matching contributions under the automatic enrollment safe harbor until completing two years of service.
Automatic deferral at specified “qualified percentage.” Under a qualified automatic contribution arrangement, an eligible employee, absent a contrary election, is treated as having elected to have the employer make elective contributions in an amount equal to a “qualified percentage” of compensation, not to exceed 10 percent. The qualified percentage, however, must be equal to at least: 3 percent of compensation during the first year of the employee’s automatic enrollment, increase to 4 percent during the second year, 5 percent during the third year, and 6 percent during the fourth year and thereafter. Note, the initial period of participation for an employee can last for two years.
Minimum qualified percentage. An employee must be allowed to make elective contributions in an amount that is at least sufficient to receive the maximum amount of matching contributions available under the plan for the plan year. The employee may also elect a lesser amount of elective contributions. However, the IRS notes in the preamble to the proposed regulations, that the minimum qualified percentages specified by statute do not prevent a QACA from authorizing higher contribution percentages, as long as the qualified percentage does not exceed 10 percent of compensation.
Uniform application of qualified percentage. The qualifying percentage must be applied uniformly to all eligible employees. However, the proposed rules would allow the elective deferral percentages under a QACA to vary based on the number of years an employee has participated in the automatic contribution arrangement. In addition, the QACA would not be required to reduce the rate of elective deferral under a participant’s prior cash or deferred election that was in effect when the QACA become effective. The QACA could also limit the amount of elective contributions so as not to exceed the applicable statutory limits on compensation, elective deferrals, or benefits and contributions (i.e., 415 limits).
Opt-out election. Employees under the automatic enrollment safe harbor, as under all automatic enrollment arrangements, have the right to make an affirmative election to not have contributions made under the arrangement, or to make the elective contributions at a different level.
Employees who opted out of current automatic enrollment arrangement not eligible under QACA. Employees eligible to participate in the automatic enrollment safe harbor include all employees other than employees who were: (a) eligible to participate in the arrangement (or a predecessor arrangement) immediately before the date on which the arrangement became a qualified automatic contribution arrangement, and (b) had an election in effect on such date either to participate at a certain percentage or not to participate in the arrangement.
The proposed regulations would define an “election in effect” as an affirmative election that remains in effect to have the employer make elective contributions on the employee’s behalf (in a specified amount or percentage of compensation) or not to have the employer make elective contributions on the employee’s behalf. The IRS notes that this will generally require the employee to have completed an election form and chosen an amount or percentage (including zero) of compensation to be deferred.
Note, that an employer may limit participation in the QACA to employees hired after the effective date on which the provision was adopted. Thus, an employer may exclude from participation not only those who have opted out of the arrangement, but employees hired before the effective date of the QACA provision. The employer is further not required to provide the annual participant notice (see below) to employees who have opted out or are not eligible to participate in the arrangement.
Annual notice requirement. The application of the safe harbor is conditioned on each employee eligible to participate in the QACA receiving, within a reasonable period of time before each plan year, written notification of the employee’s rights and obligations under the arrangement. The notice must be: (1) sufficiently accurate and comprehensive to apprise the employee of such rights and obligations under the arrangement, and (2) written in a manner calculated to be understood by the average employee to whom the arrangement applies.
Content requirements. The notice, in addition to the information required by Code Sec. 401(k)(12) under traditional safe harbor plans, must explain the employee’s rights under the qualified automatic contribution arrangement to elect not to have elective contributions made on the employee’s behalf or to elect to have such contributions made at a different percentage. In the event the arrangement allows employees to elect among two or more investment options, the notice must explain how contributions made under the arrangement will be invested absent an election by the employee.
The proposed regulations would further require the notice to disclose the level of elective contribution that would be made on the employee’s behalf, absent an affirmative election. The proposed rules would also clarify that the requirement to explain how contributions will be invested under the automatic contribution arrangement applies even if the plan does not allow an employee to make an election among two or more investment options.
Cross-reference to SPD does not satisfy notice requirement. The IRS cautions that the additional notice requirements may not be satisfied by reference to the plan’s summary plan description.
Reasonable period of time to make elections. An employee must be afforded a reasonable period of time after the receipt of the notice and before the first contribution is made, to make an election not to have contributions made or to have contributions made at a different percentage, or to make investment elections.
Deemed timing rules. The proposed regulations would interpret the requirement to provide notice within a reasonable period of time before each plan year by applying the rules of IRS Reg. §1.401(k)-3(d)(3) . Thus, the “deemed timing” rules of IRS Reg. §1.401(k)-3(d)(3)(ii) would apply, pursuant to which the timing requirement will be satisfied if the notice is provided at least 30 days (and no more than 90 days) before the beginning of each plan year.
Eligible employees under new plan. In the event an employee does not receive the notice within the specified period of time because the employee becomes eligible after the 90th day before the beginning of the plan year, the notice requirement would be deemed satisfied, under the proposed rules, if the notice is provided no more than 90 days before the employee becomes eligible (and no later than the date the employee becomes eligible). This rule would apply, for example, to all eligible employees for the first plan year under a newly established plan that provides for elective contributions, and to the first plan year in which an employee becomes eligible under an existing plan that provides for elective contributions.
Immediate eligibility plans. With respect to plans that authorize immediate eligibility upon hire, the deemed timing rule would allow for the notice to be provided to the employee on the first day of employment.
Adoption of QACA before plan year. The QACA safe harbor applies to plan years beginning after 2007. As with traditional safe harbor plans, the plan provision implementing a QACA for an existing qualified cash or deferred arrangement must, under the proposed rules, be adopted before the first day of the plan year and remain in effect for an entire 12-month plan year.
The Pension Protection Act of 2006 (P.L. 109-280), effective for plan years beginning after December 31, 2007, authorizes eligible automatic contribution arrangements (EACAs) that will enable employers to unilaterally enroll employers in their 401(k) plans at a specified percentage of compensation and invest contributions in DOL-approved default investment funds without fear of fiduciary liability, and without being subject to state garnishment law restrictions.
Automatic enrollment at uniform percentage of compensation. Under an eligible automatic contribution arrangement, as under a traditional 401(k) plan, an employee may affirmatively elect to participate in the plan by having the employer make salary reduction contributions to the plan. However, absent such an election, the employee will be treated as having elected to have the employer make a salary reduction contribution to the 401(k) plan at a uniform percentage of compensation. The contribution will be made until the participant specifically elects not to have the contribution made or specifically elects to have the contribution made at a different percentage.
Variation in contribution rates. The proposed rules that would allow for variations in the elective deferral percentage under a QACA to reflect, among other factors, the number of years an employee has participated in the plan (see above), would also apply to contribution rates under EACAs.
Default investment of contributions. Absent an investment election by the participant, contributions under the eligible automatic contribution arrangement will be invested in accord with regulations to be issued by the Department of Labor governing default investment funds. Note, the proposed rules would limit application of this requirement to plans otherwise subject to ERISA Title I. Accordingly, the requirement would not apply to government plans under Code Sec. 414(d).
CCH Note: Final rules governing the default investment of contributions were issued by the Labor Department in October and take effect on December 24, 2007 (see CCH Pension Plan Guide ¶24,807N).
Annual notice requirement. The benefits of an eligible automatic contribution arrangement to an employer and an employee are conditioned on compliance with an annual notice requirement. Specifically, the administrator of a plan containing an eligible automatic contribution arrangement must, within a reasonable period of time before each plan year, provide each employee to whom the arrangement applies with notice of the employee’s rights and obligations under the arrangement. The notice must be sufficiently accurate and comprehensive to apprise employees of their rights and be written in a manner that is calculated to be understood by the average employee to whom the arrangement applies.
Written notice. The proposed rules confirm that the notice must be in writing. However, the rules would allow for the use of electronic media to provide the notice, in compliance with the requirements of IRS Reg. §1.401(a)-21.
Contents of notice. The notice must include an explanation of the employee’s rights under the arrangement to elect (1) not to have elective contributions made on his or her behalf, or (2) to have the elective contributions made at a different percentage. The notice must also explain the manner in which contributions under the eligible automatic contribution arrangement will be invested absent an investment election by the employee.
The proposed rules would further require the notice to accurately describe: (1) the level of elective contributions that would be made on the employee’s behalf, absent an affirmative election; and (2) the employee’s right to make permissible withdrawals (see below) and the procedures for electing a withdrawal.
Timing rules. The notice must be provided within a reasonable period of time before the beginning of each plan year. The proposed rules would further require the notice due an employee who becomes eligible in a given year to be furnished within a reasonable period of time before the employee becomes eligible.
The proposed rules would allow for the deemed satisfaction of the timing rules, if the notice is provided at least 30 days and no more than 90 days before the beginning of each plan year. As with the QACA notice, in the event an employee becomes eligible after the 90th day before the beginning of the plan year (and thus, does not receive the notice within the specified time period), the timing requirement would be deemed satisfied if the notice is provided no more than 90 days before the employee becomes eligible, but no later than the date the employee actually becomes eligible.
Coordinated EACA and QACA notices. The IRS, in the Preamble to the proposed rules, suggests that the varying notice requirements applicable to automatic contribution arrangements under the Internal Revenue Code and ERISA may be satisfied in a single document. In coordination with the DOL, the IRS “anticipates” that a single document will be able to satisfy all of the applicable notice requirements, as long as the document contains all of the required information and satisfies the timing requirements applicable to each of the notices.
Refund of default contributions. An eligible automatic contribution arrangement may allow employees to elect “permissible” withdrawals of amounts that were automatically contributed to the plan on behalf of the employee. The election must be made within 90 days after the date of the first automatic contribution made for the employee under the arrangement. The distribution of such erroneous contributions will not be treated as a violation of any of the distribution restrictions generally applicable to 401(k) plans.
Employers not required to offer withdrawal option. An employer is not required to include the 414(w)(2) withdrawal provision in the plan. In the event the plan does authorize withdrawals, the option need not be made available to all employees eligible under the EACA. Accordingly, the IRS explains an employer may restrict the withdrawal option to employees for whom no elective contribution has been made under the CODA (or predecessor CODA) before the EACA is effective.
However, the IRS further cautions, an employer may not require an employee, as a condition of taking a withdrawal, to make an election to have no further contributions made on his behalf, without violating the contingent benefit rule (or the universal availability rule applicable to 403(b) plans). Alternatively, the IRS notes, an employer could provide a default election in the withdrawal election form, pursuant to which elective contributions would cease until an affirmative election was made by the employee.
Withdrawal within 90 days of first elective contribution under the EACA. Under the proposed rules, an election to withdraw contributions must be made within 90 days of the first elective contributions that were made with respect to the employees under the EACA. The effect of defining the arrangement as an EACA would be to allow the withdrawal option to apply to employees previously eligible under the CODA (including a CODA that is an automatic contribution arrangement but not an EACA).
90-day window. The 90-day window during which an employee may make a withdrawal election would, under the proposed rules, begin on the date the amount would otherwise have been included in gross income. In addition, the effective date of the election would be no later than the last day of the payroll period that begins after the date of the election.
Amount of refund distribution. The amount of the refund distribution may not exceed the amount of the default elective contributions (and attributable earnings) made with respect to the first payroll period to which the eligible automatic contribution applies to the employee and any succeeding payroll period beginning before the date of the election (and attributable earnings).
Account balance adjusted for gains and losses. The amount of the reduced distribution would, under IRS proposed rules, generally be the employee’s account balance attributable to the default elective contributions, adjusted for gains and losses.
Fees may be assessed. In addition, the distribution may be reduced for generally applicable fees. However, the plan may not assess a different fee for the refund distribution under Code Sec. 414(w) than it would impose on other distributions.
Taxation of Roth contributions. Generally, the refunded amounts will be includable in the gross income of the employee as compensation for the tax year in which the distribution is made. However, the proposed regulations would clarify that distributions of designated Roth contributions that are included in the Code Sec. 414(w) distribution would not be included in the employee’s gross income (and thus, subject to tax a second time). In addition, the proposed rules would provide that the portion of the withdrawal that is treated as an investment in the contract is determined without regard to plan contributions other than those distributed as withdrawal default election contributions.
1099-R reporting of withdrawal. The amount of the withdrawal would, under the proposed rules, be reported on Form 1099-R.
Withdrawal distribution may not be rolled over. The proposed regulations would provide that the withdrawal distribution is not an eligible rollover distribution.
Application of nondiscrimination rules. Default elective contributions that are refunded to an employee will not be taken into account in applying the ADP and ACP nondiscrimination tests. In addition, a plan that fails the nondiscrimination tests because of excess contributions under the eligible automatic contribution arrangement may issue corrective refunds of the excess contributions or excess aggregate contribution (and earnings) within 6 months after the end of the year. Any excess contributions or excess aggregate contributions (and allocable income) that are distributed within the required time period will be treated as earned and received by the recipient in the tax year within which the distribution was made.
The proposed rules clarify application of these rules. The IRS explains that the proposed rules would affect corrective distributions made in 2009.
The proposed regulations may be relied upon pending the issuance of final rules. However, written and electronic comments on the proposed rules may be submitted to the IRS by February 6, 2008. In the event the final regulations are more restrictive than the proposed rules, the final rules will be applied on a prospective basis.
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