IRS officials have informally announced the agency’s intention to sharply curtail the determination letter program for all individually designed retirement plans starting in 2017.1 Many large employers maintain individually designed plans, which include both defined benefit and defined contribution plans. These sponsors could still obtain a determination letter for initial qualification and upon plan termination. Officials said the IRS would review some types of intervening amendments through the program, although they have yet to specify which ones.
The officials indicated that, in lieu of periodically reviewing plans for compliance with qualification requirements, the IRS plans to provide model plan amendments for most or all of the changes in its annual “cumulative list of changes in plan qualification requirements.” While this could be helpful, it would not address some amendments not prompted by changes in applicable rules, such as adding a new benefit or converting a traditional defined benefit plan to a cash balance plan. If such amendments are not reviewed until plan termination, the IRS could make a retroactive determination that the plan violated some preexisting qualification requirement. The officials expressed a desire to retain a remedial amendment period for required and discretionary amendments, so perhaps this concern will somehow be addressed.
At a recent American Bar Association meeting, IRS officials discussed some additional possibilities for easing the program cutback, including:
- Training auditors not to “nitpick” sponsors who use a model amendment but make a few tweaks
- Making it easier to correct plan document failures under the Employee Plans Compliance Resolution System (EPCRS)
- Expanding the Master and Prototype (M&P) program to cover hybrid plans and employee stock ownership plans (which the IRS subsequently implemented)
- Providing greater flexibility to go outside the four corners of an M&P document
It appears that only individually designed plans will be affected — preapproved master, prototype and other volume submitter plans should still be able to obtain determination letters for all plan amendments.
If the changes proceed as planned, sponsors of individually designed retirement plans will face significantly higher compliance risks. Under the current determination letter program, a sponsor that submits its plan for a timely review (and has timely adopted any required amendments) can make any changes requested by the IRS retroactively, without being subjected to a penalty. Also, current IRS reviews are not limited to amendments in the IRS’ cumulative list. Rather, the IRS reviews the entire plan document, including amendments not required by law. A favorable determination letter verifies that nothing in the document contravenes the Internal Revenue Code or other IRS rules or regulations, and no required provisions are missing. Because of this broad scope, during a plan audit, the IRS is generally precluded from raising compliance issues about a plan document that received a favorable determination letter, at least for the period before the audit.
The scaled-back program would shift the risk of a defective or missing provision to the plan sponsor — and potentially to plan participants. This risk would accompany all provisions required or added after the IRS’ initial determination letter. Such document-based claims might arise through an IRS audit or through a participant dispute about plan benefits. In an audit, the sponsor could face penalties as part of the correction process and might need to modify benefit amounts retroactively.
If a plan were disqualified due to a defective plan document, the trust would incur income tax for which the IRS could seek payment from the trustee. Trustees might seek additional protections from sponsors for this exposure. The lack of a current determination letter might also have implications for mergers and acquisitions, annuitization of benefits through insurance products and other transactions where involved parties look to the current determination letter for assurance that the plan document meets all qualification requirements.
Finally, reduced oversight from IRS agents could adversely affect participants if sponsors decide to terminate their plans rather than continue without a favorable determination letter.
If sponsors of individually designed retirement plans no longer receive determination letters between initial qualification and plan termination, they will need to find other ways to manage their compliance risk. Periodic reviews of plan documents could ensure that all required changes on the latest IRS cumulative list have been made and that any other plan amendments satisfy IRS rules. Some sponsors already have such a process in place, and more sponsors will likely look to internal or external experts to conduct such reviews.
Any document defects discovered during such a review may be submitted to the IRS through its voluntary correction program (VCP) for remediation, which involves a submission fee but avoids IRS penalties. Some sponsors might decide to adopt a standardized plan, such as a volume submitter document, although the standard language of these documents significantly limits flexibility.
More details about the program cutback are expected this summer, along with a request for public comments.
1. Cycle A submissions (due January 31, 2017) will be the last filings accepted by the IRS under the current determination letter program for individually designed plans.