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Pension benefit plans allow an employer to make tax deductible contributions to a pension fund for employees. If the plan is "qualified" (meaning that the plan complies with the rules imposed by Internal Revenue Code Section 401(a)), such contributions are not taxed when the contribution is made, even if the employee's rights are vested (not forfeitable). Investment gains in the fund are not taxed. Plan distributions to the employee are taxed when they are distributed. Certain types of after tax employee contributions (known as Roth contributions) are never taxed. All things considered, qualified plans are tax smart.
Qualified plans can have many different rules—such as rules affecting mandatory or discretionary employer contributions, employee contributions, matching contributions, different vesting schedules, etc., etc. ERISA, and/or the Internal Revenue Code, usually both, require pension benefit plan documents to be in writing. Plan documents are often around 100 pages long.
Qualified plan documents generally fit into one of two broad categories: (1) pre-approved plans, or (2) individually designed plans. When ERISA was originally adopted, in 1974, all plans were individually designed. Pre-approved plans were invented later. Pre-approved plans are plans which have already obtained the approval of the IRS as to the form of the document. They usually are adopted by an employer by means of an "adoption agreement" which customizes the plan to the employer's purposes.
Pre-approval procedures are mostly contained in Revenue Procedure ("Rev. Proc.") 2007-44 and Rev. Proc. 2011-49. These procedures provide the means for plan document vendors, or benefit practitioners, to submit and obtain advance IRS approval for various types of retirement plans. As a practical matter, the sophistication and complexity of pension plans generally means that most employers should consider using a pre-approved plan. Even then, with Congress unable to stop making new rules, even the pre-approved plans must be continuously updated.
A principal difference between pre-approved and individually designed plans is that pre-approved plans follow a six year standard restatement cycle, and individually designed plans follow a five-year restatement cycle. At the end of the cycle, the plan must be entirely restated. The cycles establish deadlines with respect to restatements and interim amendments. These deadlines are generally dependent on the last digit of the plan sponsor's Employer Identification Number ("EIN").
Use of the pre-approved plan program has many benefits for the IRS, for practitioners, and for adopting employers. Adoption of a pre-approved plan generally eliminates the need for IRS review of the actual plan document when it is adopted. Plan practitioner time is significantly reduced, particularly when the pre-approved plan is generated using document generation software. For example, Devine Millimet is a pre-approved sponsor and maintains document generation software for pre-approved documents provided by the document vendor SunGard. There are a number of other document vendors such as SunGard. The result of this is that an employer desiring to establish a retirement plan can complete and execute an adoption agreement, resulting in cost savings by reducing or eliminating IRS filing fees and high practitioner costs.
Prototype Plans and Volume Submitter Plans
Prototype plans were the first to be invented, and volume submitter plans were invented thereafter. Both are pre-approved by the IRS. As a general matter, prototype plans are stricter and not as amenable to post-approval modifications as volume submitter documents are. Modification to prototype language results in the loss of pre-approved status and the plan becomes individually designed. There continue to be differences between prototype and volume submitter documents, although there is a general push to eliminate those differences (for example, volume submitter documents are now allowed to utilize an "adoption agreement"). However, minor modifications to volume submitter documents do not cause the loss of the pre-approved status. Modifications to a volume submitter document can be submitted to the IRS for a favorable determination letter using Form 5307.
Both prototype and volume submitter plans can be "cross-tested." Cross testing refers to nondiscrimination testing of a defined contribution plan as if it were a defined benefit plan. That means that greater contributions can be made for older employees, and non-discrimination testing can be set up for different allocation groups. There are numerous detailed considerations which are not discussed in this article. This article is intended only to identify the continents in the oceans, and not every island, lake and river. For example, prototype documents may not be used for a multiple employer plan ("MEP"). Also, money purchase pension plans with target benefit allocation formulas are prohibited from using prototypes. Prototype documents may not offer non-safe-harbor hardship distributions and may not allow employees to irrevocably elect not to participate in the plan, whereas volume submitter plan documents can provide for these optional features. Etc., etc. As a general matter, volume submitter documents are more frequently used.
Individually Designed Plans
There are a number of types of plans which are not permitted to use a pre-approved document, including ESOPs, multiemployer plans, stock bonus plans, 415(k) plans, union plans for more than a single employer, and church plans that have not made the election provided in Code Section 410(b). Individually designed plans are permitted to incorporate statutory provisions by reference more easily than pre-approved plans and this is at this time a benefit of such plans.
403(b) plans, which are governed by Code Section 403(b), are not technically "qualified" plans. They can be adopted only by 501(c)(3) tax-exempt entities or by governmental educational entities. They were invented in the first half of the 20th century and were adopted by many or most educational institutions. They are commonplace, and they are pension plans. Final 403(b) regulations were not adopted by the IRS until 2007. The final 403(b) plan regulations now mandate a written plan document, and the usefulness of a pre-approved program is obvious. In fact, the IRS indicated in announcement 2009-35 that it will be opening a pre-approved program for Code Section 403(b) plans. However, that program has not been developed yet.
Cash balance plans (a kind of mixture of a defined contribution plan and a defined benefit plan) are an historical fact and many of those cash balance plans appear to be being adopted primarily by smaller employers (100 or fewer participants). Pre-approved documents could be a benefit, but have not been developed.
Similarly, allowing ESOPs into a pre-approved program would be a great savings for IRS review time, especially for non-leveraged ESOPs. Leveraged ESOPs are most complicated.
In general, differences between prototype and volume submitter documents have been eliminated over time. Combining these two programs into one by using the best features of each would substantially streamline the pre-approval process. Until then, we have what we have.
Interim Amendments
The current favorable determination letter process, which is organized into five-year cycles (individually designed plans) and six-year cycles (pre-approved plans) requires employers to adopt interim amendments from year to year based on various regulatory or law changes. This requirement is not popular with IRS personnel and it is not popular with benefits practitioners, and employers pay the price. Various ideas have been circulated about relieving the burdens imposed as a result of the interim amendment requirements.
Favorable Determination Letters
Favorable determination letters are not required to be obtained, in order for a plan to be qualified. However, larger plans are unwilling to take the risk that its plan could be considered to be unqualified. Also, there are bankruptcy code provisions that require that a qualified plan must have received a favorable determination letter. It seems clear that favorable determination letters will continue to play a role in the pension plan document sea.
KISS
A benefits practitioner is well advised to "keep it simple, stupid" (KISS). Employers desiring to micromanage for cost savings (or other reasons) should be advised about the importance of the KISS principle. An experienced benefits practitioner should provide guidance with respect to such matters. Break in service rules, the use of elapsed time, unusual methods of determining service, and use of non-W-2 definitions of compensation can be difficult to administer. There are so many moving parts that it is advisable to keep it as simple as possible.
Get Advice
This article is intended, not as an exhaustive explication of the longitudes and latitudes associated with pension plan documents, but to provide a general assessment of the situation as it exists now, in 2012, and to impart to employers the importance of getting advice in order to avoid administrative complexities. Retirement plan tax benefits are still extremely significant, and retirement plans will continue to be most important for employers and employees into the foreseeable future.
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The Devine, Millimet & Branch Labor, Employment and Employee Benefits Group offers this free Friday E-Mail Alert service to provide information on recent developments in labor, employment and employee benefits law. If you have any questions about this e-mail, or if you know of anyone else who may be interested in receiving these alerts, please send us an email at employment@devinemillimet.com.
This is not a legal document nor is it intended to serve as legal advice or a legal opinion. Devine, Millimet & Branch, P.A. makes no representations that this is a complete or final description or procedure that would ensure legal compliance and does not intend that the reader should rely on it as such.
© Copyright 2012 Devine Millimet & Branch, Professional Association
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