Current Initiatives by IRS to Assist Small Employers that Adopt
Pre-Approved Qualified Retirement Plan Documents
By Barry Kozak, Esq.
The John Marshall Law School, Chicago, IL
All employers that sponsor a tax qualified retirement plan must
execute a plan document that clearly states how an employee becomes a
plan participant, vests in and accrues retirement benefits, and can
ultimately receive the promised benefits. The employer can hire an
attorney to draft an individually designed document, adopt a document
that is materially similar to a Volume Submitter document drafted by
an attorney, accountant or other qualified pension professional, or
can adopt an “off-the-shelf” prototype document prepared
by the bank or financial institution where the plan assets will be
invested (which generally consists of a boiler-plate document and a
fill-in-the-blanks adoption agreement). Since the latter two types are
usually the easiest for the plan sponsor, and the cheapest, the IRS
estimates that currently over 90% of all qualified retirement plans
are supported by pre-approved plans.
However, employers adopting a pre-approved plan document,
especially small employers that don't necessarily have any owners or
employees that are experts in employee benefit issues, must realize
what they are not receiving when they purchase a pre-approved
plan, especially a Master & Prototype (M&P) plan. By analogy,
let's look at married couples that divorce using pre-printed
no-contest divorce decrees to dissolve their marriages, business
owners that use pre-printed forms to incorporate their businesses, or
individuals that download pre-printed health care power of attorney
proxies to allow close family members or friend to make life or death
medical decisions on their behalves in times of emergency. It is easy
to understand how in all three situations, the parties to the divorce,
incorporation or health proxy are not receiving legal advice. As long
as no unanticipated events occur, then in the end, with hindsight, we
can say that these people properly saved money and time by using
pre-printed legal documents and their general knowledge to circumvent
the time and expense of seeking appropriate legal advice.
When an employer is selecting a pre-approved M&P plan from a
bank or financial institution, it is basically doing the same thing.
The financial institutions are looking for a cheap way to convince the
employer to select its investment vehicles, and an off-the-shelf plan
document accomplishes this goal for them. This fact is not meant in
any way to disparage or question the level of expertise that any
particular bank or financial institution maintains - incredibly
competent ERISA attorneys are generally employed in their home offices
and painstakingly draft these M&P plans for IRS
approval.1 However, the employer
looking to establish a 401(k) or profit sharing plan is generally at a
local branch talking to an investment salesperson and not at the legal
department of the corporate headquarters. While that representative is
assumedly an expert in investments and is duly
licensed,2 not all investment
advisors are experts in employee benefits
issues.3 And even those Registered
Representatives that go the extra mile and voluntarily educate
themselves on the rules and regulation of qualified plans are not
necessarily licensed to practice law, and therefore can only provide
limited advice.
Some of the legal advice that every employer sponsoring a qualified
plan should receive before executing the plan document and formally
making the retirement benefit promises to its employees include:
•
The corporate or other business-related action (such as a board of
directors resolution) needed in that particular state to execute the
initial plan document, amend it from time to time, and to ultimately
terminate it;
•
The timing and substantive requirements to amend the plan as new
legislation, regulations or judicial opinion invalidates previously
sound plan language;
•
The importance of properly selecting the individual that will be the
named fiduciary in the plan document, and then training and bonding
that individual;
•
Establishing procedures for that named fiduciary to select and monitor
other individuals to either have allocated or delegated fiduciary
responsibilities;
•
A true determination as to whether the employer is part of a
controlled group of corporations or businesses, or is part of an
affiliated service group;
•
The establishment of internal payroll procedures to report proper
compensation and business ownership percentages to any third party
administrators so that benefits and contributions are properly
calculated, and so that Highly Compensated Employees and Key Employees
are properly classified on an annual basis;
•
While the plan is expected to adopt certain procedures that comply
with the statutes and regulations (such as a claims procedure if a
benefit request is denied, a funding policy and possibly an investment
policy statement, and a procedure for determining if a Qualified
Domestic Relations Order is effective to distribute some of the
qualified plan benefits to the ex-spouse of a divorcing plan
participant), the claims procedure, specifically, generates the
written record if the case is ever litigated, and different attorneys
might desire it to be drafted in different ways to best support the
plan in litigation.
Additionally, even if the document complies with current law and is
meticulously followed, at any point in time that the IRS or Department
of Labor audit the plan, or if a disgruntled plan participant (or
class of plaintiffs) disputes the actions taken by the plan
administrator or fiduciary, then the employer will probably need to
hire an outside attorney that is not the financial institution
attorney that drafted the M&P plan; thus, the attorney will likely
charge higher fees for having to read and digest the plan provisions
on an expedited basis before he or she can offer any litigation
advice.
This commentary is simply meant to advise employers of the pitfalls
of simply using an off-the-shelf M&P plan document in the absence
of any further thought or action. The plan advisors that are employed
to administer the plan (such as accountants, actuaries, attorneys,
investment advisors, or other professional consultants) can generally
assist the employer (as plan sponsor) in understanding these legal
issues and actually getting appropriate legal advice when needed. Like
the no-contest divorce, the self-incorporation form and the
do-it-yourself health proxy, small employers need to balance a cheap
and easy way to execute a written plan document with the legal and
other professional advice that is needed to properly administer the
qualified retirement plan that will probably not be provided with the
M&P plan.
The IRS has taken this matter very seriously, and is currently
contacting many of the banks and financial institutions that sponsor
M&P plans. One of the Employee Plans Compliance Unit's (EPCU)
featured projects generates a compliance contact letter that asks the
targeted M&P sponsors to provide information on how they are
meeting their requirements and
responsibilities.4 Specifically,
the letter asks the financial institutions, among other things, for a
list of employers that have adopted their M&P plan; an explanation
(and documents) supporting their efforts that they make to educate and
monitor their pre-approved plan clients on the importance of properly
executing and following plan documents, and also for any feedback that
they can offer to the IRS to ensure compliance for the institutions
and their clients. While a contact letter from the EPCU does not rise
to the level of audit or examination, there is no guarantee that the
banks and financial institutions will timely and completely respond.
According to the website, after lists of the respective adopting
employers are received, the EPCU will likely start the second phase of
this project, and actually send contact letters to individual
employers; however, there is no indication of what the contact letters
for adopting employers will look like, when those contacts would be
made, and what percentage of all employers adopting pre-approved plans
will actually be contacted.
The IRS's own Advisory Committee on Tax Exempt and Government
Entities (ACT), looked at the issues with M&P plans as they relate
to the institutional sponsors as well as the adopting employers, and
summarized the history of M&P plans, crafted conclusions based on
past plan audits, and made substantive recommendations in a report
titled “Improving Compliance for Adopters of Pre-Approved
Plans.”5 The recommendations
to determine how seriously institutions are taking their
responsibilities with the M&P documents are basically encompassed
within the EPCU project. However, there are very important
recommendations at the end of the report for IRS outreach and
education to the adopting employers:
•
Use of IRS Newsletters,
•
Special IRS Publication for Adopting Employers,
•
Self-Audit Checklist, and
•
A specialized website.
The IRS website has a general link to “Retirement Plans
Community” and then a link for “Plan
Sponsor/Employer.”6 While
there are currently links to very useful information (such as fix-it
guides, information on different types of plans, reporting and
disclosure rules, and how to prepare for an audit), the IRS has not
yet incorporated the ACT report suggestions specifically regarding
M&P plan issues as they affect adopting employers. Additionally,
in Exhibit C of the 2007 ACT
report,7 the IRS was encouraged to
develop a “Pre-Approved Plan Acknowledgment and Information
Form” that would mandatorily need to be completed, signed, and
retained by both the M&P sponsor and each adopting employer.
Unfortunately, however, “some of the procedural recommendations
cannot be implemented at least until the next six year remedial
amendment cycle which will not begin before
2011.”8
Pre-approved M&P plans, as well as Volume Submitter plans, are
very important methods of providing technically compliant plan
documents to small employers in a very inexpensive and efficient
manner. However, the adopting employers must always be aware of the
types of substantive advice that they are generally not
receiving from the bank or financial institution that sells them the
plan document along with the investment vehicles. The adopting
employers, especially small employers without any particular expertise
in employee benefit issues, must therefore take affirmative steps to
employ other competent plan advisors. Educating these adopting
employers is crucial for the proper delivery of retirement benefits
through qualified plans, and employee benefit attorneys and
practitioners are encouraged to make presentations and provide
summaries of basic qualified plan requirements wherever they can (at
local business associations, trade shows, chambers of commerce, or
other resource points for small businesses, including programs
sponsored by the Small Business Association).
For more information, in the Tax Management Portfolios, see
Bosley and Hutzelman, 353 T.M., Employee Benefits for Small and
Mid-Sized Employers, and in Tax Practice Series, see ¶5540,
Obtaining IRS Approval.
1
Rev. Proc. 2005-16 provides the procedures for banks and other financial institutions to request a favorable determination letter request from the IRS for their M&P plan documents.
2
The Financial Industry Regulatory Authority (FINRA) (previously the National Association of Securities Dealers (NASD)) administers the Series 7 exam that allows a Registered Representative to sell and trade securities, including mutual funds and target-date investment products.
3
On a purely voluntary basis, investment advisors can take professional examinations to prove their knowledge of pension plans. The American Society of Pension Professionals and Actuaries is one of the professional organizations that has developed a professional designation (i.e., a Qualified Plan Financial Consultant (QPFC)) for these registered representatives yearning to understand the difference between selling a mutual fund share to an individual as opposed to selling that same share to a qualified plan.
4
Information on this featured project is available at www.irs.gov/retirement/article/0,,id=182053,00.html.
5
All reports of the ACT are available at http://www.irs.gov/retirement/article/0,,id=98354,00.html, and this particular 2007 report can be found at http://www.irs.gov/pub/irs-tege/tege_act_rpt6.pdf (pages 113 to 165).
6
Various information can be found at http://www.irs.gov/retirement/sponsor/index.html.
7
http://www.irs.gov/pub/irs-tege/tege_act_rpt6.pdf at page 165.
8
According to Charles M. Lax, a shareholder at Maddin, Hauser, Wartell, Roth & Heller, P.C. in Southfield, Michigan, and Project Leader of the 2007 ACT Report.
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