Design Barriers Come Tumbling Down With Preapproved Retirement Plans



With changes in how it signs off on retirement plans, the Internal Revenue Service is counting on plan design flexibility to entice more employers to adopt preapproved forms of retirement plans.

In Revenue Procedure 2017-41, the agency announced new procedures for issuing opinion letters that indicate whether retirement plans qualify for tax-favored treatment. The changes, which take effect starting Oct. 2, include elements aimed at encouraging employers to convert from individually designed plans to the preapproved plan format, the agency said.

Revenue Procedure 2017-41 “loosens up on several long-term plan design bugaboos for preapproved plans,” Louis T. Mazawey, a principal at Groom Law Group, told Bloomberg BNA. For example, the changes will allow a money purchase plan to be combined with a Section 401(k) or profit sharing plan in the same plan document, he said.

Last year, the IRS announced in Revenue Procedure 2016-37 that it was scaling back on determination letters for individual plans. Budget and personnel cuts prompted that move.

Program Differences

An individually designed plan covers only the employer for whom it is specifically drafted, while a preapproved plan potentially encompasses many more employers under the same plan document.

In a preapproved plan, a recordkeeper, attorney, financial institution, or other entity applies for an opinion letter on behalf of at least 15 employers that agree to adopt the same preapproved plan.

If the IRS approves of the plan provisions, it issues a favorable opinion letter that the employer can rely on in adopting the preapproved plan for its own situation.

Common Design

The IRS is opening up more design possibilities for preapproved plans, according to Mazawey. He pointed to new options for nonstandardized plans, which are plans that offer flexibility in certain areas not available under standardized plans.

For example, the IRS will allow a nonstandardized plan that contains an employee stock ownership plan to include a 401(k) feature. “This is a pretty common design, certainly among Fortune 500 companies,” Mazawey said. These companies often want to be able to deduct dividends on stock held by the ESOP—a benefit unique to these plans, he said.

Plan sponsors will also have more leeway under the revenue procedure to use cash balance plans, he said. Cash balance plans use interest crediting to determine part of the participant’s benefit accrual.

The revenue procedure will allow nonstandardized cash balance plans to base the interest crediting rate on the plan’s actual rate of return. Cash balance plans are subject to additional design restrictions, including that the only formula permitted is that the employee’s rate of benefit accrual can’t exceed 133 1/3 percent of the employee’s accrual rate in any earlier year of service.

Trusts and Custodial Accounts

The IRS also will no longer review or issue opinion letters for any provisions included in trust documents or custodial agreements, according to the revenue procedure.

Plan sponsors have mixed views on this, Mazawey said. “The trust document typically has few IRS-related provisions in it,” he said. However, part of having a qualified plan is having a qualified trust, he said. “The fact that the preapproved plan no longer covers that is concerning because some trust documents have different wording and many were written many years ago, leading to issues over interpretation,” he said.

Retirement plan sponsors and trustees want some assurance that they can rely on the trust document, especially as trust documents are not allowed to have any provisions that override the plan document, he said.

Legacy Benefit Formulas

A continuing issue for the IRS is what impact the retention of so-called legacy benefits will have on the conversion from an individually designed plan to a preapproved plan.

Revenue Procedure 2017-41 noted that certain legacy benefit formulas often arise in the context of mergers and acquisitions. The IRS is seeking “comments on this issue, particularly with respect to the effect that appending legacy benefit formulas would have on reliance on a plan’s Opinion Letter.”

Employers want some accommodation of these legacy formulas in the opinion letter or at least confirmation that their presence won’t knock the plan out of the pre-approved program, Mazawey said.

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