IRS Changes Determination-Letter Program for Retirement Plans

​The Internal Revenue Service (IRS) has made significant changes to the determination-letter program through which it previously issued favorable determination letters for qualified retirement plans. Employers, employee benefits practitioners and auditors have become accustomed to relying upon the existence of favorable determination letters to confirm the qualified status of retirement plans.

In 2014, the IRS began to hint that changes would be made to the process of issuing individual determination letters. In Announcement 2015-19, the IRS officially stated that it would cease issuing favorable determination letters for individually designed plans. Now the IRS generally will grant determination letters for individually designed plans only upon the establishment or the termination of such plans.

Implications for Defined Benefit Pension Plans

Because employers may no longer obtain favorable determination letters for individually designed plans, the first test of the new IRS determination-letter program has already begun. The IRS has recently issued opinion letters to various vendors confirming that their preapproved defined benefit pension plan documents are in compliance with all legal requirements.

Therefore, employers who previously maintained individually designed pension plans must consider whether they will adopt new, preapproved defined benefit plans during the two-year window that opened May 1, 2018, and will close on April 30, 2020. At a minimum, employers maintaining prototype and volume submitter defined benefit pension plans must amend their retirement plans using updated documents to remain in compliance with all legal requirements.

The unique issue for employers maintaining individually designed, defined benefit pension plans is whether the design of their plans and the maintenance of historical benefits can fit onto a vendor's preapproved prototype or volume submitter documents.

For example, it is not uncommon for large employers to have frozen benefits and to have continued a different benefit formula for individuals hired afterward. It is also not uncommon to have multiple schedules confirming the specific names of participants and their accrued benefits under previous benefit formulas.

When looking at prototype and volume submitter plans, employers must determine whether their pension plans should remain as individually drafted plans or if they can transition to a prototype or volume submitter plan.

Although not highly publicized, to the extent that an employer makes minor changes to a volume submitter plan (but not a prototype plan), it is possible for an employer to submit the new document to the IRS on Form 5307 and to request an updated determination letter. This will be an individual determination letter for a retirement plan on a volume submitter document, without the use of an individually designed plan. If too many changes are made to the document, however, the IRS may contend that it has become an individually designed plan for which it will not issue a favorable determination letter. Therefore, employers will be faced with determining whether to pursue the process of transitioning to new documents with the chance of obtaining a favorable determination letter.

Alternatively, employers may need to obtain private legal opinions from law firms to confirm the ongoing qualified status of a previously drafted, individually designed plan. These legal-opinion letters may be needed to satisfy financial auditors that a pension plan continues to be a qualified retirement plan for purposes of the Form 5500 annual audit process, or in connection with mergers, acquisitions, spinoffs or other corporate transactions.

Given the fact that the IRS defined benefit plan program has just opened, the dialogue regarding the use of existing documents versus the use of IRS preapproved prototype and volume submitter plans should begin between employers maintaining defined benefit pension plans and their legal counsel, actuaries and consultants.

Opportunities for Defined Contribution Plans

In addition to traditional defined benefit plans, most employers maintain defined contribution programs for employees in the form of profit sharing and 401(k) plans. The last two-year window to amend and restate 401(k) plans ran from May 1, 2014, to April 30, 2016. During this period, all 401(k) and other defined contributions plans required updating for all tax laws.

It is anticipated that the next two-year window to adopt preapproved "standardized" and "nonstandardized" plans (this new terminology will replace "prototype" or "volume submitter" plans) will begin May 1, 2020, and end on April 30, 2022. Between 2018 and 2020, employers with individually designed defined contribution plans may continue to make changes in plan designs as necessary to accommodate the needs of each employer.

Nevertheless, employers should seek to minimize the number of significant amendments that are made, particularly if those amendments do not fit squarely within the terms for preapproved documents. Significant amendments may cause an employer to lose reliance upon a previously issued favorable determination letter for a plan, once again requiring a private legal opinion to confirm the status of a retirement plan.

Although immediate action is not required for 401(k) and other defined contribution plan sponsors, they should begin to consider the following:

• Employers who previously maintained individually designed, qualified defined contribution retirement plans may retain such documents and obtain legal opinions regarding the qualified status of such plans.
  
• An employer with an individually designed defined contribution plan may shift to a new, preapproved nonstandardized plan document in the future.
  
• If an employee adopts a standardized plan, the only choice available to an employer will be to rely upon the opinion letter issued for the standardized plan by the IRS to the sponsor of the plan, such as a mutual fund, insurance company, bank or third-party administrator.
  
• It is important to note the distinction between an opinion letter issued to a vendor for its standard and nonstandardized documents that may be relied upon by an employer to confirm the qualified status of a retirement plan if certain conditions are satisfied, and an individual determination letter that confirms the qualified status of a specific retirement plan.
  
• Employers who adopt nonstandardized plans may make minor changes to such documents in the same manner as described above for defined benefit plans, and will still be able to submit such documents to the IRS to request an individual favorable determination letter using IRS Form 5307.
  
• In preparing minor amendments to a nonstandardized plan for a defined contribution plan, practitioners must once again exercise caution, since the degree of amendments may cause a problem with this approach. For example, if only a few changes are made to the nonstandardized plan document, it may be submitted on IRS Form 5307, and an individual determination letter may be obtained for the plan. However, if the IRS deems the changes to be too significant, the submission may be rejected by the IRS (in the same manner as addressed for defined benefit plans above), because the practitioner will have converted the nonstandardized plan into an individually designed plan. Therefore, there will be an ongoing balancing act between the number of changes that can be made to a nonstandardized plan document while receiving an individual determination letter, and not converting the plan into an individually designed plan.
  

Frank Palmieri is an attorney with Palmieri & Eisenberg in Princeton, N.J. Jason P. Lacey is an attorney with Foulston Siefkin in Wichita, Kan.