Interestingly, there was even one rumor that the global apocalypse warning arose not out of an ancient Mayan prophecy, but instead snowballed from a misplaced warning of a retirement plan apocalypse, complete with a six or seven figure Internal Revenue Service (IRS) penalty, over a single excess deferral in the plan. Thankfully, both such warnings—of the end of the world, and the end of that affected plan—are behind us, and we can move on.
For plan sponsors, moving on includes focusing attention on their retirement plans, and anticipated IRS guidance. One eagerly anticipated item for 2013 is publication of IRS plan correction guidance for 401(a), 403(a), 403(b) and employer-sponsored IRA plans, to update Revenue Procedure 2008-50. This guidance is expected, among other things, to incorporate new rules for 403(b) plans—including the written plan requirement—in the various correction alternatives. Assuming that the updated guidance maintains the same general structure as the existing guidance, it could describe the same three general alternatives that apply today:
- Self-correction, with no notice required to IRS, and no user fee, sanction or penalty. This is the Self-Correction Program (SCP) and it applies to many plan defects (the Revenue Procedure lists the eligible ones) regardless of size, if the plan has procedures designed to facilitate compliance and if the defect is found and corrected within two years following the plan year in which the defect occurred. The existing guidance provides examples of appropriate correction steps. SCP is also available more than two years after the fact, provided that the defect qualifies as “insignificant,” and SCP can even be available when the employer is under audit, if the identified defects collectively qualify as insignificant. One example of an insignificant defect is a small number of excess deferrals – including that single excess deferral that was the subject of the apocalyptic warning. Of course, SCP corrections can involve tax consequences, such as taxation to the participant for a corrective distribution. A plan sponsor will want to retain documentation of any SCP correction, to be available in the event of a future audit.
- Correction with IRS approval, and an associated user fee (plus the cost of correction). This is the Voluntary Correction Program (VCP) and it applies to all of the defects eligible for SCP plus some. VCP involves self-identification of the defect by the plan, and a voluntary submission to correct the defect. VCP has no limitations on the size of the defect, and does not require submission by a specific date. However, it does require IRS approval of the correction, and it generally involves payment of a sanction, the amount of which can vary based on several factors, including the nature and scope of the defect.
- Correction under audit, through a closing agreement. This is the Closing Agreement Program (CAP). Unlike VCP, this involves IRS discovery of the defect and thus does not involve plan self-reporting of that defect. Not surprisingly, the cost and/or effort for correcting such a defect under audit CAP is likely to be more significant than for self-reporting.
As a general rule, it will always be better for a plan to find errors first, through its compliance procedures and reviews, than for the IRS to find them for the first time on audit. For those self-identified errors that could qualify either for SCP or VCP, many plan sponsors prefer to correct and move on, and not seek IRS approval, especially for those corrections that are very simple and straightforward (such as distributing excess deferrals). By contrast, the lonely plan sponsor with little or no compliance procedures just might suffer a plan apocalypse. However, if they do, it will be one of their own making.
For the overwhelming majority of plan sponsors, there will be a tomorrow, and more tomorrows thereafter. They will properly disregard the apocalyptic warnings, eagerly await the updated correction guidance, and keep their plan focus where it should be: on providing an important employee benefit (within appropriate regulatory parameters, of course).
Richard Turner, vice president and deputy general counsel, VALIC
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.