What advisors need to know regarding DC cycle 3 restatements

Every six years, the IRS requires that plan sponsors using a pre-approved document must amend that document and have it restated. This process ensures that sponsors are using a plan document that has been updated to reflect recently enacted legislative and regulatory changes. The current amendment and restatement period for defined contribution plans (known as “DC Cycle 3”) incorporates any changes prior to February 1, 2017. Most importantly, the deadline for compliance is July 31, 2022. Failure to properly amend documents by this deadline can lead to plan disqualification resulting in an immediate income tax liability.

For advisors, the approaching July 31, 2022 deadline offers several opportunities to reengage plan sponsors and investment committees. Perhaps the first step is to help ensure the process goes as smoothly as possible. Find out from document service providers how and when clients will receive communications regarding the amendment and restatement process. Also, confirm whether the adoption agreement will already be prepopulated to reflect the plan’s existing elections (i.e., “signature ready”). In cases where a new adoption agreement must be completed, more time will likely be needed to complete the process.

Another consideration is to confirm that the documentation clients will be asked to complete will also include the necessary SECURE Act and CARES Act amendments. These legislative changes occurred in 2019 and 2020, respectively. Because these legislative changes occurred after February 1, 2017, they will not be reflected in the current trust document, but rather, addressed with “add-on” amendments. As a review, the SECURE Act increases the required beginning date from age 70½ to age 72, eliminates the Stretch IRA (some exceptions apply), and requires coverage of long-term part-time employees. The CARES Act allows, but does not require, 401(k) plans to make special distribution and loan options available to participants affected by the COVID-19 pandemic. The deadline to amend plans for both these acts is December 31, 2022 (for calendar year plans). Ideally, clients will be able to complete all the necessary amendments at the same time.

Beyond ensuring the plan document is amended in a timely fashion, now may be an ideal time to consider making discretionary design changes. Specific changes may include:

• Adopting a safe harbor provision. A safe harbor provision will allow plans to automatically pass ADP/ACP and top-heavy compliance tests. This provision requires that the employer either 1) makes a 3% of compensation nonelective contribution or 2) makes a 100% match up to 3% of compensation plus a 50% match on the next 2% of compensation. These employer contributions are immediately and fully vested. Note that special rules apply if a safe harbor election is made during the plan year.
• Adding a Roth deferral and in-plan Roth transfer. Plans have the option to allow participants the ability to contribute to a Roth account. These contributions are not tax deductible, but earnings accumulate tax free. Unlike Roth IRAs, there are no income limits to Roth 401(k) eligibility. Also, plans may allow participants the ability to make an in-plan transfer from their pre-tax account to their Roth account. The transfer would be taxed as ordinary income.
• Adding the ability for participants to make after-tax contributions. Plans might consider allowing employees the ability to make after-tax contributions beyond the 402(g) limit of $20,500 ($26,000 for participants ages 50 and older). These contributions are funded from payroll, and the earnings grow tax deferred. Some plan sponsors have rebranded their after-tax feature as an emergency savings account. Provided in-service distributions are permitted, employees can take a distribution of their after-tax contributions, incurring taxes and potential penalty only on the earnings, if any. In many cases, taking a distribution of after-tax savings from a 401(k) may be more efficient than taking a hardship distribution, or seeking high-interest consumer credit products outside of the plan to meet immediate liquidity needs. Note that after-tax contributions are subject to ACP testing, even if the plan adopted a safe harbor provision.

Preapproved documents offer sponsors a convenient and cost-effective way to establish and operate a qualified plan. Although not terribly onerous, there are some administrative tasks, including compliance with the six-year amendment and restatement requirement. Advisors should ensure clients complete their amendments by the July 31, 2022 deadline, but also should consider this an ideal time to suggest alternative plan designs and features that may be appropriate for their clients’ organization.

Matt Sommer Ph.D., CFA, CFP is Head of Defined Contribution and Wealth Advisor Services at Janus Henderson Investors.

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