Retirement Plan Setup and Administration

Employers often set up a retirement plan as a recruiting tool, to attract and keep employees. Otherwise, the only tax-advantaged retirement option for an employee is an IRA, which has much lower contribution limits than employer-provided retirement plans. Employer-provided retirement plans are also protected from creditors, both of the employer and of the retirement plan participant. The assets in an IRA are only protected under bankruptcy, and only up to a $1 million limit that is adjusted annually for inflation. To benefit from the tax and credit-protection advantages, retirement plans must follow strict rules for setup and administration. Most of these rules are promulgated either by the Internal Revenue Service or the Department of Labor.

The 1st step in setting up a retirement plan is making a decision to have one and what type of retirement plan it will be, especially whether it will be a defined benefit (DB) or a defined contribution (DC) plan. Either the Board of Directors or the owners must adopt a retirement plan and decide what funding instrument, such as a trust, should be used to hold the plan assets. The funding instrument will usually be determined by the chosen retirement plan. The employer will be required to notify all employees, including those ineligible for the plan, that a retirement plan is being initiated.

Generally, an enrollment meeting with the employees will take place, especially if it involves employee salary deferrals. To be deductible, contributions to the plan must occur before the tax filing deadline, usually April 15, to be tax-deductible.

The employer can choose to use either a preapproved plan or an individually designed plan. An employer may rely on a preapproved plan if the retirement plan conforms to the requirements of the preapproved plan. However, if the employer makes any changes not covered by the options of the preapproved plan or other IRS sanctioned changes under Revenue Procedure 2015-36, then the plan may become an individually designed plan. Although not required, the business should obtain an advance determination letter (ADL) from the IRS for official approval of an individually designed retirement plan. The ADL will assure the employer that the plan qualifies under IRC §401(a) and that the funding instrument is exempt under IRC §501(a). Employees should receive notification for the plan before applying for the ADL. Generally, the employer should submit the ADL long before the deadline for the business tax return, so that any mistakes can be corrected and resubmitted by the tax filing deadline or the end of the year, depending on the retirement plan. An ADL can only be relied upon if there is no misstatement or omission of material facts, if there is no material change in the plan, and no change in the applicable law. If the law does change, then the employer must adopt any necessary interim amendments required under §5.04 of Revenue Procedure 2007-44 .

Summary Plan Document

All employees must receive a summary plan document (SPD) that summarizes all the pertinent details of the plan in language understandable to the participants. The SPD must be distributed to the employees after the plan has been adopted, usually before the employer receives the ADL response from the IRS. The SPD must include eligibility, vesting schedules, benefit calculation formulas, withdrawal requirements, and rights granted by the Employee Retirement Income Security Act (ERISA). The SPD must also disclose any major changes to the plan, such as changes in investment objectives or termination dates that may result in a loss of benefits.

Plan Administration Requirements

Most plans will require Form 5500, Annual Return/Report of Employee Benefit Plan to be filed annually with the IRS. Companies with fewer than 100 employees can file the shorter Form 5500-SF, but only if the retirement plan will not hold employer stock. Retirement plans for only one participant and possibly a spouse do not need to file Form 5500 if the account has less than $250,000; otherwise, the participant can file the simpler Form 5500-EZ. These forms are usually filed online and must be filed before the last day of the 7th month after the end of the plan year, which would be July 31 for a plan based on the calendar year.

In addition to Form 5500, defined benefit (DB) plans must also report to the Pension Benefit Guaranty Corporation (PBGC) by filing an annual report and paying the $35 fee per participant annually. DB plan participants must also be informed of the funded status of the plan and any steps that the employer has taken to correct any underfunding within 2 months of the due date for submitting Form 5500.

Once employees begin participation in the retirement plan, they must receive a copy of the SPD. Additionally, the retirement plan fiduciary must provide a new SPD every 10 years or every 5 years if the SPD has been materially changed from the previous version. The fiduciary must also provide a summary of material modifications (SMM) to all participants. The IRS has deemed that material changes include the following: name or address change of either the plan sponsor or the plan fiduciary, any changes in vesting schedules or eligibility requirements, changes in benefit claim procedures, and any conditions resulting in a plan disqualification or a loss of benefits. The fiduciary must also report to the employees the available benefits and any investment choices.

The plan fiduciary must also process and pay distributions, including rollovers to an IRA when the participant leaves the company and direct payments of monthly benefits for retirement. All distributions must be reported on IRS Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts etc.. If the distribution was premature, then the IRS will assess a 10% tax penalty on the distribution.

The fiduciary also must manage plan loans and repayment procedures for those loans. The fiduciary must also amend the plan documents if the plan sponsor changes or terminates a plan, either because it no longer wants to offer the plan or because it is switching to a new retirement plan type. The employer should apply for a new ADL from the IRS for substantial material changes to the retirement program. Usually, only the participant may receive distributions. However, if the participant becomes divorced, then a court may issue a qualified domestic relations order (QDRO), whereupon one or more payments must be paid to the ex-spouse. A QDRO must specify at least 3 items: the exact amount to be paid, the parties involved, and the number of payments.

Discovering Noncompliance

Retirement laws, like the rest of the tax code, are complicated. Even with the help of specialists, mistakes can be made. If the employer discovers a mistake in setting up the retirement plan, then the employer should immediately correct it and notify the tax authorities. If the employer does not report the noncompliance to the IRS, significant fines may be assessed if it is later discovered. The IRS has a procedure for resolving mistakes under the Employee Plans Compliance Resolution System. If the employer self-reports the noncompliance, then the IRS may waive any fine or assess a reduced fine that would otherwise apply if the noncompliance was discovered later by the IRS. The Department of Labor also has a similar program that works similarly.