The Impact of Changes to the IRS Determination Letter Program

This January 2017 will see the last regular IRS determination letter applications filed for individually designed retirement plans. After this final Cycle A determination letter application, individually designed plans no longer will be able to get a ruling (a favorable IRS determination letter) from the IRS that the terms of the plan comply with law (except for an initial determination letter upon establishment of a new plan and a final determination letter upon the termination of the plan), although the IRS may specify other opportunities for obtaining determination letters in the future.

Individually designed plans historically have been utilized for plans that have unusual terms that do not fit on an IRS pre-approved prototype or volume submitter plan document.

The IRS will continue to issue opinion letters to prototype and volume submitter plans. Adopting employers of prototype and volume submitter plans can generally rely on favorable opinion letters covering these plans with respect to nearly all plan qualification requirements, with specific exceptions primarily concerning plan operational issues. These changes to the determination letter program mean that there may be some incentives for plan sponsors to move onto a pre-approved plan.

What is the Purpose of a Determination Letter Application?

IRS determination letters are not and never were “mandatory” but they do provide benefits for plan sponsors:

1. The determination letter process allowed a plan to identify and retroactively fix plan language that an IRS agent believes does not comply with the statutory and regulatory requirements. Otherwise the plan could only be amended prospectively and would technically be disqualified during the interim period.
2. A determination letter previously was a precondition for use of the IRS EPCRS (voluntary correction) program by individually designed plans.
3. Auditors, lenders and third parties to a transaction have historically required a representation that the plan has a valid determination letter. The existence of a determination letter bypassed extensive diligence regarding the potential disqualification risk.

Timing for Plan Amendments

The IRS rules apply different deadlines for plan amendments based on the type of amendment:

1. Amendments that prospectively eliminate a benefit generally must be adopted before the benefit would be earned.
2. Discretionary amendments generally must be adopted before the last day of the plan year in which the change is effective.
3. Amendments required to comply with changes in law used to have a longer “remedial amendment period” for adoption. Under the prior process, these amendments needed to be adopted before the expiration of the determination letter review cycle. The new amendment deadline is described in the Annual Retirement Plan Review section directly below.

Annual Retirement Plan Review

Each year, the IRS will issue two lists:

1. a Required Amendments List and
2. an Operational Compliance List.

The Required Amendments List will list the applicable changes in law for retirement plans. Under the new rules, a plan sponsor must amend its plan to comply with the new requirement by the end of the second calendar year following the calendar year in which the amendment first appears on the Required Amendments List. If a plan amendment is adopted that does not comply with law, the plan sponsor must adopt a corrected amendment by the end of the second calendar year after the later of the dates the original amendment is adopted or effective.

Even though the documentation of some amendments may be delayed, the plan is required to operate in compliance with law changes from the effective date of the rule change. The annual “Operational Compliance List” will identify changes in plan qualification requirements that are effective during a calendar year.

What Steps Should Plan Sponsors of Individually Designed Plans Take Under the New Rules?

As a result of the changes to the IRS determination letter program, plan sponsors should consider taking the following steps:

• Ensure that an annual review is performed for all retirement plans to confirm compliance with the IRS’ Required Amendment List and Operational Compliance List. Document the annual review, amend the plans if required, and conduct operational audits to ensure compliance with any legal changes. If the plan sponsor delegates this task to a third party administrator or plan consultant, the plan sponsor should confirm that these steps have been taken.
• Carefully review all proposed plan amendments for compliance with law. Plan sponsors will no longer be able to clean up problematic language during the determination letter process.
• Consider whether a pre-approved plan (a prototype or volume submitter document) can satisfy the plan’s design requirements. But, be careful: there frequently are errors in converting individually designed plans onto a pre-approved plan document, so it is important to carefully review the document (including the adoption agreement and any base document) to ensure that there are not any inadvertent or impermissible plan changes made.
• In transactions, be prepared for demands that the sponsor obtain a legal opinion confirming the qualified status of an individually designed plan, which can be quite expensive. Make sure to account for this expense during your evaluations.