Improperly amending a retirement plan can jeopardize the plan’s tax-qualified status. For health benefit plans or other welfare plans, it can be the prospect of a recovery for the plaintiff’s lawyers seeking benefits for their individual participant clients. So why assume anything is simple anymore? This article will touch on the limits to what may be accomplished in plan amendments, including the limited protections provided by the “remedial amendment period” for retirement plans and some of the ERISA snags to look out for in amending plans in general.
Let’s set the stage for the importance of properly amending a benefit plan. It almost goes without saying that any plan covered by ERISA must be established and maintained in writing. IRS regulations also require a plan to be a definite written program. It is pretty clear that one reason for the writing requirement is to enable employees to determine their rights and obligations under the plan who is responsible for operating the plan; and what their benefits are under the plan.
Oral amendments and modifications to plans by sponsors and employers are not permitted. Conversely, attempts by plan participants to vary the express written terms of a plan by alleging some form of oral agreement with the employer or plan administrator are generally unsuccessful. The failure to properly amend a plan can result in an unwanted plan provision remaining in the plan, creating a financial advantage for the participant and to the financial detriment of the employer/ sponsor. The failure of the amendment could also jeopardize the tax qualified status of the plan.
So, what can cause a purported plan amendment to fail and/or cause problems for the sponsor? It may be that the amendment is improperly adopted or executed. It may be adopted too late, or as is often intended, too late to be retroactive to the first day of a plan year. Also, ERISA imposes some strict notice requirements which must be respected in order for an amendment to be effective. Additionally, the Internal Revenue Code (Code) and ERISA provide that amendments may not “cut back” benefits that have already accrued to a participant. An amendment may also be rendered ineffective due to a misunderstanding of the applicability of ERISA’s provisions, or a misunderstanding of the scope or timing of relief afforded under the “remedial amendment period,” which we explain below. Finally, at least one federal court of appeal has taken a very literal view of ERISA’s requirement that a plan clearly state “procedures” for amending the plans and by whom it may be amended in order for any such amendments to be effective. Let’s look at each of these areas of amendment basics in turn.
What Is An Amendment?
There is no direct answer to this question in the Code, ERISA, or in the regulations. The law does require, however, that all plans governed by ERISA be in writing. It also provides that all plan amendments must be in writing. Third, it requires that every written plan state a procedure by which the plan may be amended and by whom it may be amended. That is to say, the plan sponsor really can set the ground rules for how a plan will be maintained, modified, or amended. Once this is clearly set forth in the plan, the trick is to adhere to it, scrupulously. Failing to adhere to one’s own plan amendment requirements can result in participants seeking claims for benefits based on the unamended, perhaps more generous, provisions of the plan.
So what is a preferred procedure for plan amendments? Many, if not most, plans provide that “the plan may be amended at any time by the employer/ sponsor.” In the case of a corporation, with a governance structure established in state statute and the corporation’s bylaws, it seems fairly obvious that a corporation could amend its plans by action of its governing body, the board of directors. It is possible though for the corporation to amend through authority delegated to its officers or its designated committees if the plan so provides. If the plan does not specifically provide that the board or certain officers are to carry out the actions, is it reasonable to infer that board action is a proper method for amending the plan? One would think so. In the Schoonejongen case, however, the Third Circuit Court of Appeal held that a plan must specifically state the procedure by which it is to be amended. Otherwise, any attempts by the employer to claim the plan was amended will be futile.
The devil is in the details. Just how should the corporate action be taken? Board resolutions may or may not work as practical matter in light of the pitfalls recited above, if the documentation of the board’s intentions or the specifics of the terms of the purported amendment fall short of their target. Resolutions, whether adopted at formal meetings or otherwise, are only as good as the scribe can make them. The appropriate conclusion, therefore. is that nothing short of a specifically drafted amendment, prepared with the assistance of your pension attorney or advisor and duly adopted by the governing body of the corporation or its delegate, will do. Even then, the timing aspects of the law must be taken into account.
With entities other than corporations that sponsor plans (e.g., self-employed individuals or partnerships), where the governance structure is less than intuitively obvious, what should the plan amendment process be? Furthermore, what should the plan document say about the amendment procedure? How often does the document clearly say it? In this era of master and prototype, volume submitter, and other mass produced plans sponsored by insurance companies, investment houses and plan administration firms, how many times do you find an explicit procedure stated in the plan for its amendment? Not very often, if ever. Even worse, how often does the document contain language or procedures that does not pertain or coincide with the authority or control structure of the employer/ sponsor? When was the last time you read a plan that said “the plan may be amended by the managing general partner in writing with a vote of two-thirds of the partners, or so long as the amendment does not result in a funding obligation or that will foreseeably expose the partners to a funding obligation.” It’s hard to imagine. The point to be made here is that before there is an altercation with a participant or a regulating agency over the benefits to be paid or the deductions to be taken, it should be clear what should and must be done to amend the plan.
So when, in general, is an amendment binding and when is it done right? In most cases, it will come down to when it is clearly, consistently, unambiguously and enforceably performed. (How’s that for deceptive simplicity?) Furthermore, in the event that there are benefits being affected, it may also require that it be well published to affected participants. What does this all mean? Let’s now consider the ERISA and Code constraints on amendments that may affect benefits, including the notice requirements.
The ERISA Notice Requirements: Annoying And Confounding
As you can well imagine, ERISA includes certain notice requirements to affected participants in the event of a plan amendment. Assuming for the moment that appropriate procedures have been followed to enact the amendment, two levels of ERISA notice concerns must be considered. First, for pension plans (not profit sharing or stock bonus plans), advance notice of an amendment is required by ERISA Section 204(h) (204(h) Notice) only if the amendment results in a “significant” reduction in the rate of future benefit accruals. Second, with regard to all plans, ERISA requires notice of plan amendments to the participants if it is a material amendment, but not in advance. Actually, in these cases it is sufficient that participants are notified of a material amendment to the plan within 210 days after the end of the plan year in which the amendment is effective.
For the sake of the 204(h) Notice requirement, one would think that it would be fairly clear when future benefit accruals are being reduced by an act of the employer/ sponsor. Unfortunately, such is not always the case. For example, a common cost-cutting suggestion in pension plans that have a vesting schedule is to have the sponsor adopt an amendment changing the disposition of the benefits that are forfeited when a participant is terminated prior to becoming fully vested. Such an amendment will normally provide that forfeitures are to be applied to reduce the employer’s contribution for the year, instead of being allocated among remaining active participants. Is this the kind of change that triggers the notice requirement in an ERISA plan? It could be, depending on the facts and circumstances. How about an amendment which changes the definition of compensation to eliminate commissions or bonuses? In a pension plan, this could be a trap for the unwary. If an amendment is subject to the 204(h) Notice requirement and the notice requirement is not met, the plan amendment can be treated as null and void.
The general notice requirement for material modifications is different. A document called a summary of material modifications (SMM) must be furnished to each participant and beneficiary within 210 days after the end of the plan year in which the amendment is adopted. How, as a practical matter, is this done? Is a new Summary Plan Description distributed, highlighting the changes to the plan? Or is a separate document, aptly titled “Summary of Material Modifications,” sent to each participant and beneficiary? The 210 day rule for supplying the SMM does not, however, risk the amendments enforceability. Whether participants will have an actionable claim will depend on which federal circuit they live in and whether they have suffered any injury as a result of the amendment of which they were not properly notified.
As a practical matter, plan sponsors should consider giving notice of plan amendments to participants in all plans as soon as possible in relation to an amendment decision, even if the advance notice requirements do not strictly apply. It can be a public relations disaster between employers and employees to find, for example, that a vesting schedule has been added to a matching feature of a 401(k) plan (even though duly and legally adopted) if news of that amendment does not reach the participant until 210 days after the end of the plan year. On the other hand, employers must balance the receptiveness of employees to a constant stream of amendment announcements and other communications regarding their benefit plans.
The Code’s Constraints
In addition to the ERISA hoops a sponsor must jump through, there are also three Code provisions that fundamentally affect a sponsor’s latitude in amending a plan. First, there is a prohibition against cutbacks to so-called “protected benefits.” This prohibition may extend to certain types of payment options or even the right to choose certain alternate forms of benefit. The Code provides its version of the anti-cutback rules which, if violated, will disqualify the otherwise qualified retirement plan. So, the anti-cutback rules are something to be watched both from an IRS enforcement perspective as well as from a participant claim perspective.
Second, there is a general prohibition against amending vesting schedules in a qualified plan. ERISA provides that in the event a vesting schedule is amended, participants who have at least three years of service under the pre-existing vesting schedule must have the right to choose which vesting schedule is going to apply to them. As you can imagine, most participants will choose to stay with the more favorable vesting schedule.
Finally, there is an over-arching requirement that all amendments to plans must be nondiscriminatory in effect, under the general nondiscrimination provisions of Code Section 401(a)(4). Therefore, it behooves the plan sponsor to examine the impact of the amendment on the operation of the plan to determine if it favors highly compensated employees beyond the levels permitted by the regulations. It may be necessary to apply some additional testing steps to the year of amendment to determine, in fact, that no prohibited discrimination will occur.
When Can A Plan Be Amended? (Timing Is Everything)
There are a couple of basic rules that provide the answer to this question (in most circumstances). First, conventional wisdom says that a plan must be amended on or before the last day of the plan year in order to be effective for that plan year. Second, a concept known as the “remedial amendment period” sets the time period in which a plan amendment may be adopted in order to have retroactive effect to the inception of the plan. The former basic “remedial amendment period” rule was that a plan must be submitted for a determination letter on or before the employer’s tax return due date for the year in which the plan is adopted in order to be able to retroactively add provisions to a plan to meet the basic qualification provisions of the Code. More recently, the IRS has changed its determination letter procedures to require new plans to only be submitted by the January 31 deadline, which marks the end of their plan restatement and determination letter filing cycle, based on the ending digit of the sponsor’s tax I.D. number. A new individually designed retirement plan being adopted at the end of a calendar year will be required to file for its initial determination letter by the impending January 31 deadline if it is for an employer whose EIN is in that year’s filing cycle.
The remedial amendment period also affects the timing of plan amendments. Retirement plans, that are individually designed plans, need to be submitted to the IRS every five years in order to receive a retroactive letter of determination for the provisions of all Code changes and applicable regulations and guidance issued since the last determination letter. The filing deadline is January 31 of their filing cycle, which is determined by the sponsor’s employer identification number. If a plan is not submitted by that time, then amendments cannot be included on a retroactive basis. Note, that in some instances “good faith” amendments may be required between determination filing cycle deadlines to comply with Code changes or regulations, in order to maintain a plan’s tax qualification.
One should not panic, however, if the IRS discovers that certain amendments should have been made or certain provisions are lacking in a determination letter submission. The IRS will permit a sponsor to file a Voluntary Compliance Procedure (VCP) application with the Determination letter filing (or by itself in the interim) and requalify the plan. A VCP correction fee will be charged by the IRS according to their most recently posted user fee schedule.
What Does The Remedial Amendment Period for Qualifications Leave Out?
Well, it leaves out any operational compliance aspects of the Code or the regulations. For example, failure to follow a plan provision effective during this period will not be covered.
What To Do?
There is no substitute for being careful. It is best to consider not only the procedural aspects of a proper amendment, but the impact the amendment will have on the plan’s qualified status if it is a retirement plan, and on the likelihood of disputes with participants in welfare benefit plans over what benefits are to be paid, before adoption of the amendment. In no event, however, should amendments be implemented without considering all of the hurdles and issues raised in this article.