By Dannae Delano, Seth Gaudreau and Barry Salkin
The SECURE 2.0 Act of 2022, Division T of Public Law No. 117-328 (“the Act”) includes dozens of provisions that affect retirement plans and retirement plan sponsors. This alert focuses on several changes related to the correction procedures that plan sponsors can use for the correction of errors in administering retirement plans. These changes include expansion of the IRS’s Self-Correction Program (“SCP”) for retirement plan failures under the Internal Revenue Service’s (“IRS”) Employee Plans Compliance Resolution System (“EPCRS”), changes related to recovery of inadvertent benefit overpayments, and a permanent safe harbor correction method for elective deferral failures related to automatic enrollment arrangements in certain retirement plans. In addition, the IRS has also issued the first guidance implementing these changes (“Notice 2023-43”) that clarifies that the changes are immediately applicable (with certain exceptions, including corrections by IRA custodians and trustees) and provides interim guidance that will remain in effect until EPCRS is updated.
EPCRS Self-Correction Program Expansion
The ability of plans sponsors to “self-correct” is not new. The EPCRS SCP allows certain compliance issues to be self-corrected by plan sponsors without the need to make a submission to the IRS or obtain IRS approval. Generally, self-correction has only been available for insignificant failures and failures that are corrected within a few years of the failure. Under the Act, SCP now allows for any “eligible inadvertent failure” to be self-corrected, if the failure: (i) is corrected within a reasonable time after it is discovered; (ii) is not identified by the IRS before the plan sponsor has taken actions that demonstrate a commitment to self-correction; and (iii) is not egregious, related to the diversion or misuse of plan assets, or directly or indirectly related to an abusive tax avoidance transaction. As was previously required and often overlooked, to qualify for the new SCP, the plan must have “established practices and procedures” designed to prevent failures.
Prior to the Act, EPCRS allowed certain participant loan errors to be corrected without reporting the error on Form 1099-R, only if the error was submitted for IRS approval using the Voluntary Compliance Program (“VCP”) (or Audit CAP if the error is discovered on audit). The Act specifically authorizes self-correction of inadvertent failures related to plan loans to participants. Further, if the EPCRS plan loan correction rules are followed, the Department of Labor (“DOL”) must treat self-corrected participant loan errors as satisfying the applicable requirements under its Voluntary Fiduciary Correction Program (“VFCP”). Previously, participant loan error corrections could only be submitted to the DOL’s VFCP for approval after the IRS had issued a compliance statement on the correction.
Under the Act, the current EPCRS guidance (“Rev. Proc. 2021-30”) is required to be updated within two years of enactment.
Notice 2023-43, provided in a question-and-answer format, is intended to assist taxpayers by providing interim guidance in advance of an update to Rev. Proc. 2021-30. Notably, the guidance confirms that failures that occurred before SECURE Act 2.0 was enacted on December 29, 2022, may be corrected in accordance with the new rules. The guidance is not comprehensive and does not address the recovery of plan overpayments, correction of automatic contribution errors, or any elements over which the DOL has authority.
The Notice focuses on the following issues:
- A plan sponsor may self-correct an eligible inadvertent failure before Rev. Proc. 2021-30 is updated if certain conditions are satisfied and certain exceptions do not apply;
- A custodian of an individual retirement account described in section 408(a) of the Internal Revenue Code, or an individual retirement annuity described in section 408(b) (an IRA) may not correct an eligible inadvertent failure under EPCRS before Rev. Proc. 2021-30 is updated; and
- Interim interpretive guidance that applies with respect to corrections of eligible inadvertent failures.
The guidance under which a plan sponsor may self-correct an eligible inadvertent failure under section 305 of the Act, provided certain exceptions do not apply, is as follows:
- Section 305 of the Act allows for errors not identified by the Secretary before any actions occurred that demonstrate a specific commitment to implement a self-correction with respect to the eligible inadvertent failure. The guidance clarifies the following related to self-correcting non-identified inadvertent failures:
- A plan sponsor should document the intended correction at the beginning of the correction process.
- A specific commitment is a facts and circumstances consideration so a plan sponsor must demonstrate it is actively pursuing the self-correction.
- Under examination means it has been identified by the Secretary, but an insignificant failure may still be corrected while under examination.
- Section 305 of the Act provides that a self-correction must be completed within a reasonable period after the failure was identified. The guidance clarifies the following regarding what a reasonable period is:
- Reasonable period is a facts and circumstances consideration, but for failures that are not employer eligibility failures, it includes the end of the 18th month after the plan sponsor identifies the failure. In certain circumstances, this could result in a shorter correction period than under prior law.
- For eligibility failures, the sponsor must cease all contributions to the plan as soon as practicable but no later than the last day of the 6th month after the failure is identified.
- Section 305 of the Act requires that a failure not be egregious, not directly or indirectly relate to an abusive tax avoidance transaction, and not relate to the diversion or misuse of plan assets. There is no specific guidance provided but Notice 2023-43 identifies certain failures that are ineligible for self-correction, as discussed below.
- Section 305 of the Act provides that self-correction must satisfy all the provisions applicable to self-correction in the current EPCRS with certain exceptions. The guidance clarifies the following requirements for self-correction:
- Most current EPCRS rules apply.
- Nine inadvertent failures are not eligible for self-correction until EPCRS is updated, including:
- Failure to adopt a written plan document
- A significant failure in a terminated plan
- Any amounts or coverage testing failure insufficiently corrected as provided under Rev. Proc. 2021-30
- Use of a plan amendment to correct an operation failure if the amendment is less favorable to the participant or beneficiary than the original plan terms
- Existing recordkeeping requirements for self-correction apply.
- Certain current EPCRS rules no longer apply:
- Qualified and 403(b) plans are no longer required to have a determination letter
- Certain nondiscrimination and employer eligibility failures are no longer prohibited from being self-corrected
- Prohibitions from self-correcting loan failures do not apply
- The time limits to self-correct a significant plan failure no longer apply
Plan sponsors may rely on the Notice until Rev. Proc. 2021-30 is updated pursuant to the Act. During this period, if a self-correction was completed by a plan sponsor on or after December 29, 2022, and before May 25, 2023, the plan sponsor may apply a good faith, reasonable interpretation of section 305 of the Act in completing the self-correction. A plan sponsor that completed a self-correction during this period in a manner that accords with Notice 2023-43 will be treated as having applied a good faith, reasonable interpretation of section 305 of the Act.
Recovery of Retirement Plan Overpayments
Previous IRS guidance mandated that plan fiduciaries take reasonable steps in their attempt to recover overpayments made to plan participants and beneficiaries, and there were also fiduciary implications under Title I of ERISA with respect to recovery of overpayments. The Act grants plan fiduciaries the discretion not to seek recoupment of “inadvertent benefit overpayments” made to participants or beneficiaries. If the plan fiduciary attempts recovery, the Act includes the following limitations on the ability to recover overpayments:
- No interest or fees may be sought from the participant.
- If the plan fiduciary seeks to recover overpayments of a non-decreasing annuity by reducing future benefit payments: (i) the reduction must cease after the plan has recovered the full dollar amount of the overpayment; (ii) the amount recouped each calendar year may not exceed 10 % of the full dollar amount of the overpayment; and (iii) future benefit payments may not be reduced to below 90 % of the periodic amount otherwise payable under the terms of the plan. Alternatively, if the plan fiduciary seeks to recover overpayments of a non-decreasing annuity through one or more installment payments, the payments that may be required in a calendar year may not exceed the benefit reductions that would be permitted for the year under the preceding sentence.
- If the plan fiduciary seeks to recoup past overpayments of a benefit other than a non-decreasing annuity, the plan fiduciary must satisfy requirements to be developed by the Secretary of Labor.
- Efforts to recover overpayments are: (i) not accompanied by threats of litigation, unless the responsible plan fiduciary makes a determination that there is a reasonable likelihood of recovering an amount greater than the cost of recovery, and (ii) not made through a collection agency or similar third party, unless the participant or beneficiary ignores or rejects efforts to recover the overpayment following either a final judgment in federal or state court or a settlement between the participant or beneficiary and the plan.
- Recoupment of past overpayments to a participant may not be recovered from any beneficiary of the participant, including a spouse, surviving spouse, former spouse, or other beneficiary.
- Recoupment may not be sought if the first overpayment occurred more than three years before the participant or beneficiary is first notified in writing of the error, except in the case of fraud or misrepresentation by the participant or beneficiary.
- The participant or beneficiary may contest the recoupment under the plan’s claims procedures.
- The plan may consider hardship to the participant or beneficiary.
The above limitations are not applicable if the participant or beneficiary is “culpable” for the overpayment. A participant or beneficiary is culpable if the individual bears responsibility for the overpayment based on misrepresentations or misstatements or knows that the overpayments were materially in excess of the correct amount. While this provision of SECURE 2.0 is very granular, it still leaves many open questions, including the threshold question of what constitutes an inadvertent benefit overpayment
Safe Harbor for Correction of Employee Elective Deferral Failures
The Act makes permanent a safe harbor, already included in EPCRS, for correcting certain elective deferral failures in 401(k) plans and 403(b) plans with automatic enrollment and/or automatic escalation features.
Under the safe harbor, no corrective contributions for reasonable administrative errors are required for the missed elective deferrals if, generally, correct deferrals start within 9½ months after the end of the plan year in which the failure begins (or the first pay date in the month following the month the participant notifies the plan sponsor of the error), corrective contributions are made for any missed matching contributions, and a notice is provided to the affected participant within 45 days after correct deferrals begin.
Unlike the existing safe harbor, under the Act the correction method may be used to correct errors that relate to former employees and remains available even after the IRS identifies the error. The permanent safe harbor is effective with respect to errors for which the correction deadline is after December 31, 2023.
Plan sponsors should make self-correction a priority given the new and expanded opportunities to self-correct plan qualification issues. In addition, intended corrections should be documented early on in the correction process to ensure the requirements for self-correction are met. Taking advantage of the expanded opportunities to self-correct will allow plans to remain qualified without requiring expensive VCP filings or the risk of fixing the issues found while the plan or plan sponsor is under examination by the IRS. We will continue to keep our clients and readers informed on EPCRS updates to help plan sponsors capitalize on all self-correction opportunities.