401(k) plans must operate according to the terms of a written plan document to meet IRS qualification requirements. Most plans use an IRS preapproved document for this purpose. These documents must be fully rewritten (or restated) every six years to reflect recent law changes. The last 6-year restatement cycle was called “PPA” after the Pension Protection Act of 2006. A new cycle - called "Cycle 3" - opened last year. From August 1, 2020 to July 31, 2022, all pre-approved 401(k) plans must be restated onto a Cycle 3 document.
While the Cycle 3 restatement deadline is not until mid-2022, I recommend most 401(k) plans restate in 2021. The reason - to save the cost of a mandatory hardship distribution amendment and to adopt discretionary amendments sooner rather than later at no additional cost. Below is a summary of the mandatory amendments that can be wrapped into a Cycle 3 restatement and some discretionary amendments to consider.
Mandatory Amendments to Include
Cycle 3 restatements must only incorporate 401(k) law changes enacted prior to February 1, 2017. However, most will include addendums that amend a plan for more recent changes. Below is a summary of the recent changes you should confirm your Cycle 3 restatement includes to avoid the expense of a mandatory amendment down the line.
Hardship distribution rules
On Sept. 23, 2019 the IRS updated their rules for hardship distributions. The new rule’s mandatory changes became effective January 1, 2020.
- Eliminate the six-month suspension of employee contributions following a hardship distribution (mandatory).
- Require participants to represent that “he or she has insufficient cash or other liquid assets to satisfy the financial need” before taking a hardship (mandatory).
- Eliminate the requirement that participants take a plan loan prior to receiving a hardship distribution (optional).
- Expand the contribution sources available for hardship distribution to include QNECs, QMACs, safe harbor contributions, and earnings on elective deferrals (optional).
- Add losses resulting from a federally-declared disaster as a “safe harbor” hardship expense (optional).
If your plan permits hardship distributions, it must be amended to reflect the mandatory changes no later than December 31, 2021.
The SECURE Act
On December 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law. A plan amendment is required to adopt the following SECURE Act changes:
- Required Minimum Distributions (RMDs) – The law increased the age at which RMD must start from 70½ to 72. RMDs for non-5% owners can still be postponed until the year the participant terminates employment if later. This change is effective for participants who turn 70½ on or after January 1, 2020.
- “Stretch” distributions - before the SECURE Act, individuals could “stretch” distributions from an inherited 401(k) account over the course of their lifetime. Now, only an “eligible designated beneficiary” – a surviving spouse, a minor child, a disabled person, a chronically ill person, or any person not more than 10 years younger than the employee – can do so. This change applies to participants who die on or after January 1, 2020.
- Part-time employees - 401(k) plans can no longer prevent “long-term, part-time employees” – defined as employees that complete at least 500 hours of service annually for three consecutive years – from making elective deferrals. This change is effective for plan years that start on or after January 1, 2021. Service earned prior to 2021 does not count, so the soonest employees affected by this change could become plan-eligible is January 1, 2024.
401(k) plans must be amended to reflect these mandatory changes no later than December 31, 2022 (assuming a calendar-based plan).
The CARES Act
The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law on March 27, 2020 in response to the COVID-19 crisis. The law allowed – but did not require - 401(k) plans to make special distribution and loan options available to participants affected by the crisis.
- Coronavirus-related distributions (CRDs) – available between January 1, 2020 and December 30, 2020, CRDs were not subject to mandatory withholding or the 10% early distribution penalty. They can also be repaid.
- Coronavirus-related loans – available to CRD-eligible participants between March 27, 2020 and September 23, 2020. They could be made up to $100,000 – double the normal 401(k) loan limit.
- Suspension of loan repayments – the law allowed CRD-eligible participants to suspend their loan repayments between March 27, 2020 and December 31, 2020.
If your plan permitted any of these options in 2020, it must be amended to formally reflect them no later than December 31, 2022 (assuming a calendar-based plan).
Discretionary Amendments to Consider
There is no better time to make discretionary changes to your 401(k) plan than restatement time – because you can make them at no additional cost. However, you should keep the following 401(k) amendment rules in mind when considering a discretionary change:
- Discretionary amendments must be adopted no later than the last day of the plan year in which the change is effective.
- No amendment can reduce or eliminate benefits that plan participants have already accrued (earned). Common benefits you can’t “cut-back” include in-service distribution options (excluding hardships) and vested contributions. Benefits that can be reduced or eliminated by amendment at any time include plan eligibility, the right to make salary deferrals, and participant loans.
Safe harbor 401(k) plans are subject to additional rules. A mid-year amendment must meet the following requirements for the plan to retain its safe harbor status for the year:
- The change cannot be one of the prohibited changes listed in Notice 2016-16.
- If the change affects the information contained in the safe harbor notice, participants must receive an updated notice and the chance to change their deferral election
- If the change increases safe harbor matching contributions, it must be adopted at least three months before the end of the year.
Changes to consider:
- Adding a safe harbor 401(k) feature to automatically pass the ADP/ACP and top heavy tests.
- Adding an automatic enrollment feature to get a $500 tax credit for 3 years.
- Adding a Roth deferral feature to allow participants to save on an after-tax basis.
- Adding a participant loan feature to borrow against their 401(k) account.
- Reducing the plan’s eligibility requirements to sidestep the SECURE Act’s complicated “long-term, part-time employees” requirement.
- Adding a “new comparability” profit sharing contribution to a nonelective-based (not a match-based) safe harbor 401(k) plan to target certain participants for higher annual contributions.
Maximize your Restatement Fee!
401(k) providers can charge dramatically different fees for Cycle 3 restatements – from $500 to $2,000 in my experience. You want to get as much bang for that buck as possible. Wrapping required and discretionary amendments – which would otherwise trigger an additional fee - into your restatement is how you do that.
For additional questions about your 401(k) plan’s Cycle 3 restatement, contact your 401(k) provider.