Secure an Employee Plan’s Future by Proactively Self-Correcting

By Grant Shuman and Anne Tyler Hall, Hall Benefits Law

SECURE 2.0 provides retirement plan sponsors an avenue to control the narrative in resolving any compliance issues under EPCRS, say Grant Shuman and Anne Tyler Hall of Hall Benefits Law.

Retirement plan sponsors can take advantage of new and expanded self-correction remedies under the Employee Plans Compliance Resolution System even before the IRS releases updated guidance on it pursuant to “SECURE 2.0,” the Setting Every Community Up for Retirement Enhancement Act of 2022.

SECURE 2.0 made sweeping changes to employer-sponsored retirement plans. These changes include, among others, increasing the age for required monthly distributions beginning January 1, 2023, allowing for student loan contributions to be eligible for employer matching contributions beginning on January 1, 2024, and requiring the eligibility of employees who work 500 hours or more a week in a consecutive, two-year period to make 401(k) contributions beginning on January 1, 2025. SECURE 2.0 also continues the recent legislative trend of Congress attempting to modernize and expand employer-sponsored retirement plans governed by the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).

While much of the early emphasis has been on preparing plan sponsors and service providers for the Act’s provisions to go into effect in a relatively short timeframe, one of the most significant developments ushered in by SECURE 2.0 is to provide plan sponsors with new tools to remedy past and future ERISA retirement plan compliance issues. Indeed, SECURE 2.0 contains provisions that ease the administrative burden of complying with the myriad requirements of ERISA by expanding the ability of plan sponsors to self-correct various failures that may arise in the daily operation and administration of retirement plans.

Given the size and scope of potential penalties for operational and other errors under ERISA, the time is ripe for plan sponsors to undertake a careful review of their retirement plans, and to correct any errors proactively under EPCRS.
Notice 2023-43 (May 25, 2023) provides interim guidance which sponsors may rely on until the IRS issues updates on EPCRS, as mandated by SECURE 2.0, by December 29, 2024 (id. at 1).

EPCRS: Proactive Beats Reactive

The most current iteration of EPCRS—as well as the general principles, definitions, rules, and corrective methods for qualified plan failures—are set forth in Rev. Proc. 2021-30, to which IRS refers in Notice 2023-43, which (at 2) describes EPCRS as a “system of correction programs for sponsors of qualified plans, section 403(b) plans, SEPs, and SIMPLE IRA plans that have failed to satisfy the requirements of section 401(a), 403(a), 403(b), 408(k), or 408(p) of the Code, as applicable.”

EPCRS consists of three components:

  1. The Self-Correction Program (SCP), which allows a plan sponsor to self-correct certain plan failures without payment of any fee or sanction, under certain circumstances;
  2. The Voluntary Correction Program (VCP), which allows a plan sponsor to pay a limited fee and receive the IRS’s approval for the correction of a plan failure prior to commencement of an investigation; and
  3. The Audit Closing Agreement Program (Audit CAP), which allows a plan sponsor to correct certain plan failures identified by the IRS on examination and to pay a sanction. Id.

In summary, EPCRS sets forth which program applies to each type of error and the appropriate method to resolve a plan’s failures and to bring it into compliance. For example, some plan failures are not eligible for the SCP and must be submitted to the IRS through VCP.

Key Areas in the SCP Expansion by SECURE 2.0

Correction of ‘Eligible Inadvertent Failures’ SECURE 2.0 or the “Act”—Division T of the Consolidated Appropriations Act, 2023 (Pub. L. No. 117-328)—allows for self-correction of any “eligible inadvertent failure,” and further provides for an expanded correction period, as long as the correction incepts prior to the IRS’s discovery of the error and is completed with- in a reasonable time (generally 18 months) after the error is discovered (§305(a)). An “eligible inadvertent failure” is defined under the Act as any failure that occurs, despite compliance practices and procedures in place, so long as the failure is not egregious (i.e., misuse of plan assets) or an abusive tax practice (§305(e)). Therefore, the retrospective period in which a plan sponsor can self-correct “eligible inadvertent failures” is effectively open-ended due to the elimination of the distinction between “significant” and “insignificant” failures. Under prior practice, most significant errors could be self-corrected if the correction was largely completed by the last day of the third plan year after the error occurred. See EPCRS §9.02.

Where SECURE 2.0 upon enactment (Dec. 29, 2022) was unclear as to the effective date of the SCP expansion, Notice 2023-43, issued five months later, clarified that plan sponsors can avail themselves of the expanded SCP before the IRS issues updates to EPCRS. An exception applies to IRA custodians, who may not begin using SCP for eligible inadvertent failures until EPCRS has been updated (id. at 8–9 (Q&A-12)).

SCP for Plans in IRS Audit

Pursuant to the expansion, there is no longer any restriction on the ability to correct while the plan is under examination if the sponsor can demonstrate to the IRS that significant self-correction efforts were made before the IRS identified the failure (Act §305(a)).

Relief for Loan Failures

SECURE 2.0 permits plan sponsors to self-correct participant loan failures, which previously had to go through the VCP or Audit CAP. Accordingly, plan sponsors can now use the SCP to correct participant loans that have defaulted or that, for example, exceed maximum withdrawal amount limits.

The Act also relieves plan sponsors from having to report corrected deemed distributions on Form 1099-R for self-corrected failures (id. at §305(b)(1)). Previously, this relief was available only through the VCP or Audit CAP (EPCRS §6.07).

Further, the SCP may now be used to satisfy the Department of Labor’s (DOL) Voluntary Fiduciary Correction Program (VFCP) for loan-related fiduciary breach issues. Therefore, the DOL must treat any self-corrected, eligible inadvertent plan loan failure as meeting the requirements of DOL’s VFCP (Act §305(b)(2)–(3)). While the DOL may impose certain reporting requirements should a plan sponsor elect to use the SCP, those requirements cannot implicate a fiduciary breach if the plan sponsor otherwise satisfies its obligations under EPCRS.

Taking Advantage of the EPCRS Expansion

Reviewing the interim guidance is the starting point for a plan sponsor considering whether or not it can self-
correct an operational failure. Even if a plan sponsor has been through the EPCRS process in the past, it is important to understand the changes ushered in by SECURE 2.0.

Certain “significant” operational failures may have been at one time barred from the SCP and required to go through the VCP. Examples of such failures that would no longer be subject to the three-year limitation and are now “eligible inadvertent failures” include:

  • Allowing the early entry of certain plan participants;
  • Failing to offer an eligible employee the opportunity to elect and make elective deferrals;
  • Failing to implement elective deferrals;
  • Failing to make required matching or profit-sharing contributions;
  • Not correcting failures in ADP or ACP testing;
  • Not making required minimum distributions; and
  • Distributing nonvested benefits.

Previously, whether a particular operational failure was “significant” under EPCRS required the analysis of several non-determinative factors, including the size of the failure, duration of the failure, and plan assets at issue. See EPCRS §8.02. Removal of this distinction eliminates uncertainty as to the character of the operational failure.

Certain other operational errors will require a plan sponsor to go through the VCP prior to further IRS guidance, even though they meet the definition of “eligible inadvertent failures.” Examples of these failures include:

  • Failing to initially adopt a written plan;
  • Failures in an orphan plan;
  • Significant failures in a terminated plan; and
  • Certain demographic failures (A complete list is in Notice 2023-43 at 5 (Q&A-2).)

In other words, processes that were once more onerous and time-consuming may no longer be so, and consequently, a plan sponsor should not be reluctant to explore EPCRS anew. Accordingly, if a plan sponsor discovers an operational failure that would have required going through the VCP prior to SECURE 2.0, then the plan sponsor should review the changes to EPCRS to determine whether relief for the failure is available under the SCP. The expansion should promote the correction of plan failures in light of its more flexible and forgiving processes.

Identifying Failures and ‘Cleaning House’

Generally speaking, under the prior EPCRS system, the SCP was limited to errors identified and remedied within a limited time after the error occurred. SECURE 2.0 significantly expanded that timeframe by focusing on when the plan sponsor discovers the operational failure, not when it occurred or whether the error is “significant” (Act §305(a)).

This leads to some practical observations:

  • The overall policy behind SECURE 2.0 and EPCRS is to encourage plan sponsors to correct plan failures without the intervention of the IRS. By relaxing the time limits for a plan sponsor to avail themselves of the SCP, SECURE 2.0 makes it even more attractive for plan sponsors to ensure their retirement plans are operating within the terms of the plan documents and within the requirements of ERISA.
  • Plan sponsors should enlist their service providers in this effort. Collaborating with third-party administrators, investment advisors/managers, and payroll coordinators could allow plans to identify and rectify any number of errors. Eligibility errors (including ineligible participants and excluding eligible participants), inaccurate contributions from using the inappropriate amount of compensation, and impermissible in-service withdrawals are three examples of where service providers can provide plan sponsors valuable assistance.

Because retirement plan sponsors are required to amend their plan document in any event due to SECURE 2.0, it makes sense to perform an overall checkup on plan compliance and operation now.

Controlling the Narrative

The SCP both allows and requires a plan sponsor, among other things, to explain how it identified the error, what it did to correct the error, and how it will avoid repeating the error in the future.

This also provides opportunities for the plan sponsor to:

  • Control the narrative. This is not to suggest that a plan sponsor should be less than candid. However, a plan sponsor can use the SCP to highlight its internal controls and procedures.
  • Describe the breadth and depth of its investigation to highlight the steps it took to determine the extent of a plan failure and whether that investigation led to other issues in need of correction.
  • Use the SCP to avoid the recurrence of similar plan failures in the future. This process has the added benefit of allowing the plan sponsor to carefully consider the safeguards it implements.

The SCP requires plan sponsors to take these steps in any event, but the level of detail and the narrative they choose to share is entirely in their hands. As opposed to a rote recitation of what EPCRS requires, plan sponsors can and should take the opportunity to explain how the operational failure occurred, why it occurred, and the circumstances that caused it to occur. An operational failure in this context is “inadvertent.” In other words, it is human error and unintentional, and such fact should be highlighted.

The investigation may show, for example, that:

  • A new payroll program or provider caused a glitch in reporting the accurate amount of compensation.
  • Confusion between the plan sponsor and the plan’s recordkeeper as to which entity tracked eligibility.
  • Plan sponsor recently merged with another company, and the human resources systems of the companies were initially incompatible.

These factors and others like it help to explain the genesis of the operational failure, and why it occurred in the first place. Uncovering and describing these details will not only help underscore that the failure was inadvertent, but also demonstrate that the plan sponsor’s diligence and operational controls were instrumental in catching the failure and effectuating a remedy as quickly and completely as possible under the circumstances.

The Audience for the SCP Is the IRS

It is important to recall that the SCP serves a practical purpose and an important regulatory purpose.

  • The practical purpose is to ensure that the plan is operating properly and in conformity with the law.
  • The regulatory purpose is that the self-correction memorandum (or other self-correction tool, such as a corrective plan amendments) is designed with the IRS as its audience.

In the case of an audit, the plan sponsor should be able to rely on the SCP to document and describe the actions it took to resolve plan failures in good faith and in accordance with the guidance set forth in EPCRS. In turn, the SCP should provide the IRS with the information it requires to determine that the plan is compliant and that the plan sponsor addressed any plan failures appropriately, thoroughly, and timely.

In addition to telling a compelling story, the SCP should track the appropriate corrective method outlined in EPCRS. Thus, if EPCRS prescribes a particular process, a plan sponsor should ensure that a self-corrective memorandum, as an example, identifies the corrective method and explains how the plan sponsor complied with that method, provided any required notice to participants, and so forth. In doing so, a plan sponsor will satisfy both the practical and regulatory purposes of the SCP.

Plan Sponsor Action Items

In light of the significant expansion of the SCP, plan sponsors should:

  • Take note of new avenues for SCP. “Clean house” and identify any operational failures.
  • Control the narrative and explain the circumstances in human terms.
  • Remember the audience is the IRS—the SCP should leave no doubt of compliance with EPCRS.

SECURE 2.0 provides an avenue for plan sponsors to take advantage of the expansion of the SCP under EPCRS. Now is a great time to review past and current practices pursuant to the plan amendments required by the Act in the coming years. The SCP is an invaluable tool to identify, correct, and document plan failures, along with establishing safeguards for future compliance.

But there is always a story, and the SCP gives plan sponsors the opportunity to tell it by marshaling the facts and the fix in a compelling and coherent fashion. By combining the narrative aspect of the SCP and the corrective methods set forth in EPCRS, a plan sponsor demonstrates to the IRS in the event of an audit that the plan sponsor takes the oversight and compliance of its retirement plan seriously.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Grant Shuman is a partner, and Anne Tyler Hall a managing partner, of Hall Benefits Law. Grant’s primary areas of practice are ERISA legal compliance and ERISA litigation. Anne helps clients create strategic legally compliant benefit plans aimed at attracting, motivating, and retaining top employees.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.