Form 5500-EZ Updates for 2021

Most qualified retirement plans are required to file an annual return with the IRS. For plans subject to Title I of ERISA, this requirement is satisfied by filing Form 5500 or Form 5500-SF with the DOL. Other plans may file an abbreviated form known as Form 5500-EZ. For 2020, Form 5500-EZ received some important updates.

Electronic Filing Now Available

Since 2009, plans that file Form 5500 or Form 5500-SF have been required to file electronically through the DOL’s EFAST website. One-participant plans had the option to file electronically through EFAST as well, by using a special option to file a Form 5500-SF as a one-participant plan. However if the plan administrator wanted to file Form 5500-EZ, they would have had to do so on paper.

Starting with any forms filed for plan years beginning on or after January 1, 2020, Form 5500-EZ may be filed electronically through EFAST. As a result, Form 5500-SF may no longer be used for a one-participant plan. Form 5500-EZ may continue to be filed on paper for the time being, although we would encourage all filers to migrate towards the electronic system.

Expanded Eligibility to File

The term “one-participant plan” has been mentioned a few times already in this article, without having been clearly defined. A one-participant plan is a plan that is eligible to file Form 5500-EZ. A one-participant plan includes any plan that covers only the 100% owner of a business and his or her spouse, or a plan that covers only partners in a partnership and their spouses.  As long as the plan provides no benefits to anyone other than those, it is considered to be a one-participant plan. Note that the name is misleading, since a one-participant plan can cover more than one participant. Likewise, not every plan that covers only one participant would be a one-participant plan.

Starting with the 2020 Form 5500-EZ, the IRS expanded (or perhaps merely clarified) the definition of one-participant plan to provide that a 2% shareholder in an S-corporation is considered a partner. This is helpful, since it resolves the ambiguity about whether an S-corporation is treated as a partnership, where the plan can cover any number of partners, or a corporation, where the plan would be considered a one-participant plan only if it covered the 100% owner.

However, the real news is that the IRS specified that the term “2% shareholder” is defined under IRC sec. 1372(b), which means that family attribution applies in determining who is a 2% shareholder. Prior to 2020, a plan which covered the 100% owner of an S-corporation, their spouse, and their child would not have been considered a one-participant plan and would have been required to file Form 5500-SF. Under the new rules, the child is also considered a partner, and therefore the plan is considered a one-participant plan, and is therefore eligible to file Form 5500-EZ. However, this only applies in the case of an S-corporation - if the company were a sole proprietorship, partnership or C-corporation, Form 5500-SF would still be needed.

Finally, a 2% shareholder in an S corporation is defined as someone who, after the above family attribution rules are applied, owns more than 2% of the company’s stock or voting power at any time during the year. Ironically, a person who owns exactly 2% is not considered a 2% shareholder.

The changes to Form 5500-EZ for 2020 are expected to streamline the filing process for many plans. If you have any questions about how these changes could impact your plan, please contact us.

Catching Up with Catch Up Contributions

401(k) plans, 403(b) plans, 457(b) plans, and IRAs are all popular retirement savings vehicles with their own annual contribution limits. Each of these types of plans allows individuals to exceed the annual limit by making catch up contributions. The rules for catch up contributions are slightly different for each type of plan.

401(k) Catch Up

In a 401(k) plan, a participant may make a catch-up contribution starting in the year in which they attain age 50. They do not have to actually be 50 years old at the time the contribution is made as long as they will be 50 before the end of the year.

For 2020 and 2021, the normal 401(k) contribution limit is $19,500. A participant who is eligible to make a catch up contribution can exceed that by up to the amount of the catch up limit, which is $6,500 for both 2020 and 2021. So, anyone born on or before December 31, 1970 can contribute $26,000 to their 401(k) plan for both 2020 and 2021. Someone born in 1971 could contribute $19,500 for 2020, but $26,000 for 2021.

Besides being of the appropriate age, a participant must also make sure that their plan allows for catch up contributions. Most 401(k) plans will allow them but plans are not required to do so. If a plan allows any participant to make catch up contributions, however, it must allow them for all eligible participants. Catch up contributions are disregarded when performing the ADP test, and when determining the plan’s top heavy minimum.

403(b) Catch Up

403(b) plans can allow for the same age 50 catch up as 401(k) plans, plus an additional catch up for long-term employees. If an employee has completed at least 15 years of service with the employer sponsoring the plan (or, if the employer is a church-related organization, any organization related to the same church), then they are eligible to contribute a catch up amount equal to the least of:

  1. $3,000;

  2. $15,000 less the total amount of this special catch up used in prior years; or

  3. $5,000 multiplied by the participant’s total years of service, less the sum of all elective deferrals made to any plan sponsored by the employer, including 401(k), 403(b), SARSEP or SIMPLE plans.

This is a complex determination, and some 403(b) sponsors will choose not to permit this special catch up simply to avoid the burden of calculating this limit.

Clause (3) of the limit is the most burdensome on the employer, since it requires the employer to retain records of how much the employee deferred through their entire history. The employer must count all the employee’s years of service (which must be at least 15, if we are considering this special catch up) and multiply that number by $5,000; for an employee with 15 years of service that is $75,000. Then the employee’s lifetime deferrals - including those into any 401(k) or other plan sponsored by the employer, even if the plan no longer exists - are subtracted from that amount to get our limit. If our employee with 15 years of service has deferred more than $75,000 in their entire history with the employer, then their limit is $0 and they are effectively not eligible for the special catch up. Another way of looking at this is if the employee’s average annual deferral contribution exceeds $5,000, then they are not eligible.

Considering the other extreme, if an employee had never deferred at all, then clauses (1) and (2) limit the contribution. Clause (2) says the lifetime maximum contribution that can be made under this special catch up rule is $15,000, and clause (1) says the maximum contribution that may be made in a single year is $3,000. Taken together these limit the special catch up to a maximum of $3,000 a year for 5 years. An employee who made some deferrals in the past, but less than $5,000 per year on average, will still be eligible to make some catch up contributions, but may not be eligible to get the full $3,000 for 5 years.

The 403(b) long service catch up limit applies in addition to the age 50 catch up, so an employee who is at least age 50 and has at least 15 years of service could potentially contribute $19,500 (annual 403(b) limit) + $6,500 (annual catch-up limit) + $3,000 (special catch up limit) = $29,000 in a single year. Like 401(k) plans, 403(b) plans are not required to offer either the age 50 catch up or the long service catch up, and may offer just one or the other, so participants should confirm their plan’s provisions with their employer.

457(b) Catch Up

457(b) plans can offer a unique type of catch up contributions but only in the three years immediately preceding the participant’s normal retirement age, as defined in the plan. The limit on this catch up contribution is equal to the lesser of the annual contribution limit, or the amount by which any past years’ limits were not fully used.

The effect of this is to allow a participant to make up for an underutilized contribution limit from a prior year. This is sometimes referred to as a missed opportunity. Depending on how much less than the annual maximum they contributed, they may not be able to fully recoup the missed opportunity, however they should still be able to contribute 200% of the normal annual limit. Timing is crucial with non-governmental 457(b) catch up since it is only available in the 3-year window leading up to normal retirement.

Governmental 457(b) plans may offer the age 50 catch up with the same limits as apply to 401(k) plans in addition to the 3-year catch up; however both types of catch up may not be used in the same plan at the same time. Since 457(b) limits are not aggregated with 401(k) or 403(b) limits, if an employee is a participant in both a 457(b) plan and a 401(k) or 403(b) plan, they may be able to take advantage of both types of contribution and catch up limits, as long as they are eligible. 

IRA Catch Up

IRAs, including Roth IRAs, allow catch up contributions for individuals age 50 or older. The catch up limit is $1,000, in addition to the IRA contribution limit that would otherwise apply. Like other IRA contributions, the individual has until their tax filing deadline to make the catch up contribution.

Getting All Caught Up

Catch up contributions are a useful way to boost retirement savings for individuals getting closer to retirement. The rules can be complex and vary significantly depending on circumstances. Leveraging catch up contributions can allow you to save more and possibly reduce your annual tax bill. To learn how to tax advantage in your particular situation, please call us today. 


Flexible Safe Harbor Plan Options for 2020 and Beyond

As 2020 winds down, it is time to start thinking about annual compliance testing! One of the more intractable pieces of the testing puzzle each year is the ADP (Actual Deferral Percentage) Test. The SECURE Act, which was passed into law in December 2019, added some new options to help plan sponsors comply with the ADP Test.

The ADP Test

The ADP Test is a test that is used to demonstrate that 401(k) plans do not discriminate in favor of Highly Compensated Employees (HCE). The test looks at the 401(k) contribution rate for each employee, determined on an annual basis, then takes the average of the contribution rates for the highly compensated and non-highly compensated employee groups. If the average for the HCE is greater than the average for the non-HCE by more than a certain amount, the test fails.

A failed test is generally corrected in one of two ways: either the employer can make additional contributions (known as Qualified Non-Elective Contributions or QNECs) to the non-HCEs’ accounts to bring up the average for that group, or the HCEs can take refunds of a portion of their contributions for the year. QNECs can be prohibitively expensive, depending on the size and contribution rates of the non-HCE group, and refunds are detrimental to HCEs’ retirement savings.

Another non-discrimination test, the ACP test, is similar to the ADP test except that it tests employer matching contributions, rather than employee deferral contributions.

Safe Harbor 401(k) Plans

What makes the ADP Test particularly irksome is that since it is based on employee contribution rates, and because employees can generally start, stop, or change their contributions at any time, it is often difficult, if not impossible to know what the outcome of the test will be in advance, and therefore to plan for it. Rather than face this uncertainty each year, some plan sponsors choose to adopt a safe harbor plan design which allows them to automatically satisfy the ADP test, in exchange for making safe harbor contributions to the employees’ accounts. Safe harbor plan designs come in two varieties: a safe harbor match (or “SHMAC”), where the employer makes a contribution to those employees who defer into the plan, and a safe harbor non-elective (or “SHNEC”) where the employer makes a contribution to all eligible employees, even those who were not contributing themselves. A SHMAC is typically capped at 4% of the employee’s compensation, whereas the SHNEC is generally equal to 3% of compensation.

A major limitation of safe harbor plan designs is their inflexibility. Merely making the contribution is not enough; the plan administrator must also provide a notice to participants before the beginning of the year stating their commitment to provide the contribution. Since the notice must be provided before the beginning of the year, it would make it impossible for a non-safe harbor plan to decide that they want to become a safe harbor plan after the beginning of the year. On the other hand, if the sponsor of a safe harbor plan decides during the plan year that they no longer wish to have a safe harbor plan, they may only terminate the safe harbor under certain limited circumstances.

The SECURE Act, which was passed into law in December of 2019, offered some welcome flexibility to sponsors of safe harbor non-elective plans. Section 103 of the SECURE Act does two things: first, it eliminates the notice requirement, and second, it allows plan sponsors to add SHNEC provisions to their plans not just mid-year, but even retroactively after the end of the year, by increasing the employer contribution to 4%.

Notice Requirement

The requirement to provide a notice was eliminated, but only with respect to safe harbor non-elective plans, and only to the extent the safe harbor is being used to satisfy the ADP test. If the plan sponsor wishes to use the safe harbor non-elective contribution to satisfy the ACP test, because they are making a discretionary matching contribution, then the advance notice is still required. SHMAC plans were not affected by this change and must continue to provide the notice.

Plan sponsors may wish to continue providing the notice on an annual basis, even if it is no longer required. As mentioned, providing the notice allows the sponsor to make a matching contribution without being subject to the ACP test. Providing the notice also gives the sponsor an opportunity to revoke the plan’s safe harbor status mid-year, should they wish to do so, without the need to be operating at an economic loss. Furthermore, the timing of the notice aligns with the timing of other required notices, such as the QDIA notice, so continuing to provide the safe harbor notice should not place too much additional burden on plan sponsors.

Retroactive Safe Harbor Amendment

The ability to decide, up until 30 days before the end of the plan year, whether or not to have a SHNEC for the current year has always existed via the so-called “Conditional SHNEC” in which the sponsor provides a notice (sometimes called the “maybe” notice) before the beginning of the year informing participants that the plan might be safe harbor, then follows it up with a supplemental notice before the end of the year that contains the final decision. The SECURE Act did away with the need for the “Maybe” notice (although sponsors may still wish to provide it, for the reasons mentioned earlier), but the more interesting effect of this new rule is that it allows even a plan which did not contain any safe harbor provisions at all to become a SHNEC plan. The added flexibility will be especially appreciated by sponsors who experience a change in plan demographics or contribution patterns which causes them to unexpectedly be in danger of failing the ADP test.

Perhaps the biggest change to come out of section 103 of the SECURE Act is the all-new ability to adopt SHNEC provisions within 30 days of the end of the year, all the way up until the last day of the following plan year. This deadline to retroactively adopt SHNEC provisions is the same as the deadline under the 401(k) regulations to make a QNEC that will count towards the ADP test, or to refund excess contributions. In other words, adopting retroactive SHNEC provisions gives plan sponsors a new way to correct a failed ADP test. In many cases, a 4% SHNEC can turn out to be less costly than a QNEC. Contributions made to satisfy a SHNEC may also be used in the plan’s 401(a)(4) test, to help satisfy nondiscrimination of the plan’s profit sharing contribution, whereas QNECs may not be included in the 401(a)(4) test.

Mid-Year Changes Affecting HCEs

Back in 2016, the IRS issued guidance on what types of changes may and may not be made to safe harbor plans mid-year. Among the restrictions is a prohibition on any amendment that reduces the group of employees eligible for a safe harbor contribution. What was not clear, however, was how this applied to any HCEs covered by a safe harbor plan. Because a plan is permitted to, but is not required to provide safe harbor contributions to HCEs, it would stand to reason that since the contributions to HCEs are not required in order for the plan to have safe harbor status, it should be permissible to suspend those contributions without jeopardizing safe harbor status. However, if the plan defines the contributions to HCEs as safe harbor contributions, then suspending them for any group of employees, even HCEs, might violate the mid-year amendment rule.

IRS notice 2020-52, while mostly focusing on relief related to the COVID-19 pandemic, also provided clarification on this topic. The notice states clearly that, for purposes of the 2016 rules, contributions made to HCEs are not included in the definition of safe harbor contributions. Therefore, a mid-year amendment to suspend safe harbor contributions to HCEs would be permissible under those rules. The 2020 notice did point out, however, that if the employees were provided with a notice stating that HCEs would receive a safe harbor contribution, and if after the amendment that notice is no longer accurate, then an updated notice must be provided.

Safe Harbor plan designs are a great way for employers to offer the advantages of a 401(k) plan to their employees, while being able to meet their obligations under the ADP test in a straightforward way. The new flexible safe harbor options under the SECURE Act add another tool to the compliance toolbox and are sure to be useful going forward. If you would like to learn more about how the SECURE Act can be put to work in your 401(k) plan, please contact us.