How a Qualified Plan’s Effective Date Contributes to a Plan’s Success
By Cindy Fairchild, QKA, CIP
With the passing of key retirement legislation in the last few years, there are many incentives for employers to adopt a qualified retirement plan that can provide meaningful benefits to employees. While there are numerous factors to consider during the establishment process, employers should consider certain effective dates that will significantly affect the success of their plan’s initial year of operation.
What are the rules regarding the plan effective date?
The SECURE Act of 2019 allows employers to establish a plan retroactively to the first day of the prior tax year (for profit sharing contributions only) if they adopt the plan no later than their tax filing due date, plus extensions for that tax year. Employers adopt a plan by signing a written plan document that serves as the legal contract between an employer and the federal government. This allows the employer to obtain favorable tax treatment of contributions into the plan.
There are several benefits to having the plan’s initial effective date be the first day of the plan year, including the following.
Limits applicable to the plan, such as the annual additions limit (IRC Sec. 415) are not prorated.
Employees who meet the age and service requirements for the plan as of the initial effective date can enter the plan as of the initial effective date and are eligible to use full year compensation for employer contributions.
A short plan year will occur if a date other than the first day of the plan year is used. During a short plan year, compensation is limited to what the participant received during the short plan year when calculating employer contributions. In addition, the limits applicable to the plan—not including the salary deferral limit—will be prorated based on the number of months within the short plan year, reducing the amount of contributions that can be made into the plan for the initial year.
What is a deferral commencement date and why do I need to establish one for my plan?
While an employer may retroactively adopt a plan for purposes of making employer contributions, elective deferrals can only be made on compensation received on or after the adoption date (i.e., signature date) or the established deferral commencement date in the plan document, whichever is later. As employer matching contributions are directly tied to elective deferrals, the ability to receive an employer match is restricted to the same timing as the effective date for elective deferrals in an initial plan year.
Can I waive the eligibility rules for employees hired as of the plan’s effective date?
If an employer wants to ensure that all employees hired as of the plan’s effective date are included in the initial enrollment, eligibility rules (age and service) for all employees can be waived as of the plan’s effective date (initial effective date) or as of a particular date (deferral commencement date if different).
Depending upon an employer’s goals for the initial year of a retirement plan’s operation for participation and contributions, there are many factors that will need to be reviewed before making decisions on these key dates. Employers should always consult with their tax or legal advisor before determining the best options for their retirement plan.
