Advisers Add Extra Value in a Short Plan Year

An adviser’s broad perspective and timely nudges can help the plan sponsor steer clearly through major changes.

Plan sponsors polled about what they want in a retirement plan adviser often say they are looking for a guide—someone who will be there, regularly, to help set a path and move the plan forward. This is especially true when a plan’s operations and deadlines are in flux, for example during a short plan year.

According to experts, four situations commonly lead to a short plan year. These are the start of a new retirement plan, the termination of an old one, the shifting of the plan year—from calendar to fiscal or the other way around—or, by far the most common, a merger or acquisition of businesses with distinct plans. Because retirement plans typically operate based on a 12-month cycle and follow strict regulations applying to a year, to change that time frame can cause multiple issues, some of which sponsors may fail to consider until serious damage has been done.

“You don’t want to shift the plan year rashly,” says Jeff Bograd, director and managing ERISA [Employee Retirement Income Security Act] consultant for John Hancock Retirement. “It can definitely have an effect on participants and their contributions. You’ll want to have a plan of action.”

The adviser, as a third-party from the plan provider and the employer, is in a unique position to aid in the creation of this action plan, which will involve structuring the short plan year, then administering it once established. The adviser should act “as a second set of eyes” and ensure that all the players—the client, the recordkeeper, ERISA counsel and others—are on the same page with regard to the short plan year.

“Everyone should understand his responsibilities,” Bograd says.

NEXT: Planning for the short plan year

Advisers should keep in mind the task of a managing a short plan year may complicate what is already a challenging situation for the plan sponsor. In the case of an acquisition, there could be newly acquired staff to integrate or staff working to learn new systems, taking the focus away from the retirement plan.

Each set of circumstances that produces a short plan year is different. “They are fact-specific,” notes attorney Diane Morgenthaler, a partner with McDermott Will & Emery LLP. For that reason, she says, there are no “categorical rules” that define what a short plan year should look like.

A good starting point, therefore, is to consider the particular reason for the short plan year and for the initial business decision that called for it, she says. Maybe the company was sold, so the plan will be terminated and wound down. Or a brand new company wants to adopt a new 401(k) to attract talent.

Generally, she recommends the plan sponsor sit down with the recordkeeper, payroll vendor, plan attorney and human resources staff to weigh all the facts and play out all the different scenarios. By doing so, the sponsor can, for example in an acquisition, gauge when the two companies’ plans can be merged by determining how soon payroll can handle the transition. The goal is to choose the scenario that makes the most sense from each perspective, while having the least impact on the participants and their savings, she says.

Strategies to structure a short plan year run the gamut. In the case of a merger, for example, Bograd says, “Some companies will say these are our new employees—we want them in our regular plan right away, so we’ll do the plan merger right away.”

However, in some situations, “a company will put its employees into the new plan right away but not merge the plans until the end of the year to keep it cleaner and avoid that short plan year situation,” he says. This may cause complications, though, such as how to repay loans in the frozen plan. “It can get a little messy there,” he acknowledges. “In each situation, you have to weigh the pluses and minuses of what’s the easiest thing to do.”

NEXT: Compliance challenges

How quickly the recordkeeper or payroll vendor anticipates being able to meet any new service demands coming into effect is also a factor to consider. Occasionally, with a swift transaction, the seller will lag behind the closing in removing ex-employees from its payroll. To avoid what would amount to a multiple employer plan situation if those employees also remained in their old 401(k), “the buyer and seller may agree that the target employees have no 401(k) plan available for a few months until a separate payroll and 401(k) plan for target employees can be established,” Morgenthaler says.

There is also room for the adviser to deliver value through ongoing investment-related advice, especially if plan changes will require changing of funds or share classes. Whatever the reason for the short plan year, “the investment committee, or whatever entity has investment oversight, should engage his advice on the best path forward for the plan’s investments,” says Morgenthaler.

Once the short year has been created, the plan sponsor will turn its attention to compliance and administration. A big part of this will be informing participants about the change and how it will affect them.

“The adviser should help coordinate the message going to the participants,” Bograd notes. He recommends creating a calendar hat lists the upcoming events impacting participants. “It can get confusing for them, especially if changes that are being made effects the amount they can put into the plan or their vesting,” he says. For some, such as the highly compensated employees (HCE), their timing to receive such information could be critical from a tax planning perspective, he says.

Plans with too many high-earners could fail nondiscrimination tests in a short plan year—especially when bonuses are not carefully considered. Bograd explains, “You have to prorate the compensation limit of $265,000, for example, by taking half of that—$132,500 if you have a six-month plan year. If you know you’ll be changing your plan year, communicate that so they can spread their contributions over the full calendar year,” he says.

NEXT: Adjusting for vesting

“It’s easier to exceed limits in a short plan year,” Morgenthaler agrees. In another common example, participants moved into their new company’s 401(k) may think they get a second opportunity to save $18,000 during that plan year. “It doesn’t work that way,” she says. “Plan A is going to have to accept the contribution history of Plan B, so the 401(k) contributions of both may not exceed $18,000. It has to be explained to people.”

Changes in vesting also could create compliance challenges. In instances of a plan year change from a fiscal to a calendar plan year, a company needs to carefully consider how many hours employees have worked, Bograd says. You need to track that 1,000 hours twice: for example, from July 1 through June 30—the old plan-year end—and January 1 through December 31—the new plan-year end, he says. “You’re counting the 1,000 hours in both places, so they count in both years.” This procedure—mandated by ERISA—ensures that participants are not punished by the change of plan year.

Conversely, a plan year change will not impact vesting for a plan that uses the elapsed-time method, as vesting is measured from date of hire to anniversary of date of hire and is unrelated to the number of hours worked.

Vesting could be important to consider when a company first debates the shortened plan year. It could affect the amount of forfeitures the plan sponsor may have been planning to use for plan-related expenses, Bograd says.

Short plan years for start-up and terminating plans face similar issues, he adds. “Specifically, sponsors should be aware that prorated compensation limits can lead to failing compliance tests.”

NEXT: Don’t forget the Form 5500

The most serious potential compliance issue, though, could involve Form 5500. People forget to file it, both experts say. “Form 5500 is always due seven months after the last day of the plan year,” Morgenthaler says. For a company that terminated or merged its plan on June 30, the form will be due seven months after that date—“far earlier than you’re used to filing that return for the calendar year. That’s what trips up people sometimes. It’s a moving target.”              

Further, the person who traditionally submitted the form may have been a casualty of the acquisition. So someone else has to remember to do it—and to do it off-cycle, she says. “You’re going to forget a few times; it’s not how you’re used to doing it.” Her recommendation: Have a good transition plan in place, and a good calendar.

Any transition plan should cover the service providers as well, including those of the acquired company, Bograd says. If that firm’s plan will be merged with the parent firm’s own plan in a short plan year, you may be dealing with two different recordkeepers, he says. If so, “make sure the recordkeeper of the plan that’s going away understands what they’re processing and what the requirements are—meaning they’re still doing the 1099s for that short period, that they’re going to do the 5500 on a timely basis. I’ve seen situations where prior recordkeepers will forget that—they’ll think because the plan isn’t there at the end of the year they’re not responsible for it anymore.”

Plan sponsors that discover they have missed the date may apply to the Department of Labor (DOL)’s Delinquent Filer program. “And bring in your auditor as fast as you can,” Morgenthaler advises.

With a good adviser on the job, those steps shouldn’t be necessary.