Frozen 401k Plan - impact on vesting?

Hi. We had both a 403b and 401k plans. We decided to freeze our 401k plan (no contributions) a few years ago and use the 403b as our sole DC plan. The question is what does this plan freeze do to our vesting (3 year cliff)? I had thought we could just continue with applying our vesting schedule. But I read that the IRS may view a 401k freeze as a "complete discontinuation of contributions" and require full vesting of all participants. I couldn't find anything official, but did find the language below on an IRS website. I also found this: https://www.irs.gov/retirement-plans/no-contributions-to-your-profit-sharing-401-k-plan-for-a-while-complete-discontinuance-of-contributions-and-what-you-need-to-know

Does anyone have experience with this? Any thoughts?

Thanks.

We haven’t made many contributions to our profit-sharing plan. How will this impact our plan termination?

Although employers are not required to contribute every year to a profit-sharing plan, contributions must be recurring and substantial. If the amount is not significant enough to show an intention to continue the plan, the IRS will treat the contributions as discontinued.

A plan is treated as terminated for vesting purposes if the employer completely discontinues contributions. The employees affected by the discontinuance must become 100% vested. Generally, you must vest all affected employees no later than the end of the taxable year following the taxable year in which you made your last substantial contribution (IRC Section 411(d)(3)).

The IRS presumes that an employer has completely discontinued contributions when the employer fails to make substantial contributions for at least 3 years in a 5-year period. If this happens, the burden shifts to the employer to show that a complete discontinuance has not occurred (Announcement 94-101).

Why was the 401(k) plan frozen and not terminated outright at that time?

28 minutes ago, justanotheradmin said:

Why was the 401(k) plan frozen and not terminated outright at that time?

 

I am not sure of the rationale to freeze and not terminate. It is possible that it will be unfrozen at some point. But it is also possible that it will never be unfrozen and will be eventually terminated.

When the complete discontinuation of employer contributions is deemed to have occurred, then you will require full vesting of all affected participants in the 401(k) Plan.

2 minutes ago, Lou S. said:

When the complete discontinuation of employer contributions is deemed to have occurred, then you will require full vesting of all affected participants in the 401(k) Plan.

I guess I am trying to understand when/how this determination is made. All that I have found is the language below but not in any official IRS-issued guidance. I have not found any legislation or other official guidance.

The IRS presumes that an employer has completely discontinued contributions when the employer fails to make substantial contributions for at least 3 years in a 5-year period. If this happens, the burden shifts to the employer to show that a complete discontinuance has not occurred

I don't believe the IRS has given a bright line. If they have I am not aware of such guidance. 

I believe it is fact and circumstances. In your case for example maintaining a second defined contribution plan might weigh in your favor for a longer period, particularly if the plan covers substantially the same group of employees, makes recurring employer contributions and has a vesting schedule that is similar to the frozen plan. But the ultimate decision rests with the IRS.

There are two places to look for guidance.  One is 1.411(d)-2(d)(1), and the other is the plan document.

Within the reg you will find:

"Among the factors to be considered in determining whether a suspension constitutes a discontinuance are:

(i) Whether the employer may merely be calling an actual discontinuance of contributions a suspension of such contributions in order to avoid the requirement of full vesting as in the case of a discontinuance, or for any other reason;

This item suggests you can suspend contributions for a short time and not have to fully vest everyone. 

The IRS weighs in on the topic here https://www.irs.gov/retirement-plans/no-contributions-to-your-profit-sharing-401-k-plan-for-a-while-complete-discontinuance-of-contributions-and-what-you-need-to-know with:

"Employee Plans Exam guidelines state that if the employer hasn’t made contributions in three of the past five consecutive years, the plan may have incurred a complete discontinuance of contributions.

When a complete discontinuance of contributions occurs, the plan sponsor must treat the plan as a terminated plan and fully vest all participant accounts for the plan to remain qualified. Determining if there’s been a complete discontinuance of contributions is based on facts and circumstances, for example, the plan sponsor’s history of profitability, and the probability of future contributions from the sponsor."

If you are using a preapproved document with an Adoption Agreement, definitely read the Basic Plan Document.  Some document providers include provisions with more explicit language or with other terminology than is found in the regs that would require full vesting.  This may be done to avoid the ambiguity of a determination based on facts and circumstances.  If you find such language, then you must follow the terms of the plan.

With regard to this specific situation, if a "few years ago" means three or more years ago, you likely will have a hard time convincing an IRS agent that everyone should not be fully vested.

But what if there is no Internal Revenue Service examination, and no Employee Benefits Security Administration investigation?

In the first instance, the plan’s administrator decides whether to administer the plan with a finding that a discontinuance happened, or with a finding that it has not happened.

A plan’s administrator might want its lawyer’s advice to support a finding.

A court might defer to an administrator’s discretionary finding if it has a plausible reasoning.

Keep in mind that that our IRC income tax system relies on voluntary compliance.  If you are thinking, "Can I get away with it?" (because in this case there is no bright line), then you are playing the wrong game.  When you say "We decided to freeze our 401k plan (no contributions) a few years ago and use the 403b as our sole DC plan," doesn't that sound like you intended not to make further contributions to the k plan, but rather to just go with the b plan?  That sure sounds to me like a complete discontinuance of contributions (match) to the k plan.  Therefore, full vesting.  This is not legal advice.  Just my opinion.

No one in this discussion suggests a plan’s administrator use “Can I get away with it?” as a way to form a discretionary finding. And no one here suggests an administrator form its finding by considering that IRS or EBSA might lack resources to examine or investigate the administrator’s decision-making.

Everyone recognizes that a plan’s administrator decides in the first instance. A plan’s administrator must make its finding when needed to decide a participant’s claim, or to decide the amount of an involuntary distribution. If there is a claim to decide, an administrator must not wait for a government agency’s review.

Paul I suggests a plan’s administrator use ERISA § 404(a)(1)(D) obedience in following the plan’s governing documents.

And I suggest a plan’s administrator use ERISA § 404(a)(1)(B) prudence in recognizing that a fiduciary who lacks complete skills or experience might want the advice of someone specially trained in how to read and interpret an ambiguous text, and in how to apply law—public, private, or both—to ambiguous facts.

A rule mentioned above expressly states that “whether a complete discontinuance of contributions under the plan has occurred” turns on “all the facts and circumstances in the particular case[.]” The rule describes three factors to be considered, but states those are not the only factors to be considered.

26 C.F.R. § 1.411(d)-2(d)(1) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR686e4ad80b3ad70/section-1.411(d)-2#p-1.411(d)-2(d)(1).

A plan’s administrator decides its interpretation of the plan’s provisions, including those one interprets to follow an applicable or relevant statute or regulation. And after discerning the plan’s provisions, an administrator decides how to apply those provisions to the particular facts. Even fact-finding involves discretion.

That an administrator recognizes that no bright-line test completely governs the finding and that one’s decision-making involves discretion does not mean anyone seeks to defeat the application of public law or a plan’s governing documents.

Paul's suggestion to first check the plan document is excellent. I personally haven't noticed (but I haven't really looked) a document that specifically defines what constitutes a "complete discontinuance" - ours merely says that if there is a complete discontinuance, then any affected participant will become 100% vested. Which still leaves it up to Administrator discretion to determine what constitutes a complete discontinuance.

Unless there is a whole lot of money at stake, I say discretion is the better part of valor in these determinations.