2-year 401k plan - audit risk exposure

Having informed a small business owner who plans to retire in 2024 that they cannot start a pension plan for 2023, contribute for 2023 and 2024, then retire and terminate the plan, since there is no long term intent for the plan and it would create a significant audit risk of disqualification, she is asking if she can instead create a 401k/ps plan for 2023-2024.

I feel like the answer is the same, but I'm really not sure if the risk exposure is as great as if it were a pension plan.

You can give them the guidelines on Plan permanency rules and let them make the decision if they want to implement a plan and what kind.

Then you as a service provider need to decide if you are comfortable with providing administration for the decision they make or direct them to seek other service providers.

While the IRS views any plan in existence for 10 years to be permanent, plans can (and do) terminate in shorter time frames but it would be a facts and circumstance determination whether the IRS would view the Plan as qualified or not based on the Plan permanency rules.

Based on your facts, I agree with you that this seems to fit well with in the regs of a plan that is NOT intended to be permanent but I've certainly seen plans over the years, even ones that have gotten DLs on termination, (though not for many years) that fit your fact pattern and i have not yet seen the IRS come to disqualify one. Though that is purely anecdotal and I am not suggesting you propose audit roulette to the client, just an observation.

Interestingly I don't think the Plan permanency rules apply to SEPs so that might be an alternative for them if demographics work if you and/or they are not comfortable with the risk of a qualified plan

Here’s the Treasury department’s interpretive rule: 26 C.F.R. § 1.401-1(b)(2) https://www.ecfr.gov/current/title-26/part-1/section-1.401-1#p-1.401-1(b)(2).

TPApril, does the business have employees other than the owner? If so, is it imaginable that an already anticipated buyer of the business might continue the retirement plan for the employees (or might merge the recently created seller’s plan into the buyer’s plan)?

One could argue that without a date certain for the plan term, there is no actual decision for the plan to be non-permanent.  In that case its more along the lines of "it will be permanent until we decide to retire" which is an unknown future date. And if you sell the business at retirement, why assume that the plan would term? It could continue with a new owner.

Love navigating the gray! The early termination for a business transaction such as selling the business should not be a concern unless the transaction was foreseen at the time the plan was established. That is, I would not start a plan effective 2023 if I had a contract to sell the business in a specific year in the not too distant future.

Retirement is a trickier situation, as people plan to retire at a certain age all the time but then keep working for various reasons. Is having employees a positive or negative factor where the owner has plan for 2-3 years and then retires? Was it just a short-term tax deferral for the owner or did employees actually benefit?

A lot of sides to the arguments and a lot of angles from which to approach accommodating the objective. If no employees to worry about, why not start the plan for 2023 and then freeze after 2024 or run it active another year or two at minimal earnings/compensation before ultimately terminating after 5 or more years? It doesn't get you to the presumptive 10 years but gets you closer - I intended longer but income dropped after 2 years so I froze and then after a few more years I decided to retire.

BUT, your responsibility is to communicate the rules and various options and let client decide how to proceed given the risks.

Has anyone actually had a client’s plan (DC or DB) disqualified for not being permanent enough?

Agreeing with all the comments, you list this under 401(k) but mention a "pension plan".  Not knowing the amount they are looking to contribution would a SEP or SIMPLE, be an alternative, no permanency issue with SEPs or SIMPLE-IRAs.