Plan (ESOP) diversification error

We were asked to look at this plan - they also have a 401(k) plan - and we referred it to another TPA. Too much of a mess, and ESOP's aren't our thing. But I did have one question, for my own edification. The plan diversification provisions provide that the amount may be transferred to the company's 401(k) plan. However, some number of prior diversification amounts were distributed in cash.

How might this be corrected? I can't see any way to fix, other than to go through VCP, and ask the IRS to bless a retroactive amendment permitting a distribution in cash? Is there another option?

Actually, it seems like this could qualify for SCP by amendment, under RP 2019-19 - other thoughts?

(2) Availability of correction by plan amendment in SCP. SCP is available for corrections made by plan amendment, as provided in section 4.05(2)(a), (b), and (c). In addition, a Plan Sponsor may adopt a plan amendment to reflect corrective action. For example, if the plan failed to satisfy the actual deferral percentage (ADP) test required under § 401(k)(3) and the Plan Sponsor must make qualified nonelective contributions not already provided for under the plan, the plan may be amended to provide for qualified nonelective contributions.

(a) Correction of Operational Failure by plan amendment for a Qualified Plan or 403(b) Plan. A Plan Sponsor of a Qualified Plan or 403(b) Plan may correct an Operational Failure by plan amendment in order to conform the terms of the plan to the plan’s prior operations only if the following conditions are satisfied: (i) The plan amendment would result in an increase of a benefit, right or feature. (ii) The increase in the benefit, right, or feature applies to all employees eligible to participate in the plan. (iii) Providing the increase in the benefit, right, or feature to participants is permitted under the Code (including the requirements of §§ 401(a)(4), 410(b), 411(d)(6), and 403(b)(12), as applicable), and satisfies the correction principles of section 6.02 and any other applicable rules of this revenue procedure.

4 hours ago, Belgarath said:

The plan diversification provisions provide that the amount may be transferred to the company's 401(k) plan. However, some number of prior diversification amounts were distributed in cash.

Language is key - plan could allow for transfers or distributions, but must be at participant's discretion/election and not the employer's. Is that your issue or are you saying the plan only allows for transfers and not distributions for diversification? We have to clear on what the violation may be, if there is indeed one, to determine how to fix.

19 minutes ago, CuseFan said:

Language is key - plan could allow for transfers or distributions, but must be at participant's discretion/election and not the employer's. Is that your issue or are you saying the plan only allows for transfers and not distributions for diversification? We have to clear on what the violation may be, if there is indeed one, to determine how to fix.

 

My reaction was the same here.  Does the plan require the diversification go to the 401(k) plan or is that one of several options including taking a payment. 

I don't know if I have ever seen an ESOP document require the 401(k) plan be an option and not allow for a distribution also.   It could be written so that the 401(k) is the only option but it would strike me as odd.  

So agree check the document again. 

Sorry, I should have been more precise in my wording. The document did mandate that the diversification could ONLY be transferred to the 401(k) plan. Hence the operational violation that prompted the question. Thanks.

That is some interesting drafting on the part of the attorney.  

On 5/28/2020 at 3:41 AM, Belgarath said:

Sorry, I should have been more precise in my wording. The document did mandate that the diversification could ONLY be transferred to the 401(k) plan. Hence the operational violation that prompted the question. Thanks.

 

That is some interesting drafting on the part of the attorney and not required under 409.  Yes, there is a operation error.  They should fix their forms asap.  Without amending the ESOP, the fix would be to have the participant return the funds and then ask the participant whether he/she wants to make a diversification distribution into the 401(k).  It is also interesting because most 401(k) plans allow participants to request in-service distributions of rollover funds.   

Glad I don't have to deal with it...

We have some ESOP clients who only permit transfers to their 401(k) plan. The logic is the same as an employer who doesn't permit in-service withdrawals. It's a less-common option in my personal experience, but I don't think it's necessarily a drafting "error" that needs to be "fixed" (unless it truly was an error and they meant to allow a choice from the beginning). 

2 hours ago, EBECatty said:

We have some ESOP clients who only permit transfers to their 401(k) plan. The logic is the same as an employer who doesn't permit in-service withdrawals. It's a less-common option in my personal experience, but I don't think it's necessarily a drafting "error" that needs to be "fixed" (unless it truly was an error and they meant to allow a choice from the beginning). 

If it wasn't a plan document drafting error then it is a diversification election form drafting error. 

Bringing this up again, due to a non-ESOP question where the SCP issue is raised.

I originally thought, without doing much research, that perhaps (as stated in OP) such a situation could be corrected via amendment under SCP. I think that is wrong - the IRS states that SCP may not be used to retroactively amend/conform the plan to the operation if it doesn't provide for a UNIFORM increase in benefits, rights, or features. The fact that this error only affected a few participants wold seem to negate this requirement.

This brings up my real question, for a non-ESOP situation: if a plan misses the restatement deadline for pre-approved plans (401(k), 403(b), etc.) can the restatement be done after the fact via SCP, within the two year timeframe, of course, since document failures are always "significant?" A strict reading might seem to say no, yet I have seen opinions that it is allowable, without going through VCP as a non-amender. Any thoughts on this?

Amendment needs to be done within the remedial amendment period.  Otherwise, you need to file a VCP application with the IRS.  SCP method are not available for non-amender.