February 16, 2005
401(a) Plans for Termination Pay
We understand that the IRS has been contacting the sponsors of 401(a) volume submitter plans regarding allowable conversion provisions in such plans. Based upon our review of a letter to one such sponsor, it appears the IRS changed its position with respect to what types of conversion provisions are acceptable.
Ongoing Contributions. According to the letter, a 401(a) volume submitter plan including a feature that allows termination pay to be converted to an employer non-elective contribution must meet several new requirements. For example, the plan cannot restrict eligibility to the plan year in which the employee terminates employment and must provide for regular employer contributions based on a percentage of pay, a rate determined by contract, or matching contributions. In other words, the plan cannot be adopted for the sole purpose of making conversion contributions upon termination; it must provide for regular contributions during active employment.
According to the letter, the IRS is directing sponsors of 401(a) volume submitter plans that do not comply with these requirements to amend their specimen plan documents in order to remain a “qualified plan.” The amendments must be effective the first day of the plan year beginning on or after January 1, 2005. Thus, each employer that has adopted such a plan must sign a new adoption agreement adopting the changes. The new adoption agreement must be executed on or before the end of the first plan year beginning on or after January 1, 2005 and the amendment must be retroactive to the first day of the plan year.
Minnesota Law. Before adopting the changes required by the IRS, keep in mind the federal requirements must be coordinated with state law. Section 356.24 of the Minnesota Statutes prohibits contributions to supplemental pension or deferred compensation plans except certain specific plans identified in the statute. One such plan is “a supplemental plan organized and operated under the federal Internal Revenue Code, as amended, that is wholly and solely funded by the employee’s accumulated sick leave, accumulated vacation leave, and accumulated severance pay.” Previously, this exception allowed the use of 401(a) plans to receive contributions of accumulated leave and/or severance. However, a 401(a) plan amended to comply with our understanding of the new IRS requirements will no longer satisfy the exception, because the plan now must be funded with other employer contributions in addition to accumulated leave and severance pay.
Accordingly, unless the Minnesota legislature amends Section 356.24, it appears governmental employers in Minnesota will no longer be able to use 401(a) plans.