By Carol Buckmann
We need more employers to adopt 401(k) plans to help fill the retirement savings gap, but we all know that the complexity of administering a qualified plan and the risk of being sued over investments deter some employers from adopting plans. Multiple employer plans (MEPs) in which employers that do not share a relationship other than adopting the plan can participate, known as “open MEPs”, could help fill this savings gap. These are pooled plans with a professional third party administrator and professional investment selection. However, legal barriers, such as requiring each adopting employer to file its own form 5500 and have its own audit , have held back the expansion of open MEPs. A particular deterrent has been the “one bad apple rule” under Section 413(c) of the Internal Revenue Code, which provides that a qualification failure by one employer can disqualify the entire plan. The pension industry has long sought repeal of the “one bad apple” rule, and it now appears that some level of repeal will become reality.
Parallel Paths to Eliminating the Rule. The SECURE Act currently before Congress would eliminate this rule by statutory amendment for some-but not all- plans effective January 1, 2021. Meanwhile, the IRS has just proposed regulations that separately provide a path for “defined contribution MEPs” to avoid application of the “one bad apple rule”. The rules are not identical and seem to be proceeding on parallel tracks. Employers need to understand the differences.
The Regulatory Solution. The IRS was responding to President Trump’s Executive Order on Strengthening Retirement Security in America. That Executive Order included a direction to the IRS and the DOL to consider ways to expand access to MEPs. In response, the IRS has proposed a cumbersome multi-step procedure that may be followed to avoid application of the “one bad apple” rule. The ultimate sanction if an adopting employer failed to correct a qualification problem or respond to information requests when there was a known qualification problem would be for the employer or the MEP administrator to direct a spinoff of the non-compliant plan. The spinoff would remove assets allocable to that employer’s employees from the MEP trust. The successor plan would then be terminated.
Up to 3 notices outlining the necessary corrective action could be required to be sent to the adopting employer with a known qualification problem. The affected employer would have up to 90 days to respond to each notice. If the plan so provided, after a failure of the Adopting Employer to respond appropriately, which could include making making voluntary corrections under EPCRS, the MEP Administrator could initiate the spinoff of the assets attributable to that Adopting Employer’s employees. The correction procedure could not be used if the plan was “under examination” at the time the first notice would be sent out. “Under examination” is defined as having received verbal or written notice of a referral for examination or of an impending examination, or having the issue reviewed as part of a determination application. (This is similar to the definition applied to determine eligibility for voluntary corrections under Rev. Proc. 2019-19.)
The spinoff would have to reported to the IRS. The proposed regulations do not state that the successor plan must be disqualified in its entirety and generally provide that distributions will remain eligible for rollover. However, IRS could pursue remedies for the qualification failure against any party, including the owner of a business responsible for the failure. As an example, the IRS could determine that the owner’s plan distribution was ineligible for rollover to an IRA or other eligible retirement plan.
Open Issues. Hopefully, the final regulations will simplify the required procedures and clarify the extent to which (once appropriate procedures have been adopted) the procedures may be applied to pre-existing qualification violations. There is also a question whether, in the absence of a statutory exception to the “one bad apple” rule, regulations alone can override the general statutory requirement to treat the MEP as a unified plan, or whether a statutory amendment of the type that would be made by the SECURE Act is required.
Effective Dates. The proposed regulations may be relied on whenever they are issued in final form, whereas the SECURE Act changes would be effective in plan years beginning on and after January 1, 2021. Neither explicitly provides for retroactive application; however, the IRS regulations could be read to permit a plan that adopted written procedures to apply them to pre-existing qualification problems. The SECURE Act is less clear because its relief applies to a form of open MEP that is not yet in existence.
Need for Coordination with the SECURE Act. If the SECURE Act is passed, it will also require the IRS to issue regulations replacing the “one bad apple” rule with spinoff procedures, but does not contain detail about what they should be. The Act appears to repeal the rule only for closed MEPs where the employers have a business relationship and open MEPs run by “pooled plan providers” registered with the IRS who satisfy new requirements set out in the Act. ( The reach may therefore be narrower than that of the recently proposed regulations.) The SECURE Act as passed by the House also states that the Secretary may take into account factors such as the length of time the Adopting Employer’s failure has continued to determine whether a spinoff is necessary and, unlike the proposed regulations, permits the IRS to waive the spinoff requirement in appropriate circumstances. If the SECURE Act is passed, the IRS will have to provide guidance as to the scope and overlap of the two sets of rules and should try to harmonize them.
Why We Still Need the SECURE Act. The SECURE Act would establish a new type of MEP, a “pooled employer plan” (PEP) managed by a “pooled plan provider” registered with the IRS. These plans would be able to take advantage of other helpful rules to limit the obligations of adopting employers and the provider, such as limitations on the fiduciary responsibility of adopting employers and simplified MEP reporting . The SECURE Act goes farther than the regulations previously proposed by the DOL in response to the Executive Order, which modestly expand the types of plans that could be treated as one plan for reporting purposes. We still need the more substantial changes to the MEP rules that would be implemented by the SECURE Act to encourage more employers to participate in MEPs.
It would also be helpful to have some form of additional statutory relief from the “one bad apple” rule for open MEPs that do not qualify under the rules created by the SECURE Act, even if it is for the period prior to 2021 when PEPs become available.