New IRS Rules Limit Discretion in Employer 401(k) “Discretionary” Matches

by Prof. Robert Bloink and Prof. William H. Byrnes

The phrase “definitely determinable” is one that’s floated around the retirement community for years. Typically, it serves to require defined benefit plan benefits to be determined in accordance with a definitely determinable formula—rather than at the employer’s own discretion. Employer-sponsored 401(k) plans and other defined contribution plans are subject to a different set of rules. Despite this, the IRS has recently changed the game as a/ part of its mandatory “Cycle 3” plan document restatement process that opened in August 2020. Many small business clients may have overlooked this detail, given the volume of IRS guidance released during the COVID-19 pandemic. Any employer who offers a 401(k) discretionary match should be advised of the new IRS position and plan accordingly to incorporate the changes.

Employer Matching Contributions: The Rules

Subject to nondiscrimination rules, employers have had the flexibility to determine whether or not to award employer matching 401(k) contributions each year.

Generally, employers have also had complete discretion over the type of matching formula to use. Employers have also been fully able to use different matching formulas for different employees or different groups of employees. They’ve also had the ability to determine the timing for calculating the amount of the matching contribution (i.e., whether to calculate the match each pay period, plan year, etc.).

Employers historically have not been required to offer any notice to participants or the IRS about these decisions. Employer discretionary match information also hasn’t been required to be adopted by plan amendment or any type of formal documentation.

Typically, plans that rely on IRS preapproved plan documents must restate the plan every six years to comply with new qualification rules and laws (individually designed plans are not included). The current amendment and restatement cycle for most 401(k) plans began August 1, 2020 and ends July 31, 2022. This is referred to as the “Cycle 3 DC” and will require all plans to be amended to comply with new IRS rules.

The New Requirements

The new IRS rules place some limits on how much discretion an employer may use when awarding a discretionary 401(k) matching contribution. Those limits include new rules regarding the uniformity and timing of employer discretionary matching contributions.

Fortunately, the employer retains discretion over the matching formula that will be used to determine the matching contribution each year. Employers must, however, specify how the match will be determined (for example, as a flat dollar amount or a percentage of matched employee contributions).

The discretionary formula must generally be uniform for eligible plan participants going forward. The employer can, however, use a different formula for different groups of employees. Employees can be grouped according to non-discriminatory criteria, such as job classification or business location. The employer does have to instruct the plan administrator to identify the groups in the plan document and specify the matching formula that will be used for each relevant group.

The employer must also now specify the period to which the discretionary match applies. For example, in many cases, the formula applies on a quarterly or monthly basis. Employers remain permitted to use a pay period, month, quarter or even yearly period.

Employers who don’t use a uniform formula and specify the relevant computation period in the plan document can continue to provide a discretionary employer matching contribution. However, those employers who wish to retain more flexibility over their discretionary matching contributions will soon be subject to a new notice requirement.

Plan sponsors will be required to provide a summary of both the matching formula, period used to calculate the match and related information to participants who receive the contribution within 60 days after the match has been deposited for the plan year.

Fortunately, however, the implementation date for these notice and instruction requirements comes with a delayed implementation date. Plan sponsors aren’t required to provide the notice or instruction until the plan year after the plan year when the sponsor signs the Cycle 3 document.

Conclusion

While these requirements may not seem particularly difficult, it’s important for employers to comply with the new disclosure requirements going forward. These employers should be advised to review their plan documents and operations to ensure consistency now that the IRS is requiring this new level of information.