IMPORTANT CHANGES HAVE BEEN MADE TO THE EMPLOYEE PLANS DETERMINATION LETTER IN 2012 BY THE IRS. CLICK ON THE FOLLOWING LINK TO SEE IF IT APPLIES TO YOUR SCENARIO.
Actually, there is no such thing as a “401k termination letter”, though it is a commonly [mis]used phrase.
What people really mean when they say it is a 401k plan “determination” letter. You can see how one may confuse the two.
But, it just so happens that this IRS letter IS an important necessity when terminating 401k plans.
What You Need To Know About “401k Termination Letters”
A 401k determination letter is Form 5310 that is filed with the IRS.
An affirmative response from the IRS indicates that it has reviewed the plan document and found that all of its provisions comply with the requirements for a qualified 401k plan.
An employer who sponsors a 401k plan is strongly advised to get an IRS determination letter when the plan is first established, whenever it is amended and before the plan is terminated.
However it is not a requirement. In fact, we see many plans that terminate without first filing this form.
A favorable IRS 401k determination letter is important to the employer sponsoring the 401k plan when they want the peace of mind that they have followed all the rules.
Why Determination Letters Are Important
Qualified 401k plans give substantial tax benefits to both parties.
If the plan has a favorable determination letter, then workers know their contributions to the 401k plan, the employer’s contribution to the plan and all investment earnings will NOT be subject to federal income tax until the balance in the account is distributed.
As stated, as an employer, you’re NOT legally required to ask the IRS for a determination letter, but it is always best to follow the normal process.
If the plan is audited and found to be out of compliance, then past worker elective deferrals and employer contributions could be deemed to have been taxable income.
In the worst case, workers may have to re-file prior tax returns and may owe substantial amounts of back taxes, interest and penalties.
The employer will likely face similar or worse problems, since it is the party responsible for the rules violation.
A 401k plan determination letter is beneficial in 401k plan termination situations because sponsors can gain confidence that the plan termination itself will not have a negative impact on the plan’s qualified status.
Upon 401k plan closure, many workers will transfer their accounts balance to another employer’s plan or to a rollover IRA.
If one of these plans accepts money from a nonqualified plan, it will disqualify their plans as well.
Therefore, plan sponsors may not accept a rollover from another qualified plan unless that plan has received a favorable determination letter.
Did That Help?
We hope that this informative article helped answer your questions. If you still have questions about how to terminate 401k plans OR how to terminate any qualified defined contribution plans, we can help.
The experts here at RCP Solutions can take you by the hand and walk you through the entire plan closure process.
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