Frequently a plan sponsor’s operational failure to follow the terms of its 401(k) or other qualified plan can be corrected under the IRS’s Employee Plans Compliance Resolution System (“EPCRS”) (described at http://www.irs.gov/Retirement-Plans/EPCRS-Overview) with a retroactive amendment instead of a sometimes expensive financial correction. This possibility should not be surprising, given that the maintenance of qualified plans depends heavily on IRS rules and procedures that permit plan sponsors to keep plan documents in compliance with all legally required written provisions by retroactively adopting required restatements and amendments. Apart from what the plan document states, however, the IRS also considers any uncorrected failure to follow the terms of the plan to constitute a qualification defect that threatens the current income exemption and other tax benefits of the plan.

Under EPCRS, a few operational failures, such as making hardship distributions or plan loans from a plan that has no plan terms allowing such distributions or loans, may be self-corrected by the plan sponsor with a retroactive amendment. In general, however, a retroactive amendment fix will require the employer or other sponsor to submit an application to the IRS under the Voluntary Correction Program (“VCP”) to get IRS approval.

As a threshold requirement, the way the plan was actually operated must have been permissible under the law and regulations in order to obtain approval for a retroactive amendment conforming the plan terms to that operation. For example, a retroactive amendment can be considered if a 401(k) plan actually allowed deferrals on bonuses even though the plan’s definition of compensation did not include bonuses, because the plan could have so provided under the law. If the plan was a prototype or volume submitter, then the amendment must also be permitted under the vendor’s pre-approved document.

IRS standards for approving a retroactive amendment fix are not formally set out anywhere. In practice, however, the IRS normally needs to see some convincing documentary evidence indicating that the way the plan was actually operated was the way the sponsor, participants and any relevant TPAs or vendors assumed the plan was written. A summary plan description (“SPD”) that provides for the particular event or practice that occurred is usually considered the best evidence. However, other good evidence might be emails, internal memoranda or correspondence that reflect the way some or all parties thought the plan actually read.

A retroactive amendment is often appropriate to correct a failure to follow plan terms that occurs after a sponsor restates its plan on the pre-approved form of a new vendor as part of a change in plan investments and/or administrative services. In such cases, even though it is clear from the record that no plan design change was intended in conjunction with the vendor change, the plan is sometimes incorrectly mapped over to the new document. The IRS frequently approves a retroactive amendment in such cases as long as the amendment is permissible under the vendor’s document.