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Payroll Deduction IRA vs. Employer-Sponsored IRA

Is there a difference between payroll deduction IRAs and employer-sponsored IRAs?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from New Jersey is representative of a common inquiry related to workplace IRAs.

Highlights of the Discussion

Payroll deduction IRAs and employer-sponsored IRAs are similar, but they have important differences. A key difference is level of involvement by the employer.

The IRS views payroll deduction IRAs as arrangements that merely allow employees to make contributions to IRAs by having amounts deducted from their paychecks by their employers which are then directed to IRAs for deposit. There are no employer contributions. All the standard IRA rules apply. Further, if a payroll deduction IRA program follows the IRS’s safe harbor rules for structure, it is not considered an employer pension plan and, therefore, exempt from the rules of the Employee Retirement Income Security Act of 1974 (ERISA) (see DOL Reg. 2510.3-2(d) and Interpretive Bulletin 99-1).

Generally, a payroll deduction IRA is not considered an ERISA plan if

  1. it is voluntary;
  2. there are no employer contributions;
  3. the employer does not endorse a particular IRA provider (although limiting the number of IRA providers is permitted within limits); and
  4. the employer receives only reasonable compensation for administrative services.

In contrast, IRC Sec. 408(c) and IRC Sec. 219(f)(5) allow employers and employee associations to establish employer-sponsored IRA arrangements and make employer contributions to employees’ IRAs or a common trust fund that separately accounts for the employees’ contributions. Employers who want an IRS ruling on their employer-sponsored IRA plans may file IRS Form 5306, Application for Approval of Prototype or Employer-Sponsored Individual Retirement Arrangement. These are savings arrangements other than simplified employee pension (SEP) plans under IRC Sec. 408(k) or savings incentive match plans for employees (SIMPLE) IRA plans under IRC Sec. 408(p). Consequently, all the standard IRA rules apply.

Any amount contributed by an employer to an IRA that is employer sponsored under IRC Sec. 408(c) shall be treated as payment of compensation to the employee (other than for a self-employed individual), deductible by the employer and subject to Social Security and unemployment taxes. Employees may be able to deduct such contributions under the standard rules that apply for the deductibility of traditional IRA contributions [Treasury Regulation 1.219-1(c)(4)]. In this scenario, the employer-sponsored IRA arrangement is considered an ERISA plan for certain purposes, for example, they are subject to limited Form 5500 Reporting (See “IRA Plans” IRS Form 5500 instructions).

Conclusion

While payroll deduction IRAs and employer-sponsored IRAs have similarities, the DOL views them differently, depending on the level of involvement by the employer.

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Deadlines for Adopting 401(k) Safe Harbor Provisions

Is it too late to establish as 401(k) safe harbor plan for 2018?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from New York is representative of a common inquiry related to adopting 401(k) safe harbor provisions.

Highlights of the Discussion

The answer is highly dependent on your client’s current plan situation. Generally, a plan sponsor that intends to use the standard 401(k) safe harbor provisions[1] for a plan year must adopt those provisions before the first day of that plan year (i.e., adopt safe harbor provisions in 2017, effective for 2018). However, there are some exceptions for 1) newly established 401(k) plans, 2) newly established employers, 3) businesses that already have a profit sharing plan in place and 4) sponsors who follow the “maybe provisions” (see Treasury Regulation  1.401(k)-3(e)(2), IRS Notice 98-52, Section X  and IRS Notice 2000-3).

Employer With No 401(k) Plan

The IRS requires the first plan year of a newly established safe harbor 401(k) plan (other than a successor plan) to be at least three months long. For example, No Plan, Inc., has been around as a business for several years, but does not have a 401(k) plan. As long as No Plan, Inc., sets up a safe harbor 401(k) plan by October 1, 2018, and satisfies the notice requirements, the business can operate the safe harbor 401(k) plan during the last three months of 2018.

Employer Created Within Last Three Months of the Year

The initial year of a safe harbor 401(k) plan can be shorter than three months in the case of a newly established employer, as long as the business establishes the plan as soon as administratively feasible after the employer comes into existence. For example, New Biz is incorporated on November 1, 2018. New Biz can establish a safe harbor 401(k) plan that operates for the last two months of 2018.

Employer With a Profit Sharing Plan

An employer can convert an existing profit sharing plan to a safe harbor 401(k) plan during the current year as long as the plan will function as a safe harbor 401(k) plan for at least three months. For example, PSP, LLC, has had a profit sharing plan since 2016. As long as PSP amends its current profit sharing plan to add the 401(k) safe harbor features by October 1, 2018, and satisfies the notice requirements, the business can operate the safe harbor 401(k) features during the last three months of 2018.

Employer That Follows the “Maybe” Provisions

A 401(k) plan can be amended as late as 30 days prior to the end of a plan year to use a safe harbor nonelective contribution method for that plan year, provided that a regular safe harbor notice (with modified content) was given to eligible employees before the beginning of the plan year and a supplemental notice is given no later than 30 days before the end of the plan year. For example, Maybe So, Inc., maintains a calendar-year 401(k) plan for 2018. Maybe So wanted to have the flexibility to decide toward the end of 2018 whether or not to adopt a 401(k) safe harbor nonelective contribution method, so it provided an initial safe harbor notice with the appropriately altered information before the beginning of the plan year (i.e., in 2017). Consequently, Maybe So can decide no later than December 1 of 2018 to 1) amend the 401(k) plan accordingly and 2) provide a supplemental notice to all eligible employees stating that a three-percent safe harbor nonelective contribution will be made for the plan year.

Conclusion

Generally, in order to use 401(k) safe harbor provisions, a plan sponsor must adopt them before the beginning of the plan year. However, even though it is late in 2018, it may not be too late to take advantage of 401(k) safe harbor provisions for 2018 in certain circumstances.

[1] Mandatory employer matching contribution or nonelective contribution

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Sham termination of employment and distributions

“What are the rules regarding firing an employee, allowing the individual to take a distribution from his 401(k) account and then rehiring the same individual? Is it a valid distribution? If not, is the plan in jeopardy of processing an impermissible withdrawal?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from West Virginia is representative of a common inquiry related to severance of employment and distributions.

Highlights of the Discussion

The IRS could view the firing and re-hiring of an employee who has taken a distribution of plan assets due to separation of service or severance of employment[1] as either a “sham” or a “bona fide” termination depending on the facts and circumstances. Qualified retirement plan assets, typically, are not distributable until the participant incurs a distribution triggering event as outlined in the governing plan document, for example, separation of service or severance of employment (see pages 196-197 from the pdf for Revenue Ruling 56-214). In the case of a sham termination, the processing of an impermissible distribution without a legitimate distribution triggering event is an operational failure that, potentially, could put the plan at risk of disqualification, resulting in possible adverse tax consequences to the participant and the employer (see Private Letter Ruling 2000-0245).

There is no definitive rule prohibiting the rehiring of an employee who has received a plan distribution as a result of leaving employment. For example, at least one court ruled that a participant had a true termination, even though he returned to employment with his former employer five months after he retired, because at the time of his retirement he had no intention of returning to work and was only able to return to employment following an unforeseen change in circumstances (see Barrus v. United States, 23 AFTR 2d 990 (DC NC 1969)).  And in Revenue Ruling 69-647 (see pages 100-101 of Internal Revenue Cumulative Bulletin 69[2] , the IRS ruled that a senior executive who retired from full-time employment and continued to render services to the same company, but on a part-time basis as an independent contractor, was considered to have terminated employment.

However, if the IRS determines the termination is a ruse merely to facilitate a distribution not otherwise available, and both the plan sponsor and participant know in advance that the fired individual will be rehired, the IRS may view such action as a sham termination. The IRS specifically “does not endorse a prearranged termination and rehire as constituting a full retirement” (see the preamble to REG-114726-04 ).

The basic rule is that, to receive a distribution from a 401(k) plan on account of a severance of employment, the participant must have experienced a bona fide termination of employment in which the employer/employee relationship is completely severed.

Facts and circumstances the IRS will consider include the following:

  1. Did the plan sponsor follow the terms of the plan document? (Allowing a distribution as a result of a sham termination would constitute a failure to follow the terms of the plan document because plan assets were distributable in a situation not provided for under the terms of the plan).
  2. Did the termination of employment and processing of the distribution follow all the established administrative procedures?
  3. How long was the time interval between termination and rehire?
  4. What documentation exists to substantiate the termination and distribution?
  5. Did the alleged sham termination involve a highly compensated employee?

Conclusion

A plan sponsor and participant(s) who collude to stage a firing/re-hiring scenario to facilitate a qualified plan distribution are potentially putting the qualified status of the plan at risk. Under investigation, the IRS could determine the termination is a sham and impose sanctions.

Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.

[1] Prior to January 1, 2002, most plans used the term “separation from service” rather than “severance of employment.” Separation of service carried the “same desk rule,” which prevented many 401(k) plans from making distributions to former employees who continued working at the same job but for a different employer as the result of a merger, acquisition or similar transaction. The Economic Growth and Tax Relief Reconciliation Act of 2001 allowed plan sponsors to replace the separation from service/same desk requirement to allow for distribution upon a participant’s severance from employment with the employer sponsoring the plan.

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Changes to hardship distributions for 2019

“Are the rules for hardship distributions from 401(k) plans changing?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Illinois is representative of a common inquiry related to hardship distributions.

Highlights of the Discussion

Yes, changes to the hardship distribution rules for 401(k) plans as a result of the Bipartisan Budget Act of 2018 will take effect for the 2019 plan year (e.g., as of January 1, 2019, for calendar year plans). There are three primary changes to the current hardship distribution rules.

Participants will

  1. Not be required to take plan loans before a hardship distribution is granted;
  2. Not need to suspend their employee salary deferrals for six months following a hardship withdrawal; and
  3. Will be able to distribute other types of contributions beyond employee salary deferrals and grandfathered, pre-1989 earnings thereon as part of a hardship distribution, including qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), safe harbor contributions, and earnings from all eligible sources (including post 1988 earnings on elective deferrals).

Items 1. and 2. are currently part of the IRS’s requirements for a hardship distribution to meet the safe harbor definition of “necessary to satisfy an immediate and heavy financial need.” [See Treasury Regulation Section 1.401(k)-1(d)(3)].

In order to implement the new provisions, plan sponsors will need to

  • Update their hardship distribution procedures,
  • Ensure plan record keepers are making necessary administrative changes, and
  • Review plan document language for necessary amendments.

We believe it was Congress’s intent to have the same changes apply to hardship distributions from 403(b) plans, but clarifying guidance from the IRS is needed. Treasury regulations under Section 403(b) of the Internal Revenue Code state that a hardship withdrawal from a 403(b) plan has the same meaning, and is subject to the same rules and restrictions, as a hardship withdrawal under the 401(k) regulations [see Treasury Regulation Section 1.403(b)-6(d)(2)]. The Treasury Secretary has until early 2019 to modify the current 401(k) regulations to reflect the new hardship distribution rules.

Conclusion

Come 2019, plan sponsors may incorporate softer hardship distribution rules into their plans, policies and procedures as a result of changes under the Bipartisan Budget Act of 2018.

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Defined Benefit Plan Annual Funding Notice

What information does the Annual Funding Notice for a defined benefit (DB) plan reveal and why is it important?

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Missouri is representative of a common question related to DB plan Annual Funding Notices.

Highlights of Discussion

The Annual Funding Notice is one of several important retirement plan notifications that should be considered as part of a comprehensive financial planning process. It is one of the best tools for a participant and his or her advisor to measure the solvency or health of a DB plan.

The law requires sponsors of all DB plans that are subject to Title IV of the Employee Retirement Income Security Act of 1974 (ERISA) to provide an Annual Funding Notice to each DB plan participant and beneficiary, as well as other entities. Businesses that fail to provide an Annual Funding Notice each year face a Department of Labor (DOL) penalty of $110 per day of delay, up to a maximum of $1,100 per request. (See related final DOL Regulations, which include a model notice, at Annual Funding Notice for Defined Benefit Plans.)

The notice provides participants with information about

  • How well the pension plan is funded, measured by the funding target attainment percentage (FTAP);
  • The value of pension plan’s assets and liabilities;
  • How a pension plan’s assets are invested; and
  • Employer events taking place during the current year that are expected to have a material effect on the plan’s liabilities or assets
  • The legal limits on how much the Pension Benefit Guaranty Corporation (PBGC) can pay participants if the PBGC (the federal agency that insures private-sector DB plans) determines it is in the participants’ best interest to step in and take control of the plan.

The first thing to focus on when looking at an Annual Funding Notice is the FTAP, which is a measure of how well the plan is funded to meet liabilities on a particular date. This figure is the best single indicator of the current health of a DB plan. The FTAP must be reported for the current year and two preceding years. In general, the higher the percentage, the better funded the plan and the better able the plan is to pay promised benefits. The FTAP is a determinant as to whether the plan is considered “at risk.”

If a plan’s FTAP for the prior plan year is below 80 percent that is the first indication the plan may be entering at-risk status. The plan’s actuary calculates whether a plan is at risk using the FTAP and a multi-step process. At-risk plans require more funding by the employer because they are required to use actuarial assumptions that result in a higher value of plan liabilities. The annual funding notice must state whether the plan has been determined to be in at-risk status, and must reflect the increased at-risk liabilities due.

Beyond the FTAP, Annual Funding Notices must include important information regarding a DB plan’s assets and liabilities. For example, notices must include a statement of the value of the plan’s assets and liabilities on the same date used to determine the plan’s FTAP. Notices also must include a description of how the plan’s assets are invested as of the last day of the plan year.

Annual Funding Notices must disclose “material effect events,” which are plan amendments, scheduled benefit increases (or reductions) or other known events having a material effect on the plan’s assets and liabilities if the event is taken into account for funding purposes for the first time in the year following the notice year. If an event first becomes known to a plan administrator 120 days or less before the due date of a notice, the plan administrator is not required to explain, or project the effect of, the event in that notice.

Finally, Annual Funding Notices must include a general description of the benefits under the plan that are guaranteed by the PBGC, along with an explanation of the limitations on the guaranteed benefits and the circumstances under which such limitations apply.

Some DB plan sponsors must provide supplements to their plans’ standard Annual Funding Notices if all three of the following circumstances are true:

  1. The funding target is less than 95% of the funding target determined without regard to the adjusted interest rates of MAP-21 and HAFTA, and
  2. There is a funding shortfall greater than $500,000, and
  3. There are 50 or more participants on any day during the preceding plan year. (See supplemental Notice Guidance FAB 2013-01and FAB 2015-01. )

With the information on this supplement, participants will be able to compare the FTAP, funding shortfall in dollars, and minimum required contributions in dollars calculated with the adjusted interest rates of MAP-21/HAFTA and without MAP-21/HAFTA adjusted interest rates for the applicable plan year and the two preceding years. The most conservative approach to evaluating this information from a retirement planning standpoint is to focus on the numbers “without adjustment,” which in recent years have resulted in lower funding levels than calculations made using the MAP-21/HAFTA adjusted interest rates.

Conclusion

The Annual Funding Notice is one of several important retirement plan notifications that should be considered as part of a comprehensive financial planning process. It reveals important information about the overall health of a DB plan, such as how well the plan is funded, assets and liabilities, the plan’s investment policy, business events that may affect the plan and whether the plan is considered at risk.

 

 

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Qualifying for Medicare on Spouse’s Record

“I have a 68-year-old client whose spouse will be 65 this year. My client signed up for Medicare at age 65. His spouse will not have 40 quarters of covered employment when she attains age 65. Is there any way she can qualify for Medicare on her spouse’s record when she turns 65?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Minnesota is representative of a common inquiry related to Medicare.

Highlights of Discussion

Good news. She will likely be eligible for premium-free Part A Medicare coverage at 65 based on her spouse’s record. Let’s review how the Medicare eligibility rules work.

Medicare consists of four basic parts: Parts A (hospital insurance), B (medical insurance), C (Advantage Plans) and D (drug coverage).  While Parts B, C and D have a premium amount attached to them—Part A may not.  Medicare Part A coverage is premium-free if the individual has forty 40 quarters of covered employment for Social Security retirement benefits at age 65. That means the individual paid Medicare taxes while working for roughly 10 years.

If, at age 65, the individual does not have 40 quarters of coverage, he or she may be able to buy Part A coverage. The premium for Part A coverage in this case is up to $422 a month. However, if the individual’s spouse had 40 quarters of coverage and is eligible for Social Security retirement benefits (and the couple has been married at least a year), then the spouse without the 40 quarters is considered eligible at 65 and would not be subject to a

Part A premium.[1] The result in the prior example would be the same if the married couple was now divorced, provided they had been married for at least 10 years.

The Medicare Website has an online eligibility and premium calculator for consumers, which may be of help in making a determination based on their individual circumstances.

Conclusion

Medicare Part A coverage is premium-free for individuals who have forty quarters of covered employment for Social Security retirement benefits at age 65. If they don’t personally have the covered employment and are married, they may be able to qualify on their spouses’ record.

[1] Note: if the older spouse has less than forty quarters they are eligible for Medicare at age 65 if the younger spouse is at least 62 and has forty quarters of coverage.

 

 

 

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Suspending Plan Loan Repayments

“Under what circumstances, if any, can a 401(k) plan participant with an outstanding plan loan suspend repayments?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Massachusetts is representative of a common inquiry related to plan loans.

Highlights of Discussion

There are just two scenarios under which the IRS will allow a plan to suspend loan repayments of a participant with an outstanding loan: 1) in the case of a leave of absence of up to one year or 2) for the period during which an employee is performing military service [Treasury Regulation Section 1.72(p)-1, Q&A-9(a) and (b)]. Check the terms of the plan document and loan agreement regarding a participant’s ability to suspend loan repayments.

If a plan permits loan repayments to be suspended during a leave of absence, upon return, the participant must make up the missed payments either by increasing the amount of each monthly payment or by paying a lump sum at the end, so that the term of the loan does not exceed the original five-year term.

EXAMPLE: Leave of Absence

On July 1, 2018, Adrian borrows $40,000 from her 401(k) account balance under the agreement that it will be repaid in level monthly installments of $825 over five years (by June 30, 2023). Adrian makes nine payments and then starts a one-year, nonmilitary leave of absence. When Adrian resumes active employment, she also resumes making her loan repayments. However, the amount of monthly installment is increased to $1,130 in order to repay the loan by the end of the initial five-year term. Alternatively, she could have continued making the monthly $825 installment payment, provided she repaid the full balance due at the end of the five-year term (i.e., make a balloon payment).

A plan may permit a participant to suspend loan repayments during a leave of absence for military service (as defined in Chapter 43 of Title 38, United States Code). In such cases, the participant will not violate the level payment requirement provided loan repayments resume at the end of the military service, the frequency and amount of payments is not less than what was required under the terms of the original loan, and the loan is repaid in full (including interest that accrues during the period of military service) by the end of the loan term, which is five years, plus the period of military service.  Consequently, the suspension could exceed one year and the term of the loan could exceed five years.

Of additional note on suspensions due to military service, the plan is limited on the rate of interest it may charge on the loan during the period of military service to six percent. A loan is subject to the interest rate limitation if the following are true: 1) the loan was incurred prior to the military service; and 2) the participant provides the plan with a written notice and a copy of the military orders within 180 days after the date of the participant’s release or termination from military service [Service Members Civil Relief Act of 2003 (SCRA) Pub. L. No. 108-189]. The plan must forgive any interest that exceeds six percent. For this purpose, “interest” includes service charges, renewal charges, fees, and any other charges (except bona fide insurance).

EXAMPLE: Military Service

On July 1, 2018, Joshua borrows $40,000 from his 401(k) account balance under the agreement that he will repay it in level monthly installments of $825 over five years (by June 30, 2023). Joshua makes nine payments and then starts a two-year, military leave of absence. His service ends on April 2, 2021, and he resumes active employment on April 19, 2021, after which, he resumes making loan repayments in the amount of $825. On June 30, 2025, Joshua makes a balloon payment for the full remaining balance due.

Alternatively, Joshua could have increased the monthly repayment amounts so no remaining balance was due at the end of the term (i.e., June 30, 2025).

Conclusion

Under limited circumstance, plans may suspend loan repayments for participants. Be sure to check the terms of the plan document and loan agreement for specific procedures and requirements.

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SEP and SIMPLE IRA Plans and ERISA Fidelity Bonds

“Do SEP and SIMPLE IRA Plans Require an ERISA Fidelity Bond?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Florida is representative of a common inquiry related to savings incentive match plans for employees (SIMPLE) IRA plans and simplified employee pension (SEP) plans.

Highlights of Discussion

Generally, yes, but this is a great question with a multi-layered answer depending on the individuals and/or entities that handle the assets of these plans. ERISA Section 412 requires that every fiduciary of an employee benefit plan and every person who handles funds or other property of such a plan be bonded in order to protect the assets of the plan against the risk of loss due to fraud or dishonesty. For this purpose, SEP and SIMPLE IRA plans are considered employee benefit plans. The DOL further explained (albeit somewhat vaguely) its position on the matter in Field Assistance Bulletin (FAB) 2008-4, Q&A 16. With regard to having a fidelity bond, the DOL states: “There is no specific exemption … for SEP or SIMPLE IRA retirement plans. Such plans are generally structured in such a way, however, that if any person does “handle” funds or other property of such plans that person will fall under one of ERISA’s financial institution exemptions” (See DOL Reg. §§ 2580.412-27 and 28).

The logic here is that, typically, employees establish their SIMPLE IRAs and SEP IRAs at banks, trust companies or insurance providers, and such institutions are exempt from the bonding requirement provided they are subject to supervision or examination by federal or state regulators and meet certain financial requirements. The Pension Protection Act added an exemption to the ERISA bonding requirement for entities registered as broker/dealers under the Securities Exchange Act of 1934 if the broker/dealer is subject to the fidelity bond requirements of a self-regulatory organization. Consequently, the employees of qualified financial institutions that hold SEP IRA and SIMPLE IRA plan assets need not be covered by an ERISA fidelity bond.

However, there is no exemption from the ERISA bonding requirement for the fiduciaries of employers who handle SEP and SIMPLE IRA plan assets prior to the assets being held in their respective IRAs. When do SEP and SIMPLE IRA contributions become plan assets? In the case of salary reduction (SAR) SEP and SIMPLE IRA employee salary deferrals, such amounts become plan assets as of the earliest date on which they can reasonably be segregated from the employer’s general assets (DOL Reg. 2510.3-102). In contrast, employer contributions generally become plan assets only when the contributions actually have been made to the plan (FAB 2008-01 and Advisory Opinion 1993-14A).

Court cases provide evidence that this is indeed how the DOL enforces the bonding requirement for SAR-SEP and SIMPLE IRA plans. In Chao v. Smith, Civil Action No. 1:06CV0051, the employer failed to remit employee contributions to a SIMPLE IRA plan. In addition to restoring the salary deferrals to the plan, as part of the settlement the employer was required to secure a fidelity bond and keep it active throughout the life of the plan “as required by the Employee Retirement Income Security Act.”  Similarly, in Chao v. Harman, Civil Action Number 4:07cv11772,  the DOL sued business executives and trustees of a firm’s SIMPLE IRA plan in Jackson, Michigan, for failing to forward employee contributions to workers’ accounts and obtain a fidelity bond. Finally, the DOL sued an employer with a SAR-SEP plan for mishandling of employee deferrals and lack of a fidelity bond (Chao v. Gary Raykhinshteyn, Civil Action No. 01-60056).

In each case, the DOL made a point to state employers with similar problems who are not yet the subject of an investigation may be eligible to participate in the DOL’s Voluntary Fiduciary Correction Program (VFCP) to correct the errors and avoid enforcement actions and civil penalties as well as any applicable excise taxes.

Since some form of employer contribution is required with a SIMPLE IRA plan, employers who fail to make these contributions have an IRS operational failure and may have the ability to correct the error by following the applicable provisions of the Employee Plans Compliance Resolution System in Revenue Procedure 2016-51.

Conclusion

While the DOL offers exemptions from the ERISA fidelity bonding requirement to qualified financial institutions that hold SEP and SIMPLE IRA assets, the agency requires employers who sponsor SEP or SIMPLE IRA plans and other plan fiduciaries who handle plan assets to be covered by an ERISA fidelity bond to prevent against loss as a result of fraud and/or dishonesty.

 

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Distributions from Nonqualified Deferred Compensation Plans

“With respect to distributions from nonqualified deferred compensation (NQDC) plans, what are the timing requirements?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Texas is representative of a common inquiry related to distributions from Internal Revenue Code Section (IRC §) 409A NQDC plans.

Highlights of Discussion

Sponsors of NQDC plans must enforce strict distribution rules that are dictated by IRC §409A, the terms of the governing plan document and the elections made by participants (if permitted). Regarding the last variable, if a plan permits participants to elect how and when they will take distributions, they must execute their elections before deferring their compensation into the plan. The timing of withdrawals is an important tax consideration that requires advance planning. Once the form and timing of distributions are set (typically when deferral elections are made), there are complex rules that apply if participants want to make changes.

Under IRC §409A, payment events are limited to

  • Separation from service (as defined by the plan);
  • Death;
  • Disability;
  • A specified time or according to a fixed schedule;
  • An unforeseeable emergency; or
  • A change in the ownership or effective control of the corporation, or a change in the ownership of a substantial portion of the assets of the corporation (as defined by the plan) (see Treasury Regulation 1.409A-3).

Sponsors can elect to include all or a subset of the above listed distributable events in their plans. A person must look at the specific plan document in order to know which payment events apply to a particular plan and whether participants are allowed any discretion in selecting from among them.

A NQDC plan may allow employee elections regarding the timing and method of payment; or it can dictate the payment regime with no elections allowed. If participants have options, they record their distribution choices when they make their deferral elections. They must elect 1) when they will receive distributions from the NQDC plan, and 2) in what form the distributions will take (lump sum withdrawal or installment payments). The deadline for these elections is typically by December 31 of the year prior to the year for which salary is deferred or for which nonelective (employer) contributions are made to the plan; or within 30 days of becoming eligible to participate in the plan. If participants fail to make distribution elections when permitted, plan terms will dictate a default.

Like the timing for distributions, the methods of payment vary for each NQDC plan. The plan may allow for lump sum withdrawals, installment payments (e.g., over five or 10 years) or both, and participants may be allowed to select the payment type. The plan document will specify the available methods of payment.

With rare exception, distributions may not be accelerated. However, there is a mechanism by which participants may delay receipt of payments beyond which they initially elected [see Treas. Reg.§409A-2(b)]. In general, a participant is allowed to change the timing and method of the payment if an election is filed with the employer at least 12 months prior to the date the first payment would be due; and the payment is postponed for at least five years. Again, it is important to review the plan document to see if the plan allows for distributions to be delayed and, if so, whether distributions are treated as a series of payments or as a single payment for this purpose.

The penalties for noncompliance with these withdrawal rules are severe. The IRS will consider any compensation deferred under an errant plan as taxable income to the participant, plus it will assess a 20 percent excise tax, including accruing interest. Taxes, penalties and interest are payable by the recipient of the deferred compensation, not the employer [see IRC §409A(a)(1)(B)].

Conclusion

The form and timing of payments from IRC §409A NQDC plans is an important consideration because of the potential for income tax liability. Depending on the terms of the governing plan, participants may have flexibility in selecting when payments are due and what form they take and, therefore, have more control over when the amounts become taxable income to them. Understanding the terms of each plan and advance planning are the keys to mitigating the share Uncle Sam will take.

© Copyright 2018 Retirement Learning Center, all rights reserved
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Safe Harbor Validation of Rollovers

“What responsibility does a plan sponsor have in validating whether an incoming rollover contribution is legitimate?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Texas is representative of a common inquiry related to rollover contributions.

Highlights of Discussion

A qualified retirement plan isn’t required to accept rollover contributions from other plans or IRAs, but if it does under the terms of its governing plan document, the incoming assets must consist of valid rollover amounts. In order for the plan to retain its tax-preferred status, the plan sponsor must reasonably conclude that an amount is a valid rollover contribution as defined in Treasury Regulation Section (Treas. Reg. §) 1.401(a)(31)–1, Q&A–14(b)(2) and retain documentation. The IRS has provided examples of what would constitute proof of a valid rollover, including safe harbor options detailed in IRS Revenue Ruling 2014-9 .

Historically, plan sponsors followed the guidance of Treas. Reg. 1.401(a)(31)-1, Q&A-14(b)(2) for acceptable forms of documentation, which include a participant providing the sponsor of the receiving plan with a letter from the plan sponsor of the distributing plan that states the distributing plan has received a determination letter from the IRS or that the plan, to the best of the sponsor’s knowledge, is qualified. Further guidance from IRS Form 5310, Application for Determination for Terminating Plan, states a sponsor  who is filing this form is required to “… submit proof that any rollovers or asset transfers received were from a qualified plan or IRA.” The instructions to the form indicate that a copy of the distributing plan’s determination letter and timely interim amendments is one example of acceptable proof.

For an indirect rollover where a plan participant has received the assets from a distributing plan or IRA and, within 60-days, rolls over the amount to the receiving plan the individual can certify that the distribution is eligible for rollover and was received not more than 60 days before the date of the rollover. Many plans use a type of standard rollover certification form for this purpose. If the rollover contribution is late, the plan sponsor can accept the contribution if the individual has a waiver from the IRS or self-certifies under Revenue Procedure 2016-47.

In addition to the methods listed in the regulations, IRS Revenue Ruling 2014-9 provides additional streamlined safe harbor due diligence procedures described below that, in the absence of evidence to the contrary, will allow the sponsor of the plan receiving the rollover to reasonably conclude that the amount is a valid rollover contribution.

Plan-to-Plan Rollovers

The sponsor of the receiving plan can confirm the previous employer’s plan is intended to be qualified by looking up the plan on the DOL’s EFAST2 website. If Code 3C appears on the plan’s most recent Form 5500 filing, then the plan IS NOT intended to be qualified under IRC Code §§ 401, 403, or 408, indicating that a distribution from the plan would not be eligible for rollover.

If the receiving plan receives a check made payable to the trustee of the plan for the benefit of the participant from the trustee of another qualified plan, it is reasonable for the receiving plan sponsor to conclude that the plan that initiated the rollover determined the distribution is an eligible rollover distribution.

IRA-to-Plan Rollovers

When a receiving plan gets a check that is made payable to the trustee of the plan from the trustee of an IRA for the benefit of an employee, the recipient plan administrator may reasonably conclude that the source of the funds is a traditional IRA and not an inherited IRA and, therefore, eligible for rollover.

Keep copies of documentation

As proof rollover amounts were valid, plan sponsors should keep copies of the following items:

  • Checks or check stubs with identifying information;
  • Confirmations of wire or other electronic transfers; and
  • Participant certifications.

Special considerations for RMDs

Required minimum distributions (RMDs) are not eligible rollover distributions. A qualified plan is responsible for ensuring that any RMDs are paid to plan participants. Therefore, the IRS has indicated it is reasonable for the receiving plan to conclude that the distributing plan has already paid to the participant any RMDs and remaining amounts are eligible for rollover.

In contrast, IRA trustees and custodians are not responsible for automatically distributing RMDs to IRA owners. Therefore, a plan sponsor may not reasonably conclude that an IRA rollover consists only of eligible rollover funds. The plan administrator should seek additional documentation to confirm that the IRA owner has satisfied any RMD that may be due.

Conclusion

When rollovers to a qualified plan are permitted, plan sponsors must ensure such incoming amounts are, indeed, eligible for roll over. Validation can be done through employee certification of the source of the funds for a 60-day rollover; verification of the payment source (via information on the incoming rollover check or wire transfer) from the participant’s IRA or former plan; or, if the funds are from a plan, looking up that plan’s Form 5500 filing for assurance that the plan is intended to be a qualified plan.

© Copyright 2018 Retirement Learning Center, all rights reserved