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Fiduciary Advisers

What is a 408(g) fiduciary adviser?

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 and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Washington is representative of a common inquiry involving investment advice fiduciaries.

Highlights of discussion

  • “Fiduciary Advisers” may provide investment advice to qualified plan participants through an “eligible investment advice arrangement” that is based on a level-fee arrangement for the fiduciary adviser, a certified computer model or both [ERISA §408(g)].
  • A fiduciary adviser may also work with IRA owners as well.
  • Plan sponsors who engage a fiduciary adviser for their participants will not be responsible for the specific investment advice given, provided the adopting plan sponsors follow certain monitoring and disclosure rules. Plan sponsors are still responsible for the prudent selection and monitoring of the available investments under the plan and the fiduciary adviser.
  • The fiduciary adviser role is part of a statutory prohibited transaction exemption for the provision of investment advice that has been around since 2007, having been created by the Pension Protection Act of 2006 (PPA-06).  It has received very little attention over the years until now given the new emphasis on defining investment advice fiduciaries.
  • A fiduciary adviser could be a registered investment adviser, a broker-dealer, a trust department of a bank, or an insurance company.
  • To satisfy the exemption, a fiduciary adviser must provide written notification to plan fiduciaries that he/she intends to use an eligible investment advice arrangement that will be audited by an independent auditor on an annual basis. The fiduciary adviser must also give detailed written notices to plan participants regarding the advice arrangement before any advice is given.
  • Every year the eligible investment advice arrangement must be audited by a qualified independent auditor to verify that it meets the requirements. The auditor is required to issue a written report to the plan fiduciary that authorized the arrangement. If the report reveals noncompliance with the regulations, the fiduciary adviser must send a copy of the report to the Department of Labor (DOL). In both cases the report must identify the 1) fiduciary adviser, 2) type of arrangement, 3) eligible investment advice expert and date of the computer model certification (if applicable), and 4) findings of the auditor.

Conclusion

Under PPA-06, plan sponsors can authorize fiduciary advisers to offer investment advice to their plan participants and beneficiaries as part of an eligible investment advice arrangement.  Plan sponsors will not be held liable for the advice given by fiduciary advisers, provided all the requirements of the prohibited transaction exemption are met.

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SIMPLE IRA Plan Annual Notices

What are the annual notice requirements for a SIMPLE IRA plan?

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 and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in New Hampshire is representative  of a common inquiry involving SIMPLE IRA plans.

Highlights of Discussion

By November 1 of each year, an employer that sponsors a SIMPLE IRA plan must provide eligible employees with two important notices:

  1. the Summary Description; and
  2. the Annual Deferral Notice (IRS Notice 98-4).

The Summary Description must include the following information:

  1. The name and address of the employer and the trustee or custodian;
  2. The requirements for eligibility for participation;
  3. The benefits provided with respect to the arrangement;
  4. The time and method of making employee elections with respect to the arrangement; and
  5. The procedures for, and effects of, withdrawals (including rollovers) from the arrangement.

If a plan sponsor established the SIMPLE IRA plan using either IRS Form 5305-SIMPLE or 5304-SIMPLE , he or she can fulfill the Summary Description requirement by providing eligible employees completed copies of pages one and two of those forms. If a plan sponsor used a prototype SIMPLE IRA plan document, then the information is obtained from the forms vendor.

The Annual Deferral Notice must include the following information:

  1. The employee’s opportunity to make or change a salary deferral choice under the SIMPLE IRA plan;
  2. The employee’s ability to select a financial institution that will serve as trustee of the employee’s SIMPLE IRA, if applicable;
  3. The plan sponsor’s decision to make either matching contributions or nonelective contributions and the amount; and
  4. Written notice that an employee can transfer his or her balance without cost or penalty if he or she is using a designated financial institution.

IRS Forms 5305-SIMPLE and 5304-SIMPLE have model Annual Deferral Notices that a plan sponsor can use to satisfy this requirement.

If the employer fails to provide one or more of the required notices he or she is liable for a penalty of $50 per day until the notices are provided.

Notification failures of this sort may be eligible for correction under the IRS’ Employee Plans Compliance Resolution System (EPCRS).

Conclusion

Sponsors of SIMPLE IRA plans must ensure compliance with the annual notification requirements for eligible employees or, potentially, face IRS penalties.

 

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October–Think “Recharacterization Deadline”

Is it too late to recharacterize a Roth conversion for 2016?

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 and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in New Jersey is representative of a common inquiry involving recharacterizations.

Highlights of discussions

A 2016 conversion to a Roth IRA, generally, can be undone (“recharacterized”) as late as October 16, 2017 [IRC Sec. 408A(d)(6)].  However, if your client completed a conversion of 401(k) assets to a designated Roth account within the 401(k) plan (rather than to an external Roth IRA), he or she would not be able to recharacterize the in-plan conversion, regardless of when the conversion occurred (IRS Notice 2010-84, Q&A 6.)

The IRS will allow taxpayers to recharacterize an unwanted Roth IRA conversion for any reason without tax or penalty as long as it is done by the deadline, which is generally October 15th of the year following the year of conversion. (If the time for completing the rechacterization falls on a Saturday, Sunday or legal holiday, the deadline becomes the next businesses day. October 15, 2017, is a Sunday, so the deadline becomes the 16th IRC Sec. 7503.)

The recharacterization timeframe is connected to when your client filed his or her tax return. For a conversion to a Roth IRA completed in 2016, if your client filed his or her 2016 tax return on time (i.e., by April 17, 2017) he or she could recharacterize the unwanted conversion without tax or penalty at any time up to October 16, 2017. Of course, he or she would have to properly amend the 2016 tax return to reflect the recharacterization.

For a conversion completed in 2017, if your client files his or her 2017 tax return on time (i.e., by April 16, 2018) the individual would have until October 15, 2018, to recharacterize the unwanted conversion without tax or penalty.

To accomplish a recharacterization, your client would need to transfer the converted amount, along with any gains or losses, back to a traditional IRA within the prescribed IRS timeframe. Even in the case of a qualified plan-to-Roth IRA conversion, the rechacterization must go to a traditional IRA; it cannot go back to the original qualified plan (Treasury Regulation 1.408A-4, Q&A 3 and IRS Notice 2008-30, Q&A 5).

Following a recharacterization, your client has the option to “reconvert” a similar amount to a Roth IRA after satisfying the required waiting period for a “reconversion.” The required waiting period ends on the date that is the later of

  • 30 days after the recharacterization or
  • January 1 of the year following the conversion

EXAMPLE:

Thom converted a portion of his 401(k) plan assets in 2016 to a Roth IRA. He filed his 2016 tax return timely on April 17, 2017. Thom elects to recharacterize his 2016 Roth IRA conversion to a traditional IRA by October 16, 2017, and amends his 2016 tax return. The soonest Thom could reconvert a similar amount would be November 15, 2017.

As a rule of thumb, if a client converts and recharacterizes in the same year, he or she must wait until the following year to reconvert.

Conclusion

The IRS’ Roth IRA conversion/recharacterization/reconversion rules give taxpayers a great deal of flexibility if the proper process steps are completed within the set deadlines. Clients who are contemplating any of the three actions should carefully discuss them with their tax advisors.

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Compliance Rules Guidelines Regulations Laws
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Waiver of the 60-Day Rollover Time Limit

“My client has heard there is a way to obtain a waiver of the 60-day rollover time limit. Can you provide the 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 and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Maryland is representative of a common inquiry involving rollovers.

Highlights of discussion

Yes, in fact, there are three ways a recipient of an eligible rollover distribution from an IRA or qualified retirement plan may obtain a waiver of the requirement to roll over the distribution within 60 days in order to avoid tax consequences. Your client may obtain a waiver by: 1) qualifying for an automatic waiver; 2) requesting and receiving a private letter ruling granting a waiver; or 3) self-certifying that he or she meets the requirements of a waiver, and the IRS determines during an audit of your client’s income tax return that he or she does qualify for a waiver.

Internal Revenue Code Sections (IRC §§) 402(c)(3) and 408(d)(3) provide that any amount distributed from a qualified plan or IRA will be excluded from income if it is transferred to an eligible retirement plan no later than the 60th day following the day of receipt. A similar rule applies to IRC §403(a) annuity plans, IRC §403(b) tax sheltered annuities, and IRC §457(b) eligible governmental plans [please see §§ 403(a)(4)(B), 403(b)(8)(B), and 457(e)(16)(B)].

The automatic waiver comes into play when the failure to complete the rollover timely results from an error made by the receiving financial organization. In order to qualify, all of the following must be satisfied:

1. The financial organization received the funds before the end of the 60-day rollover period;

2.  The individual followed all of the procedures set by the financial organization for depositing the funds into an IRA or other eligible retirement plan within the 60-day rollover period (including giving instructions to deposit the funds into a plan or IRA);

3.The funds were not deposited into a plan or IRA within the 60-day rollover period solely because of an error on the part of the financial organization;

4. The funds are deposited into a plan or IRA within one year from the beginning of the 60-day rollover period; and

5. It would have been a valid rollover if the financial organization had deposited the funds as instructed.

Your client could apply for a 60-day rollover waiver by requesting a private letter ruling (PLR) from the IRS according to the procedures outlined in Revenue Procedure 2003-16 and Revenue Procedure 2017-4. Note that an IRS user fee of $10,000 applies to the request. The IRS will issue a PLR waiving the 60-day rollover requirement in cases where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster or other events beyond the reasonable control of the taxpayer.

Finally, your client may be able to “self certify” that he or she qualifies for the waiver if all of the following are true:

  • Your client presents a letter (a model is included in Revenue Procedure 2016-47) to the receiving financial organization that certifies the late rollover is eligible for the waiver;
  • The rollover contribution is, otherwise, a valid rollover (except the 60-day deposit requirement);
  • Your client can demonstrate that one or more of the 11 approved reasons listed in Revenue Procedure 2016-47 prevented him or her from completing a rollover before the expiration of the 60-day period (e.g., the distribution was deposited into an account that your client mistakenly thought was a retirement plan or IRA);
  • The distribution came from your client’s IRA or retirement plan;
  • The IRS has not previously denied a request for a waiver (see previous bullet);
  • The rollover contribution is made to an eligible plan or IRA as soon as possible (usually within 30 days) after the reason for the delay no longer prevents the individual from making the contribution; and
  • The representations the individual makes in the certification letter are true.

Conclusion

The IRS has provided three potential ways to obtain a waiver of the 60-day rollover time limit. Distribution recipients should carefully consider which may be most appropriate for their situations.

 

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IRA
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Setting Up a SIMPLE IRA Plan

“My client and I want to know if there is a deadline for establishing a SIMPLE IRA plan for 2017?”

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 and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in New Mexico is representative of a common inquiry involving savings incentive match plans for employees (SIMPLE) IRA plans.

Highlights of discussion

  • Yes, there is. The general deadline for establishing a SIMPLE IRA plan for a given year is October 1. For example, the deadline for an eligible business owner to set up a SIMPLE IRA plan for 2017 is October 1, 2017.
  • There are two exceptions to the general rule. First, if the business comes into existence after October 1 of the year the SIMPLE IRA plan is desired, then the new business owner may still set up a SIMPLE IRA plan for the year, provided he or she does so as soon as administratively feasible after the start of the new business. Second, if a business has previously maintained a SIMPLE IRA plan, then it may only set up a new SIMPLE IRA plan effective on January 1 of the following year (e.g., set up the plan in 2017 with an effective date of January 1, 2018).
  • Businesses that are eligible to establish SIMPLE IRA plans are those that
  1. Do not maintain any other qualified retirement plans; and
  2. Have 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding year [IRC §408(p)(2)(c)(i) IRC §408(p)(2)(c)(i) and IRS Notice 98-4, Q&A B4 ].
  • The basic steps for establishing a SIMPLE IRA plan are
  1. Execute a written plan document (either a government Form 5304-SIMPLE or Form 5305-SIMPLE, or a prototype plan document from a mutual fund company, insurance company, bank or other qualified institution);
  2. Provide notice to employees; and
  3. Ensure each participant sets up a SIMPLE IRA to receive contributions.
  • Employees who are eligible to participate in a SIMPLE IRA plan are those who received at least $5,000 in compensation from the employer during any two preceding years, and are reasonably expected to receive at least $5,000 in compensation during the current year.Business owners who are interested in establishing SIMPLE IRA plans must be aware of the deadline to do so, and the additional steps involved to ensure a successful set up.

Conclusion

Business owners who are interested in establishing SIMPLE IRA plans must be aware of the deadline to do so, and the additional steps involved to ensure a successful and compliant set up.

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When are safe harbor 401(k) employer contributions distributable?

“My client is age 47. Can he take a distribution of his safe harbor 401(k) plan matching contributions while he is still working?”

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 and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Ohio is representative of a common inquiry involving safe harbor 401(k) employer contributions.

Highlights of discussion

  • No, safe harbor 401(k) employer contributions—either matching or nonelective—may not be distributed earlier than separation from service, death, disability, plan termination, or the attainment of age 59 ½ [IRC §§ 401(k)(12) and 401(k)(2)(B)]. This would include the earnings on such amounts as well.
  • IRS Notice 98-52, Section IV, H. provides further clarification on the distribution of safe harbor 401(k) employer contributions: “Pursuant to § 401(k)-(2)(B) and § 1.401(k)-1(d)(2)(ii), hardship is not a distributable event for 401(k) safe harbor contributions other than elective contributions.”
  • The distribution rules for safe harbor 401(k) employer contributions are different (more restrictive) than those for non-safe harbor 401(k) plans, where it may be possible, under the terms of the plan, to take an in-service withdrawal of employer matching or profit sharing contributions prior to age 59 ½.
  • Safe harbor 401(k) employer contributions must be fully vested when made. They cannot be subject to a vesting schedule as is the case with non-safe harbor 401(k) employer matching or profit sharing contributions.
  • The bottom line is to always refer to the provisions of the plan document or summary plan description for a definitive answer on when plan assets are distributable.

Conclusion

The IRS’ distribution rules for safe harbor 401(k) employer contributions are different (more restrictive) than those for non-safe harbor 401(k) plans. The soonest that a working participant would be able to request a withdrawal of safe harbor 401(k) employer  contributions would be age 59 ½.

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Can NUA in employer stock count towards an RMD?

“Can the portion of a distribution from a 401(k) plan that takes advantage of NUA tax treatment be used to satisfy the receiving participant’s RMD for the year?”

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 and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Colorado is representative of a common inquiry involving net unrealized appreciation (NUA) and required minimum distributions (RMDs).

Highlights of discussion

  • Yes— amounts excluded from income at the point of distribution, such as NUA on employer securities, are amounts a plan participant may count toward satisfying an RMD under Internal Revenue Code Section (IRC §) 401(a)(9). (NUA is eventually included in the participant’s income as taxable long-term capital gains when the employer securities are eventually sold.)
  • According to Treas. Reg. 1.401(a)(9)-5, Q&A 9, with a few, limited exceptions, all amounts distributed from a qualified plan are amounts that are taken into account in determining whether an RMD is satisfied for a participant, regardless of whether the amount is includible in income.
  • For example, amounts that are excluded from income as recovery of “investment in the contract under IRC§ 72” (i.e., after-tax contributions) are taken into account for purposes of determining whether an RMD is satisfied for a year. Similarly, amounts excluded from income as NUA on employer securities are counted towards satisfying an RMD of the participant.
  • The following amounts are not taken into account in determining whether a participant’s RMD is satisfied for the year:
  1. Amounts returned to a participant to correct plan excesses;
  2. Loans treated as deemed distributions;
  3. The cost of life insurance coverage (i.e., PS 58 costs);
  4. Dividends on employer securities; and
  5. Other similar amounts as deemed by the IRS and published in the Internal Revenue Bulletin from time to time.

Conclusion                                                   

The IRS is clear that NUA on employer securities is a distribution amount that a plan participant may count toward satisfying his or her RMD for the year.

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How do the IRS and DOL determine whether a closed MEP exists?

“What criteria do the Internal Revenue Service (IRS) and Department of Labor (DOL) consider when determining whether a single multiple employer plan (MEP) exists for an association of employers?”

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 and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Oregon is representative of a common inquiry involving multiple employer plans.

Highlights of discussion

  • A single MEP, otherwise known as a “closed MEP,” is a single employee benefit plan maintained by two or more employers that meets the requirements of Internal Revenue Code Section (IRC §) 413(c), where the employers are not related under IRC §414(b) (regarding a controlled group of employers), IRC §414(c) (regarding trades or businesses under common control), or IRC §414(m) (regarding affiliated service groups).
  • The IRS has put together a chart that indicates how specific IRC provisions apply to closed MEPs (Internal Revenue Manual, Part 7, Chapter 11, Section 7 Multiple Employer Plans).
  • The failure of one participating employer or the failure of the plan itself to satisfy an applicable qualification requirement will result in disqualification of the multiple employer plan for all participating employers [Treasury Regulation 1.413-2(a)(3)(iv)]. For example, the failure of any participating employer to satisfy the top-heavy rules disqualifies the entire multiple employer plan for all of the employers maintaining the plan (Treasury Regulation 1.416-1, Q&A G-2).
  • The DOL categorizes plans covering more than one employer as either a single employee pension benefit plan, or a combination of separate, individual plans. If the MEP is a single plan under ERISA (i.e., a closed MEP), then the plan administrator files a single Form 5500, which requires only one independent audit for the group. Similarly, the ERISA §412 fidelity bonding requirements for a closed MEP apply as if to a single plan, rather than independently as to a series of individual plans.
  • Pursuant to § ERISA §3(5) , the DOL requires that the employers in a closed MEP must be part of a bona fide group or association that has something in common besides cosponsoring one or more plans. It is the DOL’s view that where several unrelated employers merely execute identically worded trust agreements or similar documents as a means to fund or provide benefits, in the absence of any genuine organizational relationship between the employers, no employer group or association exists for purposes of ERISA §3(5).
  • In DOL Advisory Opinion 2012-04A , the DOL opined that determining whether a bona fide employer group or association exists for purposes of maintaining a closed MEP depends on all of the facts and circumstances involved. Relevant factors in judging whether a plan sponsor is a bona fide group or association of employers include the following:
  1. How members are solicited;
  2. Who is entitled to participate and who actually participates in the association;
  3. The process by which the association was formed,
  4. The purposes for which it was formed, and what, if any, were the preexisting relationships of its members;
  5. The powers, rights, and privileges of employer members that exist by reason of their status as employers; and
  6. Who actually controls and directs the activities and operations of the benefit program.
  • The employers that participate in a closed MEP must, either directly or indirectly, exercise control over the program, both in form and in substance, in order to act as a bona fide employer group or association with respect to the program.
  • Courts have ruled that the entity or group maintaining a closed MEP must be tied to the employees or the contributing employers by genuine economic or representational interests unrelated to the provision of benefits [MDPhysicians & Associates, Inc. v. State Bd. Ins., 957 F.2d 178,185 (5th Cir.), cert. denied, 506 U.S. 861 (1992) and Wisconsin Educ. Assoc. Ins. Trust v. Iowa State Bd., 804 F.2d 1059, 1063 (8th Cir. 1986)].
  • In DOL Advisory Opinion 94-07A the DOL emphasized it is the commonality of interest among the individuals that benefit from the plan and the party that sponsors the plan that forms the basis for sponsorship of a closed MEP.
  • As a rule of thumb, examples of employer associations that are likely to qualify to maintain closed MEPs include
  1. Well-established associations whose members are very similar (e.g., members of a particular trade possibly within a specific geographic region);
  2. Employers related by common ownership (but where ownership does not reach the level to require aggregation under the controlled group rules);
  3. Employers who regularly and closely cooperate in serving a particular group of clients (but do not aggregate under the affiliated service group rules); and
  4. Certain Professional Employer Organizations (PEOs).

Conclusion

Under the current regulatory framework, whether several independent employers represent a bona fide employer group or association that is eligible to maintain a closed MEP depends on the facts and circumstances of the particular situation, taking into consideration a number of factors as identified by the DOL in several of its advisory opinions on the topic.

 

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What Constitutes a Partial Plan Termination?

My client is in the process of acquiring another company, which has a 401(k) plan. I’m concerned about a partial plan termination situation because of a reduction in force. What constitutes a partial plan termination and how might it affect the plan?”

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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of discussion

  • When a significant number or percentage of employees who are participating in a business’s qualified plan are terminated and/or are no longer eligible to participate in the plan, a partial termination may have occurred in the eyes of the IRS.
  • Similar to a situation involving a complete plan termination, the IRS requires that all participants covered under the portion of the plan deemed terminated become 100% vested in matching contributions and other employer contributions [IRC 411(d)(3)]. Failure to fully vest participants could result in underpayments from the plan upon distribution of former participants’ account balances. These underpayments could, potentially, cause the IRS to disqualify the plan if the error is not corrected.
  • The IRS makes it clear that the determination of a partial plan termination is based on the facts and circumstances of the particular scenario [Treasury Regulation § 1.411(d)-2(b)]. However, within Revenue Ruling 2017-43 the IRS provides the following guidance in helping to determine if a partial plan termination has occurred.
  • A partial termination may be deemed to occur when an employer reduces its workforce (and plan participation) by 20%.
  • The turnover rate is calculated by dividing employees terminated from employment (vested or unvested) by all participating employees during the applicable period.
  • The applicable period is generally the plan year, but can be deem longer based on facts and circumstances. An example would be if there are a series of related severances of employment the applicable period could be longer than the plan year.
  • The only severance from employment that is not factored in determining the 20% are those that are out of the employer control such as death, disability or retirement.
  • Partial plan termination can also occur when a plan is amended to exclude a group of employees that were previously covered by the plan or vesting is adversely affected.
  • In a defined benefit plan partial plan termination can occur when future benefits are reduced or ceased.
  • The IRS adopted the 20% guideline in Rev. Proc. 2007-43 from a 2004 court case Matz v. Household International Tax Reduction Investment Plan, 388 F. 3d 577 (7th Cir. 2004), which, ironically, was dismissed in 2014 after its fifth appeal [Matz v. Household Int’l Tax Reduction Inv. Plan, No. 14-2507 (7th Cir. 2014)]. The 20% threshold still stands under the IRS’s revenue procedure.
  • If a partial termination may be an issue, a plan sponsor may seek an opinion from the IRS as to whether the facts and circumstances amount to a partial termination. The plan sponsor can file, IRS Form 5300, Application for Determination for Employee Benefit Plan with the IRS to request a determination of partial plan termination.

Conclusion

Based on facts and circumstances, a company could be deemed to have a partial plan termination. The participants affected by the partial plan termination must become 100% vested upon termination. Plan sponsors should monitor their companies’ turnover rates to ensure they are not experiencing a partial plan termination and, if they are, ensure affected former participants receive proper distributions from the plan.

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Non Statutory Stock Options and 401(k) Deferrals

“My client has participants in his company’s 401(k) plan who are receiving cash as a result of exercising their stock options. The client is going to report the income on the participants’ IRS Form W-2 for the year. Is this eligible/included as compensation for purposes of withholding salary deferrals? ”

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 and qualified retirement plans.

Highlights of discussion

  • Whether income from the exercise of stock options is includable as W-2 income as defined in 1.415(c)-2(d)(4) income for purposes of making salary deferrals to a 401(k) plan depends on whether the stock options are statutory or nonstatutory.
  • W-2 income includes income from the exercise of nonstatutory stock options for the year the options are exercised.
  • In contrast, income from the exercise of statutory stock options is excludable from W-2 income.
  • Therefore, when a participant exercises nonstatutory stock options, he or she will have additional taxable income, reported on IRS Form W-2, which can increase the amount of money the individual has available for making 401(k) employee salary deferrals.
  • The IRS has several publications with helpful information regarding the taxation of stock options: Topic 27, Publication 525, IRS CPE Compensation, Instructions Form W-2.

Conclusion

  • Income from the exercise of nonstatutory stock options is included in W-2 income, and is eligible for deferral into a 401(k) plan up to the maximum annual limit.

 

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