Posts

Print Friendly Version Print Friendly Version

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

© Copyright 2018 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

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.

© Copyright 2018 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

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.

© Copyright 2018 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Rollover of Plan Loan Offsets and 402(f) Notices

“Has the IRS issued an updated model plan distribution notice to reflect the changes related to rollovers of plan loan offset amounts?”

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 plans, including nonqualified plans. 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 the special tax notice required for plan distributions under Internal Revenue Code 402(f).

Highlights of Discussion

The IRS periodically issues model plan distribution notices, also referred to as a “special tax notice,” “rollover notice” or the IRC Sec. “402(f) notice,” in order to incorporate any changes to the language as a result of law changes. As of this posting, the IRS had not issued updates to its model 402(f) notice to reflect changes in the information as a result of the Tax Cuts and Jobs Act of 2017 (TCJA-2017), effective January 1, 2018. The last model notice was issued in 2014 (Notice 2014-74).

Plan sponsors are required to provide up-to-date 402(f) notices to convey important tax information to plan participants and beneficiaries who have hit a distribution trigger under a qualified plan and may receive a payout that would be eligible for rollover (Treasury Regulation 1.402(f)-1). A 402(f) notice, in part, explains the rollover rules and describes the effects of rolling—or not rolling—an eligible rollover distribution to an IRA or another plan, including the automatic 20 percent federal tax withholding that the plan administrator must apply to an eligible rollover distribution that is not directly rolled over. Plan administrators must provide the 402(f) notice to plan participants no less than 30 days and no more than 180 days before the distribution is processed. A participant may waive the 30-day period and complete the rollover sooner.

A plan may provide that if a loan is not repaid (is in default) the participant’s account balance is reduced, or “offset,” by the unpaid portion of the loan. The value of the loan offset is treated as an actual distribution for rollover purposes and, therefore, may be eligible for rollover. In most cases, participants (or beneficiaries) who experience a loan offset can rollover an amount that equals the offset to an eligible retirement plan. Instead of the usual 60-day rollover deadline, effective January 1, 2018, as a result of TCJA-2017, if the plan loan offset is due to plan termination or severance from employment, participants have until the due date, including extensions, for filing their federal income tax returns for the year in which the offset occurs to complete a tax-free rollover (e.g., until October 15, 2019, for a 2018 plan loan offset).

Conclusion

Even though the IRS has not updated its model 402(f) to reflect the extended rollover period for certain loan offsets as a result of TCJA-2017, plan sponsors and administrators must ensure the distribution paperwork and 402(f) notices that they are currently using include language that reflects the new rollover timeframe. For those that rely on plan document providers, ask if the new 402(f) notice is available.

 

© Copyright 2018 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Maximum contributions to 403(b), 401(k) and 457(b) plans

“One of my clients participates in a 401(k) plan [her own “solo (k)”], plus a 403(b) plan and a 457(b) plan (through the public school system). Her accountant is telling her that she, potentially, could contribute twice the $18,500 deferral limit for 2018. How can that be so?”

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 plans, including nonqualified plans. 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 the maximum annual limit on employee salary deferrals.

Highlights of Discussion

First off, kudos to your client for working with you and a tax advisor in order to determine what amounts she can contribute to her employer-sponsored retirement plans as this is an important tax question based on her personal situation that is best answered with the help of professionals. Generally speaking, it may be possible for her to contribute more than one would expect given the plan types she has and based on existing plan contribution rules, which are covered in the following paragraphs.

For 2018, 457(b) contributions (consisting of employee salary deferrals and/or employer contributions combined) cannot exceed $18,500, plus catch-up contribution amounts if eligible [Treasury Regulation Section (Treas. Reg. §1.457-5)]. Since 2002, contributions to 457(b) plans no longer reduce the amount of deferrals to other salary deferral plans, such as 401(k) plans. A participant’s 457(b) contributions need only be combined with contributions to other 457(b) plans when applying the annual contribution limit. Therefore, contributions to a 457(b) plan are not aggregated with deferrals an individual makes to other types of plans.

In contrast, the application of the maximum annual deferral limit under Internal Revenue Code Section (IRC §) 402(g) (the “402(g) limit”) for an individual who participates in both a 401(k) and a 403(b) plan requires the individual to aggregate deferrals between the two plans [Treas. Reg. §1.402(g)-1(b)]. Consequently, an individual who participates in both a 457(b) plan and one or more other deferral-type plans, such as a 403(b), 401(k), salary reduction simplified employee pension plan, or savings incentive match plan for employees has two separate annual deferral limits. Let’s look at an example.

Example #1:

For 2018, 32-year-old Erika has an individual 401(k) plan for her business as a self-employed tutor. She is also on the faculty at the local state university, and participates in its 457(b) and 403(b) plans. Assuming adequate levels of compensation, Erika can defer up to $18,500 between her 401(k) plan and her 403(b) plan, plus another $18,500 to her 457(b) plan.

Also, keep in mind the various special catch-up contribution options depending on the type of plan outlined next.

Catch-Up Contribution Options by Plan Type

401(k) 403(b) 457(b)
Age 50 or Over Option

 

Employees age 50 or over can make catch-up contributions of $6,000 beyond the basic 402(g) limit of $18,500.

 

15-Years of Service with Qualifying Entity Option:[1]

402(g) limit, plus the lesser of

1) $3,000 or

2) $15,000, reduced by the amount of additional elective deferrals made in prior years because of this rule, or

3) $5,000 times the number of the employee’s years of service for the organization, minus the total elective deferrals made for earlier years.

 

Age 50 or Over Option

 

Employees age 50 or over can make catch-up contributions of $6,000 beyond the basic 402(g) limit.

 

Note: Must apply the 15-year option first

Age 50 or Over Option

Employees age 50 or over can make catch-up contributions of $6,000 beyond the basic 457 deferral limit of $18,500.

Special “Last 3-Year” Option

 

In the three years before reaching the plan’s normal retirement age employees can contribute either:

•Twice the annual 457(b) limit (in 2018, $18,500 x 2 = $37,000),

 

Or

 

•The annual 457(b) limit, plus amounts allowed in prior years not contributed.

 

Note: If a governmental 457(b) allows both the age-50 catch-up and the 3-year catch-up, one or the other—but not both—can be used.

 

415 Annual Additions Limit

Another consideration when an individual participates in more than one plan is the annual additions limit under IRC Sec. 415(c),[2] which typically limits plan contributions (employer plus employee contributions for the person) for a limitation year [3] made on behalf of an individual to all plans maintained by the same employer. However, contributions to 457(b) plans are not included in a person’s annual additions (see 1.415(c)-1(a)(2). With respect to 403(b) plans and the 415 annual additions limit, there are special plan aggregation rules that apply.

Generally, the IRS considers 403(b) participants to have exclusive control over their own 403(b) plans [Treas. Reg. Section 1.415(f)-1(f)(1)]. Therefore, in many cases, contributions to a 403(b) plan are not aggregated with contributions to any other defined contribution plan of the individual (meaning two 415 annual additions limits in some cases). An exception to this rule, however, occurs when the participant is deemed to control the employer sponsoring the defined contribution plan in which he or she participates. In such case, a participant must aggregate his or her 403(b) contributions with contributions to any other defined contribution plans that he or she may control [see  IRC § 415(k)(4)].Regarding the treatment of catch-up contributions, the “Age 50 or Over” catch-up contributions [see 1.415(c)-1(b)(2)(ii)(B)] are not included as annual additions, regardless of plan type, whereas the 403(b) “15-Years of Service” catch-up contributions are included as annual additions (IRS 403(b) Fix-It Guide.)

Example #2

Adam is a non-owner, employee of an IRC 501(c)(3) organization that contributes to a 403(b) plan on his behalf. Adam is also a participant in the organization’s defined contribution plan. Because Adam is deemed to control his own 403(b) plan, he is not required to aggregate contributions under the qualified defined contribution plan with those made under the 403(b) plan for purposes of the 415 annual additions test.

 

Example #3

The facts are the same as in Example #2, except that Adam is also a participant in a defined contribution plan of a corporation in which he is more than a 50 percent owner. The defined contribution plan of Adam’s corporation must be combined with his 403(b) plan for purposes of applying the limit under IRC 415(c) because Adam controls his corporation and is deemed to control his 403(b) plan.

Example #4

Dr. U.R. Well is employed by a nonprofit hospital that provides him with a 403(b) annuity contract. Doctor Well also maintains a private practice as a shareholder owning more than 50% of a professional corporation. Any qualified defined contribution plan of the professional corporation must be aggregated with the IRC 403(b) annuity contract for purposes of applying the 415 annual additions limit.

For more examples, please see the IRS’ Issue Snapshot – 403(b) Plan – Plan Aggregation.

Conclusion

Sometimes individuals who are lucky enough to participate in multiple employer-sponsored retirement plan types are puzzled by what their maximum contribution limits are. This is especially true when a person participates in a 401(k), 403(b) and 457(b) plan. That is why it is important to work with a financial and/or tax professional to help determine the optimal amount based on the participant’s unique situation.

[1] A public school system, hospital, home health service agency, health and welfare service agency, church, or convention or association of churches (or associated organization)

[2] For 2018, the limit is 100% of compensation up to $55,000 (or $61,000 for those > age 50).

[3] Generally, the calendar year, unless the plan specifies otherwise

© Copyright 2018 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Using unused PTO as 401(k) plan contributions

“My client has unused PTO with his employer and participates in the company’s 401(k) plan. Is there any way he can use the equivalent dollar amount of unused PTO to increase his 401(k) contributions?”

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 plans, including nonqualified plans. 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 Pennsylvania is representative of a common inquiry related to paid time off (PTO)[1] and 401(k) plans.

[1] Generally refers to a sick and vacation arrangement that provides for paid leave whether the leave is due to illness or incapacity.

Highlights of Discussion

Yes, it is possible that the equivalent dollar amount of unused PTO can be contributed to the 401(k) plan, provided 1) the 401(k) and PTO governing plan documents contain provisions to accommodate such conversions and contributions; 2) the contributions do not unduly discriminate in favor of highly compensated employees; and 3) the contributions do not exceed mandatory contribution limits (see Revenue Rulings 2009-31 regarding the conversion of annual unused PTO and 2009-32 for the conversion of unused PTO upon termination of employment).

Revenue Ruling 2009-31 outlines two possible PTO conversion-to-contribution scenarios that could be applied on an annual basis: 1) where the value of any unused PTO that would otherwise be forfeited is instead converted and contributed to a 401(k)/profit sharing plan as an employer nonelective contribution; and 2) where the value of any unused PTO that would otherwise be paid out in cash to the employee is instead converted to a salary deferral to the 401(k) plan at the employee’s election.

Scenario 1

Company Z maintains a PTO plan and a 401(k) plan. Under Company Z’s PTO plan, no unused PTO as of 12/31 may be carried over to the following year. Company Z amends its 401(k) plan and PTO plan to provide that the dollar equivalent of

1) Any unused PTO of an employee as of the close of business on 12/31 is forfeited under Company Z’s PTO plan and the dollar equivalent of the amount forfeited is allocated to the participant’s account under Company Z’s 401(k) plan as of 12/31 as a nonelective contribution up to the applicable annual additions limitation under IRC § 415(c) (the “415 limit”), and

2) Any remaining unused PTO is paid to the employee by 02/28 of the following year.

Nondiscrimination testing under IRC §401(a)(4) based on the contributions made for individual participants, generally, will be required, because the amount contributed and allocated for each participant will vary based on the amount of each participant’s unused PTO.

Example:

Sam works for Company Z and earns $25 per hour. He also participates in Company Z’s 401(k) and PTO plans with provisions as described in Scenario 1. As of 12/31/17, Sam had 20 hours of unused PTO. Therefore, the dollar equivalent of Sam’s unused PTO is $500. Because of the 415 limit, Company Z may contribute only $400 of unused PTO to Sam’s account under the 401(k) plan as an employer nonelective contribution.

Consequently, Company Z contributes $400 to its 401(k) plan on behalf of Sam as a nonelective contribution on 02/28/18, and allocates this amount to Sam’s account under Company Z’s 401(k) plan as of 12/31/2017. Company Z pays Sam the remaining $100 in cash on 02/28/2018.

Scenario 2

Company A maintains a PTO plan and a 401(k) plan. Under A’s PTO plan, at the end of the year employees may carry over to the following year an amount of unused PTO that does not exceed a specified number of hours (the carryover limit). The dollar equivalent of any unused PTO for a year in excess of the carryover limit is paid to the participant by 02/28 of the following year. Company A amends its 401(k) and PTO plans to provide that a participant may, prior to receipt, elect to treat all or part of the dollar equivalent of any unused PTO as an employee salary deferral to the 401(k) plan and have it allocated to the participant’s account as of the beginning of the third pay period of the following year as long as the amount does not exceed the 415 limit nor IRC §402(g) limit [the “402(g) limit”]. The dollar equivalent of any unused PTO that is not deferred to Company A’s 401(k) plan is paid to the participant by 02/28 of the following year.

Scenario 2

Company A maintains a PTO plan and a 401(k) plan. Under A’s PTO plan, at the end of the year employees may carry over to the following year an amount of unused PTO that does not exceed a specified number of hours (the carryover limit). The dollar equivalent of any unused PTO for a year in excess of the carryover limit is paid to the participant by 02/28 of the following year. Company A amends its 401(k) and PTO plans to provide that a participant may, prior to receipt, elect to treat all or part of the dollar equivalent of any unused PTO as an employee salary deferral to the 401(k) plan and have it allocated to the participant’s account as of the beginning of the third pay period of the following year as long as the amount does not exceed the 415 limit nor IRC §402(g) limit [the “402(g) limit”]. The dollar equivalent of any unused PTO that is not deferred to Company A’s 401(k) plan is paid to the participant by 02/28 of the following year.

Example:

Barb works for Company A and participates in its PTO and 401(k) plans under the terms described in Scenario 2. As of the close of business on 12/31/17, Barb had 15 hours of unused PTO in excess of the carryover limit and earns $30 per hour, so the dollar equivalent of Barb’s unused PTO in excess of the carryover limit is $450. Before receipt of the amount, Barb elects to have 60% of the dollar equivalent of the unused PTO, or $270, contributed to Company A’s 401(k) plan as an employee salary deferral. The contribution does not cause Barb’s deferrals to exceed the 402(g) limit nor the 415 limit. Company A allocates $270 to Barb’s account under the 401(k) plan as of 02/01/18. Under the terms of Company A’s 401(k) plan, this amount is treated as a contribution for the 2018 plan year. Company A pays Barb the remaining $180 on 02/01/18.

Conclusion

As a way for companies to increase their employees’ ability to save for retirement, a number of plan sponsors have amended or are considering amending their 401(k) and PTO plans to allow the equivalent dollar amount of unused PTO time to be converted to 401(k) plan contributions. The terms of the plan documents will dictate the process and treatment of the contributed amounts. Plan sponsors can refer to Rev. Ruls. 2009-31 and 2009-32 for specific guidance.

© Copyright 2018 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Complete discontinuance of profit sharing plan contributions

“I came across a prospect that froze it’s profit sharing plan several years ago, and has not made contributions since. Are there any concerns regarding 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, qualified retirement plans and other types of retirement savings plans. 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 Colorado is representative of a common inquiry related to on going contributions to a profit sharing plan.

Highlights of Discussion

While contributions to profit sharing plans are generally discretionary, meaning a plan sponsor can decide from year to year whether to make a contribution or not, the IRS expects that contributions will be “recurring and substantial” over time in order for a plan to be considered ongoing and remain viable [Treas. Reg. § 1.401-1(b)(2)].

If contributions cease, a complete “discontinuance of contributions” has occurred in the IRS’s eyes, which triggers a plan termination and complete (100%) vesting of participants’ accounts [Treas. Reg. § 1.411(d)-2(a)(1)].  Contrast this with a “suspension of contributions” under the plan, which is merely a temporary cessation of contributions by the employer. A complete discontinuance of contributions still may occur even though the employer makes contributions if such contributions are not substantial enough to reflect the intent on the part of the employer to continue to maintain the plan (e.g., only forfeitures are allocated).

The IRS makes a determination as to whether a complete discontinuance of contributions under a plan has occurred by considering all the facts and circumstances in the particular case, and without regard to any employee contributions (i.e. pre-tax deferrals, designated Roth or after-tax contributions). According to the IRS’s exam guidelines at Part 7.12.1.4, examiners are to review IRS Form 5310, line 19a, which indicates employer contributions made for the current and the five prior plan years, to determine if the plan has had a complete discontinuance of contributions. In a profit sharing plan, if the plan sponsor has failed to make substantial contributions in three out of five years, there may be a discontinuance of contributions. Other considerations include whether the employer is calling an actual discontinuance of contributions a suspension of such contributions in order to avoid the requirement of full vesting, and whether there is a reasonable probability that the lack of contributions will continue indefinitely.

Under Treas. Reg. § 1.411(d)-2(d)(2) a complete discontinuance becomes effective for a single employer plan on the last day of the employer’s tax year after the tax year for which the employer last made a substantial contribution to the profit-sharing plan. For a plan maintained by more than one employer, a complete discontinuance becomes effective the last day of the plan year after the plan year within which any employer last made a substantial contribution.

If a plan suffers a complete discontinuance and the plan sponsor has made partially vested distributions, the plan’s qualified status is at risk. The plan sponsor can fix the error by using the Employee Plans Compliance Resolution System. The correction will require restoring previously forfeited accounts to affected participants, adjusted for lost earnings, and correcting IRS Form 5500 filings for the plan.

For additional information, please refer to the IRS guidance No Contributions to your Profit Sharing/401(k) Plan for a While? Complete Discontinuance of Contributions and What You Need to Know.

Conclusion

While employer contributions to a profit sharing or stock bonus plan are discretionary in most cases (check the document language), the IRS still expects them to be recurring and substantial to a certain extent. For example, if the plan sponsor has failed to make substantial contributions in three out of five years, there may be a discontinuance of contributions, which triggers plan termination and complete vesting of benefits.

© Copyright 2018 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Reasonable interest rate on plan loans

“What interest rate should a plan apply as part of its plan loan program?”

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 plans. 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 Ohio is representative of a common inquiry related to 401(k) plan loans.

Highlights of Discussion

Loans to 401(k) plan participants are generally prohibited unless they

  • Are available to all plan participants and beneficiaries on a reasonably equivalent basis;
  • Are not made more readily available to highly compensated employees, officers or shareholders than they are to other employees;
  • Are made in accordance with specific provisions set forth in the plan;
  • Are adequately secured; and
  • Bear a reasonable rate of interest [see DOL Reg. § 2550.408b-1].

The Department of Labor (DOL) gives us a guideline for what is reasonable, but with room for interpretation. According to DOL Reg. § 2550.408b-1(e), a plan’s loan interest rate is reasonable if it is equal to commercial lending interest rates under similar circumstances (see also DOL Advisory Opinion 81-12A). In an example, the DOL explained, “The trustees, prior to making the loan, contacted two local banks to determine under what terms the banks would make a similar loan taking into account the plan participant’s creditworthiness and the collateral offered.”

The IRS has similar requirements in order for a plan loan to avoid excise tax under Internal Revenue Code Section (IRC §) 4795(c) and (d)(1) for prohibited transactions. In a September 12, 2011 IRS phone forum, IRS personnel stated informally: “… as a general rule the Service generally considers prime plus 2% as a reasonable interest rate for participant loans.”

The prime rate is an interest rate determined by individual banks, and is often based on a review of the Federal Reserve Boards’ H.15 Selected Interest Rates release of prime rates posted by the majority of the largest 25 banks in the U.S.  Prime is often used as a reference rate (also called the base rate) for many types of loans.[1] Conceivably, adding one or two percentage points to the prime rate makes the interest rate charged to a participant more consistent with general consumer rates, as individuals can rarely get a loan at the going prime rate.

In its Winter 2012 publication, “Retirement News for Employers,” the IRS suggests asking the following questions to determine if a loan interest rate meets the reasonable standard:

  • What current rates are local banks charging for similar loans (amount and duration) to individuals with similar creditworthiness and collateral?
  • Is the plan rate consistent with the local rates?

According to Internal Revenue Manuals, Part 4, Section 4.72.11.4.2.1.1, IRS examination steps related to verifying a reasonable rate of interest include

  • Determining whether the plan loans’ interest rates and other conditions are comparable to the terms of similar commercial loans in the relevant community; and
  • Checking the overall rate of return on plan assets when a large percent of the plan’s assets are invested in participant loans.

On the second point above, even if the interest rate on the loans is reasonable, the overall rate of return might be unreasonable. This could occur if it is determined that a plan’s substantial investment in participant loans is causing the overall rate of return to be materially less than what could have been earned in other investment options under the plan. The DOL has opined that a participant loan as an investment would not be prudent if it provided the plan with less return, relative to risk, than comparable investments available to the plan.

Conclusion

Determining reasonableness is a question of fact and circumstances, and there is no DOL or IRS “safe harbor” rate. Plan sponsors’ must 1) take into consideration relevant current market conditions, and 2) conduct periodic reviews of the interest rate to ensure it continues to reflect current market conditions. Anytime a participant loan is refinanced, the interest rate should be reviewed and updated, if needed. Above all, plan sponsors must be able to document the process they used to determine reasonable interest rates for participant loans in order justify their selection.

[1] https://www.federalreserve.gov/faqs/credit_12846.htm

 

© Copyright 2018 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

After-Tax Contribution Limits in 401(k) Plans

“What are the considerations for a 401(k) plan participant who wants to “max out” his/her after-tax contributions in 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, qualified retirement plans and other types of retirement savings plans. 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 Ohio is representative of a common inquiry related to after-tax contributions in 401(k) plans.

Highlights of Discussion

  • There are several considerations for making after-tax contributions to a 401(k) plan, including whether the plan allows for after-tax contributions and, if so, what limits apply.
  • In order for a participant to make after-tax contributions to his or her 401(k) plan, the plan document must specifically allow for this type of contribution. For example, using our “Plan Snapshot” library of employer plan documents, RLC was able to confirm that the 401(k) plan in question does permit after-tax contributions.
  • Additional considerations when making after-tax contributions include any plan specified contribution limits; the actual contribution percentage (ACP) test; and the IRC Sec. 415 annual additions test.
  • Despite having a plan imposed contribution limit of 50 percent of annual compensation according to the plan document, the advisor determined his client could maximize his pre-tax contributions and still make a large after-tax contribution as well.
  • After-tax contributions are subject to the ACP test—a special 401(k) test that compares the rate of matching and after-tax contributions made by those in upper management (i.e., highly compensated employees) to the rate made by rank-and-file employees (i.e., nonhighly compensated employees) to ensure the contributions are considered nondiscriminatory. Even safe harbor 401(k) plans are required to apply the ACP test to the after-tax contributions if any are made. If the plan fails the ACP test, a typical corrective method is a refund of after-tax contributions to upper management employees.
  • In addition, each plan participant has an annual total plan contribution limit of 100 percent of compensation up to $54,000 for 2017 and $55,000 for 2018, plus an additional $6,000 for catch-up contributions, under IRC Sec. 415 (a.k.a., the annual additions limit). All contributions for a participant to a 401(k) (e.g., salary deferrals, profit sharing, matching, designated Roth and after-tax) are included in a participant’s annual additions. If a participant exceeds his annual additions limit, a typical corrective method is a refund of contributions.
  • In general, a 401(k) plan participant can convert his after-tax account balance to a Roth IRA while working as long as 1) the plan allows for in-service distributions; 2) the after-tax contributions and their earnings have been segregated from the other contribution types in a separate account; and 3) the participant follows the standard conversion rules (IRS Notices 87-13, 2008-30 and 2014-54).

Conclusion

Roughly one-third of 401(k) plans today offer participants the ability to make after-tax contributions.[1]  While this may be viewed as a benefit from many perspectives, there are several important considerations of which plan participants must be aware.

[1] Plan Sponsor Council of America, 59th Annual Survey; and Retirement Learning Center Plan Document Database, 2018

© Copyright 2018 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Plan Compensation and Imputed Income

“What is imputed income and how does it affect a 401(k) plan, if at all?”

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 plans. 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 Virginia is representative of a common inquiry related to compensation.

Highlights of Discussion

Imputed income relates to group term life insurance (GTLI). Offering GTLI may affect the administration of an employer’s qualified retirement plan, depending on the definition of compensation selected for plan purposes.

The first $50,000 of employer-provided GTLI is excludable from an employee’s taxable income pursuant to Internal Revenue Code Section (IRC) §79. Once the amount of coverage exceeds $50,000, the imputed cost of coverage, based on the IRS Premium Table, is subject to income, Social Security and Medicare taxes (see IRS Publication 15-B). The imputed income is considered a taxable fringe benefit to the employee.

An employer must report the amount as wages in boxes 1, 3, and 5 of an employee’s Form W-2, and also show it in box 12 with code “C.” At an employer’s discretion, it may withhold federal income tax on the amount.

As taxable income, the amount may be included in the definition of compensation that is specified in the governing documents of an employer’s retirement plan. For example, with respect to the safe harbor definitions of compensation that plans may use, treatment of imputed income is as follows.

Compensation Type Form W-2 3401(a) 415 Safe Harbor
Taxable premiums for GTLI Included Excluded Included

 

Conclusion

Imputed income from GTLI coverage may be includible compensation for retirement plan administrative purposes. Employers and plan administrators must always refer to the specific definition of compensation elected in the plan document to know when to include or exclude imputed income.

 

 

© Copyright 2018 Retirement Learning Center, all rights reserved