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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.

© Copyright 2018 Retirement Learning Center, all rights reserved
IRA
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Active Plan Participant and IRA Contributions

“Active participation in an employer’s retirement plan can affect whether an IRA contribution made by the participant is deductible on the tax return. What does ‘active participation’ mean?”

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 Minnesota is representative of a common inquiry involving a taxpayer’s ability to make a deductible IRA contribution. 

Highlights of Discussion

For purposes of the IRA deduction rules, an individual shall be an “active participant” for a taxable year if either the individual or the individual’s spouse actively participates during any part of the year in a(n)[1]

  • Qualified plan described in Internal Revenue Code Section [IRC §401(a)], such as a defined benefit, profit sharing, 401(k) or stock bonus plan;
  • Qualified annuity plan described in IRC §403(a);
  • Simplified employee pension (SEP) plan under IRC §408(k);
  • Savings incentive match plan for employees (SIMPLE) IRA under IRC §408(p);
  • Governmental plan established for its employees by the federal, state or local government, or by an agency or instrumentality thereof (other than a plan described in IRC §457);
  • IRC §403(b) plan, either annuity or custodial account; or
  • Trust created before June 25, 1959, as described in IRC §501(c)(18).

When an individual is considered active depends on the type of employer-sponsored plan.

Profit Sharing or Stock Bonus Plan:   During the participant’s taxable year, if he or she receives a contribution or forfeiture allocation, he or she is an active participant for the taxable year.

Voluntary or Mandatory Employee Contributions: During the participant’s taxable year, if he or she makes voluntary or mandatory employee contributions to a plan, he or she is an active participant for the taxable year.

Defined Benefit Plan: For the plan year ending with or within the individual’s taxable year, if an individual is not excluded under the eligibility provisions of the plan, he or she is an active participant for that taxable year.

Money Purchase Pension Plan: For the plan year ending with or within the individual’s taxable year, if the plan must allocate an employer contribution to an individual’s account he or she is an active participant for the taxable year.

Refer to IRS Notice 87-16 for specific examples of active participation.

As a quick check, Box 13 on an individual’s IRS Form W-2 should contain a check in the “Retirement plan” box if the person is an active participant for the taxable year.

 

Form W-2 Box 13 Retirement Plan Checkbox Decision Chart

Type of Plan Conditions Check Retirement Plan Box?
Defined benefit plan (for example, a traditional pension plan) Employee qualifies for employer funding into the plan, due to age/years of service—even though the employee may not be vested or ever collect benefits Yes
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee is eligible to contribute but does not elect to contribute any money in this tax year No
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee is eligible to contribute and elects to contribute money in this tax year Yes
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee is eligible to contribute but does not elect to contribute any money in this tax year, but the employer does contribute funds Yes
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee contributed in past years but not during the current tax year under report No (even if the account value grows due to gains in the investments)
Profit-sharing plan Plan includes a grace period after the close of the plan year when profit sharing can be added to the participant’s account Yes

 

If a person is an active participant, he or she must apply income thresholds to determine whether an IRA contribution is deductible or not. Please refer to the following chart

IRA Contribution Deductibility

 

Conclusion

Participating in certain employer-sponsored retirement plans can affect an individual’s ability to deduct a traditional IRA contribution on an individual’s tax return for the year. The IRS Form W-2 should indicate active participation in an employer-sponsored retirement plan. When in doubt, taxpayers should check with their employers.

 

 

[1]  IRS Notice 87-16

 

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IRAs, SEPs, SIMPLEs and Qualified Charitable Distributions

 

My client has a simplified employee pension (SEP) IRA through his place of employment. He’s wondering if he can make a tax-free, qualified charitable distribution (QCD) from his SEP IRA?

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 South Dakota is representative of a common inquiry involving charitable IRA distributions.

Highlights of Discussion

A QCD is any otherwise taxable distribution (up to $100,000 per year) that an “eligible IRA owner or beneficiary” directly transfers to a “qualifying charitable organization.” QCDs were a temporary provision in the Pension Protection Act of 2006.  After years of provisional annual extensions, the Protecting Americans from Tax Hikes Act of 2015 reinstated and made permanent QCDs for 2015 and beyond.

With tax rates dropping in 2018 as a result of the Tax Cuts and Jobs Act of 2017, taxpayers may get more “bang for their bucks” on their 2017 tax returns by completing a QCD by December 31, 2017.

Generally, IRA owners must include any distributions of pre-tax amounts from their IRAs in their taxable income for the year. Aside from the benevolent aspect of making a QCD, a QCD is excludable from taxable income, plus it may count towards the individual’s required minimum distribution (RMD) for the year, and may lower taxable income enough for the person to avoid paying additional Medicare premiums. Note that he or she would not be entitled to an additional itemized tax deduction for a charitable contribution when making a QCD. (Apart from a QCD, IRA owners who take taxable IRA distributions and donate them to charitable organizations may be eligible to deduct such amounts on their tax returns for the year if they itemize deductions (Schedule A of Form 1040). See IRS Tax Topic 506 and IRS Publication 526, Charitable Contributions for more information.)

An eligible IRA owner or beneficiary for QCD purposes is a person who has actually attained age 70 ½ or older, and has assets in traditional IRAs, Roth IRAs, or “inactiveSEP IRAs or savings incentive match plans for employees (SIMPLE) IRAs. Inactive means there are no ongoing employer contributions to the SEP IRA or SIMPLE IRA. A SEP IRA or a SIMPLE IRA is treated as ongoing if the sponsoring employer makes an employer contribution for the plan year ending with or within the IRA owner’s taxable year in which the charitable contribution would be made (see IRS Notice 2007-7, Q&A 36).

Generally, qualifying charitable organizations include those described in §170(b)(1)(A) of the Internal Revenue Code (IRC) (e.g., churches, educational organizations, hospitals and medical facilities, foundations, etc.) other than supporting organizations described in IRC § 509(a)(3) or donor advised funds that are described in IRC § 4966(d)(2). The IRS has a handy online tool Exempt Organization Select Check, which can help taxpayers identify organizations eligible to receive tax-deductible charitable contributions.

Where an individual has made nondeductible contributions to his or her traditional IRAs, a special rule treats amounts distributed to charities as coming first from taxable funds, instead of proportionately from taxable and nontaxable funds, as would be the case with regular distributions.

Be aware there are special IRS Form 1040 reporting instructions that apply to QCDs.

Section IX of IRS Notice 2007-7 contains additional compliance details regarding QCDs. For example, QCDs are not subject to federal tax withholding because an IRA owner that requests such a distribution is deemed to have elected out of withholding under IRC § 3405(a)(2) (see IRS Notice 2007-7, Q&A 40 ).

Conclusion

Eligible IRA owners and beneficiaries, including those with inactive SEP or SIMPLE IRAs, should be aware of the benefits of directing QCDs to their favorite charitable organizations.

 

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December 2017 IRA and Retirement Plan Deadlines

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 California is representative  of a common inquiry involving December deadlines.

Highlights of Discussion

There are several IRA and retirement-plan related deadlines that occur in December as summarized next.

December 1, 2017 Deadline for calendar-year plans to provide plan participants with safe harbor, qualified default investment alternative (QDIA) and automatic enrollment notices.
December 15, 2017 ERISA extended deadline for distributing the Summary Annual Report to plan participants (for plans that filed Form 5500 with an extension)
December 29, 2017* Deadline for IRA owners and retirement plan participants to satisfying their second and subsequent years’ required minimum distributions for 2017
Deadline for making qualified nonelective contributions or qualified matching contributions to correct failed actual deferral percentage (ADP) or actual contribution percentage (ACP) tests in the previous plan year for plans using the current-year testing method
Deadline for removing an ADP or ACP excess contribution for the prior plan year with a 10% excess tax in order to avoid an IRS correction program
Deadline to complete a 2017 Roth IRA conversion or designated Roth in-plan conversion
Deadline to amend an existing 401(k) plan to a safe harbor design for 2018
Deadline to amend a 401(k) safe harbor plan to remove safe harbor status for 2018
Deadline to amend plan for discretionary changes implemented during the 2017 plan year

*Generally, December 31st.  However, December 31, 2017, falls on a Sunday.

Conclusion

December is a busy month for IRA and retirement-plan related deadlines. Have you marked your calendar?

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fiduciary
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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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