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Safe Harbor Validation of Rollovers

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

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

Highlights of Discussion

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

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

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

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

Plan-to-Plan Rollovers

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

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

IRA-to-Plan Rollovers

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

Keep copies of documentation

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

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

Special considerations for RMDs

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

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

Conclusion

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

© Copyright 2018 Retirement Learning Center, all rights reserved
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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
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Can a plan sponsor merge 401(k) and 403(b) plans?

“I have at least one of my plan sponsor clients who has both a 401(k) plan and a 403(b) plan. Could my client merge the two plans in order to consolidate the assets?”

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 York is representative of a common inquiry involving the merging of retirement plans.

Highlights of Discussion

  • Save for two exceptions, no, your client cannot merge 403(b) assets with an unlike plan (e.g., a profit sharing, 401(k), 457(b) plan, etc.) without causing the 403(b) assets to become taxable to the participants. Such a transfer could also jeopardize the tax-qualified status of the 401(k) plan.
  • 403(b) plan assets may only be transferred to another 403(b) plan. Further, the final 403(b) regulations are clear that neither a qualified plan nor a governmental 457(b) plan may transfer assets to a 403(b) plan, and a 403(b) plan may not accept such a transfer (see Treasury Regulation Section 1.403(b)-10 and Revenue Ruling 2011-07).
  • The two exceptions noted previously are plan-to-plan transfers by participants to governmental defined benefit plans in order to 1) purchase permissive service credits; or to make a repayment of a cash out.
  • This does not preclude a 403(b) or 401(k) participant with a distribution triggering event (such as plan termination) to distribute and complete a rollover to another eligible plan [e.g., a 401(k) or 403(b) plan] that accepts such amounts.

Conclusion

While there are similarities between a 401(k) plan and 403(b), the IRS treats them as unlike plans and, therefore, incompatible, for the purpose of plan-to-plan transfers or mergers. Participant rollovers, on the other hand, are potentially possible between the two.

 

 

© Copyright 2018 Retirement Learning Center, all rights reserved
IRA
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Taxability of IRA Conversions

I believe the IRS requires a person to treat a Roth IRA conversion as consisting of a pro rata share of the individual’s pre- and after-tax retirement assets. When determining the taxable amount of a traditional-to-Roth IRA conversion, does my client include his 401(k) plan balance in the calculation?

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 a financial advisor in Illinois is representative of a question we commonly receive related to Roth conversions.

Highlights of Discussion

  • Your client would not include his 401(k) balance when determining the taxable amount of a traditional IRA-to-Roth IRA conversion. Please see IRS Publication 590-A for further guidance.
  • When calculating the taxability of a conversion in this case, your client would include all of his nonRoth IRAs for which he is the direct owner, including traditional IRAs, simplified employee pension (SEP) IRAs, and savings incentive match plan for employees (SIMPLE) IRAs.
  • Retirement accounts that are not considered include
    • Inherited traditional, SEP or SIMPLE IRAs (unless a spouse beneficiary has elected to treat the inherited IRA as his or her own);
    • Defined contribution plans (e.g., 401(k) plans);
    • Defined benefit pension plans;
    • 403(b) plans;
    • 457 plans;
    • Nonqualified accounts and plans; and
    • Annuities (unless they are individual retirement annuities under Section 408(b) of the Internal Revenue Code).
  • The steps for calculating the taxable amount of a traditional IRA-to-Roth IRA conversion are part of the IRS Form 8606, which your client must complete and file to report the conversion.
  • Encourage your client to discuss the conversion with his tax advisor.

Conclusion

Because a traditional IRA-to-Roth IRA conversion is (generally) a taxable and (always) a reportable transaction, investors should consult their tax attorneys or professional tax advisors concerning their particular situations.

 

© Copyright 2018 Retirement Learning Center, all rights reserved
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.

 

© Copyright 2018 Retirement Learning Center, all rights reserved
Compliance Rules Guidelines Regulations Laws
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Rollovers as Business Startups (ROBS)

Rollovers as business startups (ROBS)

“One of my clients, who participates in his employer’s 401(k) plan, asked me about an arrangement whereby he could use a tax-free rollover from the plan to start his own new business?  Are you aware of such a scheme?”

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

  • Your client is likely referring to “Rollovers as Business Start-Ups” (ROBS). The IRS has commented that promoters in the industry are aggressively marketing ROBS (described below) as a means for prospective business owners to access accumulated tax-deferred retirement funds, without paying applicable distribution taxes, in order to cover new business start-up costs. While the IRS does not consider all ROBS to be abusive tax avoidance transactions, it has found that some forms of ROBS violate existing tax laws and, therefore, are prohibited.
  • Anyone considering a ROBS transaction should consultant with a tax and/or legal advisor before proceeding as there are several issues the IRS has identified that must be considered on a case-by-case basis in order to determine whether these plans operationally comply with established law and guidance. These issues and guidelines for compliance are detailed in a 2008 IRS Technical Memorandum.
  • Here is an example of a common ROBS arrangement.  An individual sets up a C-Corporation and establishes a 401(k)/profit sharing plan for the business.  The plan allows participants to invest their account balances in employer stock. (At this point the business owner is the only employee in the corporation and the only participant in the plan.)  The new business owner then executes a tax-free rollover from his or her prior qualified retirement plan (or IRA) into the newly created qualified plan and uses the assets from the rollover to purchase employer stock. The individual next uses the funds to purchase a franchise or begin some other form of business enterprise. Note that since the rollover is moving between two tax-deferred arrangements, the new business owner avoids all otherwise assessable taxes on the rollover distribution.
  • The two primary issues that the IRS has identified with respect to ROBS that would render them noncompliant are 1) violations of nondiscrimination requirements related to the benefits, rights and features test of Treas. Reg. § 1.401 (a)(4 )-4; and 2) prohibited transactions resulting from deficient valuations of stock.
  • Other concerns the IRS has with ROBS relate to the plan’s permanency (which is a qualification requirement for all retirement plans, violations of the exclusive benefit rule, lack of communication of the plan when other employees are hired, and inactive cash or deferred arrangements (CODAs).
  • The Employee Plan Compliance Unit of the IRS completed a research project on ROBS in 2010. The research revealed that while some of the ROBS studied were successful, many of the companies in the sample had gone out of business within the first three years of operation after experiencing significant monetary loss, bankruptcy, personal and business liens, or having had their corporate status dissolved by the Secretary of State (voluntarily or involuntarily). The full project summary is accessible here.

 

Conclusion

Caution should prevail when considering a ROBS arrangement. Those interested should seek the guidance of a tax and/or legal advisor, and consider the guidance from the IRS’ 2008 Technical Memorandum.

 

© Copyright 2018 Retirement Learning Center, all rights reserved
pension benefits
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401(k) and Nonqualified Deferred Compensation plans

 

“My client has a 401(k) excess contribution as a result of a failed actual deferral percentage (ADP) test.  However, he was told he could roll over the excess contribution to another of his employer’s plans.  How could that be; I thought excess contributions were ineligible for rollover?”

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

  • You are correct; 401(k) excess contributions are not eligible to be rolled over to an “eligible retirement plan” pursuant to Internal Revenue Code Section (IRC §) 402(c)(8)(b). The term eligible retirement plan is defined as an individual retirement account under IRC §408(a); an individual retirement annuity under IRC § 408(b); a qualified trust; a qualified annuity plan under IRC § 403(a); a governmental plan under IRC §457(b); and an IRC §403(b) plan.
  • However, it is possible that, in addition to the 401(k) plan, your client’s employer maintains a plan that is not an eligible retirement plan, such as a nonqualified deferred compensation plan (NQDC) under IRC §409A.
  • An NQDC plan is an agreement, method, or arrangement between an employer and an employee (or service recipient and service provider) to pay the employee or independent contractor compensation in the future for service presently performed. NQDC plans allow employees to defer compensation until retirement or some other predetermined date. A thorough discussion of NQDC plans is beyond the scope of this writing.
  • NQDC plans are an attractive benefit for highly paid employees because they are free from the contribution limits, participation requirements and nondiscrimination restrictions that apply to qualified plans. Because NQDC plans are not subject to the limitations of qualified retirement plans, they can allow some executives and high-level managers to defer a much larger portion of their compensation than permitted under qualified plans.
  • If permitted under the terms of the plan document, participants may have the option to contribute to the NQDC their excess contributions that occurred in their 401(k) plans. These NQDC plans may be referred to as “401(k) excess plans” or “401(k) wrap plans.” The contribution to the NQDC plan is not a rollover, but is considered an additional type of permissible deferral under the NQDC plan.
  • A best practice would be to get a copy of the NQDC plan document and check to see if there is language in the plan that addresses the ability of participants to defer excess contributions. The consultants at the Learning Center review NQDC plans documents, as well as other types of plan documents, daily.

 

Conclusion

While 401(k) participants may not roll over excess contributions to another eligible retirement plan, it may be possible for them to defer their excesses into a NQDC or 401(k) wrap plan, if one exists. Check the NQCD plan document for accommodating language.

 

 

© 2017 Retirement Learning Center, LLC

© Copyright 2018 Retirement Learning Center, all rights reserved
rules
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Non Spouse Beneficiary Rollovers

“My client, who is a nonspouse beneficiary of a deceased 401(k) plan participant, requested and received a distribution of the inherited account balance.  Can she complete a 60-day rollover?”

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

  • No, the IRS does not allow nonspouse beneficiaries to complete indirect or 60-day rollovers of amounts received from a 401(k) plan.
  • If a nonspouse beneficiary wants to complete a rollover of inherited plan assets, he or she must do so through a “direct rollover” to an inherited IRA.  (See IRS Notice 2007-7  Q&A 15). The Pension Protection Act of 2006 introduced this option for nonspouse beneficiaries, effective for 2007 and later years. The direct rollover option for nonspouse beneficiaries applies to IRC §401(a) qualified retirement plans, as well as IRC §§403(b) and governmental 457(b) plans.
  • A direct rollover is a transfer of plan assets from the trustee of the plan to the trustee of the inherited IRA (i.e., a trustee-to-trustee transfer), without receipt by the beneficiary of the assets.
  • A qualified plan can (but is not required to) offer a direct rollover of a distribution to a nonspouse beneficiary, provided the distributed amount satisfies all the requirements to be an eligible rollover distribution.
  • The direct rollover must be made to an IRA established on behalf of the designated beneficiary that will be treated as an inherited IRA. If a nonspouse beneficiary elects a direct rollover, the amount directly rolled over is not includible in gross income in the year of the distribution.
  • The receiving IRA must be established in a manner that identifies it as an IRA with respect to the deceased plan participant and the beneficiary, for example, “Tom Smith as beneficiary of John Smith.”
  • If a nonspouse beneficiary receives an amount distributed from a plan, the distribution is not eligible for rollover, and is includible in income in the year of the distribution.

Conclusion

The plan-to-IRA rollover rules for nonspouse beneficiaries are different than those that apply to spouse beneficiaries. If a nonspouse beneficiary wants to complete a rollover of inherited plan assets, he or she must do so through a direct rollover to an inherited IRA.

 

 

© 2017 Retirement Learning Center, LLC

© Copyright 2018 Retirement Learning Center, all rights reserved