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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.

 

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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

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Forms of SEP plan documents and when to use them

“I have a client that would like to establish a SEP plan. What document options are available and what are the considerations for selection?”

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 New York is representative of a common inquiry related simplified employee pension (SEP) plans.

Highlights of Discussion

Employers that sponsor SEP plans must maintain them pursuant to a written document [Internal Revenue Code Section (IRC §) 408(k)(5). There are three document format options for SEP plans: 1) the IRS model form, which is IRS Form 5305-SEP Simplified Employee Pension – Individual Retirement Accounts Contribution Agreement; a prototype document offered by banks, insurance companies, mutual fund companies and other qualified financial institutions or forms providers; or 3) individually designed documents, which are typically written by attorneys. There are several considerations when selecting a SEP plan document including, but not limited to, cost, whether the sponsor maintains other retirement plans and desired design features.

Regardless of the format used, the deadline for establishing a SEP plan for a particular year is the business’s tax return deadline, plus extensions for that year.

EXAMPLE:

Pete’s Partnership operates on a calendar year, and has a five-month filing extension for its 2017 tax return. If the partnership wants a 2017 SEP plan, it has until September 15, 2018, to sign a document to set up the plan.

Form 5305-SEP

The IRS model Form 5305-SEP is available free of charge from the IRS’ website and there is no need to file a completed copy of it with the IRS. The IRS will consider a SEP plan as established using the model form when the sponsor completes and signs the form without modification; each eligible employee (or, as a last resort the SEP plan sponsor on behalf of an employee) establishes a traditional IRA to receive contributions, and the employer gives required notices to all eligible employees.

A SEP plan sponsor may not use the model Form 5303-SEP if any of the following statements are true. The employer

  • Maintains any other qualified retirement plan (except for another SEP or salary reduction SEP plan);
  • Has any eligible employees for whom traditional IRAs do not exist;
  • Uses the services of leased employees;
  • Wants a plan year other than the calendar-year;
  • Wants to exclude members of a controlled group of employers; or
  • Wants a contribution allocation formula that is other than pro rate (i.e., integrated with Social Security or flat dollar).

Prototype SEP

Prototype SEP plan documents are available for a nominal fee from various prototype document sponsors for use when a model form is not permitted and/or the employer wants more flexibility in plan design. By filing IRS Form 5306-A, Application for Approval of Prototype Simplified Employee Pension (SEP) or Savings Incentive Match Plan for Employees of Small Employers (SIMPLE IRA Plan), and paying a fee, a prototype document sponsor (e.g., a bank, credit union, mutual fund company, etc.) can receive pre-approval of its plan document from the IRS in the form of an IRS opinion letter. An opinion letter states that a SEP agreement is acceptable in form. The IRS has prepared a Listing of Required Modifications (LRMs), or sample language, to assist document sponsors in drafting an acceptable prototype SEP.

An employer using a prototype SEP plan document, rather than a model, can

  • Use the business’s fiscal year as the plan year rather than the calendar year;
  • Use the services of leased employees;
  • Select a pro rata, integrated or flat dollar contribution allocation formula;
  • Maintain another qualified plan in addition to the SEP plan; and
  • Contribute a top-heavy minimum contribution only when the plan is actually top-heavy.

Individually Designed

An employer can engage an attorney to draft an individually designed SEP plan document that is unique to the employer, and request a letter ruling from the IRS as to its acceptability, if desired. While these employer-specific documents can be more flexible than a model or prototype document, an adopting employer will incur higher costs as a result of drafting, establishment and maintenance fees.

Conclusion

The IRS requires businesses that want SEP plans to execute a written plan document containing the terms of the arrangement. There are three general SEP plan document formats from which to choose. Considerations as to the most appropriate form include, but are not limited to, cost, whether the business maintains other retirement plans and desired design features. Business owners should consult a tax and/or legal advisor regarding their particular circumstances.

© Copyright 2018 Retirement Learning Center, all rights reserved