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Suspending Plan Loan Repayments

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“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 2024 Retirement Learning Center, all rights reserved
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SEP and SIMPLE IRA Plans and ERISA Fidelity Bonds

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“Do SEP and SIMPLE IRA Plans Require an ERISA Fidelity Bond?”

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 Florida is representative of a common inquiry related to savings incentive match plans for employees (SIMPLE) IRA plans and simplified employee pension (SEP) plans.

Highlights of Discussion

Generally, yes, but this is a great question with a multi-layered answer depending on the individuals and/or entities that handle the assets of these plans. ERISA Section 412 requires that every fiduciary of an employee benefit plan and every person who handles funds or other property of such a plan be bonded in order to protect the assets of the plan against the risk of loss due to fraud or dishonesty. For this purpose, SEP and SIMPLE IRA plans are considered employee benefit plans. The DOL further explained (albeit somewhat vaguely) its position on the matter in Field Assistance Bulletin (FAB) 2008-4, Q&A 16. With regard to having a fidelity bond, the DOL states: “There is no specific exemption … for SEP or SIMPLE IRA retirement plans. Such plans are generally structured in such a way, however, that if any person does “handle” funds or other property of such plans that person will fall under one of ERISA’s financial institution exemptions” (See DOL Reg. §§ 2580.412-27 and 28).

The logic here is that, typically, employees establish their SIMPLE IRAs and SEP IRAs at banks, trust companies or insurance providers, and such institutions are exempt from the bonding requirement provided they are subject to supervision or examination by federal or state regulators and meet certain financial requirements. The Pension Protection Act added an exemption to the ERISA bonding requirement for entities registered as broker/dealers under the Securities Exchange Act of 1934 if the broker/dealer is subject to the fidelity bond requirements of a self-regulatory organization. Consequently, the employees of qualified financial institutions that hold SEP IRA and SIMPLE IRA plan assets need not be covered by an ERISA fidelity bond.

However, there is no exemption from the ERISA bonding requirement for the fiduciaries of employers who handle SEP and SIMPLE IRA plan assets prior to the assets being held in their respective IRAs. When do SEP and SIMPLE IRA contributions become plan assets? In the case of salary reduction (SAR) SEP and SIMPLE IRA employee salary deferrals, such amounts become plan assets as of the earliest date on which they can reasonably be segregated from the employer’s general assets (DOL Reg. 2510.3-102). In contrast, employer contributions generally become plan assets only when the contributions actually have been made to the plan (FAB 2008-01 and Advisory Opinion 1993-14A).

Court cases provide evidence that this is indeed how the DOL enforces the bonding requirement for SAR-SEP and SIMPLE IRA plans. In Chao v. Smith, Civil Action No. 1:06CV0051, the employer failed to remit employee contributions to a SIMPLE IRA plan. In addition to restoring the salary deferrals to the plan, as part of the settlement the employer was required to secure a fidelity bond and keep it active throughout the life of the plan “as required by the Employee Retirement Income Security Act.”  Similarly, in Chao v. Harman, Civil Action Number 4:07cv11772,  the DOL sued business executives and trustees of a firm’s SIMPLE IRA plan in Jackson, Michigan, for failing to forward employee contributions to workers’ accounts and obtain a fidelity bond. Finally, the DOL sued an employer with a SAR-SEP plan for mishandling of employee deferrals and lack of a fidelity bond (Chao v. Gary Raykhinshteyn, Civil Action No. 01-60056).

In each case, the DOL made a point to state employers with similar problems who are not yet the subject of an investigation may be eligible to participate in the DOL’s Voluntary Fiduciary Correction Program (VFCP) to correct the errors and avoid enforcement actions and civil penalties as well as any applicable excise taxes.

Since some form of employer contribution is required with a SIMPLE IRA plan, employers who fail to make these contributions have an IRS operational failure and may have the ability to correct the error by following the applicable provisions of the Employee Plans Compliance Resolution System in Revenue Procedure 2016-51.

Conclusion

While the DOL offers exemptions from the ERISA fidelity bonding requirement to qualified financial institutions that hold SEP and SIMPLE IRA assets, the agency requires employers who sponsor SEP or SIMPLE IRA plans and other plan fiduciaries who handle plan assets to be covered by an ERISA fidelity bond to prevent against loss as a result of fraud and/or dishonesty.

 

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Distributions from Nonqualified Deferred Compensation Plans

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“With respect to distributions from nonqualified deferred compensation (NQDC) plans, what are the timing 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, 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 distributions from Internal Revenue Code Section (IRC §) 409A NQDC plans.

Highlights of Discussion

Sponsors of NQDC plans must enforce strict distribution rules that are dictated by IRC §409A, the terms of the governing plan document and the elections made by participants (if permitted). Regarding the last variable, if a plan permits participants to elect how and when they will take distributions, they must execute their elections before deferring their compensation into the plan. The timing of withdrawals is an important tax consideration that requires advance planning. Once the form and timing of distributions are set (typically when deferral elections are made), there are complex rules that apply if participants want to make changes.

Under IRC §409A, payment events are limited to

  • Separation from service (as defined by the plan);
  • Death;
  • Disability;
  • A specified time or according to a fixed schedule;
  • An unforeseeable emergency; or
  • A change in the ownership or effective control of the corporation, or a change in the ownership of a substantial portion of the assets of the corporation (as defined by the plan) (see Treasury Regulation 1.409A-3).

Sponsors can elect to include all or a subset of the above listed distributable events in their plans. A person must look at the specific plan document in order to know which payment events apply to a particular plan and whether participants are allowed any discretion in selecting from among them.

A NQDC plan may allow employee elections regarding the timing and method of payment; or it can dictate the payment regime with no elections allowed. If participants have options, they record their distribution choices when they make their deferral elections. They must elect 1) when they will receive distributions from the NQDC plan, and 2) in what form the distributions will take (lump sum withdrawal or installment payments). The deadline for these elections is typically by December 31 of the year prior to the year for which salary is deferred or for which nonelective (employer) contributions are made to the plan; or within 30 days of becoming eligible to participate in the plan. If participants fail to make distribution elections when permitted, plan terms will dictate a default.

Like the timing for distributions, the methods of payment vary for each NQDC plan. The plan may allow for lump sum withdrawals, installment payments (e.g., over five or 10 years) or both, and participants may be allowed to select the payment type. The plan document will specify the available methods of payment.

With rare exception, distributions may not be accelerated. However, there is a mechanism by which participants may delay receipt of payments beyond which they initially elected [see Treas. Reg.§409A-2(b)]. In general, a participant is allowed to change the timing and method of the payment if an election is filed with the employer at least 12 months prior to the date the first payment would be due; and the payment is postponed for at least five years. Again, it is important to review the plan document to see if the plan allows for distributions to be delayed and, if so, whether distributions are treated as a series of payments or as a single payment for this purpose.

The penalties for noncompliance with these withdrawal rules are severe. The IRS will consider any compensation deferred under an errant plan as taxable income to the participant, plus it will assess a 20 percent excise tax, including accruing interest. Taxes, penalties and interest are payable by the recipient of the deferred compensation, not the employer [see IRC §409A(a)(1)(B)].

Conclusion

The form and timing of payments from IRC §409A NQDC plans is an important consideration because of the potential for income tax liability. Depending on the terms of the governing plan, participants may have flexibility in selecting when payments are due and what form they take and, therefore, have more control over when the amounts become taxable income to them. Understanding the terms of each plan and advance planning are the keys to mitigating the share Uncle Sam will take.

© Copyright 2024 Retirement Learning Center, all rights reserved
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Safe Harbor Validation of Rollovers

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“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 2024 Retirement Learning Center, all rights reserved