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Adding In-Service Distributions to a Company’s Retirement Plan

“What are the considerations around adding an in-service distribution option to a company’s qualified retirement 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 and income plans, including nonqualified plans, stock options, and 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 in-service distributions from qualified retirement plans.

Highlights of the Discussion

There are several important considerations surrounding adding an in-service distribution option to a company’s qualified retirement plan, including, but not limited to,

  • Type of plan,
  • The process to add,
  • The parameters for taking,
  • Potential taxes and penalties to recipients,
  • Nondiscrimination in availability, and
  • The effect on top-heavy determination.

Several types of retirement plans can offer in-service distributions, including 401(k), profit sharing, employee stock ownership and even defined benefit plans. If a plan sponsor desires an in-service distribution option, it must be formally written into the plan document, either when adopted or later through a plan amendment. The plan sponsor would need to check with its document provider for the exact adoption or amendment steps. For example, adding an in-service distribution option to a prototype 401(k) plan can be as easy as checking a box on the adoption agreement, selecting an effective date, signing the amendment and notifying participants of the change.

There are pros and cons to including an in-service distribution option in a plan. The pros include increased participant control of plan assets, and a higher level of participant satisfaction with the plan. The cons include the potential for greater administrative burdens and cost to the plan sponsor as a result of an increase in the number of distribution requests, potential taxes and penalties for the distribution recipient, and depletion of savings meant for retirement income.

Plan participants need to understand the taxation rules that apply to in-service distributions. Any pre-tax amounts that are distributed from a plan prior to age 59½ will be subject to taxation and, possibly, an early distribution penalty tax, unless an exception applies. Completing a rollover of the in-service distribution either directly or indirectly within 60 days of receipt is one way to delay any tax impact.

If a plan sponsor wants to add an in-service distribution option, it can choose to make the option very liberal or attach restrictions such as a requirement for a participant to reach a certain age, or complete a set amount of service. It is important to note that the IRS does not allow employee pre-tax elective deferrals to be distributed prior to age 59½, nor defined benefit assets to be distributed prior to age 62 under the in-service distribution rules. The plan sponsor could also limit access to a particular contribution source or sources (e.g., matching contributions, after-tax, etc.).

Distributions are part of the benefits, rights and features of a plan under Treasury Regulation §1.401(a)(4)-4. Therefore, if a plan offers in-service distributions, it must do so in a nondiscriminatory manner (i.e., not make them disproportionately more available to highly compensated employees (HCEs) than nonHCEs).

Finally, keep in mind that in-service distributions from a qualified retirement plan can affect top-heavy determination for up to five years. A plan is top-heavy if the key employees own more than 60 percent of the plan’s assets or benefits on the determination date. In-service distributions for active employees are added back to account balances if the distribution occurred within the five-year period ending on the determination date (Treasury Regulation §1.416-1, T-30)).

Conclusion

When the desire to give plan participants greater control of their plan assets exists, plan sponsors and participants may look to in-service distributions of retirement plan assets as a possible solution. But there are several important considerations surrounding such a plan feature. Financial advisors can help educate their clients on the pros and cons of adding, or changing the terms of an existing, in-service distribution option.

 

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Tax Reporting of Retirement Plan Contributions for Unincorporated Businesses

“Tax season has me wondering how sole proprietors deduct contributions they make to their qualified retirement plans?”

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, stock options, and 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 Oklahoma is representative of a common inquiry related to deducting retirement plan contributions.

Highlights of the Discussion

Unincorporated business owners, such as sole proprietors, farmers and partnerships, are among the IRS’s list of “pass through” business entities. Why the name—because the profits of these firms directly pass through the businesses to their owners, and are taxed on the owners’ individual income tax returns.

Special rules apply for how such businesses report and deduct contributions to their retirement plans for themselves and their employees. The following table provides a general, informational summary of annual tax reporting requirements for unincorporated business owners who make retirement plan contributions. The table is based on the instructions to the filing forms noted. IRS Publication 560, Retirement Plans for Small Businesses provides additional information. Please consult a tax advisor for specific guidance.

Tax Reporting of Retirement Plan Contributions for Unincorporated Businesses

Type of Employer Contributions for Common Law Employees Contributions for the Business Owner
Sole proprietorship Line 19 of 2018 Schedule C, Profit or Loss From Business (attachment to IRS Form 1040)

 

Instructions to Schedule C

 

Line 28 of 2018 Schedule 1, Additional Income and Adjustments to Income,(attachment to IRS Form 1040)

 

Instructions for Schedule 1

 

Farmers Line 23 of 2018 Schedule F, Profit or Loss From Farming, (attachment to IRS Form 1040)

 

Instructions to Schedule F

 

Line 28 of 2018 Schedule 1, Additional Income and Adjustments to Income, (attachment to IRS Form 1040)

 

Instructions for Schedule 1

 

Partnership Line 18 of 2018 Form 1065, U.S. Return of Partnership Income

 

Instructions to Form 1065

 

Box 13 of Schedule K-1 Partner’s Share of Income, Deductions, Credits, etc. (attachment to Form 1065)

 

Instructions for Schedule K-1

 

 

 

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Proxy voting on securities held in qualified plans

“Who or what entity is responsible for proxy voting[1] on securities held in a qualified retirement 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 and income plans, including nonqualified plans, stock options, and 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 stock or securities held in an employer-sponsored retirement plan.

Highlights of the Discussion

For the definitive answer, one must turn to the language of the governing plan document. The responsible party will be different depending on whether the plan specifies that plan investments are directed by 1) the plan participant; 2) a discretionary trustee; 3) an ERISA 3(38) investment manager; or 4) plan administrator or other named fiduciary. The DOL issued guidance on this matter in Interpretive Bulletin (IB) 2016-01.

In plans where investments are participant-directed, a plan participant has the responsibility to direct the trustee as to the manner in which any voting rights should be exercised. Assuming the plan participant timely received all notices, prospectuses, financial statements and proxy solicitation, the terms of the plan document should address who or what entity assumes the voting responsibility when participants fail to give instructions. For example, many plan documents will specify the plan trustee as the entity to vote in lieu of receiving participant instructions. Alternatively, the plan may specify another plan fiduciary such as an investment manager.

In some cases, the plan trustee, who has investment discretion, has the obligation to vote proxies on securities held in a qualified retirement plan. That responsibility is an extension of the trustee’s fiduciary responsibility to prudently manage plan assets in the best interest of plan participants. However, if the trustee is a directed trustee (i.e., subject to the direction of a named fiduciary), then the named fiduciary would retain the responsibility for the voting of proxies.

The plan document may specify that an ERISA 3(38) investment manager is responsible for directing investments, including the responsibility for proxy voting. If the plan document or investment management agreement provides that the investment manager is not required to vote proxies, but does not expressly preclude the investment manager from voting proxies, the plan’s investment manager has exclusive responsibility for voting proxies. However, if the plan document or investment management agreement expressly precludes the investment manager from voting proxies, the plan’s discretionary trustee has exclusive responsibility for voting proxies.

IB 2016-01 is clear that the investment policy statement for the plan should include a statement of the plan’s proxy voting policy. An IPS is a written statement that provides fiduciaries responsible for plan investments with guidelines or general instructions on investment management decisions.

Conclusion

For guidance on the individual or entity responsible for the voting of proxies for securities held in a 401(k) plan—turn to the governing plan documents. Proxy voting is a fiduciary responsibility. The authority for proxy voting should be addressed in the plan document and the procedure outlined in the plan’s IPS.

[1] A way for shareholders to vote on matters affecting a company without having to personally attend the meeting.

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