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Retirement Plan Benefits and Prenuptial Agreements Do Not Mix

“My client asked me what effect, if any, a prenuptial agreement would have on 401(k) plan assets?

ERISA consultants at the Retirement Learning Center (RLC) 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 an advisor in California is representative of a common question related to spouses as retirement plan beneficiaries.

Highlights of Discussion

Generally, a prenuptial or antenuptial agreement  is an agreement made between a couple before they legally marry by which they forfeit future rights to each other’s property in the event of a divorce or death. The short answer is that a prenuptial agreement has no impact on a spouse’s claim to 401(k) plan assets because it does not satisfy the applicable spousal consent requirements of Internal Revenue Code Section (IRC §) 417(a)(2) and Treasury Regulation Section (Treas. Reg.) 1.401(a)-20, Q&A 28.

In most cases, spousal consent is required before a plan can pay out benefits in a form other than a Qualified Joint and Survivor Annuity. The Retirement Equity Act of 1984 (REA) added the mandate to obtain spousal consent before a plan participant could take a distribution so that the nonemployee spouse would have some control over the form of benefit the participant chose, and would, at the very least, be aware that retirement benefits existed. There are exceptions to the spousal consent rule when

  1. The payable benefit is ≤ $5,000;
  2. There is no spouse or the spouse cannot be located;
  3. The spouse has been legal abandoned or the couple is legally separated;
  4. The spouse is incompetent; or
  5. The plan must satisfy requirement minimum distribution rules.

Even if a 401(k) plan is drafted as a “REA Safe Harbor Plan” (meaning it meets the criteria to be exempt from the QJSA requirements)[1], the spouse must generally consent in writing to the naming of anyone other than the spouse as primary beneficiary.

For its reasoning on antenuptial agreements, the IRS relied on several court cases, which found that the antenuptial agreements were not valid because, in part, they were signed by the participant’s fiancée (not spouse), and the agreements did not comply with REA since they did not specify the nonspouse beneficiary who would receive the benefit [See Hurwitz v. Sher, 982 F.2d 778 (2d Cir. 1992), cert. denied, 508 U.S. 912 (1993) and Nellis v. Boeing Co., No. 911011, 15 E.B.C. 1651 (D.Kan. 5/8/1992)].

Conclusion

Based on numerous court cases and Treasury Regulations, the IRS has made it clear that a prenuptial agreement has no impact on a spouse’s claim to 401(k) plan assets.

 

[1] Treas. Reg. 1.401(a)-20, Q&A 3

 

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Active Plan Participation May Affect IRA Deductibility

“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

This is an important tax question that can only be answered definitively by a person’s own tax advisor.  Generally speaking, for purposes of the IRA deduction rules, an individual is 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.

If an individual is an active participant, then the following applies for IRA contribution deductibility.  The maximum traditional IRA contribution for 2020 and 2021 is $6,000 for those under age 50 and $7,000 for those age 50 0r greater.

IF your filing
status is …
AND your modified adjusted gross income (modified AGI)
is …
THEN you can take …
single or
head of household
$65,000 or less a full deduction.
more than $65,000
but less than $75,000*
a partial deduction.
$75,000 or more no deduction.
married filing jointly or
qualifying widow(er)
$104,000 or less a full deduction.
more than $104,000
but less than $124,000**
a partial deduction.
$124,000 or more no deduction.
married filing separately2 less than $10,000 a partial deduction.
$10,000 or more no deduction.
Not covered by a plan, but married filing jointly with a spouse who is covered by a plan  $196,000 or less a full deduction.
  more than $196,000
but less than $206,000***
a partial deduction.
Source:  IRS 2020 IRA Deduction Limits

 

$206,000 or more no deduction.
*$66,000-$76,000 for 2021; **$105,000-$125,000 for 2021; and ***$198,000-$208,000 for 2021

 

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] See www.legalbitstream.com for IRS Notice 87-16

 

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The Line Between Education and Fiduciary Advice

Does the industry have a clear definition of what the Department of Labor (DOL) would consider investment education (not advice) in a 401(k) plan so that a financial advisor would not have to follow the requirements of Prohibited Transaction Exemption (PTE) 2020-02?

ERISA consultants at the Retirement Learning Center (RLC) 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 an advisor in Minnesota is representative of a common question related to investment education.

Highlights of Recommendations

The DOL believes it provides a clear roadmap for determining when financial advisors are, and are not, investment advice fiduciaries under Title I of the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (IRC) in PTE 2020-02 and Interpretive Bulletin (IB) 96-1. 

“Oldie but goodie” DOL IB 96–1 identifies four categories (or “safe harbors”) of investment-related educational materials that advisors or others can provide to plan participants and beneficiaries without being considered to have provided fiduciary investment advice: 1) Plan information, 2) General Financial and Investment Information, 3) Asset Allocation Models and 4) Interactive Investment Materials.

Plan Information

Information about the benefits of plan participation, the benefits of increasing plan contributions, the impact of preretirement withdrawals on retirement income, the terms of the plan, the operation of the plan, or descriptions of investment alternatives under the plan would not constitute investment advice.

General Financial and Investment Information

General financial and investment concepts, such as risk and return, diversification, dollar cost averaging, compounded return, and tax-deferred investment; historic differences in rates of return between different asset classes (e.g., equities, bonds, or cash) based on standard market indices; effects of inflation; estimating future retirement income needs; determining investment time horizons; and assessing risk tolerance would not constitute investment advice.

Asset Allocation Models

Examples would include pie charts, graphs, or case studies that provide a participant or beneficiary with asset allocation portfolios of hypothetical individuals with different time horizons and risk profiles.  Such models must satisfy the following requirements.

  1. The models must be based on generally accepted investment theories that take into account the historic returns of different asset classes (e.g., equities, bonds, or cash) over define periods of time.
  2. All material facts and assumptions on which such models are based (e.g., retirement ages, life expectancies, income levels, financial resources, replacement income ratios, inflation rates, and rates of return) must accompany the models.
  3. To the extent that an asset allocation model identifies any specific investment alternative available under the plan, the model must be accompanied by a statement that
    • Indicates that other investment alternatives having similar risk and return characteristics may be available under the plan;
    • Identifies where information on those investment alternatives may be obtained; and
    • Discloses that, when applying particular asset allocation models to their individual situations, participants or beneficiaries should consider their other assets, income, and investments (e.g., equity in a home, IRA investments, savings accounts, and interests in other qualified and non-qualified plans) in addition to their interests in the plan.

Interactive Investment Materials

Examples in this category could include, but are not limited to, questionnaires, worksheets, software, and similar materials that provide a participant or beneficiary the means to estimate future retirement income needs and assess the impact of different asset allocations on retirement income.

Such materials must

  1. Be based on generally accepted investment theories that take into account the historic returns of different asset classes (e.g., equities, bonds, or cash) over defined periods of time;
  2. Contain an objective correlation between the asset allocations generated by the materials and the information and data supplied by the participant or beneficiary;
  3. Include all material facts and assumptions (e.g., retirement ages, life expectancies, income levels, financial resources, replacement income ratios, inflation rates, and rates of return) that may affect a participant’s or beneficiary’s assessment of the different asset allocations (Note: These facts and assumptions could be specified by the participant or beneficiary);
  4. (To the extent they include an asset allocation generated using any specific investment alternatives available under the plan), include a statement indicating other investment alternatives having similar risk and return characteristics may be available under the plan and where information on those investment alternatives may be obtained; and
  5. Take into account or are accompanied by a statement indicating that, in applying particular asset allocations to their individual situations, participants or beneficiaries should consider their other assets, income, and investments (e.g., equity in a home, IRA investments, savings accounts, and interests in other qualified and nonqualified plans) in addition to their interests in the plan.

While the provision of investment education is not a fiduciary act, the designation of a person or entity to provide investment educational services to plan participants and beneficiaries is a fiduciary act. Therefore, persons making this designation must act prudently and solely in the interest of the plan participants and beneficiaries.

Conclusion

The DOL provides examples of investment education in IB 96-1 that, when delivered, would not be considered investment advice, thereby helping the educator to avoid fiduciary liability for the information. However, the act of selecting the individual or entity to provide investment education to 401(k) plan participants and beneficiaries is a fiduciary act, subject to the standards of loyalty and prudence.

 

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