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Small Estate Affidavits and Retirement Plan Assets

“One of my clients who sponsors a 401(k) plan asked me about a “small estate affidavit;” what is it and can it be used with retirement account 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 a financial advisor from Minnesota is representative of a common inquiry related to retirement account beneficiaries.

Highlights of the Discussion

A small estate affidavit is a creature of state law. A small estate affidavit is a sworn written statement that authorizes someone to claim a decedent’s assets outside of the formal probate process when the estate is below a set value. Each state that authorizes the use of such documents sets forth the process and procedure for their use in state statute. For example, the governing Minnesota state statute for collection of personal property by affidavit is §524.3-1201 when the value of the estate does not exceed $75,000.

A small estate affidavit may come into play when a person dies “intestate,” that is, without a will (or named beneficiaries in the case of retirement plan assets.) Usually, the estate of a person who has died intestate goes through probate court to determine who will inherit the decedent’s assets. Use of a small estate affidavit can bypass the probate process.

When it comes to retirement plan assets, ERISA 3(8) allows participants to designate beneficiaries directly. The governing plan documents will outline the steps and forms necessary to properly assign beneficiaries of the plan. Federal law requires the spouse of a plan participant to be the beneficiary by default, unless he or she formally waives his or her right to the assets. If a participant fails to properly designate a beneficiary, or if no beneficiary so designated survives the participant, most plan documents specify the beneficiary shall be the surviving spouse, or if there is no surviving spouse, the deceased participant’s estate.

Whether a plan sponsor or plan administrator should honor a small estate affidavit is an important legal question. A “best practices approach” for plan sponsors could include the following steps.

  1. Review what the governing plan document says about the distribution of assets when no beneficiary is named, particularly with respect to the use of small estate affidavits.
  2. If the plan document is silent on small estate affidavits, determine if there are distribution administration policies in place that address the use of small estate affidavits.
  3. Absent plan document and distribution policy guidance, or if the guidance is unclear, seek the advice of an attorney and document the recommended course of action.
  4. Consider formally addressing the use of small estate affidavits within the plan’s distribution policies and/or plan document.

Conclusion

Plan administrators may encounter small estate affidavits when a deceased plan participant’s estate is small as determined by state law. Honoring a small estate affidavit is an important legal question for plan sponsors. The most prudent course of action would be to proceed with caution with the guidance of legal counsel.

 

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Hierarchy of Payroll Deductions

An advisor asked, “I’ve run across the client situation where an individual’s paycheck is too small to handle all the mandatory deductions or withholdings (e.g., payroll taxes, health insurance premiums, FSA contributions, life insurance, garnishments for child support and taxes, repayment of qualified loans, union dues, elective deferrals to a 401(k) plan, etc.) Is there a hierarchy of deductions that a payroll department should follow?

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 a financial advisor from California is representative of a common inquiry related to withholding on payroll.

Highlights of the Discussion

First, check to see if the employer or payroll processor have a written policy. With respect to 401(k) salary deferrals, you could check the governing plan documents to see if there is a written policy (although few plans contain such information).

If no policy exists, it is best to put one in place. ERISA does not prescribe a hierarchy of withholding, neither is one specified in federal tax law. For guidance, it would be prudent to discuss the issue with a tax attorney. For reference, here’s one example of withholding order that applies to Federal civilian employees issued by the United States Office of Personnel Management.

Generally, payroll deductions are either mandatory or optional. Mandatory deductions would include those identified under federal, state, and local law. An employer is legally obligated to collect this money and remit it to the proper authority. Optional deductions, on the other hand, are voluntary, and an employee must provide written authorization to have such amounts withheld from a paycheck.  Notice that 401(k) salary deferrals are akin to Thrift Savings Plan deferrals and, therefore,  are considered “optional.”

Conclusion

If an employer does not have a policy regarding the hierarchy of payroll withholdings, a best practice is to put one in place with the help of a tax advisor, and apply it consistently.

 

© Copyright 2022 Retirement Learning Center, all rights reserved
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Is Congress Closing the Backdoor to Roth IRAs?

An advisor asked: “Is Congress Closing the Backdoor to Roth IRAs?”

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 a financial advisor from California is representative of a common inquiry related to Roth conversions.

Highlights of the Discussion
Potentially, yes, as well as restricting other Roth conversion strategies. As part of the tentative measures to help fund the proposed $3.5 trillion budget reconciliation package (a.k.a., Build Back Better Act ), the House Ways and Means Committee has suggested, among other tactics, restricting “back-door Roth IRAs,” a popular tax-reduction strategy where individuals convert traditional IRA and/or retirement plan assets to Roth IRAs. If enacted as proposed, after-tax IRA and after-tax 401(k) plan conversions would be eliminated after 12/31/2021. For amounts other-than after-tax (i.e., pretax assets), traditional IRA and plan conversions for taxpayers who earn over the following taxable income thresholds would cease after 12/31/2031:

• Single taxpayers (or taxpayers married filing separately) with AGI over $400,000,
• Married taxpayers filing jointly with AGI over $450,000, and
• Heads of households with AGI over $425,000 (all indexed for inflation).

The buildup of Roth assets can be a source of tax-free income later if certain conditions are met. Ending Roth conversions using after-tax contributions in a defined contribution plan or IRA, and restricting Roth conversions of pre-tax plan or IRA assets would materially limit many taxpayers’ ability to accumulate Roth assets in a tax-free or tax-reduced manner.
You won’t find the phrase backdoor Roth IRA in the Internal Revenue Code or Treasury regulations. Nor is it a specific product, but the industry has known about the phenomena for years. A backdoor Roth IRA is merely a series of transactions or steps an individual can take to have a Roth IRA—regardless of income level. While initially poorly understood and lacking clear IRS guidance, so called “back-door Roth IRAs” have been legitimized over the years by the IRS.

The ability to make a 2021 Roth IRA contribution is phased out and eliminated for single tax filers with income between $125,000-$140,000; and for joint tax filers with income between $198,000-$208,000. Consequently, if a person earns too much, he or she cannot make a Roth IRA contribution directly (i.e., through the front door). But many can still take another route—by converting traditional IRA or qualified retirement plan assets, a transaction that has become known as the backdoor Roth IRA.

Congress repealed any income limitations for Roth IRA conversions in 2010. Consequently, regardless of income level, anyone could fund a Roth IRA through a conversion. For example, if a person exceeds the income limitation for contributions to a Roth IRA, he or she could contribute amounts (deductible or nondeductible) to a traditional IRA based on earned income and, shortly thereafter, convert the contribution from the traditional IRA to a Roth IRA. Similarly, a person with a 401(k)-plan account balance could convert eligible plan assets either in-plan to a designated Roth account (if one exists) or out-of-plan to a Roth IRA through a plan distribution. Assets that are taxable at the point of conversion would be included in the individual’s taxable income for the year. Going forward, earnings would accumulate tax-deferred and, potentially, would be tax-free upon distribution from the Roth IRA. Under the authority of IRS Notice 2014-54, a qualified plan participant can rollover pre-tax assets to a traditional IRA for a tax-free rollover and direct any after-tax assets to a Roth IRA for a tax-free Roth conversion.

Conclusion
Plan participants and IRA owners need to be aware that as part of the 2021 budget reconciliation process, the ability to convert assets to Roth assets may be sunsetting. If revenue-generating provisions of the Build Back Better Act are enacted as currently proposed, Roth conversions of after-tax IRA and after-tax 401(k) plan assets would be eliminated after 12/31/2021; and Roth conversions of pre-tax IRA and plan assets would cease after 12/31/2031.

Click here for an RLC webinar on the proposed changes.

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