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Designated Roth 401(k) Contributions and IRS Form 8606

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“My client made designated Roth 401(k) contributions in 2021. Because these contributions are made on an after-tax or nondeductible basis, does that mean he must file IRS Form 8606 to report them?”

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 Tennessee is representative of a common question related to designated Roth 401(k) contributions.

Highlights of Discussion

  • When dealing with tax-related questions, always seek the guidance of a tax professional. What follows is general information based on IRS tax forms.
  • No, designated Roth contributions made to a 401(k) plan are not reported on IRS Form 8606, Nondeductible IRAs (see the instructions for Form 8606). The 401(k) [or 403(b) or governmental 457(b)] plan administrator reports such contributions on a worker’s IRS Form W-2, Wage and Tax Statement in box 12. Because designated Roth 401(k) contributions are subject to federal income tax withholding and Social Security and Medicare taxes (and railroad retirement taxes, if applicable), they also must be included in boxes 1, 3, and 5 (or box 14 if railroad retirement taxes apply) on Form W-2.
  • Please note that where designated Roth 401(k) contributions might show up on Form 8606 is on Line 22, which is used to report the basis in a Roth IRA. Any designated Roth 401(k) amounts an individual rolls into his Roth IRA during the year would be included as basis in the Roth IRA and included in the figure reported on Line 22.

Conclusion

Designated Roth contributions made to a 401(k) plan are not reported on IRS Form 8606, Nondeductible IRAs. However, a taxpayer will need to include designated Roth 401(k) amounts rolled into a Roth IRA in the value of the Roth IRA’s basis.

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Deadline for Summary Annual Reports

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“I have a client who failed to deliver the 2020 Summary Annual Report (SAR) on time for the business’s 401(k) plan. What are the consequences?”

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 required plan reports.

Highlights of Discussion

  • Let’s start with the due date of the SAR. The date a plan sponsor must deliver a SAR to plan participants and beneficiaries is tied to the due date for filing the Form 5500 series report for the plan. The SAR is a summary of Form 5500 information. The appropriate Form 5500 is generally due seven months after the end of the plan year (i.e., July 31st for a calendar year plan). The regulations require distribution of the SAR within nine months after the close of the plan year. So, a calendar year plan has a SAR distribution deadline of September 30th following the end of the plan year.
  • If the plan sponsor has an extension to file Form 5500 for the year, the sponsor also has additional time to provide the SAR (i.e., two months after the close of filing extension [DOL Reg. § 2520.104b-10(c)]. For example, if a calendar year plan has an extension to file Form 5500 until October 15th of the following year, the plan sponsor must distribute the SAR for the plan by December 15th.
  • If a plan fails to provide the annual SAR, there is no stated penalty per se. However, plan sponsors have a fiduciary duty to ensure compliance with all plan reporting and notice rules. The error could result in DOL fines or criminal action upon discovery. The best course of action is to distribute a current SAR as quickly as possible and document how this failure will be avoided in the future.
  • There is a potential penalty if a plan participant or beneficiary requests a SAR and the sponsor fails to provide one in a timely manner. Failure to provide a SAR within 30 days of receiving a request from a plan participant or beneficiary could result in a penalty of $110 per day per participant [ERISA § 502(c)(1)].

Conclusion

When applicable, plan sponsors have a fiduciary duty to distribute SARs each year to participants and beneficiaries. They also have a responsibility to timely provide them upon request.

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“How is a lump-sum payout of unused vacation treated for plan purposes–is it compensation?”

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“How is a lump-sum payout of unused vacation treated for plan purposes–is it compensation?”

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 Massachusetts is representative of a common question compensation for plan purposes.

Highlights of Discussion

  • To answer this question, we need to consider two issues—ideally with the help of a tax advisor. First, how does the IRS treat a lump-sum payout of unused vacation for tax purposes and, second, what is the definition of compensation for plan purposes according to the governing plan document?
  • The following is not tax advice, but a general explanation of the rules based on IRS source materials. With respect to the first question, the IRS treats a lump-sum payout of unused vacation as “supplemental wages” subject to Social Security and Medicare taxes according to the IRS Publication 15, (Circular E), Employer’s Tax Guide. Any federal income tax withheld will be at the IRS supplemental wage tax rate, depending on whether the supplemental payment is identified as a separate payment from regular wages or combined with regular wages. (For more information, please see Publication 15 and Treasury Decision 9276.)
  • Regarding question number two, as supplemental wages, a lump-sum payout of unused vacation would be included in the definition of compensation for plan purposes—unless it is explicitly excluded under the terms of the plan document. Therefore, be sure to check the wording of the plan document carefully.

Conclusion

The IRS treats the lump-sum payout of unused vacation as supplemental wages for tax purposes. As supplemental wages, a lump-sum payout of unused vacation would be included in the definition of compensation for plan purposes—unless it is explicitly excluded under the terms of the plan document. For specific tax advice, please see the guidance of a tax professional.

 

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How to make a $28,000 Roth or Traditional IRA contribution

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A colleague of mine said a 60-year-old couple who is a client of hers plans to make a $28,000 IRA contribution by April 18, 2022. How is that possible? Won’t that be after the deadline and over the limit?

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 Columbus, OH is representative of a common question involving IRA contributions.

Highlights of Recommendations
• A $28,000 IRA contribution by April 18, 2022, for the couple is possible, courtesy of a combination of several IRS rules covering

1. carry-back and current year contributions,
2. spousal contributions,
3. catch-up contributions, and
4. the Emancipation Day holiday in Washington D.C.

• From January 1, 2021, to April 18, 2022, it is possible for a traditional or Roth IRA owner age 50 and over to make a $14,000 contribution: $7,000 (with catch-up) as a 2021 carry-back contribution and $7,000 (with catch-up) as a 2022 current-year contribution. That means a married couple filing a joint tax return could potentially make a $28,000 IRA contribution, with $14,000 going to each spouse’s respective IRA.

The tax filing deadline is, usually, April 15th, but the IRS said in a 2022 news release that because of the Emancipation Day holiday in Washington D.C. the tax filing deadline is moved to Monday, April 18, 2022. And the because of Patriot’s Day in Maine and Massachusetts the filing deadline is April 19, 2022

• Why April 18, 2022? By law, Washington, D.C. holidays impact tax deadlines for everyone in all states in the same way as federal holidays do. Because of the Emancipation Day holiday in the District of Columbia on Friday April 15th, the IRS has moved the due date for 2021 personal tax returns to Monday April 18, 2022.

• What about the Patriot’s Day holiday on April 18, 2022, in Maine and Massachusetts? The IRS has indicated that taxpayers in those states have until April 19, 2022, to file their returns considering the holiday.

• When making the contributions it is important to clearly designate to the IRA administrator that a portion is a carry-back contribution for 2021 and a portion is a 2022 current-year contribution in order to avoid having the full amount treated as a current-year contribution and, subsequently, an excess contribution for 2022.

• Such a large, combined contribution for the couple would only be possible if

  • The couple had not previously made a 2021 contribution to a traditional or Roth IRA,
  • Each spouse was age 50 or older as of 12/31/2021,
  • The couple has earned income for 2021 and 2022 to support the contributions, and
  • For a Roth IRA contribution, the couple’s income is under the modified adjusted gross income (MAGI) limits for Roth IRA contribution eligibility.

• Whether the traditional IRA contributions would be tax deductible depends upon “active participation” of either spouse in a workplace retirement plan and the couple’s MAGI.

• Please see the applicable MAGI ranges in the following chart.

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Conclusion
The deadline for making 2021 traditional or Roth IRA contributions is April 18, 2022 (April 19, 2022, for residents of Maine and Massachusetts). That means there is a window of opportunity that allows eligible couples to double up their IRA contributions (for 2021 and for 2022) to the tune of $28,000.

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Failure to Fulfill PTE 2020-02’s Requirements

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“When relying on PTE 2020-02 to provide investment advice for a fee, what are the penalties for failing to fulfill the 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, 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 Massachusetts is representative of a common inquiry regarding Prohibited Transaction Exemption (PTE) 2020-02.

Highlights of Discussion

PTE 2020-02 is the Department of Labor’s (DOL’s) newest PTE which, when followed, allows financial institutions and investment professionals to provide investment advice to retirement investors for a fee. Failure to comply with the PTE’s requirements could result in a variety of penalties, depending on the severity of the breach. Adopting the PTE is optional.

The most severe penalty is the imposition of a 10-year ineligibility period in the following scenarios.

  1. Financial institutions and investment professionals who are convicted of certain crimes arising out of their provision of investment advice to retirement investors will be ineligible to rely on the exemption for 10 years. “Crimes” are described in ERISA Sec. 411 (e.g., embezzlement, fraud, perjury, etc.). A financial institution with such a criminal conviction may submit a petition to the DOL to seek a determination that would allow it to continue to rely on the exemption. Petitions must be submitted to the DOL within 10 business days of the conviction.
  2. Financial institutions and investment professionals also will be ineligible to rely on the exemption for 10 years if they engage in systematic or intentional violations of the PTE’s conditions or provide materially misleading information to the DOL in relation to their conduct under the exemption. The DOL will first issue a warning and provide a six-month cure period. But without correction, the DOL will issue a written “ineligibility notice.”

Parties found to be ineligible to rely on PTE 2020-02 are permitted to rely on an otherwise available statutory exemption or administrative class exemption, or they can apply for an individual prohibited transaction exemption from the DOL.

With any misstep of the PTE’s requirements, the DOL has the right to transmit information to the IRS regarding the party’s violation of the prohibited transaction provisions of ERISA Sec. 406. IRC Sec. 4975 imposes a 15 percent tax on disqualified persons participating in prohibited transactions involving plans and IRAs.

Participants, beneficiaries, and fiduciaries with respect to plans covered under Title I of ERISA have a statutory cause of action under ERISA Sec. 502(a) for fiduciary breaches and prohibited transactions under Title I. The exemption, however, does not expand to IRA owners. ERISA Sec. 502(a) provides a cause of action for fiduciary breaches and prohibited transactions with respect to Title I Plans (but not IRAs) (see DOL FAQ #21).

Note the nonenforcement period that applies through June 30, 2022, for the rollover disclosure and documentation requirements of PTE 2020-02. (See an earlier Case of the Week for more details.)

Conclusion

Those who take advantage of the protections offered under PTE 2020-02 should be aware that failure to uphold the requirements could result in penalties and, potentially, loss of the PTE’s shield for a decade.

 

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