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What is a 414(k) Plan?

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“My client emailed me asking about a ‘414(k) plan.” Is that a new type of plan—or  was that a typo?’ 

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 Nevada focused on plan design.

Highlights of the Discussion

While it may have been a typo, there is such a thing as a 414(k) plan—or more precisely—a 414(k) account.  A 414(k) account [created pursuant to IRC Sec. 414(k)] is a separate account within a defined benefit (DB) plan that is derived from employer contributions and, for the most part, is treated as a defined contribution (DC) plan [IRC Sec. 414(k)].

The 414(k) separate account balance is treated as a DC plan for purposes of satisfying the minimum participation and vesting standards, maximum contribution limitations, nondiscrimination tests for matching and after-tax contributions, and treatment of after-tax contributions as a separate contract [IRC Sec. 414(k)(1) and (2)]. To create a 414(k) account, the plan document provisions describing this separate account must contain language similar to the language of other DC plans.

Generally, contributions to a 414(k) account are in addition to the contributions that fund the DB plan’s basic retirement benefits and are used to enhance retirement benefits. The 414(k) separate account is credited with actual trust earnings. Under the individual account rules of IRC Sec. 414(i), 414(k) separate account benefits are based solely on the amounts contributed to the account and any income, expenses, gains, losses, or forfeitures that may be allocated to the participant’s account. 414(k) accounts may be appealing because they could allow participant direction of assets.

Certain transfers from the DB portion of the plan to the 414(k) separate account are prohibited: Sponsors cannot transfer

  • Excess earnings from the DB portion of the plan to the 414(k) separate account;
  • Assets from the DB plan to the 414(k) account; or
  • Excess DB assets to fund matching contributions in the 414(k) account.

Transferring a distribution from the DB portion of the plan to the 414(k) account is also questionable.

Conclusion

Not a new type of plan, a 414(k) account is a separate account within a DB plan derived from employer contributions and, for the most part, treated as a DC plan. The plan document must contain language to support this arrangement.

 

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Deadline for Setting Up a SIMPLE IRA Plan

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Did SECURE Acts 1.0 and/or 2.0 Change the Deadline for Setting Up a SIMPLE IRA Plan?

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 New Mexico is representative of an inquiry involving a savings incentive match plan for employees (SIMPLE) IRA plan.

Highlights of the Discussion

The short answer is no. While SECURE Acts 1.0 and/or 2.0 have given us a multitude of retirement plan changes, they did not affect the deadline for setting up a SIMPLE IRA plan. The general deadline for establishing a SIMPLE IRA plan for a given year is still October 1 of the year.  For example, the deadline for an eligible business owner to set up a SIMPLE IRA plan for 2023 is October 1, 2023.

There are two exceptions to the general rule as follow (See IRS Notice 98-4, Q&A K-1).

  1. If the business comes into existence after October 1 of the year the SIMPLE IRA plan is desired, then the new business owner may still set up a SIMPLE IRA plan for the year, provided he or she does so as soon as administratively feasible after the start of the new business.
  2. If a business has previously maintained a SIMPLE IRA plan, then it may only set up a new SIMPLE IRA plan effective on January 1 of the following year (e.g., set up the plan in 2023 with an effective date of January 1, 2024).

Businesses that are eligible to establish SIMPLE IRA plans are those that

  1. Do not maintain any other qualified retirement plans; and
  2. Have 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding year [IRC §408(p)(2)(c)(i) and IRS Notice 98-4, Q&A B4 ].

However, an employer can use less restrictive participation requirements if it so desires.

(Note that SECURE Act 2.0, beginning in 2024, will allow employers to replace their SIMPLE IRA plans mid-year with an “eligible 401(k) replacement plan.” See a prior Case of the Week  “A SIMPLE Switch” for more information.)

The basic steps for establishing a SIMPLE IRA plan are

  1. Execute a written plan document (either a government Form 5304-SIMPLE or Form 5305-SIMPLE, or a prototype plan document from a mutual fund company, insurance company, bank or other qualified institution);
  2. Provide notice to employees; and
  3. Ensure each participant sets up a SIMPLE IRA to receive contributions.

Employees who are eligible to participate in a SIMPLE IRA plan are those who received at least $5,000 in compensation from the employer during any two preceding years and are reasonably expected to receive at least $5,000 in compensation during the current year.

Conclusion

Business owners who are interested in establishing SIMPLE IRA plans must be aware of the deadline to do so, and the additional steps involved to ensure a successful set up.

 

 

© Copyright 2024 Retirement Learning Center, all rights reserved
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Automatic enrollment and governmental 457(b) plans

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My client maintains a governmental 457(b) plan. The plan’s recordkeeper told us they cannot add an auto enrollment provision to the plan because state law prohibits it. Is that true?”

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 Pennsylvania focused on governmental 457(b) plans and automatic enrollment.

Highlights of Discussion

Note:  For general informational purposes only. For specific guidance, seek legal advice.

For governmental 457(b) plans in Pennsylvania, that is true, unless it is a collectively bargained plan. Based on our reading of Pennsylvania state law, automatic enrollment is not allowed unless authorized by an employees’ written authorization or pursuant to a collective bargaining agreement (34 Pa. Code §9.1).

Generally, automatic enrollment is available for governmental 457(b) plans, but state law will dictate whether a particular state will allow it. The issue revolves around having written authorization to withhold amounts from an employee’s pay.

Automatic enrollment was universally authorized in the private sector more than a decade ago through the Pension Protection Act of 2006. However, public sector defined contribution plans were not included in the legislation. For public sector plans, each state is responsible for determining whether it will allow automatic enrollment, and many states have laws preventing its establishment.

According to the National Association of Governmental Defined Contribution Administrators (NAGDA), nine states allow automatic enrollment, 25 states do not allow automatic enrollment and 16 states allow “some” automatic enrollment. For example, Texas is a state that is reported to allows some automatic enrollment. Texas law states: “Employees participating in the state plan are automatically enrolled. However, public employees of other political subdivisions are subject to wage deferral laws that prevent the implementation of automatic enrollment,” (Tex. Labor Code Ann. §61.018, §609.5025, § 609.007).

Conclusion
Whether a governmental 457(b) plan can include an automatic enrollment feature depends on state law. For specific questions on a particular state, seek legal guidance from a professional who is well-versed in that state’s statutes.

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Can My Client Still Set Up a 401(k) Plan for 2022?

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“I’m a wealth advisor working with sole proprietor who wants to set up a 401(k) plan for 2022. Is that still possible and could she make salary deferrals for 2022?”

Highlights of the Discussion

Because this question deals with specific tax information, business owners and other taxpayers should always seek the guidance of their tax professionals for advice on their specific situations. What follows is general information based on IRS guidance and does not represent tax or legal advice and is for informational purposes only.

With respect to setting up a plan for 2022, the short answer is, yes, provided your client has an extension to file her 2022 tax return. However, she could only make an employer contribution for herself—not employee salary deferrals for 2022. Here’s why.

Under the SECURE Act 1.0, for 2020 and later tax years, a business has until its tax filing deadline, plus extensions for a particular tax year to set up a plan. The plan establishment deadline is tied to the type of business entity and its associated tax filing deadline. Please see a prior Case of the Week, “Plan Establishment and Compensation,” for more detailed information.

For example, a sole proprietorship [or limited liability corporation (LLC) taxed as sole proprietorship] would have an extended plan establishment deadline of October 15, 2023, to set up a plan for 2022. That means your client could set up a 401(k) plan up until that date if she has a tax filing extension.

Regarding the ability to make retro-active employee salary deferrals, unfortunately, it is too late for your client to make salary deferrals for 2022. The change that allows sole proprietors or single member LLCs to make retroactive first-year elective deferrals under Section 317 of SECURE Act 2.0 takes effect for plan years beginning after December 29, 2022. Consequently, if she sets up a 401(k) plan now, she could only make salary deferrals on a prospective basis.

Conclusion
SECURE Acts 1.0 and 2.0 have made favorable changes to plan establishment and funding rules, including the ability to make retroactive first-year elective deferrals for certain unincorporated business owners beginning for the 2023 plan year. Before jumping into a plan, be aware there are lots of details that investors should discuss with their tax and legal advisors.

 

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Chapter 7 vs. Chapter 11 Bankruptcy and Considerations for Retirement Plans

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“I know of several businesses that have filed either Chapter 7 or Chapter 11 bankruptcies in my area. Are the considerations for an employer’s retirement plan different based on whether the bankruptcy is categorized as a Chapter 7 or 11?”

Highlights of the Discussion
If a firm is filing for bankruptcy, the considerations regarding the business’s retirement plans will differ based on the type of bankruptcy. Generally, there are two types of bankruptcy filings, based on which chapter of the Bankruptcy Code applies: Chapter 7 (liquidation) or Chapter 11 (reorganization).
Regardless of the type of bankruptcy, participants’ qualified plan assets are fully protected from the general creditors of the business under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 and the Employee Retirement Income Security Act of 1974.

In a Chapter 7 liquidation bankruptcy filing, the bankrupt business typically liquidates it assets to pay its creditors and ceases to exist. In cases like this, the bankrupt business usually terminates its retirement plans and pays out the assets to participants.
In a Chapter 11 reorganization bankruptcy filing, the bankrupt business receives protection from the court while it works to restructure its financial affairs so that the business can continue to exist. In cases like these, the effect of the reorganization on a business’s retirement plans could vary from no affect at all to plan termination.

If the bankrupt business maintains a defined benefit plan, it must notify the Pension Benefit Guaranty Corporation (PBGC—the governmental agency that insures private sector defined benefit plans) of the bankruptcy filing—either Chapter 7 or Chapter 11. The PBGC, however, does not automatically take over the defined benefit plan. The PBGC’s goal is to work with the business to help it preserve its plan if at all possible.

The PBGC will only assume the responsibility for paying benefits to participants of a private employer’s defined benefit plan following either a distress-initiated plan termination (where the employer determines it is financially unable to support the plan further), or a PBGC-initiated plan termination (where the PBGC determines the employer cannot fulfill its financial responsibilities to the plan).
For more in depth coverage of the topic and participant considerations, please see this Department of Labor participant fact sheet on employer bankruptcy.

Conclusion
When a business files for bankruptcy, there will be unique considerations with respect to the business’s retirement plan depending on the type of filing (Chapter 7 or 11). Participants assets are always protected from a bankrupt employer’s creditors, but whether the plan continues depends on the situation.

© Copyright 2024 Retirement Learning Center, all rights reserved