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CalSavers Sign Up Begins

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“The CalSavers program has been in the news. What is it?”

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 types of retirement plans.

Highlights of the Discussion

The CalSavers Retirement Savings Program (CalSavers) is a mandatory retirement savings program run by the state of California for private sector workers of California. California state law requires employers to either offer their own retirement plan[1] or register to facilitate CalSavers. On threat of penalty,[2] the employer is required to register with the state for CalSavers if the business

  • Has at least five California-based employees, at least one of whom is age 18, and
  • Does not sponsor a qualified retirement plan.

July 1, 2019, marked the opening for registration. There are staggered compliance deadlines depending on the size of employer. For eligible employers with

  • More than 100 employees, the deadline to participate is June 30, 2020;
  • More than 50 employees, the deadline to participate is June 30, 2021; and
  • With five or more employees, the deadline to participate is June 30, 2022.

Employer Involvement

An eligible employer is responsible for registering for the program, providing basic employee roster information to the state for eligible employees (i.e., name, date of birth, Social Security Number or ITIN, and contact information), and facilitating by payroll deduction the appropriate contributions each pay cycle.

Employee Involvement

Covered employees are automatically enrolled in CalSavers, and the state will contact employees directly to make them aware of the program and inform them of their ability to opt-out or customize their contributions. The default contribution is five percent of an employee’s gross salary, with an automatic one percent increase each year up to a maximum of eight percent. Currently, the CalSavers Program uses after-tax Roth IRAs, but is working on adding a Traditional IRA choice in late 2019 or early 2020. For 2019, the contribution limit is $6,000 for those under age 50 and $7,000 for those ages 50 and over. Note that this limit applies to all of an individual’s IRAs in aggregate—including a CalSavers account. Standard Roth IRA distribution rules apply. Unless an employee selects another investment option, the first $1,000 in contributions will be invested in the CalSavers Money Market Fund and subsequent contributions will be invested in a target retirement date fund based on the individual’s age. Employees can decide at any time whether to keep their investments in these funds or choose from a menu of other investment options. That’s just the top of the waves. The CalSavers website contains a wealth of information for employers and savers.

Conclusion

Registration is now officially open for the California-run CalSavers Retirement Savings Program—a automatic Roth IRA program for California workers who do not have access to a workplace retirement plan.

[1] Qualified retirement plans include pension plans; 401(k) plans; 403(a) plans; 403(b) plans; Simplified Employee Pension (SEP) plans; Savings Incentive Match Plan for Employees (SIMPLE) plans; or Payroll deduction IRAs with automatic enrollment.

[2] A penalty of $250 per eligible employee applies if noncompliance extends 90 days or more after notice, and if found to be in noncompliance 180 days or more after notice, an additional penalty of $500 per eligible employee will apply.

© Copyright 2024 Retirement Learning Center, all rights reserved
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De-villainizing Backdoor Roth IRAs

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“Backdoor Roth IRAs sound bad. Are they?”  

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 IRA conversions.

Highlights of the Discussion

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.

The ability to make a 2019 Roth IRA contribution is phased out and eliminated for single tax filers with income between $122,000-$137,000; and for joint tax filers with income between $193,000-$203,000. 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—through a traditional IRA.

For traditional IRA contributions, there are modified adjusted gross income (MAGI) thresholds that apply above which individuals are prevented from making deductible contributions.[1] However, anyone under the age of 70½ with earned income can make a nondeductible contribution to a traditional IRA, regardless of income level.  Anyone with a traditional IRA can convert it to a Roth IRA regardless of income level. The traditional-IRA-to-Roth-IRA conversion is another route to having a Roth IRA—what has become known as the backdoor Roth.

IRA technicians through the years have raised the specter of the Step Transaction Doctrine to cast a shadow over the efficacy of the backdoor Roth IRA. The Step Transaction Doctrine is a broad application tax law policy in which the IRS may view a series of separate but related transactions as a single transaction and apply any tax liability based on that transaction rather than the individual transactions in the series.

A traditional-IRA-to-Roth-IRA conversion is a taxable event to the extent a person converts pre-tax dollars. There are ways to maximize the tax efficiency of the transaction, for example, by rolling over IRA pre-tax dollars first to a qualified retirement plan. Those strategies are beyond the scope of this writing, but the consultants at RLC’s Resource Desk would be happy to have those discussions.

Informal guidance from the IRS and Congress from a year ago seems to have put to rest the concerns about backdoor Roth IRAs and the Step Transaction Doctrine. First, Congress made reference to the legitimacy of the traditional-IRA-to-Roth-IRA conversion in its conference report for the Tax Cut and Jobs Act (see page 289).

Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA.

Second, in a July 10, 2018, Tax Talk Today, Donald Kieffer Jr., a tax law specialist in employee plans rulings and agreements with the IRS Tax-Exempt and Government Entities Division, said the backdoor Roth is allowed under the law. Mr. Kieffer stated: “I think the IRS’s only caution would be whenever we see words like ‘backdoor’ or ‘workaround’ or other step transactions that are putatively enabling a way to get around limits – especially statutory contribution limits – you generally find the IRS is not happy and prepared to challenge those. But in this one that we’re talking about, it’s allowed under the law.”

Conclusion

According to IRS and Congressional guidance, “backdoor” is no longer a cue for a potentially illicit tax activity when linked to Roth IRA. Therefore, it’s time to de-villainize the transaction.

[1] If filing a joint return and covered by a workplace retirement plan $103,000,-$123,000; Single or head of household $64,000-$74,000; and Joint return with spouse not covered by a workplace plan $193,000-$203,000

© Copyright 2024 Retirement Learning Center, all rights reserved
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What is a “flexible” ERISA 3(38)

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“Is there such a thing as a ‘flexible’ ERISA 3(38) fiduciary?”  

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 Hampshire is representative of a common inquiry related to ERISA fiduciary services.

Highlights of the Discussion

According to a strict reading of ERISA and its regulations under 29 U.S.C. Title 29 §3(38)—no; there is no such legally defined entity. However, in practice, there are ERISA 3(38) fiduciary services that are advertised as “flexible.” Let’s start with the definition of an ERISA §3(38) plan fiduciary. An ERISA 3(38) fiduciary is an investment manager that is a registered investment advisor (e.g., RIA, bank or insurance company), appointed by the plan sponsor to fully manage the assets of the plan. Such individual or entity has the power to manage, acquire, or dispose of any asset of a plan; is responsible for selecting, monitoring and replacing plan investment options; and has full discretion regarding a plan’s investment management process. When the 3(38) fiduciary is appointed, a written agreement must be executed acknowledging the 3(38)’s fiduciary responsibility for managing the assets of the plan. ERISA 3(38) relieves the plan sponsor of fiduciary liability with respect to the selection, performance, monitoring and replacement of the investments for a plan when the sponsor has prudently selected the 3(38) investment manager; and the sponsor continues to monitor the 3(38)’s services. As one can see, the strict definition of an ERISA 3(38) does not seem to leave room for too much, if any, flexibility.

A few firms that offer 3(38) services have added the “flexible” moniker or adjective to describe situations where the plan sponsor can provide the 3(38) investment manager with “suggestions” regarding the investment line up. These plan sponsor suggestions could range widely from encouraging the 3(38) to take over and assume responsibility for an existing investment line up; providing input on investments the plan sponsors would like the 3(38) to add to the 3(38)’s available options; or having the ability to select from a broad universe of investments that are within the 3(38)’s fiduciary coverage universe to create the investment line up. The gnawing question becomes has the plan sponsor exerted discretion over the investment decisions and, thereby, clawed back some of the fiduciary responsibility it sought to relinquish? There is no clear answer. It is another one of those “facts and circumstances” situations the DOL and courts would evaluate on a case by case basis. But it is important to be aware of and take into consideration when making a decision that flexibility can muddy the fiduciary liability and relief waters.

Conclusion

Some firms advertise a flexible 3(38) investment management solution. Plan sponsors and their advisors should be sure they 1) understand what precisely the flexibility is; 2) evaluate if it could potentially affect liability; 3) make a prudent, educated decision based on the information; and 3) record the decision making process for their fiduciary process records.

© Copyright 2024 Retirement Learning Center, all rights reserved
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Qualified Separate Line of Business

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“How are the qualified separate line of business (QSLOB) rules helpful for a defined contribution 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 Massachusetts is representative of a common inquiry related to plan testing.

Highlights of the Discussion

The QSLOB rules can help a plan satisfy minimum coverage rules. Among other requirements, a defined contribution plan must cover or “benefit” a minimum number of a firm’s employees in order to remain qualified and receive favorable tax treatment from the IRS [Treasury Regulation Section (Treas. Reg. §) 1.410(b)-1]. Generally, all employees of a single employer are considered when applying the minimum coverage requirements. One exception to applying this test on a firm-wide basis exists by following the QSLOB rules of Treas. Reg. §1.414(r)-8. If an employer operates QSLOBs, then it may apply the minimum coverage requirement separately with respect to the employees of each QSLOB. That could make it easier for the employer to pass testing.

Treas. Reg. §1.414(r)-1

The above flow chart from the IRS is a helpful guide and is explained as follows. A line of business (LOB) is a portion of an employer that is identified by the property or services it provides to customers of the employer. For this purpose, the employer is permitted to determine the LOBs it operates by designating the property and services that each of its LOBs provides to customers of the employer.

A separate LOB (SLOB) is a line of business that is organized and operated separately from the remainder of the employer. In order to be a SLOB, the LOB must satisfy four statutory requirements 1) separate organizational unit; 2) separate financial accountability; 3) separate employee workforce; and 4) separate management [Treas. Reg. §1.414(r)-3].

In order to be a qualified SLOB (QSLOB), the SLOB must meet three additional requirements: 1) it must have 50 dedicated employees at all times during the testing year; 2) the employer must notify the Secretary of the Treasury that it intends to treat a SLOB as a QSLOB (by filing IRS Form 5310-A, Notice of Plan Merger or Consolidation, Spinoff, or Transfer of Plan Assets or Liabilities; Notice of Qualified Separate Lines of Business; and 3) the SLOB must satisfy the administrative scrutiny test—for which there are seven safe harbor options (see Treas. Reg. §1.414(r)-5 and Treas. Reg. §1.414(r)-6).

Finally, if all the property and services of the business are provided by the QSLOBs, then the employer may test the QSLOBs separately in order to satisfy the minimum coverage rules. A couple additional notes:

  • The QSLOB testing exception can be used in controlled group situations but not with affiliated service groups [see IRC §414(r)(8)].
  • Defined benefit plans may use the exception for minimum coverage testing, and for minimum participation testing pursuant to IRC §401(a)(26) with IRS approval.

A complete analysis of the QSLOB rules are beyond the scope of this writing.

Conclusion

The QSLOB testing exception for minimum coverage can be beneficial, but, as one can see, is complicated. Employers considering its application should consult with tax attorneys or advisors who are well-versed in the subject.

 

© Copyright 2024 Retirement Learning Center, all rights reserved
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401(k) Plan Committee Charter

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“If a 401(k) plan has an investment or administrative committee, is the committee required to have a charter?”

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 Ohio is representative of a common inquiry related to 401(k) plan committees.

Highlights of the Discussion

Neither the Department of Labor (DOL) nor the IRS, both of which regulate qualified retirement plans, specifically require that a 401(k) plan committee have a charter. However, more and more firms with plan committees are adopting committee charters as a fiduciary best practice. Practically speaking, a committee charter can help committee members understand their roles and responsibilities.

Retirement plan committee charters are distinct from an investment policy statement. (Please see Investment Policy Statement Checklist and an Education Policy Statement.)

A plan committee charter should be approved by the board of directors of the company and answer the following questions:

  • What authority does the committee have?
  • What is the committee’s purpose?
  • How is the committee structured?
  • Who may serve on the committee?
  • How are committee members replaced?
  • How will the committee delegate authority?
  • How will the committee assign responsibilities and duties?
  • How frequently will the committee meet?
  • What procedures will the committee follow?
  • What are the standing agenda items and how are new topics introduced?
  • What is the process for selecting and managing plan service providers?
  • What reporting will the committee do and to whom?
  • What are the procedures for protecting committee members financially?

Retirement plan committees that do have charters should be sure to follow them, and review them regularly to determine if adjustments are needed.

Here is a sample format:

  • Introduction
  • Purpose of the Plan Committee
  • Committee Membership
  • Schedule and Organization of Meetings
  • Authority and Responsibilities
  • Procedures for Decision Making
  • Meeting Minutes and Reports
  • Fiduciary Liability and Protection

Conclusion

For retirement plans that have investment or administrative committees, having a committee charter in place could be a good fiduciary liability mitigation tactic—as long as it is followed.

© Copyright 2024 Retirement Learning Center, all rights reserved
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Form 5500 and the “80-120 Rule”

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“My client was told by the record-keeper for her plan that it would be filing the plan’s IRS Form 5500 annual report under the “80-120 Rule.” Can you explain what that rule is?

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.

Highlights of the Discussion

Generally, plans with more than 100 participants are required to file the long version of Form 5500, Annual Return/Report of Employee Benefit Plan, as a “large plan.” However, there is an exception referred to as the “80-120 participant rule” that allows certain plans that would otherwise be considered large to continue to file as “small plans” following the streamlined Form 5500-SF, Short Form Annual Return/Report of Small Employee Benefit Plan, requirements (see 2018 Form 5500 Instructions).

The DOL defines small plans for Form 5500 purposes as plans with fewer than 100 participants at the beginning of the plan year. Small plans file Form 5500-SF and Schedule I Financial Information—Small Plans, (instead of Form 5500 and Schedule H Financial Information), plus certain other applicable schedules. However, small plans, typically, are exempt from the independent audit requirement that applies to large plans.

Under the 80-120 participant rule, if your client filed as a small plan last year and the number of plan participants is fewer than 121 at the beginning of this plan year, your client may continue to follow the Form 5500-SF requirements for this year.

EXAMPLE: For the 2017 plan year, Smally’s Inc., had 93 participants, so the plan administrator filed a Form 5500-SF and applicable schedules as a small plan.  The number of plan participants at the beginning of the 2018 plan year rose to 112.  Under the 80-120 participant rule, Smally’s Inc., may elect to complete the 2018 Form 5500-SF, instead of the long-form Form 5500 and schedules, in accordance with the instructions for a small plans.

Conclusion

The 80-120 participant rule may allow some plans that would otherwise be required to follow the arduous large plan filing requirements for Form 5500 to, instead, continue to file under the streamlined Form 5500-SF process.

 

© Copyright 2024 Retirement Learning Center, all rights reserved
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Contribution limits with combined DB/DC plans

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“I am meeting with a new client who has a defined benefit (DB) plan and would like to add an “individual k” plan. Can he do this and, if so, what are the contribution limitations?”

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 Rhode Island is representative of a common inquiry related to an employee covered by two plans.

Highlights of the Discussion

There are several layers to consider in your client’s situation. First, keep in mind that an individual k plan is a type of 401(k) plan that is designed to cover only small business owners and their spouses, (i.e., businesses without eligible common-law employees).

To answer your question, yes, a business owner can have both a 401(k)/profit sharing plan and a DB plan. The question on contribution limitations depends on whether the DB plan is covered by the Pension Benefit Guaranty Corporation (PBCG—the governmental entity that insures private sector DB plans). If a sponsor has a question about coverage, it can ask the DOL to make the call: Requesting a coverage determination

The PBGC insures most private-sector (i.e., non-governmental) DB plans [ERISA 4021(a)]. There are some notable exceptions to coverage, however ([ERISA 4021(b)].

Among others, the PBGC does not insure the following types of plans:

  • Governmental plans;
  • Small professional service plans;
  • Substantial owner plans;
  • Certain Puerto Rico plans;
  • Certain church plans.

Please see the PBGC’s definitions for the above listed exemptions on the PBGC’s website at PBGC Insurance Coverage.    

Where a DC and DB plan are combined, and the DB plan is covered by the PBGC, then there is no combined contribution limit. The deduction limits for contributions to DC and DB plans apply separately. A business owner, in this case, can fully contribute to both a DC and a PBGC-covered DB plan within the prescribed limits for each.

In the case at hand, one must be mindful of the substantial owner exemption from PBGC coverage. A private-sector DB plan is exempt from PBGC coverage if it is established and maintained exclusively for substantial owners of the plan sponsor (i.e., if all participants are substantial owners).

A participant is a substantial owner if, at any time during the last 60 months, the participant:

  • Owned the entire interest in an unincorporated trade or business, or
  • In the case of a partnership, is a partner who owned, directly or indirectly, more than 10 percent of either the capital or profits interest in such partnership, or
  • In the case of a corporation, owned directly or indirectly more than 10 percent in value of either the voting stock or all the stock of that corporation.

Where a DC and DB plan are combined, and the DB plan is not covered by the PBGC, as would be the case in an owner-only situation, then there is a combined contribution limit as follows:

If there is an employer contribution to the DC plan, then the maximum deductible contribution to both types of plans combined is the greater of

  • 25 percent of the aggregate compensation of all participants; or
  • the amount necessary to meet the minimum funding standard for the defined benefit plan.

Consequently, the plan sponsor would fund the DB plan up to the required amount, then fund the DC plan if there is still room.

For this purpose, the IRS says the first six percent of deductible contributions made to the DC plan is ignored for the above limits; and salary deferrals to the 401(k) plan are not counted toward the deduction limit.

Conclusion

Determining the maximum deductible contribution that a plan sponsor can make to a DB and DC plan that are combined can be tricky. Business owners should always seek advice from their tax advisors when calculating plan contribution limits.

© Copyright 2024 Retirement Learning Center, all rights reserved
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Universal Availability Rule

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“Can you explain the universal availability rule and does that apply to 401(k) 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 Illinois is representative of a common inquiry related to 403(b) plans.

Highlights of the Discussion

The universal availability requirement is a rule that relates to eligibility to make elective deferrals in 403(b) plans—not 401(k) plans. It is the nondiscrimination test for 403(b) elective deferrals. Universal availability requires that if the sponsor of a 403(b) plan allows any employee to make elective deferrals to the plan, it must permit all employees to make elective deferrals as well [Treas. Reg. Sec. 1.403(b)-5(b)]. There are a few limited exceptions explained next.

The IRS allows a 403(b) plan sponsor to disregarding the following excludable employees when applying the universal availability test to their plans:

  • Nonresident aliens with no U.S. source income;
  • Employees who normally work fewer than 20 hours per week (or a lower number if specified in the plan document);
  • Student workers performing services as described in Treas. Reg. Sec. 31.3121(b)(10)–2 (note that medical residents are not considered to be students for this purpose);
  • Employees whose maximum elective deferrals under the plan are less than $200; and
  • Employees eligible to participate and make elective deferrals under another 401(k), 403(b) or 457(b) plan sponsored by the same employer.

Under the fewer-than-20-hours-per-week and student worker exclusions listed above, if any employee who would be excluded under either exclusion is permitted to participate, then no employee may be excluded under that exclusion [ Treas. Reg. Sec. 1.403(b)-5]. Consequently, if the plan allows an employee working fewer than 20 hours per week to participate, the plan cannot exclude any employee using the fewer-than-20-hours-per-week exclusion.

A 403(b) plan may not exclude employees based on a generic classification such as the following:

  • Part-time,
  • Temporary,
  • Seasonal,
  • Substitute teacher,
  • Adjunct professor or
  • Collectively bargained employee.

However, if these employees fall under the fewer-than-20-hours criterion, then they may be excluded on that basis. For examples on the application of the exclusion, please see IRS 403(b) Universal Availability. The key to this exclusion is that a plan must determine eligibility for making 403(b) elective deferrals based on whether the employee is reasonably expected to normally work fewer than 20 hours per week and has actually never worked more than 1,000 hours in the applicable 12-month period.

And don’t forget, an employee is not considered to have had the right to make a deferral election unless he or she has had what the IRS calls an “effective opportunity” to make such an election. Effective opportunity is a facts-and-circumstances test. Essentially, at least once during a plan year, employees must receive a deferral notice and have a window of time to make or change a deferral election.

If a plan violates the universal availability rule, the effect can be loss of IRC 403(b) status. In that extreme case, contributions to the plan would become subject to income tax, employment tax and withholding. But the IRS wants to avoid that, so it provides correction remedies in its Employee Plans Compliance Resolution System (See the IRS’s 403(b) Fix-It Guide and Rev. Proc. 2019-19 for remedies.)

Conclusion

The ability to make elective deferrals in a 403(b) plan must be universally available to all eligible employees of a 403(b) plan sponsor. Be aware of the subtle nuances and follow IRS guidance on applying this important rule.

© Copyright 2024 Retirement Learning Center, all rights reserved
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Valuing employer stock in an ESOP

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“My client has an employee stock ownership plan (ESOP). How does he value the stock within the plan if it is not traded on a securities market?”

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 Wisconsin is representative of a common inquiry related to valuing stock of the sponsoring employer in qualified retirement plans.

Highlights of the Discussion

For employer securities that are not readily tradable on an established securities market, the IRS requires the shares be valued by an independent appraiser [IRC 401(a)(28)(C)]. Valuation by an independent appraiser is not required in the case of employer securities that are readily tradable on an established securities market.

There are a number of factors to consider when determining the value of an asset within a qualified retirement plan. In its examination guidelines, the IRS supports the use of Revenue Ruling 59-60, which relates to valuing assets for estate tax and gift tax purposes, for valuing assets in qualified retirement plans as well.

In valuing the stock of closely held corporations or the stock of corporations where market quotations are not available, all available financial data, as well as all relevant factors affecting the fair market value must be considered. For example, some factors to consider include the following:

  • Nature and history of the business issuing the security;
  • General economic outlook and the outlook for the specific industry;
  • Book value of the securities and the financial condition of the business;
  • Company’s earning capacity;
  • Company’s dividend paying capacity;
  • Goodwill value; and
  • Recent stock sales.

The list of factors to consider in Rev. Rul. 59–60 is not an exclusive list for valuing closely-held employer securities. It may be necessary to consider other factors when appropriate. Also, not all of the listed factors will be relevant to all companies and transactions. The IRS’ examination guidelines note that the independent appraisal will not, in and of itself, be a good faith determination of value unless all relevant factors are considered.

IRS examiners will look at Form 5500 (Schedule R, line 12) to the question: Does the ESOP hold any stock that is not readily tradable on an established securities market? If the answer is yes, examiners are directed to determine if the securities were valued that year and by whom in order to confirm it was done by an independent, third-party auditor.

Conclusion

An ESOP that holds employer securities that are not readily tradable on an established securities market must follow specific guidelines for annual asset valuation. The valuation requires the use of an independent auditor who observes the requirements of Rev. Rul. 59-60.

 

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Retirement and life insurance in a qualified retirement plan

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“My client has a life insurance policy inside his profit sharing plan at work. He will be retiring soon. Can he leave the policy in the plan after retirement?”

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 Wisconsin is representative of a common inquiry related to life insurance in qualified retirement plans.

Highlights of the Discussion

No, the IRS says a life insurance policy cannot remain in a plan past the plan participant’s retirement or separation from service (Revenue Rulings 54-51 and 74-307).[1] The reasoning for this relates to the IRS’s rules that holding life insurance in a qualified retirement plan is OK as long as the death benefits are “incidental,” meaning they must be secondary to other plan benefits.

Death benefits are considered incidental if the plan meets two conditions: 1) employer contributions used to purchase coverage are limited as prescribed; and 2) the plan requires the trustee to convert the entire value of a life insurance contract at or before retirement into cash, provide periodic income so that no portion of the policy may be used to continue life insurance protection beyond retirement, or distribute the contract to the participant (IRS Publication 6392, Explanation #4, Miscellaneous Provisions.)  Participants and their financial advisors should check the terms of their retirement plan documents to see what the plan language dictates.

Regarding the contribution limits, life insurance coverage in a defined contribution plan is considered incidental if the amount of employer contributions and forfeitures used to purchase whole or term life insurance benefits are limited to 50 percent for whole life, and 25 percent for term policies. No percentage limit applies if the participant purchases life insurance with company contributions held in a profit sharing plan for two years or longer.

Conclusion

The incidental benefit rules that apply to holding life insurance in a qualified retirement plan prevent the plan from retaining the policy past a participant’s retirement.

[1] See www.legalbitstream.com

 

© Copyright 2024 Retirement Learning Center, all rights reserved