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Using unused PTO as 401(k) plan contributions

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“My client has unused PTO with his employer and participates in the company’s 401(k) plan. Is there any way he can use the equivalent dollar amount of unused PTO to increase his 401(k) contributions?”

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, including nonqualified 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 Pennsylvania is representative of a common inquiry related to paid time off (PTO)[1] and 401(k) plans.

[1] Generally refers to a sick and vacation arrangement that provides for paid leave whether the leave is due to illness or incapacity.

Highlights of Discussion

Yes, it is possible that the equivalent dollar amount of unused PTO can be contributed to the 401(k) plan, provided 1) the 401(k) and PTO governing plan documents contain provisions to accommodate such conversions and contributions; 2) the contributions do not unduly discriminate in favor of highly compensated employees; and 3) the contributions do not exceed mandatory contribution limits (see Revenue Rulings 2009-31 regarding the conversion of annual unused PTO and 2009-32 for the conversion of unused PTO upon termination of employment).

Revenue Ruling 2009-31 outlines two possible PTO conversion-to-contribution scenarios that could be applied on an annual basis: 1) where the value of any unused PTO that would otherwise be forfeited is instead converted and contributed to a 401(k)/profit sharing plan as an employer nonelective contribution; and 2) where the value of any unused PTO that would otherwise be paid out in cash to the employee is instead converted to a salary deferral to the 401(k) plan at the employee’s election.

Scenario 1

Company Z maintains a PTO plan and a 401(k) plan. Under Company Z’s PTO plan, no unused PTO as of 12/31 may be carried over to the following year. Company Z amends its 401(k) plan and PTO plan to provide that the dollar equivalent of

1) Any unused PTO of an employee as of the close of business on 12/31 is forfeited under Company Z’s PTO plan and the dollar equivalent of the amount forfeited is allocated to the participant’s account under Company Z’s 401(k) plan as of 12/31 as a nonelective contribution up to the applicable annual additions limitation under IRC § 415(c) (the “415 limit”), and

2) Any remaining unused PTO is paid to the employee by 02/28 of the following year.

Nondiscrimination testing under IRC §401(a)(4) based on the contributions made for individual participants, generally, will be required, because the amount contributed and allocated for each participant will vary based on the amount of each participant’s unused PTO.

Example:

Sam works for Company Z and earns $25 per hour. He also participates in Company Z’s 401(k) and PTO plans with provisions as described in Scenario 1. As of 12/31/17, Sam had 20 hours of unused PTO. Therefore, the dollar equivalent of Sam’s unused PTO is $500. Because of the 415 limit, Company Z may contribute only $400 of unused PTO to Sam’s account under the 401(k) plan as an employer nonelective contribution.

Consequently, Company Z contributes $400 to its 401(k) plan on behalf of Sam as a nonelective contribution on 02/28/18, and allocates this amount to Sam’s account under Company Z’s 401(k) plan as of 12/31/2017. Company Z pays Sam the remaining $100 in cash on 02/28/2018.

Scenario 2

Company A maintains a PTO plan and a 401(k) plan. Under A’s PTO plan, at the end of the year employees may carry over to the following year an amount of unused PTO that does not exceed a specified number of hours (the carryover limit). The dollar equivalent of any unused PTO for a year in excess of the carryover limit is paid to the participant by 02/28 of the following year. Company A amends its 401(k) and PTO plans to provide that a participant may, prior to receipt, elect to treat all or part of the dollar equivalent of any unused PTO as an employee salary deferral to the 401(k) plan and have it allocated to the participant’s account as of the beginning of the third pay period of the following year as long as the amount does not exceed the 415 limit nor IRC §402(g) limit [the “402(g) limit”]. The dollar equivalent of any unused PTO that is not deferred to Company A’s 401(k) plan is paid to the participant by 02/28 of the following year.

Scenario 2

Company A maintains a PTO plan and a 401(k) plan. Under A’s PTO plan, at the end of the year employees may carry over to the following year an amount of unused PTO that does not exceed a specified number of hours (the carryover limit). The dollar equivalent of any unused PTO for a year in excess of the carryover limit is paid to the participant by 02/28 of the following year. Company A amends its 401(k) and PTO plans to provide that a participant may, prior to receipt, elect to treat all or part of the dollar equivalent of any unused PTO as an employee salary deferral to the 401(k) plan and have it allocated to the participant’s account as of the beginning of the third pay period of the following year as long as the amount does not exceed the 415 limit nor IRC §402(g) limit [the “402(g) limit”]. The dollar equivalent of any unused PTO that is not deferred to Company A’s 401(k) plan is paid to the participant by 02/28 of the following year.

Example:

Barb works for Company A and participates in its PTO and 401(k) plans under the terms described in Scenario 2. As of the close of business on 12/31/17, Barb had 15 hours of unused PTO in excess of the carryover limit and earns $30 per hour, so the dollar equivalent of Barb’s unused PTO in excess of the carryover limit is $450. Before receipt of the amount, Barb elects to have 60% of the dollar equivalent of the unused PTO, or $270, contributed to Company A’s 401(k) plan as an employee salary deferral. The contribution does not cause Barb’s deferrals to exceed the 402(g) limit nor the 415 limit. Company A allocates $270 to Barb’s account under the 401(k) plan as of 02/01/18. Under the terms of Company A’s 401(k) plan, this amount is treated as a contribution for the 2018 plan year. Company A pays Barb the remaining $180 on 02/01/18.

Conclusion

As a way for companies to increase their employees’ ability to save for retirement, a number of plan sponsors have amended or are considering amending their 401(k) and PTO plans to allow the equivalent dollar amount of unused PTO time to be converted to 401(k) plan contributions. The terms of the plan documents will dictate the process and treatment of the contributed amounts. Plan sponsors can refer to Rev. Ruls. 2009-31 and 2009-32 for specific guidance.

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IRC §401(h) Plans

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“Can you tell me what a 401(h) plan 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 plans, including nonqualified 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 California is representative of a common inquiry related to plan types.

Highlights of Discussion

A “401(h) plan” is a retiree medical benefit account that is set up within a defined benefit pension plan[1] to provide for the payment of benefits for sickness, accident, hospitalization and medical expenses for retired employees, their spouses and dependents if the arrangement meets the requirements of Internal Revenue Code Section (IRC §) 401(h)(1) through (h)(6) (see page 1057 of link). A 401(h) account cannot discriminate in favor of officers, shareholders, supervisory employees, or highly compensated employees with respect to coverage or with respect to contributions and benefits.

401(h) plans are appealing because contributions to fund 401(h) benefits are deductible as contributions to a qualified plan; earnings on the account remain taxed deferred; and distributions are tax-free when used for qualified health care expenses. The amount contributed to the 401(h) account may not exceed the total cost of providing the benefits, and the cost must be spread over the future service.

According to Treasury Regulation § 1.401-14(c), a qualified 401(h) account must provide for the following:

  1. Retiree medical benefits must be “subordinate” to the pension benefits;
  2. Retiree medical benefits under the plan must be maintained in a separate account within the pension trust;
  3. For any key employee, a separate account must also be maintained for the benefits payable to that employee (or spouse or dependents) and, generally, medical benefits payable to that employee (or spouse or dependents) may come only from that separate account;
  4. Employer contributions to the account must be reasonable and ascertainable;
  5. All contributions (within the taxable year or thereafter) to the 401(h) account must be used to pay benefits provided under the medical plan and must not be diverted to any purpose other than the providing of such benefits;
  6. The terms of the plan must provide that, upon the satisfaction of all liabilities under the plan to provide the retiree medical benefits, all amounts remaining in the 401(h) account must be returned to the employer.

The subordinate requirement is not satisfied unless the plan provides that the aggregate contributions for retiree medical benefits, when added to the actual contributions for life insurance under the plan, are limited to 25 percent of the total contributions made to the plan (other than contributions to fund past service credits).

Aside from employer and/or employee contributions to a 401(h) account, plan sponsors may make tax-free “qualified transfers” of excess pension assets within their defined benefit plans to related 401(h) accounts. A plan is deemed to have excess assets for this purpose if assets exceed 125 percent[2] of the plan’s liability (IRC §420).  The requirements of a qualified transfer include the following:

  1. The transferred amount can be used to pay medical benefits for either the year of the transfer or the year of transfer and the future transfer period (i.e., a qualified future transfer);
  2. The transferred amount must approximate the amount of medical expenses anticipated for the year of transfer or the year of transfer and future years during the transfer period;
  3. An employer can make only one such transfer in a year;
  4. All accrued benefits of participants in the defined benefit plan must be fully vested; and
  5. The employer must commit to a minimum cost requirement with respect to the medical benefits.

Conclusion

Pension plan sponsors may find 401(h) accounts appealing as one way to provide for the payment of retiree medical benefits. Depending on the terms of the plan, a 401(h) account can receive employer and/or employee contributions as well as transfers of excess pension benefits, provided certain requirements are met. 401(h) account contributions are tax deductible; earnings are tax-deferred; and distributions can be tax free.

[1] Or money purchase pension plan or annuity plan

[2] For qualified future transfers, substitute 120 percent

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Correcting IRC §409A Plan Compliance Errors

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“Is there a correction program for Internal Revenue Code Section (IRC §) 409A nonqualified plans, similar to the Employee Plans Compliance Resolution System (EPCRS) for qualified retirement 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 plans, including nonqualified 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 Massachusetts is representative of a common inquiry related to nonqualified deferred compensation plans.

Highlights of Discussion

While there is no one comprehensive program like EPCRS for the correction of failures for IRC § 409A nonqualified deferred compensation plans (409A plans), the IRS has issued a series of notices containing pre-approved correction methods for certain operational failures and document noncompliance issues for such plans [IRS Notices 2008-113, 2010-6, 2010-80 and 2007-100  (which employers can follow in lieu of Notice 2008-113 for pre-2009 operational errors)]. Following the correction methods can help participants reduce or delay early taxation of their deferred compensation and avoid penalties.

If a business with a 409A plan fails to operate the plan in accordance with the requirements of IRC §409A, affected participants may become subject to current income taxation of their deferred compensation, as well as have interest and penalties assessed. Generally, all amounts that are deferred under a noncompliant 409A plan for the taxable year and all preceding taxable years are includable in gross income for the taxable year, unless the amount is subject to a substantial risk of forfeiture or has previously been included in gross income. The IRS assesses interest on such amounts included in income at the IRS underpayment rate plus one percent, and applies a 20 percent penalty.  Moreover, state and local tax rules and penalties may apply. The IRS has issued proposed regulations [Treasury Regulations Section 1.409A-4(a)(1)(ii)(B)] on how to calculate the amount of income to include when a failure occurs.

IRS Notice 2008-113 covers corrections for 409A operational failures, including, but not limited to, failures to defer amounts, excess deferrals, incorrect payments, and the correction of exercise prices. The guidance of IRS Notice 2010-6 allows businesses to correct many types of 409A plan document errors, including impermissible definitions of separation of service, disability or change in control; impermissible payment events or payment schedules; impermissible payment periods following a permissible payment event; impermissible initial or subsequent deferral election procedures; and a failure to include the six-month delay of payment for specified employees of publicly traded companies.  Please note that IRS Notice 2010-80 modifies certain provisions of Notices 2008-113 and 2010-6, and should be referred to for the latest guidance.

Plan sponsors can refer to the IRS’ Nonqualified Deferred Compensation Audit Techniques Guide for issues the IRS focuses on when auditing businesses that offer 409A plans.

Conclusion

The IRS has issued a series of notices containing pre-approved correction methods for certain operational failures and document noncompliance issues for 409A plans. Following the correction methods can help participants reduce or delay early taxation of their deferred compensation and avoid penalties.

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Complete discontinuance of profit sharing plan contributions

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“I came across a prospect that froze it’s profit sharing plan several years ago, and has not made contributions since. Are there any concerns regarding the 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 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 Colorado is representative of a common inquiry related to on going contributions to a profit sharing plan.

Highlights of Discussion

While contributions to profit sharing plans are generally discretionary, meaning a plan sponsor can decide from year to year whether to make a contribution or not, the IRS expects that contributions will be “recurring and substantial” over time in order for a plan to be considered ongoing and remain viable [Treas. Reg. § 1.401-1(b)(2)].

If contributions cease, a complete “discontinuance of contributions” has occurred in the IRS’s eyes, which triggers a plan termination and complete (100%) vesting of participants’ accounts [Treas. Reg. § 1.411(d)-2(a)(1)].  Contrast this with a “suspension of contributions” under the plan, which is merely a temporary cessation of contributions by the employer. A complete discontinuance of contributions still may occur even though the employer makes contributions if such contributions are not substantial enough to reflect the intent on the part of the employer to continue to maintain the plan (e.g., only forfeitures are allocated).

The IRS makes a determination as to whether a complete discontinuance of contributions under a plan has occurred by considering all the facts and circumstances in the particular case, and without regard to any employee contributions (i.e. pre-tax deferrals, designated Roth or after-tax contributions). According to the IRS’s exam guidelines at Part 7.12.1.4, examiners are to review IRS Form 5310, line 19a, which indicates employer contributions made for the current and the five prior plan years, to determine if the plan has had a complete discontinuance of contributions. In a profit sharing plan, if the plan sponsor has failed to make substantial contributions in three out of five years, there may be a discontinuance of contributions. Other considerations include whether the employer is calling an actual discontinuance of contributions a suspension of such contributions in order to avoid the requirement of full vesting, and whether there is a reasonable probability that the lack of contributions will continue indefinitely.

Under Treas. Reg. § 1.411(d)-2(d)(2) a complete discontinuance becomes effective for a single employer plan on the last day of the employer’s tax year after the tax year for which the employer last made a substantial contribution to the profit-sharing plan. For a plan maintained by more than one employer, a complete discontinuance becomes effective the last day of the plan year after the plan year within which any employer last made a substantial contribution.

If a plan suffers a complete discontinuance and the plan sponsor has made partially vested distributions, the plan’s qualified status is at risk. The plan sponsor can fix the error by using the Employee Plans Compliance Resolution System. The correction will require restoring previously forfeited accounts to affected participants, adjusted for lost earnings, and correcting IRS Form 5500 filings for the plan.

For additional information, please refer to the IRS guidance No Contributions to your Profit Sharing/401(k) Plan for a While? Complete Discontinuance of Contributions and What You Need to Know.

Conclusion

While employer contributions to a profit sharing or stock bonus plan are discretionary in most cases (check the document language), the IRS still expects them to be recurring and substantial to a certain extent. For example, if the plan sponsor has failed to make substantial contributions in three out of five years, there may be a discontinuance of contributions, which triggers plan termination and complete vesting of benefits.

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Reasonable interest rate on plan loans

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“What interest rate should a plan apply as part of its plan loan program?”

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

Highlights of Discussion

Loans to 401(k) plan participants are generally prohibited unless they

  • Are available to all plan participants and beneficiaries on a reasonably equivalent basis;
  • Are not made more readily available to highly compensated employees, officers or shareholders than they are to other employees;
  • Are made in accordance with specific provisions set forth in the plan;
  • Are adequately secured; and
  • Bear a reasonable rate of interest [see DOL Reg. § 2550.408b-1].

The Department of Labor (DOL) gives us a guideline for what is reasonable, but with room for interpretation. According to DOL Reg. § 2550.408b-1(e), a plan’s loan interest rate is reasonable if it is equal to commercial lending interest rates under similar circumstances (see also DOL Advisory Opinion 81-12A). In an example, the DOL explained, “The trustees, prior to making the loan, contacted two local banks to determine under what terms the banks would make a similar loan taking into account the plan participant’s creditworthiness and the collateral offered.”

The IRS has similar requirements in order for a plan loan to avoid excise tax under Internal Revenue Code Section (IRC §) 4795(c) and (d)(1) for prohibited transactions. In a September 12, 2011 IRS phone forum, IRS personnel stated informally: “… as a general rule the Service generally considers prime plus 2% as a reasonable interest rate for participant loans.”

The prime rate is an interest rate determined by individual banks, and is often based on a review of the Federal Reserve Boards’ H.15 Selected Interest Rates release of prime rates posted by the majority of the largest 25 banks in the U.S.  Prime is often used as a reference rate (also called the base rate) for many types of loans.[1] Conceivably, adding one or two percentage points to the prime rate makes the interest rate charged to a participant more consistent with general consumer rates, as individuals can rarely get a loan at the going prime rate.

In its Winter 2012 publication, “Retirement News for Employers,” the IRS suggests asking the following questions to determine if a loan interest rate meets the reasonable standard:

  • What current rates are local banks charging for similar loans (amount and duration) to individuals with similar creditworthiness and collateral?
  • Is the plan rate consistent with the local rates?

According to Internal Revenue Manuals, Part 4, Section 4.72.11.4.2.1.1, IRS examination steps related to verifying a reasonable rate of interest include

  • Determining whether the plan loans’ interest rates and other conditions are comparable to the terms of similar commercial loans in the relevant community; and
  • Checking the overall rate of return on plan assets when a large percent of the plan’s assets are invested in participant loans.

On the second point above, even if the interest rate on the loans is reasonable, the overall rate of return might be unreasonable. This could occur if it is determined that a plan’s substantial investment in participant loans is causing the overall rate of return to be materially less than what could have been earned in other investment options under the plan. The DOL has opined that a participant loan as an investment would not be prudent if it provided the plan with less return, relative to risk, than comparable investments available to the plan.

Conclusion

Determining reasonableness is a question of fact and circumstances, and there is no DOL or IRS “safe harbor” rate. Plan sponsors’ must 1) take into consideration relevant current market conditions, and 2) conduct periodic reviews of the interest rate to ensure it continues to reflect current market conditions. Anytime a participant loan is refinanced, the interest rate should be reviewed and updated, if needed. Above all, plan sponsors must be able to document the process they used to determine reasonable interest rates for participant loans in order justify their selection.

[1] https://www.federalreserve.gov/faqs/credit_12846.htm

 

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After-Tax Contribution Limits in 401(k) Plans

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“What are the considerations for a 401(k) plan participant who wants to “max out” his/her after-tax contributions in the 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 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 Ohio is representative of a common inquiry related to after-tax contributions in 401(k) plans.

Highlights of Discussion

  • There are several considerations for making after-tax contributions to a 401(k) plan, including whether the plan allows for after-tax contributions and, if so, what limits apply.
  • In order for a participant to make after-tax contributions to his or her 401(k) plan, the plan document must specifically allow for this type of contribution. For example, using our “Plan Snapshot” library of employer plan documents, RLC was able to confirm that the 401(k) plan in question does permit after-tax contributions.
  • Additional considerations when making after-tax contributions include any plan specified contribution limits; the actual contribution percentage (ACP) test; and the IRC Sec. 415 annual additions test.
  • Despite having a plan imposed contribution limit of 50 percent of annual compensation according to the plan document, the advisor determined his client could maximize his pre-tax contributions and still make a large after-tax contribution as well.
  • After-tax contributions are subject to the ACP test—a special 401(k) test that compares the rate of matching and after-tax contributions made by those in upper management (i.e., highly compensated employees) to the rate made by rank-and-file employees (i.e., nonhighly compensated employees) to ensure the contributions are considered nondiscriminatory. Even safe harbor 401(k) plans are required to apply the ACP test to the after-tax contributions if any are made. If the plan fails the ACP test, a typical corrective method is a refund of after-tax contributions to upper management employees.
  • In addition, each plan participant has an annual total plan contribution limit of 100 percent of compensation up to $54,000 for 2017 and $55,000 for 2018, plus an additional $6,000 for catch-up contributions, under IRC Sec. 415 (a.k.a., the annual additions limit). All contributions for a participant to a 401(k) (e.g., salary deferrals, profit sharing, matching, designated Roth and after-tax) are included in a participant’s annual additions. If a participant exceeds his annual additions limit, a typical corrective method is a refund of contributions.
  • In general, a 401(k) plan participant can convert his after-tax account balance to a Roth IRA while working as long as 1) the plan allows for in-service distributions; 2) the after-tax contributions and their earnings have been segregated from the other contribution types in a separate account; and 3) the participant follows the standard conversion rules (IRS Notices 87-13, 2008-30 and 2014-54).

Conclusion

Roughly one-third of 401(k) plans today offer participants the ability to make after-tax contributions.[1]  While this may be viewed as a benefit from many perspectives, there are several important considerations of which plan participants must be aware.

[1] Plan Sponsor Council of America, 59th Annual Survey; and Retirement Learning Center Plan Document Database, 2018

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“Off Again” Form 5500 Compliance Questions

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“For the past couple of years, the IRS has added some extra compliance questions to the Form 5500 and related schedules—but told plan sponsors not to answer them. What is the current status of these questions?”

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 California is representative of a common inquiry related to Form 5500.

Highlights of Discussion

You are correct. For the 2015 and 2016 filings, the IRS added compliance questions to Forms 5500, 5500-SF, 5500-EZ and Schedules H, I and R. But, for each year, the IRS later instructed filers not to answer them. The IRS removed these additional questions from the 2017 version of Form 5500 and related schedules, which plan sponsors will file later in 2018 (see the 2017 Instructions to Form 5500).

“The IRS-only questions that filers were not required to complete on the 2016 Form 5500 have been removed from the [2017] Form 5500 and Schedules, including preparer information, Schedules H and I, lines 4o, and 6a through 6d, regarding distribution during working retirement and trust information, and Schedule R, Part VII, regarding the IRS Compliance questions.”

Be aware, however, that the DOL/IRS/PBGC are working on a long-term project that would improve and modernize Form 5500 in the areas of financial and other annual reporting requirements, and make the investment and other information more data mineable. We expect more updates to come in 2018.

Conclusion

The on again, off again additional IRS compliance questions on Forms 5500 are officially off the 2017 version of the forms that plan sponsors will file in 2018. There is more to come regarding a long-term project to overhaul the forms.

 

 

 

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Plan Compensation and Imputed Income

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“What is imputed income and how does it affect a 401(k) plan, if at all?”

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 Virginia is representative of a common inquiry related to compensation.

Highlights of Discussion

Imputed income relates to group term life insurance (GTLI). Offering GTLI may affect the administration of an employer’s qualified retirement plan, depending on the definition of compensation selected for plan purposes.

The first $50,000 of employer-provided GTLI is excludable from an employee’s taxable income pursuant to Internal Revenue Code Section (IRC) §79. Once the amount of coverage exceeds $50,000, the imputed cost of coverage, based on the IRS Premium Table, is subject to income, Social Security and Medicare taxes (see IRS Publication 15-B). The imputed income is considered a taxable fringe benefit to the employee.

An employer must report the amount as wages in boxes 1, 3, and 5 of an employee’s Form W-2, and also show it in box 12 with code “C.” At an employer’s discretion, it may withhold federal income tax on the amount.

As taxable income, the amount may be included in the definition of compensation that is specified in the governing documents of an employer’s retirement plan. For example, with respect to the safe harbor definitions of compensation that plans may use, treatment of imputed income is as follows.

Compensation Type Form W-2 3401(a) 415 Safe Harbor
Taxable premiums for GTLI Included Excluded Included

 

Conclusion

Imputed income from GTLI coverage may be includible compensation for retirement plan administrative purposes. Employers and plan administrators must always refer to the specific definition of compensation elected in the plan document to know when to include or exclude imputed income.

 

 

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Mid-Year Changes to Safe-Harbor 401(k) Plans

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“What changes, if any, can an employer make to a safe harbor 401(k) plan during the plan year, while maintaining safe harbor status?”

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 Washington D.C. is representative of a common inquiry related to making changes to a safe harbor 401(k) plan.

Highlights of Discussion

Sponsors of safe harbor 401(k) plans[1] have a limited ability to alter their plans mid-year without jeopardizing their safe harbor status. Any change must be one the IRS views as “permissible” and, oftentimes, employees must receive notification and have a new deferral election opportunity.

Notice 2016-16 provides that a mid-year change to a safe harbor plan or to a plan’s safe harbor notice does not violate the safe harbor rules merely because it is a mid-year change, if the

  • Plan satisfies the notice and election opportunity conditions, if applicable, and
  • Change is not a prohibited mid-year change as listed in Notice 2016-16.Permissible Changes
  • According to the notice, permissible mid-year changes include
  1. Increasing future safe harbor non-elective contributions from 3% to 4% for all eligible employees;
  2. Certain increases to matching contributions adopted at least three months before the end of the plan year;[2]
  3. Adding an age-59 ½, in-service withdrawal feature;
  4. Changing the plan’s default investment fund;
  5. Altering the plan rules on arbitration of disputes;
  6. Shifting the plan entry date for employees who meet the plan’s minimum age and service eligibility requirements from monthly to quarterly; and
  7. Adopting mid-year amendments required by applicable law (for example, newly effective laws).

Changes 1-4 require an updated notice and an additional election period as explained next.

Notice Requirements

When required, sponsors must provide an updated safe harbor notice that describes the mid-year change and its effective date within a reasonable period before the effective date of the change. Providing the notice 30-90 days before the effective date is deemed reasonable. If is it not possible for the plan sponsor to distribute the updated safe harbor notice before the effective date of the change, it must provide the notice as soon as practicable, but not later then 30 days after the date the changes is adopted.

Election Requirement

When required, sponsors must give each notified employee a reasonable period of time to change his or her cash or deferral election after receipt and before the effective date of the change. A 30-day election period is deemed reasonable. However, if it is not possible to provide the election opportunity before the effective date of the change (e.g., retroactive plan amendment), then the election opportunity must begin as soon as practicable after the notice date, but not later than 30 days after the date the change is adopted.

EXAMPLE Plan M:

  • Traditional 401(k) matching safe harbor plan
  • Operated on a calendar year
  • Match is calculated on a per payroll-period basis
  • A mid-year amendment is made August 31, 2018, to 1) increase the safe harbor matching contribution from 4% to 5%; and 2) change from a payroll-period match to a full-plan-year match
  • Both changes are retroactively effective to January 1, 2018

Due to the retroactive effective date of the change, the sponsor cannot provide an updated notice and give an additional election opportunity to employees prior to the January 1, 2018, effective date. On September 3, 2018, the first date that an updated notice and additional election opportunity can practicably be provided, the sponsor distributes an updated notice that describes the increased contribution percentage and gives an additional 30-day election period starting September 3, 2018. The mid-year change is a permissible change, and notice and election requirements are met.

Conclusion

Sponsors of safe harbor plans often wonder if they can make changes to their plans mid year. The answer is yes, provided any change is of the permissible variety, and notice and election requirements are met.

 

[1] IRC §§ 401(k)(12) or 401(k)(13) and/or 401(m)(11) or 401(m)(12), and 403(b) plans that apply the IRC § 401(m) safe harbor rules pursuant to IRC § 403(b)(12).

[2] Adopted at least three months before the end of the plan year, made retroactively effective, revocation of payroll period allocation, and new notice and election period apply.

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IRA
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Active Plan Participant and IRA Contributions

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“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

For purposes of the IRA deduction rules, an individual shall be 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.

 

Form W-2 Box 13 Retirement Plan Checkbox Decision Chart

Type of Plan Conditions Check Retirement Plan Box?
Defined benefit plan (for example, a traditional pension plan) Employee qualifies for employer funding into the plan, due to age/years of service—even though the employee may not be vested or ever collect benefits Yes
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee is eligible to contribute but does not elect to contribute any money in this tax year No
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee is eligible to contribute and elects to contribute money in this tax year Yes
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee is eligible to contribute but does not elect to contribute any money in this tax year, but the employer does contribute funds Yes
Defined contribution plan (for example, a 401(k) or 403(b) plan, a Roth 401(k) or 403(b) account, but not a 457 plan) Employee contributed in past years but not during the current tax year under report No (even if the account value grows due to gains in the investments)
Profit-sharing plan Plan includes a grace period after the close of the plan year when profit sharing can be added to the participant’s account Yes

 

If a person is an active participant, he or she must apply income thresholds to determine whether an IRA contribution is deductible or not. Please refer to the following chart

IRA Contribution Deductibility

 

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]  IRS Notice 87-16

 

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