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Participant in SIMPLE IRA and 401(k) with Separate Employers

Deferral limit involving SIMPLE IRA and 401(k) plans

“I have a client—over age 50—who participates in a savings incentive match plan for employees (SIMPLE) IRA plan with one of his employers and a 401(k) plan with a separate employer. How much can my client defer into the SIMPLE IRA plan and 401(k) 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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • To determine the answer to your question your client must look at his overall Internal Revenue Code Section (IRC §) 402(g) employee salary deferral limit and the rule that limits employee salary deferrals to the SIMPLE IRA plan under IRC § 408(p)(2)(A)(ii).
  • For each tax year IRC §402(g) limits an individual’s overall employee salary deferrals combined across all eligible plans (e.g., deferrals made to a SIMPLE IRA plan and 401(k) plan) to a set amount. For 2016 and 2017, a person’s 402(g) limit is 100 percent of compensation up to a maximum of $18,000 if he or she is under age 50, and is $24,000 if he or she is age 50 or greater and making catch-up contributions.
  • The maximum amount that a SIMPLE IRA plan participant may defer into the SIMPLE IRA plan is limited to 100 percent of compensation up to a maximum of $12,500 for 2016 and 2017 or, if he or she is age 50 and over, to $15,500 (which includes catch-up contributions of $3,000).
  • Therefore, your client, being over age 50, could choose to make employee salary deferral contributions to the SIMPLE IRA plan in any amount as long as he does not exceed 100 percent of compensation up to $15,500. He could defer the balance of his 402(g) limit up to 100 percent of compensation up to $24,000 to the 401(k) plan IRS Publication 560 and IRS Notice 98-4, Q&A C-3.

 

EXAMPLE

Seth, age 53, participates in a SIMPLE IRA plan with Employer A and a 401(k) plan with Employer B.  Based on his compensation he decides to defer $15,500 to his SIMPLE IRA plan ($3,000 of which is considered a catch-up contribution).  In order to stay within his 402(g) annual limit across all eligible plans in which he participates, Seth may only defer up to $8,500 to his 401(k) plan.  Note that Seth’s overall 402(g) limit of $24,000 could be allocated as he wishes between the two plans, as long as his deferrals do not exceed $15,500 to the SIMPLE IRA plan.

 

Conclusion

An individual who participates in a SIMPLE IRA plan and a 401(k) plan of a different employer must look at his or her overall 402(g) employee salary deferral limit and the rule that limits employee salary deferrals to the SIMPLE IRA plan in order to determine the amount that can be deferred into each plan.

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Aggregating RMDs

My client, who is retired, has a Roth IRA, multiple traditional IRAs and a 401(k) plan, and is over age 70 ½.  Can a distribution from his 401(k) plan satisfy all RMDs that he is obliged to take for the year?

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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

    • No, your client may not use the RMD due from his 401(k) plan to satisfy the RMDs due from his IRAs (and vice versa). He must satisfy them independently from one another.
    • Participants in retirement plans, such as 401(k) plans, are not allowed to aggregate their RMDs [Treasury Regulation 1.409(a)(9)-8, Q&A 1]. If an employee participates in more than one qualified retirement plan, he or she must satisfy the RMD from each plan separately.
    • However, there are special RMD “aggregation rules” that apply to individuals with multiple traditional IRAs, as explained next.
    • The IRA RMD rules allow IRA owners to independently calculate the RMDs that are due from each IRA they own directly (including savings incentive match plan for employees (SIMPLE IRAs, simplified employee pension (SEP) IRAs and traditional IRAs), total the amounts, and take the aggregate RMD amount from an IRA (or IRAs) of their choosing that they own directly (Treasury Regulation 1.408-8, Q&A 9).
    • RMDs from IRAs that an individual holds as a beneficiary of the same decedent may be distributed under these rules for aggregation, considering only those IRAs owned as a beneficiary of the same decedent.
    • Roth IRA owners are not subject to the RMD rules but, upon death, their beneficiaries would be required to commence RMDs.
    • 403(b) participants have RMD aggregation rules as well. A 403(b) plan participant must determine the RMD amount due from each 403(b) contract separately, but he or she may total the amounts and take the aggregate RMD amount from any one or more of the individual 403(b) contracts.  However, only amounts in 403(b) contracts that a individual holds as an employee may be aggregated. Amounts in 403(b) contracts that an individual holds as a beneficiary of the same decedent may be aggregated [Treasury Regulation 1.403(b)-6(e)(7)].

Conclusion

Individuals who are over age 70 ½, generally, are required to take RMDs from their tax-favored retirement accounts on an annual basis. There is some ability to pool certain accounts for RMD purposes, but the RMD aggregation rules are complex. Therefore, the guidance of a financial professional is suggested.

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ESOP Tax Advantaged 1042 exchange

 

“I have a client who is retiring from a company with an ESOP, and will be selling his shares in his company.  This could subject him to a large tax bill.  Do you have any suggestions on how he might lessen the tax hit?”

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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of discussion

  • Yes, if your client qualifies for a tax-free “1042 Exchange” he can defer capital gains tax on “qualified securities” sold to an ESOP if the proceeds of the sale are reinvested in “qualified replacement property” (QRP) as defined in IRC §1042(c)(4). Stockholders interested in a 1042 Exchange should discuss the option with their attorneys and/or tax advisors before proceeding.
  • Qualified securities for this purpose are employer securities of a C corporation that are either 1)  common stock with voting and dividend rights at least equal to the class of common stock with the greatest dividend rights and the greatest voting rights) or 2) noncallable preferred stock which is convertible into such common stock.
  • QRP includes common stock, preferred stock, bonds, and convertible bonds of operating companies incorporated in the U.S., where 50% of the company’s assets are used in active conduct of a trade or business and no more than 25% of its gross receipts can come from passive sources.
  • The seller will not owe taxes until he later sells the QRP. If the 1042 Exchange is structured properly, the seller could avoid paying all long-term capital gains taxes in certain circumstances. If the selling shareholder dies before liquidating the QRP, thereby leaving the funds as an asset of the estate, the property receives a stepped-up basis and can avoid capital gains all together.
  • Generally, for the sale of stock to qualify for the special tax treatment allowed under IRC 1042, certain criteria must be met.
  • The qualified securities must be sold to an ESOP
  • The selling shareholder must have held the stock for at least three years to qualify
  • Following the sale to the ESOP, the plan must own at least 30% percent of each class of stock or the total value of all outstanding stock of the corporation.
  • The seller must reinvest the proceeds into QRP within 12 months following the sale to the ESOP.
  • Treasury Regulations Section 1.1042-1T  prescribes the requirements of a proper 1042 Election.  The taxpayer must make a written statement of election, attach it to his income tax return, and file on or before the due date (including extensions) for the taxable year in which the sale occurs. The domestic company must consent. Taxpayers who fail to make a timely election cannot subsequently make it on an amended return. And once made, elections are irrevocable.

Conclusion

Properly executed, a 1042 Exchange with an ESOP can be a tax-advantaged way for certain shareholders to sell their stock and delay and, potentially, avoid long-term capital gains tax. Stockholders interested in such a transaction should discuss the option with their attorneys and/or tax advisors.

 

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401(k) and Nonqualified Deferred Compensation plans

 

“My client has a 401(k) excess contribution as a result of a failed actual deferral percentage (ADP) test.  However, he was told he could roll over the excess contribution to another of his employer’s plans.  How could that be; I thought excess contributions were ineligible for rollover?”

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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • You are correct; 401(k) excess contributions are not eligible to be rolled over to an “eligible retirement plan” pursuant to Internal Revenue Code Section (IRC §) 402(c)(8)(b). The term eligible retirement plan is defined as an individual retirement account under IRC §408(a); an individual retirement annuity under IRC § 408(b); a qualified trust; a qualified annuity plan under IRC § 403(a); a governmental plan under IRC §457(b); and an IRC §403(b) plan.
  • However, it is possible that, in addition to the 401(k) plan, your client’s employer maintains a plan that is not an eligible retirement plan, such as a nonqualified deferred compensation plan (NQDC) under IRC §409A.
  • An NQDC plan is an agreement, method, or arrangement between an employer and an employee (or service recipient and service provider) to pay the employee or independent contractor compensation in the future for service presently performed. NQDC plans allow employees to defer compensation until retirement or some other predetermined date. A thorough discussion of NQDC plans is beyond the scope of this writing.
  • NQDC plans are an attractive benefit for highly paid employees because they are free from the contribution limits, participation requirements and nondiscrimination restrictions that apply to qualified plans. Because NQDC plans are not subject to the limitations of qualified retirement plans, they can allow some executives and high-level managers to defer a much larger portion of their compensation than permitted under qualified plans.
  • If permitted under the terms of the plan document, participants may have the option to contribute to the NQDC their excess contributions that occurred in their 401(k) plans. These NQDC plans may be referred to as “401(k) excess plans” or “401(k) wrap plans.” The contribution to the NQDC plan is not a rollover, but is considered an additional type of permissible deferral under the NQDC plan.
  • A best practice would be to get a copy of the NQDC plan document and check to see if there is language in the plan that addresses the ability of participants to defer excess contributions. The consultants at the Learning Center review NQDC plans documents, as well as other types of plan documents, daily.

 

Conclusion

While 401(k) participants may not roll over excess contributions to another eligible retirement plan, it may be possible for them to defer their excesses into a NQDC or 401(k) wrap plan, if one exists. Check the NQCD plan document for accommodating language.

 

 

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RMDs and More than 5 Percent Owners

“My client’s 401(k) plan allows participants who are not five-percent owners of the company to delay taking their RMDs until after they retire. How is ‘five-percent owner’ defined for RMD purposes?”

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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

•The IRS requires those who are considered “five-percent owners” of the employer to begin their RMD no later than April 1 of the calendar year following the year in which they attain age 70½. For example, if a five-percent owner turns age 70 ½ in 2016, he or she must begin RMDs by April 1, 2017.

•For RMD purposes, a five-percent owner is an employee who is a five-percent owner [as defined in Internal Revenue Section (IRC §416) with respect to the plan year ending in the calendar year in which the employee attains age 70 ½ [Treasury Regulation §1.401(a)(9)-2, Q&A-2(c)].

•Under IRC §416(i)(1)(B)(I), the term “five-percent owner” means the following:

•If the employer is a corporation, any person who owns (or is considered as owning within the meaning of IRC § 318) more than five-percent of the outstanding stock of the corporation or stock possessing more than five-percent of the total combined voting power of all stock of the corporation, or

•If the employer is not a corporation, any person who owns more than five-percent of the capital or profits interest in the employer.

•A person might be a more than five-percent owner through “constructive ownership.” The IRS outlines its constructive ownership rules in IRC § 318. Generally, an individual shall be considered as owning the stock owned, directly or indirectly, by or for his spouse, and his children, grandchildren, and parents.

Conclusion

401(k) plan participants who are more than five-percent owners of the business sponsoring the plan must begin their RMDs no later than April 1 of the year following their age 70 ½ year. Constructive ownership rules could cause a plan participant to be considered a more than five-percent owner for RMD purposes.

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Non Spouse Beneficiary Rollovers

“My client, who is a nonspouse beneficiary of a deceased 401(k) plan participant, requested and received a distribution of the inherited account balance.  Can she complete a 60-day rollover?”

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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • No, the IRS does not allow nonspouse beneficiaries to complete indirect or 60-day rollovers of amounts received from a 401(k) plan.
  • If a nonspouse beneficiary wants to complete a rollover of inherited plan assets, he or she must do so through a “direct rollover” to an inherited IRA.  (See IRS Notice 2007-7  Q&A 15). The Pension Protection Act of 2006 introduced this option for nonspouse beneficiaries, effective for 2007 and later years. The direct rollover option for nonspouse beneficiaries applies to IRC §401(a) qualified retirement plans, as well as IRC §§403(b) and governmental 457(b) plans.
  • A direct rollover is a transfer of plan assets from the trustee of the plan to the trustee of the inherited IRA (i.e., a trustee-to-trustee transfer), without receipt by the beneficiary of the assets.
  • A qualified plan can (but is not required to) offer a direct rollover of a distribution to a nonspouse beneficiary, provided the distributed amount satisfies all the requirements to be an eligible rollover distribution.
  • The direct rollover must be made to an IRA established on behalf of the designated beneficiary that will be treated as an inherited IRA. If a nonspouse beneficiary elects a direct rollover, the amount directly rolled over is not includible in gross income in the year of the distribution.
  • The receiving IRA must be established in a manner that identifies it as an IRA with respect to the deceased plan participant and the beneficiary, for example, “Tom Smith as beneficiary of John Smith.”
  • If a nonspouse beneficiary receives an amount distributed from a plan, the distribution is not eligible for rollover, and is includible in income in the year of the distribution.

Conclusion

The plan-to-IRA rollover rules for nonspouse beneficiaries are different than those that apply to spouse beneficiaries. If a nonspouse beneficiary wants to complete a rollover of inherited plan assets, he or she must do so through a direct rollover to an inherited IRA.

 

 

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Valuing Life Insurance

 

“Is there any guidance on valuing a life insurance contract distributed from a 401(k) 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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • Fortunately, there is.  The IRS has provided safe harbor rules for determining the fair market value of life insurance contracts distributed from a qualified retirement plan in Revenue Procedure (Rev. Proc.) 2005-25.
  • Under Internal Revenue Code Section (IRC §) 402(a), amounts distributed to a plan participant, generally, are taxable in the year in which they are paid to the employee.
  • Treasury regulations (Treas. Regs.) provide that the cash value of any retirement income, endowment or other life insurance contract is includible in gross income at the time of the distribution [Treas. Reg. § 1.402(a)-1(a)(2)].
  • However, sometimes the stated cash surrender value of a contract does not accurately reflect its actual fair market value.  In Rev. Proc. 2004-16, which was superseded by Rev. Proc. 2005-25, the IRS provides a formulaic approach to valuing a life insurance contract. The IRS issued the rev. procs. primarily to address the issue of a “springing cash value plan,” a policy in which, for the first few years, the cash surrender value of the policy is much lower than the value of the premiums paid or the reserve accumulations (Internal Revenue Manual 4.72.8.5.3).
  • Plan sponsors should ensure providers of life insurance contracts and plan record keepers are following the guidance of Rev. Proc. 2005-25 when determining the fair market value of a distributed life insurance contract.

 

Conclusion

Sometimes the stated cash surrender value of a life insurance contract does not accurately reflect its actual fair market value. Rev. Proc. 2005-25 provides a safe harbor means to calculate the fair market value of life insurance contracts.

 

 

 

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Multi and Multiple Employer Plans: What’s the Difference?

“I’ve heard the terms ‘multiemployer plan’ and ‘multiple employer plan;’ is there a difference?”

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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • Yes, there is a difference, and knowing the distinction is important. The two terms are often confused.
  • A multiemployer plan refers to a collectively bargained plan maintained by more than one employer, usually within the same or related industries, and a labor union. These plans are often referred to as “Taft-Hartley plans” [(ERISA §§ 3(37) and 4001(a)(3)]. Multiemployer plans must comply with the qualification rules under IRC §414(f).
  • Multiemployer plans allow employees who move among employers within unionized industries – such as trucking, construction and grocery-store chains – to participate in the same retirement plan negotiated under either separate or common collective bargaining agreements.
  • For in-depth guidance on multi-employer plans, please refer to the IRS’ Internal Revenue Manual, Part 7, Chapter 11, Section 7.11.6
  • In contrast, a multiple employer plan is a plan maintained by two or more employers who are not related under IRC §414(b) (controlled groups), IRC §414(c) (trades or businesses under common control), or IRC § 414(m) (affiliated service groups). Multiple employer plans must comply with the qualification rules under IRC §413(c).
  • The Department of Labor provided some important guidance on the treatment of multiple employer plans in Advisory Opinion 2012-04A .
  • For in-depth guidance on multiple employer plans, please refer to the IRS’  Internal Revenue Manual, Part 7, Chapter 11, Section 7.11.7

 

Conclusion

The terms multi- and multiple employer plans are often confused. Knowing the difference is important as they refer to two completely different types of plans that involve more than one employer.

 

 

 

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Definition of Compensation in a 401 (k) Plan

“What is the definition of compensation used in a 401(k) 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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • Generally speaking, there are several definitions of compensation that may come into play for the purposes of administering qualified retirement plans, such as 401(k) plans. The definition can vary depending on the purpose for its application [e.g., nondiscrimination testing, annual additions testing, maximum deductible contribution, etc.].
  • Ultimately, plan administrators must carefully read the plan document, and follow the definition(s) of compensation as specified therein for the unique purpose.
  • Take nondiscrimination testing, for example. A plan must use a definition of compensation that satisfies Internal Revenue Code Section (IRC §) 414(s) in determining whether the plan has satisfied the nondiscrimination rules [e.g., actual deferral percentage (ADP) and actual contribution percentage (ACP) testing]. There are several definitions of compensation that qualify as IRC §414(s) compensation:
  1. The statutory definition of Treas. Reg. §1.415(c)-2(a)–2(c) (a.k.a., “415 compensation”)
  2. The simplified definition, which is defined at Treas. Reg. §1.415(c)-2(d)(2)
  3. W-2 wages, which is defined at Treas. Reg. §1.415(c)-2(d)(4)
  4. Wages for income tax withholding under IRC §3401(a), defined at Treas. Reg. §1.415(c)-2(d)(3)
  5. One of the above definitions with certain adjustments
  6. Any reasonable definition of compensation that does not favor highly compensated employees
  • The IRS has a helpful comparison table that illustrates what items of pay (e.g., nonstatutory stock options or tips) are included or excluded under the various definitions of compensation for nondiscrimination purposes.  It is part of “Exhibit B,” found on page 47 of the IRS’ CPE course on Compensation.
  • It warrants repeating that it is essential for plan administrators to understand 1) the particular plan purpose for which a definition of compensation is needed, 2) how the plan document defines compensation for that particular purpose, and 3) how to accurately apply the definition.
  • Failure to follow the correct definition of compensation for a plan is an operational failure that could affect its qualified status if not properly corrected.  The IRS has suggestions on Avoiding Compensation Errors in Retirement Plans and how to correct them if they occur.

 

Conclusion

Several definitions of compensation may come into play for the purposes of administering qualified retirement plans. It is essential for plan administrators to understand 1) the particular plan purpose for which a definition of compensation is needed, 2) how the plan document defines compensation for that particular purpose, and 3) how to accurately apply the definition.

 

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Standards for Form 5500 Plan Audits

“For qualified retirement plans that are subject to an audit by an independent qualified public accountant (IQPA) as part of Form 5500 filing requirements, what audit standards apply?”

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 and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • Sponsors of plans subject to a Form 5500 audit have a fiduciary responsibility to prudently select the IQPAs they use.1 Incomplete, inadequate, or untimely audit reports may result in penalties for the plan sponsor.  The DOL has a booklet sponsors can refer to, Selecting an Auditor for Your Employee Benefit Plan.
  • IQPAs must perform their ERISA plan audits using three sets of auditing standards:  the Generally Accepted Auditing Standards (GAAS), the Generally Accepted Accounting Principles (GAAP) and the Employee Retirement Income Security Act of 1974 (ERISA) reporting and disclosure requirements as defined by Department of Labor (DOL) regulations.
  • GAAP and GAAS standards are set by the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA).  The DOL plays no role in establishing GAAP and GAAS standards.
  • ERISA’s reporting and disclosure requirements are found at ERISA §103(a)(3)(A) and DOL regulation 29 CFR 2520.103-1(b).
  • In 2015, the DOL released a report, Assessing the Quality of Employee Benefit Plan Audits, in which it summarized the results of a study on the quality of IQPAs’ audits of ERISA-covered employee benefit plans. The study showed that 39 percent of the audits contained major deficiencies with respect to one or more relevant GAAS and/or GAAP requirements.  The leading GAAS and GAAP failures were
  • Inadequate footnote disclosures,
  • Inappropriate presentation of financial information on financial statements,
  • Lack of ASC 820 Fair Value Measurement disclosures,
  • Report not modified for lack of ERISA schedules,
  • Opinion does not extend to all financial statements and/or years presented and
  • Failure to refer to supplemental information (e.g., ERISA required schedules).
  • Furthermore, 17 percent of the audit reports failed to comply with one or more of ERISA’s reporting and disclosure requirements. The areas of ERISA noncompliance related to
  • Not attaching the supplemental schedule(s) required,
  • Incomplete or missing footnotes to the plan’s financial statements,
  • The IQPA did not manually sign the report and
  • Failure to report delinquent employee contributions.

Conclusion

The audit performed by a IQPA is an essential fiduciary element. Plan sponsors should pay keen attention and document their adherence to the DOL’s suggestions on selecting IQPAs for their plans.

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