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Beneficiary Disclaimer—Is it All or Nothing?

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“One of my clients is the beneficiary of an IRA and may want to disclaim the assets—at least in part. Could she do a partial disclaimer?”

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 New Mexico involved disclaiming an inherited IRA.

Highlights of Discussion
According to Treasury regulations, a beneficiary may disclaim a whole or partial interest in inherited property (e.g., an IRA or retirement plan account balance) and be treated as if he or she had never had rights to the property [IRC Sec. 2518(b)]. By executing a “qualified disclaimer” of benefits, the disclaimant effectively relieves herself of any tax consequences of receiving (and potentially gifting) the property that would have otherwise applied.

Disclaimers, typically, are used as a tax planning tool.  Therefore, consultation with a tax and/or legal advisor is essential. Individuals may also choose to use a beneficiary disclaimer as a pseudo legacy planning tool and disclaim their beneficial interests so that others may receive the assets. This usage is limited by the qualified disclaimer rules, which require that the disclaimant not be allowed to choose to whom the disclaimed assets will eventually pass. That is another good reason to speak with a professional advisor regarding the specifics of the situation.

A beneficiary disclaimer must be “qualified,” which means it must meet the following criteria.
1. It must be in writing.
2. It must be irrevocable.
3. The disclaiming party must give the written disclaimer to the holder of the property’s legal title (e.g., the IRA or qualified plan administrator) not later than nine months after the later of
• The death of the original owner (e.g., IRA owner or plan participant), or
• The day on which such person attains age 21.
4. The disclaimant may not have accepted the disclaimed interest or any of its benefits.
5. The disclaimed interest shall pass—without direction on the part of the disclaimant— to any remaining beneficiaries.
6. The disclaimer must meet all requirements of applicable state law

A beneficiary of an IRA or retirement plan account balance that properly disclaims inherited assets during the period between the IRA owner’s or plan participant’s death and September 30 of the year following the year of death will not be considered a designated beneficiary for distribution purposes [Treasury Regulation (Treas. Reg.) 1.401(a)(9)-4, Q&A-4].

Regarding disclaimers of a partial interest, pursuant to Treas. Reg. 25.2518.3, it is possible for a beneficiary to disclaim less than an entire interest in property. The key to a valid partial disclaimer is the ability to identify a “separate interest” in severable property. Severable property is property that can be divided into separate parts each of which, after severance, maintains a complete and independent existence. For example, a beneficiary of shares of corporate stock may accept some shares of the stock and make a qualified disclaimer of the remaining shares. Because the rules are intricate, guidance by tax and/or legal advisors is recommended.

Conclusion
A qualified disclaimer is an irrevocable refusal by a beneficiary, including a beneficiary of retirement assets, to accept an interest in property pursuant to IRC Sec. 2518(b). A beneficiary can refuse to accept her entire interest in property or a partial share under certain circumstances. The nuances of beneficiary disclaimers are many. Therefore, anyone interested in executing a qualified disclaimer is cautioned to seek the guidance of an experience tax and/or legal advisor for his or her specific situation

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Filing Form 5500 Without an Audit Report

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“My client is afraid the audit report for his 401(k) plan will not be complete by the October 15th extended filing deadline. Can he file Form 5500 without the audit report by the deadline, and provide the audit report later?”

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 West Virginia involved filing a Form 5500, Annual Return/Report of Employee Benefit Plan.

Highlights of Discussion

The Department of Labor’s (DOL’s) EFAST2 electronic system will accept a Form 5500 filing without the independent qualified public accountant (IQPA) audit report attached, however the DOL will treat the submission as an “incomplete filing and [it] may be subject to further review, correspondence, rejection, and assessment of civil penalties” (see Q&A 25 of FAQs on EFAST2 Electronic Filing System).

The guidance goes on to state that filers must correctly complete Schedule H, Part III, line 3 regarding the plan’s IQPA report. That means your client will only be able to fill in the information on 3(c) Name and EIN of the IQPA. Lines 3(a), (b) and (d) would not apply in this case and must be left blank. If your client files Form 5500 without the required IQPA report, he or she should correct that error as soon as possible.

Excerpt from Schedule H, Form 5500

 

Without the required IQPA report, the filing is incomplete and the DOL may (and likely will) reject the filing pursuant to ERISA Sec. 104(a)(5). If your client receives an official rejection letter or notice from the DOL, he or she has 45 days to resubmit the filing correctly [see ERISA Sec. 104(a)(5)] . Failure to submit a corrected filing allows the DOL to issue a notice of intent to assess a penalty. Note, there is a 30-day grace period to ask for waiver of the penalty due to reasonable cause [DOL Regulation 2560.502c-2(b) & (e)].

The DOL can assess a penalty of up to $2,400 a day for each day a plan administrator fails or refuses to file a complete report (ERISA Sec. 502(c)(2) and DOL Reg. 2560.502c-2). The IRS may separately assess penalties per the SECURE Act, effective for returns due after December 31, 2019, the IRS late fees are $250 per day up to $150,000. Both agencies could waive or abate those penalties if the plan sponsor can establish “reasonable cause” for the late filing.

The DOL’s Delinquent Filer Voluntary Compliance Program (DFVCP) encourages voluntary compliance with Form 5500 filing requirements and gives delinquent plan administrators a way to avoid higher civil penalty assessments by satisfying the program’s requirements and voluntarily paying a reduced penalty. Eligibility for the DFVCP is limited to plan administrators who have not been notified in writing by the DOL of a failure to file.

Conclusion

The DOL will accept a Form 5500 filing without the IQPA audit report attached, however the agency will treat the submission as an incomplete filing, subject to penalties if not timely corrected and resubmitted.

 

 

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What’s My Limit? Contributions to both a 403(b) and a governmental 457(b) plan

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“One of my clients participates a 403(b) plan and a governmental 457(b) plan (through a state university). Her accountant is telling her that she, potentially, could contribute $41,000 of deferrals between the two plans for 2022.  How can that be so?”

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 Illinois is representative of a common inquiry related to the maximum annual limit on employee salary deferrals.

Highlights of Discussion

Generally speaking, it may be possible for her to contribute more than one would expect given the plan types she has and based on existing plan contributions rules, which are covered in the following paragraphs. Your client should rely on her tax advisor in order to determine what amounts she can contribute to her employer-sponsored retirement plans because this is an important tax question that is best answered with the help of professionals.

For 2022, 457(b) contributions (consisting of employee salary deferrals and/or employer contributions combined) cannot exceed $20,500, plus catch-up contribution amounts ($6,500) if eligible [Treasury Regulation Section (Treas. Reg. §1.457-5)]. Since 2002, contributions to 457(b) plans no longer reduce the amount of deferrals to other salary deferral plans, such as 401(k) or 403(b) plans. A participant’s 457(b) contributions need only be combined with contributions to other 457(b) plans when applying the annual contribution limit. Therefore, contributions to a governmental 457(b) plan are not aggregated with deferrals an individual makes to other types of deferral plans.

Consequently, an individual who participates in both a governmental 457(b) plan and one or more other deferral-type plans, such as a 403(b), 401(k), salary reduction simplified employee pension plan, or savings incentive match plan for employees has two separate annual deferral limits. Here’s an example.

Example

For 2022, 32-year-old Toni is on the faculty at the local state university and participates in its 457(b) and 403(b) plans. Assuming adequate levels of compensation, Toni can defer up to $20,500 in her 403(b) plan, plus another $20,500 to her 457(b) plan—for a total of $41,000.

Also, keep in mind the various special catch-up contribution options depending on the type of plan outlined next.

 

403(b) 457(b)
15-Years of Service with Qualifying Entity Option:[1]

 

402(g) limit, plus the lesser of

 

1) $3,000 or

2) $15,000, reduced by the amount of additional elective deferrals made in prior years because of this rule, or

3) $5,000 times the number of the employee’s years of service for the organization, minus the total elective deferrals made for earlier years.

 

Age 50 or Over Option

 

Employees age 50 or over can make catch-up contributions of $6,500 beyond the basic 402(g) limit.

 

Note:  Must apply the 15-year option first

 Age 50 or Over Option

 

Employees age 50 or over can make catch-up contributions of $6,500 beyond the basic 457 deferral limit of $20,500.

 

Special “Last 3-Year” Option

 

In the three years before reaching the plan’s normal retirement age employees can contribute either:

•Twice the annual 457(b) limit (in 2022, $20,500 x 2 = $41,000),

 

Or

 

•The annual 457(b) limit, plus amounts allowed in prior years but not contributed.

 

Note:  If a governmental 457(b) allows both the age-50 catch-up and the 3-year catch-up, one or the other—but not both—can be used.

 

Another consideration when an individual participates in more than one plan is the annual additions limit under IRC Sec. 415(c),[2] which typically limits plan contributions (employer plus employee contributions for the person) for a limitation year [3] made on behalf of an individual to all plans maintained by the same employer. However, contributions to 457(b) plans are not included in a person’s annual additions (see 1.415(c)-1(a)(2).

 

Conclusion

Sometimes individuals who are lucky enough to participate in multiple employer-sponsored retirement plan types may be puzzled by what their maximum contribution limits are. This is especially true when a person participates in a 403(b) and 457(b) plan. That is why it is important to work with a financial and/or tax professional to help determine the optimal amount based on the participant’s unique situation.

[1] A public or private school, hospital, home health service agency, health and welfare service agency, church, or convention or association of churches (or associated organization) and it is allowed by the terms of the plan document

[2] For 2022, the limit is 100% of compensation up to $61,000 (or $67,500 for those > age 50).

[3] Generally, the calendar year, unless the plan specifies otherwise

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Check Your Plan for ACA Notice Requirements

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“My client’s 401(k) plan has an automatic contribution arrangement (ACA) with immediate plan eligibility. How can the notice and plan entry requirements for this plan be satisfied?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Wisconsin addressed a question on an ACA.

Highlights of the Discussion

The notice requirements for an ACA are that an eligible employee have an “effective opportunity” to make or change an election at least once during each plan year [see Treas. Reg. Section 1.401(k)-1(e)(2)(ii)]. Effective opportunity is based on a “facts and circumstances” test.  Consequently, determining effective opportunity when a plan has immediate eligibility can be tricky.

According to IRS Revenue Ruling 2000-8, an effective opportunity occurs if the employee receives notice of the availability of the election and the employee has a “reasonable” period before the cash is currently available to make the election.  Here again, reasonable, is based on facts and circumstances. For a plan that provides for immediate entry—the notice will still be considered timely, provided the employer gives it as soon as possible after the employee’s eligibility date, and the employee may elect to defer on any compensation earned beginning on the date he or she becomes eligible. But be aware of plan document provisions that may address notice and deferral timing and/or recordkeeping platforms that may impose a “30-90 days prior” timing requirement.

IRS Notice 2009-65 contains sample plan document language that can be used for adding automatic enrollment to plans.  The notice specifies, “At least 30 days, but not more than 90 days, before the beginning of the Plan Year, the Employer will provide each Covered Employee a comprehensive notice …”  An IRS Issue Snapshot points out that

“… if the plan document has specific language describing annual notice and election requirements, compliance in operation is required. For example, Notice 2009-65, 2009-39 I.R.B. 413, includes sample language for an ACA plan that is neither a QACA[1] nor an EACA[2]. The sample language includes a mandatory annual notice to participants that must be distributed at least 30 days but not more than 90 days before the beginning of a plan year. It is common for plans to adopt the IRS’ sample plan language.”

Further, some recordkeeping systems will not allow a new plan participant to be added until after 30 days from date of hire as that is their set internal process tied to the safe harbor for notice distribution.

Conclusion

Under an ACA, an eligible employee must receive notice of the availability of the deferral election and be given a reasonable period before the cash is currently available to make the election. A reasonable period is based on facts and circumstances, but be sure to check the plan document for specific language or recordkeeper internal processes that may affect the timing.

[1] Qualified Automatic Contribution Arrangement

[2] Eligible Automatic Contribution Arrangement

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Making a “1042” Election

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“My client has an ESOP and several employees have inquired about making a ‘1042 election.’  Can you explain what a 1042 election is and how it is made?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Illinois involved questions on stock exchanges under IRC Sec. 1042.

Highlights of the Discussion

How to make a proper 1042 election is a very important tax and legal question. That is why my first response is to say that an individual contemplating such a move should work with an experienced tax or legal advisor to ensure proper filing of the 1042 election. What follows is for informational purposes only and should not be construed or relied upon as tax or legal advice.

Basically, a 1042 election allows qualifying individuals and entities to defer capital gains tax on “qualified securities” sold to an Employee Stock Ownership Plan (ESOP) if the proceeds of the sale are reinvested in “qualified replacement property” (QRP) as defined in IRC Sec. 1042(c)(4). For a general overview of qualified securities and QRP, please see an earlier Case of the Week ESOP Tax Advantaged 1042 Exchange.

Treasury Regulations Section 1.1042-1T prescribe the requirements of a proper 1042 Election. Also, see IRS Publication 550, Investment Income and Expenses  page 62 for filing details as well as Part II of IRS Form 8949, Sales and Other Dispositions of Capital Assets  and the instructions, along with Schedule D of Form 1040  and the accompanying instructions.

The IRS guidance states a taxpayer that meets the qualifications for a 1042 election, must attach three statements to his or her tax return filed with the IRS to successfully communicate his or her intent to make a 1042 election to defer capital gains tax (See Pub. 550 page 63 and PLR 200019002).

  1. Statement of Election: The filer must demonstrate his or her express written intent to elect not to recognize capital gains with respect to the sale of C corporation stock to an ESOP under IRC Sec. 1042. A very detailed description of the sale must accompany the election.
  2. Notarized Statement of Purchase: The filer must provide a signed and timely notarized statement that he or she has completed the sale of stock to the ESOP. The statement must also describe the QRP, date of purchase, the cost of the property and declare the property to be QRP for the qualified stock sold to the ESOP.
  3. Statement of Consent: The company sponsoring the ESOP must provide written consent to allow the filer to defer taxes on the sale. It must also consent to the application of certain IRS penalties under IRC Secs. 4978 and 4979A if the company sells shares purchased by the ESOP within three years or allocates them to the selling shareholder(s) and/or their families.

According to Publication 550, the filer must also attach to his or her tax filing an appropriately completed IRS Form 8949.

Conclusion

As this general description alludes, making a 1042 election to defer capital gains tax on a sale of qualified securities to an ESOP is highly nuanced. Anyone contemplating such a transaction should work with an experienced tax or legal advisor to ensure proper execution.

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“What is the ’20 percent rule’ when defining highly compensated employees?”

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“I’m familiar with the IRS’s standard definition of highly compensated employee (HCE) for retirement plans, but recently I overheard another advisor talk about applying the “20 percent rule” when determining HCEs for plan purposes. What is the 20 percent rule?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in New Jersey addressed a question on the definition of highly compensated employee (HCE).

Highlights of the Discussion

In lieu of using the IRS’s standard definition of HCE, a plan sponsor has the option of applying the 20 percent rule, otherwise known as a “Top Paid Group” election. This election allows the plan to limit the number of HCEs based on compensation to only those who are in the top 20 percent of all employees when ranked by pay.

Employers with many HCEs as determined under the standard definition of HCE, sometimes make Top Paid Group elections to limit the overall number of HCEs for plan testing purposes if the election will help them satisfy nondiscrimination requirements. Plan sponsors should work with their TPAs and recordkeepers to determine if a Top Paid Group election makes sense for their plans.

The definition of HCE for a plan is contained in the governing plan document. Generally, under IRC Sec. 414(q)(1), an HCE for a plan is a participant who either

1. Owns more than five percent of the company at any time during the current year, or the immediately preceding year; or
2. Received compensation exceeding the IRS-prescribed limit for the immediately preceding year (look back) ($130,000 for 2021 and $135,000 for 2022). [See IRC Sec. 414(q)(1)(A) and (B)]

Under the Top Paid Group election [IRC Sec. 414(q)(1)(B)(ii)], a plan participant is an HCE if he or she

• Earns over the income limit for the look-back year (as mentioned above) and
• Is within the top 20 percent of all individuals at the company when they are ranked by compensation during the look-back year.

More than 5% owners would also be HCEs if a Top Paid Group election is made.

A Very Simple Example:
Participant   % Owner   Look-Back Comp   HCE Standard   HCE Top Paid Group
Alpha            50               $750,000                Yes                        Yes
Bravo              0               $650,000                Yes                        Yes
Charlie           0               $600,000                Yes                         No
Delta              0               $130,000                 Yes                         No
Echo             50                $125,000                Yes                        Yes
Foxtrot           0                $  95,000                 No                        No
Golf                0                $  60,000                  No                        No
Hotel              0                 $   45,000                No                        No
India               0                $   35,000                 No                        No
Juliet              0                $   30,000                 No                        No

As the chart illustrates, under the standard HCE definition, HTK Inc., has five HCEs (i.e., Alpha, Bravo, Charlie, Delta and Echo). If HTK Inc., makes a Top Paid Group election, there are three HCEs (i.e., Alpha, Bravo and Echo). Charlie and Delta are no longer considered HCEs because they are not in the top-paid group, and they do not own more than 5% of HTK.

Conclusion

HCEs in a plan can be determined under the IRS’s standard or Top Paid Group definition. Plan sponsors should always check the terms of their plan document to see which definition applies, and work with their TPAs and recordkeepers to ensure proper application.

 

 

©2022 Retirement Learning Center, LLC

 

 

 

 

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Applying a QACA Election

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“My client is implementing a QACA in her 401(k) plan. Does she have to apply the default election provision to all participants?”

Highlights of the Discussion

In general, according to IRS rules, your client would not have to apply the QACA default election to any employee who is eligible to participate in the 401(k) plan prior to the effective date of the QACA and has a previous salary deferral election in place or has affirmatively elected not to defer at all [ Treas. Reg. § 1.401(k)-3(j)(1)(iii)].

However, your client should check the terms of the plan document for the precise application of the default election. Sometimes a plan can be designed to apply the default election to those participants whose current deferral percentages are less than the QACA default deferral percentage.

Also, it could be possible for a plan to contain a provision where a participant’s current election expires after a set amount of time. In that case, the plan could then apply the QACA default percentage unless the affected participant executes another affirmative deferral election or opts out.

Conclusion

In a 401(k) plan with a QACA, there are exceptions to applying the QACA default deferral percentage. The best source to turn to is the plan document for the precise application of the QACA default election.

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When a Governance Review Reveals Something is Missing

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“What should a plan committee include in its governance process?”

The Retirement Learning Center works with plan committees to help assess the effectiveness of their plan governance process. This process, known as a governance review, consists of reviewing various plan related documents to help assess how well the plan committee is satisfying its ERISA obligations. Recently, RLC completed a review for an organization in the Midwest and it was clear- something was missing.

We had requested and received the prior three years of agendas, meeting minutes and handouts, service agreements, the investment policy statement (IPS) and the plan document.

The documentation we reviewed was good. The meeting minutes were clear and well done; the investment review and assessment process was thorough and it appeared the IPS was followed appropriately. A solid array of investment options was maintained for the benefit of the participants.

Our concern was not what we saw but what was absent in meeting minutes and other materials.

The committee’s documentation only addressed investment-related issues and was devoid of any consideration or issues other than the investment process. Pursuant to the plan committee meeting minutes, no non-investment topics were ever discussed. RLC’s view is that  such an omission is problematic.

Good governance goes beyond oversight of the investment options. A good governance process should include ongoing

  • Fiduciary education,
  • Reviews of service agreements and standards,
  • Evaluations of plan documents and amendments,
  • Analyses of annual plan audits,
  • Checks on payroll remissions and
  • Participant notices and communication and
  • Government reporting.

Those are just a few of the key elements that a governance committee should evaluate, document and reflect in the agenda and meeting minutes.

A good governance process extends beyond oversight of the investment menu. We encourage plan officials to ensure their governance process is holistic and covers all aspects of plan operations, communications, and overall plan effectiveness.

 

© Copyright 2024 Retirement Learning Center, all rights reserved