Tag Archive for: 401k

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“How is a lump-sum payout of unused vacation treated for plan purposes–is it compensation?”

How is a lump-sum payout of unused vacation treated for plan purposes–is it compensation?”

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 Massachusetts is representative of a common question compensation for plan purposes.

Highlights of Discussion

  • To answer this question, we need to consider two issues—ideally with the help of a tax advisor. First, how does the IRS treat a lump-sum payout of unused vacation for tax purposes and, second, what is the definition of compensation for plan purposes according to the governing plan document?
  • The following is not tax advice, but a general explanation of the rules based on IRS source materials. With respect to the first question, the IRS treats a lump-sum payout of unused vacation as “supplemental wages” subject to Social Security and Medicare taxes according to the IRS Publication 15, (Circular E), Employer’s Tax Guide. Any federal income tax withheld will be at the IRS supplemental wage tax rate, depending on whether the supplemental payment is identified as a separate payment from regular wages or combined with regular wages. (For more information, please see Publication 15 and Treasury Decision 9276.)
  • Regarding question number two, as supplemental wages, a lump-sum payout of unused vacation would be included in the definition of compensation for plan purposes—unless it is explicitly excluded under the terms of the plan document. Therefore, be sure to check the wording of the plan document carefully.

Conclusion

The IRS treats the lump-sum payout of unused vacation as supplemental wages for tax purposes. As supplemental wages, a lump-sum payout of unused vacation would be included in the definition of compensation for plan purposes—unless it is explicitly excluded under the terms of the plan document. For specific tax advice, please see the guidance of a tax professional.

 

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Remember the Saver’s Tax Credit

“Can you remind me of the special tax credit available for individuals who make retirement savings contributions, please?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Nevada is representative of a common inquiry regarding available tax credits for personal contributions to eligible plans.

Highlights of Discussion

Absolutely, after all, it is tax time! IRA owners, retirement plan participants (including self-employed individuals) and others may qualify for the IRS’s “Saver’s Credit” for certain contributions made to eligible savings arrangements. Details of the credit appear in IRS Publication 590-A and here Saver’s Credit.

The credit

  • Equals an amount up to 50%, 20% or 10% of eligible taxpayer contributions up to $2,000 ($4,000 if married filing jointly), depending on adjusted gross income (as reported on Form 1040, 1040SR or 1040NR);
  • Relates to contributions taxpayers make to their traditional and/or Roth IRAs, or elective deferrals to a 401(k) or similar workplace retirement plan (other plans qualify so see full list below); and
  • Is claimed by a taxpayer on Form 8880, Credit for Qualified Retirement Savings Contributions.

Contributors can claim the Saver’s Credit for personal contributions (including voluntary after-tax contributions) made to

  • A traditional or Roth IRA;
  • 401(k),
  • Savings Incentive Match Plan for Employees (SIMPLE) IRA,
  • Salary Reduction Simplified Employee Pension (SARSEP),
  • 403(b),
  • Governmental 457(b),
  • Federal Thrift Savings Plan,
  • ABLE account* or
  • Tax-exempt, union pension benefit plan under IRC Sec. 501(c)(18)(D).

In general, the contribution tax credit is available to individuals who

1) Are age 18 or older;

2) Not a full-time student;

3) Not claimed as a dependent on another person’s return; and

4) Have income below a certain level (see table that follows).

* The Achieving a Better Life Experience (ABLE) Act of 2014 allows states to create tax-advantaged savings programs for eligible people with disabilities (designated beneficiaries). Funds from ABLE accounts can help designated beneficiaries pay for qualified disability expenses on a tax-free basis.

2021 Saver’s Credit Income Levels

Credit Rate Married Filing Jointly Head of Household All Other Filers*
50% of your contribution AGI not more than $39,500 AGI not more than $29,625 AGI not more than $19,750
20% of your contribution $39,501 – $43,000 $29,626 – $32,250 $19,751 – $21,500
10% of your contribution $43,001 – $66,000 $32,251 – $49,500 $21,501 – $33,000
0% of your contribution More than $66,000 More than $49,500 More than $33,000

*Single, married filing separately, or qualifying widow(er)

The IRS has a handy on-line “interview” that taxpayers may use to determine whether they are eligible for the credit.

Conclusion

Every deduction and tax credit counts these days. Many IRA owners and plan participants may be unaware of the retirement plan-related tax credits for which they may qualify.

 

 

 

 

 

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“I’m confused about the deadlines for correcting 401(k) plan excesses. Can you give me quick tutorial?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Minnesota is representative of a common inquiry regarding 401(k) plan nondiscrimination testing.

Highlights of Discussion

I’ll try my best to summarize, generally, but be sure to seek out tax and/or legal advice for actual plan situations. One of the characteristics that sets 401(k) plans apart from other defined contribution plans are the unique contribution limits that apply to employee salary deferrals and matching contributions, namely the actual deferral percentage (ADP) limit, the actual contribution percentage (ACP) limit, and the IRC Sec. 402(g) annual deferral limit.

I’ll cover the three following excesses in this space:

  1. ADP failures—where the highly compensated employees (HCEs) defer too much in relation to the nonHCEs and create “excess contributions” [IRC Sec. 401(k)(8)(b)]
  2. ACP failures—where matching and/or after-tax contributions are too high for HCEs in relation to those for nonHCEs and create “excess aggregate contributions” [IRC Sec. 401(m)(6)(B)]
  3. 402(g) failures—where plan participants, either HCEs or nonHCEs, defer above the annual limit and create “excess deferrals” [IRC Sec. 402(g)(3)]
401(k) Excess Correction Deadlines
Type of 401(k) Excess Time of Correction Consequences of Failing to Timely Correct
Excess Contributions (ADP test failure where HCEs defer too much compared to nonHCEs)

 

Or

 

Excess Aggregate Contributions (ACP test failure where HCEs’ matching and or after-tax contributions are too high compared to nonHCEs’)

 

Within 2½ months after plan year end (March 15th for a calendar year plan)

Issue corrective distributions to affected HCEs

 

 

 

Excess and earnings taxed in the year distributed

 

 

After 2 ½ months after plan year end

 

Two Corrective Options:

1. Issue corrective distributions to HCEs

or

2. Make a Qualified Nonelective Contribution/Qualified Matching Contribution to correct the failure

·     Excess and earnings taxed in the year distributed

·     Employer subject to a 10% penalty tax

After the end of the plan year following the year of the excess

 

·   Employer subject to a 10% penalty tax

·   Potential for plan disqualification

·   Correct through Employee Plans Compliance Resolution System (EPCRS)

 

If “eligible automatic contribution arrangement” Excess Contribution or Excess Aggregate Contribution

 

6 months following the end of the plan year (June 30 for calendar year plan)

 

Issue corrective distributions to affected HCEs

 

Excess and earnings taxed in the year distributed
After 6 months following the end of the plan year

 

Two Corrective Options:

 

1. Issue corrective distributions to HCEs or

2. Make a Qualified Nonelective Contribution/Qualified Matching Contribution to correct the failure

·   Excess and earnings taxed in the year distributed

 

·   Employer subject to additional 10% penalty tax

 

After the end of the plan year following the year of excess (December 31 for calendar year plan)

 

·      Employer subject to additional 10% penalty tax

·      Potential for plan disqualification

·      Correct through EPCRS

 

Excess Deferrals (402(g) failure, Pre-Tax and Designated Roth) On or before April 15th of year after deferral

Issue corrective distributions of excess deferrals, plus their earnings

·      Excess deferral taxed as income in the year deferred.

·      Earnings on excess taxed in the year distributed.

After April 15 of year following excess

 

·   Excess deferral taxed in the year deferred.

·   Both the excess deferral and earnings taxed in the year removed.

·   If excess deferrals result from deferrals to one or more plans maintained by the same employer, possible loss of qualified plan status

 

Amounts in excess of any one of these limits could have serious consequences for the employer, the participant and/or the plan as a whole. Plan penalties are costly to plan sponsors and every effort should be made to avoid them. But worse than paying the IRS an extra penalty fee is the potential loss of qualified status for the 401(k) plan. If the IRS disqualifies a plan, the plan sponsor loses the tax-saving benefits of the plan, and the assets become immediately taxable to the participants. Therefore, such excesses must be avoided and timely corrected when failures occur.

Conclusion

Treasury regulations contain clear steps and deadlines by which plan sponsors must correct 401(k) excesses. If done so timely, the plan sponsor can avoid additional penalties and potential plan disqualification. Corrections made after the specified deadlines must follow the terms of the IRS’s EPCRS.

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Remember Plan Tax Credits for 2021

“Can you remind me of the special tax credits available for small businesses who set up qualified retirement plans, please?”

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

A recent call with a financial advisor from Arizona is representative of a common inquiry related to incentives for setting up retirement plans.

Highlights of Discussion

My pleasure! Small business owners (with fewer than 100 employees) are eligible for additional tax credits for setting-up retirement plans and/or adding an automatic enrollment feature. The credits are available if the owner establishes a 401(k), a SEP or a SIMPLE IRA plan. The business must

• Have had fewer than 100 employees who received at least $5,000 in compensation for the preceding year;
• Have at least one plan participant who was a nonhighly compensated employee; and
• Not have maintained a plan in the past.

The “Startup Credit” is up to $5,000 (a formula applies), available for the first three years the plan is in existence and offers real benefits to owners by freeing up tax dollars for other important business purposes. The credit was greatly improved as part of the Setting Every Community Up for Retirement Enhancement of 2019 Act (SECURE Act), effective January 1, 2020 (increasing the maximum credit from $500 to $5,000). It is intended to encourage owners to establish retirement plans by helping make the plan more affordable during the startup process. In addition, the owners receive full tax deductions for all contributions made to the plan.

On top of that, if an owner elects to add an automatic enrollment feature to the plan, an additional $500 credit (for the first three years) is also available. The automatic enrollment feature calls for newly eligible participants to be enrolled automatically in the plan with a specified default deferral rate. The IRS provides additional details about the startup and auto deferral credits here.

Eligible businesses may claim the credit using Form 8881, Credit for Small Employer Pension Plan Startup Costs.

See the Instructions for Form 8881 for more details.

Conclusion
Tax credits for setting up a plan and having an automatic enrollment feature are great tools to help small businesses defray the initial costs of starting and maintaining a plan. Business owners should discuss the credits with their accountants and advisors to determine if it makes sense for them to establish a plan.

 

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Is Congress Closing the Backdoor to Roth IRAs?

An advisor asked: “Is Congress Closing the Backdoor to Roth IRAs?”

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

A recent call with a financial advisor from California is representative of a common inquiry related to Roth conversions.

Highlights of the Discussion
Potentially, yes, as well as restricting other Roth conversion strategies. As part of the tentative measures to help fund the proposed $3.5 trillion budget reconciliation package (a.k.a., Build Back Better Act ), the House Ways and Means Committee has suggested, among other tactics, restricting “back-door Roth IRAs,” a popular tax-reduction strategy where individuals convert traditional IRA and/or retirement plan assets to Roth IRAs. If enacted as proposed, after-tax IRA and after-tax 401(k) plan conversions would be eliminated after 12/31/2021. For amounts other-than after-tax (i.e., pretax assets), traditional IRA and plan conversions for taxpayers who earn over the following taxable income thresholds would cease after 12/31/2031:

• Single taxpayers (or taxpayers married filing separately) with AGI over $400,000,
• Married taxpayers filing jointly with AGI over $450,000, and
• Heads of households with AGI over $425,000 (all indexed for inflation).

The buildup of Roth assets can be a source of tax-free income later if certain conditions are met. Ending Roth conversions using after-tax contributions in a defined contribution plan or IRA, and restricting Roth conversions of pre-tax plan or IRA assets would materially limit many taxpayers’ ability to accumulate Roth assets in a tax-free or tax-reduced manner.
You won’t find the phrase backdoor Roth IRA in the Internal Revenue Code or Treasury regulations. Nor is it a specific product, but the industry has known about the phenomena for years. A backdoor Roth IRA is merely a series of transactions or steps an individual can take to have a Roth IRA—regardless of income level. While initially poorly understood and lacking clear IRS guidance, so called “back-door Roth IRAs” have been legitimized over the years by the IRS.

The ability to make a 2021 Roth IRA contribution is phased out and eliminated for single tax filers with income between $125,000-$140,000; and for joint tax filers with income between $198,000-$208,000. Consequently, if a person earns too much, he or she cannot make a Roth IRA contribution directly (i.e., through the front door). But many can still take another route—by converting traditional IRA or qualified retirement plan assets, a transaction that has become known as the backdoor Roth IRA.

Congress repealed any income limitations for Roth IRA conversions in 2010. Consequently, regardless of income level, anyone could fund a Roth IRA through a conversion. For example, if a person exceeds the income limitation for contributions to a Roth IRA, he or she could contribute amounts (deductible or nondeductible) to a traditional IRA based on earned income and, shortly thereafter, convert the contribution from the traditional IRA to a Roth IRA. Similarly, a person with a 401(k)-plan account balance could convert eligible plan assets either in-plan to a designated Roth account (if one exists) or out-of-plan to a Roth IRA through a plan distribution. Assets that are taxable at the point of conversion would be included in the individual’s taxable income for the year. Going forward, earnings would accumulate tax-deferred and, potentially, would be tax-free upon distribution from the Roth IRA. Under the authority of IRS Notice 2014-54, a qualified plan participant can rollover pre-tax assets to a traditional IRA for a tax-free rollover and direct any after-tax assets to a Roth IRA for a tax-free Roth conversion.

Conclusion
Plan participants and IRA owners need to be aware that as part of the 2021 budget reconciliation process, the ability to convert assets to Roth assets may be sunsetting. If revenue-generating provisions of the Build Back Better Act are enacted as currently proposed, Roth conversions of after-tax IRA and after-tax 401(k) plan assets would be eliminated after 12/31/2021; and Roth conversions of pre-tax IRA and plan assets would cease after 12/31/2031.

Click here for an RLC webinar on the proposed changes.

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Are Plan Committee Members Fiduciaries?

An advisor asked: “Can an individual member of a 401(k) plan committee have personal fiduciary liability?”

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 Indiana is representative of a common question on plan committee members.

Highlights of the Discussion

  • A plan committee member may be a plan fiduciary and, consequently, held personally liable to the plan if he or she is granted or exercises discretion in the operation or administration of a retirement plan that is subject to the Employee Retirement Income Security Act of 1974 (ERISA).
  • According to the Department of Labor (DOL) Interpretive Bulletin 75-5, if the governing plan documents state the plan committee controls and manages the operation and administration of the plan and specifies who shall constitute the plan committee (either by position or by naming individuals to the committee), then such individuals are named fiduciaries of the plan pursuant to ERISA §402(a) (see page 212 of linked document).
  • A number of court cases have found that a plan committee member may be a functional fiduciary of the plan because of his or her actions and subject to personal liability if he or she exercises discretion in the administration of the plan Gaunt v. CSX Transp., Inc., 759 F. Supp. 1313 (N.D. Ind. 1991).
  • Pursuant to ERISA §409 (see page 250 of linked document):

Any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries … shall be personally liable to make good to such plan any losses to the plan resulting from each such breach, and to restore to such plan any profits of such fiduciary which have been made through use of assets of the plan by the fiduciary, and shall be subject to such other equitable or remedial relief as the court may deem appropriate, including removal of such fiduciary.

  • Having a committee charter may help mitigate fiduciary liability for the committee members by carefully outline the members roles and responsibilities. Please see our Case of the Week 401(k) Plan Committee Charter for best practices.

Conclusion

A plan committee member may be a plan fiduciary and, consequently held personally liable to the plan for losses resulting from fiduciary breaches.  Having a committee charter may help mitigate fiduciary liability for the committee members.

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Real Estate Agents and Retirement Plans

“A client of mine is a real estate agent who receives income that is reported on Form 1099-MISC, Miscellaneous Income. Can this individual contribute to a retirement plan?”

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

Highlights of Discussion

• Some unique rules for retirement plan eligibility apply for real estate agents, based on their worker status as a “statutory nonemployee.” (Since each employment scenario is based on unique facts and circumstances; it is recommended that workers seek professional tax advice for a definitive determination in their particular situations.)
• Individuals who perform services for businesses may be classified as an independent contractor, a common law-employee, a statutory employee, or a statutory nonemployee. The IRS explains each classification in more detail in Publication 15-A, Employer’s Supplemental Tax Guide.
• There are three categories of statutory nonemployees: direct sellers, licensed real estate agents, and certain companion sitters. Licensed real estate agents include individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output.  Direct sellers and real estate agents are treated as self-employed for all Federal tax purposes, including income and employment taxes, if the following are true.

1. Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked; and
2. Their services are performed under a written contract that provides they will not be treated as employees for Federal tax purposes.
Because real estate agents are considered self-employed, they are eligible to establish a retirement plan based on their earnings from self-employment. Please see IRS Publication 560, Retirement Plans for Small Businesses.

Conclusion
If a licensed real estate agent meets the above criteria, he or she could establish a retirement plan using his or her Form 1099-MISC income. Since each employment scenario is based on unique facts and circumstances, it is recommended that workers seek professional tax advice for a definitive determination.

 

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401(k) Plans for Owner-Only Businesses

“Can an unincorporated, owner-only business have a 401(k) plan and, if so, are there any special considerations of which we need to be aware?”

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 North Carolina is representative of a common question related to owner-only businesses and retirement plans.

Highlights of Discussion

  • Yes, an unincorporated, owner-only business may have a 401(k) plan—commonly referred to as a(n) “individual (k)” or “solo (k)” plan.
  • Special considerations with respect to the solo (k) plan include, but would not be limited to, the
    • Deadline for establishing a 401(k) plan,
    • Deadline for making a salary deferral election, and
    • Owner’s compensation for contribution purposes.
  • The deadline for establishing a 401(k) plan for any eligible business changed beginning in 2021 to the business’s tax filing deadline plus applicable extensions.[1] The prior deadline was the last day of the business’s tax year (e.g., December 31 for a calendar year tax year). However, keep in mind the timing of when a salary deferral election must be made has not changed.
  • Salary deferrals can only be made on a prospective basis [Treasury Regulation (Treas. Reg.) 1.401(k)-1(a)(3)]. Therefore, the salary deferral election must be made prior to the receipt of compensation. For self-employed individuals (i.e., sole proprietors and partners), compensation is considered paid on the last day of the business owner’s taxable year. The timing is connected to when the individual’s compensation is “deemed currently available” [see Treas. Reg. § 401(k)-1(a)(6)(iii)]. Therefore, a self-employed person has until the end of his or her taxable year to execute a salary deferral election for the plan (e.g., December 31, 2020, for the 2020 tax year).
  • The definition of compensation for contribution purposes for an unincorporated business owner is unique [IRC 401(c)(2)(A)(I)]. It takes into consideration earned income or net profits from the business which then must be adjusted for self-employment taxes. Please refer to the worksheet for calculating compensation for and contributions to a solo (k) plan for a self-employed individual in Publication 560, Retirement Plans for Small Businesses. A business owner who wants to have a 401(k) plan should work with his or her CPA or tax advisor to determine his or her earned income and maximum contribution for plan purposes.
  • The 2020 contribution for an unincorporated business owner to a solo (k) plan with enough earned income could be as high as $57,000 (or $63,500 if he or she turned age 50 or older before the end of the year). For 2021, those limits are $58,000 and $64,500, respectively.

Example:

Ryan is a sole proprietor who would like to set up a solo k plan effective for 2020.  The IRS extended his tax filing deadline for 2020 to May 17, 2021, and if Ryan files for an extension, his extended tax deadline would be October 15, 2021. Therefore, the latest Ryan could potentially set up a solo k plan for 2020 would be October 15, 2021. Since Ryan is past the deadline for making a salary deferral election for 2020, however, his contribution would be limited to an employer profit sharing contribution based on his adjusted net business income for 2020. The sooner Ryan sets up the solo k for his business, the sooner he will be able to make employee salary deferrals for 2021.

Conclusion

For self-employed individuals and their tax advisors, there are several special considerations with respect to setting up and contributing to solo (k) plans, including, but not limited to, the deadline for establishing a 401(k) plan, the deadline for making a salary deferral election, and the owner’s compensation for contribution purposes.

[1] Section 201 of the Setting Every Community Up for Retirement Enhancement Act of 2020

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Still Time for a 2020 Nonelective Safe Harbor Plan?

“Although it is already November, can my client amend her traditional 401(k) plan to be a safe harbor plan for 2020?”

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

A recent call with a financial advisor from Illinois is representative of a common inquiry related to safe harbor plans.

Highlights of the Discussion

Yes, but she must hurry. The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 relaxed the deadline for amending a 401(k) plan to add a safe harbor nonelective contribution for the current year.

Under Section 103 of the SECURE Act, plan sponsors may amend their plans to add a three percent safe harbor nonelective contribution at any time before the 30th day before the close of the plan year. The SECURE Act also did away with the mandatory participant notice requirement for this type of amendment.

Furthermore, amendments after that time would be allowed if the amendment provides

1) a nonelective contribution of at least four percent of compensation for all eligible employees for that plan year,

and

2) the plan is amended no later than the close of the following plan year.

EXAMPLE:

Safety First, Inc., maintains a calendar-year 401(k) plan. Based on the plan’s preliminary actual deferral percentage (ADP) test (which the plan is failing), Safety First decides a safe harbor plan is a good idea for 2020. It’s too late to add a safe harbor matching contribution for 2020. However, the business could add a three percent safe harbor nonelective contribution for the 2020 plan year (without prior participant notice) as long as Safety First amends its plan document prior to December 1, 2020. While Safety First still could add a nonelective safe harbor contribution to the plan for 2020 after that date, the minimum contribution would have to be at least four percent of compensation, and the company would have to amend its plan document no later than December 31, 2021.

Conclusion

Thanks to the SECURE Act, 401(k) plan sponsors have more flexibility to amend their plans for “safe harbor” status. Plan sponsors who are failing their ADP tests for the year may find this type of plan amendment attractive as a correction measure.

 

 

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Two Plans–Two Limits?

“My client is a fireman who participates in the department’s 457(b) plan. He also runs his own electrical business. Can he set up a 401(k) plan and contribute to both plans?”

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 Massachusetts is representative of a common inquiry related to multiple retirement plans.

Highlights of Discussion

This is an important tax question that your client should discuss with his tax professional to make sure all the facts and circumstances of his financial situation are considered. Generally speaking, however, the IRS rules would allow your client to contribute to both his 457(b) plan and 401(k) plan up to the limits in both.

For 2020, 457(b) contributions (consisting of employee salary deferrals and/or employer contributions combined) cannot exceed $19,500, plus catch-up contribution amounts if eligible [Treasury Regulation Section (Treas. Reg. §1.457-5)]  and 457(b) contribution limit].  The same maximum deferral limit applies for 401(k) plans in 2020 (i.e., $19,500, plus catch-up contributions). The catch-up contribution rules differ slightly between the two plan types.

401(k) and 457(b) Catch-Up Contribution Rules

401(k) 457(b)
Age 50 or Over Option

 

Employees age 50 or over can make catch-up contributions of $6,500 beyond the basic 402(g) limit of $19,500 for 2020.

 

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 $19,500 for 2020.

 

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 2020, $19,500 x 2 = $39,000),

 

Or

 

•The annual 457(b) limit, plus amounts allowed in prior years 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.

Since 2002, contributions to 457(b) plans no longer reduce the amount of deferrals to other salary deferral plans, such as 401(k) 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 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 457(b) plan and one or more other deferral-type plans, such as a 403(b), 401(k), salary reduction simplified employee pension plan (SAR-SEP), or savings incentive match plan for employees (SIMPLE) has two separate annual deferral limits.

Another consideration when an individual participates in more than one plan is the annual additions limit under IRC Sec. 415(c),[1] which typically limits plan contributions (employer plus employee contributions for the person) for a limitation year [2] made on behalf of an individual to all plans maintained by the same employer. It this situation, the annual additions limit is of no concern for two reasons:  1) there are two separate, unrelated employers; and 2) contributions to 457(b) plans are not included in a person’s annual additions [see 1.415(c)-1(a)(2)].

Conclusion

IRS rules would allow a person who participates in a 457(b) plan and a 401(k) plan to contribute the maximum amount in both plans. However, 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] For 2020, the limit is 100% of compensation up to $57,000 (or $63,500 for those > age 50).

[2] Generally, the calendar year, unless the plan specifies otherwise.

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