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Are conduit IRAs still a thing?

“My client wants to take an in-service distribution from his 401(k) plan and roll it to an IRA.  He wants to know if he should roll it to a new, separate IRA (i.e., a conduit IRA) or if it is OK to commingle the rollover with the assets in his existing IRA?”   

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 Florida is representative of a common inquiry related to qualified plan-to-IRA rollovers.

Highlights of the Discussion

While there is no law or regulation that requires an individual to segregate assets rolled over from a qualified retirement plan in a separate or conduit IRA that holds only those assets, there are some tax and creditor protection reasons why your client may want to consider a conduit IRA. Below are three examples.

Retain the ability to roll the assets back to an employer-sponsored plan.

If your client intends to roll over the IRA assets that originated in a qualified retirement plan to another qualified retirement plan at a later date, he should be aware that some retirement plans will only accept rollovers that have been maintained in a conduit IRA and not commingled with other assets. Plan language will dictate which assets from an IRA, if any, a plan will accept as a rollover.

Preserve certain tax benefits for those born before January 2, 1936.[1]

Plan participants who were born before January 2, 1936, who receive lump-sum distributions from qualified plans may be able to elect special methods of figuring the tax on the distributions. First, assets in the plan from active participation before 1974 may qualify as capital gains, subject to a 20 percent tax rate (instead of ordinary income tax rates). Second, such individuals also may be able to use a 10-year tax option (i.e., 10-year forward averaging) to figure the taxes on the ordinary income portion of their lump sum distributions. This special option allows an eligible individual to figure the tax on his/her lump-sum distribution by applying 1986 tax rates to 1/10th the amount of a lump sum distribution, then multiplying the resulting tax amount by 10. This tax is payable for the year in which a person receives the lump-sum distribution. Taxpayers who qualify for the capital gains or 10-year forward averaging tax treatments who are contemplating a rollover must use a conduit IRA in order to preserve their ability to take advantage of these options should they later roll the assets back to a qualified plan (IRS Fast Sheet 2003-04).

Ensure creditor protection in bankruptcy is preserved.

As a result of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, individuals can exempt certain qualifying assets from their estates for bankruptcy protection. Assets in a defined contribution plan (including a 401(k) plan), or in a defined benefit, 403(b), 414, 457 or 501(a) plan are protected from bankruptcy in their entirety with no limit. Even old “Keogh” plans (qualified retirement plans for owner-only businesses) have unlimited protection in bankruptcy situations. Assets rolled over from one of the protected plans to an IRA retain the unlimited bankruptcy protection given to them while held in the plan. In contrast, contributory assets in a traditional or Roth IRA are protected from bankruptcy up to the 2020 limit of $ $1,362,800 (i.e., 1,000,000 adjusted periodically for inflation). When determining bankruptcy protection, it may be advantageous from a recordkeeping standpoint for an individual to keep rollover assets from a retirement plan in a conduit IRA separate from assets in his/her contributory IRA.

Conclusion

While not mandated by the IRS or DOL, conduit IRAs may still play a helpful role for some individuals. Before completing a qualified plan-to-IRA rollover, it would be prudent for plan participants to consult with their tax and legal advisors about whether they would benefit from using a conduit IRA.

[1] IRS Form 4972, Tax on Lump Sum Distributions

 

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August 31 Is 2020 RMD Rollover Deadline For Some

“Can you remind me of the key points related to the waiver of RMDs 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 Maryland is representative of a common inquiry related to the 2020 waiver of required minimum distributions (RMDs) and rollovers of such amounts.

Highlights of the Discussion

  • You ask a timely question as August 31, 2020, is a key deadline by which certain rollovers of 2020 RMDs must be accomplished.
  • Section 2203 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act (CARES Act) waives RMDs for IRAs, defined contribution, 403(a) qualified annuity, 403(b) or governmental 457(b) plans for 2020.
  • Defined benefit plans are not covered by this wavier.
  • As an added bonus under the CARES Act, and as clarified by Notice 2020-51, a distributed amount that otherwise would have been an RMD for 2020 is eligible for rollover, including
    • First-year 2019 RMDs that were taken by April 1, 2020,
    • First-year 2020 RMDs due to be taken by an April 1, 2021; plus
    • Amounts that are part of a series of periodic payments (that include a 2020 RMD) made at least annually over life expectancy, or over a period of 10 or more years.[1]
  • The deadline for rolling over 2020 RMDs is the later of August 31, 2020, or 60 days after receipt of the distribution;
  • A 2020 RMD that is rolled over by the August 31, 2020, deadline does not count toward the one-rollover-per-12-month rule applicable to IRA-to-IRA rollovers;
  • Nonspouse beneficiaries also are allowed to roll over 2020 RMDs, if they do so by August 31, 2020; and
  • A 2020 RMD from a plan or IRA may be rolled back into the same plan or IRA (provided the plan permits incoming rollovers).

Conclusion

The CARES Act waives the necessity to take 2020 RMDs from IRAs and most qualified retirement plans. August 31, 2020, is a key deadline by which certain rollovers of 2020 RMDs must be accomplished. Please refer to IRS Notice 2020-51 for additional guidance.

 

[1] Not to be confused with substantially equal periodic payments exempt from the 10% early distribution penalty tax under IRC Sec. 72(t)

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401(k)s, the 2020 RMD Waiver and Rollovers

“My client was told by his human resources representative that the 401(k) plan from his former place of work will distribute his 2020 RMD from the plan this year as usual. I thought that under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, all RMDs were waived for 2020. Can you clarify, 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 California is representative of a common inquiry related to required minimum distributions (RMDs) from 401(k) plans.

Highlights of the Discussion

The application of the IRS’s waiver of 2020 RMDs can be confusing for qualified retirement plans, because the plan sponsor can choose whether it will suspend all RMDs for 2020 or continue to distribute RMDs as usual under the terms of the plan.[1] Plans have the ability to distribute a participant’s plan balance without his or her consent once the assets are no longer “immediately distributable,” which is the later of the time a participant attains normal retirement age or age 62  [Treasury Regulation 1.411(a)-11(c)(4)].  Consequently, despite the IRS not treating the distribution as an RMD for 2020, a plan may continue to force the payment for the year. A likely reason would be to maintain consistent distribution processing procedures from year to year.

There is good news, however, for your client. Although, typically, RMDs are ineligible for rollover [IRC Sec. 402(c)(4)(B)], in this case, because the IRS does not consider the distribution as an RMD for 2020 (as a result of the CARES Act waiver), your client may roll over the amount —if it is otherwise eligible. (Note that the plan does not have to offer a direct rollover of the amount, nor withhold 20 percent for federal tax purposes. A 60-day, indirect rollover would still remain an option.)

Conclusion

Despite the temporary waiver of RMDs for 2020 allowed under the CARES Act, qualified plans may still choose to distribute such amounts. Therefore, it is imperative for participants and their financial advisors to know how their plans intend to address the optional 2020 RMD waiver and plan accordingly.

[1] The 2020 RMD waiver does not apply to defined benefit plans.

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Rollovers to Qualified Retirement Plans

“My client changed jobs and was hoping to move at least a portion of his prior 401(k) plan balance to his new employer’s 401(k) plan? When he inquired about the rollover with the new employer, he was told that the plan cannot accept his rollover. I thought all qualified retirement plans had to offer rollovers. What could be the issue here?”  

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 New York is representative of a common inquiry related to rollovers to qualified retirement plans.

Highlights of the Discussion

Some qualified plan distributions simply are not eligible for rollover (e.g., required minimum distributions, excess contributions, substantially equal periodic payments, etc.).[1]  But, in this case, I think the new employer may be refusing the rollover because its plan does not accept some or all rollover amounts—period.

While is it true that pursuant to Internal Revenue Code Section (IRC §) 401(a)(31) the IRS requires qualified plans to offer distribution recipients a direct rollover option of their eligible rollover distributions of $200 or more to an eligible retirement plan, it imposes no such requirement that an eligible retirement plan accept rollovers. Thus, a plan can refuse to accept rollovers if the language of the governing plan document does not address the ability of the plan to receive eligible rollover distributions. Even if a plan accepts rollovers of eligible amounts, a plan could limit the circumstances under which it will accept rollovers. For example, a plan could limit the types of plans from which it will accept a rollover or limit the types of assets it will accept in a rollover (See Treasury Regulation Section 1.401(a)(31)-1, Q&A 13). Plan administrators must apply their policies regarding the acceptance of rollovers in a nondiscriminatory and uniform manner to all participants.

Statistically speaking, 97 percent of all qualified retirement plans accept some types of rollovers.[2] That number declines based on the size of the receiving plan. It is more likely that a plan will limit the sources of rollover contributions. For example, 66 percent of all plans surveyed accept rollovers from IRAs; 46 percent accept rollovers from defined benefit pension plans; and 40 percent accept rollovers from governmental 457(b) plans.[3]

Some plans will limit when they will accept rollover contributions. For example, some plans make new hires wait until they satisfy the eligibility requirements to make deferrals before being eligible to bring in a rollover contribution.

The best guidance is to have your client confirm with the new plan administrator—perhaps through the HR Department—whether or not rollovers are allowed according to the plan document, and, if so, what type of contributions the plan will accept and when.

The IRS has a number of helpful links on its website covering rollover information; here are a few:

Conclusion

A plan can refuse to accept or limit rollovers coming in depending on the language of the governing plan document. When in doubt—check the plan document provisions regarding rollovers. Plan administrators must apply their policies regarding the acceptance (or nonacceptance) of rollovers in a nondiscriminatory and uniform manner to all participants.

[1] Treas. Reg.§ 1.402(c)-2(Q&A 3 and 4)

 

[2] Plan Sponsor Council of America, 61st Annual Survey, 2018

[3] Ibid

 

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Adding In-Service Distributions to a Company’s Retirement Plan

“What are the considerations around adding an in-service distribution option to a company’s qualified retirement plan?”

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

Highlights of the Discussion

There are several important considerations surrounding adding an in-service distribution option to a company’s qualified retirement plan, including, but not limited to,

  • Type of plan,
  • The process to add,
  • The parameters for taking,
  • Potential taxes and penalties to recipients,
  • Nondiscrimination in availability, and
  • The effect on top-heavy determination.

Several types of retirement plans can offer in-service distributions, including 401(k), profit sharing, employee stock ownership and even defined benefit plans. If a plan sponsor desires an in-service distribution option, it must be formally written into the plan document, either when adopted or later through a plan amendment. The plan sponsor would need to check with its document provider for the exact adoption or amendment steps. For example, adding an in-service distribution option to a prototype 401(k) plan can be as easy as checking a box on the adoption agreement, selecting an effective date, signing the amendment and notifying participants of the change.

There are pros and cons to including an in-service distribution option in a plan. The pros include increased participant control of plan assets, and a higher level of participant satisfaction with the plan. The cons include the potential for greater administrative burdens and cost to the plan sponsor as a result of an increase in the number of distribution requests, potential taxes and penalties for the distribution recipient, and depletion of savings meant for retirement income.

Plan participants need to understand the taxation rules that apply to in-service distributions. Any pre-tax amounts that are distributed from a plan prior to age 59½ will be subject to taxation and, possibly, an early distribution penalty tax, unless an exception applies. Completing a rollover of the in-service distribution either directly or indirectly within 60 days of receipt is one way to delay any tax impact.

If a plan sponsor wants to add an in-service distribution option, it can choose to make the option very liberal or attach restrictions such as a requirement for a participant to reach a certain age, or complete a set amount of service. It is important to note that the IRS does not allow employee pre-tax elective deferrals to be distributed prior to age 59½, nor defined benefit assets to be distributed prior to age 62 under the in-service distribution rules. The plan sponsor could also limit access to a particular contribution source or sources (e.g., matching contributions, after-tax, etc.).

Distributions are part of the benefits, rights and features of a plan under Treasury Regulation §1.401(a)(4)-4. Therefore, if a plan offers in-service distributions, it must do so in a nondiscriminatory manner (i.e., not make them disproportionately more available to highly compensated employees (HCEs) than nonHCEs).

Finally, keep in mind that in-service distributions from a qualified retirement plan can affect top-heavy determination for up to five years. A plan is top-heavy if the key employees own more than 60 percent of the plan’s assets or benefits on the determination date. In-service distributions for active employees are added back to account balances if the distribution occurred within the five-year period ending on the determination date (Treasury Regulation §1.416-1, T-30)).

Conclusion

When the desire to give plan participants greater control of their plan assets exists, plan sponsors and participants may look to in-service distributions of retirement plan assets as a possible solution. But there are several important considerations surrounding such a plan feature. Financial advisors can help educate their clients on the pros and cons of adding, or changing the terms of an existing, in-service distribution option.

 

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Rollovers to SIMPLE IRAs

“Can my client roll over money to her SIMPLE IRA.”

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

A recent call with a financial advisor from California is representative of a common inquiry related to savings incentive match plans for employees (SIMPLE) IRA rollovers.

Highlights of the Discussion

As of 2016, (or December 18, 2015, to be more precise), SIMPLE IRAs can receive rollovers from traditional IRAs and simplified employee pension (SEP) IRAs, as well as from eligible employer-sponsored retirement plans, such as 401(k), 403(b), or governmental 457(b) plans, as long as it has been two years since the individual first participated in the SIMPLE IRA plan. So, if your client has owned her SIMPLE IRA for two years, then she can roll over money into it from another eligible plan. SIMPLE IRAs still may not accept rollovers from Roth IRAs or designated Roth accounts within 401(k) plans.

Prior to 2016, a SIMPLE IRA plan could only accept rollover contributions from another SIMPLE IRA plan. The Consolidated Appropriations Act, effective December 18, 2015, allowed greater portability between SIMPLE IRAs and other plan types by broadening the retirement plans that are eligible for rollover to a SIMPLE IRA.

The restrictions on rollovers from a SIMPLE IRA during the first two-years of participation have remained constant. Under both prior and current law, during the initial two-year period, a SIMPLE IRA owner may only move assets between SIMPLE IRAs via a trustee-to-trustee transfer.  If, during the initial two-year period, a SIMPLE IRA owner transfers or rolls over assets to an IRA or plan that is not a SIMPLE IRA, then the IRS treats the payment as a distribution from the SIMPLE IRA. The SIMPLE IRA owner must include the amount in his or her taxable income. On top of that, a 25 percent additional early distribution penalty tax applies to the amount, unless the taxpayer qualifies for an exception under IRC 72(t).

SIMPLE IRA assets may never be rolled over to a designated Roth account in a 401(k) plan and vice versa.

For a handy reminder of what retirement assets can roll where and when, please link to the IRS’s Rollover Chart.

Conclusion

The rules regarding rollovers to SIMPLE IRAs changed after December 18, 2015, allowing more freedom to move eligible retirement assets into a SIMPLE IRA. The restrictions on rollovers from a SIMPLE IRA during the first two-years of participation have remained constant.

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Safe Harbor Validation of Rollovers

“What responsibility does a plan sponsor have in validating whether an incoming rollover contribution is legitimate?”

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, 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 Texas is representative of a common inquiry related to rollover contributions.

Highlights of Discussion

A qualified retirement plan isn’t required to accept rollover contributions from other plans or IRAs, but if it does under the terms of its governing plan document, the incoming assets must consist of valid rollover amounts. In order for the plan to retain its tax-preferred status, the plan sponsor must reasonably conclude that an amount is a valid rollover contribution as defined in Treasury Regulation Section (Treas. Reg. §) 1.401(a)(31)–1, Q&A–14(b)(2) and retain documentation. The IRS has provided examples of what would constitute proof of a valid rollover, including safe harbor options detailed in IRS Revenue Ruling 2014-9 .

Historically, plan sponsors followed the guidance of Treas. Reg. 1.401(a)(31)-1, Q&A-14(b)(2) for acceptable forms of documentation, which include a participant providing the sponsor of the receiving plan with a letter from the plan sponsor of the distributing plan that states the distributing plan has received a determination letter from the IRS or that the plan, to the best of the sponsor’s knowledge, is qualified. Further guidance from IRS Form 5310, Application for Determination for Terminating Plan, states a sponsor  who is filing this form is required to “… submit proof that any rollovers or asset transfers received were from a qualified plan or IRA.” The instructions to the form indicate that a copy of the distributing plan’s determination letter and timely interim amendments is one example of acceptable proof.

For an indirect rollover where a plan participant has received the assets from a distributing plan or IRA and, within 60-days, rolls over the amount to the receiving plan the individual can certify that the distribution is eligible for rollover and was received not more than 60 days before the date of the rollover. Many plans use a type of standard rollover certification form for this purpose. If the rollover contribution is late, the plan sponsor can accept the contribution if the individual has a waiver from the IRS or self-certifies under Revenue Procedure 2016-47.

In addition to the methods listed in the regulations, IRS Revenue Ruling 2014-9 provides additional streamlined safe harbor due diligence procedures described below that, in the absence of evidence to the contrary, will allow the sponsor of the plan receiving the rollover to reasonably conclude that the amount is a valid rollover contribution.

Plan-to-Plan Rollovers

The sponsor of the receiving plan can confirm the previous employer’s plan is intended to be qualified by looking up the plan on the DOL’s EFAST2 website. If Code 3C appears on the plan’s most recent Form 5500 filing, then the plan IS NOT intended to be qualified under IRC Code §§ 401, 403, or 408, indicating that a distribution from the plan would not be eligible for rollover.

If the receiving plan receives a check made payable to the trustee of the plan for the benefit of the participant from the trustee of another qualified plan, it is reasonable for the receiving plan sponsor to conclude that the plan that initiated the rollover determined the distribution is an eligible rollover distribution.

IRA-to-Plan Rollovers

When a receiving plan gets a check that is made payable to the trustee of the plan from the trustee of an IRA for the benefit of an employee, the recipient plan administrator may reasonably conclude that the source of the funds is a traditional IRA and not an inherited IRA and, therefore, eligible for rollover.

Keep copies of documentation

As proof rollover amounts were valid, plan sponsors should keep copies of the following items:

  • Checks or check stubs with identifying information;
  • Confirmations of wire or other electronic transfers; and
  • Participant certifications.

Special considerations for RMDs

Required minimum distributions (RMDs) are not eligible rollover distributions. A qualified plan is responsible for ensuring that any RMDs are paid to plan participants. Therefore, the IRS has indicated it is reasonable for the receiving plan to conclude that the distributing plan has already paid to the participant any RMDs and remaining amounts are eligible for rollover.

In contrast, IRA trustees and custodians are not responsible for automatically distributing RMDs to IRA owners. Therefore, a plan sponsor may not reasonably conclude that an IRA rollover consists only of eligible rollover funds. The plan administrator should seek additional documentation to confirm that the IRA owner has satisfied any RMD that may be due.

Conclusion

When rollovers to a qualified plan are permitted, plan sponsors must ensure such incoming amounts are, indeed, eligible for roll over. Validation can be done through employee certification of the source of the funds for a 60-day rollover; verification of the payment source (via information on the incoming rollover check or wire transfer) from the participant’s IRA or former plan; or, if the funds are from a plan, looking up that plan’s Form 5500 filing for assurance that the plan is intended to be a qualified plan.

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Rollover of Plan Loan Offsets and 402(f) Notices

“Has the IRS issued an updated model plan distribution notice to reflect the changes related to rollovers of plan loan offset amounts?”

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 special tax notice required for plan distributions under Internal Revenue Code 402(f).

Highlights of Discussion

The IRS periodically issues model plan distribution notices, also referred to as a “special tax notice,” “rollover notice” or the IRC Sec. “402(f) notice,” in order to incorporate any changes to the language as a result of law changes. As of this posting, the IRS had not issued updates to its model 402(f) notice to reflect changes in the information as a result of the Tax Cuts and Jobs Act of 2017 (TCJA-2017), effective January 1, 2018. The last model notice was issued in 2014 (Notice 2014-74).

Plan sponsors are required to provide up-to-date 402(f) notices to convey important tax information to plan participants and beneficiaries who have hit a distribution trigger under a qualified plan and may receive a payout that would be eligible for rollover (Treasury Regulation 1.402(f)-1). A 402(f) notice, in part, explains the rollover rules and describes the effects of rolling—or not rolling—an eligible rollover distribution to an IRA or another plan, including the automatic 20 percent federal tax withholding that the plan administrator must apply to an eligible rollover distribution that is not directly rolled over. Plan administrators must provide the 402(f) notice to plan participants no less than 30 days and no more than 180 days before the distribution is processed. A participant may waive the 30-day period and complete the rollover sooner.

A plan may provide that if a loan is not repaid (is in default) the participant’s account balance is reduced, or “offset,” by the unpaid portion of the loan. The value of the loan offset is treated as an actual distribution for rollover purposes and, therefore, may be eligible for rollover. In most cases, participants (or beneficiaries) who experience a loan offset can rollover an amount that equals the offset to an eligible retirement plan. Instead of the usual 60-day rollover deadline, effective January 1, 2018, as a result of TCJA-2017, if the plan loan offset is due to plan termination or severance from employment, participants have until the due date, including extensions, for filing their federal income tax returns for the year in which the offset occurs to complete a tax-free rollover (e.g., until October 15, 2019, for a 2018 plan loan offset).

Conclusion

Even though the IRS has not updated its model 402(f) to reflect the extended rollover period for certain loan offsets as a result of TCJA-2017, plan sponsors and administrators must ensure the distribution paperwork and 402(f) notices that they are currently using include language that reflects the new rollover timeframe. For those that rely on plan document providers, ask if the new 402(f) notice is available.

 

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Can a plan sponsor merge 401(k) and 403(b) plans?

“I have at least one of my plan sponsor clients who has both a 401(k) plan and a 403(b) plan. Could my client merge the two plans in order to consolidate the assets?”

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. A recent call with an advisor in New York is representative of a common inquiry involving the merging of retirement plans.

Highlights of Discussion

  • Save for two exceptions, no, your client cannot merge 403(b) assets with an unlike plan (e.g., a profit sharing, 401(k), 457(b) plan, etc.) without causing the 403(b) assets to become taxable to the participants. Such a transfer could also jeopardize the tax-qualified status of the 401(k) plan.
  • 403(b) plan assets may only be transferred to another 403(b) plan. Further, the final 403(b) regulations are clear that neither a qualified plan nor a governmental 457(b) plan may transfer assets to a 403(b) plan, and a 403(b) plan may not accept such a transfer (see Treasury Regulation Section 1.403(b)-10 and Revenue Ruling 2011-07).
  • The two exceptions noted previously are plan-to-plan transfers by participants to governmental defined benefit plans in order to 1) purchase permissive service credits; or to make a repayment of a cash out.
  • This does not preclude a 403(b) or 401(k) participant with a distribution triggering event (such as plan termination) to distribute and complete a rollover to another eligible plan [e.g., a 401(k) or 403(b) plan] that accepts such amounts.

Conclusion

While there are similarities between a 401(k) plan and 403(b), the IRS treats them as unlike plans and, therefore, incompatible, for the purpose of plan-to-plan transfers or mergers. Participant rollovers, on the other hand, are potentially possible between the two.

 

 

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Taxability of IRA Conversions

I believe the IRS requires a person to treat a Roth IRA conversion as consisting of a pro rata share of the individual’s pre- and after-tax retirement assets. When determining the taxable amount of a traditional-to-Roth IRA conversion, does my client include his 401(k) plan balance in the calculation?

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.  A recent call with a financial advisor in Illinois is representative of a question we commonly receive related to Roth conversions.

Highlights of Discussion

  • Your client would not include his 401(k) balance when determining the taxable amount of a traditional IRA-to-Roth IRA conversion. Please see IRS Publication 590-A for further guidance.
  • When calculating the taxability of a conversion in this case, your client would include all of his nonRoth IRAs for which he is the direct owner, including traditional IRAs, simplified employee pension (SEP) IRAs, and savings incentive match plan for employees (SIMPLE) IRAs.
  • Retirement accounts that are not considered include
    • Inherited traditional, SEP or SIMPLE IRAs (unless a spouse beneficiary has elected to treat the inherited IRA as his or her own);
    • Defined contribution plans (e.g., 401(k) plans);
    • Defined benefit pension plans;
    • 403(b) plans;
    • 457 plans;
    • Nonqualified accounts and plans; and
    • Annuities (unless they are individual retirement annuities under Section 408(b) of the Internal Revenue Code).
  • The steps for calculating the taxable amount of a traditional IRA-to-Roth IRA conversion are part of the IRS Form 8606, which your client must complete and file to report the conversion.
  • Encourage your client to discuss the conversion with his tax advisor.

Conclusion

Because a traditional IRA-to-Roth IRA conversion is (generally) a taxable and (always) a reportable transaction, investors should consult their tax attorneys or professional tax advisors concerning their particular situations.

 

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