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Retirement Savings Tax Credit

“What contributions are eligible for the retirement savings tax credit?”

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 Oklahoma is representative of a common inquiry regarding available tax credits for retirement contributions.

Highlights of Discussion

IRA owners and retirement plan participants (including self-employed individuals) may qualify for a retirement savings contribution tax credit. 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 the taxpayer’s retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on adjusted gross income (as reported on Form 1040, 1040A 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; 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) IRA,
  • 403(b) or
  • Governmental 457(b) plan.

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.

2018 Saver’s Credit Income Levels

Credit Rate Married Filing Jointly Head of Household All Other Filers*
50% of your contribution AGI not more than $38,000 AGI not more than $28,500 AGI not more than $19,000
20% of your contribution $38,001 – $41,000 $28,501 – $30,750 $19,001 – $20,500
10% of your contribution $41,001 – $63,000 $30,751 – $47,250 $20,501 – $31,500

*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.

© Copyright 2019 Retirement Learning Center, all rights reserved
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403(b) 15 years-of-service catch-up contribution election

“How does the special 15-year catch-up contribution rule works for 403(b) plans?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings 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 Massachusetts is representative of a common inquiry related to 403(b) salary deferrals.

Highlights of the Discussion

The IRS allows certain long-term employees to catch-up on the funding of their 403(b) plans by electing to increase their elective deferrals over the standard dollar limit. The election is available only to employees who have completed at least 15 years of service with one of the following types of employers:

With the exception of church-related organizations or organizations controlled by a church-related organization, years with different employers cannot be added together for purposes of satisfying the 15-year requirement.

Example 1

Anna is a teacher with the West County School System. She has been employed by West County for six years, but worked for the East County School System for 10 years prior to coming to West County. There is a State Teachers Retirement System that covers all of Anna’s years with both West and East Counties. However, only the years that Anna worked while a teacher for West County may be counted for purposes of eligibility for the 15-year catch-up contribution election [see Treas. Regs. 1.403(b)-4(c)(3)(ii)(B) and 1.403(b)-4(e)(3)].

Under the special 15-year catch-up election, the standard annual deferral limit (i.e., $18,500 for 2018) is increased by the lesser of the following three numbers:

  1. $3,000 or
  2. $15,000 minus any elective deferrals previously excluded under this catch-up election, plus any amount of designated Roth contributions in prior years under this catch-up, or
  3. $5,000 multiplied by the employee’s years of service minus the elective deferrals made to plans of the organization in prior taxable years.

There is a lifetime limit of $15,000 for this catch-up election. And, to complicate matters further, an individual age 50 or older may make an additional standard catch-up of $6,000. For an employee eligible to use both the 15-year catch-up and the age 50 catch-up, he or she must apply the 15-year catch-up first. Then an amount may be contributed as an age 50 catch-up to the extent the age 50 catch-up limit exceeds the 15-year catch-up limit.

Example 2

Let’s apply all this in an example.

For 2018, Dion, age 50, has taxable compensation of $70,000. He has worked for the local hospital for 15 years. Dion has made no other elective deferrals during the year, and this will be the first year he contributes to the hospital’s 403(b) plan.

The general 402(g) limit is $18,500. Dion can use up to $3,000 of the 15-year catch-up, and he qualifies for the age 50 catch up of $6,000. Therefore, the maximum amount Dion can elect to defer is $27,500 ($18,500 + $3,000 + $6,000). If Dion defers only $24,500, then $3,000 will count as his 15-year catch-up contribution (reducing future 15-year catch-up contributions because of the $15,000 lifetime limit) and $3,000 will count as his age 50 catch-up.

Example 3

Similarly, Fiona, age 50, has taxable compensation of $70,000 for 2018. She has worked for the local hospital for 20 years. Fiona has made no other elective deferrals during the year, but she has made elective deferrals in prior years to the 403(b) plan of $175,000.

The general 402(g) limit is $18,500. The 15-year catch-up is only available if prior deferrals do not exceed $5,000 x her years of service (i.e., $5,000 x 20 = $100,000). Fiona had prior deferrals of $175,000. Therefore, she has used up her 15-year catch-up. However, because she has attained age 50, she is eligible for the age 50 catch-up limit of $6,000. Consequently, the maximum Fiona can elect to defer is $24,500 ($18,500 plus $6,000 under the age 50 catch-up).

Be sure to check the terms of the 403(b) document for any additional limitations that may apply on salary deferrals.

Conclusion

Certain long-tenured 403(b) plan participants who work for eligible employers such as a public school system, hospital or church have special considerations when it comes to the maximum amount they can defer into their 403(b) plans. Plan language can also affect how much participants are eligible to contribute. The rules are complicated; therefore, 403(b) plan participants should be encouraged to discuss their contributions with a tax advisor.

© Copyright 2019 Retirement Learning Center, all rights reserved
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Using unused PTO as 401(k) plan contributions

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

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

A recent call with a financial advisor from Pennsylvania is representative of a common inquiry related to paid time off (PTO)[1] and 401(k) plans.

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

Highlights of Discussion

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

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

Scenario 1

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

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

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

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

Example:

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

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

Scenario 2

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

Scenario 2

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

Example:

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

Conclusion

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

© Copyright 2019 Retirement Learning Center, all rights reserved