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Important Regulatory Update: Department of Labor (DOL) Finalizes the 7-Day Rule for Small Plan Deposits
On January 14, 2010, the Department of Labor issued final regulations that provide a “safe harbor” deadline for depositing employee contributions into small employer plans. The regulations are effective January 14, 2010 and apply to both retirement (401(k) and defined benefit) and welfare benefit plans with fewer than 100 participants. Plans with 100 or more participants cannot rely on this safe harbor rule.
To satisfy the safe harbor, employee contributions (including loan repayments) must be made to the plan no later than the seventh business day following the day the amount would have otherwise been paid to the employee in cash.
This safe harbor should provide more certainty to small employers with respect to the general rule on depositing employee contributions, which says that these contributions must be deposited as of the earliest date they can reasonably be segregated from the employer’s general assets, but in no event later than the 15th business day of the month following the month in which the contributions would have otherwise been paid to the employee. The DOL is considering an appropriate safe harbor rule for large plans, but for now, the general rule above will continue to apply to them.
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“Banking” Vacation Time for Retirement
SITUATION: Our company has a paid time off (PTO) plan. At the end of the year, employees forfeit any vacation days they have not used. We are short-staffed and have several employees who generally do not use all of their allotted vacation time.
QUESTION: Can we amend our 401(k) profit sharing plan to allow us to contribute the dollar equivalent of the unused vacation days to these employees’ accounts?
ANSWER: Yes. Contributions of the dollar equivalent of unused paid time off are permissible. The contributions will not jeopardize a plan’s tax-qualified status as long as the plan meets all relevant tax law requirements.
DISCUSSION: A recent IRS revenue ruling* gives two examples. In the first, a company’s PTO plan provides that employees forfeit any paid time off they haven’t used by the end of the year. At that time, the company allocates the dollar equivalent of the forfeited time to the employee’s plan account to the extent applicable tax law limitations are not exceeded.
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“Contributions of the dollar equivalent of unused paid time off are permissible . . . .”
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At the close of business on December 31, 2009, an employee has unused paid time off equal to $500 (number of unused PTO hours multiplied by pay rate). After applying the tax law’s limitation on annual additions, the company can contribute only $400 to the employee’s account. The company makes the contribution in February 2010 and pays the employee the remaining $100. The employee includes the $100 in his gross income for 2010, the year he receives the payment.
Since the employee wasn’t given the option of receiving the $500 in cash, the plan contribution is a nonelective employer contribution instead of an elective deferral. The contribution is considered made in 2009.
What happens if employees have a choice of receiving a cash payment for their unused paid time off or having the dollar equivalent contributed to the employer’s 401(k) plan? The second IRS example illustrates this scenario.
In the situation described, the employee defers only a portion to the 401(k) plan and receives the rest in cash. The plan contribution is considered an employee elective deferral and is subject to both the annual additions and deferral limitations. The amount not contributed is taxed to the employee in the year paid.
The ruling does not provide a nondiscrimination safe harbor. Plans offering contributions of unused paid time off need to test to ensure they do not discriminate in favor of highly compensated employees.
* Rev. Rul. 2009-31 (9/4/2009)
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Recent Developments In Benefit Plans
No 2010 COLAs. Because the cost-of-living index for the quarter ended September 30, 2009, was lower than the index for the same period in 2008, these retirement plan contribution and benefit limitations are unchanged for 2010:
- Maximum annual additions to defined contribution plan account, $49,000
- Maximum annual benefit from defined benefit pension plans, $195,000
- Maximum annual compensation used to determine qualified plan benefits or contributions, $245,000
- 401(k), 403(b), and 457 plan deferrals and catch-up contributions, $16,500/ $5,500
- SIMPLE deferrals and catch-up contributions, $11,500/$2,500
- The maximum annual contribution that can be made to an IRA, $5,000/$6,000 for individuals age 50 or older
- Dollar limit used in the definition of “highly compensated employee,” $110,000
- Compensation limit for determining whether officers are key employees for top-heavy plan purposes, $160,000
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Talking to Preretirees
In 1999, 17.2 million American workers were age 55 or older. By mid-2009, this number had increased to 27.1 million. With this aging of the U.S. work force, it’s important for employers to take care that their retirement education programs meet the needs of preretirees as well as those of younger employees. Below we answer some questions about providing preretirees with the information they need to make the transition from work to retirement.
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“. . .as employees move closer to retirement age, they need additional information . . .”
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How are the communication needs of older employees different? Most retirement education materials focus on encouraging employees to enroll in the company's plan and contribute as much as they can to their plan accounts. Increasing the number of younger and lower paid plan participants to help the plan meet nondiscrimination testing requirements is often one goal of these materials. Communications concentrate on plan basics: how the plan works; the advantages of pretax contributions, tax-deferred compounding, starting early, and contributing regularly; and how to invest plan contributions to reach retirement goals. Investment education stresses "growing your account." This is important information for most plan participants. But, as employees move closer to retirement age, they need additional information about their plan distribution options and how to invest their accounts to preserve their assets.
With all the statistics on the “baby boomers” not having saved enough for retirement, don’t older employees need to be encouraged to contribute, too? Yes, they do. But you may want to customize some “contribute more” messages to appeal specifically to preretirees. If your plan allows catch-up contributions, send annual reminders to workers age 50 and older. Many of these employees are in their highest earning years. Consider participant newsletter articles or other communications that remind participants that they can really focus on retirement “now that the kids are through college” or “now that your home mortgage is paid off.” Online tools that help older workers project their retirement budgets and calculate the gap between current retirement savings and the amount of savings needed at retirement may be particularly helpful.
What kinds of distribution information do these employees need? Before they are actually ready to retire, employees need to be aware of the types of retirement distributions available from your plan and how each option works. One survey* of participants age 50 to 64 found that, when asked whether they could withdraw their account balances as a life annuity rather than a lump-sum distribution, fewer than half answered correctly. An employee’s distribution options can have an impact on retirement planning. Older participants also need to know that they generally must begin taking annual required minimum distributions from their plan accounts after they turn age 70½.
What about investment education? Targeted communications can help older employees understand the need to review their asset allocations periodically as they move closer to retirement and, in many cases, gradually shift some of their growth investments into more conservative investments that can help them preserve their savings. The impact inflation can have on retirement expenses and the resulting need to keep some growth investments to stay ahead of inflation is another important topic for both preretirees and retirees.
How about communicating with retirees who stay in the plan? Along with providing statements, you should communicate to retirees the importance of keeping the plan informed of changes in their lives, such as residential or e-mail address changes and family changes that may require them to update their beneficiary designation(s).
To help your plan participants make informed decisions about plan distribution options and investing their accounts, contact the Retirement and Investment Solutions Center at 800.999.8786, option 3, or email psu@cunamutual.com **
* U.S. Survey of Older Employees’ Attitudes Toward Lump Sum and Annuity Distributions from Retirement Plans, May 2007, Watson Wyatt
**Representatives are registered, securities are sold and investment advisory services offered through CUNA Brokerage Services, Inc. (CBSI), member FINRA/SIPC, a registered broker/dealer and investment advisor, 2000 Heritage Way, Waverly, Iowa 50677, toll-free 866.512.6109. Non-deposit investment and insurance products are not federally insured, involve investment risk, may lose value and are not obligations of or guaranteed by the financial institution. CBSI is under contract with the financial institution, through the financial services program, to make securities available to members.
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Roth IRA Conversion in 2010
Roth IRA conversions are a hot topic. Effective January 1, 2010, a provision in the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) eliminates the $100,000 limit on adjusted gross income (AGI) that previously prevented higher income taxpayers from converting a traditional individual retirement account (IRA) to a Roth IRA. This change opens up a number of retirement and tax planning opportunities for both employees and plan sponsors.
Background
Contributions made into a Roth IRA have already been taxed; therefore when a traditional IRA is converted into a Roth IRA, the individual is required to pay taxes on the conversion amount by including it as gross income for the year the conversion occurs. One reason Roth IRA conversions are attractive is that earnings may ultimately be withdrawn tax free (as long as all requirements are met).
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“. . . taxpayers can opt to defer their tax burden by a year and then spread it over two years. . .
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To be eligible for tax-free treatment, the Roth IRA must have been in existence for five years and the IRA owner must be age 59½ or older, disabled, or deceased. Another benefit is that Roth IRAs are not subject to the required minimum distribution (RMD) rules. (Note that an individual currently receiving RMDs from a traditional IRA cannot convert the current year’s RMD amount to a Roth IRA.)
2010 Conversion Rules
Taxpayers who convert a traditional IRA into a Roth IRA in 2010 have a special opportunity for paying the income tax due on the conversion amount. Ordinarily, the taxpayer would include the total amount as income for the 2010 tax year. Under the new law, instead of paying income tax on a 2010 Roth conversion in the same year, taxpayers can opt to defer their tax burden by a year and then spread it over two years, paying equal amounts in 2011 and 2012. This relief applies only to Roth conversions in 2010.
Example: Jane decides to convert $200,000 from her traditional IRA into a Roth IRA in 2010. The next decision she must make is whether to:
- Include the full $200,000 in gross income in 2010, or
- Include $100,000 in gross income in 2011 and another $100,000 in 2012.
Some individuals who convert to a Roth IRA in 2010 may prefer to pay the taxes in 2010, especially if they are wary of possible tax rate increases. After 2010, those who convert to a Roth IRA will have to pay related income taxes in the year the conversion is completed. However, there’s one way taxpayers can moderate the tax burden of a Roth conversion: Instead of converting the entire value of a traditional IRA to a Roth IRA in a single tax year, they can convert smaller amounts over the course of several years.
Not So Fast
Volatility in the investment markets can sometimes throw a wrench into the works. Fortunately, it’s possible to undo a Roth IRA conversion through a process called “recharacterization,” a popular option when the value of an individual’s account drops soon after converting to a Roth IRA. Recharacterization allows an individual to change the amount that was initially converted to a Roth IRA (with earnings) back to a traditional IRA, and the amount recharacterized remains tax deferred. Taxpayers have until the due date of their federal income-tax return (including extensions) for the year the Roth IRA conversion occurs to consider a recharacterization.
Example: John converts his $250,000 traditional IRA into a Roth IRA in February of 2008. In February of 2009, his account balance has dropped to $150,000.
If John takes no further action, he will have to include the $250,000 conversion amount as income for the 2008 tax year, even though it is now worth only $150,000. If John recharacterizes his Roth IRA back into a traditional IRA, the conversion and recharacterization will have no tax consequences for the 2008 tax year. John may convert this money to a Roth IRA at a later time.
End Run
In 2010, the AGI income restriction still applies to Roth IRA contributions. (The limit for 2009 was $101,000, $159,000 for married joint filers.) However, those with AGI exceeding the eligibility limit will have the option of contributing to a traditional IRA and later converting it to a Roth IRA. TIPRA has generally circumnavigated the Roth IRA AGI limit for all taxpayers.
Caution for Wisconsin Taxpayers
Wisconsin has not yet adopted the new federal rules regarding Roth IRA conversions. Legislative hearings are currently being held on bills that would bring Wisconsin in line with the federal rules and there is optimism that a bill will eventually pass. However, if state law doesn’t change, Wisconsin residents who are under age 59½ and who earn more than $100,000 will encounter some harsh tax consequences if they convert a traditional IRA to a Roth IRA in 2010 – a 3.3% penalty for an early IRA withdrawal, plus an additional 2% tax each year for making an impermissible contribution to a Roth IRA.
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New Nonspouse Beneficiary Rollover Rules
The Worker, Retiree, and Employer Recovery Act of 2008 (WRERA), enacted December 23, 2008, contains provisions pertaining to distributions made to nonspouse beneficiaries. The requirements are effective for plan years beginning after December 31, 2009, and affect the distribution options and mandatory tax withholding rules of distributions for nonspouse beneficiaries.
The provision allowing a nonspouse beneficiary the option of rolling over a deceased participant’s plan balance to an inherited IRA was introduced by the Pension Protection Act of 2006. There have been subsequent changes, but WRERA clears up the confusion and provides new rules.
Many plan sponsors have already updated their plans to allow this type of transaction. Sponsors who already offer this option — as well as sponsors who don’t — may not be aware of the changes that WRERA requires starting in 2010.
No Longer Optional. Under WRERA, the nonspouse beneficiary rollover distribution is a required plan provision. Thus, all qualified plans must allow for nonspouse beneficiary distributions by direct rollover.
Mandatory Withholding Applies. An equally important change is that nonspouse beneficiary distributions will be considered “eligible rollover distributions,” thus making them subject to mandatory 20% tax withholding and notice requirements. Changing this type of death benefit to an eligible rollover distribution will now result in a 20% mandatory tax withholding on any amounts not directly rolled over to an inherited IRA.
Notice Requirements. If they have not already been doing so, plan sponsors must begin providing nonspouse beneficiaries with the 402(f) notice, also known as the “Special Tax Notice” or “Rollover Notice,” when a distribution is requested. The normal 30- to 180-day time frame for this notice applies.
Take Heed. All plan sponsors should ensure that these requirements are met and that distributions to nonspouse beneficiaries have federal income tax withheld appropriately. Special explanations may have to be provided to nonspouse beneficiaries so that they fully understand the tax impact of their decisions beginning next year.
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This newsletter and the material contained in it is not intended as legal or tax advice. Please consult the appropriate professional with any specific questions you have.
CUNA Mutual Group is a leading provider of financial services to cooperatives, credit unions, their members, and valued customers worldwide. With more than 70 years of market commitment, CUNA Mutual’s vision is unwavering: to be a trusted business partner who delivers service excellence with customer-focused, best-in-class products and market-driven innovation.
For questions or comments contact the Retirement Service Center at 800.999.8786, option 1, or email us.
10001218-1109 © NPI and McKay Hochman
12/13/08
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