|
Roth
401(K) Provisions
Great
news!
If you sponsor a 401(k) plan,
beginning in 2006, you have the option to take
advantage of a new tax-planning feature – the
Roth 401(k) Account. The Roth 401(k) Account is
an additional account within your existing
401(k) plan.
As its name suggests, it is intended to
mirror many of the benefits of Roth IRAs.
Roth IRAs have been a tax-planning tool
since 1998.
Under a Roth IRA, an individual can make
after-tax contributions and receive tax-free
distributions.
In addition, minimum distribution rules
(applicable to individuals once they reach age
70½) do not apply.
You
may ask why Congress created the new Roth 401(k)
Account when we already have Roth IRAs.
The answer is that Roth IRAs are only
available for individuals whose adjusted gross
income is below a set dollar limit.
Roth 401(k) Accounts, on the other hand,
are available to all participants in the plan,
including high-income wage earners.
The
new Roth 401(k) Account is effective January 1,
2006. In
March 2005, the IRS issued proposed regulations
that address some of the issues associated with
Roth 401(k) Accounts.
However, the regulations did not address
all issues, so there are still many unanswered
questions, particularly those relating to
taxation of distributions.
Even though we are still waiting for
additional guidance from the IRS, we are
introducing you to Roth 401(k) Accounts now,
because many of you will choose to add this
feature for 2006 – particularly since the
availability of the feature is limited (the
legislation that created the Roth 401(k) Account
is currently scheduled to expire on December 31,
2010).
A.
Designated Roth Contributions
As
mentioned above, Roth 401(k) Accounts are
available to all participants.
Beginning with deferrals made after
December 31, 2005, a participant can designate
that all or a portion of her/his salary
deferrals will be made to a Roth 401(k) Account.
These deferrals are called
"designated Roth contributions" or
"DRCs".
Like
Roth IRAs, DRCs are made with after-tax
dollars.
DRCs are immediately 100% vested.
Any portion of salary deferrals that the
participant does not designate as DRCs will be
pre-tax 401(k) deferrals.
DRCs and pre-tax 401(k) deferrals are aggregated
for purposes of the 402(g) limit (see discussion
of this limit on pages 3 and 4).
B.
Qualifying Distributions
If
a distribution of a participant's balance in a
Roth 401(k) Account is "qualified",
then investment earnings are tax-free. This
means that the participant will not pay any
income tax (or capital gains) when she/he
withdraws her/his Roth 401(k) Account balance
from the plan.
A
distribution must satisfy two requirements in
order to be "qualifying" – (1) the
distribution must occur after attainment of age
59½, death or disability; and (2) the
distribution must occur at least 5 years after
the participant contributes her/his first DRC.
For example, if the participant makes
her/his first DRC in 2006, then the first
"qualifying" distribution can be made
on or after January 1, 2011 (assuming the first
requirement is also satisfied).
Qualifying
distributions can be taken in cash or rolled
over to an individual Roth IRA or to a Roth
401(k) Account in another 401(k) plan.
Be aware that participants who roll out
their total
account balance under the plan will potentially
have to establish two IRAs to receive the
rollover – a traditional IRA for pre-tax
401(k) deferrals and employer contributions and
a Roth IRA for DRCs.
If
a distribution is "non-qualifying",
then the investment earnings are subject
to tax. We
do not know exactly how this tax will be
determined.
The IRS did not address this in the
proposed regulations. They have asked for public
comments and we expect additional guidance from
them in the near future.
C.
Administrative Requirements
There
are many additional administrative steps that
will be involved in accounting for DRCs.
You should talk to your plan
administrative firm to determine if these
additional administrative steps will result in
an increased cost to you.
First,
participants must make a written election to
designate their deferrals as DRCs in advance,
before the wages are earned.
Normally, this would be done on the
salary reduction agreement form.
Participants can change their election in
accordance with the plan's rules, but once
deposited, DRCs must stay in the Roth 401(k)
Account.
Second,
a participant's DRCs must be separately
accounted for under the plan.
This is a separate "source"
account maintained by the plan's administrative
firm and not a separate investment account.
A participant's Roth 401(k) Account must
be maintained on the plan's records until it is
fully distributed.
No other contributions or forfeitures can
be allocated to the participant's Roth 401(k)
Account.
Third,
for those of you who do not have a safe
harbor plan, DRCs are subject to
non-discrimination testing (ADP/ACP).
This testing is already performed on
pre-tax 401(k) deferrals under the plan.
Those of you with safe harbor plans are
not subject to this testing.
Finally,
unlike Roth IRAs, DRCs are subject to minimum
distribution rules.
This means that the required minimum
distributions will have to include amounts from
the participant's Roth 401(k) Account. However,
to avoid this requirement, older participants
and beneficiaries can simply roll their Roth
401(k) Account into a Roth IRA.
D.
Steps to Adopt the Roth 401(k) Account
The
first step is to decide whether or not to add
the Roth 401(k) Account to your plan.
This is an elective feature – you are not required to offer it.
If you have any questions about adding
the Roth 401(k) Account, we recommend that you
discuss them with your financial advisor.
The
second step is to notify the participants that
you have added a new feature to the plan.
For those of you with a safe harbor plan,
this notice will be included in the 2006 Safe
Harbor Notice that will be provided to you by
your administrative firm this fall.
A special notice will have to be prepared
for non-safe harbor 401(k) plans.
The
Salary Reduction Agreement (SRA) form for your
plan must also be revised so that participants
can elect for their deferrals to be DRCs.
Most likely, this form will be provided
with the notice described above.
The SRA form must explain the timing
rules that will apply to the participant's
ability to change between DRCs and pre-tax
401(k) deferrals.
In addition, it must state that a
participant cannot change the designation of
deferrals that have already been deposited in
the plan (i.e., any change will be prospective
only).
Next,
you will need to work with your payroll support
company to make sure that they are prepared to
implement a participant's election to make DRCs.
As discussed above, the tax treatment is
different for traditional pre-tax 401(k)
deferrals and DRCs.
DRCs can begin with the first payroll on
or after January 1, 2006 so we encourage
you to contact your payroll provider now to make
sure they will be ready.
Your
plan document must also be amended.
We do not yet know the deadline, but we
expect that an amendment will have to be adopted
by the plan sponsor before the end of the plan
year during which DRCs are first allowed (i.e.,
December 31, 2006 for calendar year plans).
We anticipate that there will be other
required amendments in 2006 for 401(k) plans, so
the Roth 401(k) amendment would be done at the
same time. The
fee, if any, for the amendment will depend upon
the type of plan you maintain.
AUTOMATIC ROLLOVERS
Chances
are you have already signed or received an
amendment for your plan this year relating to a
new "automatic rollover" requirement
(if you have not already, you will soon!!).
This amendment changes the rules relating
to forced distributions of small account
balances.
Previously,
if you had a participant terminate employment
and the present value of the participant's
vested benefit under the plan was $5,000 or less, then you could distribute the participant's benefit
in cash, even without the participant's consent.
Effective with respect to distributions
after March 28, 2005, Congress changed the
rules.
Under
the new rules, if you have a participant
terminate employment and the present value of
the participant's vested benefit under the plan
is not
less than $1,000 and not greater than $5,000,
you now have to roll over the participant's
benefit to an IRA, unless the participant
affirmatively elects to take cash.
For
benefits under $1,000, you can still distribute
the benefit in cash.
To comply with these new "automatic rollover"
rules, you must locate a qualified IRA provider
to accept the automatic rollover accounts.
Your plan administrative firm or
financial advisor can assist you in locating
such a provider.
Contact them for assistance.
In
lieu of implementing the new "automatic
rollover" rules, some plan administrative
firms have recommended that the plan be amended
to provide that only benefits of $1,000 or less
can be forced out.
The advantage of this approach is that
you do not have to worry about the additional
administrative burden associated with
establishing IRAs for your participants.
The disadvantage is that you cannot make
any distributions of benefits greater than
$1,000 without the participant's consent.
If
you have any questions about this, please
contact your financial advisor, plan
administrative firm or us.
|
 |
Rehired
Employees
In
virtually all plans, if you rehire an employee
who previously worked for your business (or a
predecessor or related business), her/his prior
employment is counted in determining her/his
eligibility for the plan.
This
applies even if the prior employment occurred
before the plan existed.
Normally, a rehired employee who had met
the eligibility requirements previously, is
eligible immediately
as of her/his date of re-employment.
The
following two examples of plans with 12
month/1000 hour eligibility illustrate this.
Assume that employee Jane worked for your
business from 1985 through 1988 (and had over
1000 hours in a 12 month period).
You established a retirement plan in
2003. If
you rehire her on September 1, 2005, she is
eligible to participate in the plan immediately
on September 1, 2005, her date of rehire.
Employee Nicole was hired April 1, 2000
and worked until December of 2000.
When she quit, she had worked over 1000
hours. If
she is rehired on May 1, 2005, she is eligible
to participate in the plan immediately on May 1,
2005, her date of rehire.
This is because more than 12 months has
passed since her original hire date and she
worked more than 1000 hours before she quit in
2000.
Note
that the rehire rules apply even if the employee
is coming back to work on an intermittent,
temporary or part-time basis.
If a rehired employee is eligible and you
have a safe harbor 401(k) plan, you must give
her the
Safe
Harbor
Notice and Salary Reduction Agreement form on
her date of rehire.
You will also need to give her a copy of
the current Summary Plan Description. For
any
rehired employees, we recommend that you contact
your plan administrative firm or us immediately upon rehire to determine exactly when they will be
eligible to participate.
SAFE
HARBOR NOTICE FOR 401(K) PLANS
The
Safe Harbor Notice is the key document in the
annual operation of a safe harbor 401(k) plan.
The notice describes in simple terms the
major provisions of the plan.
A
new participant must be given the Safe
Harbor Notice (and preferably also the Summary
Plan Description and Salary Reduction Agreement
form) 30 to 90 days before her/his plan entry
date. Check
your Summary Plan Description to identify the
entry dates for your plan.
For most plans, the plan entry dates are
the first day of the plan year and the first day
of the 7th month of the plan year on or after the date the employee completes the eligibility
requirements.
For calendar year plans, those entry dates are January 1 and July 1.
So, if a new participant will enter the
plan on July 1, 2006, you must give her/him the
Safe Harbor Notice sometime between April 2 and
June 1 of 2006.
In addition to providing the initial
notice, a
Safe
Harbor
Notice must be given annually to all plan
participants.
The notice must be given 30 to 90 days
before the year begins (thus, between
approximately October 2 and November 30 of 2005
for a 2006 calendar year plan).
Your plan administrative firm will assist
you in providing this notice.
A
participant must have at least 30 days at some
time after receiving the Safe Harbor Notice to
make or modify her/his salary reduction
agreement. In
addition, changes to the salary reduction
agreement can be made as of the dates set out in
the salary reduction agreement form.
CONSEQUENCES
TO GIVE NOTICE TIMELY
f
you do not give an eligible employee (including
a rehired employee) the Safe Harbor Notice
timely and allow salary deferrals to be made,
you have caused, at the very least, an
operational error which should be corrected
under the IRS program known as Employee Plans
Compliance Resolution System (EPCRS).
This will result in increased funding
costs and administrative and legal expenses to
you.
401(k) SALARY DEFERRAL LIMITS
The
dollar limits for making salary deferrals to
401(k) plans (called the 402(g) limit) and the
new "catch-up" rules continue to
increase. The
catch-up rules can allow plan participants who
are 50 or
older at any time during the year to make
additional "catch-up" salary
deferrals. The
limits through 2006 are listed below.
After 2006 the
limits are indexed for inflation.
Additional
Calendar
year
402(g) limit Catch-up limit
2005
$14,000 $4,000
2006
$15,000 $5,000
PLAN LOANS TO PARTICIPANTS
Some
plans allow loans to be made to participants.
Loans must comply with a number of
precise rules and restrictions, including a
specific repayment schedule.
Repayment
of the loan must begin within 90 days of the
date it is made, according to the repayment
schedule. The
trustee of the plan is responsible for
collecting the payments on a timely basis.
If any of the loan restrictions
are violated, or if
repayments are not timely, the entire
loan could be treated as a taxable distribution
to the borrower participant.
This means that it will be reported as current taxable income.
An additional 10% penalty tax may also be
assessed. In
addition, the loan may still have to be repaid.
Because
of the complexities and serious consequences of
improper loans, contact your plan administrative
firm to prepare the documentation for any loans
from the plan and strictly adhere to the
repayment schedule.
IRS AUDITS
The
IRS is currently auditing defined benefit plans
and 401(k) plans.
If the IRS contacts you about an audit, contact us immediately.
IRAs
AND ROLLOVERS
A
qualified plan may accept rollovers from a
traditional IRA; from IRAs that have been
commingled with distributions from qualified
plans; from distributions from 403(b) plans; or
from certain governmental 457 plans.
Generally, Roth IRAs and other IRAs
containing any
after-tax contributions may not be rolled into a
qualified plan.
Before
you make or allow any rollovers, contact your
financial advisor or us.
DEPOSITING 401(K) DEFERRALS
The assets of your 401(k) plan include the amounts that participants
have requested your business withhold from their
wages to defer into the plan.
Labor Department regulations state that participant
401(k) salary deferrals (including the new DRCs,
if applicable) must be transmitted (i.e.,
deposited into or a check mailed) to the plan
trust account as of the earliest
date on which it is reasonably possible to
do so. We
continue to recommend that you transmit
participant 401(k) salary deferrals as
soon as practical after they are withheld from
the participants' paychecks, but in no event
later than 7 days after they are withheld.
Please
give your financial advisor, plan administrative
firm or us a call if you have any questions.
In
the past, many of you have been able to apply
your pre-funded employer
contributions to "cover" any late
deposits of 401(k) salary deferral amounts.
Effective in 2006, the IRS will no longer
allow this practice.
Thus, it is more important than ever that
you get each deposit into the plan on a timely
basis.
CHANGES IN YOUR BUSINESS
OPERATION
Any
change in your business structure
(incorporation, new partner, split in
partnership, etc.) may impact your qualified
retirement plan.
Please
let us know about any change in your business
structure as soon as possible.
Also, please notify us of any changes
regarding your office, mailing or email address
or your telephone or fax number (including area
code) so that we may keep our records up to
date.
EGTRRA PLAN RESTATEMENT
Over
the past decade, Congress has been very busy
making changes to retirement plan rules.
All of these changes must be incorporated
in your plan documents.
Your
plans have already been amended for many of
these changes – including the GUST restatement
in 2001/2002, the EGTRRA good faith amendment in
2002, the final 401(a)(9) regulations for
defined contribution plans (Post-EGTRRA
amendment) in 2003 and now the automatic
rollover amendment in 2005.
These
have all been legally required amendments.
We
understand that keeping up with these changes
can seem exasperating at times.
So, we thought we would take just a
minute to prepare you for what is ahead.
We anticipate that there will be another
required amendment for most plans next year (the
Roth 401(k) provisions would be included, if
applicable).
Sometime between 2007 and 2010, all
qualified plans will have to be completely
restated to incorporate all the changes from the
2001 EGTRRA legislation and several post-EGTRRA
laws and regulations.
We
are certainly aware of the costs involved with
all of these changes.
We remain committed to providing
high-quality, cost-effective service.
__________________________________________
This
newsletter contains general information and
should not be used to resolve legal questions
regarding specific fact situations.
|
