| Roth
401(K) Provisions
Most
of you who sponsor a 401(k) plan are now familiar
with the new Roth tax-planning feature. Under the
Roth feature, a participant may have an additional
Roth 401(k) Account within your existing 401(k) plan.
The new Roth feature was first effective January
1, 2006, though you may have added it to your plan
on a later date. The IRS has issued various regulations
that address many of the issues associated with the
Roth feature, but they are still sorting through all
of the areas that are impacted by Roth.
A.
Designated Roth Contributions
If you
elected to add the new Roth feature to your 401(k)
plan, then 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 traditional 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 page 3).
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 federal 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 – (1) a traditional
IRA for pre-tax 401(k) deferrals and employer contributions
and (2) a Roth IRA for DRCs.
If a distribution is "non-qualifying",
then the investment earnings are subject to tax (though
the participant may defer the tax by rolling over
her/his Roth 401(k) Account as discussed above). The
IRS has issued proposed regulations addressing how
this tax will be calculated, but 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 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 any 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
Many
of you have already taken the steps to adopt the Roth
401(k) Account under your 401(k) plan. For those of
you who are not currently offering the Roth 401(k)
Account, you may decide to add it at any time in the
future. Of course, 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.
If you decide that you would like to add the Roth
401(k) Account, please contact our office for more
information
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. This also applies even if the employee
is only rehired on a "fill-in", temporary
or part-time basis. Normally, a rehired employee who
had previously met the eligibility requirements 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
Betty 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, 2006, she is eligible to participate
in the plan immediately on September 1, 2006, her
date of rehire. Employee Leslie 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, 2006, she is eligible to participate in
the plan immediately on May 1, 2006, 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.
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, 2007, you should give her/him
the Safe Harbor Notice sometime between April 2 and
June 1 of 2007.
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
plan year begins (thus, between approximately October
2 and November 30 of 2006 for a 2007 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
OF FAILURE TO GIVE NOTICE TIMELY
If 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 allow plan participants who are 50
or older at any time during the year to make
additional "catch up" salary deferrals. For 2006,
the 402(g) limit and catch-up limit are $15,000
and $5,000, respectively. After 2006 the limits
are indexed for inflation. |
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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 understand from
industry insiders that the Labor Department will soon
be issuing a "safe harbor" deadline for
depositing 401(k) salary deferrals.
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 the pay date.
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 no longer permits this
practice. In addition, the IRS does not allow an employer
to "pre-fund" the 401(k) salary deferral
amounts (i.e., deposit such amounts prior to the payroll
date). Thus, it is more important than ever that you
get each deposit into the plan on a timely basis.
If you do not, you will be required to report the
late salary deferrals on your Form 5500 and contribute
an amount representing "lost earnings" to
the plan.
Please be aware that the Labor Department is taking
a much more proactive role in policing the late deposit
of 401(k) salary deferral amounts. Thus, you may receive
a letter from the Labor Department regarding salary
deferral amounts that have been reported as late on
Form 5500. Generally, the Labor Department letter
will invite you to participate in a voluntary correction
program. However, in some cases, plan sponsors are
being notified that their plan has been selected for
an audit. If you are contacted by the Labor Department,
we recommend that you contact your plan administrative
firm or us immediately.
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.
NON-TRADITIONAL
INVESTMENTS
There
are many legal issues that arise in connection with
any "non-traditional" investments. Basically,
this includes any investment that is not in publicly
traded stocks, bonds, mutual funds or qualified group
pooled trusts. Examples include real estate investments,
partnership interests, non-publicly traded stocks
or loans. With respect to plan investments, we see
three legal issues that often require analysis - fiduciary
duties, prohibited transaction rules and plan asset
regulations. In addition, there are administrative
issues concerning valuation and reporting of the non-traditional
asset.
If you are considering investing plan assets in a
"non-traditional" investment, please contact
your financial advisor or us for a general review
of the legal issues. In certain circumstances,
we may also advise a more thorough analysis of your
specific facts and circumstances.
CHANGES
IN YOUR BUSINESS OPERATION
AND/OR CONTACT INFORMATION
Any
change in your business structure (incorporation,
new partner, split in partnership, etc.) or purchase
of an interest in another business 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, your telephone or
fax number (including area code), or your plan advisors
so that we may keep our records up to date.
EGTRRA PLAN RESTATEMENT
Over
the past decade, Congress and the IRS have 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
2001-2003, the EGTRRA good faith amendment in 2002-2003,
the final 401(a)(9) regulations for defined contribution
plans (Post-EGTRRA amendment) in 2003, the automatic
rollover amendment in 2005 and now the final 401(k)/401(m)
regulations amendment this year. 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. 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. Over the
next year, we will be developing internal procedures
for handling this restatement with the least possible
inconvenience to you. In this regard, sometime in
the next several months, we will be asking you to
sign an IRS form certifying your present intent to
adopt our EGTRRA document. Then, at a later time,
you can expect to receive individual correspondence
from us describing the restatement process.
We are certainly aware of the costs involved with
all of these changes. As always, we remain committed
to providing high-quality, cost-effective service.
PENSION PROTECTION ACT OF 2006
On August 17, 2006, President Bush
signed into law a massive 907-page piece of legislation
called the Pension Protection Act (PPA). PPA contains
a number of wide-ranging changes, much too many to
address here. In the paragraphs below, we have attempted
to summarize just a few of the most significant provisions
contained in this law.
PPA makes a number of the 401(k)/profit sharing and
pension changes contained in the 2001 EGTRRA legislation
mentioned above permanent. This means that the current
law limits for salary deferrals ($15,000), catch-up
salary deferrals ($5,000), the maximum annual dollar
allocation limits for defined contribution/401(k)
plans ($44,000), the maximum annual benefits from
defined benefit plans ($175,000), and the maximum
compensation considered ($220,000) will continue now
and beyond 2010. Of course, those amounts will continue
to be subject to cost of living adjustments. In addition,
the new DRCs will continue to be permitted past 2010.
PPA also makes a number of changes impacting defined
benefit plan funding. For 2006 and 2007 plan years,
the maximum permitted deductible amounts for defined
benefit pension plans have, in many cases, been increased
to 150% of current liabilities, less plan assets.
Required contribution amounts to defined benefit plans
will likely increase beginning with the 2008 plan
year. Where an employer or affiliated employer group
sponsors both defined benefit and 401(k)/profit sharing
plans, the deduction limit has been increased to the
greater of (1) 25% of compensation of the participants
benefiting under the plans or (2) the required defined
benefit funding amount plus 6% of compensation of
the participants benefiting under the plans. Salary
deferral amounts are deductible in addition to this
limit. Between 2008 and 2012, PPA also changes the
interest rate used in calculating the present value
of a participant's benefit in a defined benefit plan.
Several significant changes made by PPA effective
for plan years beginning after 2006 include: (1) If
a plan permits participant direction of investments
(even if participants do not actually choose to direct
their investments), then the plan must prepare and
distribute quarterly statements. If your plan allows
participant direction of investments, you should contact
your administrative firm and investment advisor to
be sure that these statements will be provided. The
penalty for failure to provide the statements can
be up to $110 per day per participant. (2) The Labor
Department and IRS are required to implement simplified
Form 5500 reporting for plans with fewer than 25 participants.
However, this simplified reporting will not apply
where the plan sponsor is part of an affiliated service/control
group or uses leased employees. (3) Non top-heavy
defined contribution plans must adopt one of the two
basic top-heavy vesting schedules.
Finally, a significant PPA provision effective in
2007 allows a non spouse beneficiary (including a
trust) to rollover a distribution from a qualified
plan directly to a rollover IRA. Distributions from
that rollover IRA can then be treated like an "inherited
IRA" under the minimum required distribution
rules.
We will be providing more information on the various
PPA provisions in future newsletters. If you have
specific questions about any of these provisions,
feel free to contact us.
__________________________________________
This
newsletter contains general information and should not
be used to resolve legal questions regarding specific
fact situations.
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