Window of Savings Opportunities with Backdoor Roth IRAs

Featured

Estimated reading time: 5 minutes

What is a mega backdoor Roth IRA? Can I do a backdoor Roth IRA in 2021? What is the limit to a backdoor Roth IRA? Is a backdoor Roth IRA worth it? Can I do a backdoor Roth every year?

Mega backdoor Roth IRAs have made headlines in recent months which likely means you have at least a few employees in your organization, especially highly compensated employees (HCEs), who are curious about the savings strategy and asking those kinds of questions. Understanding the strategy helps you answer their queries and provide guidance on the steps employees need to make the contributions.

Backdoor Roth IRA

Backdoor Roth IRA

To understand the concept that has become known as the mega backdoor Roth, it’s helpful to break down the terminology, starting with the Roth savings approach:

A Roth account refers to any account where retirement savings dollars are taxed initially when money is deposited into the account, but subsequent earnings and distributions are tax-free (assuming certain conditions are met). The Roth concept was created with the Roth IRA added by the Taxpayer Relief Act of 1997 (TRA 97) and extended to other retirement accounts beginning with the addition of Roth 401(k) accounts with the Economic Growth and Tax Relief Reconciliation Act of 2001.

Roth accounts can be more beneficial than traditional tax-deferred accounts if tax rates are expected to be higher during an individual’s retirement. These accounts can add an element of tax diversification if a portion of an account is Roth and another portion is a traditional tax-deferred account, which offers some protection against rising tax rates.

A backdoor Roth, as opposed to a mega backdoor Roth, refers to the ability to place money in a Roth account (historically, a Roth IRA) even if the individual is not otherwise eligible to make contributions directly into a Roth account. For the 2021 tax year, an individual earning more than $198,000 cannot make a full contribution into a Roth IRA or tax-deductible IRA and no contribution is allowed at all for individuals earning more than $208,000. Reduced income limits apply to tax-deductible IRA contributions for those covered by a retirement plan at work. However, an individual (regardless of income) can make a non-deductible contribution to a traditional IRA of up to the $6,000 annual limit. While the contribution receives no current favorable tax treatment, the income on contributions is tax-deferred until distributed.

As a result, these traditional IRA accounts typically offered limited value. This changed when a provision of TRA 97 sunset in 2010. TRA 97 introduced the concept of converting a traditional IRA to a Roth IRA by paying current income taxes on the amount converted. The ability to convert has a provision that precluded higher-income taxpayers from converting their traditional IRA contribution amount. That provision expired in 2010, and today, taxpayers of any income can make a non-deductible IRA contribution and then convert that amount into a Roth IRA.

Often, the conversion happens immediately after the contribution is made. It’s important to note that the conversion of non-deductible IRAs can create taxable income for any traditional IRA dollars that the taxpayer has saved.

A mega backdoor Roth takes the backdoor Roth to another level because the accounts may be part of an employer’s retirement plan. For decades, retirement plans have been allowed to permit employees to make after-tax contributions. From a tax perspective, the after-tax contributions are identical to non-deductible IRAs. However, these amounts are not limited directly to $6,000, but are limited in combination with other contributions by the Code 415(c) limit ($58,000 for 2021).

If an individual is deferring $19,500 in pre-tax and Roth deferral and receives employer contributions of $10,500, they can still make after-tax contributions of up to $28,000 ($58,000-$19,500-$10,500). However, there are numerous compliance issues (see the following discussion) that must be addressed before contributions of that size are permitted. Once in the plan, these after-tax amounts can either be converted to Roth dollars within the plan or distributed to a traditional IRA and then converted to a Roth IRA.

Setting a Mega Strategy

For employees who have more money to save after contributing the annual maximum to their 401(k)/403(b) accounts, your company’s retirement savings plan may provide a route to the mega backdoor Roth strategy if:

  • The 401(k)/403(b) plan allows after-tax contributions, and
  • In-plan Roth conversion option is allowed in the plan, or
  • In-service distributions or withdrawals that are not hardship withdrawals from the plan to a Roth IRA are permitted

This savings tactic comes with a variety of risks. Employees should be strongly encouraged to discuss backdoor Roth options with their financial advisors. They will need to make sure they can afford to proceed with the savings strategy, and they will need to follow through carefully with each required step of the Roth conversion to reap the benefits.

The Pros to a Mega Backdoor Roth

The mega backdoor Roth savings approach offers several benefits to employees who make the Roth IRA conversion:

  • No taxation on the earnings
  • May withdraw the contributions at any time
  • May withdraw the contributions and earnings tax-free for specific purposes (first-time home purchase, etc.)
  • Withdrawal of the contributions and earnings is tax-free after age 59-1/2 (with five-year waiting period)

In addition, required minimum distributions at age 72 are not required from Roth IRAs; participants can leave their accounts untouched until a later age.

The Cons to a Mega Backdoor Roth

The strategy is not without caveats. While the mega backdoor Roth IRAs boasts several benefits, there are drawbacks that employees must weigh before implementing a mega backdoor Roth:

  • Taxes must be paid on the accumulated earnings on the conversion at the time the conversion is made.
  • Employees may not realize a benefit from the mega backdoor Roth IRA if their tax rate decreases in the future.

There’s a five-year waiting period before tax-free withdrawals can be made, even if you are 59-1/2 or older.

Attempts to Repeal

Since the income limits on conversions sunset in 2010, numerous congressional proposals have attempted to restrict or eliminate the ability for high-income individuals to utilize backdoor Roth IRAs and associated strategies. This includes a proposal as recent as September 2021 by the House Ways and Means Committee. Any retirement plan or individual utilizing these strategies should closely monitor the evolving legislative and legal landscape around these programs.

Plan Design Considerations

Plan sponsors should also consider their current plan design and plan participation to determine if adding an after-tax feature would be wise. Since after-tax contributions are subject to nondiscrimination testing (under the ACP test), several scenarios would likely lead to test failures, requiring refunds, and ultimately prohibiting the HCE from executing the strategy.

  • If the plan does not provide a match, and mostly HCEs utilize the after-tax contributions, the ACP test would fail.
  • If you currently provide a safe harbor match, those contributions are exempt from ACP testing, so the after-tax contributions would be tested alone. If mostly HCEs choose to make after-tax contributions, the ACP test would fail.
  • If you currently provide employer matching contributions which would be averaged in with the after-tax contributions, the impact to the ACP test would be less severe. You should review how much the HCEs’ average contribution rates could increase before causing the test to fail.
  • If you have a safe harbor plan, adding the after-tax source will void the top-heavy exemption you might otherwise have had. If the plan is determined to be top heavy, the employer must satisfy the minimum contribution requirements (generally 3% of pay) with respect to all non-key employees.

Understanding these cautions, plan sponsors should consider adding the backdoor Roth features if the plan:

  • Is not a safe harbor plan;
  • Provides a matching contribution;
  • Passes ADP/ACP testing by a wide margin;
  • Has broad participation and good deferral rates among non-highly compensated employees; and
  • Automatically enrolls new participants, and regularly re-enrolls participants contributing less than the automatic deferral rate.

Conclusion

Through 401(k) and 403(b) plans, organizations of all kinds may offer opportunities for employees to implement a mega backdoor Roth IRA strategy. Reviewing your retirement savings plan and its provisions will allow you to answer inquiries from employees who are seeking additional ways to save and reduce taxes.

For more information regarding mega backdoor Roth IRAs, or to get a better understanding of how your company’s retirement savings plan may provide options for backdoor IRAs, contact Laura Guin, CPC at laura.guin@usi.com.

Published October 21, 2021

© 2021 Findley, A Division of USI. All Rights Reserved

This information is provided solely for educational purposes and is not to be construed as investment, legal or tax advice. Prior to acting on this information, we recommend that you seek independent advice specific to your situation from a qualified investment/legal/tax professional.

1021.S0921.99143a

Defined Benefit Pension Plan Contributions: To 2021 and Beyond

While so many people across the country are looking forward to the end of this calamitous year – believing that 2021 will offer remedies for a global pandemic and an ailing economy, plan sponsors now should be plotting a strategy for the upcoming year and beyond. The Federal Reserve’s recent statement of “lower interest rates for longer” impacts defined benefit plan sponsors as they determine an approach to plan contributions – not just for 2021, but likely the next few years. Navigating a possible multi-year stretch of lower interest rates will be challenging for defined benefit pension plan sponsors, particularly for organizations feeling the effects of a pandemic-induced recession.

Forecast to Move Forward

This is an unusual recession, where the economic impact of the pandemic is varied. A number of industries are suffering, while others are seeing strong growth.  Certain manufacturers, supermarkets and online retailers, video conferencing firms and other companies enabling remote work have reported robust sales in recent months. The hospitality and entertainment industries, auto manufacturers and their suppliers, and numerous sectors of retail and manufacturing industries have been especially impacted through this pandemic.

Steering safely forward will require forecasting and guidance from the plan’s actuaries, and the first discussion with your actuary should focus on how the organization is currently faring. Organizations that have been hurt financially are likely to experience a “double whammy” as the company’s income drops and required contributions to their defined benefit pension plan increase.

Defined Benefit Pension Plan Contributions Forecast Chart

2020 Plan Contributions vs 2021 Cash Flow

Key to the contribution strategy conversation is determining how much the organization can afford to contribute. Some plan sponsors may choose to defer required 2020 plan contributions to January, 2021, while those companies having a good financial year may opt to contribute on the normal schedule, and may also contribute more than the required amount.

The decision to defer 2020 plan contributions, effectively at least doubling their contribution requirements in 2021, should be made only after weighing the pros and cons. Deferring may give the company time to come up with the funds needed, but the deferral may strain the organization’s cash flow with a large lump sum contribution coming due at the beginning of next year and other plan contributions required through 2021. Forecasting the organization’s financial picture is essential and it’s important to get answers to these questions in determining the contribution strategy:

  • When will the company’s cash flow improve?
  • How will our business be affected if another partial shutdown occurs and the economy continues to falter over the next nine months?
  • Should the organization finance its plan contributions now to either accelerate or avoid deferring future funding?
  • If plan contributions are deferred, can the lump sum contribution and other plan contributions be paid later from cash flow, through borrowing, or a combination?
  • Beyond the contribution impact, are there other impacts to the plan or the organization, such as PBGC premiums, by deferring or prepaying the plan contributions?

Look Beyond 2021

For most calendar year defined benefit plans, 2020 contributions will be lower than those required for the 2019 calendar year. Strong asset returns in 2019 resulted in that bit of good news, but plan sponsors should expect contributions to be higher for 2021 and beyond.

Economists are forecasting that the ripple effects of the pandemic on the economy will be widespread, taking several years to fully recover.  In light of an expected gradual recovery and the Fed’s message of ‘lower for longer’ interest rates, plan sponsors should anticipate having to manage their plans through a period of lower investment earnings and higher contributions, and understanding the reasonable range of contributions to expect is important.  Having a five- to ten-year contribution forecast that incorporates the economic outlook for the next several years will provide valuable insight on future contribution levels and help companies develop a longer-term funding strategy.

With low interest rates, plan sponsors have slowed down their annuity purchases from previous years, but some companies may consider offering a lump-sum window to their eligible participants to continue shrinking their obligations for their plans. These de-risking initiatives can create additional costs, so it’s important to understand the impact of these initiatives on future plan contributions before taking action. 

In addition, implementing a lump-sum window, not only needs to be fully explored with your actuarial team and legal counsel, the plan sponsor will also need to fully communicate the offer to participants to achieve the desired results. Support staff should be available to answer questions and assist participants with completing and submitting paperwork, if needed. During the pandemic, support should be virtual through call centers, microsites and other electronic meeting solutions.

Conclusion

As 2020 draws to a close, charting a course for DB plan contributions over the next few years is a wise decision that plan sponsors can make. Forecasting contribution levels, developing a contribution strategy, and implementing the plan are integral to moving forward as we experience “lower rates for longer”. Findley’s actuaries and consultants can offer guidance in developing defined benefit pension plan contribution strategies to navigate the return to normal.

Questions regarding what your plan’s contributions requirements for 2021 and beyond? Contact Tom Swain in the form below.

Published October 8, 2020

Print this article

Copyright © 2020 by Findley, Inc. All rights reserved.

Middle Tennessee Employee Benefits Council Virtual Breakfast Meeting

Join Findley’s Tom Swain and Cory Panning for the Middle Tennessee Employee Benefits Council Virtual Breakfast Meeting where they will present a strategic approach for building a financial well-being program that engages employees, helping them achieve better control of their financial lives and better planning and action for their retirement. 

Friday, September 18, 2020

8AM-9AM CT

Retirement Readiness Starts with Financial Wellbeing: A Strategic Approach for Building Your Financial Well-Being Program – Check it out!

How To Successfully Navigate A DOL ESOP Investigation

“Dear Sir or Madam…our office has scheduled a review of the above captioned plan to determine compliance with the provisions of ERISA.” A formal notice from the Department of Labor (DOL) can bring a sense of unease to any employee stock ownership plan (ESOP) practitioner. However, by developing an understanding of why DOL ESOP investigations occur and familiarizing oneself with the DOL’s audit practices, navigating one will be less ominous.

What Is A DOL ESOP Investigation?

The DOL enforces the federal laws of retirement plans under the Employment Retirement Income Security Act of 1974 (ERISA). ERISA provisions grant the DOL authority to conduct investigations of ESOPs and, unlike those conducted by the Internal Revenue Service (IRS), it has the discretion to investigate and reinvestigate any plan it so chooses. Because ESOPs fall under the governance of ERISA, fiduciary duty is required to those who administer, manage, or control plan assets and any ESOP fiduciary is required to act solely in the best interests of the plan’s participants.

Beginning in 2005, the DOL’s ESOP review project initially focused on the valuation of privately-held employer securities purchased by the ESOP.  Even more so today, ESOP trustees are under continued scrutiny from the DOL regarding this subject matter. The trustee must continually demonstrate due diligence in analyzing the transaction and determine that the valuation procedures considered when authorizing the share purchase result in the trust’s payment of no more than fair market value (i.e. “adequate consideration”). Ultimately, the DOL monitors whether participants are being overcharged for the stock acquired by the plan. Failure of any ESOP trustee to uphold this duty may result in them being held liable for making the ESOP trust whole, as evidenced by an increase of monetary settlements in recent court rulings.

How To Successfully Navigate A DOL ESOP Investigation

Why Was Our ESOP Selected?

Because the DOL does not detail their selection process, understanding why your ESOP is under investigation remains unclear. They commence for various reasons, including through referrals from other government agencies or media sources, via plan participant complaints, through computer generated targeting (e.g. collecting information on Form 5500), or by random audit. Many of the investigations do not occur until after a fiduciary breach occurs and the severity of any infraction will determine any company/civil penalties or criminal proceedings. Additionally, DOL enforcement agencies typically provide little advance notice, so knowing how to respond before an investigation begins is critical.

What Can We Expect?

The formal investigation process begins after receipt of a notification letter from a DOL regional office. This letter requests an abundance of plan documentation, including:

  • Plan and trust document
  • ESOP board minutes and correspondence
  • ESOP allocation report
  • ESOP trust statements
  • Copies of Form 5500
  • ESOP loan documents
  • Payroll data
  • Service provider agreements

This information must be provided to the investigator within a certain deadline, although extensions may be granted. It is good practice for a company to establish a point of contact (i.e. ERISA legal counsel) to help aid in the information exchange process. This helps to avoid disruptions, maintains organization, and ensures all requested materials are reviewed and properly addressed. Once all requested documentation is received, the DOL conducts on-site visits comprised of in-person interviews, including key personnel, plan fiduciaries, and those involved with the day-to-day operations of the ESOP. During this stage, it is crucial that legal counsel represent those being interviewed since they can detail what to expect and inform those interviewed of their rights during the process.

What Happens Next?

At the end of the audit period, the DOL must decide whether to take any further action. This phase of the DOL ESOP investigation may take several months and, during that time period, the DOL may discontinue communication with the contact person. Ideally, an investigation ends with receipt of a “no action” letter, meaning the DOL has found no improprieties during its audit. To the extent that the DOL ESOP investigation uncovers violations of ERISA, they will issue a Voluntary Compliance Letter. The letter generally details the facts gathered by the DOL during the investigation, outlines the violations that they have uncovered, and invites discussions related to the remedy of such violations. The DOL may also insist on entering into a written settlement agreement, of which, civil penalties may be imposed. Should settlement not be amenable to both parties, the DOL may also provide the IRS with their findings, which may impose further penalties or excise taxes.

In summary, one should not underestimate the seriousness of a DOL ESOP investigation or the resulting outcome. In the interest of transparency, the department does provide online access to its enforcement manual, detailing their internal audit guidelines and checklists. With a thorough review of these documents and an understanding of the general steps of an ESOP DOL investigation, any plan sponsor can successfully navigate one.

Questions regarding the process of ESOP investigations? Contact the Findley consultant you normally work with or Aaron Geibel in the form below.

Published August 28, 2020

Print this article

Copyright © 2020 by Findley, Inc. All rights reserved.

SOA Releases Public Plan Mortality Tables (Pub-2010)

The first mortality tables specifically for public-sector retirement plans were released by the Society of Actuaries (SOA) in early 2019. Prior to 2019, there were no publicly available mortality tables for public sector plans despite the general consensus that mortality experience for public-sector retirement plans differs from those of private pension plans. The current mortality assumptions used by public plans vary considerably, and many plans must rely on tables that were created using data for private pension plans such as RP-2000 or RP-2014.

The Importance of Mortality Tables

Using the right mortality table for your plan, whether it’s one of the Pub-2010 tables or another table, is very important. As mortality improves, people live longer and receive benefits for a longer period of time which increases the cost of your plan. In order to measure this cost and to fund your plan enough to pay future benefits, you need to choose an appropriate mortality assumption that reflects expectations. If you are using an outdated mortality table or one that doesn’t fit your plan’s population, your liability could be much larger than you realize. Your future contributions could increase significantly, or your plan may be unable to pay future benefits.

SOA Releases Public Plan Mortality Tables

Pub-2010 Mortality Tables

The new mortality tables, referred to as “Pub-2010”, are not a single table but a set of 94 tables. The SOA analyzed multiple factors that affect mortality rates, and the published tables use combinations of these factors:

  • Gender (male/female)
  • Job category (teacher/public safety employee/general employee)
  • Employment status (active employee, deferred vested participant, retiree, survivor)
  • Health status (healthy/disabled)
  • Income level (above/below median)

Plan Characteristics to Consider

Job category and income level were the two most statistically significant factors. You should pay special attention to job categories when considering using these tables.

The SOA did not release a combined table using data from all job categories, because the experience varied significantly between the categories. If your plan covers multiple categories, your Findley consultant could help you consider either valuing the groups using separate mortality tables or constructing a combined table that reflects the demographic breakdown of your specific population.

Not all plans may be able to easily divide their participants into these categories. For example, a plan for a regional transit authority with primarily blue-collar workers such as bus drivers may not be able to use these tables, since their workers do not easily fit into any of these job categories. The below-median Pub-2010 table for general employees is an option, but the RP-2014 Blue Collar table may be more appropriate.

Impact of New Tables

Using these tables is likely to increase the measurement of your liability, depending on your current mortality table and the demographics of your plan. Based on the study, teachers have the longest expected lifespan; liabilities for teachers are expected to be higher using the Pub-2010 tables than using the RP-2014 White Collar table. General employees have mortality rates in the Pub-2010 tables similar to those of the RP-2014 White Collar table. As expected, public safety employees have the highest mortality of the three groups, more similar to the RP-2000 table projected with Scale BB.

Income level is also a big determinant of mortality. The study population showed that lower income people had higher mortality rates than higher income people and had a shorter lifespan. If your plan is primarily composed of lower or higher paid employees, you should consider using the below or above median tables, respectively.

Location, Location, Location

The SOA was also expected to release tables based on geographic region. Ultimately, data based on geographic region was not used, because it was much less statistically significant than other factors and the data was not uniform across the geographic regions. If you expect your plan to have mortality rates that differ greatly from the national average, your Findley consultant can use the mortality information from the Center for Disease Control (CDC) to help develop adjustment factor(s) for geography. The CDC has mortality rates by census region, state, and county. If most of your participants live in one county that has a much higher mortality rate than the national average, you could scale the Pub-2010 tables by a factor in order to more closely model your plan population’s expected mortality.

What Now

Now that there are public plan tables available, you and your actuary need to consider adopting them or have a sufficient explanation as to why they are not appropriate. Keep in mind that there’s a lot of flexibility to tailor the tables to best match your plan’s population. You should discuss this with your plan actuary and your auditor. For further information and questions, contact Catie Barger in the form below.

Published August 17, 2020

Print this article

Copyright © 2020 by Findley, Inc. All rights reserved.

Coronavirus Crisis Workforce Reduction Can Adversely Affect Retirement Programs

The coronavirus pandemic continues to ripple across the country and many organizations face several unprecedented, difficult decisions surrounding their workforce and the use of cash. While payroll-reducing strategies may be necessary during this time of substandard revenue, they may also present other costs or hurdles in the company’s pension, retiree medical, and retiree life insurance programs. Significantly changing employee demographics can trigger unexpected accounting, cash flow, and compliance issues that could be an unwelcome surprise given current market conditions.

State mandated stay-at-home orders not only reduce the ability for consumers to purchase, but also the need for employees to produce. For many industries, this means downsizing workforces and payroll at record levels via layoffs, furloughs, reductions in force, and salary cuts. However, in this time where management decisions are focused on the best positioning of their organization from “crisis” to “rebound” mode, it is important that pension and retirement programs are not placed on the back burner. 

Coronavirus Crisis Workforce Reduction Can Adversely Affect Retirement Programs

Identify and Prepare for Potential Consequences

A proactive analysis of an organization’s workforce reduction program, as well as the group of employees impacted, may help identify and prepare for the impact of some of these potential unintentional consequences due to coronavirus:

Curtailment Accounting Under U.S. GAAP

Curtailment accounting may be initiated when more than 5-10% of the plan’s active participants are impacted by a workforce reduction event such as layoffs or forced termination, or a reduction or elimination of future benefit accruals. The curtailment impact is an immediate recognition of a portion of unrecognized prior service costs and could also prompt an interim re-measurement at the time of the event, likely unfavorable given the current market environment. Curtailment accounting can increase the “below the line” expense for accounting for pension, retiree medical, and retiree life insurance plans under U.S. GAAP.

Settlement Accounting Under U.S. GAAP and Cash Concerns for Pension Plans Offering Lump Sums

Settlement accounting is set into motion when lump sum payouts exceed the service cost and interest cost components of net periodic pension cost during the fiscal year. This may be increasingly likely as laid off participants may access their pension benefits for their own financial security. The settlement impact is an immediate recognition of unrecognized gains and losses, and similar to curtailments, could also cause an interim re-measurement at the time of the event. 

In addition, while payroll reducing strategies may be advantageous for cutting current expenses, pension plans that offer lump sums upon termination could end up in a situation where the plan requires more cash in the future. Paying an increased number of lump sums to participants could force the pension plan to raise cash by selling equities at a time when the market is significantly depressed. Selling equity at market lows may inhibit the pension plan’s ability to recover in the long term. 

Benefit Enhancements and Plant Shutdown Liability under PBGC and ERISA

Benefit enhancements and plan shutdown liability may be triggered when either a facility closure impacts more than 15% of the plan sponsor’s active participants benefitting in any pension or defined contribution plan; or if the pension plan document provides for special shutdown benefits in any size closure. Special, enhanced shutdown benefits that can increase pension plan liability and plan costs may be required to protect employees close to retirement if defined in the plan document. In addition, the Pension Benefit Guaranty Corporation (PBGC) may require special reporting and accelerated cash contributions under ERISA 4062 for some underfunded pension plans. The PBGC also may require a special report under ERISA 4043 if the number of active participants is significantly reduced for any reason.

Vesting Enhancements under IRS Partial Pension Plan Termination

A partial pension plan termination may occur when more than 10-20% of the plan’s active participants are impacted by closing a facility or division, or from any higher turnover due to economic factors. Partial pension plan termination requires the plan sponsor to grant immediate vesting eligibility or face Internal Revenue Service (IRS) disqualification in the pension plan. This is ultimately an IRS decision based on facts and circumstances and might be avoided if the reduction is structured to furlough (not typically a formal separation) rather than permanently terminate employees. 

Increased Liability and Cash Requirements for Unfunded Retiree Medical Plans

Eliminating participants who are retirement eligible can lead to a spike in retiree medical claims costs and liabilities. Unfunded retiree medical plans “pay as you go” and do not have back-up trust assets to use toward claims in the event more participants begin retiree medical plan benefits sooner than expected. Retiree medical plans with early eligibility may be responsible for benefits over a much longer period than expected at a time when rates charged by insurers may also be increasing. Together, plan sponsors may see increased claim costs in 2021, as well as higher liability and net periodic benefit costs in fiscal 2021.

IRS Compliance Concerns Related to Passing Pension Plan Non-discrimination Testing

There is a likelihood for increased difficulty in obtaining favorable non-discrimination testing (NDT) results when there is a significant change in the demographics of the plan’s active employees. For example, NDT results will be less favorable when non-highly compensated employees (NHCEs) are forced to terminate at higher rates than highly compensated employees (HCEs) and also when salaries for NHCEs are reduced at higher levels than HCEs. Alternatively, workforce reductions impacting HCEs at higher rates could improve testing results.

Violation of Union Agreements and Debt Covenants

While not tied exclusively to workforce reductions, any decision that deviates from normal practice has a potential to violate established agreements with union contracts and debt covenants. Keep in mind, relief permitted by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) may not be permitted under current arrangements.

Minimum or Variable Interest Credit Rates for Cash Balance Plans

While interest crediting rates have already been set for most cash balance plans with calendar plan years, if low interest rates persist it could mean a significant drop in the crediting rate for 2021, possibly requiring the minimum interest crediting rate to apply. In addition, plans using variable interest crediting rates may see negative returns, making non-discrimination testing more difficult.   

Seek Guidance

The bottom line is this: the coronavirus crisis continues to evolve and any workforce strategy decision should be pursued with guidance from your actuary, auditor, or legal counsel. Early analysis may help your company prepare for retirement program concerns that may arise from implementation of the selected cost-saving payroll strategy. Contact your Findley consultant to discuss any workforce reduction program you may be considering to ensure all relevant issues are addressed.

Questions? For more information, contact the Findley consultant you normally work with, or contact Debbie Sichko at debbie.sichko@findley.com, or 216.875.1930

Published April 13, 2020

Print this article

© 2020 Findley. All Rights Reserved.

Breaking Down the Secure Act – Required Minimum Distributions

Benefits experts are still poring through the SECURE Act’s various mandated provisions, optional provisions, and effective dates, some of which may be retroactive. This series of articles will break down the implications that the Act has for existing tax-qualified retirement plans. This article will focus on the Act’s impact on required minimum distributions (RMDs) for both defined benefit and defined contribution plans. Related articles will address (1) changes that impact 401(k) and other defined contribution plans only, (2) changes for defined benefit plans only; and (3) other changes to the retirement plan landscape.

Remedial Amendment Period

Plan sponsors generally have until the last day of the 2022 plan year to adopt amendments that reflect the Act’s required revisions.  For calendar year plans the last day is December 31, 2022. Governmental plans have until the 2024 plan year to amend. Remember that operational compliance is still required during the period from the effective date for the Act’s required changes and the date the plan is amended.

Delay of Lifetime RMDs – MANDATORY

Prior law: Distributions from an eligible employer retirement plan must be made by April 1 of the calendar year following: (a) the calendar year in which the participant turns age 70-1/2, or (b) for a participant who is not a 5% owner, the calendar year in which he or she terminates employment after age 70-1/2.

Under the Act: The required age for RMDs is raised from 70-1/2 to 72. Participants who are not 5% owners and who work beyond the required age for RMDS, under the Act still don’t trigger RMDs until the calendar year in which they retire. The Act did not change the way in which 5% owners are determined. In addition, post-death distributions to a participant’s surviving spouse are not required to begin before the calendar year in which the participant would have obtained age 72 (formerly 70-1/2). 

Effective date: The new age applies to employees who turn age 70-1/2 after December 31, 2019; that is, for those born after June 30, 1949. For those born on or before June 30, 1949 (already obtained age 70-1/2 prior to January 1, 2020), the prior law applies.

What to do and when: Plan sponsors should work with their service providers to track two populations: those born on and before June 30, 1949 (for whom age 70-1/2 is the RMD trigger date), and those born after that date (for whom age 72 is the RMD trigger date). Distributions of RMDs for the latter population therefore need not begin until April 1 of the calendar year following the year they attain age 72.

This change to tax-qualified retirement plans will necessitate updates to distribution forms, SPDs, 402(f) notices, and participant communications.

Post-Death RMDs are accelerated – MANDATORY

Prior law: In general, distributions are permitted to be paid annually over the beneficiary’s life expectancy. In general, if the participant died before RMDs began, distributions could be made at various times, provided the entire account was distributed by the end of the fifth year following the participant’s year of death.

Under the Act:  Following the death of the participant, distributions must generally be made by the end of the 10th calendar year following the year of death. The determination of the 10-year period is presumably calculated in the same way that the 5-year period was calculated. Payments can be made over the beneficiary’s life expectancy provided the beneficiary is an “eligible designated beneficiary”, which can be the surviving spouse, a disabled/chronically ill individual, a minor child of the participant or a beneficiary no more than 10 years younger. Prior rules still apply to a beneficiary that is not a “designated beneficiary”.

Effective date: The rule regarding the acceleration of post-death RMDs is effective for deaths that occur after December 31, 2019. Special delayed effective dates apply to collectively bargained and governmental retirement plans. 

What to do and when: Sponsors of tax-qualified retirement plans should be working with their service providers to implement these rules now.

This change will impact beneficiary designation forms, distribution forms, SPDs and other participant/beneficiary communications.

Special Note for Defined Benefit Pension Plans

The Act does not change actuarial increases required by Internal Revenue Code 401(a)(9)(C).  For individuals who continue working and choose to retire late, a defined benefit plan must provide actuarial increases beginning at age 70-1/2.  

General Thoughts

Commentators anticipate IRS guidance to provide self-correction relief for plans that fail to implement the new rules correctly during the remedial amendment period and clarify the Act’s impact on current regulations. Tax-qualified plan sponsors considering an amendment prior to the remedial amendment deadline, for the sake of clarity for itself and its service providers, may want to wait to see how further guidance may affect that amendment.

Questions? Please contact the Findley consultant you regularly work with or Sheila Ninneman at Sheila.Ninneman@findley.com, or 216.875.1927.

To learn more about the passage of the Secure Act and changes to retirement plans, click here

Published March 19, 2020

Print this article

© 2020 Findley. All Rights Reserved

Are You Looking for Missing Participants?

The Department of Labor (DOL) continues to focus on missing participants in retirement plans. In recent years, the DOL, in conjunction with the Employee Benefits Security Administration (EBSA), has been auditing retirement plans and reinforcing the actions that plan sponsors must take to locate lost participants and pay the benefits due to them.

“There’s really no more basic fiduciary duty than the duty to operate the plan for the purpose of paying benefits, so falling down here is a serious matter,” explained Preston Rutledge, Assistant Secretary of Labor for EBSA, while speaking at a policy conference. “We can’t just look the other way.”

While formal guidance is primarily directed at terminating plans, DOL auditors still expect sponsors of active, ongoing plans to be routinely searching for missing participants. As mentioned in Pension & Invesments, Plan sponsors under DOL investigation have reported surprising positions taken by some DOL auditors, including:

  • Failure to find a missing participant is a breach of fiduciary duty.
  • A plan which forfeits funds back to the plan until a participant is found is engaging in a prohibited transaction.
  • Sponsors must document their efforts to find missing participants and should try different search methods every year.
missing participants for retirement plans

These Searches Make Sense

Aside from the DOL’s focus, there are a number of practical reasons plan sponsors should address lost participant accounts:

  • There are large amounts of money at issue. In fiscal 2018, the DOL reported recovering $807 million for terminated, vested participants in retirement plans.
  • Missing participants may prevent payment of required minimum distributions (RMDs), which may result in penalties to the employer and participant.
  • Missing participants may prevent payment of death benefits. This is another important reason to maintain up-to-date beneficiary election data.
  • Missing participants may prevent payment of annual cash-out distributions for balances under $5,000. When processed timely, these cash-outs help reduce the number of accounts for which the employer is paying its recordkeeping service.
  • Missing participants may delay plan terminations, requiring another year of audit and governmental filings.

In addition, sponsors should address uncashed checks on a consistent basis to avoid prohibited transactions related to income earned by the trustee on uncashed check accounts. While many recordkeepers and trustees issue periodic reports alerting the sponsor of outstanding checks, the sponsor must conduct an address search or request that those checks be reissued.

Current Guidance

While the retirement industry awaits formal guidance addressing active plans, plan sponsors can refer to prior guidance issued for terminating plans. This guidance offers recommended steps to document attempts to locate missing participants.

The DOL released Field Assistance Bulletin (FAB) 2014-01 listing the fiduciary duties related to missing participants in terminating 401(k) plans (and other defined contribution plans). It requires plan fiduciaries to take all of the following steps to search for missing participants:

  1. Send a notice by certified mail.
  2. Check related plan and employer records.
  3. Contact the participant’s named beneficiary.
  4. Use free internet search tools (such as search engines, public record databases, obituaries, and social media).
  5. If the fiduciary does not find the missing participant during the required steps above, the fiduciary must consider additional search methods that may involve fees (such as, fee-based Internet search services, commercial locator services, or credit reporting agencies). Sponsors may take into account the size of the account balance and may charge associated fees against the account.

Since 2014, other agencies have released similar guidance. The IRS issued a Memorandum in 2017 for when its Employee Plans (EP) examiners should not enforce penalties for missed RMD payments. This memo required the plan to take virtually the same search steps before concluding it would not or could not pay an RMD.

Similarly, when the Pension Benefit Guarantee Corporation (PBGC) expanded its Missing Participants Program to terminating 401(k) plans in 2018, it pointed to the guidance under FAB 2014-01 for its requirement to conduct a “diligent search” before reporting or transferring missing participant accounts to the PBGC.

Handling Small Balances

Many sponsors have adopted distribution provisions to promptly pay out terminated employees with small balances, which can help prevent participants from losing track of their accounts in the first place. The IRS requires balances between $1,000 and $5,000, which are distributed without the participant’s consent, to be rolled into a default IRA. Therefore, most 401(k) plans will only force-pay balances under $1,000 as true cash-out distributions. Even when these cash-outs are paid annually, some of the smallest checks may go uncashed, and end up on the list of “missing participants” to be dealt with another way.

Retirement Clearinghouse, LLC (RCH) recently received approval from the DOL for its Auto-Portability Program, which may help connect participants with their old accounts. This service identifies when an individual with a default IRA has opened a new plan account with a new employer. If the participant does not respond to two letters of notification, RCH then automatically transfers the default IRA into the new plan account. This way, the account follows the participant – even when they take no action. The DOL has given RCH a prohibited transaction exemption (for five years) on fees collected for facilitating rollovers of small balances.

Best Practices

It’s important to be diligent in monitoring the plan for uncashed checks or nonresponsive participants. The DOL has made it clear that this is a fiduciary duty of the plan sponsor. Service providers often can help identify accounts that may need special attention, so sponsors should coordinate efforts to establish proper procedures and designate an individual or team to ensure necessary follow-up efforts are taken

Consider the following questions. Do you:

  • Have a formal procedure for identifying missing participants?
  • Conduct a full plan review for missing participants at least annually? (Consider timing this review with another annual process, such as annual cash-out distributions.)
  • Review uncashed check reports from the trustee? (These are typically made available on a monthly or quarterly basis.)
  • Conduct address searches for returned checks?
  • Document the steps that are taken annually to locate missing participants?

Questions? Contact the Findley consultant you normally work with, or contact Laura Guin, CPC at 615.665.5420 or Laura.Guin@findley.com

Published March 18, 2020

Print this article

© 2020 Findley. All Rights Reserved

Year-End Spending Bill includes the SECURE Act and other Retirement Plan Changes

Featured

With the passage of the 2020 federal government spending bill less than a week before Christmas, Congress has gifted us with the most significant piece of retirement legislation in over a decade. This newly enacted legislation incorporates the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) that was overwhelmingly passed by the House of Representatives earlier this year but never considered by the Senate. The spending bill even has a few additional retirement-related tidbits that were not part of the SECURE Act.

Here are some of the key changes:

Frozen Defined Benefit Plan Nondiscrimination Testing

Currently- Defined benefit plans that were frozen to new hires in the past and operate with a grandfathered group of employees continuing to accrue benefits have ultimately run into problems trying to pass nondiscrimination or minimum participation requirements as the group of benefiting employees became smaller and normally higher paid. This problem for frozen defined benefit plans has been around for a while and the IRS has been providing stop-gap measures to deal with it every year.

Effective as of the date of enactment of this legislation and available going back to 2013 – plans may permit the grandfathered group of employees to continue to accrue benefits without running afoul of nondiscrimination or minimum participation rules so long as the plan is not modified in a discriminatory manner after the plan is closed to new hires. This special nondiscrimination testing relief also extends to:

  • defined benefit plans that close certain plan features to new hires,
  • defined contribution plans that provide make-up contributions to participants who had benefits in a defined benefit plan that were frozen.

Increasing the 10% Limit on Safe Harbor Auto Escalation

Currently – a safe harbor 401(k) Plan with automatic enrollment provisions cannot automatically enroll or escalate a participant’s contribution rate above 10%.

Effective for Plan Years beginning after Dec. 31, 2019 – the 10% cap would remain in place in the year the participant is enrolled but the rate can increase to 15% in a subsequent year.

Simplifying the Rules for Safe Harbor Nonelective 401(k) Plans

Currently – All safe harbor plans must provide an annual notice prior to the beginning of the year that provides plan details and notifies employees of their rights under the plan. Also, any plan sponsors that want to consider implementing a safe harbor plan generally must adopt the safe harbor plan provisions prior to the beginning of the plan year.

Effective for Plan Years beginning after Dec. 31, 2019 – the notice requirement for plans that satisfy the safe harbor through a nonelective contribution has been eliminated. Also, sponsors can amend their plan to become a nonelective safe harbor 401(k) plan any time up until 30 days prior to year-end. The safe harbor election can even be made as late as the end of the next year if the plan sponsor provides for at least a 4% nonelective contribution.

Open Multiple Employer Plans (Open MEPs)

CurrentlyMultiple employer plans (MEPs) are legal and actually quite common, but a couple of limitations have stunted the development of a concept called open MEPs. An open MEP is a situation where the employers within the MEP are not tied together through a trade association or some common business relationship. In 2012 the DOL issued an Advisory Opinion provided that a MEP made up of unrelated employers that did not have “common nexus” must operate as a separate plan for each of these unrelated employers and not as a single common plan. This advisory opinion took away much of the perceived advantages of operating an open MEP. Additionally, the IRS has followed a policy that provides if one employer within the MEP makes a mistake, that the error can impact the qualified status of the entire plan; this is known as the “one bad apple” rule, this policy is clearly a negative selling point for any plan sponsor that might consider signing up to participate in a MEP.

Effective for Plan Years beginning after Dec. 31, 2020 – the “common nexus” requirement and the “one bad apple” rule are eliminated. The new open MEP rules provide for a designated “pooled plan provider” that would operate as the MEPs named fiduciary and the ERISA 3(16) plan administrator. The open MEP will be required to file a 5500 with aggregate account balances attributable to each employer. These changes are expected to create a market for pooled plans that will offer efficient retirement plan solutions to smaller plan sponsors.

Required Minimum Distribution Age Now 72

Currently Required Minimum Distribution from a qualified plan or IRA must begin in the year the participant turns 70 ½.

Effective for Distributions after 2019, with respect to individuals who attain 70 ½ after 2019. – This is a simple change to age 72 for computation purposes, but note the effective date means that if the participant is already subject to RMD rules in 2019 they remain subject to RMDs for 2020 even though the person may not be 72 yet. Also, plan sponsors should be aware that distributions made in 2020 to someone that will turn 70 ½ in 2020 will not be subject to RMD rules and therefore would be eligible for rollover and subject to the mandatory 20% withholding rules.

Increase Retirement Savings Access to Long-Term Part-Time Workers

Currently– Plans can exclude employees that do not meet the 1,000 hours of service requirement

Effective for Plan Years beginning after Dec. 31, 2020 – Plans will need to be amended to permit long-term part-time employees who work at least 500 hours over a 3 year period to enter the plan for the purpose of making retirement savings contributions. The employer may elect to exclude these employees from employer contributions, nondiscrimination, and top-heavy testing.

Stretch IRAs are Eliminated

Currently– If Retirement plan or IRA proceeds are passed upon death to a non-spouse beneficiary; the beneficiary can set up an inherited IRA and “stretch” out payments based upon the beneficiary’s life expectancy. Depending upon the age of the beneficiary and the size of the IRA this strategy potentially provided significant tax advantages.

Effective for distributions that occur as a result of deaths after 2019 – Distributions from the IRA or plan are generally going to need to be made within 10 years. There are exceptions if the beneficiary is (1) the surviving spouse, (2) disabled, (3) chronically ill, (4) not more than 10 years younger than the IRA owner or plan participant, or (5) for a child that has not reached the age of majority, the ten year rule would be delayed until the child became of age.

Increased Penalties for Failure to File Retirement Plan Returns and Other Notices

Current Penalty Structure:

Failure to file Form 5500$25 per day maximum of $15,000
Failure to report participant on Form 8955-SSA$1 per participant, per day maximum of $5,000
Failure to provide Special Tax Notice$10 per failure up to a maximum of $5,000

New penalty structure:

Failure to file Form 5500$250 per day maximum of $150,000
Failure to report participant on Form 8955-SSA$10 per participant, per day maximum of $50,000
Failure to provide Special Tax Notice$100 per failure up to a maximum of $50,000

Other Retirement Plan Changes Effective for Years Beginning After December 31, 2019

  • Phased retirement changes – defined Benefit Plans can be amended to provide voluntary in-service distributions begin at age 59 ½, down from the current age 62 requirement.
  • Start-up credits – the cap on tax credits that small employers (up to 100 employees) can get for starting up a new retirement plan has gone up from $500 to $5,000.
  • Auto-Enroll credits for small employers – small employers can get an additional $500 tax credit for adopting an automatic enrollment provision.
  • More time to adopt a plan – currently a qualified plan must be adopted by the end of the employer’s tax year to be effective for that year. The new rule will permit a plan to be adopted as late as the due date of the employer’s tax return for the year.
  • Plan annuity provisions – in recognition that defined contribution plans typically do not offer lifetime income streams two changes have been added to encourage in-plan annuity options.
    • A fiduciary safe harbor standard that if followed, would protect plan sponsors from potential liability relating to the selection of an annuity provider.
    • Plans may permit tax-advantaged portability of lifetime income annuity options from one plan to another.
  • 403(b) changes include providing a mechanism for the termination of a 403(b) custodial account and clarification that non-qualified church controlled organizations (e.g. hospitals and schools) can participate in Section 403(b)(9) retirement income accounts.
  • Penalty free distribution for birth or adoption expenses – up to $5,000 could be distributed from a defined contribution or 403(b) plan to cover costs relating to birth or adoption of a child.
  • Special tax penalty relief and income tax treatment for distributions for qualified disaster distributions from qualified plans up to $100,000.  Additionally, plan sponsors can permit the $50,000 participant loan limit to be increased to $100,000 with increased repayment periods for participants that suffered losses in a qualified disaster area.

Other Changes with a Delayed Effective Date

  • Lifetime income disclosure – this provision will require a defined contribution plan to provide all participants with an annual statement that discloses the projected lifetime income stream equivalent of the participant’s account balance.  This requirement will become effective for benefit statements furnished one year after applicable DOL guidance has been issued that will be necessary to provide the prescribed assumptions and explanations that will be used to create this disclosure.
  • Combining 5500 – IRS and DOL have been directed to permit a consolidation of Form 5500 reporting for similar plans. Defined contribution plans with the same trustee, same-named fiduciary and same plan administrator using the same plan year and same plan investments may be combined into one 5500 filing. This is scheduled to begin no later than January 1, 2022, for 2021 calendar plan year filings.

What to Do Now

Obviously the SECURE Act is bringing a lot of changes to retirement plans. Many of the operational aspects to this new retirement legislation will need to be implemented immediately, in particular, tax withholding related items that will change in 2020 will necessitate plan sponsors and their recordkeepers act immediately to review tax withholding and distribution processes. Plans do have until the end of the 2022 plan year to adopt conforming amendments to their documents. The amendment deadline is the 2024 plan year for governmental plans.

If you have any questions about the SECURE Act and this new retirement plan legislation we encourage you to contact the Findley consultant you normally work with, or contact John Lucas at 615.665.5329 or John.Lucas@findley.com.

Published December 23, 2019

Print the article

© 2019 Findley. All Rights Reserved.

Two of a Kind? Not All 457(b) Plans Are the Same

You may already know there are significant differences between a 457(b) plan sponsored by a governmental entity and a 457(b) plan sponsored by a tax-exempt organization. But do you know what they are? It can be confusing for plan sponsors because the plans are so similar and articles on the subject of 457(b) plans do not always point out the distinctions.

How All 457(b) Plans Are Alike

A 457(b) plan is a deferred compensation plan that permits certain employers or employees to contribute money for retirement on a tax-deferred basis. Internal Revenue Code (Code) Section 402(g) provides the contribution limit (402(g) Limit) which for 2019 is $19,000. Earnings on these contributions are also tax-deferred. A 457(b) plan is not subject to coverage or nondiscrimination testing.

If you are familiar with 401(k) plans, you’ll recognize many of the other common requirements or provisions described below that apply to both tax-exempt and governmental 457(b) plans.

  • Documentation: the plan must be in writing.
  • Catch-up contributions: a participant may be permitted to elect to increase salary reductions for the final three years before reaching normal retirement age up to the lesser of
    1. two times the applicable dollar limit ($38,000 for 2019), or
    2. the applicable dollar limit plus the sum of unused deferrals in prior years provided the prior deferrals were less than the applicable deferral limits (not counting any age 50 catch-up contributions (permitted only in governmental plans)).
  • Deferral election timing: the election to make contributions through salary reduction must be made before the first day of the month in which the compensation is paid or available.
  • 402(g) Limit: employer and employee contributions in the aggregate are measured against the 402(g) Limit.
  • Hardship distributions: these are permitted if the distribution is required as the result of an unforeseeable emergency beyond the participant’s or beneficiary’s control, all other sources of financing have been exhausted and the amount distributed is necessary to satisfy the need (and the tax liability arising from the distribution).
  • Required minimum distributions: Code Section 401(a)(9) rules apply.
  • Distributable events: these include attainment of age 70½, severance from employment, hardships, plan termination, qualified domestic relations orders, and small account distributions (with a minor difference).

How Governmental and Tax-Exempt 457(b) Plans Differ

The differences between a tax-exempt 457(b) plan and a governmental 457(b) plan include:

  • Eligible employees: governmental plans can include any employee or independent contractor who performs services for the employer while tax-exempt plans can only make select management or highly compensated employees eligible.
  • Automatic enrollment: governmental plans may provide for automatic enrollment while tax-exempt plans may not.
  • Roth contributions: governmental plans may provide for the designation of Roth contributions for all or a portion of salary reductions while tax-exempt plans may not permit Roth contributions.
  • Catch-up contributions: governmental plans may permit age 50 catch-up contributions ($6,000 in 2019) while tax-exempt plans may not.
  • Correction of excess deferrals: governmental plans must distribute any excess contribution (plus income) as soon as practicable after the plan determines that an amount is in excess while tax-exempt plans must distribute the excess by April 15 following the close of the taxable year in which the excess deferral was made.
  • Loans: governmental plans may permit loans while tax-exempt plans may not.
  • Contributions to a trust: governmental plans are permitted to contribute to a trust while tax-exempt plans are not.
  • Rollovers: governmental plans may provide for rollovers to other eligible retirement plans (401(k), 403(b), governmental 457(b), and IRAs) while tax-exempt plans may not.
  • Taxation: for governmental plans, taxation is at the time of distribution, while for tax-exempt plans, taxation is at the earlier of when amounts are made available or distributed.
  • Statutory period for correction of plan failures: governmental plans have until the first day of the plan year beginning more than 180 days after notice from the Internal Revenue Service regarding failure to meet applicable requirements while such correction period is not available to tax-exempt plans.
  • Correction programs: a governmental plan can apply for a closing agreement with a proposal to correct failures that will be evaluated under EPCRS standards while such corrections are generally not available to tax-exempt plans.

If you sponsor a 457(b) plan, you may want to review your plan design to make sure it provides the available optional features you want for your employees. In addition, you’ll want to make sure that the plan is compliant as written and in operation.

Questions? Please contact the Findley consultant you regularly work with or Sheila Ninneman at Sheila.Ninneman@findley.com, 216.875.1927.

Posted January 15, 2019

Print the article