IRS Issues Guidance on 2009 Required Minimum Distribution Waiver

IR-2009-85, Sept. 24, 2009

WASHINGTON ― The Internal Revenue Service today provided guidance for retirement plan administrators, plan participants and retirees regarding recent legislation affecting required minimum distributions. The Worker, Retiree, and Employer Recovery Act of 2008 waives required minimum distributions for 2009 from certain retirement plans.

Generally, a required minimum distribution is the smallest annual amount that must be withdrawn from an IRA or an employer’s plan beginning with the year the account owner reaches age 70½. The 2008 law waives required minimum distributions for 2009 for IRAs and defined contribution plans (such as 401(k)s) and allows certain amounts distributed as 2009 required minimum distributions to be rolled over into an IRA or another retirement plan.

Notice 2009-82 provides relief for people who have already received a 2009 required minimum distribution this year. Individuals generally have until the later of Nov. 30, 2009, or 60 days after the date the distribution was received, to roll over the distribution.

The notice also provides guidance for retirement plan sponsors. It contains two sample plan amendments that plan sponsors may adopt or use to amend their plans to either stop or continue 2009 required minimum distributions. Both sample amendments provide that participants and beneficiaries can choose to receive or not to receive 2009 required minimum distributions. Also, both sample amendments allow the employer to offer direct rollover options of certain 2009 required minimum distributions.

Plan sponsors may need to tailor the sample amendment to their plan’s particular terms and administration procedures and must adopt the amendment no later than the last day of the first plan year beginning on or after Jan. 1, 2011 (Jan. 1, 2012 for governmental plans).

Source: http://www.irs.gov/newsroom/article/0,,id=213561,00.html

The Fix Is In: Common Plan Mistakes – Top-Heavy Errors in Defined Contribution Plans

The Issue

Many of you have a 401(k) plan or some other form of defined contribution plan that needs to meet what are called “top-heavy plan rules.” These rules are found in section 416 of the Internal Revenue Code. The top-heavy rules are designed to ensure that lower paid employees receive at least a minimum benefit in plans where most of the assets are owned by higher paid employees (referred to as “key employees” and defined below). When a plan is top-heavy, certain minimum vesting and allocation requirements must be satisfied. Plans with fewer than 100 participants are the most likely to become top-heavy and thus affected by the top-heavy rules.

A key employee is an employee, who at any time during the plan year containing the determination date is:

• A more than 5% owner of the employer (family attribution rules apply);
• A more that 1% owner of the employer with annual compensation greater than $150,000 (family attribution rules apply); or
• An officer with annual compensation greater than $135,000 (annually indexed for cost-of-living adjustments – $145,000 for 2007).

A defined contribution plan is top-heavy when, as of the last day of the preceding plan year (the determination date), the aggregate value of the plan accounts of key employees exceeds 60% of the aggregate value of the plan accounts of all employees under the plan. For top-heavy purposes, aggregate – not yearly – contributions and earnings are counted to ensure the top paid group does not benefit disproportionately. Note: It’s even possible for a plan to become top-heavy after a year in which no contributions are made.

If the plan is top-heavy, the allocation made to a participant in a defined contribution plan must satisfy certain minimum benefit standards. Generally, under a top-heavy plan, the allocation of a “non-key employee” must not be less that 3% of compensation for the entire plan year. Elective deferrals made by a non-key employee in a 401(k) plan do not count toward the 3% minimum. Generally, if the employee’s allocation is at least 3%, no further contribution is required to satisfy the top-heavy rules.

A top-heavy plan must also satisfy one of two minimum vesting schedules: the “three-year cliff” or “six-year graded” vesting schedule. A plan must state the vesting rules that will apply if the plan is top-heavy, even if the plan isn’t currently top-heavy. Under three-year cliff vesting, employees must be 100% vested once they have three years of service. Prior to completing the third year of service, the employee’s vesting percentage may be any percentage, including zero. Under six-year graded vesting, employees must be 100% vested once they have six years of service with certain minimum requirements for the interim periods.

The Problem

To properly comply with the top-heavy rules, unless the plan has been designed to satisfy the top-heavy rules in all years, employers must test their plans every year to determine their status. If the plan is top-heavy for a given year, the minimum benefits and vesting must be given for that year. The failure to properly follow the top-heavy rules can cause the plan to lose its qualified status.

Some commonly overlooked top-heavy rules that lead to problems include:

• If the participant is a key employee at any time during the previous plan year, the person is considered a key employee for the entire year.
• If the key employee account balances exceed 60%, the plan is top-heavy. There is no leeway.
• The plan may provide that only employees employed on the last day of the plan year are entitled to the top-heavy contribution.
• There is no 1,000 hour requirement in a defined contribution plan for a top-heavy allocation.
• The top-heavy minimum contribution is based on a total compensation definition (not just compensation while a participant).
• Elective deferrals made by a non-key employee to a 401(k) plan cannot be considered for the top-heavy minimum contribution.

The Fix

A top-heavy violation will cause a plan to become disqualified, resulting in adverse tax consequences to the employer and employees under the plan; however, employers may get relief from these adverse consequences through the Employee Plans Compliance Resolution System (EPCRS) by correcting the top-heavy failures. The Self-Correction Program (SCP) or Voluntary Correction Program (VCP) can be used to correct these mistakes. In order to fix the mistake under SCP, generally the mistake must be fixed within two years after the end of the plan year is which the failure occurred. Unless the failure can be classified as insignificant, VCP must be used after this time.

To correct a top-heavy allocation failure, the employer must make a corrective contribution on behalf of the employee who received an insufficient allocation in an amount equal to the insufficiency, adjusted for earnings. There is more than one way to correct a vesting failure under EPCRS.

Under the Contribution Correction Method, the employer makes a corrective contribution on behalf of the employee whose account balance was improperly forfeited by the amount of the improper forfeiture. The corrective contribution is adjusted for earnings. If, as a result of the improper forfeiture, an amount was improperly allocated to the account balance of another employee, no reduction need be made to the account balance of that employee.

Another way to correct these errors is the Reallocation Correction Method. Generally, the account balance of the employee who incurred the improper forfeiture is increased by the amount of the improper forfeiture and the amount is adjusted for earnings. The account balance of each employee who shared in the allocation of the improper forfeiture is reduced by the amount of the improper forfeiture that was allocated to that employee’s account.

Making Sure It Doesn’t Happen Again

Calculating the top-heavy status of a plan accurately and timely is vital for plan sponsors. The plan document, employee data, etc., should be carefully reviewed to ensure that the test is done correctly.

Important Tip: A plan can be structured so that the top-heavy minimum allocation requirement and vesting schedule is automatically satisfied every year. This eliminates the need to test for top-heavy status.

However, despite all of your good efforts, mistakes can happen. In that case, the IRS can help you correct the problem and retain the benefits of your qualified retirement plan.

Source: http://www.irs.gov/retirement/article/0,,id=151142,00.html

Additional Information on Correcting Top Heavy Errors: Correcting Plan Defects

Some Frequently Asked Questions

This is in no way a complete list of questions, but it represents many of the topics that concern clients, brokers and employees

What are ADP/ACP Tests?
A test designed to prevent discrimination in 401(k) plans. It compares the amount deferred by highly compensated employees to the deferrals of non-highly compensated employees. The object is to ensure highly compensated employees do not contribute at a disproportionately higher rate than rank and file employees. This encourages owners to promote plan participation among the non-highly compensated employees. See also ’safe harbor plan’.

What is the top-heavy Plan?
A plan in which 60% of account balances (both vested and non-vested) are held by “key” employees will be considered ‘top heavy’. Such a plan will require that to the extent any key-person gets or makes a deposit in the following year, an amount equal to the key-persons deposit, as a percentage of pay, must be contributed on behalf of all other non-key employees, up to 3%.

What are minimum coverage tests?
A plan, to be qualified, must cover a reasonable portion of the employees of the company. The basic rule is that a plan must cover 70% of the employees. Thus a plan could exclude all employees at a specific job site, but only if they were a small minority of the total. Most plans cover all employees (minimum age/service, union and non-resident alien exclusions aside), thus this is not a consideration. However, care must be taken in designing eligibility requirements beyond the standard.

What is a controlled group?
If the owner of a business owns some or all of a second or more business, the separate businesses may be considered a ‘controlled group’. Any qualified plan put in for one business in a controlled group of businesses must cover the employees of the other business. The actual rules as to ownership, family members, partnerships etc. are complex. Failure to abide by them, however, can result in covering many more employees than planned for and dramatic cost increases. Buying new companies and other acquisition activity must be carefully reviewed to properly plan in the event of controlled group conditions.

Do I need a Fidelity Bond?
Yes, the IRS required that all fiduciaries and others that handle plan money be bonded for 10% of the assets, with the maximum bond $500,000. Note that plans covering only 1 participant are exempt.

When is the Form 5500 due?
7 months after the close of the plan year, with the ability for one automatic extension for 2 & 1/2 months.

What is a “TPA”?
A TPA is a Third Party Administrator. Qualified plans must be operated in compliance with the plan document, IRS and DOL rules and regulations, and provide the benefits promised. When a business establishes a qualified plan such as a 401(k) plan, it is the duty of the Plan Administrator and Trustees to keep the plan in compliance. This requires skills and knowledge not often in the hands of the owner, HR people and CFO etc. It is then appropriate to retain a responsible, trained and qualified party to assist in the duties of plan compliance. That is what a Third Party Administrator does.

Are Matching Contributions mandatory?
No. A 401(k) may consist only of employee elective deferrals. It may, however, elect to match those deferrals. Matching may be done on a payroll to payroll basis, or determined after the plan/fiscal year ends. This also applies to Profit Sharing contributions.

What is a safe harbor plan?
In order to avoid the 401(k) ADP discrimination testing, a plan can choose to be treated as a ’safe harbor plan’. To get this treatment the employer must contribute either; (1) 3% for all employees, or, (2) a matching contribution to those employees who contribute, the match being dollar for dollar up to 4% (with variations). These contributions must be 100% vested. In small plans this can greatly help the owners to optimize the plan.

What is a Prototype Plan?
There are three formats available when preparing the plan document for a pension, profit sharing or other qualified plan. The most expensive, but most flexible, is an individually drafted plan, generally prepared by an attorney well versed in this area. This type requires the document be submitted to the IRS for review and approval.

At the other end of the spectrum are Prototype plans. These are pre-drafted and pre-approved documents with limited options that can be elected. These do not require submission to the IRS.

In the middle are Volume Submitter plans. These offer much greater flexibility than prototype, and if the elections made by the employer do not stray too far from acceptable limits, the plan can rely on the determination letter granted to the sponsor of the Volume Submitter document.

What is a Volume Submitter Plan?
See answer to “What is a Prototype Plan”

What is Fiduciary Liability Insurance?
Anyone with discretionary control over a plan or its investments is a fiduciary. There is a requirement that fiduciaries act in a manner tantamount to that of a prudent expert in matters of funding etc. It is conceivable that a plan’s investment policy may not be followed, or it is flawed, or some disgruntled employee simply wants to make up for bad investment judgment. In any event, a suit could be brought, and the cost of defending will be borne by the fiduciary in question. Defense costs and more can be insured against by using Fiduciary Liability Insurance.

Why am I the Plan Administrator?
Although technically possible to name someone other than the employer as plan administrator, the duties and activities of plan maintenance are properly the responsibility of the employer. Note that is the Employer, not an individual, who is considered the plan administrator. See also “What is a TPA”.

What is vesting?
Vesting is the participant’s ownership right to a percentage of their account balance. Typically a year of vesting is calculated based upon a twelve month period as defined in your plan’s document, in which a participant works 1,000 hours or more.

What are the plan’s eligibility and entry requirements?
Eligibility is the determination of when an employee is eligible to become a participant in the plan. The entry date is when the participant can enter the plan. The plan document will state the age and service and entry date requirements to join the plan such as first of the month following the attainment of age 21 and one year of service from the employee’s hire date.

For more frequently asked questions, CLICK HERE.

Source: http://www.penret.com/Penret’s%20page/faq.htm

What is a 1099R?

Form 1099R is an IRS form reporting a taxpayer’s distributions from pensions, annuities, IRAs, insurance contracts, profit-sharing plans and/or retirement plans (including section 457 state and local government plans). Form 1099R must be sent to the taxpayer by January 31 of the year following the calendar year in which the distributions occurred. Form 1099R is sent to the taxpayer for any distribution exceeding $10. Form 1099R reports the gross distribution, any taxable amount applicable to that gross distribution, and any portion of federal income that was withheld. Form 1099R also shows capital gains associated with the distribution. Form 1099R will also report insurance premium paid or contributions to the plan made by the taxpayer. In the case of lump sum distributions from a qualified plan or employee contributions, Form 1099R will show the net unrealized appreciation (NUA) in employer’s securities or in the employee contributions. Form 1099R must also identify the nature of the distribution by reporting a distribution code.

Source: http://www.investorglossary.com/1099r.htm

ERISA plan record retention: how long is long enough?

Attorney Rush Nigot blogging about Document Retention and Electronic Discovery on his new Blog, Rush on Business, tells us that in today’s business environment, organizations need to respond to an increasing number of document requests, from regulatory compliance issues to internal investigations to full-scale litigation.

And there’s certainly an ERISA component to that. So in a brief Q and A format, here is some basic information about document retention for ERISA plans.

What are the legal requirements?

In the addition to the reporting and disclosure obligations that fiduciaries have, ERISA also requires that plan sponsors retain the records that support the information included in the 5500 filing and other reports.

The short answer is that all plan-related materials should be kept for a period of at least six years after the date of filing of an ERISA-related return or report, and the materials should be preserved in a manner and format (electronic or otherwise) that permits ready retrieval. All records that support the plan’s annual reporting and disclosure should be retained.

Who is responsible for retaining plan records?

While it is fairly common for a plan sponsor to contract with outside service providers, such as our firm, who provide certain reports and prepare the 5500 filing, the plan administrator remains ultimately responsible for retaining adequate records that support these reports and filings. In addition, the Department of Labor (DOL) requires employers to maintain records sufficient to determine the amount of benefits accrued by each employee participant.

What are best practices?

As noted above, generally, these documents should be kept for a period of six years after the date of the filing to which they relate. However, best practices would be to keep certain records for the life of the plan. This would include all plan documents dating from the plan’s inception. The thicker the paper trail, the easier it will be for the plan to respond to an inquiry from a governmental agency or a request for information from a plan participant. Most recently, the Internal Revenue Service (IRS) requested specific employee records from a client going back 10 years during a plan termination process. Fortunately, the employer was able to provide it.

But don’t consider this a boring subject. The IRS or the DOL can require the plan administrator to recreate plan records.

Source: http://www.retirementplanblog.com/-401-k-plans-erisa-plan-record-retention-how-long-is-long-enough.html

Cross-Tested 401(k) Plan

A Cross-Tested 401(k) Plan design allows a plan sponsor to contribute and allocate an employer profit sharing contribution to the older, presumably key and highly compensated participants while allocating a much lower contribution to the younger and presumably lower paid participants. If the employer’s demographics support this type of plan design, the overall contribution percentage allocated to the ownership group will be considerably higher than that allocated to the non-ownership group. Furthermore, this design will yield far better results for the ownership group than an allocation utilizing permitted disparity or an allocation based on compensation to total compensation.

The cross-tested design divides plan participants into separate and distinct groups defined in the plan document.
Examples of Groups are:

• Group 1 – Owner 1
• Group 2 – Spouse/Family Member of Owner 1
• Group 3 – Owner 2
• Group 4 – Spouse/Family Member of Owner 2
• Group 5 – Highly Compensated Participants
• Group 6 – Non-Highly Compensated Participants
• Group 7 – All Others

The employer’s profit sharing contribution allocation is converted to a projected benefit at retirement, much like a defined benefit plan. If the projected benefit at retirement passes required nondiscrimination tests, the contribution allocation is acceptable for that plan year. Please bear in mind that if the employee demographics “swing” too much from plan year to plan year the passage of nondiscrimination tests could be affected.

Since the employer’s profit sharing contribution is more favorable for the key and highly compensated participants and those participants receive the lion’s share of the overall contribution, a minimum gateway contribution must be provided to the non-highly compensated participants:

• A 5% allocation to each eligible non-highly compensated employee
  or

• A lesser amount as long as the highest allocation percentage any
  highly compensated participant receives is no more than three
  times what the lowest non-highly compensated participant
  receives.

This type of plan design can help achieve the retirement goals of the owners and key employees while allowing the
employer’s contribution to remain discretionary from one plan year to the next.

Source: http://www.sunwest-pensions.com/Cross-Testing.pdf

Vesting – When is a Year a Year?

(Posted at August 27, 2009)

We are coming out of the recession and our economy is showing increased signs of strength every day. However, job losses, while subsiding a bit, are continuing and the employment situation will be in a state of flux for some time to come. Moreover, many people have already lost their jobs this year and may be looking at what to do with the retirement accounts they have left behind. Before you make any decision in this regard, it might be worthwhile to pause and examine what exactly was left behind.

Vesting Schedules

Employer sponsored retirement plans like 401k plans generally have vesting schedules with respect to the amount of money that an employer may put into your account. The money you put away in the form of your 401k deferrals themselves are always “vested” and always belong to you. However, the employer contributions be they matching contributions or profit sharing contributions are often subject to a vesting schedule.

A vesting schedule is a very common retirement plan design technique that encourages employees who are receiving employer monies to remain with the company for a few years before the employees are fully entitled, vested, in those monies. A typical vesting schedule might require an employee to be employed with the company for 3 years, or sometimes even 5 years, before the employee is 100% vested in employer contributions.

A quick example might help illustrate the point. If you deferred $100 into your 401k account and the employer matched it $1 for $1, your matching account would also have $100. If the company had a 5 year vesting schedule and you left after the 3rd, you would only be vested 60% in the matching account. Therefore, your account value, ignoring earnings or losses, would be $160. Simple enough.

How do you earn another year of vesting?

However, as with most things in the retirement world simple sounding things can get complicated quickly. For example, what is a “year” for vesting purposes? Certainly 12 full months would qualify as a year, but can a year be less than Jan-Dec? Well, as the rules would have it, yes. Generally, a year-for-vesting-purposes is any 12 month period in which you work 1,000 hours. So, if you have recently been laid off in let’s say July and you worked full time up until then, it is very likely that you have accrued an additional year for vesting purposes.

Retirement plans can use different methods for determining what a “year” is for vesting purposes, so it is important that you look at your plan’s Summary Plan Description to determine what yours is. Nevertheless, it pays to understand how this works because you could have additional dollars in your old 401k account.

Source: http://www.401k-guy.com/2009/08/27/vesting-year-401k-pla/

Choosing a Retirement Plan: Money Purchase Plan

Highlights:

Money purchase plans have required contributions. That is, you, as the employer, are required to make a contribution, on behalf of the plan participants, to the plan each year.

With a money purchase plan, the plan states the contribution percentage that is required. For example, let’s say that your money purchase plan has a contribution of 5% of each eligible employee’s pay. You, as the employer, need to make a contribution of 5% of each eligible employee’s pay to their separate account. A participant’s benefit is based on the amount of contributions to their account and the gains or losses associated with the account at the time of retirement.

That type of arrangement is different than, say, a profit-sharing plan. With the profit-sharing plan, you, the employer, can decide that you’ll contribute a certain amount, say $10,000. Then, depending on the plan’s contribution formula, you allocate that $10,000 to the separate accounts of the eligible employees. Also, in past years, money purchase plans had higher deductible limits than profit-sharing plans. This is no longer the case.

If you establish a money purchase plan, you:

• Can have other retirement plans.
• Can be a business of any size.
• Need to annually file a Form 5500.

You can make a money purchase plan as simple or as complex as you want. Pre-approved money purchase plans are available to cut down on administrative headaches.

Information List:

Pros and Cons:

• Possible to grow larger account balances than under some other arrangements.
• Administrative costs may be higher than under more basic arrangements.
• Need to test that benefits do not discriminate in favor of the highly compensated employees.
• An excise tax applies if the minimum contribution requirement is not satisfied.

Who Contributes: Employer and/or employee contributions.

Contribution Limits: The lesser of 25% of compensation or $46,000 in 2008 ($49,000 in 2009 and subject to cost-of-living adjustments for later years).

Filing Requirements: Annual filing of Form 5500 is required.

Participant Loans: Permitted.

In-Service Withdrawals: Not permitted.

Source: http://www.irs.gov/retirement/article/0,,id=108949,00.html

Choosing a Retirement Plan: Profit-Sharing Plan

Highlights:

Guess what. You don’t need profits in order to make contributions to a profit-sharing plan. Of course, having a profit would probably make it easier to actually contribute something.

Contributions to a profit-sharing plan are discretionary. There is no set amount that you need to make. If you can afford to make some amount of contributions to the plan, then go ahead.

If you do make contributions, you will need to have a set formula for determining how the contributions are divided. This money goes into a separate account for each employee.

One common method for determining each participant’s allocation in a profit-sharing plan is the “comp-to comp” method. Under this method, the employer calculates the sum of all of its employees’ compensation (the total “comp”). To determine each employee’s allocation of the employer’s contribution, you divide the employee’s compensation (employee “comp”) by the total comp. You then multiply each employee’s fraction by the amount of the employer contribution. Using this method will get you each employee’s share of the employer contribution.

If you establish a profit-sharing plan, you:

• Can have other retirement plans.
• Can be a business of any size.
• Need to annually file a Form 5500.

As with 401(k) plans, you can make a profit-sharing plan as simple or as complex as you want to. Pre-approved profit-sharing plans are available to cut down on administrative headaches.

Information List:

Pros and Cons:

• Greater flexibility in contributions – contributions are strictly discretionary.
• Good plan if cash flow is an issue.
• Administrative costs may be higher than under more basic arrangements.
• Need to test that benefits do not discriminate in favor of the highly compensated employees.

Who Contributes: Employer contributions only.

Contribution Limits: The lesser of 25% of compensation or $46,000 in 2008 ($49,000 in 2009 and subject to cost-of-living adjustments for later years).

Filing Requirements: Annual filing of Form 5500 is required.

Participant Loans: Permitted.

In-Service Withdrawals: Yes, but subject to possible 10% penalty if under age 59-1/2.

Source: http://www.irs.gov/retirement/article/0,,id=108948,00.html

Has your company’s layoff caused a partial termination of your retirement plan?

Maybe you have been forced to lay off employees because of a price collapse in your industry or to brace for economic challenges ahead. Maybe you have been forced to cease operations at one of your business locations. Or maybe you are currently in the process of reducing your workforce.

During these challenging economic times, it is important to keep in mind that if you terminate a significant percentage of your
employees, you may unknowingly cause a “partial termination” of your retirement plan. Under IRS rules, when a partial
termination occurs, affected plan participants are required to become immediately 100% vested in the previously-unvested
portion of their plan accounts. Unfortunately, many employers do not recognize this issue until long after the terminated employees
have received their incorrectly-calculated distributions. By then, it can be very expensive to go back and correct the errors. Thus, it is
best to recognize the issue before, or shortly after, a layoff occurs so that you can accurately calculate each participant’s plan account
balance.

It is not easy to determine if a partial termination has occurred. The applicable statute does not define a “partial termination,”
and the applicable regulation merely states that whether a partial termination occurs is determined by looking at the “facts and
circumstances.”

Generally, the IRS looks at the “turnover rate,” i.e., the percentage reduction in plan participants. If the turnover rate is at least 20
percent, there is a presumption that a partial termination of the plan has occurred. The turnover rate is determined by dividing the
number of participating employees who had an employer-initiated severance from employment during the applicable period by the
sum of all the participating employees at the start of the applicable period plus the employees who became participants during the
applicable period.

At first glance, this analysis may seem straightforward. But what is an “employer-initiated severance”? And what is the “applicable period”? These questions, and others, can be difficult to answer. Furthermore, the turnover rate does not, by itself, determine whether a partial termination has occurred. It is merely the first step in the analysis.

If you are currently in the process of reducing your workforce, or if you have recently been forced to lay off employees or close down a business location and you need assistance in determining whether a partial plan termination has occurred, please contact your ERISA attorney.

Source: http://www.jdsupra.com/post/documentViewer.aspx?fid=76f27bbf-5be5-4e5c-9eca-bc5338bc1e44