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Newsletter
March
2004 Volume
21 - Number 1
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This newsletter is addressed to
our clients their attorneys, accountants and other professional advisors.
Citations may be included for those who want to refer directly to the source
material. IN THIS ISSUE:
New Automatic
Rollover Provisions: These proposed rules have the advantage of
cashing the participant out without the disadvantage of the federal and state
income tax withholding requirements.
Fiduciary Duties
In Response To Mutual Fund Abuses: The Department of Labor has
released guidance on the duties of plan fiduciaries in light of alleged
abuses involving mutual funds.
Participant Loan May Trigger An IRS Audit: During
recent audits of retirement plans, IRS auditors indicated that plans were
selected for audit because they contained participant loans.
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NEW AUTOMATIC
ROLLOVER PROVISIONS
These
new rules have the advantage of cashing the participant out without the
disadvantage of the federal and state income tax withholding requirements.
The automatic rollover rule should be effective 6-months after final
regulations are issued. This should allow enough time to amend plan documents
and make preparations to comply with the safe harbor requirements.
Background:
Normally retirement plans cannot distribute a terminated participant’s vested
account balance or accrued benefit until the participant consents to the
distribution in writing. In many
cases the participant’s spouse must also consent in writing. The forced
cash-out rule is an exception to these rules.
The
existing forced cash-out rule allows plans to cash-out participants that have
terminated employment and have a vested account balance or accrued benefit of
less than $5,000. This means that
unresponsive participants, who do not return completed consent and election
forms required for a plan distribution, can still be cashed-out. Cashing out
and getting the participant off the plan books reduces plan administration
cost and is considered an advantage to the plan.
The
disadvantage of the existing forced cash-out is the mandatory 20% federal tax
withholding and reporting requirements.
This 20% must be calculated and deposited when the distribution is
made and then reported on Form 945 at the end of the year. In addition your state may require
withholding and reporting as well.
California requires 2% State taw withholding, Form DE-6 filed
quarterly and From DE-7 filed annually.
Proposed
Regulations: The Employee Benefit Security Administration (EBSA) has issued
proposed regulations establishing requirements for automatic rollovers. The automatic rollover rules allow plans
to open an IRA on behalf of a terminated participant and deposit the
participant’s plan benefit in the account.
This has the advantage of cashing the participant out without the
disadvantage of the tax withholding and reporting requirements. The following
are the proposed requirements to qualify the automatic rollover for safe
harbor status:
·
The Amount of the Distribution must be between $1,000 and
$5,000. The $5,000 maximum matches
the cash-out limit. Hopefully, the final regulations will not include a
$1,000 minimum limit.
·
The IRA must be a traditional IRA not a Roth or other
non-traditional IRA. These would be
IRAs described under IRC Section 408(a) & (b).
·
The investments selected must be designed to minimize
risk, preserve assets and maintain liquidity. Money market, certificate of
deposit and interest bearing savings accounts are listed as acceptable
investments.
·
IRA Fees for establishment and maintenance may be charged
against the IRA as long as they do not exceed fees normally charged for
non-automatic rollovers and maintenance fees may only be charged against the
income of the IRA.
·
The automatic rollover procedure must be disclosed to the
participant. An explanation that describes the procedure, investment,
expenses and how to get information must be provided to the participant prior
to the distribution.
·
The rollover must not be a prohibited transaction. |
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FIDUCIARY
DUTIES IN RESPONSE TO MUTUAL FUND ABUSES
The Department of Labor has released guidance on the duties of plan fiduciaries in light of alleged abuses involving mutual funds. As ERISA requires that fiduciaries discharge their duties prudently, fiduciaries deciding whether to make any changes in mutual fund investments or investment options, must make decisions that are as well informed as possible. Where
specific funds have been identified as under investigation by government
agencies, fiduciaries should consider the nature of the alleged abuses, the
potential economic impact of those abuses on the plan’s investments, the
steps taken by the fund to limit the potential for such abuses in the future,
and any remedial action taken or contemplated to make investors whole. Fiduciaries of plans invested in such
funds may ultimately have to decide whether to participate in settlements or
lawsuits. In doing so, they will
weigh the costs to the plan against the likelihood and amount of potential
recoveries. Late
trading and market-timing abuses may extend to mutual funds and pooled
investment funds beyond those currently identified by government
regulators. Thus, plan fiduciaries
will need to consider whether they have sufficient information to conclude
that such funds have adequate procedures and safeguards in place to limit
their vulnerability to abuse. How does
this all relate to ERISA 404(c)? The
guidance provided the following two examples of approaches to limiting
market-timing that would not affect the availability of relief under ERISA
404(c), provided that the restrictions are allowed in the plan document and
are clearly disclosed to the plan’s participants: 1. A plan’s
offering of mutual fund or other investments could impose reasonable
redemption fees on sales of their shares; or 2.
A plan or investment fund could place reasonable limits on
the number of times a participant can move in and out of a particular
investment within a particular time. Further information on this guidance is available at http://www.dol.gov/ebsa/newsroom/sp021704.html
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PARTICIPANT
LOAN MAY TRIGGER AN IRS AUDIT
During recent audits of retirement plans, IRS auditors indicated that plans were selected for audit because they contained participant loans. As such it is not surprising that the participant loans were one of the principal focuses of the audit. Failure
to follow the rules for participant loans has often been a source of
aggravation for plan sponsors. This article is to alert our clients to
strictly follow all of the participant loan rules and inform our clients that
failure to follow IRS guidelines can be costly. Especially if failures are discover during an IRS audit. The following are some of
the requirements for participant loans: ·
The plan document must permit participant loans. ·
The participant must complete a Promissory note. ·
The spouse’s written consent may be required. ·
Loans are limited to the lesser of 50% of the participant’s
vested benefit or $50,000 reduced by outstanding loans within the past year. ·
Loans must use a reasonable interest rate. IRS will accept
one or two points above prime rate. ·
The loan must provide for a level amortization schedule,
with payments not less than quarterly. ·
Most loans may not be amortized for more than 5 years,
unless the loan is used to purchase a primary residence. ·
Failure to make loan payments will result in the loan
balance being taxable to the participant at the time of default. · Loans
cannot be renegotiated once they are issued. The
following are some common loan failures: ·
A loan is issued to a participant, but there is no
provision in the plan document for participant loans. The plan is at risk of disqualification (losing
its tax-deferred status), but can probably be corrected through the IRS
Voluntary Compliance Program (VCP). ·
A loan issued in excess of the applicable limits may
result a penalty for the participant and must be corrected on a timely basis
including interest. · Loan
repayments are not timely or do not follow the amortization schedule and the
loan is determined to be in default. The outstanding balance of the loan will
be treated as a deemed distribution and becomes taxable to the participant
the year of default. Form 1099-R must be issued to the participant and IRS. Please contact our
office before issuing any participant loans so we may help determine that the
proper documentation has been completed and that the loan limitations and
other requirements are met. |
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