|
|
Newsletter
June
2005 Volume
22 - Number 2
|
|||||||
|
|
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:
ROTH 401(k) CONTRIBUTIONS - Effective January 1,
2006, qualified 401(k) plans and 403(b) plans may allow participants to
designate some or all of their contributions as "Roth contributions.” SERVICE CREDITING RULES - These rules are fundamental to plan administration and apply to eligibility, vesting and benefit accrual. |
|||||||
|
|
ROTH 401(k) CONTRIBUTIONS The IRS recently published initial proposed regulations to
provide some guidance on Roth 401(k) contributions, which were a part of the
2002 EGTRRA law change. Effective
January 1, 2006, qualified 401(k) plans and 403(b) plans may allow
participants to designate some or all of their contributions as "Roth
contributions”. We hope the following Questions and Answers will provide
some basic understanding of this topic.
At the moment, IRS is gathering comments and suggestions from the
public. We expect to see more
guidance on this subject in the near future and we hope pass on any pertinent
information as it becomes available. Q: What is a Roth 401(k) Contribution? A: A Roth contribution is an
"after-tax" contribution.
Like a Roth IRA contribution, a Roth 401(k) contribution will be taxed
at the time it is deducted from a participant’s pay, but it will be exempt
from tax if distributed after age 59 1/2, or due to death or disability,
provided the distribution occurs at least 5 years after the participant began
making Roth contributions (qualified distributions). Q: What are the main benefits? A: The main benefits of Roth 401(k)
contributions are: (1)
Unlike Roth IRAs, all participants, regardless of their
gross income, can make contributions. (2)
When the participant terminates employment, Roth 401(k)
contributions may be rolled over to a Roth IRA. Since Roth IRAs are not subject to minimum distribution
requirements, this provides an opportunity to defer distributions until
death. Q: Who will benefit most from the Roth
features? A: Since the main advantage of a Roth
contribution is the tax-exempt status of distributions, it will benefit
participants who anticipate a higher tax rate in their retirement years
compared to working years and will also benefit young participants who have
the opportunity to accumulate significant earnings through the tax deferred
accumulation of compound earnings because the earnings on contributions are
also tax exempt upon qualified distribution.
Q: What are the requirements to add Roth
contribution features to your current 401(k) Plan? A: To qualify as Roth contributions, they have
to meet all of the following requirements: (1) The
401(k) plan document must explicitly permit Roth contributions. (2) A
participant's contribution must be irrevocably designated as a Roth
contribution. (3) The
employer has to treat the Roth contributions as wages subject to all
applicable payroll-withholding requirements at the time they are withheld
from pay. (4)
Plan sponsors must maintain separate accounting for the
Roth contributions and the gains and losses on those contributions. Q: What are some of the rules that apply to the operation of a plan that allows Roth contributions? A: Roth contributions are generally subject to the same rules that apply to 401(k) deferrals. They are aggregated with 401(k) deferrals for determining 402(g) annual contribution limit, must be included in the ADP testing with the 401(k) contributions, have to comply with the 70 ˝ minimum distribution requirements (unless rolled over to a Roth IRA), and cannot be withdrawn prior to age 59 ˝ unless there is a financial hardship. Q: What changes will be required of the plan
sponsors other than amending or adopting the Plan Document to allow for Roth
contributions? A: The plan sponsor may be required to make
changes in the payroll system to handle the different tax treatment of the
payroll deductions (including the different tax withholding and W-2
reporting). Additionally, your TPA
will likely implement a recordkeeping system that will handle the different
tax reporting of distributions from a Roth contribution account. |
|||||||
|
|
SERVICE CREDITING RULES Service crediting rules are fundamental to plan administration. They
apply to eligibility, vesting and benefit accrual. Incorrect application of
these concepts can result in significant IRS penalties, or in a worst-case
scenario, plan disqualification. The service crediting rules are set forth in the
plan document. The importance of understanding these portions of your plan
document cannot be overemphasized. However, the provisions are sometimes
difficult to interpret, and in such cases, we recommend that plan sponsors
contact our office and discuss any questions with a plan administrator. SERVICE RULES FOR PLAN ELIGIBILITY A plan may require employees to satisfy certain
minimum age and/or service requirements to participate. Generally, the plan
may not require more than one year of service, and it can establish a more
liberal waiting period or even none at all. If a plan provides for immediate
vesting, it can require a two-year waiting period for participation. However,
a 401(k) plan may not require a two-year waiting period with respect to
elective deferrals. Therefore, a 401(k) profit sharing plan may require two
years of service for matching contributions and employer nonelective
contributions, but only 1-year for 401(k) deferrals. A plan measures a year of service by counting an
employee's hours during an eligibility computation period (ECP). This can be
done by counting actual hours or utilizing the equivalency or elapsed time
method. This article will deal only with the actual hours method. An employee earns a year of service if he or she
completes at least 1,000 hours of service during an eligibility computation
period. However, the plan document may define a year of service for
eligibility purposes as less than 1000 hours. The plan document may credit an employee with all
years of service, including service prior to the effective date of the plan.
Some plans exclude service prior to that date. Such an exclusion must be set
forth in the plan document. ELIGIBILITY COMPUTATION PERIOD (ECP) The ECP is a period of 12 consecutive months,
however an employee need not be employed continuously during the 12 months,
nor employed on the last day of the ECP in order to receive credit for a year
of service. The first ECP is the 12-month period from date of hire to the
anniversary of the date of hire. Subsequent periods may be defined as a shift
to the plan year method or as the anniversary year method. If a plan uses the
shift to the plan year method, the second computation period begins with the
first day of the plan year following the employment commencement date (ECD).
If the plan uses the anniversary year method, the second eligibility
computation period begins on the anniversary of the employee's ECD. Most
plans shift to the plan year so that subsequent eligibility periods coincide
with the year of service for vesting and benefit accrual. WHEN IS A YEAR OF SERVICE CREDITED? Generally a year of service is credited as of the
last day of the 12-month ECP. For example, if an employee is hired on August
10, 2004, he or she is credited with a year of service on August 9,2005,
providing he or she has been credited with the 1,000 hours of service during
that 12 month period (or less if specified by the plan document). The year of
service is credited on the last day of the ECP period regardless of when the
employee actually completes the required number of hours of service. PLAN ENTRY DATE Unless excluded from participation for reasons
other than age or service, an employee who has satisfied these requirements,
as set forth in the plan document must enter the plan on the date specified
in the plan. The plan must guarantee that an employee will enter the plan by
the earlier of the first day of the next plan year or six months following
the date the employee satisfies the age and service requirements. The most common design for a plan is to use a
semi-annual entry date which is defined as the first day of the plan year and
the first day of the seventh month of the plan year. A plan may be designed
with more frequent entry dates such as quarterly or monthly. BREAK IN SERVICE RULES In some cases, a plan may disregard service for
eligibility purposes if an employee incurs a "break in service." A
typical break in service is a year in which an employee completes 500 or less
hours of service. The break in
service rules are generally applicable to rehired employees and plans that
have a 2-year waiting period, however the break in service rules are outside
of the scope of this article. REHIRED EMPLOYEES Plan documents include specific provisions that
apply to the participation of employees who are rehired by the employer. If
an employee is rehired, it must first be determined if the plan imposes any
break in service rules. If it does not, and the employee had previously
satisfied the eligibility requirements, the employee must re-enter the plan
upon reemployment. DUAL ELIGIBILITY A plan may include different eligibility
requirements for different groups of employees or have different eligibility
requirements for different features of the plan. For example, a new plan may
wish to have very liberal requirements for all current employees and adopt
more restrictive provisions for future employees; or a 401(k) plan which also
has a profit sharing feature may allow employees to participate in the 401(k)
portion of the plan after three months, but impose a 1 year waiting period
for the profit sharing portion. The purpose of this
article is to provide an understanding of the basic principles applicable to
crediting service. However, if plan sponsors or advisors have questions about
how to apply these principles please call our office. |
|||||||
|
|
|
