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Newsletter
December
2005 Volume
22 - Number 4
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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:
RETIREMENT PLAN
LIMITS FOR 2006 - Increases based on the cost-of-living index and
the statutory requirements of the Economic Growth and Tax Relief
Reconciliation Act of 2001
ROTH
401(k) FOLLOW-UP - Roth contributions can be effective as early as
January 1, 2006, but additional guidance is expected and several issues
remain unresolved. END-OF-YEAR REMINDERS - Reporting
distributions to IRS, reporting unrelated business taxable income and age 70
˝ required minimum distributions for 2005.
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RETIREMENT PLAN LIMITS FOR 2006
Limits will increase for 2006.
These increases are due to 1) adjustments to the cost-of-living index
(COLA) that meet the statutory thresholds that trigger an increase and 2)
increases due to the statutory requirements of the Economic Growth and Tax
Relief Reconciliation Act of 2001 (EGTRRA).
The FICA rates remain unchanged since 1990. For both employers and employees the FICA Tax is 7.65% (6.2% for Social Security Tax plus 1.45% for Medicare Tax). For self-employed individuals the FICA Tax is 15.3% (12.4% for Social Security Tax plus 2.9% for Medicare Tax). FICA Tax applies to earnings up to the Taxable Wage Base. |
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ROTH 401(k) FOLLOW-UP We have received many inquires on the subject of
Roth 401(k) since the release of our June newsletter. Understandably, many plan sponsors want to
be fully acquainted with the details of such an important change in plan
administration before they decide to make it possible for their participants
to make Roth contributions. Unfortunately, the lack of clarification from the
IRS on the taxable effects of Roth distributions and rollovers, and the lack
of amendment process which defines in detail the operational aspects of a
Roth program makes it difficult for plan sponsors to decide whether to add
the Roth 401(k) provision in their plan at this time. Below we
have listed some of the issues that plan sponsors might want to consider
before deciding whether a Roth 401(k) provision is a worthwhile feature to
have in their retirement programs. Distributions/Rollovers
– Roth contributions are subject to special limitations on
distributions that are more complicated in their tax consequences than
regular 401(k) contributions.
Generally both the principal amount of Roth contributions and
the earnings will be tax-free when it is a qualified
distribution. To qualify, the
distribution must be made after attaining age 59 ˝, or in the event of death
or disability, and made five taxable years after the first Roth contribution,
including rollovers from other Roth plan accounts. This requires the plan sponsors to keep track of not only the
Roth contributions in their own plan, but also any Roth rollover received from
another plan. Additionally,
when a distribution is not a qualified distribution, the earnings portion
will be subject to taxation while the principal amount will not be. Therefore, plan sponsors also need to keep
track of principal and earnings separately for Roth accounts. However, it has not been determined
whether the principal portion of the Roth contributions can be distributed
first (as in a Roth IRA) or must be distributed pro rata with the taxable
earnings (which is usually the case with after-tax employee contributions
made to a qualified plan). For the
participants, if they wanted to rollover their plan balance to an IRA after
termination of employment, the plan sponsor must make certain that they have
set up two separate IRAs; a traditional IRA for the pre-tax contributions,
and a Roth IRA for the Roth contributions. Participant
Loans from the Roth account – If a participant defaults on
a loan, presumably the portion of the loan that came from the Roth account
would be deemed a nonqualified distribution, and the earnings would be
taxable. This leads to plan sponsors
asking if they could design a loan program that excludes the use of the
earnings portion for taking the initial loan, but still considers the entire
Roth account balance, including the earnings, in the calculation of the
maximum loan amount. At this point,
no answer to this issue is available.
Plan
Documents – The proposed regulations indicated that Roth provisions
must be reflected in the terms of the plan document but did not address
precisely the way they should be reflected, including the above issues that
are yet to be determined.
Additionally, no specific guidance has been issued on the timing or
wording of the plan amendments that will be required. We are hoping that the IRS will provide
model amendment language in the near future.
Elimination of the Roth 401(k)
Option – Finally, Roth contributions were enacted as part
of the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”),
which is set to expire after 2010.
The ability for plan sponsors to establish, and for participants to
contribute to, a Roth 401(k) feature is contingent upon whether this law will
be made permanent after 2010. If the law is not made permanent,
participants will lose the ability to contribute to a Roth 401(k) after only
5 years. |
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END-OF-YEAR REMINDERS
This recap is not intended to cover all of the issues that apply to your plan, nor to be a comprehensive discussion of those issues that are mentioned. It is simply intended to alert you to some of the matters that arise at year-end. If you have further questions about anything mentioned below, feel free to contact us for more information. 1.
2005 Plan
Distributions: A Form 1099-R
must be filed with the Internal Revenue Service for each plan participant or
beneficiary who received a distribution during the 2005 calendar year.
Amounts that must be reported include: 1) Distributions of $10 or more, 2)
The cash value of any insurance contract distributed to the participant, 3) A
direct rollover or transfer to an IRA or other qualified plan, 4) The cost of
current life insurance protection provided under a qualified plan, 5) Payment
due to a Qualified Domestic Relations Order. 2.
Deemed Distributions and Loan Offsets. The
deemed distribution of a participant loan default must also be reported to
IRS on Form 1099-R. Note that a participant loan may become due and payable
upon the participant’s termination of employment and failure to repay the
balance of the loan results in default and a loan offset, which is an actual
distribution that must be reported on Form 1099-R. Check your plan loans to
be certain that any such amounts are reported to us. 3.
Form 990-T Exempt Organization Business Income Tax
Return. This form must be filed if a plan has unrelated business
taxable income (UBTI). UBTI is income from an unrelated trade or business
carried on by a qualified plan. For example income from a limited
partnership, which operates an X-ray facility would constitute UBTI. In
addition, income from investments acquired wholly or partially with borrowed
funds is treated as taxable to the plan. Form 990T must be filed to report
UBTI (and the appropriate tax paid)
by the 15th day of the 4th month following the close of
the plan year. Since this office does not prepare 990Ts, plan sponsors should
consult their tax advisors with respect to this filing. 4.
Age 70˝ Required Minimum Distributions (RMD). The
first RMD is for the year in which a participant attains age 70 ˝. This must
be made no later than April 1st of the following year. All
subsequent RMDs must be made by December 31st of each year. If the
first RMD is made in April, a second distribution would be required by
December 31 of the same year. Participants who are not more than 5% owners
may have to defer commencement of distributions until actual retirement or
may have the option to waive the commencement of distributions until the year
in which such participant actually retires depending on specific plan
provisions. The amount of the RMD is determined on the basis of the
participant’s account balance or accrued benefit and his or her life
expectancy. Please note that there is a 50% penalty for noncompliance with
this requirement. The penalty is 50% of the RMD that was required but was not
distributed to the participant. |
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