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Newsletter
March
2003 Volume
20 - 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:
412(i) PLANS: TOO GOOD TO BE TRUE - The IRS is going to shut down those plans that have
gone over the legal “edge."
CATCH-UP
CONTRIBUTIONS - Catch-up contributions allow individuals age 50 or older
to contribute an additional amount to either a 401(k) plan, SIMPLE IRA or
regular IRA.
MISSING
PARTICIPANTS - Many problems may occur when terminated participants
cannot be located. The following
procedures must be taken in order to locate and distribute amounts due to
missing participants
INFORMATION FOR MILITARY RESERVISTS ON EMPLOYEE BENEFIT RIGHTS DURING MILITARY SERVICE - the Pension and Welfare Benefits Association (PWBA) has released updated information.412(i) PLANS: TOO GOOD TO BE TRUE By Bruce Ashton (BruceAshton@Reish.com) Reish Luftman McDaniel &
Reicher APC Attorneys at Law You may have
heard about 412(i) plans: they offer a virtually unlimited tax deduction on
the front end and tax free income on the back end - plus life insurance protection
along the way. Too good to be true? Yup. And the IRS is going to shut down
those that have gone over the legal “edge." First, some
background: 412(i) is a section of the tax code. It refers to defined benefit
pension plans that are funded entirely through insurance contracts (life
and/or annuity). The required plan contribution is the premium charged by the
insurance company, and the insurance guarantees the promised retirement
benefits. Though funded differently, they are governed by the same qualification
rules as traditional pension plans, including limits on retirement and death
benefits. Properly structured, they can be a useful retirement planning tool
because they require level funding (vs. the fluctuations in traditional
plans) and generally accelerate the contributions (and tax deductions) to the
early years. Some insurance
companies have developed special 412(i) products. Unlike traditional
insurance policies, these products have high loads in the early years, very
low cash and reserve values and high death benefits. So for a relatively high
premium (and tax deduction), the contract guarantees the same amount of
benefit as a traditional contract with a lower premium. Doesn't sound too
good, except that these products are sold with the understanding that at the
end of five years, when the contract cash value is still low relative to the
premiums paid, the insured will buy the policy out of the plan. Over the next
few years, the value of the policy grows so that after 10 or 12 years, it equals
or exceeds the premiums. At that point, the insured begins borrowing the
value out of the policy - tax free. The IRS says it
doesn't work. They say it manipulates the rules by improperly valuing the
policy while it's in the plan and again when it's bought out. This causes a
violation of the maximum benefit rules, makes a large portion of the premium
non-deductible, and may violate the "exclusive benefit rule" (which
says a plan must be maintained for the exclusive Purpose of providing retirement
and incidental death benefits). The IRS also says that it results in
significant taxes when the policy is bought out. Watch
for an IRS announcement in the near future laying out their concerns in
detail. In the meantime, they may suspend issuing favorable determination
letters on 412(i) plans and treat these arrangements as tax shelters, thus
requiring the taxpayer to put a red flag on its tax return. |
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CATCH-UP CONTRIBUTIONS Catch-up contributions
allow individuals age 50 or older to contribute an additional amount to
either a 401(k), SIMPLE IRA or regular IRA.
Following are the catch-up contribution limits by plan type:
Who is eligible? §
Individuals who will attain age 50 or older by the end
of the calendar year are eligible to make catch-up contributions as of the
beginning of the year. These
individuals are eligible to make catch-up contributions even if they
terminate employment before age 50. §
These individuals must be eligible to make regular
deferral contributions to the plan. Employers unfamiliar with the catch-up
provisions should know: §
Plans are not required to offer catch-up
contributions. §
Plans must be amended to allow for catch-up
contributions. Most 401(k) plans
included the catch-up provisions in their EGTRRA amendment, which was
provided with the GUST document restatement. §
Catch-up contributions do not count against an
individual’s 415(c) limit ($40,000 allocation limit), nor are they included
in non-discrimination tests. §
Employers may report both regular and catch-up
contributions as a single amount on the W-2 form. §
Employers are not required to match catch-up
contributions, though you may do so.
This would be spelled out in the EGTRRA amendment. §
Catch-up provisions have to be universally
available in all company plans that offer elective deferrals. §
Contributions that otherwise would cause the plan
to fail the ADP test, may be retained in the plan as catch-up contributions. §
Employees do not have to sign a separate election
form to make catch-up contributions.
The 401(k) dollar limit would simply be $14,000 for those age 50 or
older verses $12,000 for those under age 50. |
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MISSING PARTICIPANTS Many
problems may occur when terminated participants cannot be located. The following procedures must be taken in
order to locate and distribute amounts due to missing participants: 1.
First the employer must make a reasonable effort to
locate the participant. Reasonable
effort should include certified mail with return receipt to the last known
address of missing participant. 2.
The employer can also use private locator services
to locate the participant. 3.
The employer can write to the IRS to request their
assistance. Include in the letter the participant’s name and social security number.
4. The
employer can write to the Social Security Administration Office to request
their service for locating missing participants. If the employer is unable to locate a participant
using these resources, there is another option. The employer can withhold 100% of the amount due to the
participant for Federal income tax and forward the withholding amount to the
IRS. If the
last option is used, after the participant files their personal income tax
return, the IRS will inform them that they have underreported both their
income and income tax withholding.
This should cause the IRS to issue a refund of overpaid taxes. The end result is the participant received
the amount due to them, the plan performed its obligation to pay benefits to
the participant and, going forward, the plan no longer has to maintain
records for this participant. While there is no statutory provision for this
technique, there is not a prohibition against it either. This procedure should only be used for
distributions under $5,000 or when a plan terminates. |
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INFORMATION FOR
MILITARY RESERVISTS ON EMPLOYEE BENEFIT RIGHTS DURING MILITARY SERVICE
The Pension and
Welfare Benefits Association (PWBA) has released updated information to help Reserve
and National Guard units preparing to be deployed understand their rights to
pension and health benefits coverage available through private sector
employers. (PWBA Press Release No. 03-11, 1/10/2003) The updated
information, “Frequently Asked Questions for Reservists Being Called to
Active Duty” provides basic information about how retirement benefits of
reservists are protected during their military service, said PWBA. Among the
topics discussed are: §
Whether a period of active duty will be
considered by employers as a break in service; §
Whether employers' are required to
continue to make employer contributions to 401(k) plans during periods of
active duty; §
The ability to designate another
individual to change 401(k) plan investment allocations and to apply for
loans and withdrawals from the plan; §
The requirement that pension plans drop
interest rates on loans, by those on active duty, to no more than 6%. The frequently asked
questions also describe the rights of family members to maintain health coverage,
including the right to keep coverage under the Consolidated Omnibus Budget
Reconciliation Act-known as COBRA continuation coverage-as well as the
various health benefit options available to family members. A copy of the questions and answers is available on
PWBA's Website at http://www.dol.gov/pwba/faqs/. Also see our December 2001 Newsletter article “Uniformed
Services Reemployment and Plan Benefit Rights.” |
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