Return to www.Rollover.net Home                                                         Second Quarter 2010

REQUIRED MINIMUM DISTRIBUTIONS (RMDs) TO CHARITIES

It was reported by Ascensus Retirement Services that both the House and Senate have versions of pending

legislation to extend the option to IRA holders over the age of 70 ½ to donate up to $100,000 from their

IRAs to qualifying charities tax free. The extension, if approved, will be due to expire on December 31,

2010. Watch for updates to follow.

BENEFICIARIES ALLOWED ROLLOVERS TO IRAs

In The Pension Protection Act, 2006 (PPA ’06), a provision permits non-spouse beneficiaries of deceased plan

participants to directly roll (transfer) their share of the plan’s assets into an inherited IRA beneficiary account,

if the plan allows. The rollover must be in the form of a direct trustee-to-trustee transfer (IRC Sec. 402(c)

(11)), as non-spouse beneficiaries are not permitted to complete indirect rollovers (no constructive receipt).

Withholding tax

Since non-spouse beneficiaries are now permitted direct trustee-to trustee inherited IRA transfers, those

beneficiaries electing to take distributions are now subject to 20% federal withholding tax. In the IRS’

2010 Instructions for Forms 1099-R and 5498, it states that, “effective January 1, 2010, eligible rollover

distributions from an employer’s plan paid directly to a non-spouse beneficiary are subject to mandatory

20% withholding."

IRS Notice 2008-30

In addition to direct transfers to inherited IRAs offered in PPA ’06, in IRS Notice 2008-30 this provi-

sion was enhanced to include direct rollovers to inherited Roth IRAs. The following is from 2008-30 in

regards to beneficiaries converting inherited plan assets directly into Roth IRAs:

Q – 7. Can beneficiaries make qualified rollover contributions to Roth IRAs.

A – 7. Yes. In the case of a distribution from an eligible retirement plan other than a Roth IRA, the modi-

fied adjusted gross income and filing status of the beneficiary are used to determine eligibility to make a

qualified rollover contribution to a Roth IRA.* Pursuant to IRC Sec. 402(c)(11), a plan may, but is not

required to, permit rollovers by non-spouse beneficiaries, and a rollover by a non-spouse beneficiary must

be made by a direct trustee-to-trustee transfer. A surviving spouse who makes a rollover to a Roth IRA

may elect either to treat the Roth IRA as his or her own or to establish the Roth IRA in the name of the

decedent with the surviving spouse as the beneficiary.

* The income and filing status to determine eligibility referred to in the above paragraph, was eliminated effective January 1, 2010.

Conversion and rollover

It’s important to note that the action to move assets from a deceased participant’s retirement plan directly

into an inherited Roth IRA is considered a conversion and direct rollover and any pre-tax dollars converted

to an inherited Roth IRA is reported as ordinary income.

Closing comment

Prior to PPA ’06 and Notice 2008-30, beneficiaries of deceased participants in qualified retirement plans

were offered a limited number of distribution options. These regulations offer non-spouse beneficiaries

flexibility to control their investments and the timing of their taxation by directly rolling QRP assets to

inherited beneficiary Traditional or Roth IRAs.

ROLLING AFTER-TAX DOLLARS INTO TRADITIONAL IRAs

If a participant of a qualified retirement plan (QRP) contributes “after-tax" dollars, and is planning to roll

over plan assets into a Traditional IRA, it’s important to know the long-term bookkeeping responsibilities

Traditional IRA owners assume if after-tax dollars are rolled into Traditional IRAs.

QRP pre-tax vs. after-tax tracking

In a QRP, it is generally the Plan Administrator’s responsibility to determine and track pre-tax vs. after-

tax dollars held and distributed for that plan’s participants. Thus, while assets are held within a plan, plan

participants have no tracking or IRS reporting responsibilities.

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2nd Quarter 2010

When participants take an in-service withdrawal or terminate

employment and request a distribution, their QRP administrator

informs them of their plan balance, which must detail pre-tax vs.

after-tax assets held.

IRA pre-tax vs. after-tax tracking

Generally, most custodians do not keep track of after-tax dol-

lars held in IRAs. IRA owners are responsible for tracking any

after-tax dollars, and unlike QRPs, the responsibility to account for

after-tax contributions includes combining the value of all of the

individual’s IRAs. IRA owners must combine the balance in every

IRA, except Roth IRAs, and track any after-tax amounts as a ratio

of the total balance of all the IRAs. IRA owners, and beneficiaries

after an owner’s death, must continue the tracking process until the

IRA assets are completely distributed.

After-tax reporting is carried out by filing an IRS Form 8606, Non-

deductible IRAs, with one’s tax return. And, a Form 8606 must be

submitted to the IRS every year there is a change in the after-tax basis.

Taxable vs. non-taxable IRA distributions

Once after-tax dollars are received into an IRA, IRA owners are

not permitted to take just after-tax distributions from any of their

IRAs. A formula must be applied to each distribution to determine

the taxable and non-taxable portion of each distribution. As an

example, an IRA owner has a total of $50,000 in all IRAs, which

consists of $47,000 pre-tax and $3,000 after-tax dollars. His after-

tax amount is 6% of his total.

So, if an IRA owner takes a distribution of $4,000, the after-tax

amount and reduced basis would be calculated as follows: $3,000

(after-tax balance) divided by $50,000 (total of all IRAs) times

$4,000 (distribution amount) = $240. The $240 represents the non-

taxable portion of the $4,000 distribution and reduces the after-tax

basis from $3,000 to $2,760. This procedure must continue for

every distribution taken, and it’s important to note that an IRA

owner must keep complete and accurate records to avoid incorrect

tax filings.

Receive or roll over.

Plan participants have the option to receive or roll over after-tax

dollars into IRAs. By rolling, the tax-free assets continue to shelter

new tax-deferred growth. However, IRA owners assume tracking

and reporting responsibilities. On the other hand, plan participants

who receive their tax-free dollars outside an IRA avoid the issue.

Which is the best way to go. A tax advisor or CPA should be

consulted when making this decision.

NOT TOO LATE FOR 2009 SEPs

An employer must establish a Qualified Retirement Plan (QRP) by

the end of the tax year for which a tax deduction is taken (Rev. Rul.

76-28). If an employer’s tax year is based upon the calendar year,

December 31, 2009 was the last day a QRP could be established for

2009. However, employers have until the due date of their federal

income tax return for the business, including extensions, to establish

a Simplified Employee Pension (SEP) Plan and make SEP contribu-

tions (Prop. Treas. Reg. 1.408-7(b): IRC Sec. 404(h)) for 2009.

GUIDANCE ON 403(b) PLANS ERISA EXEMPTION

On February 17, 2010, the Department of Labor (“DOL") issued

Field Assistance Bulletin No. 2010-01 (“the FAB"). The FAB pro-

vides guidance for applying the “safe harbor" rules to 403(b) plans

wishing to remain exempt from coverage under the Employee

Retirement Income Security Act of 1974 (“ERISA").

Background

The DOL issued a list of criteria that could be followed in order

to receive safe harbor status for purposes of ERISA exemption.

According to the 1979 regulation, in order to be exempt from

ERISA coverage, the following criteria must be met:

1. Participation is completely voluntary for employees;

2. All rights under an annuity contract or custodial account are

enforceable solely by the employee, beneficiary, or authorized

representative of such employee or beneficiary;

3. The plan sponsor receives no direct or indirect consideration or

compensation in cash or otherwise other than reasonable compensa-

tion to cover expenses incurred in the performance of the employ-

er’s duties pursuant to the salary reduction agreements; and

4. The sole involvement of the plan sponsor must be limited to any

of the following:

• permitting annuity contractors to publicize their products to

employees;

• requesting information concerning proposed products or annu -

ity contractors;

• summarizing the information provided in order to facilitate

review and analysis by the employees;

• collecting annuity or custodial account deferrals as required

by salary reduction agreements, remitting such deferrals to

annuity contractors, and maintaining records of such deferrals;

• holding in the plan sponsor’s name one or more group annuity

contracts covering its employees; and

• limiting the products available to employees, or the annuity

contractors who may approach employees, to a number and

selection which is designed to afford employees a reasonable

choice in light of all relevant circumstances.

Relevant circumstances may include, but would not

necessarily be limited to, the following types of factors:

– the number of employees affected,

– the number of contractors who have indicated interest in

approaching employees,

– the variety of available products,

– the terms of the available arrangements,

– the administrative burdens and costs to the plan sponsor, and

– the possible interference with employee performance result-

ing from direct solicitation by contractors.

In summary, meeting the criteria above will allow a 403(b) plan to

be exempt from ERISA coverage under a “safe harbor arrangement."

Overview of FAB 2010-01

The FAB provides additional guidance with respect to the DOL’s

regulation and should provide assistance to plan sponsors in

determining whether they can continue to maintain a safe harbor

non-ERISA 403(b) plan.

Limits on optional features offered in the plan

If optional features such as hardships and loans are not being ad-

ministered entirely by the provider, the FAB indicates that such op-

tional features may be removed by the plan sponsor if the removal

would result in either a reduction of the sponsor’s costs or would

permit the sponsor to administer the plan in a way that would avoid

excessive involvement on the part of the sponsor.

Plan sponsors cannot hire a third-party administrator

(“TPA") to make discretionary decisions

Generally, engaging a TPA to make decisions on behalf of the

plan sponsor would not meet the safe harbor exception and would

subject the plan to ERISA coverage. Any arrangement that a

plan sponsor enters into should limit the role of the sponsor and

allocate discretionary determinations to the annuity provider or

another responsible third party selected by a person other than the

sponsor. The plan sponsor may select providers that take respon-

sibility for discretionary decisions related to plan transactions, but

if the sponsor selects a TPA (in order to make decisions on behalf

of the employer), that would be inconsistent with the DOL’s safe

harbor criteria.

Plan Sponsors must offer a reasonable choice of providers

and investment products

A non-ERISA plan covered under a safe harbor arrangement must

offer a choice of more than one 403(b) service provider and more

than one investment product. This requirement to offer more

than one provider is essentially reinforced in the FAB, but some

contingencies are discussed in the FAB that suggest there are some

circumstances under which only one provider may be offered.

The DOL recognizes that remitting contributions through payroll

deduction may be costly and burdensome, especially to small

employers. Under such circumstances a plan sponsor could limit the

number of providers to which it will forward salary reduction con-

tributions to one if employees are allowed to transfer their interest

to a 403(b) account of another provider. But, permitting employees

to transfer to other providers will require the sponsor to enter into

Information Sharing Arrangements with any such providers.

The FAB also provides relief where an employer can demonstrate

that increased costs and difficulties would cause a plan sponsor to

cease payroll deductions entirely to all 403(b) contractors. In this

situation, providing a single service provider but offering a wide

array of investment products could be seen as affording employees

a reasonable choice. The FAB provides examples of an employer

that offers a broad range of affiliated investment products through

a single insurance company for its 403(b) program and a 403(b)

arrangement with an “open architecture" custodial account plat-

form with one service provider that gives employees access to a

broad range of unaffiliated mutual fund investment products.

If the plan sponsor decides to limit the availability of service

providers, advance notice must be provided to employees (prior

to their decision to participate in the 403(b) program) cover-

ing any limitations, costs, or assessments in connection with an

employee’s ability to transfer or exchange contributions to another

provider’s annuity contract or mutual fund account.

The plan sponsor does not have discretion to move plan funds

Under the safe harbor arrangement, a sponsor may limit the service

providers to which future salary reduction contributions will be

made, but the FAB clearly states that a plan sponsor may not unilat-

erally move plan funds from one provider to another provider.

Plan sponsors can discontinue salary reduction

contributions to providers not in compliance with the

Internal Revenue Code requirements for 403(b) plans

The FAB states that a plan sponsor may discontinue contributions

to a service provider that does not comply with the Internal Rev-

enue Code requirements for 403(b) plans.

Conclusion

While the Internal Revenue Service’s final 403(b) regulations

emphasized the need for 403(b) plan sponsor to take primary

responsibility for compliance with the Internal Revenue Code

requirements, the key to maintaining a safe harbor non-ERISA

403(b) plan continues to be limited involvement on the sponsor’s

part and leaving most of the discretionary decision-making to

the service providers of the 403(b) plan. This means that spon-

sors will need to continue to maintain a delicate balance between

ensuring the plan is operationally complaint while also keeping a

relatively arms-length distance regarding day-to-day administra-

tive decisions.

GENERATING INCOME IN RETIREMENT

Recently, the Departments of Labor, Treasury and the IRS put out

a Request for Information (RFI) regarding lifetime income options

for retirement plan participants and beneficiaries. The RFI is in

recognition of the changing dynamics within the retirement plan

system, where the government is now starting to focus in on solu-

tions to making retirement assets last throughout retirement, with

a view to possible legislation around this issue. Following is a

discussion built around some of the responses to the RFI.

Background — The life expectancy of Americans continues to

increase. Couples who are now both age 62 have a 47% chance

that at least one of them will live to age 90 (Source: U.S. Gov’t

Accountability Office). While this is good news in many respects,

this does present a challenge to making retirement assets last

throughout that extended lifetime, especially with the latest sharp

drop in financial and housing assets.

There are many pieces to the puzzle of generating adequate

income throughout retirement. How much money can safely

be drawn down each year. How should retirement savings be

invested during retirement. How much of a role should annuities

play. What type of annuity makes sense. Do retirement income

solutions make more sense within a retirement plan, or outside of

one. Should a retiree’s payout option default to an annuity versus

a lump-sum payment. This is obviously a complex topic, and the

answers to these questions are just starting to be addressed.

For many, the “three legged stool" is broken — In years past,

the discussion around retirement assets revolved around the “three

legged stool" of pension assets, personal savings, and Social

Security.

On the pension side, many employees were automatically enrolled

in a defined benefit pension plan, where many years of working at

the same employer resulted in a gold watch and a monthly check

for the rest of their lives. This pension utopia has changed drasti-

cally. The mobility of the American workforce and the heavy costs

of maintaining defined benefit plans have resulted in the demise of

these plans to where defined contribution (e.g., 401(k) plans) are

the plan of choice for many companies. While 401(k) plans have

many benefits, they do rely heavily on employee contributions

compared to defined benefit plans. Further, 401(k) plans usually

result in lump-sum distributions (compared to annuitized defined

benefit plan payouts) that the employee needs to turn into retire-

ment income.

The other two parts of the stool are also under pressure. The aver-

age person’s personal savings rate has been negligible for many

years, and the Social Security trust fund has reached the point

where more money is coming out of it than going into it.

The information contained in this newsletter has been carefully compiled from sources believed to be reliable, but the accuracy of the information is not guaranteed.

This newsletter is distributed with the understanding that the publisher is not engaging in any legal or accounting type of work such as practicing law or CPA services.

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The role of annuities — When it comes to the issue of generating

lifetime income, insurance companies have the upper hand with

the annuity products they have been developing over the years.

For example, single-premium immediate fixed lifetime annuities

have delivered a predictable, steady stream of income to many

clients. However, only 3 percent of the total amount of annui-

ties sold in 2008 were fixed immediate annuities. The majority of

annuities sold were deferred annuities, where only 1 percent were

converted to lifetime income (source: Insured Retirement Insti-

tute). These are startling statistics given the benefits of locking

in a predictable income. So why do many people avoid annuitiz-

ing. Well, there is the risk of dying early and the investment in

the annuity being lost by heirs. While this can be addressed by

purchasing a “refund-type" annuity (which refunds some money in

the event of dying early), these products are slightly more expen-

sive and provide less longevity protection. Partial annuitization is

also an option when addressing this risk. Another reason is that

many annuities are not indexed for inflation, as compared to Social

Security. There is also the issue of credit risk; the chance that

the issuer will go out of business. Many states offer a guarantee

pool, but the final covered amount varies and may be less than the

value of the annuity. Finally, there is the issue of timing and cost.

Converting to an annuity during the current recession amounts to

paying a high price (because interest rates are low) with account

balances that have lost significant value due to recent financial

market meltdowns. Also, annuities purchased by individuals are

pricier than if purchased via a group retirement plan, though some

new IRA rollover products now allow the ability to purchase insti-

tutionally priced annuities.

Another interesting approach is to purchase deferred income

annuities that begin paying out at an advanced age (age 80 to 85).

Sometimes referred to as “longevity insurance," these products can

play a key role within the retirement income puzzle. However,

when held in a tax-deferred account (e.g., IRA), these products

are subject to required minimum distributions (RMDs), whereas

immediate annuities are not. This discrepancy needs to be

addressed.

What all of this illustrates is that there are a number of solutions

available to address the retirement income issue with money

held outside of a retirement plan, though most participants are

ill-equipped to evaluate various annuities versus other investment

alternatives. Therefore, a strong educational effort will be needed

to bring out the pros and cons of incorporating annuities within

retirement income strategies.

In-plan options — A newer phenomenon in the retirement

income arena is the development of various income solutions that

are offered as an investment option within defined contribution

(DC) retirement plans, and/or the offering of annuities as a payout

alternative to a lump-sum distribution.

A key provision that these newer products offer is that participants

can maintain a higher equity exposure, while offering some sort of

principal and gains protection. This is counter to reducing equity

exposure when nearing retirement, or getting hurt by a target date

retirement fund in a down market that has more equity exposure

than you expected upon reaching retirement age.

The word is getting out on these products. In a recent survey

by the Profit Sharing Council of America (PSCA), 91% of plan

sponsor respondents had heard of these products and 22% were

considering adding them to their plans. This being said, the take-

up rate on these products has been minimal thus far. This is due

to a number of factors, including fiduciary issues, communicating

the concept to plan participants, dealing with qualified domestic

relations orders (QDROs), complying with Required Minimum

Distribution rules, portability among recordkeepers and IRAs, and

just not wanting to be the first to use one of these new products.

Vendors developing these in-plan retirement income options are

starting to address these issues, though further development is

needed, as well as an improved education of plan sponsors.

On the topic of offering payout alternatives, the PSCA survey

found that 21% of DC plans offered an annuity distribution option.

However, a low number of participants (less than 1%) took advan-

tage. There has been considerable discussion around mandating

that an annuity option be provided by DC retirement plans, or even

as a default option that would need to be declined by a plan par-

ticipant. While conceptually attractive, is it realistic to expect that

participant behavior will change drastically if such an environment

existed.

Conclusion — The need to address the issue of generating retire-

ment income is becoming quite stark. As the heart of the baby

boomers start to retire, it is estimated that more money will start

to be withdrawn from retirement plans than contributed. In other

words, we are starting to move from an asset accumulation to an

asset distribution environment. Financial firms understand the

demographics at play here, and are starting to develop innovative

products and approaches to this issue. While the government is

looking to weigh in, it would seem that there are enough profit

motives to provide a variety of products and approaches that can

offer a market-driven solution, as opposed to a legislative one.