Retirement
Plans Quarterly
Return to www.Rollover.net Home                                                      Third Quarter 2010
2010 EXTENSION FOR TAX-FREE IRA DISTRIBUTIONS TO CHARITIES STILL NOT PASSED
During the latter part of June, the Senate rejected H.R. 4213 (American Jobs and Closing Tax Loopholes
Act), which among other legislation, extended the option for IRA holders age 70 ½ and older to donate
up to $100,000 from their IRAs to qualifying charities tax-free through December 31, 2010. Since then,
the bill was pulled from the floor and a scaled-down version of H.R. 4213 (Unemployment Compensation
Extension Act of 2010) was passed by the Senate and signed into law by President Obama. However, this
legislation did not extend many of the popular tax breaks of the Tax Extenders Act, and it is unclear at this
time whether they will be considered later in 2010. Watch for updates to follow.
DEADLINE TO RECHARACTERIZE
After an IRA is converted to a Roth, there may be situations where the individual wants to reverse the conver-
sion. For example, a tax-filer that converts a Traditional IRA to a Roth and later discovers he or she is above
the eligibility income level (a 2009 Roth IRA conversion), or the market value of converted securities has
decreased in value. The individual may choose to recharacterize (reverse) the conversion back to a Traditional
IRA and without taxation or penalty. Special rules provide relief to taxpayers that reverse (recharacterize)
conversions to Roth IRAs.
Recharacterization example
To see how a reversal could benefit a taxpayer, let’s assume he or she converted securities valued at $100,000.
Since the conversion, the market value of the securities decreased to $75,000. The taxpayer will have to
include $100,000 as ordinary income received (converted) on securities now valued at $25,000 less. How-
ever, if that same taxpayer reverses the conversion, no tax will be due at that time. The IRA holder will have
another opportunity to reconvert later at the lower value, which means less ordinary income tax to pay. For
tax-filers that reverse a conversion back to a Traditional IRA, a reconversion may only occur the later of:
January 1 of the tax year following the conversion, or 30 days after the recharacterization (reversal).
Recharacterization between IRAs
In addition to reversing conversions, the IRS allows taxpayers that contribute to either a Traditional or Roth
IRA the opportunity to recharacterize (move) that contribution (plus earnings or less the loss) to the other
type of IRA. This may be a good strategy for someone who discovers their Traditional IRA is not deductible
and therefore elects to make it a Roth IRA contribution or someone who discovers they exceeded the income
limit for Roth contribution eligibility and therefore elects to make it a non-deductible Traditional IRA. Note
that in order to move a Traditional IRA contribution to a Roth IRA, the taxpayer’s AGI must be under the
allowable limits for the year the contribution is intended ($120,000 for a single filer and $177,000 for married
couples filing a joint return for 2010). However, there are no AGI limits for non-deductible contributions to
Traditional IRAs, and therefore, taxpayers may recharacterize Roth contributions to a Traditional IRA.
Deadline
Note that to qualify for a recharacterization of contributions between IRAs, the reversal must be completed
prior to October 15 of the year following the year the contribution was made and the individual must have
filed their Federal income tax return by the normal filing deadline, plus extensions. So, for 2009 conversions
and contributions, the deadline is quickly approaching.
Recharacterization steps:
1. Inform the custodian to complete a transfer of the original contribution/conversion amount from one IRA
to another. The transfer must include any net income (or loss) from the original date of the contribution,
which the custodian will calculate.
2. Report the recharacterization with the IRA holder’s tax return on Form 8606 using the date of the origi-
nal contribution. The individual may have to amend their return if the recharacterization is for a previous
year’s contribution/conversion.
3. Custodian will issue a form 1099-R and the amount for the changed IRA on Form 5498.
Individuals should consider this as an opportunity to take advantage of the flexibility of being able to rechar-
acterize/reverse their ineligible IRA contribution or underperforming Roth IRA conversion. Remember, a
recharacterization must occur before tax filing deadline plus extension (October 15). It is always recommended
that individuals seek the aid of a competent tax advisor or tax attorney to assist with tax advice and guidance.
3rd Quarter 2010
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SIMPLE IRAS - OCTOBER 1 DEADLINE
The SIMPLE IRA is an employer-sponsored plan that allows eli-
gible employees to make pre-tax salary deferrals into an IRA and
requires the employer to make annual contributions into the IRA of
each eligible employee. SIMPLE IRA plans must be maintained
on a calendar-year basis (IRC Sec. 408(p)(6)(C)).
New plans
October 1 is an important date for new SIMPLE plans, as there is
a requirement that all new plans be established by October 1 of the
year for which deferrals will be made. In addition, within a 60-day
period preceding a plan year, the employer must allow eligible
employees to make deferral elections (IRC Sec. 408(p)(5)(C)).
The 60-day election period for new plans must begin by October 1
to include 2010 deferrals.
There is one exception to the October 1 establishment deadline.
Newly established companies may open SIMPLE IRA plans as
soon as administratively feasible to accept contributions immedi-
ately.
Existing plans
For existing plans, employers should furnish a 60-day election
notice and salary deferral notice by November 1 each year. This
notice allows newly eligible employees to make elections or exist-
ing employees to modify elections for the upcoming year.
October 1 is quickly approaching, and employers wishing to estab-
lish a SIMPLE plan for 2010 should do so immediately, as plans
established after this date are effective for 2011.
EXTENSION DEADLINE FOR EMPLOYER
CONTRIBUTIONS
Employers may wait until the company’s tax filing due date plus
extensions to make company contributions to SEP or SIMPLE
IRAs and to Qualified Retirement Plans.
For fiscal-year business owners, the normal filing date is the 15th
day of the 3rd month after the end of the corporation’s tax year.
Extensions stretch the employer funding and filing deadline an ad-
ditional six months following the normal filing date.
For calendar-year filers, March 15, 2010 was the 2009 filing date
for Corporations and for S-Corps. The normal 2009 filing date for
the self-employed was April 15, 2010.
Extension deadlines
Business owners may request automatic extensions for tax filing
and for contributing by submitting appropriate forms by their nor-
mal filing date. If an extension was granted, September 15, 2010 is
the final day a corporation may make company contributions and to
submit their tax returns. For the self-employed, October 15, 2010
is the final day employer contributions may be accepted and tax
returns filed.
DOES YOUR 401(K) PLAN NEED A SAFE HARBOR PLAN.
Does your 401(k) retirement plan keep failing the nondiscrimina-
tion tests. Or are your highly compensated employees (HCEs)
unable to defer as much as they would like because of the low level
of deferrals by the non-highly compensated employees (NHCEs).
If so, you should consider as one of your alternatives adopting a
“safe harbor" plan where the deferrals are no longer tested for
nondiscrimination and the HCEs can defer up to the maximum dol-
lar amount allowable. In order to adopt a safe harbor plan, there
are some required employer contributions. The traditional two safe
harbor plan contribution alternatives are described below, along
with an additional option that is seldom mentioned or utilized.
Non-elective safe harbor contribution
The non-elective safe harbor contribution requires that the plan
sponsor make a contribution to the plan (or another defined
contribution plan) equal to at least 3% of compensation for each
NHCE who was eligible to defer under the plan. This contribution
is made for all eligible NHCEs regardless if they elect to partici-
pate in the plan or not. There can be no additional requirements
imposed on these NHCEs, such as being credited with at least
1,000 hours of service during the year or being employed by the
employer on the last day of the plan year (although see below for
a twist on this approach). The NHCEs must be immediately 100%
vested in this contribution.
Matching safe harbor contribution
The matching contribution safe harbor requires that the plan spon-
sor make a matching contribution to the plan (or another defined
contribution plan) equal to 100% of each NHCE’s deferrals up to
3% of compensation and 50% of each NHCE’s deferrals between
3% and 5% of compensation. Alternatively, the employer may
make a matching contribution equal to 100% of each NHCE’s
deferrals up to 4% of compensation. In addition, the matching safe
harbor contribution requires that the rate of plan sponsor match-
ing contributions for any HCE, at any rate of deferrals, cannot
be greater than the rate of plan sponsor matching contributions
provided to the NHCEs. As with the non-elective safe harbor
contributions, the NHCEs must be immediately 100% vested in
this contribution.
Can the plan sponsor match deferrals in excess of 5% of compen-
sation. Yes; however, if a plan sponsor matches deferrals in excess
of 6% of compensation, the safe harbor will no longer apply to
the matching contributions portion of the plan and the employer
matching contributions will have to be tested (although the safe
harbor would still apply to the deferral portion of the plan).
Other alternatives
The wait-and-see safe harbor is a variation of the non-elective
contribution safe harbor. It seems to be seldom mentioned or uti-
lized, perhaps because it is a little more difficult to understand and
requires extra work. Under the wait-and-see safe harbor, the plan
sponsor waits until near the end of the plan year to decide whether
the plan is going to make a non-elective safe harbor contribution
for the plan year – typically by running preliminary nondiscrimi-
nation tests for the plan year. If the plan sponsor decides to make
the plan a safe harbor plan for the plan year involved, the sponsor
must, no later that 30 days before the end of the plan year, (i) give
a safe harbor notice to the employees and (ii) amend the plan to be
a safe harbor plan for that entire plan year.
Notice requirements
Regardless of which approach is used, the plan sponsor must notify
its employees about the safe harbor being used (or possibly used
under the wait-and-see alternative) before the beginning of the plan
year involved (at least 30, but no more than 90, days in advance).
Additional notice is required if the plan sponsor uses the wait-and-
see alternative – as indicated above, the sponsor must notify the
participants if the non-elective safe harbor contribution is going to
be used at least 30 days before the end of the plan year involved.
pg_0003
The plan sponsor must also make sure that the plan document con-
tains the appropriate safe harbor provisions before the beginning
of the plan year involved. In the case of a plan sponsor that uses
the wait-and-see alternative, the plan must be amended to provide
for the non-elective contributions at least 30 days before the end of
the plan year involved.
Warnings
A plan sponsor should carefully consider making the decision to
install a safe harbor plan. Once made, the decision may be dif-
ficult to undo because the rules prohibit a plan from ceasing to be
a safe harbor plan once the plan year is underway except in limited
circumstances (another reason for why the wait-and-see alterna-
tive may be appealing). Also, as the plan document gets amended,
there may be additional charges from the third-party administrator.
What to do next
If you are a plan sponsor considering adopting a safe harbor plan
or would like to find out more, contact your third-party adminis-
trator (TPA) and your benefits council to determine if doing so is
appropriate for your plan’s situation and, if so, which approach
best suits your plan. Your TPA should be able to give you an
estimate on the matching and non-elective contributions required
under the safe harbor rules. Remember, no matter which approach
you take, plan sponsors need to start planning well in advance of
the upcoming plan year to allow for time to give the appropriate
notices and have the appropriate documents in place well before
the beginning of the next plan year. The deadline for providing
notice to employees is a minimum of 30, but no more than 90 days
prior to the beginning of the plan year. For calendar years, this
means from October 1 to November 30 for the plan year beginning
January 1, 2011.
LABOR DEPARTMENT RELEASES NEW FEE
DISCLOSURE RULES
After much anticipation, the Department of Labor (DOL) has
released new fee disclosure rules for service providers to retire-
ment plans. The aim of the rules (under section 408(b)(2) of the
Employee Retirement Income Security Act (ERISA)) is to help
plan fiduciaries evaluate whether arrangements with their service
providers are “reasonable" and that “reasonable" compensation is
paid for those services. The rules focus on service provider com-
pensation arrangements that are most likely to raise questions for
plan fiduciaries. These new rules – technically interim final rules
– are set to go into effect in July 2011 and apply to plan service
providers that expect to receive at least $1,000 in compensation in
connection with their services to any qualified retirement plans.
Main disclosure requirements
• Information required of service providers must be given in
writing to the plan fiduciary, though a formal written contract
containing the information is not required
• Information required includes direct and indirect compensation
to the service provider, affiliates, or subcontractors. Direct
compensation is compensation directly from the plan. Indirect
compensation is compensation received from a source other
than the plan.
• To avoid conflicts of interest, all services provided must be
broken out with a cost associated with each, even though the
services provided may have been packaged together under one
fee.
• An indication from the service provider if they are acting as a
fiduciary to the plan.
Conclusion
While the DOL has issued guidance to plan fiduciaries on their ob-
ligations in selecting and monitoring service providers, these new
rules for the first time establish a specific disclosure obligation for
plan service providers, with the aim of providing plan fiduciaries
the information they need to make better decisions. The many
changes to the way services are provided to plans has improved
efficiency and reduced the costs of plan administrative services,
though the complexities resulting from these changes has made it
more difficult for plan sponsors and fiduciaries to understand just
how much service providers are being compensated. These new
rules are designed to help plan fiduciaries to better navigate these
complexities.
2009 – THE YEAR OF THE RETIREMENT
PLAN PARTICIPANT
Recently, The Vanguard Group released a study on its 2009 defined
contribution plan recordkeeping data entitled, “How America Saves
2010," which was filled with generally very good news for the state
of savings of retirement plan participants. Considering the current
state of the economy, and the implosion of the financial markets in
2008, a rebound in 2009 in a variety of data points for plan partici-
pants was not necessarily expected, though is obviously welcome.
Background
The Vanguard Group, which offers Vanguard retirement plan
recordkeeping services (among other financial products), is the
6th largest retirement plan recordkeeper by total plan participants
(Source: Plan Sponsor Magazine, 2009). With over 3.4 million
plan participants in 1,700 plans, and $400 billion in defined contri-
bution plan assets, the data that is derived from their recordkeep-
ing system gives a good indication as to the general state of the
defined contribution plan market.
Defined contribution plans, such as 401(k), profit sharing, 403(b),
and money purchase plans, are the dominant type of retirement
plans sponsored by private sector employers in the United States,
covering nearly half of all private-sector workers. With older style
“pension plans" (i.e., defined benefit plans) being made available
less often to workers, an analysis of data in the defined contribu-
tion market gives a very good indication as to how a key portion
(outside of Social Security and personal savings) of the U.S.
retirement savings system is performing.
Participant account balances improve
Median account balances rose in 2009 by 33% from 2008 levels.
About two-thirds of participants had account balances at the end
of 2009 that were higher than they were in September 2007, just
prior to the stock market peak in October 2007. Interestingly, over
this 27-month period, only 6% of participants suffered declines of
more than 30% in their account balances, a lower figure than many
would have expected.
Automatic investment solutions on the rise
One of the more interesting developments in DC plans in 2009
was the increased use of automatic investment solutions. Auto-
matic investment solutions can be defined as “all-in-one" portfo-
lio programs such as target date funds, lifestyle funds, balanced
funds, and managed account advisory services. At the end of
2009, 25% of all Vanguard participants were solely invested in
pg_0004
a single automatic investment solution, versus just 7% only five
years ago. A single target date fund was chosen by 16% of all
participants, 6% held one traditional balanced fund, and 3% used a
managed account program.
Use of target date funds increases
The Pension Protection Act of 2006 (PPA) established the qualified
default investment alternative (QDIA) regulations, establishing
plan fiduciary protections when plans adopt QDIAs such as target
date funds. Target date funds are mutual funds that periodically
rebalance or modify the asset mix (stocks, bonds, and cash
equivalents) of the fund’s portfolio and change the underlying
fund investments with an increased emphasis on income and
conservation of capital as they approach the target date. Different
funds will have varying degrees of exposure to equities as they ap-
proach and pass the target date. As such, the fund’s objectives and
investment strategies may change over time. The target date is the
approximate date when investors plan to start withdrawing their
money, such as retirement. The principal value of the funds is not
guaranteed at any time, including at the target date.
As of year-end 2009, half of plans had designated a QDIA,
whether for automatic enrollment of employees or other default
purposes. Of plans choosing a QDIA, 80% have selected a target
date fund and 20% a balanced fund. In 2005, 25% of Vanguard
plans with automatic enrollment used a money market or stable
value fund as a default investment. In 2009, only 1% of these
plans still used a money market or stable value fund as the default
investment, since they do not qualify as QDIAs. Obviously, the
QDIA regulations have had an impact here.
Roth 401(k) plan adoption
The ability to start a Roth 401(k) plan, or add a Roth contribution
component to an existing 401(k) plan, has been allowed by the
Treasury Department and IRS since January 1, 2006. As of year-
end 2009, one-third of all Vanguard plans allowed for this feature,
of which 8% of participants took advantage. Considering that there
are no income limits when contributing to a Roth 401(k), versus a
Roth IRA, the percentage of participants adopting this feature is
on the lower end of what was expected when Roth 401(k)s were
first made available.
Participant trading remains low
As a general rule, the majority of participants do not trade their
accounts in a given year, not even to rebalance their accounts to a
target allocation. In 2009, only 13% of participants traded in their
account, which was down slightly from the 16% who traded in
2008. On a net basis, traders shifted only 0.6% of assets to fixed
income in 2009. Overall, despite some high market volatility in
2009, only 1% of traders abandoned equities altogether, where
they moved all of their money into fixed income.
Participant shift in investment allocations
Through a combination of market declines and participant trading
activity, the percentage of plan assets invested in equities declined
from 73% in 2007 to 66% in 2009. Vanguard estimates that ap-
proximately one-third of this movement was from traders shifting to
fixed income, and the remaining two-thirds from market declines.
Interestingly, there is some tendency towards extreme equity
allocations, where one in three participants hold either 100% in
equities (14% of participants) or less than 20% in equities (15% of
participants).
Loan activity
Until 2009, loan requests had been on the decline for four years.
In 2009, though, the number of new loans issued increased 22% to
levels not seen since 2006. The average loan balance was $8,700,
essentially unchanged over recent years, and 16% of participants
had a loan outstanding. Only about 2% of aggregate plan assets
were borrowed by participants.
Infrequent in-service withdrawals
Though economic conditions remain weak, hardship and general
in-service withdrawal activity remained low in 2009. All in-
service withdrawal activity amounted to only 1% of plan assets.
An in-service withdrawal, of about one quarter of their account,
was taken by 4% of participants. Of those withdrawals, about half
were for a financial hardship.
Assets are largely being used for retirement
Participants leaving employment for the most part preserved
their assets for retirement. In 2009, 10% of participants left their
employer and were eligible for a distribution. Of these, 69%
continued to preserve their plan assets for retirement by either
remaining in their employer’s plan or rolling over into an IRA or
new employer plan. Of all plan assets available for distribution,
92% were preserved and only 8% were taken out in cash.
Conclusion
Defined contribution plans are a cornerstone of the U.S. retirement
savings system. With $4 trillion in assets, and 55 million par-
ticipants covered by defined contribution plans, it is important to
periodically analyze the data inherent within these plans to better
understand the state of the retirement plan industry. What can be
said of the data relative to the year 2009, as reported by Vanguard,
is that retirement plan participants have weathered the ongoing
economic crisis better than could have been expected. The majority
of participant account balances are now above what they were
when the stock market peaked in late 2007. This is primarily due
to low trading activity that allowed for the majority of plan partici-
pants to participate in the dramatic market rebound that began in
March of 2009.
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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