Return to www.Rollover.net Home                                                         First Quarter 2011

2010 TAX-FILING DEADLINE EXTENDED TO APRIL 18, 2011

On November 4, the IRS issued Notice IR-2011-1 which includes an extension to the filing deadline for

the 2010 tax year. Taxpayers will have until Monday, April 18 to file their 2010 tax returns and pay any

tax due because Emancipation Day, a holiday observed in the District of Columbia on April 16, will be

celebrated on Friday, April 15. By law, District of Columbia holidays impact tax deadlines in the same

way that federal holidays do; therefore, all taxpayers will have three extra days to file this year. Taxpayers

requesting an extension will have until October 17, 2011 to file their 2010 tax returns.

Note: Contributions to IRAs can be made at any time during the year but no later than the tax filing dead-

line (April 18, 2011 for 2010), not including extensions.

IRA DISTRIBUTIONS FOR QUALIFIED CHARITABLE DONATIONS EXTENDED

The Pension Protection Act of 2006 allowed certain IRA holders the opportunity to donate assets in their

IRA to qualified charitable organizations. If it’s done correctly, the distributions are tax-free and not

included as ordinary income. The provision applies for Traditional and Roth IRAs and does not typically

apply to distributions from active SEP or SIMPLE IRAs unless an employer contribution was not made to

the SEP or SIMPLE IRA during or for the year the charitable distributions are made.

Originally, this benefit was available only through December 31, 2009. However, on December 17, 2010,

President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Cre-

ation Act of 2010, which included a provision that extends the qualified charitable donation (QCD) benefit

through December 31, 2011. In addition, the bill provides a one-month extension that permits QCDs made

from January 1 through January 31, 2011 to be treated as having been made on December 31, 2010. If

a taxpayer makes the election as prescribed by the IRS, then the distribution made in January 2011 will

count towards:

• The taxpayer’s $100,000 exclusion limitation for the 2010 calendar year and

• The taxpayer’s required minimum distribution (RMD) for the 2010 calendar year.

Eligibility and donation limit

To be eligible for QCDs, IRA holders must be at least 70 ½ years of age on or before the actual day of

making the donation. In addition, to qualify as a QCD, the IRA custodian/trustee must make the distribu-

tion directly to the qualified charity. Any distributions, including RMDs, which the IRA owner actually

receives cannot qualify as a QCD.

For those who do qualify by age, their maximum QCD is limited to $100,000 per tax year. Any distribu-

tions in excess of this limit will not qualify for the tax exclusion benefit and will be treated as ordinary

income. Note that distributions of base contributions and tax-paid conversions to Roth IRA holders are

generally not considered taxable income.

Benefit of excluding income

By not including a QCD from an IRA as ordinary income, an individual’s adjusted gross income is not

increased, which could affect the ability to qualify for Roth contributions or have other tax ramifications.

Qualified charities

For information pertaining to qualified charities, go to the IRS web site, www.irs.gov/individuals, and

select the “Charities and Non-Profits" tab and review the “Search for Charities" section.

EDUCATION SAVINGS ACCOUNT (ESAs) BENEFITS EXTENDED

Provisions were included in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)

that increased certain benefits for ESAs. Contribution limits were increased to $2,000, donor eligibility

was expanded, the definition of “qualified educational expenses" was expanded to include K-12 expenses,

Hope and Lifetime Learning Credits were coordinated with ESA distributions, and the filing deadline for

contributions was changed to the tax return due date, not to include extensions.

Although EGTRRA was due to expire December 31, 2010, the increased benefits for ESAs are extended

until December 31, 2012 through the signing of the Tax Relief, Unemployment Insurance Reauthorization,

and Job Creation Act of 2010.

Retirement

Plans Quarterly

1st Quarter 2011

ROTH IRA WITHDRAWALS AFTER 2010 CONVERSIONS

Under a provision in the Tax Increase Prevention and Reconcilia-

tion Act of 2005 (TIPRA), the $100,000 AGI restriction has been

eliminated for Roth IRA conversions as of January 1, 2010. This

allowed taxpayers with AGI of $100,000 or more to convert their

Traditional, SEP, or SIMPLE IRAs (after two years), or retirement

plan assets to Roth IRAs in 2010 and beyond.

Tax considerations

For conversions completed in the year 2010, taxes can be deferred.

Unless a taxpayer affirmatively elects full taxation in 2010, a 2010

Roth IRA conversion will be taxed “ratably" by reporting 50% of

the taxable amount converted in 2011 and 50% in 2012.

Accelerated taxation for distributions

TIPRA includes a provision intended to discourage the withdrawal

of converted assets until their 2011 and 2012 tax obligations are

satisfied.

Under the provision, if a 2010 converted amount is subsequently

withdrawn in 2010 or 2011, the amount of the distribution will

be added as ordinary income to the IRA holder’s taxable income

reported in the year of the distribution. The same amount will be

subtracted from the income that would have been reported in the

individual’s 2012 tax filing.

Accelerated Taxation for Pre-2012 Withdrawals

Year

Action

Income

Reportable

in 2010

Income

Reportable

in 2011

Income

Reportable

in 2012

2010 Converted

$100,000

(50/50 taxation)

$0 $50,000 $50,000

2010 Withdraw

$25,000*

(50/50 taxation)

$25,000 $50,000 $25,000

2011 Withdraw

$25,000*

(50/50 taxation)

$0 $75,000 $25,000

2012 Withdraw

$25,000*

(50/50 taxation)

$0 $50,000 $50,000

*10% pre-mature penalty applies if under 59

½

years of age

Distribution ordering rules

Assets must be distributed from Roth IRAs in a defined order.

Annual contributions must be distributed first, followed by taxable

conversions, non-taxable conversions, and lastly earnings. In the

event that a Roth IRA owner has other assets held in Roth IRAs,

in addition to amounts converted in 2010, the individual must

determine (according to these ordering rules) what portion, if any,

of a distribution in 2010 or 2011 is subject to the accelerated 2010

conversion taxation rules. Note that all Roth IRAs owned by the

individual must be taken into consideration.

Non-Roth employer plan conversions

In addition to conversions from Traditional, SEP, or SIMPLE (after

two-years from the first contribution date) IRAs, the two year rat-

able 50/50 taxation option is available for 2010 conversions from

non-Roth type employer-sponsored plans. The tax acceleration

rules for pre-2012 distributions will also apply.

This information is for educational purposes only. It is always

recommended that you seek the aid of a competent tax advisor or

tax attorney to assist you with tax advice and guidance.

RECOGNIZING LOSSES ON IRA INVESTMENTS

According to IRS Publication 590, Individual Retirement Arrange-

ments (IRAs), under certain conditions, individuals may be eligible

to recognize the loss on a Traditional or Roth IRA investment

when filing their income tax return.

Conditions for a tax loss

In order for a tax-filer to claim a loss in a Traditional IRA, the fol-

lowing conditions must be met:

1. All amounts in all Traditional IRAs (not Roth IRAs) owned by

that individual must be distributed.

2. The total Traditional IRA distributions must be less than the

individual’s unrecovered basis, if any.

The same holds true for Roth IRAs; Traditional IRA assets are not

considered when meeting these requirements, but all Roth accounts

for an individual must be distributed.

Determining basis

“Basis" is defined as the total amount of non-deductible contri-

butions in the individual’s Traditional IRAs that were reported

on IRS Form 8606 (Nondeductible IRAs and Coverdell ESAs).

“Unrecovered basis" is created when assets are distributed and the

value of the investments distributed is lower than the amount of

all nondeductible contributions (the basis). Note that distributions

may be taken “in-kind."

For example, an individual has a Traditional IRA and previously

reported $5,000 as a non-deductible contribution (the basis). In

2010, the value of the IRA is now $4,000 and the individual takes

a complete distribution. The individual has a net unrecovered basis

of $1,000 ($5,000 - $4,000) and can claim the loss as a miscella-

neous itemized tax deduction. Note, however, a tax-filer’s mis-

cellaneous expenses must exceed a minimum of 2% of AGI. For

instance, if an individual has AGI of $50,000, a miscellaneous tax

deduction would be allowed for amounts exceeding $1,000 (2%

of $50,000). For the above example, if no other miscellaneous

itemized expenses are reported, the amount does not exceed the

minimum and, therefore, a deduction is not available.

Given the recent drop in value of most investments, many IRA

holders may be able to take advantage of the loss at this time with

the prospect of improved security value at a future date.

For additional information, reference IRS Pub. 590 Individual

Retirement Arrangements (IRAs) at www.irs.gov.

IN-PLAN ROTH CONVERSIONS

Roth accounts in 401(k)s and 403(b)s have been allowed since

2006. The Small Business Jobs and Credit Act of 2010 estab-

lished the ability for non-Roth accounts in 401(k), 403(b), and

governmental 457(b) plans to be converted to Roth accounts

within the same plan. Prior to this, non-Roth accounts in these

plan types could only be converted to a Roth if rolled outside of

the plan into a Roth IRA.

Provided a plan sponsor amends its plan document to allow for

this provision, in-plan Roth conversions are permitted after

September 27, 2010 for 401(k) or 403(b) plans and after

December 31, 2010 for governmental 457(b) plans. In all cases,

the monies converted must meet the rules required for an in-plan

Roth conversion.

What funds can be converted.

Employee salary deferrals must meet the requirements for an in-

service distributable event under the terms of the plan (e.g., reach-

ing age 59 ½) in order to be eligible to convert. Plan sponsors

may want to consider expanding the available in-service distribut-

able events available under a plan, as these events can be made

specific to in-plan Roth conversions only.

Employer contributions that are vested can be converted if the

contributions have aged for two years or the employee has been a

participant in the plan for at least five years, provided these contri-

butions meet the requirements for an in-service distributable event.

Only distributions that are “eligible for rollover" may be convert-

ed. Therefore, hardship withdrawals, required minimum distribu-

tion amounts, and corrective distributions may not be converted.

What are the tax implications.

A 10% early distribution penalty tax does not apply to the con-

verted amount, though it would apply to a rollover or distribution

of the taxable portion of the in-plan Roth conversion that occurs

within five years of the original in-plan Roth conversion. The tax-

able amount of the in-plan Roth conversion is not subject to a 20%

withholding tax.

Unlike conversions or rollovers to Roth IRAs, in-plan Roth

conversions may not be “recharacterized" or returned back to the

pre-tax accounts from which they came.

Administration of In-Plan Conversions

The in-plan conversion feature is not required to be added to a

plan by the plan sponsor, though a plan must first permit the Roth

account feature in order to do so. A plan amendment can apply

retroactively to allow for 2011 Roth contributions, or Roth con-

tributions and in-plan Roth conversions, provided that the amend-

ment is in place by December 31, 2011. Thereafter, amendments

for Roth contributions and in-plan Roth conversions will need

to be in place prior to allowing participants to take advantage of

these features.

Currently, few retirement plan vendors and third-party administra-

tors (TPAs) have prepared their recordkeeping systems to accom-

modate in-plan Roth conversions. Further clarifications of this

new law should lead to widespread availability.

Plan loans that are included as part of an in-plan Roth conversion

are not considered new loans. The taxable amount of the loan is

the outstanding loan balance.

There is no spousal consent required prior to conducting an in-

plan Roth conversion.

Planning point

Adding the in-plan conversion feature can be a valuable benefit

used to attract and retain talented employees.

Converting pre-tax deferrals and employer contributions to an

after-tax Roth account can have its advantages. High net worth in-

dividuals unable to transfer their plan balances to Roth IRAs now

have the opportunity to take advantage of Roth accounts before

their retirement or leaving their current employer.

Communicating how it works and what assets are eligible are key

steps for providers, TPAs, and plan sponsors to take in order for

participants to understand and assess in-plan conversions. For

further details concernign in-plan Roth Conversions, please go to

the IRS web site at: www.irs.gov/ep and select the In-Plan Roth

Rollovers link.

RETIREMENT PLAN DESIGN STRATEGIES

In mid-2010, Towers Watson conducted a survey of plan sponsors

(entitled “New Strategies in Defined Contribution Plan Design")

to better understand what employers are doing to improve the

success of their defined contribution (DC) retirement plans during

these tough economic times. 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 frequently to workers, an

analysis of data in the defined contribution market can give 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.

Background

Towers Watson is a leading global professional services company

that helps organizations improve performance through effective

people, risk, and financial management. A key focus area of Tow-

ers Watson is employer retirement plans, where they consult with

companies on retirement plan design, funding, investing, govern-

ing, and employee engagement. Towers Watson’s “New Strategies

in Defined Contribution Plan Design" survey involved 334 plan

sponsors, representing over 5.3 million plan participants, $387

billion in defined contribution plan assets, and 14 industry sectors,

including manufacturing, financial services, and health care.

Plan participation rates

When measuring the success of a DC retirement plan, such as

a 401(k) plan, one main place to focus is on the percentage of

eligible employees that elect to participate in the plan. Over 75%

of the plans surveyed indicated that their plan participation rate

was 70% or higher. The majority of plans in the pharmaceutical,

energy, and financial services sectors had participation rates of

80% or better. The Towers Watson survey probed deeper here, in

order to analyze the plan design elements that resulted in different

plan participation rates.

Automatic enrollment

One of the more interesting design developments in 401(k) plans

of late has been the automatic enrollment of employees. Here,

employees have the ability to subsequently opt out of the plan,

rather than enroll into it. The survey indicated that 57% of the

plans surveyed automatically enroll employees into their plans.

Of that 57%, approximately 18% auto-enroll all employees, and

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.

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39% auto-enroll only new employees. The manufacturing sector

had the most plans that auto-enroll, while the retailing sector had

the least amount of plans that auto-enroll.

Auto enrollment has a profound effect on plan participation rates.

Of the respondents that auto-enroll all employees, 93% report a

participation rate of at least 70%, and 84% of respondents that

auto-enroll only new employees report the same 70% or higher

participation rate. With respondents that do not auto-enroll

employees, only 53% report a 70% or higher participation rate, in

comparison.

The successful participation rates in many automatically enrolled

retirement plans has to do with the fact that many employees don’t

actively take the time to opt out of participating in the plan. The

plans surveyed by Towers Watson supported this fact, as 53% of

plan sponsors that auto-enroll all employees report a 5% employee

opt out rate, while only 5% of those same plan sponsors report an

opt out rate of 15% or more. For plan sponsors that auto-enroll

only new employees, 59% reported an opt out rate of 5%, while

5% report an opt out rate of 15% or more.

Automatic enrollment coupled with automatic escalation

Increasingly common with automatically enrolled plans is to add

automatic escalation of the contribution deferral level made by

plan participants. Of those plans in the survey that auto-enroll em-

ployees, 58% also automatically escalated employee contributions.

Plans that automatically enroll all employees were most likely

(68%) to automatically escalate as well. This is most likely due

to the fact that the IRS discrimination test safe harbor requires,

in part, the combination of automatically enrolling all employees

with automatically escalating their contributions. The most com-

mon auto escalation approach reported was to start contribution

levels at 3% of salary and to then increase that rate each year by

1%, with a 6% cap on auto-escalated contributions. This specific

approach to auto escalation also fits into the requirements to com-

ply with the IRS discrimination test safe harbor.

Automatically escalating contributions had a positive impact on

plan participation rates, as 79% of plan sponsors that chose to

escalate reported an 80% or better plan participation rate. On the

other hand, only 50% of plans that chose not to automatically es-

calate contributions report an 80% or better plan participation rate.

Interestingly, the opt out rate of employees that are in an auto-

escalated plan is extremely low. Of plans that chose to auto-

escalate, an opt out rate of 15% or more was reported by only 1%

of those plans, while an opt out rate of 15% or more was reported

by 10% of plans that chose not to auto-escalate.

All in all, auto-escalation is a newer design element than straight

auto-enrollment, so it will be interesting to see if the high partici-

pation rates/low opt out rates will continue in the years ahead as

participants are required to defer more money into their 401(k)

plans.

Matching contributions

Arguably, there is no better incentive for employees to participate

in a 401(k) plan than for a company to match (i.e., provide “free

money") plan participant retirement plan contributions. The vast

majority of the plans surveyed (94%) reported that they did pro-

vide company matching contributions. However, since late 2008,

13% of those plans polled reported suspending their match, and an

additional 5% reported lowering their match. Plan sponsors with

lower participation rates were more likely to suspend their match;

21% of plans with participation rates of 40% or lower did so,

whereas only 7% of plans with participation rates of 80% or above

decided to suspend their match.

Of the plans that suspended their match, 46% have reinstated a

match, though only 37% have actually reinstated the full match.

Of those that have not reinstated the match as of yet, 49% indicate

that they are currently considering reinstating at least some type of

match within the next 12 months. Improvements in the status of

suspended or decreased matching contributions should be consis-

tent with improvements in the overall economy.

Match suspensions from an industry perspective were most com-

mon among retailers (27%) and manufacturers (21%). Those

plan sponsors within the pharmaceutical and food and beverage

industries did not change their matching contributions.

Conclusion

DC plans, such as 401(k) plans, are now the main retirement plans

utilized by plan sponsors, covering over 55 million plan partici-

pants and $4 trillion in assets. A key aspect to how successful

these plans can be has to do with the design features used in these

plans. For many years, the concept of companies matching the

employee plan contributions has been the primary design element

to encourage plan participation. However, company matching

contributions have not led to a 100% participation rate for most

plans, thus leading to a focus on more innovative design elements

such as automatically enrolling employees and/or automatically

escalating their retirement plan contributions. The Towers

Watson survey shows that it can be seen as a best practice for plan

sponsors to utilize automated plan design elements from a cost,

effectiveness, and consistency standpoint.