Return to www.Rollover.net Home                                                         Second Quarter 2012

PENALTY-FREE IRA WITHDRAWALS

If an IRA owner wishes to take a distribution from an IRA before reaching age 59 ½, a 10% premature

withdrawal penalty on the untaxed portion of that distribution is generally due. However, several excep-

tions to the general rule exist, and one such exception is found under IRC Sec. 72(t)(2)(A)(iv), or “Rule

72(t)." This rule allows IRA owners to receive predetermined distributions based on their life expectancy

through a scheduled series of periodic payments (not less frequently than annually) that continue unal-

tered over a specified period of time.

These penalty-free withdrawals are also available to Qualified Retirement Plan (QRP) participants after

they separate from service.

Payment methods

There are three basic methods by which payments will be considered to be substantially equal periodic

payments:

1. The life expectancy method – Using this method, payments are determined by dividing the indi-

vidual’s IRA or QRP balance by their single life expectancy factor, or a joint factor of the individual

and the primary beneficiary. The factor to be used is selected from the single life expectancy table,

the joint life and last survivor table, or the uniform lifetime table. Once a table is selected, that same

table must be used to determine each subsequent year’s distribution. The account balance that is used

to determine payments must be determined in a reasonable manner based on the facts and circum-

stances.

2. Fixed amortization method – Under this method, the payments are determined by amortizing the

IRA or QRP balance over the single life expectancy of the individual, the joint life expectancy of the

individual and the designated beneficiary, or the life expectancy found in the uniform lifetime table.

Any interest rate that is not more than 120% of the federal mid-term applicable federal rate, deter-

mined on the date payments begin, may be used.

3. Fixed annuitization method – The final method is to divide the IRA or QRP balance by an annuity

factor. The factor is determined based on the present value of an annuity of $1 per year beginning at

the individual's age attained in the first distribution year and continuing for the life of the individual.

This factor is determined by using an interest rate of not more than 120% of the mid-term applicable

federal rate on the date payments begin.

Payment period

Once payments begin, they must continue for the later of a period of at least five years or until the actual

day the IRA holder reaches age 59 ½. Note that no other additional distributions may be taken from the

IRA during this period of time.

Changes to account balance

Under all three methods, 72(t) payments are calculated with respect to the account balance established

prior to the first 72(t) payment. This means that a modification to the 72(t) program will occur if, after the

starting date, there is:

• Any additions to the current account balance other than gains or losses;

• Any nontaxable transfer of a portion of the account balance to another retirement plan; or

• A rollover by the taxpayer of a 72(t) payment received resulting in such amount not being taxable.

Relief for depreciating accounts

Under Revenue Ruling 2002-62, if substantially equal periodic payments are no longer supported by

depreciating account balances, individuals are offered relief by:

1. Allowing a one-time switch to change their distribution method to the life expectancy method.

2. Allowing that a complete depletion of the IRA assets will not be treated as a “modification" of payments.

Retirement

Plans Quarterly

2nd Quarter 2012

One-time change

An individual who began distributions based on the amortiza-

tion or annuitization method will be allowed in any subsequent

year to switch to the Required Minimum Distribution (RMD)

calculation method for the year of the switch and for all subse-

quent years. This is a one-time only switch, and any subsequent

change in method will be considered a modification of payments

(subject to penalty).

Conclusion

There are specific IRS guidelines that govern the “substantially

equal periodic payment" program, and once the program is

initiated by an individual, it cannot stop (or be modified) until

the conclusion of the program. It is always recommended that

individuals who are considering this program seek the aid of

a competent tax advisor or attorney before making any decisions.

For detailed information, go to the irs.gov web site and key in

Substantially Equal Periodic Payments in the “SEARCH" block.

ROLLING AFTER-TAX DOLLARS INTO

TRADITIONAL IRAS

If a qualified retirement plan (QRP) participant has contributed

“after-tax" dollars to his or her plan and is planning to roll over

plan assets into a Traditional IRA, it’s imperative to be aware of

the bookkeeping responsibilities Traditional IRA owners assume

if after-tax dollars are rolled into Traditional IRAs.

QRP pre-tax vs. after-tax tracking

Generally, with a QRP, the Plan Administrator tracks pre-tax

and after-tax dollars contributed, held, and distributed for the

plan participants. This keeps the burden of tracking and IRS

reporting off of the plan participant’s shoulders.

IRA pre-tax vs. after-tax tracking

By and large, most custodians do not keep track of after-tax

dollars held in IRAs. Unlike QRPs, IRA owners are responsible

for tracking any after-tax dollars. 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.

Form 8606

After-tax contribution reporting is completed by filing an IRS

Form 8606, Nondeductible IRAs, with an individual’s tax return.

Also, every year there is a distribution or any change in tax

basis, the IRA owner will be required to submit a Form 8606. If

an individual fails to file the Form 8606, for whatever reason, it

will trigger a $50 penalty. And, overstating an after-tax amount

on the 8606 will yield a $100 penalty.

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 distribu-

tion. As an example, an IRA owner has a total of $100,000 in

all IRAs, which consists of $92,000 pre-tax and $8,000 after-tax

dollars. His after tax amount is 8% of his total.

So, if this IRA owner takes a distribution of $6,000, the after-

tax amount and reduced basis would be calculated as follows:

$8,000 (after-tax balance) divided by $100,000 (total of all IRAs)

times $6,000 (distribution amount) = $480. The $480 represents

the non-taxable portion of the $6,000 distribution and reduces

the after-tax basis from $8,000 to $7,520. This procedure must

continue for every distribution taken. It’s important to note that

an IRA owner must keep complete and accurate records and file

a Form 8606 each time to avoid incorrect tax filings.

Receive or roll over.

Qualified Plan participants have the option to receive or roll over

after-tax dollars into IRAs. By rolling, the tax-free assets con-

tinue to shelter new tax-deferred growth. However, IRA owners

assume tracking and reporting responsibilities. On the flip side,

plan participants who receive their tax-free dollars outside an

IRA avoid the issue. Individuals should consult with a tax advi-

sor or CPA when making this decision.

ELIMINATE 401(K) PLAN REFUNDS WITH A SAFE

HARBOR PLAN

Often 401(k) retirement plans fail the year-end nondiscrimination

tests due to the low level of salary deferrals by the non-highly

compensated employees (NHCEs). This failure can result in re-

funds to the highly compensated employees (HCEs) and a restric-

tion to the amount these HCEs can contribute in the future. The

answer to avoid these refunds and allow the HCEs to maximize

their contributions is a “safe harbor" plan. In a safe harbor plan,

there are mandatory employee notices and required employer

contributions; however, adopting a safe harbor provision results

in automatic passage of the nondiscrimination tests and allows

the HCEs to maximize their contributions to the plan. Two safe

harbor plan contribution alternatives are described below in addi-

tion to the notice requirements. Plan sponsors can choose either

option in any year as long as the proper notification is given to

the participants in advance.

Non-elective safe harbor contribution

The non-elective safe harbor contribution requires the plan spon-

sor to make a contribution to the plan (or another defined contri-

bution plan) equal to at least 3% of compensation for all NHCEs

who are 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 working at least 1,000 hours

during the year or being employed by the employer on the last

day of the plan year. The NHCEs must be 100% vested immedi-

ately in this contribution, although other contributions can still be

subject to a vesting schedule.

Matching safe harbor contribution

The matching safe harbor contribution requires the plan sponsor

to make a contribution to the plan (or another defined contribu-

tion 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 rate of matching con-

tributions for any HCE, at any rate of deferrals, cannot be greater

than the rate provided to the NHCEs. As with the nonelective

safe harbor contributions, the NHCEs must be immediately 100%

vested in this contribution, and other contributions can still be

subject to a vesting schedule.

Can the plan sponsor match deferrals in excess of 5% of com-

pensation. 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 those

contributions will have to be tested (although the safe harbor

would still apply to the deferral portion of the plan).

Notice requirements

Regardless of which safe harbor contribution is used, the plan

sponsor must notify its employees about the safe harbor being

used before the beginning of the plan year involved (at least 30,

but no more than 90, days in advance). A safe harbor plan can

be started during the calendar year as well, but the same notifica-

tion requirements apply. Also, any contributions will be based

on compensation for the entire plan year, not just from when the

plan was started. And finally, the plan sponsor must also make

sure that the plan document contains the appropriate safe harbor

provisions before beginning the plan.

Caution

A plan sponsor should carefully consider making the decision

to install a safe harbor plan. Once made, the decision may be

difficult 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. Also, as the plan document gets

amended, there may be additional charges from the administrator

or recordkeeper.

What to do next

If a business owner is considering adopting a safe harbor plan or

would like to find out more, contact the plan administrator, CPA,

and benefits counsel to determine if doing so is appropriate for

the plan’s situation and, if so, which approach best suits the plan.

The administrator should be able to give an estimate of the value

of the matching and non-elective contributions required under

the safe harbor rules. Remember, no matter which approach is

determined to be best for the plan, plan sponsors need to start

planning well in advance to allow time to give the appropriate

notices and have the appropriate documents in place.

There are many benefits to adopting a safe harbor plan. By

making the required contributions, the plan automatically passes

the year-end discrimination tests. Passing these tests allows the

HCEs to maximize their contributions to the plan and avoid any

refunds. And finally, by adopting a safe harbor plan, there may

be a discount from the administrator due to reduced testing.

THE NEW 408(B)(2) REGULATION

What it is, and how it may affect qualified plans

The Department of Labor has been concerned, for quite some

time, that service providers to qualified retirement plans have not

adequately disclosed their fees. This lack of fee clarity created

some frustration among participants and sponsors, but it also

kept plan fiduciaries from having the information necessary to

make required prudent decisions regarding the reasonableness of

plan fees, which is an ongoing fiduciary requirement.

The objective of 408(b)(2) is to have plan service providers give

fee disclosures so that plan sponsors can properly fulfill their

fiduciary duty to determine if the plan’s fees are reasonable.

What is 408(b)(2).

408(b)(2) is a Department of Labor (DOL) regulation that will

require “covered service providers" to make a comprehensive

disclosure of their fees and services to a “responsible plan

fiduciary" of an ERISA-governed tax-qualified plan, such as

defined contribution, defined benefit, and ERISA 403(b) plans.

The regulation does not include IRAs, SEPs, or SIMPLE Plans.

The “responsible plan fiduciary" will usually be the individual

who has the power to make decisions and sign documents. The

fee disclosures must be made by July 1, 2012. Only fees that are

paid out of a plan’s assets need to be disclosed. So, for example,

if the company writes a check for administration services, that

fee will not need to be disclosed under 408(b)(2).

Going forward, any changes to previously disclosed fees, for

example, due to a change in investments, must be communicated

by the covered service provider within 60 days of the change.

Who are covered service providers.

An entity that provides plan services, such as fiduciary services,

investment advice, recordkeeping, investment brokerage, ac-

counting, appraisal, banking, legal, or third-party administration,

and who enters into an arrangement with the covered plan and

reasonably expects to receive at least $1,000 in compensation

would be considered a covered service provider.

What information must be disclosed by the covered

service providers.

Three types of information: service, status, and compensation.

A covered service provider must give a description of their

services and a statement regarding its status as a fiduciary to the

plan (if the service provider is not acting in a fiduciary role, then

the statement is not necessary). Compensation to be disclosed

includes direct compensation, which is paid by the plan, and

indirect, which is paid from investments, such as 12b-1 fees.

The fee disclosure may be expressed in different ways, such as

by dollar amounts, formula, percentages, per capita charges, or

other reasonable methods. A description of how the compensa-

tion will be received must also be communicated; for example,

the plan will be billed, or the compensation will be deducted

directly from the plan’s accounts or investments.

What happens if a covered service provider fails to

provide the required disclosure.

If the plan sponsor discovers that a service provider has not

disclosed the required fee information, he or she must make a

written request for the required disclosure. If the fee disclosure

is not made promptly after a 90-day period, the plan sponsor

must then report it to the DOL and terminate the covered service

provider “…as expeditiously as possible, but consistent with his

or her duty of prudence as a fiduciary."

Do plan sponsors have any responsibilities under

408(b)(2).

ERISA requires plan sponsors to compile and analyze the vari-

ous plan fee disclosures and make “reasoned and informed"

decisions regarding the reasonableness of the plan fees. If after

the analysis, the plan sponsor deems the fees to be unreasonable

based on the services rendered, he or she may need to negotiate

better fees or potentially change service providers.

Also, under Regulation 404(a)(5), the plan sponsor is responsible

for disclosing fees and other information to the plan participants,

effective 60 days after July 1, 2012, or August 30, 2012. The

plan sponsor must disclose basic plan information, such as how

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.

Member SIPC and New York Stock Exchange, Inc.

National Headquarters: One Financial Plaza • 501 North Broadway • St. Louis, Missouri 63102

(314) 342-2000 • www.stifel.com

Investment Services Since 1890

to give investment instructions, plan level administration fees,

individually charged fees, and how to access the participant web

site for additional information. The plan sponsor must provide

comparative investment information, including a description of

the investments and their performance data for 1, 5, and 10 years

versus applicable benchmarks or indices. Most recordkeepers

will notify participants about their fees and investment results on

behalf of the plan sponsor and as a service to the plan on each

quarterly participant statement.

What actions can a plan sponsor take to make a

“reasoned and informed" decision regarding the

reasonableness of plan fees.

The DOL has not explained precisely what is necessary to

determine if plan fees are reasonable. However, benchmarking

is widely regarded as a good way to assess fees. To help plan

sponsors, at Stifel we have a benchmarking software

called 401(k) Averages that compares your plan fees to an ap-

plicable subset of like plans from a database which includes 198

products from 72 providers. Stifel performs this benchmarking

service at no charge.

Who should a plan sponsor contact with questions

regarding 408(b)(2).

Each service provider will be responsible for disclosing their

own fees, so at the risk of expressing the obvious, it would likely

be best to contact the representative of the service provider

who is most closely related to the inquiry. For example, contact

the third-party administrator regarding administration fees, the

appropriate vendor for record keeping and asset fees, and the at-

torney and/or CPA for legal, tax issues, and plan audits.

Conclusion

With 408(b)(2), the Department of Labor has acted toward hav-

ing plan service providers give fee and service disclosures that

can better allow plan sponsors to fulfill their fiduciary duty in

determining the reasonableness of plan fees. Only time will tell

if the DOL’s actions achieve their desired result.