FAQ’s from Plan Sponsor regarding the CARES Act Participant Loans

On March 27, 2020 the President signed the Coronavirus, Aid, Relief, and Economic Security (CARES) Act into law. This legislation provides relief for those suffering financially and physically from the COVID-19 pandemic.  With respect to retirement plans, the CARES Act provides targeted relief for plan participants who need access to their retirement plan funds through loans or distributions, waives required minimum distributions for the 2020 calendar year for most plans, and provides funding relief for employers who sponsor single-employer defined benefit plans.

This is the second in a series addressing questions most frequently being asked by 401(k) plan sponsors related to the CARES Act, specifically focusing on Participant Loans under the Act.

The CARES Act increased the maximum amount for participant loans to “qualified individuals” from the lesser of 50% of a participant’s vested account balance or $50,000 to 100% of a participant’s vested account balance up to $100,000. These new loan limits apply to loans made to qualified individuals from March 27, 2020 to September 23, 2020.

Additionally, the CARES Act permits suspension of loan payments due from March 27, 2020 through December 31, 2020 for new and existing plan loans for a period of up to a year for qualified individuals. Further, it allows for extension of the term of the loan for a period of up to a year, without violating the maximum 5-year term.

Who is a “qualified individual” for this purpose?

Qualified individuals are defined as any individual:

  • who has been diagnosed with COVID-19, or whose spouse or dependent has been diagnosed
  • who has experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, or having their hours reduced as a result of COVID-19
  • who is unable to work due to lack of childcare resulting from COVID-19
  • who owns or operates a business that is completely or partially closed as a result of COVID-19
  • other factors as determined by the Secretary of Treasury

Is a plan required to provide for CARES Act loans?

No. This is an optional provision, not a required one.

Does a plan have to be amended before permitting CARES Act loans?

No. The provision can be implemented immediately like coronavirus-related distributions. The plan must adopt a conforming amendment no later than the last day of the plan year beginning after December 31, 2021 (December 31, 2022 for calendar year plans), unless extended by the IRS.

Can a participant take a CARES Act loan if he or she has been furloughed or laid off?

Yes. A qualified individual can take a plan loan under the CARES Act provisions if they have been furloughed or laid off as a result of COVID-19. Additionally, the CARES Act permits loan payments due from March 27, 2020 through December 31, 2020 to be suspended for a period of up to a year. This means that an eligible participant could receive a plan loan, and the payments could be immediately suspended.

Note that interest will accrue during the suspension period. Further, it would be permissible to extend the term of the loan for a period of up to one year without violating the maximum 5-year loan term.

Do existing participant loans have to be taken into consideration when determining the maximum amount available?

Yes. Under the CARES Act, the maximum loan is equal to the lesser of 100% of the participant’s vested account balance or $100,000. If a participant has (or has had) an existing loan, the plan still must consider the participant’s highest outstanding loan balance during the last 12 months for purposes of the $100,000 limit.

For example, assume a participant has a $300,000 account balance and that he or she has taken a $50,000 plan loan within the last 12 months. In that case, the maximum CARES Act loan would be $50,000 ($100,000 less $50,000).

Do participants have to provide certification that they are a qualified individual to receive a CARES Act loan?

Unclear. The CARES Act doesn’t specifically require participant certification for this purpose, although certification is required for coronavirus-related distributions. Hopefully, the IRS will issue guidance on this point, but absent that guidance, it would be prudent for plan sponsors to obtain certification.

After the suspension period, how will loan repayments be applied?

Unclear. The Act doesn’t specifically dictate how the suspended loan repayments coordinates with the “one-year” suspension period, whether the loans will be re-amortized, deductions will be doubled, or the repayment period will be extended past the original term. Hopefully, the IRS will issue guidance on this point before January 2021, but absent that guidance, it would be prudent for plan sponsors to re-amortize the note to the original term.

Important Note: It is expected the IRS and DOL will issue guidance with respect to the provisions of the CARES Act, as well as other retirement plan-related matters that were not addressed in the Act. It is also possible Congress will pass additional legislation, so the situation remains fluid.

Note: this is the second in EJReynolds’ series on the  CARES Act . To see the first in this series “FAQ’s from Plan Sponsor regarding the CARES Act Coronavirus-related distributions”: PLEASE CLICK

As regulations and further legislation is passed, EJReynolds will keep you informed and up to date. We are taking all necessary precautions and monitoring the situations, but we are here for you and want to assure you we will continue to provide the level of service you have come to expect. We hope you, your families and circle of friends are and remain healthy. We will get through this, one day at a time.

FAQ’s from Plan Sponsors regarding the CARES Act Coronavirus-related Distributions

On March 27, 2020 the President signed the Coronavirus, Aid, Relief, and Economic Security (CARES) Act into law. This legislation provides relief for those suffering financially and physically from the COVID-19 pandemic.  With respect to retirement plans, the CARES Act provides targeted relief for plan participants who need access to their retirement plan funds through loans or distributions, waives required minimum distributions for the 2020 calendar year for most plans, and provides funding relief for employers who sponsor single-employer defined benefit plans.

This is the first in a series to address questions most frequently being asked by 401(k) plan sponsors related to the CARES Act, specifically related to Coronavirus-related distributions under the Act.

The Act allows eligible retirement plans to make “coronavirus-related distributions” to “qualified individuals”.  Such distributions are exempt from the additional 10% income tax for early withdrawals, and any plan distribution, up to $100,000, can qualify.  Additionally, the new law allows participants to pay the applicable income tax ratably over a three-year period, and also provides participants the opportunity to defer taxation by “repaying” the distribution to a qualified plan or IRA during the three-year period immediately following the distribution.

What plans are “eligible retirement plans”?   Eligible retirement plans include 401(k) and other qualified plans, 403(b) plans and governmental 457(b) plans. Individual Retirement Accounts, including SIMPLE IRAs and SEPS, are also considered eligible retirement plans for this purpose.

Who are “qualified individuals”?   Qualified individuals are defined as any individual:

  • who has been diagnosed with COVID-19, or whose spouse or dependent has been diagnosed
  • who has experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, or having their hours reduced as a result of COVID-19
  • who is unable to work due to lack of child care resulting from COVID-19
  • who owns or operates a business that is completely or partially closed as a result of COVID-19
  • other factors as determined by the Secretary of Treasury

Are plans required to permit coronavirus-related distributions?   No. This is an optional provision, not a required one.

Does a plan need to be amended before it can permit coronavirus-related distributions?   No. The provision can be implemented immediately. The plan must adopt a conforming amendment no later than the last day of the plan year beginning after December 31, 2021 (December 31, 2022 for calendar year plans). Note that this deadline could be extended by the IRS.

Is this a new type of hardship distribution?   No. Rather, a “coronavirus-related distribution” is defined as any distribution made on or after January 1, 2020 through December 31, 2020 to a qualified individual. This means that any distribution could qualify, even if it was made before the law was enacted and could include hardship distributions, termination distributions, in-service distributions made upon attainment of age 59 ½, etc. A plan is permitted to allow coronavirus-related distributions to qualified individuals even if they would not otherwise be eligible for a distribution under the terms of the plan document.

What 401(k) plan accounts are available for coronavirus-related distributions?   The CARES Act provides a waiver of most of the normal distribution restrictions. This means that coronavirus-related distributions can be made from any of the following accounts in a 401(k) plan:

  • Elective deferral accounts (including 401(k) and Roth accounts)
  • Safe harbor contribution accounts
  • Employer profit sharing and matching contribution accounts
  • Rollover contribution accounts
  • Voluntary after-tax contribution accounts
  • QNEC and QMAC accounts

Note: The CARES Act did not waive the distribution restrictions applicable to pension plan accounts. As a result, if a 401(k) plan has pension plan account balances (i.e. merged or transferred money purchase pension plan accounts), those accounts would not be eligible for a coronavirus-related distribution unless the participant has terminated or attained age 59 ½.

Can terminated participants receive coronavirus-related distributions?   Yes. Provided they are a qualified individual.

Does a participant have to provide proof of their need?   No. But they do have to provide certification that they meet the requirements to receive a coronavirus-related distribution. The key here is whether the individual is a qualified individual; it is not dependent on a specific “need” like hardship distributions. Under the CARES Act, the plan sponsor can rely on the participant’s certification that he or she is a qualified individual to make such a distribution.

Is there a limit on coronavirus-related distributions?   Yes. From a plan perspective, coronavirus-related distributions cannot exceed $100,000, considering all plans maintained by the employer (including controlled or affiliated service group members) on an aggregated basis.

On an individual basis, coronavirus-related distributions are also limited to $100,000, after considering all distributions made from eligible retirement plans. This means that if a participant takes a $100,000 distribution from their employer’s qualified plan and also takes a distribution from their IRA, any amounts in excess of $100,000 would be subject to the 10% additional excise tax on early withdrawals (if they would not otherwise be exempt, e.g. they have attained age 59 ½). Additionally, the amounts in excess of $100,000 would be taxable in 2020 and could not be repaid to defer taxation.

Is there a window for making coronavirus-related distributions?   Yes. Only distributions made between January 1, 2020 and December 31, 2020 can qualify.

Are coronavirus-related distributions subject to mandatory 20% federal withholding?   No. For this purpose, coronavirus-related distributions are not considered to be eligible rollover distributions. As such, they are not subject to mandatory 20% federal withholding. Rather, they are subject to 10% federal withholding, unless the participant elects otherwise (like a hardship distribution).

Note: Participants are not required to receive the special tax notice (i.e. the “402(f) notice”) normally required for eligible rollover distributions; however, the plan sponsor must provide notification to the participant of their right to waive the applicable 10% federal withholding and provide them the opportunity to do so.

How does a plan report coronavirus-related distributions on Form 1099-R?   At this point, the IRS has not issued guidance. Presumably, it will be reported normally as a taxable distribution, although it is possible the IRS will create a new code for this purpose.

How does a participant tell the IRS they want to pay the applicable income tax over the three-year period?   It is anticipated the IRS will update IRS Forms 8915A and 8915B (which address previous Disaster Retirement Plan Distributions and Repayments) for this purpose.

How does a participant “repay” the distribution to defer taxation?  If a participant repays all (or a portion) of a coronavirus-related distribution, it is treated as a 60-day rollover provided it is made within the three-year window. The repayment can be made to the distributing plan (if accepts rollovers), to another employer’s qualified plan that accepts rollovers, or to an IRA. Further, the repayment can be made in one (or more) payments.

Again, it is anticipated the IRS will update IRS Forms 8915A and 8915B to be used for this purpose. In that case, the reporting burden will be on the plan participant, not the plan itself.

If a participant “repays” a coronavirus-related distribution, how is it treated from a plan and recordkeeping perspective?    The answer isn’t entirely clear. Since it is treated as a 60-day rollover, however, it would presumably be treated as a rollover contribution. In that case, if repaid to the distributing plan, it would be treated as a related rollover for top-heavy purposes.  Hopefully, the IRS will provide guidance on this point.

Important Note: It is expected the IRS and DOL will issue guidance with respect to the provisions of the CARES Act, as well as other retirement plan-related matters that were not addressed in the Act. It is also possible Congress will pass additional legislation, so the situation remains fluid.

As regulations and further legislation is passed, EJReynolds will keep you informed and up to date. We are taking all necessary precautions and monitoring the situations, but we are here for you and want to assure you we will continue to provide the level of service you have come to expect. We hope you, your families and circle of friends are and remain healthy. We will get through this, one day at a time.

The Families First Act and CARES Act

They used to say that March comes in like a lion and leaves like a lamb. Not March of 2020. Thirty days ago, little did we know the month we’d be enduring. Two new laws have been enacted to calm the struggling economy in response to the pandemic of the Coronavirus, helping both employers and employees with a safety net of benefits. We will go over the specific items that relate to pension and payroll issues explained below.

The Families First Coronavirus Response Act, signed on March 18, 2020 and scheduled to take effect on April 1, 2020 provides benefits for employees that need to take time off to care for themselves or family members due to COVID-19, without worry of a loss of income. The law requires employers with fewer than 500 employees to offer fully paid sick leave for up to 10 days, if:
1) The employee is subject to a federal, state or local quarantine or isolation order related to COVID-19.
2) The employee has been advised by a healthcare provider to self-quarantine due to COVID-19.
3) The employee is experiencing symptoms of COVID-19 and is seeking a medical diagnosis.

Employers must provide paid leave at 100% of the employee’s regular rate of pay, up to $511 per day and $5,110 in total. In other situations, employers must provide paid sick leave at two-thirds of the employee’s regular rate of pay, up to $200 per day and $2,000 total, if:
1) The employee is caring for an individual who
a. Is subject to a federal, state, or local quarantine or isolation order related
to COVID-19, or
b. Has been advised by a healthcare provider to self-quarantine due to
COVID-19.

2) The employee is caring for a child whose school or childcare provider has been closed or is otherwise unavailable due to COVID-19 precautions.

3) The employee is experiencing any other symptoms similar condition specified by the Secretary of Health and Human Services in consultation with the Secretary of the Treasury and the Secretary of Labor.

The law further expanded the Family Medical Leave Act to provide for up to 12 weeks of job-protected leave, 10 weeks of which would be paid, for any employee unable to work or telework because they have to care for a child under the age of 18 whose school or care provider is made unavailable for reasons related to COVID-19. This expansion requires the employee to be paid at two-thirds regular pay, up to $200 per day and $10,000 total, after the first 10 days. Those first 10 days are still unpaid, although they may be paid through accrued vacation, personal or sick leave.

The law provides refundable payroll tax credits to reimburse the employer for these costs. The tax credit applies to wages the employer pays through December 31, 2020.

Keep in mind, unless your Plan Document specifically provides otherwise, paid sick leave is eligible for 401(k) contributions, pension credits, matching and other similar employer contributions.

The Coronavirus, Aid, Relief and Economic Security (CARES) Act, signed into law on March 27, 2020, made sweeping changes to pension and 401(k) plans as well:

1) Coronavirus Distributions – The CARES Act waives the 10% early withdrawal penalty tax on withdrawals up to $100,000 from a retirement plan or IRA for any individual diagnosed with COVID-19, whose spouse or dependent is diagnosed, or is experiencing financial difficulties as a result of being quarantined, furloughed, laid off, having hours reduced or unable to work due to lack of child care due to COVID-19. Those individuals are permitted to pay tax on the income from the distribution over a three-year period, and they may repay the distribution to the plan over the next three years. The repayments would not be subject to the individual retirement plan contributions limits, and the individual can apply for a tax deduction for the taxes they will have paid as a result of the premature distribution.

2) Plan Loans – The CARES Act increases the current retirement plan loan limits to the lesser of $100,000 or 100% of the participant’s vested interest, and any existing loans with a repayment due date of March 27, 2020 through the end of the year can delay their loan repayments for up to one year.

3) Required Minimum Distributions – The Act waives required minimum distributions (RMDs) for defined contribution plans for the 2020 calendar year. Note, this is only for 401(k) 403(b), 457(b), profit sharing or money purchase pension plans. Defined Befit Plans, including Cash Balance plans, are not exempt from the requirement. Although not considered a corporate plan, IRA holders may waive the RMD for 2020 as well.

4) Single Employer Defined Benefit Funding Rules – in general, pension contributions are due by September 15th, or 8 ½ months after the end of the plan year for minimum funding purposes. The CARES Act delays that required due date until January 1, 2021.

5) Expansion of the Department of Labor – as somewhat of a catch-all provision, the Act expands the DOL authority to change or postpone certain deadlines under ERISA. While not specific, this would generally allow limited changes without legislative acts in the future.

As regulations and further legislation is passed, EJReynolds will keep you informed and up to date. We are taking all necessary precautions and monitoring the situations, but we are here for you and want to assure you we will continue to provide the level of service you have come to expect. We hope you, your families and circle of friends are and remain healthy. We will get through this, one day at a time.

SECURE Act Increases Tax Credit for New Retirement Plans

As part of the Further Consolidated Appropriations Act late last year, the SECURE Act greatly increased the tax credit available for “small employers” who adopt a new retirement plan. Previously, a tax credit of 50% of eligible plan-related expenses was available for the first 3 years, with a maximum credit of $500 per year. Under the new law, the maximum credit is increased to $5,000 per year with certain limitations.

In addition, the new law added a $500 credit for 3 years for new and existing plans that add an eligible automatic enrollment feature.

Which employers are eligible for the tax credit?

There are several conditions that must be satisfied in order to be eligible for the credit:

  • The employer must have had no more than 100 employees in the prior year with compensation of $5,000 or more (employees who earned less than $5,000 are not considered for this purpose).
  • The new retirement plan must cover at least one employee who is non-highly compensated (NHCE). Generally, an NHCE is a non-owner with compensation in the prior year that is less than the applicable threshold ($125,000 in 2019). In other words, the credit is not available for “owner-only” or “Solo 401(k)” plans.
  • The employer cannot have maintained a retirement plan covering substantially the same employees in any of the previous 3 years (for this purpose, a retirement plan includes the same types of plans described below).

Which types of retirement plans qualify?

  • 401(k) plans
  • Any other type of qualified plan, including profit sharing plans, money purchase pension plans, traditional defined benefit plans, and cash balance plans
  • 403(b) plans
  • SEP IRAs
  • SIMPLE IRAs

What types of expenses qualify for the start-up credit?

Expenses paid by the employer in connection with establishing the plan (e.g. plan document fees), administering the plan, or providing related employee education.

How is the start-up tax credit calculated?

For taxable years beginning after December 31, 2019, the maximum credit is equal to the lesser of (1) $5,000, or (2) $250 times the number of NHCE covered under the plan. The new law also added a minimum credit of $500.

For example, assume a plan covers the owners of a business and 10 NHCEs. Additionally, assume that plan-related expenses for the first plan year were $6,000. The available tax credit would be $2,500 for that year (10 NHCEs x $250). The credit available for the next 2 years would depend on the number of NHCEs covered and actual plan-related expenses.

If the employer adopts a 401(k) plan and a cash balance plan, is the start-up credit available for both plans?

Yes, however, the plans are aggregated for purposes of determining the maximum credit. In other words, expenses paid for both plans can be considered, but the credit is determined based on the expenses paid for the plans on a combined basis.

What are the requirements for the automatic enrollment tax credit?

Small employers (as described above) who add an eligible automatic contribution feature (EACA) to a new OR existing plan are eligible for a $500 tax credit for 3 years.  This credit is available without regard to plan expenses and is effective for plan years beginning after December 31, 2019.

How are the credits claimed?

IRS Form 8881 is used to claim both tax credits. They are reported differently depending upon structure of employer (i.e. sole proprietorship, partnership, corporation, etc.).

How can I learn more?

If you are currently working with a client to adopt a retirement plan for their employees or if you would like to learn more about this important tax incentive, please contact us.

Age for Required Minimum Distributions Increased under the SECURE Act

The SECURE Act, passed as part of Further Consolidated Appropriations Act late last year, increased the age for required minimum distributions (RMDs) from age 70 ½ to age 72. The new rule applies to RMDs required to be made after December 31, 2019 for individuals who attain age 70 ½ after that date.

Under the old rules, RMDs were required to begin no later than April 1st following the later of the calendar in which the participant attained age 70 ½ or retired. RMDs must have commenced, however, for “5-percent” owners no later than April 1st following the calendar year in which the participant attained age 70 ½ even if the owner was still working. Under the new rules, the age requirement was increased to 72 without making changes to the other requirements.

If a participant turned 70 ½ in 2019, do they still have to take their 2019 RMD by April 1, 2020?

Yes. As mentioned above, the new rules only apply to individuals who attain age 70 ½ after December 31, 2019. The old rules continue to apply to any individuals who were 70 ½ on or before that date. This also means that if RMDs have commenced, they cannot be suspended until the participant attains age 72.

Does the plan have to be amended before using the new rules?

No. A plan can implement the new rules operationally before adopting the amendment. Currently, the deadline for adopting the required amendment is December 31, 2022 for calendar year plans.

Do the same rules apply to IRAs?

Not exactly. Under the old rules, the requirement for IRAs was that RMDs must have commenced no later than April 1st of the calendar year following the calendar year in which the individual IRA owner attained age 70 ½ . There was (and is) no exception based on whether the individual was actively employed. Under the new rules, the age was increased to 72 for individuals who attain age 70 ½ after December 31, 2019.

Were there other changes made with respect to IRAs?

Yes. Previously, individuals could not make deductible contributions to traditional IRAs if they were age 70 ½ or older. The new law removed this restriction entirely, rather than increasing the age to 72. As a result, for taxable years beginning after December 31, 2019, there is no longer an age restriction for making deductible IRA contributions.

Were there changes made to death benefits payable to beneficiaries?
Yes. Generally, the life-time distribution option (often referred to as a “stretch IRA”) was eliminated for beneficiaries who are not considered to be “eligible designated beneficiaries”. Death benefits to these beneficiaries generally must be paid the end of the 10th calendar year following the year the participant or IRA owner died.

For this purpose, “eligible designated beneficiaries” include the decedent’s spouse, minor children, disabled or chronically ill individuals, and other beneficiaries who are less than 10 years younger than the deceased participant or IRA owner.

Note: The new rules only apply if the participant (or IRA owner) dies after December 31, 2019.

How can I learn more about these rules?

The rules regarding RMDs are quite complex, and the consequences of failing to issue RMDs in a timely manner are severe. Please contact your EJReynolds Consultant to learn more about these rules.

Pre-tax vs. Roth 401(k) contributions – a guide for participants

Contributing to your employer’s 401(k) plan is a great way to save for retirement, but the type of contributions you choose can have a huge impact on your finances both for now and for the future. The issue is, most employees don’t understand the differences between the Pre-tax 401(k) and the Roth 401(k), or the impact such a decision will have on their later years.

There are several similarities.

Pre-tax and Roth 401(k) contributions are both deducted from payroll, so they are contributed throughout the year, rather than in one lump-sum. Both are invested for a long period of time, and the earnings are not taxable to you while they are invested. They have the same annual contribution limits (currently $19,500 a year for workers under 50 and $26,000 a year for those 50 and over).

This is an annual, individual limit, meaning the limit applies to the total of all contributions, no matter if pre-tax or Roth contributions, or a combination of the two. Both may have distribution options available to you while still employed, depending on the plan design, and both may receive a match from the employer, again, depending on the plan design.

The main difference between Pre-tax and Roth 401(k) contributions is the timing of the taxation – when tax is paid.

A Pre-tax 401(k) contribution is deducted before federal withholding taxes are calculated. They are still subject to FICA and Medicare taxes, but reduce your current taxable income. This means that on a paycheck of $1,000 with a 10% deferral, you are taxed on $900. Over the course of a year, this can result in a large tax savings if you are in a higher tax bracket. When you take those funds out later in life, the money you distribute is taxed as standard income.

A Roth 401(k) plan is an after-tax contribution. Using the same example above of a paycheck of $1,000, your withholding taxes are calculated on $1,000. When you access those funds at retirement, both the contributions and the earnings thereon are distributed completely tax-free, assuming certain criteria are met. You must be at least age 59 ½, and it must be at least five years from your first Roth 401(k) contribution in order to distribute tax-free. If you distribute the funds prior to the criteria being met, the income on those funds is taxable and subject to the 10% excise tax on premature distributions. Unlike Roth IRAs, Roth 401(k) accounts are subject to the minimum distribution requirements. They must be rolled out of the plan and over to a Roth IRA by the time you reach age 72, or terminate employment, whichever is later, so the minimum distribution rules do not apply. For owners or certain members of their family, the account must be rolled out prior to reaching age 72, even if you continue to work.

Which Plan is right for you?

Whether you contribute to a Pre-tax or Roth 401(k) account depends on your personal circumstances. Here are a few things to consider helping you make the right choice.

  • Your age and the age you plan on retiring; a large part of the decision is to determine how long the funds will be invested and will the bulk of the money at retirement age be your own contributions or the earnings on those contributions. It may make sense to pay the tax on the contributions now in order to take out the earnings tax-free
  • Your ability to make contributions; if the tax savings allows you to make a greater contribution now, the pre-tax method may make more sense for you. At a tax bracket of 15%, a Pre-tax deduction of $100 feels like $85, but a Roth deduction feels like $100. If you would make the same contribution either way, then paying the taxes on the contributions now so you don’t pay taxes on future distributions may work out better for you in retirement.
  • Your current and expected future income; if you are just starting out in a field that will pay a much higher salary in the future, the current deduction may not make a difference to you now and will start the five year clock running, while you may want the deduction in the future.
  • Your expected tax bracket when you retire; if the tax rate stays the same, then the net effect is the same either way. If your tax rate changes and you would hope to be in a lower tax bracket in retirement, the Pre-tax account gives you the benefit of the reduction of income now while you pay less in taxes in retirement.
  • Your expected financial needs and other sources of income when you retire; keep in mind, any employer contributions (and the earnings thereon) will always be taxable to you when you receive them. Your tax professional may suggest taking all your non-taxable income first, or a combination of both in order to minimize your taxes based on your other income or financial needs.

In Conclusion:

The decision to make Pre-tax or Roth 401(k) contributions can be especially complex and vary from individual to individual. The decision should essentially be based on expectation of future income, needs and projected taxes. Don’t let the complexity keep you from contributing at all. The beauty of the situation is that nothing is carved in stone forever, your elections can be changed at least annually, depending on the rules of the plan. The most important thing is to start making contributions as soon as possible, as delays in contributions have a greater opportunity cost than any tax ramifications.

Feel free to ask your plan’s administrator, investment advisor or your own tax consultant to see what would be most beneficial to you.

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Big Changes for Safe Harbor 401(k) Plans under the SECURE Act

The 401(k) plan has quickly become the preferred retirement plan offered by most businesses today. Under the Safe Harbor Plan Design, plan sponsors can eliminate the 401(k) and 401(m) discrimination tests by providing certain minimum contributions: either by matching an individual employee’s contribution or making contributions to all eligible employees.  The SECURE Act, passed as part of Further Consolidated Appropriations Act late last year, made significant changes to rules related to Safe Harbor Non-elective contributions (the contributions to all employees approach), generally reducing the administrative burden and providing employers with greater flexibility.  Although these changes are effective for plan years beginning after December 31, 2019, the IRS has not provided guidance or updated the applicable regulations. As a result, plan sponsors may want to wait until guidance has been issued before making certain changes to their plans.

 

Caution: The law changes discussed below have no impact on plans that provide for Safe Harbor Matching contributions.  There were no changes made to the rules applicable for these plans.

What changes were made?

  • The annual participant notice requirement was eliminated for plans that provide for Safe Harbor Non-elective contributions.
  • Employers now have the option of adding a 3% Safe Harbor Non-elective contribution (used to satisfy the ADP test) up to 30 days before year-end without providing the advance “maybe” or follow-up notice.
  • Additionally, employers now have the option of adding a 4% Safe Harbor Non-elective contribution after the 30-day deadline but on or before the deadline for correcting ADP testing failures (the last day of the following plan year) so that the ADP test is deemed satisfied.

If the plan provides for additional matching contributions intended to satisfy the ACP Safe Harbor requirements, do they still need to provide the annual Safe Harbor Notice?

Yes, if the plan is designed so that any matching contributions (fixed or discretionary) will satisfy the requirements to be exempt from the ACP test, the Safe Harbor notice would still be required.

If an employer makes a permissible change to an existing Safe Harbor Non-elective contribution plan mid-year, do they need to provide an updated Safe Harbor notice?

It does not appear so, given the plan doesn’t also provide for matching contributions intended to satisfy the ACP Safe Harbor requirements. Presumably, this also means that participants will not be required to be provided the opportunity to make changes to their deferral elections prior to the change, but the IRS has not yet provided updated guidance on this point.

Can an employer remove their current Safe Harbor Non-elective provision and take a “wait and see” approach?

It appears so, absent future IRS guidance to the contrary. While the new law specifically prohibits a plan that provided for Safe Harbor matching contributions at any time during the plan year from adopting a Safe Harbor Non-elective contribution retroactively for that same year, it makes no such distinction with respect to plans that provided Safe Harbor Non-elective contributions for a portion of the plan year.

Keep in mind, the plan would still need to meet the regulatory requirements to reduce or suspend the Safe Harbor Non-elective contribution mid-year, and again, the IRS has not yet updated the regulations. Apparently, the pre-plan year notice (regarding the employer’s right to reserve the ability to reduce or suspend Safe Harbor contributions mid-year) and the 30-day advance (mid-year) notice would not be required since the general notice requirement was eliminated. Participants will no longer need the option to make changes to their deferral elections prior to the change.  The plan sponsor would still need to make the Safe Harbor Non-elective contribution through the effective date of the amendment.  We anticipate additional guidance from the IRS on this issue. Hopefully, it will come sooner rather than later.

How does the new 4% Safe Harbor Non-elective contribution work?

Under the new rules a traditional 401(k) can be amended after the 30-day deadline but any time on or before the last day of the following plan year to provides for a 4% Safe Harbor Non-elective contribution so that the ADP test is deemed to be satisfied. Essentially, this change allows any traditional 401(k) plan to be a “maybe” Safe Harbor plan, without any participant notice requirements. This affords plan sponsors much greater flexibility, giving them the ability to amend the plan after the ADP test has been performed so they can weigh the cost of the 4% Safe Harbor contribution against the refunds that would otherwise be issued to the plan’s highly compensated employees.

Does a plan that adopts a 4% Safe Harbor Non-elective contribution retroactively for the prior year have to make a 4% Safe Harbor Non-elective contribution for the current year?

No, the Safe Harbor contribution would only be required for the prior year. The employer could still take a “wait and see” approach for the current year or amend the plan to the 3% Safe Harbor Non-elective contribution if amended before 30 days prior to the end of the current Plan Year. If the employer wants to change from the Safe Harbor Non-elective contribution to the Safe Harbor Match, they must wait till the beginning of the next plan year.

Were there any other changes to Safe Harbor plans?

Yes. Automatic Enrollment plans that use the Qualified Automatic Contribution Arrangement (QACA) Match have changed as well. The SECURE Act increased the maximum default deferral rate from 10% to 15% for QACA Safe Harbor plans, and, changed the cap on the maximum auto-escalation percentage from 10% to 15%.

How can I learn more?

If you would like to learn more about the new rules, please contact your EJReynolds’ Consultant.

ADP/ACP Nondiscrimination Testing – What is it all about?

Since it’s time for most 401(k) plans to perform annual nondiscrimination testing, it makes sense to review the requirements for the Average Deferral Percentage/Average Contribution Percentage (ADP/ACP) tests and the options for plans that fail one or both tests.

Note: Plans that provide for safe harbor matching or safe harbor nonelective contributions are generally deemed to satisfy both tests.

What are the ADP and ACP tests?

The ADP/ACP tests are performed to demonstrate that the plan does not discriminate in favor of highly compensated employees (HCEs) with respect to 401(k)/Roth deferrals and employer matching contributions. The ADP test compares the average deferral rates of the HCEs to that of the non-highly compensated employees (NHCEs); the ACP test does the same for matching contributions. Plans may use either the current year or prior year average of the NHCEs for this purpose; however, the method selected must be specified in the plan document.

In general, a plan passes these tests if the average of the HCEs does not exceed the lesser of (1) the NHCE average plus 2%, or (2) 2 times the average of the NHCEs.

Do catch-up contributions get counted in the ADP test?

No. If a participant makes catch-up contributions by either exceeding the statutory limit ($19,000 for 2019/$19,500 for 2020) or a plan-imposed limit, the amounts are excluded from the ADP test.

What happens if a plan fails these tests?

The plan sponsor must take corrective actions which typically involves issuing corrective distributions to certain HCEs. Although this is the most common way to correct failures, many plans also allow for the employer to make an additional contribution to the plan on behalf of certain NHCEs. These amounts, known as QNECs (Qualified Nonelective Contributions) and QMACs (Qualified Matching Contributions), must be 100% vested and are subject to certain distribution restrictions.

Note: It may be possible to correct or reduce the impact of an ADP testing failure by “reclassifying” deferrals of eligible HCEs as catch-up contributions. When this occurs, corrective distributions are reduced by the reclassified amounts to the extent they do not exceed the catch-up limit ($6,000 for 2019, $6,500 for 2020).

Is there a deadline for correcting failures?

Yes. Generally, corrective distributions must be issued within 2 ½ months following the close of the plan year to avoid a 10% excise tax imposed on the excess amounts. Plan sponsors of 401(k) plans that include an “eligible automatic contribution arrangement” have up to 6 months to issue corrective distributions without incurring excise taxes.

Regardless of the method chosen (i.e. corrective distributions or QNEC/QMACs), corrections must be made no later than the last day of the plan year following the plan year in which the testing failure occurred.

What happens if a plan doesn’t correct the failure in a timely manner?

In short, the qualified status of the plan may be jeopardized, and “late” corrections are much costlier for the employer. The IRS provides two methods for making late corrections under its Employee Plans Compliance Resolution System (EPCRS). Under the first option, the employer must make a QNEC on behalf of the NHCEs. This method is often more expensive than making a “normal” QNEC because the contribution must be made on behalf of all eligible NHCEs. Under the second option (the “one-to-one” correction method), the plan sponsor must issue corrective distributions and must make a QNEC in an amount equal to the corrective distributions. The QNEC is then allocated to the NHCEs.

Can a plan do anything to prevent failures?

Yes. As mentioned above, plans that provide for either safe harbor matching or safe harbor nonelective are generally deemed to pass these required tests. Additionally, there are other options available that may help reduce or eliminate ADP/ACP testing failures such as adding automatic enrollment, making a top-paid group election, or adding a plan-imposed limit for HCEs.

If you would like to learn more about these options or if you have any questions, please contact us.

Annual Compliance Testing for 401(k) Plans 2020

Several tests must be performed each year to demonstrate that 401(k) plans do not discriminate in favor of highly compensated employees and that contributions do not exceed certain limitations. Since many 401(k) plans are on a calendar year basis, your clients are probably working on these tests now or in the next few weeks. It is probably a good idea to review some of the most common tests, including:

  • ADP/ACP Tests
  • Annual Deferral Limit
  • Annual Additions Limit
  • Coverage Test
  • Top Heavy Determination

Highly Compensated and Key Employees

For purposes of all these tests, it is important to understand two basic definitions.

  • Highly Compensated Employees (HCEs) are employees who (1) own more than 5% of the company*, or (2) earned compensation in excess of an annual dollar amount in the prior year (for example, earning over $180,000 in 2018 makes for an HCE in 2019, while earning over $125,000 in 2019 makes for an HCE in 2020). Some plans limit the number of employees considered to be highly compensated by making a “top paid group” election. Whether this is beneficial for a given plan depends on several factors including the demographics of the workforce.
  • Key Employees are employees who at any time during the plan year (1) owned more than 5% of the company*, (2) owned more than 1% of the company* and had compensation in excess of $150,000, or (3) were officers of the company with compensation greater than a certain dollar amount ($180,000 for 2019, $185,000 for 2020).

*Stock attribution rules apply when determining ownership. This means direct relatives of the owner(s) are generally considered to “own” the same percentage for purposes of determining highly compensated and key employee status.

ADP/ACP Tests

The Average Deferral Percentage/Average Contribution Percentage (ADP/ACP) tests are performed to demonstrate that the plan does not discriminate in favor of highly compensated employees with respect to 401(k)/Roth deferrals and employer matching contributions. If the plan fails one or both tests, corrective actions must be taken which often includes issuing corrective distributions, generally by March 15th of the following year. Note: Plans that provide for safe harbor matching or safe harbor nonelective contributions are generally deemed to satisfy both tests. Eligible Automatic Contribution Arrangements have until June 30th to make these corrections.

Annual Deferral Limit

The annual deferral limit ($19,000 for 2019 plus $6,000 for participants age 50 or older, or $19,500 and $6,500 respectively for 2020) is a limit placed on the amount a participant may contribute through pre-tax deferrals and/or Roth contributions. This combined limit is always measured on a calendar year basis and applies to the individual. As a result, the participant has the responsibility of informing the plan administrator if they made excess deferrals and participated in an unrelated employer’s plan. The excess amount, along with related earnings, must be distributed no later than April 15th of the following year. If this deadline is not met the participant will be taxed on the excess amount in both the year of the deferral and the year of distribution.

Annual Additions Limit

Participants are also subject to an overall contribution limit known as the “415 limit” (the lesser of 100% of gross compensation or $56,000 for 2019, $57,000 for 2020). This limit generally includes all contributions made to the plan for a plan year; however, it does not include rollover contributions or catch-up contributions. If the limit is exceeded, corrective actions must be taken which normally involves issuing corrective distributions or forfeiting the excess amounts, adjusted for related earnings.

Coverage Test

The coverage test is performed to demonstrate that the plan meets the minimum coverage standards required by law. This test must be run separately for each contribution type or component of the plan (e.g. 401(k), match, and profit sharing). In general, the test is satisfied if the plan covers at least 70% of all the employees who have met the minimum statutory age and service requirements (i.e. age 21 and 1 year of service). In the event of a failure, the employer typically must make an additional contribution to the plan on behalf of non-highly compensated employees.

Top Heavy Determination

In general, a 401(k) plan is top heavy when more than 60% of plan assets are attributable to key employees as of the last day of the prior plan year. Top heavy plans are subject certain minimum contribution and vesting requirements.

Other Required Tests

This is a broad overview of the general testing requirements for 401(k) plans and is not meant to be comprehensive. Other tests may be required depending upon a plan’s design and its features. For example, plans that exclude certain types of compensation, such as commissions, or allocate profit sharing contributions to different groups of participants are subject to additional testing requirements.

To learn more about the testing requirements for your specific plan, please contact us.

The SECURE Act of 2019

On December 20, 2019, President Trump signed into law the Setting Every Community Up for Retirement Enhancement Act of 2019 (the SECURE Act) as part of a compromise bill to avoid a potential government shutdown. The SECURE Act contains many changes to retirement savings accounts in general. Although IRS guidelines have not yet been established, plan sponsors may take advantage of some of the changes in 2020. Following is a summary of new rules that current and potential 401(k) plan sponsors need to know:

  • For Existing Plans

    • Safe Harbor Plans Have New Flexibility – The IRS requires that 401(k) plans conduct and pass compliance testing to ensure a plan does not discriminate against Non-Highly Compensated Employees. However, a plan sponsor can satisfy the testing requirements by implementing a Safe Harbor 401(k) Plan. Under the SECURE act, the following Safe Harbor plan designs have been given more flexibility:
        • Safe Harbor Nonelective (“SHNEC”): With this design, a plan sponsor can satisfy discrimination testing by making an employer contribution of at least 3% of compensation to all eligible employees. Under prior law, a sponsor can adopt a SHNEC 401(k) plan provided a notice was distributed to plan participants 30 days before the beginning of the plan year.  The SECURE Act eliminates the notice requirement in general and permits a plan sponsor to decide to have a nonelective safe harbor plan mid-year, provided they decide prior to 30 days before the end of the plan year. They may decide even later than that, potentially after the end of the plan year, provided they make a safe harbor contribution of at least 4% of compensation.  The notice requirement remains the same for plans that use the Safe Harbor Match design.
        • Safe Harbor Qualified Automatic Contribution Arrangement: Under this plan design, an eligible employee is automatically enrolled in the plan with a pre-set deferral deduction that automatically escalates the employee’s contributions each year. The cap on the automatic escalation will increase from 10% to 15%.
    • Part-Time Employees Must Be Covered in All 401(k) Plans – Currently, plans may exclude employees who don’t complete at least 1,000 hours of service in a 12-month eligibility computation period. This allowed a plan sponsor to exclude a part-time employee from the plan, if they worked less than 1,000 hours in a year. In 2021, the SECURE Act, will require that part-time employees who complete more than 500 hours of service in three consecutive eligibility years be permitted to contribute to 401(k) plans. They will not be required to receive employer contributions and will be excluded from non-discrimination testing but must be given the opportunity to contribute.
    • For Plans that have participant loans – Effective immediately, 401(k) plans are not permitted to make plan loans available by credit card. Existing programs using this form of payment must be discontinued.
    • Mandatory Distribution Date – Under current law, an owner or related employee, or any terminated participant must begin taking minimum distributions by April 1st after turning age 70 ½, or face penalties of a 50% excise tax. The SECURE Act increases that age to age 72. This applies to individuals attaining age 70 ½ after December 31, 2019. This means that if you turn 70 in 2019 but were born on or before June 30, 1949, the age is still 70 ½, and you must take a distribution by April 1, 2020. However, anyone born July 1, 1949 or later can wait until April 1, 2023 before taking their first distribution.
  • For Employers Considering Adopting a Plan

    • Higher Tax Credits May Be Available – The tax credit for small employers who start new retirement plans increases from $500 per year to as much as $5,000 per year for three years. There is also a new $500/year tax credit for up to three years for small employers that adopt new plans that include automatic enrollment. Small employers are considered those that had no more than 100 employees who earned at least $5,000 in the preceding year.
    • More Time to Adopt – Under current law, qualified plans must be adopted by the last day of the year for employers to make deductible contributions for that year. For Tax Years beginning in 2020, qualified plans can be adopted after the end of the tax year and up until the tax return due date. This will provide much needed flexibility to employers considering qualified plans but will not permit employees to make retroactive 401(k) contributions.
    • New Options under Multiple Employer Plans – The SECURE Act will make open multiple employer plans, called Pooled Employer Plans, or PEPs, available as an option beginning in 2021. These will be professionally managed plans that permit unrelated employers to participate.  Adopting employers will be relieved of much (but not all) of their fiduciary responsibilities. PEPs are a major step towards increasing small employer plan coverage, and they will be the subject of a separate upcoming post.

There are several other sections, including a tenfold increase in penalties for failure to file Form 5500 and certain other returns timely and easing the in-service distribution rules for the birth or adoption of a child that we will discuss in greater detail in future articles. For now, contact your EJReynolds’ Plan Consultant with any specific questions as to how the SECURE Act may affect your plan.

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