Blogging Employee Benefits

October 26, 2006

415 and 401(k) COLAs Revisited

Filed under: 401(k), Pensions — Fuguerre @ 2:27 pm

So we have the official word from the IRS on next year’s 415 limits, as previously noted here. But what if you wish to project an advance estimate of a future threshold, such as we did back here? When I forwarded inquiries about the innards of the little spreadsheet I’d been given over to my pet actuary, I was sent a copy of this IRS information letter from 1993.

For current thresholds that employ the same methodology as Code §415(d), one needs monthly CPI-U results for the applicable base period and for the year preceding the year for the limit, the original level for the threshold for the year following the base year, a rounding multiple comparable to the numbers given in 415(d)(4), and the particular calculation methodology used by the IRS (including a curious truncate-round two-step in the middle of the calculation).

Let’s walk it through several instructive examples from this year’s edition –

  • Limitation on Annual Addditions to Defined Contribution Plan, Code §415(d)(1)(C).
    1. Base period is 2001. CPI-U index numbers for July, August, and September 2001 were 177.5, 177.5, and 178.3 respectively. The sum of those three numbers is 533.3.
    2. For the 2007 threshold, we need the comparable CPI-U numbers from 2006, which for July, August, and September 2006 were 203.5, 203.9, then quite surprisingly dropping to 202.9. The sum of those three numbers is 610.3.
    3. The ratio of the second sum to the first sum is something like 1.14438024 (i.e., 610.3/533.3, here carrying that result out to enough places to continue), but then here comes the odd little truncate-round two-step: (a) The 1.14438024 result is truncated to 5 decimal places, giving us 1.14438; then (b) That intermediate result is rounded to 4 decimal places, yielding 1.1444.
    4. For the threshold being adjusted, the original level in 2002 was $40,000, which is now multiplied by the truncated-rounded factor of 1.1444, giving $45,776, which doesn’t then require rounding to the nearest dollar since it is already an integer number of dollars.
    5. The truncating multiple for this particular threshold is $1,000. We round down, rather than to the nearest multiple, so dropping $45,776 down to the next lower $1,000 gives us $45,000 for the 2007 limitation on annual additions to a defined contribution plan.

    That drop in this year’s CPI-U index from August to September dropped the result here from my original estimate of $46,000 to the ultimate actual ceiling of $46,000, serving as warning to anyone attempting to play actuary or economist with future inflation expectations.

  • Limitation on Elective Deferrals, Code §402(g)(1).
    1. Base period this time is 2005, since EGTRRA hard-wired the recent years’ ceiling increases. CPI-U index numbers for July, August, and September 2005 were 195.4, 196.4, and 198.8 respectively. The sum of those three numbers is 590.6.
    2. For the 2007 threshold, we use the comparable CPI-U numbers for 2006 as described for the DC annual addition ceiling, yielding the same sum of 610.3 for the July-August numbers.
    3. Since we have a different base period, the ratio of the second sum to the first sum is of course different, looking something like 1.033355909, which truncated to 5 decimal places becomes 1.03335, which rounded to 4 decimal places turns into 1.0334.
    4. For the elective deferral threshold, the starting level is this year’s $15,000, which is now multiplied by the truncated-rounded factor of 1.0334, giving $15,501, which doesn’t then require rounding to the nearest dollar since it is already an integer number of dollars.
    5. The truncating multiple for the elective deferral limit is $500. Rounding $15,501 down to next lower $500 gives us $15,500 for the 2007 limitation on elective deferrals.

    We just barely made that increase! A smidge more of a drop in September’s CPI-U (or comparably different numbers in others of the 6 quarters used for the indexing), and we might have remained at $15,000 for 2007, instead of jumping up to actual ceiling of $15,500, echoing the warning expressed earlier.

  • Limitation on 401(k) Catch-Up Contributions, Code §414(v)(2)(C).
    1. Base period for this is also 2005, so the first step here repeats what we did for elective deferrals.
    2. Ditto.
    3. Ditto.
    4. But here, the starting level is this year’s $5,000, which is then multiplied by the truncated-rounded factor of 1.0334, giving us $5,167, which again doesn’t then require rounding to the nearest dollar since it is already an integer number of dollars.
    5. Although in 2006 the catch-up deferral ceiling is at one-third the level of the elective deferral ceiling, the truncating multiple is the same: $500. Rounding $5,167 down to next lower $500 leaves us at $5,000 for the 2007 limitation on catch-up contributions, and will likely continue to do so for several more years.

    In this instance, although the same warning about future projections, as expressed for the previous two calculations, still does hold (particularly when the unrounded amount nears $5,500 several years from now), for 2007 we were rather safe in expecting that number to remain the same as for 2006.

Actually, there’s no official word that the IRS is still using exactly the same methodology (updated to use 3rd-quarter comparisons and to step up in terms of the rounding multiples, both of which were introduced after the 1993 IRS letter), or is there any particular guarantee that future methodology will remain the same. For all years since 1993, however, I’m told that this methodology has precisely reproduced all of the official figures published by the IRS, even when there were close calls such as this years $15,501. So unless and until anything more formal is published, this looks good enough for my needs.

(P.S. – In case I haven’t made it rather obvious by now, I absolutely adore what Cornell has done with its U.S. Code!! And as far as I can tell so far, all without making the blunder that some websites make of wrecking all of the links you had previously made to their material. Quite commendable.)


August 16, 2006

Expect $15,500 Elective Deferral Cap for 2007

Filed under: 401(k), Pensions — Fuguerre @ 4:26 pm

But without getting overbearing with my cautious side, as much as ever slap this weblog’s Disclaimer on that speculation.

The point being that the Bureau of Labor Statistics gave us the July 2006 CPI-U this morning. Now under IRC §402(g)(4) as added by EGTRRA, we technically will want those CPI-U numbers for August 2006 and September 2006 before we have all of the pieces we need to make this official; so we won’t see a formal announcement from the IRS for another two months or so. But given the methodology of IRC §415(d) referenced in 402(g)(4) and given July’s CPI-U, we’d need deflation for the next two months in order to have a third quarter that would keep the 2007 elective deferral limit flat at $15,000 — it actually wouldn’t take a great deal of deflation, but don’t count on the price of oil letting us off that easy. Conversely, we’d need the annualized inflation rate to go ballistic up to more than 40% for each of the next two months in order to jump up to a deferral limit of $16,000, and the Fed would shoot the economy before that would happen. So with the almost impossible chance that a brief September lull could keep us flat at this year’s level, and again remembering that this won’t be official until the IRS says so, look for the 2007 limit on elective deferrals to increase to $15,500.

Other threshold’s COLAs are closer to straddling lines that can go either way. The maximum benefit under IRC §415(b) will quite likely increase from this year’s $175,000 to $180,000 — there too, we’d need a pinch of deflation for that not to increase, while a higher jump is next to impossible. But while I’d put my money on $46,000 for the §415(c) limit on contributions (up from $44,000) and $230,000 for the §401(a)(17) compensation limit (up from $220,000), some further moderation of inflationary pressures during the rest of the quarter could make those two come in at $45,000 and $225,000 respectively.

Update: See my 10/18 post reflecting full 3rd quarter CPI.

July 3, 2006

Excise Tax on Late Deferrals

Filed under: 401(k), Prohibited Transactions — Fuguerre @ 6:58 am

If an employer does not deposit participant deferrals into a 401(k) plan in a timely manner, then the prohibited transaction excise tax under §4975 is based on interest on those elective deferrals. [Rev. Rul. 2006-38]

April 23, 2006

Abandoned Individual Account Plans

Filed under: 401(k), DOL, Termination (Plan) — Fuguerre @ 9:52 am

Qualified termination administrators may wind up the affairs of abandoned individual account plans under final regulations and a class exemption published by the Department of Labor. [71 FR 20819 (regulations); 71 FR 20855 (class exemption); 06-717-NAT (press release); Fact Sheet; Abandoned Plan Program. See also the 11/8/2002 report of the ERISA Advisory Council's Working Group on Orphan Plans.] The regulations and class exemption are effective May 22, 2006.

  • Qualified Termination Administrator (QTA)- To qualify as a QTA, an institution must meet two conditions: (1) the institution must be eligible to serve as a trustee or issuer of an individual retirement plan; and (2) the institution must be holding the assets of the plan for which it will serve as QTA. See the Model Notice of Plan Abandonment and Intent to Serve as Qualified Termination Administrator.Only one institution should serve as a plan's QTA. If more than one institution holds assets of the plan, then the other institutions are expected to cooperate with the QTA.
  • Determination of Plan Abandonment– An individual account plan, such as a 401(k) plan, will generally be considered abandoned if no contributions to or distributions from the plan have been made for at least 12 consecutive months, and if the QTA has determined that the plan sponsor no longer exists, cannot be located, or is unable to maintain the plan.
  • Deemed Termination– An abandoned plan will be deemed terminated on the 90th day following the DOL's acknowledgement of receipt of the notice of plan abandonment. The plan termination will not go through or will be delayed if either the plan sponsor or the DOL objects to the proposed termination. The DOL may waive some or all of the 90-day period, in which case the plan is deemed terminated when the DOL provides notice of the waiver to the QTA.
  • Winding Up the Affairs of an Abandoned Plan– The regulations provide procedures for a QTA to conclude the affairs of an abandoned plan, including –
    • Notification to the DOL before and after winding up the affairs of and terminating the plan;
    • Locating and updating plan records;
    • Calculating amounts payable to plan participants and beneficiaries;
    • Notification to plan participants and beneficiaries regarding the plan termination and individuals' rights and options;
    • Distribution of amounts to participants and beneficiaries; and
    • Filing a summary terminal report.

    Reasonable expenses incurred in the plan's winding-up and termination may be paid from plan assets. The regulation includes provisions addressing the allocation of expenses and unallocated assets (e.g., forfeitures or amounts in a suspense account), including rules for situations where a plan document is unavailable or ambiguous. The QTA must notify the DOL of any known delinquent employer contributions, but is not required to collect delinquent contributions on the plan's behalf.

    The QTA is not required to amend the plan in order to proceed with the plan's winding-up and termination. Rather, the plan is deemed to have been amended to the extent necessary for the QTA to conduct its responsibilities.

  • Limited Liability– If the QTA conducts its duties in accordance with the regulations, then it will be deemed to satisfy its responsibilities under ERISA §404(a), except with respect to selection and monitoring of service providers. If service providers are selected and monitored prudently, then the QTA will not be held liable for service provider acts or omissions about which the QTA has no knowledge.
  • Plan Qualification– Although not directly within the scope of the DOL's own enforcement authority, the preamble to its regulations state that the IRS will not challenge the qualified status of any plan terminated under the regulation or initiate any adverse action against the QTA, the plan, or any participant or beneficiary, provided the QTA satisfies three conditions –
    • Survivor Annuity Requirements – The QTA must reasonably determine the extent to which the survivor annuity requirements apply to benefits payable under the plan and take reasonable steps to comply with those requirements if applicable.
    • Vesting – Each participant and beneficiary must have full nonforfeitable rights to accrued benefits as of the date of deemed termination, subject to income, expenses, gains and losses between that date and the date of distribution.
    • 402(f) Notice – Participants and beneficiaries must receive notice of their rights under IRC §402(f).

January 26, 2006

Rules for Roth 401(k) Distributions

Filed under: 401(k), Distributions, IRS, Regulations — Fuguerre @ 6:34 am

The IRS has proposed regulations regarding the taxation of distributions from Roth 401(k) accounts. The proposed regulations also address Roth 401(k) reporting requirements and designated Roth contributions in 403(b) plans.  [71 FR 4320, REG-146459-05]  Final regulations covering the basic rules for Roth 401(k) accounts were issued earlier this year. (See BeneBlog 1/9/06.)

Designation of 401(k) deferrals as Roth 401(k) contributions is permissible beginning 1/1/2006.  Under current law, authorization of Roth 401(k) accounts would sunset December 31, 2010. Neither the earlier published regulations nor the newly proposed regulations address the potential sunset.

Qualified Distributions.  Taxation of distributions from a Roth 401(k) account depend upon whether or not the distribution is a qualified distribution. As prescribed by IRC 402A(d)(2), a qualified distribution must be made on or after attainment of age 59-1/2, death, or disability, and must be made at least 5 years after establishment of the Roth 401(k) account.

The 5-year period begins on the first day of the employee’s taxable year during which the employee designated the first Roth 401(k) contribution under the plan.  If the makes a direct rollover from a Roth 401(k) account under a different plan, then the 5-year period begins on the first day of the employee’s taxable year during which the employee had designated the first Roth 401(k) contribution under the transferor plan, if earlier.

Nonqualified Distributions.  Roth 401(k) distributions that do not satisfy the conditions for qualified distributions are not eligible for the tax exemption that would apply to qualified distributions. Accordingly, income attributable to the designated Roth 401(k) contributions is taxable, although the contributions themselves – which had been included in taxable income upon contribution – are tax-free basis upon distribution.

The IRS declined requests to apply the Roth IRA special ordering rules for taxation of nonqualified Roth 401(k) distributions. Thus, a nonqualified distribution from a Roth 401(k) account is taxed under the rules of IRC 402 and IRC 72, treating the Roth 401(k) account separately from any non-Roth 401(k) distributions as prescribed by IRC 402A(d)(4). Note that the preamble of the final regulations published earlier this year stated that a 401(k) plan could grant a plan participant the right to allocate the amount of a 401(k) distribution that would come from a Roth 401(k) account versus the non-Roth 401(k) account.

Roth 401(k) Rollovers. The portion of any Roth 401(k) distribution that is not includible in income may be rolled over to a designated Roth account under a 401(a) plan only if – (1) The transaction is made by a direct rollover, rather than through direct distribution to the employee; and (2) The transferee plan accepts rollovers and agrees to separately account for the amount not includible in income. The transferor plan must report to the transferor plan the investment under the account and the first year of the 5-year period.

An individual may roll over the portion of a Roth distribution that is taxable to a 401(a) or 403(b) plan within 60 days of receipt. In the instance of rollover of taxable Roth 401(k) amounts, Roth participation under the transferor plan is not carried over to the transferee plan for purposes of the 5-year rule.

If a Roth 401(k) distribution has been made directly to the individual, then a rollover to another plan may not be made, but the individual may roll over any portion of the distribution into a Roth IRA within 60 days. Participation under the Roth 401(k) account does not count for purposes of the Roth IRA version of the 5-year rule.

The Roth IRA income limits on contributions do not apply for purposes of a rollover from a Roth 401(k) account to a Roth IRA. If only a portion of the distribution is rolled over, then the portion not rolled over is treated as consisting first of the amount of the distribution that is taxable.

Treatment of Excess Deferrals. If secess deferrals are not distributed by April 15 of the following year, then any portion of that distribution that is attributable to a designated Roth contribution is included in taxable income, with no exclusion for amounts attributable to basis. The result is dobule taxation: although the contribution was included in taxable income during the year contributed, it would also be included in taxable income during the year of distribution. In most instances, the way to avoid this double hit would be to either distribute excess deferrals before the April 15 deadline, or for the plan to provide highly compensated employees with the right to designate that distribution of excess deferrals should be made entirely from the non-Roth 401(k) account. Note, however, that if excess deferrals have remained undistributed and if the individual takes a distribution from the Roth 401(k) account, then a special ordering rule prevails, characterizing the first portion of that distribution to constitute distribution of excess deferrals, thereby circling back to the double taxation problem. Thus, if excess deferrals are present and if the April 15 deadline has passed, the individual should distribute the excess deferrals from the non-Roth portion of the account, if possible under the plan terms to do so, before taking a distribution from the Roth 401(k) account.

Designated Roth Accounts under 403(b) Plans. Generally 403(b) plans may permit members to designate contributions as Roth contributions under rules parallel to those that have been prescribed for 401(k) plans.  The one additional nuance is the universal availability rule of 403(b)(12)(A)(ii): if any one member of a 403(b) plan is given the opportunity to designate a contribution to the plan as a Roth contribution, then all members of the plan must be given that same right.  In contrast, for a 401(k) plan the right to designate a deferral as a Roth 401(k) contribution would be a plan feature subject to the nondiscriminatory availability rules of Reg.1.401(a)(4)-4.

Reporting and Recordkeeping.  The administrator of a plan with Roth 401(k) accounts is generally responsible for keeping track of the 5-year period and the amount of contribution designated by a plan participant as Roth 401(k) contributions. 

Effective Date.  Reliance on the proposed regulations is permitted for any periods after the 1/1/2006 effective date of the statute. The reporting and recordkeeping requirements will not be effective prior to the 2007 plan year; but plan administrators are cautioned that compliance will necessitate keeping track of each account from the outset.

January 22, 2006

Capital Gains from 401(k) Company Stock

Filed under: 401(k), Investment — Fuguerre @ 9:22 am

Post-Enron, some individuals have been hesitant to keep large portions of their 401(k) accounts invested in company stock, fearful of seeing their retirement security evaporate. An article in this month’s issue of AARP Magazine reminds us that if stock is transferred upon distribution, then income tax is owned only on the stock’s cost basis, and subsequent stock sales are subject to lower capital gains taxes.  [AARP Magazine, Jan/Feb 2006, Karen Hube, p38]

Even that favorable capital gains treatment won’t protect the individual from a crash as severe as the one that brought Enron stock down. Diversification of investments would have been the prudent course there. But for any reasonable holdings of company stock, going the capital gains route will be better than cashing out the stock within the 401(k) plan itself, even if the stock price slips some moderate amount: you’re losing less to the market than you would lose to your Uncle Sam!

January 18, 2006

United Flight Attendants Settle on DC Plan Terms

Filed under: 401(k) — Fuguerre @ 12:02 pm

Followup to an earlier post here regarding bargaining efforts of United Airlines flight attendants, who now have reached a tentative agreement with United on the terms of a replacement defined contribution plan, subject to ratification. Under the agreement, flight attendants would receive a direct 2% contribution, together with a 3% employer matching contribution, effective January 1, 2006. The direct contribution would increase to 2.5% on 1/1/2007, then to 3% effective January 1, 2008. [AFA Press Release; United Press Release]

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