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 Sponsor News - June 2015

Required minimum distributions for 5% owner

For purposes of required minimum distributions (RMDs), the definition of a "5 owner" is an individual who owns more than 5 of the company sponsoring a qualified retirement plan. The required beginning date (RBD) for 5 owners to begin taking RMDs is April 1 of the year after they reach age 70 ½ , regardless of whether they are still working.

It's possible for an individual's owner ship percentage to change. The timing of such a change can have a critical impact on whether the individual is required to take an RMD. An explanation of the current rules for 5 owners follows, as well as some examples that outline how ownership changes can affect RMD requirements.

When are RMDs "locked in"?

Under the final RMD regulations, if an individual is a 5 owner, his or her RED is April 1 of the year after he or she reaches age 70 ½ . Whether the individual is a 5 owner is determined by whether he or she owns more than 5 of the company on any day in the plan year that ends in the year he or she attains age 70 ½.

If an individual's ownership percentage drops to 5 or less within that time frame (or any year thereafter), he or she will still be required to start taking RMDs by April 1 of the year after reaching age 70 ½ (and to continue taking RMDs thereafter).

Example 1: A client was a 5 owner

in 2014 through the family attribution rules because his wife owned 100% of the business. He reached age 70 ½ in 2014, the same year his wife sold the entire business. Is he still considered to be a 5% owner for RMD purposes?

Yes. When the plan year is the calendar year, if you are a 5% owner on any day in the calendar year in which you attain age 70 ½ , then you are a 5% owner for RMD purposes. In this example, the husband must start taking RMDs by April 1, 2015.

Example 2: A 74-year-old 5% owner began taking RMDs from his company's 401(k) plan when he attained age 70 ½. He is still working for the same company and recently sold his entire owner ship interest in the company. Must he continue taking RMDs?

Yes. The determination of who is a 5% owner for RMD purposes is determined by the person's ownership interest in the plan year ending in the year the individual attains age 70 ½ . If a 5% owner wishes to sell his or her interest after that date, RMDs must continue, regardless of ownership status.

Example 3: Following this rule can be more challenging for off-calendar-year plans. In this example, the 401(k) plan year is July 1, 2013, to June 30, 2014. A 5% owner sold his interest in the company on July 12, 2014, and turned age 70 ½ on July 31, 2014. The plan year ending in the calendar year the individual attains age 70 ½ is the plan year ending June 30, 2014. Since the individual was a 5% owner during the plan year (July 1,2013, to June 30, 2014), he must begin taking RMDs, regardless of the fact that he sold his interest before actually reaching age 70 ½. His RBD is April l, 2015.

The answer would be the same if the 5% owner had sold his interest on July 12, 2013, for example, because that was still during the plan year ending in the calendar year during which the individual reached age 70 ½.

The TEFRA 242(b) election

The Tax Equity and Fiscal Responsibility Act of 2002 (TEFRA) introduced RMDs to corporate plans and permitted individuals who filed a TEFRA 242(b) election to follow the distribution rules that applied to their qualified plans in 1983.* The election generally delayed the date working employees had to begin taking distributions beyond age 70 ½ . They could wait until they severed employment. The election required participants to select from the plan's distribution rules at that time and was available to both 5% owners and non-5% owners. Note that some firms had all their employees make the election.

There are individuals, usually professionals like doctors or lawyers, who filed such an election and are still working. And even though they are well beyond age 70 ½ , they have not started taking distributions. For example, when an institution was acquired, a review of RMDs by individuals' ages discovered a one-person plan with an 84-year old doctor who had timely filed a TEFRA 242(b) election delaying the start of distributions until he retired. He was still working and had never taken RMDs.

Note that if there is an involuntary revocation of the TEFRA 242(b) election, the individual must make up missed payments.

Permitted RBD delays

Under current regulations, there are two events that permit the delay of an individual's RBD. One is for an annuity payment from an insurance company involved in a state insurer delinquency program. The other is if the individual is in the midst of an 18-month qualified domestic relations order (QDRO) period.

Plans subject to the qualified joint and survivor annuity rules

For plans subject to spousal consent requirements, spousal consent is required for RMDs. Typically, a blanket spousal consent is acceptable (i.e., one spousal consent for all future RMDs).

Plan documents define RBD

A document may permit non-5% owners who work after age 70 ½ to wait until retiring before reaching RBD. Alternatively, a plan document may define RBD as April 1 after reaching age 70 ½ for all individuals.

* The TEFRA 242(b) election had to be executed by December 31, 1983.






Excess Elective Deferrals

With the 2015 tax season in full swing, this is a good time for a brief review of the rules governing the treatment of excess elective deferrals. The IRC Section 402(g) limit on elective deferrals for the 2014 calendar year was $17,500 for individuals under age 50. Individuals age 50 or older could contribute an additional $5,500 as catch-up contributions for a total 402(g) limit of $23,000. The 402(9) limit is applied on an individual taxpayer basis to the aggregate of all cash or deferred arrangements (including 401(k) and 403(b) plans) the individual participates in during a given calendar year. This is a calendar-year limit, not a plan-year limit for off-calendar-year plans.


Errors can be tough to spot. Most payroll systems are programmed to prevent excess deferrals. As a result, excess deferrals do not typically occur when an employee works for only one employer during a calendar year and contributes to only one 401(k) plan. Excess deferral errors tend to occur when individuals have either changed employers or participated in more than one plan of unrelated employers during a calendar year. In these situations, employers are generally not aware of amounts an individual has contributed to another planes). Thus, employers would not be aware of a potential 402(g) violation until a participant notifies them of the excess deferral amounts.


Correction procedures. When elective deferrals exceed the annual limit, the excess deferral amount plus earnings must be distributed by April 15 of the following calendar year. For example, an excess deferral related to the 2014 calendar year must be distributed from a plan by April 15, 2015. Excess pretax deferral amounts are taxable in the year they were contributed, while earnings associated with the deferrals are taxable in the year the excess is distributed. Excess designated Roth deferral amounts are not taxed if distributed prior to April 15; however, the earnings are taxable in the year distributed.

The distribution of excess deferrals is not treated as a premature distribution, although the distribution of earnings is. Excess deferrals and the earnings on the excess may not be rolled over, since they are not eligible rollover distributions. Plans that permit designated Roth and pretax deferrals can allow participants with both types of excess deferrals to decide which type is distributed.


Adverse consequences. If the April 15 distribution deadline is not met, excess deferrals must still be distributed, but amounts will be subject to ordinary income tax as a distribution. Thus, the employee will pay tax in the year the excess deferral was made (excess deferrals may not be deducted) and again in the year the elective deferral is ultimately distributed.

Failure to refund excess deferral amounts is a plan disqualifying event. Therefore, plan sponsors should take prompt action when they become aware that an excess deferral has occurred.




Which type of fiduciary should plan sponsors hire?

Posted July 29, 2014 by Robert C. Lawton at 09:11AM. Comments (0)

Recently, there has been a lot of discussion about whether plan sponsors should contract with their administrative providers for section 3(16) fiduciary services. Outlined below are the different types of fiduciary services available to plan sponsors.

ERISA Section 3(16) Fiduciary Services

A new offering in the marketplace, some third party plan administration firms (TPAs) are willing to be named as ERISA Section 3(16) plan fiduciaries for various plan administration duties. Typically, the different administrative services that these TPAs are willing to serve as fiduciaries for are listed. As a result, the type and quality of 3(16) offerings varies by provider.

For example, there are some TPAs that are willing to serve as 3(16) fiduciaries for distributions and loans but are unwilling to make a determination on whether a Domestic Relations Order is qualified. As a result, at this time the marketplace is a bit uneven in terms of 3(16) fiduciary services.

Plan sponsors should keep in mind that choosing a 3(16) fiduciary to be responsible for some or all of their plan administration duties does not relieve them of all fiduciary responsibility.

ERISA Section 3(21) Fiduciary Services

An ERISA Section 3(21) fiduciary generally provides investment advice to plan sponsors. Typically this takes the form of mutual fund recommendations in 401(k) plans. A 3(21) fiduciary shares fiduciary responsibility with a plan sponsor for any recommendations that are acted upon. Most 401(k) retirement plan sponsors who have retained an investment advisor who is a fiduciary, work with a 3(21) advisor.

ERISA Section 3(38) Fiduciary Services

An ERISA Section 3(38) financial advisor has discretionary authority over plan assets. He/she can buy and sell investments for a retirement plan without plan sponsor knowledge or approval. Section 3(38) financial advisors often are a best fit for non-employee directed retirement plans, like defined benefit plans.

Although there are fairly uniform product offerings for ERISA Section 3(21) and ERISA Section 3(38) fiduciary services, the marketplace for ERISA Section 3(16) fiduciary services is evolving. There are significant differences in service offerings, the quality of those offerings and questions about the ability of some TPAs to financially support their fiduciary responsibilities in the case of a fiduciary breach. Plan sponsors should carefully review ERISA Section 3(16) service offerings with their legal counsel before signing a service agreement.




Investment Policy Statement

An investment policy statement (IPS) defines the processes that a company has adopted to make investment-related decisions with respect to the assets of a ERISA 403(b) and 401(k) plan. The IPS identifies the investment goals and objectives of the plan, establishes how decisions will be made regarding the selection of investments and specifies the procedures for measuring investment performance. While the law does not require that a plan adopt an IPS, it may be the single most important task that a fiduciary performs for the following reasons:

  1. An IPS documents that there is a defined process by which the ERISA 403(b) and 401(k) is being managed.
  2. It helps prevent fiduciaries from making unsteady investment decisions when markets are turbulent.
  3. It clearly identifies plan fiduciaries and helps them manage their responsibilities.
  4. An IPS defines roles and responsibilities of trustees, advisors, custodians and investment managers.
  5. It explains how to hire, monitor and replace investment managers when necessary.
  6. It provides evidence that a clear process and a methodology exist for selecting and monitoring plan investments.
  7. It is a well-articulated, documented procedure for investment selection and ongoing investment evaluation, which are fiduciary obligations.

Get started on your IPS by gathering all of your plan documents (trust documents, summary plan descriptions, written minutes, current vendor service agreements, investment performance reports, enrollment reports, participant educational material, procedural manuals and Form 5500) and review them to determine whether:

  • the plan documents identify the trustees and named fiduciaries;
  • the plan is intended to be ERISA section 404(c)-compliant;
  • there is a clear understanding of the plan expenses and whether they are reasonable;
  • there is a formal process for making investment-related decisions;
  • there is a clear paper trail relative to the process being followed;
  • it is clear who has the authority to make investment decisions; and
  • the trust documents prohibit certain asset classes.

After you have reviewed your plan documents, you are ready to write your IPS. While no single approach is appropriate for everyone, a typical IPS may cover the following:

  1. The Plan – General explanation of the purposes and goals of the IPS; acknowledges applicability of ERISA fiduciary standards and rules; addresses whether the plan is intended to be ERISA section 404(c)-compliant.
  2. Purpose of the IPS – Identifies the objective of the investment policy statement and states the intention to review the policy quarterly, or at least annually, and to amend it as necessary.
  3. The Investment Objectives – Identifies the plan investment philosophy and the processes for the selection, monitoring and evaluation of plan investments.
  4. Duties, Roles and Responsibilities – Generally defines the roles of the parties involved in the management of plan assets and administration of the plan. If there is an investment committee, the members are identified and their roles stated.
  5. Investment and Manager Selection – Identifies the policies and guidelines to be followed when selecting investments and managers.
  6. Investment Monitoring and Reporting – Provides a process by which investment options are regularly reviewed and evaluated for continuing appropriateness.
  7. Investment Manager Monitoring and Termination – States how investment managers will be monitored and how often. Explains how underperforming managers will be evaluated and replaced if necessary.
  8. Coordination with the Plan Document – Clarifies that in event of conflict between the IPS and the plan document, the plan document controls.
  9. Controlling and Accounting for Investment Expenses – Defines the process by which expenses will be reviewed for reasonableness.

It is not enough for you to simply write an IPS. You must also follow it, communicate it and review it. An ignored IPS is evidence that you are not managing or using the plan the way it was intended. Communicating the IPS is important for making sure everyone – participants, managers and service providers – is aware of what the plan involves and whether it is in compliance with the law. The needs and expectations of the plan and participants can change over time, which is why the IPS also needs to be reviewed and, if necessary, revised regularly.

With any plan document, your IPS should be reviewed by legal counsel prior to implementation.








Addressing the lifetime income stream issue

Individuals currently face a greater responsibility for managing their own assets for retirement than in the past. The trend away from defined benefit (DB) plans and toward defined contribution (DC) plans is one reason. Another is the increase in life expectancies leading to longer retirements, which could result in participants outliving their retirement savings.

As a result, there have been a number of changes aimed at providing individuals with an understanding of the need to generate a lifetime stream of income and the options for doing so. There has also been a push for products that allow assets in DC plans to produce such an income stream.

Over the past several years, the Internal Revenue Service (IRS), the Department of Labor (DOL), and the Pension Benefit Guaranty Corporation (PBGC) have responded to this need by providing new regulations, enhancing existing rules,

and issuing proposed rules, all of which are designed to provide individuals with

a lifetime stream of income throughout retirement. Following is a general over view of some recent concepts.


A qualified longevity annuity contract (QLAC) is a straight-life annuity in a DC plan that can be purchased by a participant using his or her existing account balance. QLACs became effective July 2, 2014. A QLAC begins payout at an advanced age (e.g., 80 or 85). Amounts used to purchase a QLAC are excluded from a plan participant's annual mini mum required distribution (RMD) from age 701/2 until the annuity payments begin. Once annuity payments begin, amounts paid from the annuity would count toward satisfying the RMD of the annuity asset.

The current limit on the amount a participant may use to buy a QLAC is the lesser of 25 of the participant's account balance or $125,000. Cost-of-living adjustments will be made in increments of $10,000. If the participant dies before the amount he or she paid for the annuity premium has been paid out, the participant's beneficiary may receive a refund of the remaining premium amount.

plan sponsors are not required to offer a QLAC, and companies will likely need time to develop these new products.

TDF annuities

On October 24, 2014, the IRS issued Notice 2014-66 permitting qualified DC plans to offer target date funds (TDFs) with lifetime income investment options (including deferred annuities). Under this type of arrangement, a plan's lineup of investment options would include a series of TDFs. Each TDF would hold investments appropriate for a specific participant age group, and some would hold deferred annuities. As the age of each group advances, the portfolios of TDFs for older age groups would have a greater portion of deferred annuities. When the TDF reached its target date, it would dis solve and participants with an interest

in that TDF would receive an annuity certificate that would provide either immediate or deferred payments.

Rollovers from DC plans to DB plans Some employers sponsor both a DC plan and a DB plan. DB plans have a lifetime income benefit option. In 20U, the IRS published Revenue Ruling 2012-4, which permits participants who are ready to begin receiving retirement benefits to roll over some or all of their DC plan account balance to the employer's DB plan and convert the rollover amount into an immediate annuity within the DB plan.

On November 25,2014, the PBGC published a final rule that clarifies the treatment of rollovers from DC plans to DB plans when a DB plan terminates in an underfunded status. The final rule says that amounts previously rolled into a

DB plan from a DC plan are not subject to the PBGC's maximum guaranteeable benefit limitations (i.e., the limitations that apply when the PBGC steps in to take over a bankrupt plan). Thus, DC rollover amounts are protected, as are

the amounts due from the PBGC's benefit formula for the DB plan.

Proposed benefit statement rules

In 2013, the DOL's Employee Benefit Security Administration (EBSA) proposed rules that would require lifetime income illustrations to be incorporated into periodic benefit statements so individuals could see estimates of their lifetime income payments based on their current DC account balances. The EBSA believes that illustrating account balances as income streams will motivate DC plan participants to save more so they will be better prepared for retirement.