401(k) Boot Camp Part 3 Getting Money Out of the Plan

Transcription

1 401(k) Boot Camp Part 3 Getting Money Out of the Plan November 19, 2014 Presenter: Nancy J. Manary, Director Benefits Consulting Verisight, Inc.

2 401(k) Boot Camp Part 3 Part 1 Getting People Into the Plan Eligibility rules and enrollment procedures Part 2 Getting Money Into the Plan Contribution rules and ADP/ACP tests Part 3 Getting Money Out of the Plan Loans, hardship withdrawals, and benefit distributions 2

3 401(k) Boot Camp - Overview Key Objectives for Attendees Understand your plan s actual provisions Apply plan rules correctly to avoid common operational errors Increase your comfort level with in-house plan responsibilities Improve the accuracy of your explanations of plan provisions to employees Make your plan run smoothly and effectively 3

4 Reminders from Parts 1 and 2 Know the provisions of your plan Follow the provisions of your plan Treat all participants in a non-discriminatory manner Keep good records Call your TPA for assistance 4

5 Definitions Plan Sponsor the employer in the case of an employee benefit plan established or maintained by a single employer, the employee organization in the case of a plan established or maintained by an employee organization, or in the case of a plan established or maintained by two or more employers or jointly by one or more employers and one or more employee organizations, the association, committee, joint board of trustees, or other similar group of representatives of the parties who establish or maintain the plan. Plan Administrator person specifically so designated by the terms of the instrument under which the plan is operated; in the absence of a designation in the case of a plan maintained by a single employer, the employer 5

6 Definitions Third Party Administrator (TPA) Organization that is hired by the plan sponsor (typically the employer) to run many day-to-day aspects of a retirement plan. Examples of responsibilities amending and restating plan documents; preparing employer and employee benefit statements; assisting in processing all types of distributions from the plan; preparing loan paperwork for plan participant; testing the plan each year to gauge its compliance with all IRS nondiscrimination requirements as well as plan and participant contribution limits; allocation of employer contributions and forfeitures; calculating participant vested percentages; and, preparing annual returns and reports required by IRS, DOL or other government agencies. 6

7 Definitions Recordkeeper Custodian of plan assets or the plan s investment platform. Examples of responsibilities value investments; provide participants with statements on their accounts; process distribution checks 7

8 Participant Loans 8

9 Statutory requirements for participant loans Maximum loan amount $50,000 or 50% of vested account balance, whichever is less Maximum repayment period Five years for regular loans Longer period allowed for primary residence home loans Reasonable interest rate Regular amortization with payments at least quarterly Available to all participants on reasonably equivalent basis 9

10 Plan document requirements for participant loans Not all 401(k) plans offer participant loans Check your plan document to see if it allows loans Check your plan document for loan restrictions or conditions other than the five statutory requirements A separate written loan program is required to specify operational details applicable to loans unless the details are addressed in plan document. 10

11 Audience Question Jack has a $50,000 account balance, of which $30,000 is vested. What is the maximum amount Jack can borrow from the plan (assuming he has no other plan loans)? 1. $50, $30, $25, $15,000 11

12 Allowable administrative restrictions on loans Loans available only from certain accounts deferral accounts only, for example Loans available only for certain circumstances Limit on number of loans outstanding at one time per participant Limit on number of loan requests per participant per year Minimum loan amount minimum cannot be higher than $1,000 12

13 Allowable administrative restrictions on loans Repayment by payroll deduction only Participant must pay all administrative costs for loan processing and/or recordkeeping Loan balance becomes fully due and payable when participant terminates employment Check your plan document and Loan Program to see which administrative restrictions (if any) apply to your plan 13

14 Loan documentation Maintain complete documentation on each participant loan Loan request or application form Promissory note Pledge of vested account balance as collateral for loan Spousal consent Required if plan has annuity as primary form of distribution Amortization schedule Without full documentation, a loan will look like a benefit distribution to an active employee to an IRS or DOL auditor 14

15 Determining allowable loan amount $50,000 statutory limit on maximum loan is reduced by highest loan balance in past 12 months 50% of vested account limit includes all current loan balances All plans of the employer are aggregated in applying loan limits to a participant Cannot have $50,000 loan from the 401(k) plan and another $50,000 loan from the company s separate profit sharing plan 15

16 Determining reasonable interest rate Must be based on interest rates being charged by financial institutions in your region for comparable loans Select benchmark for comparability Home equity loan rate Prime rate plus 1% Confirm w/ your plan s recordkeeper that they will maintain the interest benchmark w/ updates as needed Document the source for interest rate selected for each participant s loan to demonstrate non-discrimination in practice 16

17 Determining loan repayment period Decided by trustee(s), but participant can request a specific repayment period Can vary by loan amount Exception to five-year maximum repayment period applies only to loans used to purchase a primary residence Includes down payment or closing costs Not for home improvements Not for vacation homes Not for refinancing the mortgage on an existing primary residence 17

18 Handling loan repayments Require loan payments by payroll deduction, if possible If this is your rule, treat everyone the same; no exceptions Notify payroll department to start withholding loan payments as soon as the loan is issued Loan repayments are after-tax payroll deductions Employee may continue making salary deferrals while repaying a loan 18

19 Handling loan repayments Forwarding loan payments to the plan subject to same prompt deposit rules as employee deferrals Remember rules on this point from Part 2 Report salary deferrals and loan repayments separately to the plan s recordkeeper and TPA so loan payments not misclassified as salary deferrals Assign in-house person to track loan payments on amortization schedule so payroll deductions will cease when the loan is fully paid 19

20 Loan default Occurs when payments are behind at end of one quarter and not brought current by end of next quarter Mandatory with the following limited exceptions: Leaves of absence less than 12 months 1. Must repay loan within maximum repayment period of original loan date Qualified military leave 1. May exceed 12 months 2. Loan payments must resume after leave ends 3. Maximum loan period is original period plus qualified military leave period 20

21 Loan default Most loan defaults occur when a participant terminates employment with loan balance outstanding Participant can be given days after termination of employment to pay off the remaining loan balance Usually through refinancing commercially If not paid off within time period specified, the unpaid loan balance, including accrued interest, is defaulted 21

22 Loan default Defaulted loan is treated as a deemed distribution, taxable to the participant (federal, state, and local income taxes) 10% federal penalty tax applies in addition to ordinary income taxes if participant is under age 59½ at default Notify recordkeeper or TPA of loan defaults by terminated participants prior to end of calendar year Form 1099-R required to report the taxable deemed distribution 22

23 HARDSHIP WITHDRAWALS 23

24 Statutory issues 401(k) plan benefit payments are normally allowed only after termination of employment Hardship withdrawals by active employees are an exception to this rule against distributions while actively employed Only if certain conditions are met Only if allowed by the provisions of the plan 24

25 Statutory issues, continued Available from vested account balances only Not available from safe harbor 401(k) contribution accounts, QNECs, or QMACs Cannot include investment income earned after 12/31/1988 on salary deferrals 25

26 Document requirements Specific plan document language is required for hardship withdrawals Not all 401(k) plans allow hardship withdrawals Don t make assumptions; check your own plan document Plan may limit hardship withdrawals to certain accounts Frequently limited to salary deferral accounts only 26

27 Determining if Hardship situation exists IRS safe harbor definition of hardship events: Purchase of participant s primary residence (not just a first home) College education expenses for participant, beneficiary, or dependent Uninsured medical costs of participant, beneficiary or dependent To prevent eviction from home or foreclosure on mortgage for primary residence Funeral expenses for participant s spouse, parents, children, beneficiary, or dependent Home repairs after major casualty losses added after Hurricane Katrina 27

28 Administrative rules with IRS safe harbor definition Withdrawal must be limited to specific $ amount needed for hardship Amount can be grossed up to cover income taxes Participant must have no other resources available to meet hardship, including a loan from the plan Employer may rely on participant s written certification Salary deferrals to all deferred compensation plans must be suspended for next six months after taking hardship withdrawal Deferred compensation plans include 403(b) and 457 plans 28

29 Administrative rules w/ non-irs safe harbor definitions Hardship circumstances can be defined more broadly by employer Caution - could lead to improper distributions if too lenient Withdrawal limited to specific $ amount needed for the hardship No withdrawal of investment income earned on salary deferrals after 12/31/1988 Individual situations must be assessed by employer Employer must examine participant s financial resources to determine if other assets are available to meet the hardship need Suspension of salary deferrals for six months is not required when using a non- IRS safe harbor definition of hardship 29

30 Operational issues Provide hardship withdrawal instructions and application to employee or direct plan participants to recordkeeper s web site for hardship withdrawal instructions and forms Require full documentation of actual hardship situation & retain documentation in plan files as proof if audited by IRS/DOL Notify financial institution that the amount being paid out is a hardship withdrawal To ensure 1099-R will be coded correctly Notify payroll department or payroll company to stop employee deferrals for next six months, if applicable Participant loan payments, if any, are NOT stopped 30

31 Income tax treatment Subject to ordinary income tax in year withdrawn Federal, state, and local Subject to additional 10% federal excise (penalty) tax if participant is under age 59 ½ Hardship withdrawals are not eligible for rollover Income tax withholding on hardship withdrawals is not mandatory Participant completes IRS Form W-4P to indicate federal withholding amount desired (if any) 31

32 OTHER IN-SERVICE DISTRIBUTIONS 32

33 Other in-service distributions Several exceptions apply to the general prohibition against distributions to participants while still employed Hardship withdrawals, as previously discussed Withdrawals after a specified age (usually 59 ½) Withdrawals after reaching normal retirement age Withdrawals after specified # of years of plan participation Withdrawals after contributions have accumulated for specified time Withdrawals from a rollover account Each type of in-service distribution is available only if the plan document has specific provisions allowing such an exception 33

34 Specified age Cannot be less than 59 ½ for: Salary deferral accounts Safe harbor employer-funded accounts QNECs or QMACs Cannot be less than normal retirement age for any accounts attributable to a mergedin pension plan - NRA 62 or older Specified age not required for other accounts Such as profit sharing accounts or non safe harbor match accounts 34

35 In-service withdrawals after Normal Retirement Age Normal Retirement Age (NRA) defined in plan document can be used for in-service withdrawals from profit sharing and match accounts NRA for in-service withdrawal cannot be less than age 62 for merged-in pension accounts NRA in-service rule cannot override prohibition against in-service withdrawals prior to age 59 ½ for Salary deferral accounts QNEC & QMAC accounts (includes safe harbor 401(k) acct) 35

36 In-service withdrawals after specified time period In-service withdrawals from profit sharing and non safe harbor match accounts are allowable After employee has participated in the plan for a specified period of years (may not be less than five) After amounts being distributed have accumulated in the plan for at least two years 36

37 In-service withdrawals from rollover accounts Many plan documents allow in-service withdrawals from rollover accounts at any time and for any reason Check your plan document to see what in-service withdrawal rules are applicable to rollover accounts 37

38 Are participant loans in-service withdrawals? Participant loans are not in-service withdrawals They are loans that must be repaid w/ interest within specified time They become a deemed distribution only if the loan goes into default Loans that the participant has no intention of repaying are not treated as a loan Considered an in-service distribution by IRS or DOL If the loan would not meet the legal requirements for an in-service distribution, allowing a loan that the participant has no intention of repaying would be a serious operational error that could jeopardize the plan s tax-qualified status 38

39 Audience Question Which of the following transactions would be an allowable in-service withdrawal if provided for within the plan document? 1) In-service withdrawal from deferral acct at age 50 2) In-service withdrawal from QNEC acct at age 55 3) In-service from a merged-in pension acct at age 60 4) In-service withdrawal from a rollover acct at age 40 39

40 In-Plan Roth conversions Would permit a participant to directly roll over a pre-tax distribution to their Roth account in the same plan Participant must be eligible for a distribution from the plan Any conversion would be taxable to participant Plan amendment required 40

41 BENEFIT DISTRIBUTIONS TO TERMINATED EMPLOYEES 41

42 Timing of distributions plan provisions Plan document must specify when benefit payments will be made or will begin (for installment payments) Every plan is different Check your plan document for exact provisions No exceptions are allowed; treat everyone the same If you do not like the current plan provisions on timing of distributions, talk to your TPA or plan consultant about amending them instead of making exceptions 42

43 Participant s option to postpone distribution Terminated participants with vested benefits > $5,000 May postpone benefit distribution until age 70½ Participants with vested benefits < $5,000 Can be forced to take distribution, but only if the plan document has an involuntary distribution provision Some plans reduce $5,000 involuntary distribution threshold to $1,000 Some plans have no provisions for involuntary distributions so even small account balances can be left in the plan if former participant wants to postpone taking a distribution 43

44 Involuntary distribution of small accounts For vested benefits <$5,000 (or $1,000) Requires minimum 30 day advance notice to participant Notice must describe optional forms of benefit payment and tax consequences of the distribution Involuntary distribution occurs only if terminated employee does not respond to notice with information on how he/she would like to be paid out Rollover accounts from unrelated plans Do not have to be counted in determining $5,000 (or $1,000) involuntary distribution threshold Check document to see if rollovers are excluded from determination of involuntary distribution threshold 44

45 Involuntary distribution of small accounts Involuntary distributions of $1,000 - $5,000 Must be rolled over directly to an IRA selected by the employer Involuntary distributions < $1,000 Paid directly to terminated participant Income taxes must be withheld unless distribution is < $200 45

46 Involuntary distribution of small accounts If a plan has involuntary distribution provisions, do you have to enforce every situation? Yes you must treat all employees in a uniform, non-discriminatory manner Yes because failure to follow the terms of the plan document is a potentially disqualifying operational error If you do not like your plan s current provisions with respect to involuntary distributions, talk to your TPA or plan consultant about changing them 46

47 Why use involuntary distribution provisions? Important step in controlling administrative costs Small accounts are often forgotten by terminated participants Lost participants may be hard to find and pay out later Recordkeeping fees may be based on participant count Terminated participants with account balances are included in Form 5500 participant counts If participant count is 100/120 or more, the plan is subject to annual audit requirement 47

48 Timing of distributions employee communication Let participants know how soon they can get a distribution after terminating employment Best practice hand-out for terminating employees When benefits will be or can be paid Instructions for requesting benefit distribution Applicable forms Reminder to inform company of address changes until all benefits have been distributed 48

49 Alternate forms of benefit payment Plan document specifies available forms of benefit payment Lump sum distribution Often the only form of benefit payment available Installment payments over a period of years Annuity purchased from an insurance company 49

50 Alternate forms of benefit payment If annuities are available as form of benefit payment Employee must waive annuity to select alternate form of payment if vested benefit is > $5,000 and if an annuity is the default form of payment under the plan Spousal consent is required on waiver of annuity Annuities are not included in many 401(k) plans Check your plan document to see if annuities are still offered in your plan 50

51 Alternate forms of benefit payment Lump sum distributions Generally eligible for tax-free rollover to IRA or another retirement plan Income tax withholding required when not rolled over to IRA or another plan Investment institution holding plan assets usually handles income tax withholding and reporting on benefit distributions TPA or plan consultant can provide detailed instructions if plan sponsor handles its own benefit payments and income tax withholding and reporting 51

52 Administrative forms for terminated participants Distributions often handled by financial institution holding plan assets If your company handles the benefit distributions Provide the following forms to each terminated participant Distribution election form Annuity notice and waiver (if applicable) Notice of tax treatment of distribution TPA can provide samples of each form, if needed 52

53 DEATH BENEFITS, QDRO S, LOST PARTICIPANTS 53

54 Death benefits Every participant should complete designation of beneficiary form when eligible for the plan Even those not deferring - they might receive non-matching employer contribution If beneficiaries is not designated, plan document determines Beneficiary of a married participant Must be spouse unless spouse agrees in writing to naming another beneficiary Remind participants to keep beneficiary designations up-to-date to reflect changes in personal circumstances Marriage, divorce, or remarriage Birth or adoption of child or additional children 54

55 Death benefits Most recent beneficiary designation form will apply Unless overridden by spousal beneficiary rules Participant can designate multiple beneficiaries (with details on how the benefit is to be split between the beneficiaries) Plan document should have default rules for unmarried participants who die with no written beneficiary designation review basic plan document Plan document should have detail if a death benefit must be paid to a beneficiary who is a minor 55

56 Death benefits Beneficiary can select any form of payment allowed under the plan Timing of benefit payment rules apply to beneficiaries Including right to postpone payment if death benefit is > $5,000 Beneficiaries who postpone taking a distribution must be given similar rights and privileges as any plan participant Right to self-direct the investment of his/her account Right to take a loan from the plan Right to receive a copy of the Summary Plan Description Right to receive all notices about the plan that are provided to employees Beneficiary does not have the right to contribute to the plan 56

57 Death benefits Death benefit distributions are taxable to the beneficiary Spouse beneficiaries may roll over death benefit to his/her own IRA Non-spouse beneficiaries may roll over death benefit to an inherited IRA Death benefits are not subject to the 10% penalty tax on distributions taken prior to age 59 ½, Regardless of age of the deceased participant Regardless of age of the beneficiary 57

58 Payment of benefits under a Qualified Domestic Relations Order (QDRO) Divides a participant s account with spouse, ex-spouse, child or other dependent, through a court-approved domestic agreement Must be written to properly identify the: Plan and participant Alternate payee to whom benefits are to be paid Amount to be paid to the alternate payee Requires careful review by the plan sponsor before complying 58

59 Payment of benefits under a Qualified Domestic Relations Order (QDRO) Alternate payee can select any form of payment allowed by plan Timing of benefit payment rules apply to alternate payees Including right to postpone payment if vested benefit is > $5,000 Alternate payees who postpone taking a distribution must be given same rights and privileges as any plan participant or beneficiary Right to self-direct the investment of his/her account Right to receive a copy of the Summary Plan Description Right to receive all notices about the plan that are provided to employees Alternate payee does not have the right to contribute to the plan 59

60 Finding and paying out lost participants Pay out terminated participants as soon as possible after termination of employment Especially those with small account balances If distributions delayed, the plan is more likely to lose track of the former employee Lost participants add to administrative costs of the plan 60

61 Finding and paying out lost participants Locating lost participants Send notices by certified mail with return receipt requested Ask current employees for help Some may still be in contact with the former employee Try internet searches or commercial locator services IRS letter forwarding program is no longer available (8/31/2012) Pay people out as soon as possible to minimize the number of lost participants 61

62 COMMON OPERATIONAL ERRORS LOANS, HARDSHIPS, BENEFITS PAYMENTS 62

63 Common operational error #1 Failing to notify payroll department to start deducting loan payments after employee takes a loan from the plan If employee is behind in loan payments at end of one calendar year quarter and not caught up by end of following quarter, 1) You must declare the unpaid loan balance as defaulted and report it as a taxable distribution to the employee, or 2) You may submit to the IRS under its Voluntary Correction Program (VCP) to request make-up of missed payments; and to DOL under its Voluntary Fiduciary Correction Program (VFCP). 63

64 Best practices to prevent error #1 In-house staff (usually HR) that requests loans from vendor must immediately notify payroll department when a loan request has been approved Payroll department must have loan amortization schedule showing amount to withhold each pay period as a loan repayment Payroll must keep track of dates participant loans will be paid in full so repayment amounts will stop being withheld from paychecks 64

65 Common operational error #2 Failing to notify TPA or recordkeeper when a participant with an outstanding loan terminates employment and stops repaying the loan Same corrections as error #1 65

66 Best practices to prevent error #2 HR should always check for outstanding 401(k) plan loans when processing terminated employees Have a prepared notice to give all terminated employees with outstanding loan balances Explaining requirement to repay loan in full within a specified time or have loan balance be defaulted and reported to IRS as a taxable distribution 66

67 Common operational error #3 Missing or incomplete documentation of circumstances permitting an employee to take a hardship withdrawal If not properly documented as a hardship withdrawal, an in-service withdrawal by a participant under age 59 ½ could be treated by the IRS as a plan operational error 67

68 Best practices to prevent error #3 Train in-house staff on specific and limited circumstances that must exist for an active employee to take a hardship withdrawal Require written proof of hardship situation before approving Eviction notice Contract to purchase a home Bill for uninsured medical expenses Bill for upcoming semester s college tuition Keep all documentation regarding hardship withdrawal in permanent personnel files so it will be available in the event of a plan audit by the IRS. 68

69 Common operational error #4 Failing to stop employee salary deferrals for six months after a hardship withdrawal taken A six month suspension of salary deferrals is required whenever an employee takes a hardship withdrawal from a 401(k) plan, if the plan uses the IRS safe harbor definition of hardship 69

70 Required correction for error #4 Refund the following amounts Employee salary deferrals contributed during six months after hardship withdrawal Investment income earned on such deferrals. Refund is not eligible for rollover Forfeit the following amounts: Matching contributions based on salary deferrals made during what should have been the six-month suspension period Investment income earned on such matching amounts 70

71 Best practices to prevent error #4 Train in-house staff on requirements relating to hardship withdrawals Create in-house checklist for hardship withdrawal requests Notification of payroll to stop salary deferrals as soon as hardship withdrawal granted (but NOT loan repayments, if applicable) Send reminder in six months to find out if participant wants to resume salary deferrals (Human Resources) 71

72 Summary Understand your plan s actual provisions for participant loans, hardship withdrawals and in-service distributions Eligibility Limits Understand your plan s operational issues for distributions Requirements Documentation Understand common operational errors and how to avoid them 72

73 Thank You! ` 73