Employers --who make decisions about their 401k plans--are required by ERISA to employ a prudent process in the management and monitoring of their 401k plan investments. Plan Sponsors are required to not only look at the right information but also do it in the right way.
Five best practices for fiduciary compliance of 401k investments. The five steps are practical moves to minimize your risk of a fiduciary liability lawsuit;
1. Review plan investments once a year
2. Produce a written report covering, the investments and their use by the participants. (Written reports are good evidence of due diligence)
3. Make decisions from the report about the quality and use of the investments
4. Review the plan’s operations and participation levels.
5. Review the investment policy statement and determine whether it continues to be appropriate or requires improvement.
While this short checklist cannot capture all of the issues and deliberations in monitoring a plan’s investments, this is a good start toward both fiduciary compliance and a successful plan.
Want to retire with $1,127,376.04? With more than two decades of operational and management experience Lawrence Groves has developed a sharp eye for how businesses get clobbered with retirement plan fees and how they can retool for a sleeker, smoother, strategically focused retirement plan. He also empathetically helps other business owners create the retirement programs that get results.
With more than two decades of operational and management experience We have developed a sharp eye for how businesses get clobbered with retirement plan fees and limited investment options. We empathetically help other business owners create the retirement programs that get results through checkbook control and self directed investments.
Wednesday, March 29, 2006
Thursday, March 23, 2006
401k Loans
Loan refinancing and multiple loans in Solo 401k
A quick Q & A of the IRS regulations
Q-20: May a solo 401k participant refinance an outstanding loan or have more than one loan outstanding from a plan?
A-20: (a) Refinancings and multiple loans--(1) General rule. A solo 401k participant who has an outstanding loan that satisfies section 72(p)(2) and this section may refinance that loan or borrow additional amounts if, under the facts and circumstances, the loans collectively satisfy the amount limitations of section 72(p)(2)(A) and the prior loan and the additional loan each satisfy the requirements of section 72(p)(2)(B) and (C) and this section. For this purpose, a refinancing includes any situation in which one loan replaces another loan.
(2) Loans that repay a prior loan and have a later repayment date. For purposes of section 72(p)(2) and this section (including the amount limitations of section 72(p)(2)(A)), if a loan that satisfies section 72(p)(2) is replaced by a loan (a replacement loan) and the term of the replacement loan ends after the latest permissible term of the loan it replaces (the replaced loan), then the replacement loan and the replaced loan are both treated as outstanding on the date of the transaction. For purposes of the preceding sentence, the latest permissible term of the replaced loan is the latest date permitted under section 72(p)(2)(C) (i.e., five years from the original date of the replaced loan, assuming that the replaced loan does not qualify for the exception at section 72(p)(2)(B)(ii) for principal residence plan loans and that no additional period of suspension applied to the replaced loan under Q&A-9 (b) of this section).
Thus, for example, if the term of the replacement loan ends after the latest permissible term of the replaced loan and the sum of the amount of the replacement loan plus the outstanding balance of all other loans on the date of the transaction, including the replaced loan, fails to satisfy the amount limitations of section 72(p)(2)(A), then the replacement loan results in a deemed distribution. This paragraph (a)(2) does not apply to a replacement loan if the terms of the replacement loan would satisfy section 72(p)(2) and this section determined as if the replacement loan consisted of two separate loans, the replaced loan (amortized in substantially level payments over a period ending not later than the last day of the latest permissible term of the replaced loan) and, to the extent the amount of the replacement loan exceeds the amount of the replaced loan, a new loan that is also amortized in substantially level payments over a period ending not later than the last day of the latest permissible term of the replacement loan.
(b) Examples. The following examples illustrate the rules of this Q&A-20 and are based on the assumptions described in the introductory text of this section:
Example 1. (i) A Solo 401k participant with a vested account balance that exceeds $100,000 borrows $40,000 from a plan on January 1, 2005, to be repaid in 20 quarterly installments of $2,491 each. Thus, the term of the loan ends on December 31, 2009. On January 1, 2006, when the outstanding balance on the loan is $33,322, the loan is refinanced and is replaced by a new $40,000 loan from the plan to be repaid in 20 quarterly installments. Under the terms of the refinanced loan, the loan is to be repaid in level quarterly installments (of $2,491 each) over the next 20 quarters. Thus, the term of the new loan ends on December 31, 2010.
(ii) Under section 72(p)(2)(A), the amount of the new loan, when added to the outstanding balance of all other loans from the plan, must not exceed $50,000 reduced by the excess of the highest outstanding balance of loans from the plan during the 1-year period ending on December 31, 2005 over the outstanding balance of loans from the plan on January 1, 2006, with such outstanding balance to be determined immediately prior to the new $40,000 loan.
Because the term of the new loan ends later than the term of the loan it replaces, under paragraph (a)(2) of this Q&A-20, both the new loan and the loan it replaces must be taken into account for purposes of applying section 72(p)(2), including the amount limitations in section 72(p)(2)(A). The amount of the new loan is $40,000, the outstanding balance on January 1, 2006 of the loan it replaces is $33,322, and the highest outstanding balance of loans from the plan during 2005 was $40,000.
Accordingly, under section 72(p)(2)(A), the sum of the new loan and the outstanding balance on January 1, 2006 of the loan it replaces must not exceed $50,000 reduced by $6,678 (the excess of the $40,000 maximum outstanding loan balance during 2005 over the $33,322 outstanding balance on January 1, 2006, determined immediately prior to the new loan) and, thus, must not exceed $43,322.
The sum of the new loan ($40,000) and the outstanding balance on January 1, 2006 of the loan it replaces ($33,322) is $73,322. Since $73,322 exceeds the $43,322 limit under section 72(p)(2)(A) by $30,000, there is a deemed distribution of $30,000 on January 1, 2006.
(iii) However, no deemed distribution would occur if, under the terms of the refinanced loan, the amount of the first 16 installments on the refinanced loan were equal to $2,907, which is the sum of the $2,491 originally scheduled quarterly installment payment amount under the first loan, plus $416 (which is the amount required to repay, in level quarterly installments over 5 years beginning on January 1, 2006, the excess of the refinanced loan over the January 1, 2006 balance of the first loan ($40,000 minus $33,322 equals $6,678)), and the amount of the 4 remaining installments was equal to $416. The refinancing would not be subject to paragraph (a)(2) of this Q&A-20 because the terms of the new loan would satisfy section 72(p)(2) and this section (including the substantially level amortization requirements of section 72(p)(2)(B) and (C)) determined as if the new loan consisted of 2 loans, one of which is in the amount of the first loan ($33,322) and is amortized in substantially level payments over a period ending December 31, 2009 (the last day of the term of the first loan) and the other of which is in the additional amount ($6,678) borrowed under the new loan. Similarly, the transaction also would not result in a deemed distribution (and would not be subject to paragraph (a)(2) of this Q&A-20) if the terms of the refinanced loan provided for repayments to be made in level quarterly installments (of $2,990 each) over the next 16 quarters.
Example 2. (i) The facts are the same as in Example 1(i), except that the applicable interest rate used by the plan when the loan is refinanced is significantly lower due to a reduction in market rates of interest and, under the terms of the refinanced loan, the amount of the first 16 installments on the refinanced loan is equal to $2,848 and the amount of the next 4 installments on the refinanced loan is equal to $406. The $2,848 amount is the sum of $2,442 to repay the first loan by December 31, 2009 (the term of the first loan), plus $406 (which is the amount to repay, in level quarterly installments over 5 years beginning on January 1, 2006 the $6,678 excess of the refinanced loan over the January 1, 2006 balance of the first loan).
(ii) The transaction does not result in a deemed distribution (and is not subject to paragraph (a)(2) of this Q&A-20) because the terms of the new loan would satisfy section 72(p)(2) and this section (including the substantially level amortization requirements of section 72(p)(2)(B) and (C)) determined as if the new loan consisted of 2 loans, one of which is in the amount of the first loan ($33,322) and is amortized in substantially level payments over a period ending December 31, 2009 (the last day of the term of the first loan) and the other of which is in the additional amount ($6,678) borrowed under the new loan. The transaction would also not result in a deemed distribution (and not be subject to paragraph (a)(2) of this Q&A-20) if the terms of the new loan provided for repayments to be made in level quarterly installments (of $2,931 each) over the next 16 quarters.
A quick Q & A of the IRS regulations
Q-20: May a solo 401k participant refinance an outstanding loan or have more than one loan outstanding from a plan?
A-20: (a) Refinancings and multiple loans--(1) General rule. A solo 401k participant who has an outstanding loan that satisfies section 72(p)(2) and this section may refinance that loan or borrow additional amounts if, under the facts and circumstances, the loans collectively satisfy the amount limitations of section 72(p)(2)(A) and the prior loan and the additional loan each satisfy the requirements of section 72(p)(2)(B) and (C) and this section. For this purpose, a refinancing includes any situation in which one loan replaces another loan.
(2) Loans that repay a prior loan and have a later repayment date. For purposes of section 72(p)(2) and this section (including the amount limitations of section 72(p)(2)(A)), if a loan that satisfies section 72(p)(2) is replaced by a loan (a replacement loan) and the term of the replacement loan ends after the latest permissible term of the loan it replaces (the replaced loan), then the replacement loan and the replaced loan are both treated as outstanding on the date of the transaction. For purposes of the preceding sentence, the latest permissible term of the replaced loan is the latest date permitted under section 72(p)(2)(C) (i.e., five years from the original date of the replaced loan, assuming that the replaced loan does not qualify for the exception at section 72(p)(2)(B)(ii) for principal residence plan loans and that no additional period of suspension applied to the replaced loan under Q&A-9 (b) of this section).
Thus, for example, if the term of the replacement loan ends after the latest permissible term of the replaced loan and the sum of the amount of the replacement loan plus the outstanding balance of all other loans on the date of the transaction, including the replaced loan, fails to satisfy the amount limitations of section 72(p)(2)(A), then the replacement loan results in a deemed distribution. This paragraph (a)(2) does not apply to a replacement loan if the terms of the replacement loan would satisfy section 72(p)(2) and this section determined as if the replacement loan consisted of two separate loans, the replaced loan (amortized in substantially level payments over a period ending not later than the last day of the latest permissible term of the replaced loan) and, to the extent the amount of the replacement loan exceeds the amount of the replaced loan, a new loan that is also amortized in substantially level payments over a period ending not later than the last day of the latest permissible term of the replacement loan.
(b) Examples. The following examples illustrate the rules of this Q&A-20 and are based on the assumptions described in the introductory text of this section:
Example 1. (i) A Solo 401k participant with a vested account balance that exceeds $100,000 borrows $40,000 from a plan on January 1, 2005, to be repaid in 20 quarterly installments of $2,491 each. Thus, the term of the loan ends on December 31, 2009. On January 1, 2006, when the outstanding balance on the loan is $33,322, the loan is refinanced and is replaced by a new $40,000 loan from the plan to be repaid in 20 quarterly installments. Under the terms of the refinanced loan, the loan is to be repaid in level quarterly installments (of $2,491 each) over the next 20 quarters. Thus, the term of the new loan ends on December 31, 2010.
(ii) Under section 72(p)(2)(A), the amount of the new loan, when added to the outstanding balance of all other loans from the plan, must not exceed $50,000 reduced by the excess of the highest outstanding balance of loans from the plan during the 1-year period ending on December 31, 2005 over the outstanding balance of loans from the plan on January 1, 2006, with such outstanding balance to be determined immediately prior to the new $40,000 loan.
Because the term of the new loan ends later than the term of the loan it replaces, under paragraph (a)(2) of this Q&A-20, both the new loan and the loan it replaces must be taken into account for purposes of applying section 72(p)(2), including the amount limitations in section 72(p)(2)(A). The amount of the new loan is $40,000, the outstanding balance on January 1, 2006 of the loan it replaces is $33,322, and the highest outstanding balance of loans from the plan during 2005 was $40,000.
Accordingly, under section 72(p)(2)(A), the sum of the new loan and the outstanding balance on January 1, 2006 of the loan it replaces must not exceed $50,000 reduced by $6,678 (the excess of the $40,000 maximum outstanding loan balance during 2005 over the $33,322 outstanding balance on January 1, 2006, determined immediately prior to the new loan) and, thus, must not exceed $43,322.
The sum of the new loan ($40,000) and the outstanding balance on January 1, 2006 of the loan it replaces ($33,322) is $73,322. Since $73,322 exceeds the $43,322 limit under section 72(p)(2)(A) by $30,000, there is a deemed distribution of $30,000 on January 1, 2006.
(iii) However, no deemed distribution would occur if, under the terms of the refinanced loan, the amount of the first 16 installments on the refinanced loan were equal to $2,907, which is the sum of the $2,491 originally scheduled quarterly installment payment amount under the first loan, plus $416 (which is the amount required to repay, in level quarterly installments over 5 years beginning on January 1, 2006, the excess of the refinanced loan over the January 1, 2006 balance of the first loan ($40,000 minus $33,322 equals $6,678)), and the amount of the 4 remaining installments was equal to $416. The refinancing would not be subject to paragraph (a)(2) of this Q&A-20 because the terms of the new loan would satisfy section 72(p)(2) and this section (including the substantially level amortization requirements of section 72(p)(2)(B) and (C)) determined as if the new loan consisted of 2 loans, one of which is in the amount of the first loan ($33,322) and is amortized in substantially level payments over a period ending December 31, 2009 (the last day of the term of the first loan) and the other of which is in the additional amount ($6,678) borrowed under the new loan. Similarly, the transaction also would not result in a deemed distribution (and would not be subject to paragraph (a)(2) of this Q&A-20) if the terms of the refinanced loan provided for repayments to be made in level quarterly installments (of $2,990 each) over the next 16 quarters.
Example 2. (i) The facts are the same as in Example 1(i), except that the applicable interest rate used by the plan when the loan is refinanced is significantly lower due to a reduction in market rates of interest and, under the terms of the refinanced loan, the amount of the first 16 installments on the refinanced loan is equal to $2,848 and the amount of the next 4 installments on the refinanced loan is equal to $406. The $2,848 amount is the sum of $2,442 to repay the first loan by December 31, 2009 (the term of the first loan), plus $406 (which is the amount to repay, in level quarterly installments over 5 years beginning on January 1, 2006 the $6,678 excess of the refinanced loan over the January 1, 2006 balance of the first loan).
(ii) The transaction does not result in a deemed distribution (and is not subject to paragraph (a)(2) of this Q&A-20) because the terms of the new loan would satisfy section 72(p)(2) and this section (including the substantially level amortization requirements of section 72(p)(2)(B) and (C)) determined as if the new loan consisted of 2 loans, one of which is in the amount of the first loan ($33,322) and is amortized in substantially level payments over a period ending December 31, 2009 (the last day of the term of the first loan) and the other of which is in the additional amount ($6,678) borrowed under the new loan. The transaction would also not result in a deemed distribution (and not be subject to paragraph (a)(2) of this Q&A-20) if the terms of the new loan provided for repayments to be made in level quarterly installments (of $2,931 each) over the next 16 quarters.
Wednesday, March 22, 2006
2006 Defined Contribution Plan Limits
Each year the IRS updates the Plan Limits for Qualified Plans. Following are the limits for 2006.
Code
Section
401(a)
Annual Compensation : $220,000
401k/ 403(b)Elective
Deferrals : $15,000
Maximum
Compensation : $220,000
SIMPLE
Maximum
Contributions : $10,000
Highly
Compensated
Threshold : $100,000
401k/403(b)
Catch-up
Contributions : $5,000
414(v)(2)(B)(ii)
Catch-up
Contributions : $2,500
415(b)(1)(A)
DB Limits : $175,000
415(c)(1)(A)
DC Limits : $44,000
416(i)(1)(A)(i)
Key EE : $140,000
457(e)(15)
Deferral Limits : $15,000
TWB : $94,200
Code
Section
401(a)
Annual Compensation : $220,000
401k/ 403(b)Elective
Deferrals : $15,000
Maximum
Compensation : $220,000
SIMPLE
Maximum
Contributions : $10,000
Highly
Compensated
Threshold : $100,000
401k/403(b)
Catch-up
Contributions : $5,000
414(v)(2)(B)(ii)
Catch-up
Contributions : $2,500
415(b)(1)(A)
DB Limits : $175,000
415(c)(1)(A)
DC Limits : $44,000
416(i)(1)(A)(i)
Key EE : $140,000
457(e)(15)
Deferral Limits : $15,000
TWB : $94,200
Tuesday, March 21, 2006
Fidelity Investment Head Calls Congressmen's Abilities into Question... She Has the Answer.
In a rare February public appearance at the East Coast Defined Contribution Conference in Palm Beach Gardens, Florida, Abigail Johnson, president of Fidelity Investments’ Employer Services Co., said "It will take years before our political leaders figure out how to reform health care and fix Social Security."
"But there is a great deal that financial service providers and plan sponsors can do right now."
Citing Fidelity statistics, Johnson said that one-third of eligible employees do not participate in their 401(k) plans at all. One-fifth of participants don’t diversify and only invest in one investment option. Eighty-three percent do not seek out investment advice.
And once employees choose investments for their plans, they fail to reallocate as they grow older. The study finds that 401(k) plan participants are more likely than not to leave their retirement plan accounts unchanged over a 10-year period.
In an interview with Workforce Management following her presentation, Johnson emphasized the need to address low-income workers’ needs, since they seem to be the ones who are most at risk of not having enough money for retirement. Managed accounts, while often a good solution for some 401(k) participants, may not make sense for this group because they are expensive, she said.
By automatically enrolling employees in a lifecycle fund, companies could help low-income workers increase their retirement savings by 29 percent, she said.
If employers do this, "inertia will work in (employees’) favor in most cases," she said.
Would she apply Fidelity's approach to Employee Health Care too?
Want to retire with $1,127,376.04? With more than two decades of operational and management experience Lawrence Groves has developed a sharp eye for how businesses get clobbered with retirement plan fees and how they can retool for a sleeker, smoother, strategically focused retirement plan. As an entrepreneur who quickly built his own successful consulting business he also empathetically helps other business owners set priorities and create the retirement programs that get results.
"But there is a great deal that financial service providers and plan sponsors can do right now."
Citing Fidelity statistics, Johnson said that one-third of eligible employees do not participate in their 401(k) plans at all. One-fifth of participants don’t diversify and only invest in one investment option. Eighty-three percent do not seek out investment advice.
And once employees choose investments for their plans, they fail to reallocate as they grow older. The study finds that 401(k) plan participants are more likely than not to leave their retirement plan accounts unchanged over a 10-year period.
In an interview with Workforce Management following her presentation, Johnson emphasized the need to address low-income workers’ needs, since they seem to be the ones who are most at risk of not having enough money for retirement. Managed accounts, while often a good solution for some 401(k) participants, may not make sense for this group because they are expensive, she said.
By automatically enrolling employees in a lifecycle fund, companies could help low-income workers increase their retirement savings by 29 percent, she said.
If employers do this, "inertia will work in (employees’) favor in most cases," she said.
Would she apply Fidelity's approach to Employee Health Care too?
Want to retire with $1,127,376.04? With more than two decades of operational and management experience Lawrence Groves has developed a sharp eye for how businesses get clobbered with retirement plan fees and how they can retool for a sleeker, smoother, strategically focused retirement plan. As an entrepreneur who quickly built his own successful consulting business he also empathetically helps other business owners set priorities and create the retirement programs that get results.
Monday, March 20, 2006
IRS Attacks 401k Part-time Employee Exclusions and Your Determination Letter is useless
The IRS issued the February 14, 2006 Quality Assurance Bulletin (QAB) dealing with 401k plan exclusions of part-time, temporary, and seasonal (A.K.A. part-time) employees. This QAB revolutionizes the way IRS document examiners will look at 401k plan eligibility clauses and warns that inadequately drafted provisions dealing with part-time employees may be disqualifying, regardless of any plan determination letter.
Why the Attack ?
As 401(k) plans have matured, newly recruited employees are no longer willing to wait the traditional 1000 hour, one-year eligibility period to begin participating. Many employers are liberating their traditional 401k plans of a 1000 hrs year wait by allowing immediate eligibility, at least for the deferral portion of the plan.
Other employers, while permitting immediate eligibility, wish to also avoid covering part-time employees because of :
(1) the negative effect on the ADP test as part-timers seldom contribute and will be counted as a zero.
(2) the administrative costs of adding and deleting new employees and
(3) the part-timers zero balance will prescribe a top heavy contribution.
Employers are now looking to provide immediate deferral entry and simultaneously exclude part-timers as a classification .
The Problem:
Treas. Reg. §1.410(a)-3 notes that a service condition requiring more than one thousand hours year of service is invalid. In other words what matters is that the plan as written, could have a service requirement in excess of the Code §410(a) limits, which is enough to disqualify the plan. Therefore, as a class part-timers can not be excluded.
IRS additionally addressed this issue in the following:
1.A 1994 Field Directive instructed IRS examiners to challenge plans which had these service requirements.
2.The IRS modified Publication 794, which accompanies determination letters, added the following :
3.A 2002 Recurring Issue Focus (RIF) told IRS examiners that this would be an audit issue, not a determination letter matter.
IRS 401k Attack
Effective with the February 14, 2006 QAB the IRS examiners will again challenge 401k plans with the part-time exclusions. Examiners will not ,however, be challenging an exclusion classification that is defined without reference to hours of service (e.g., hourly paid employees). The QAB states:
Employers 401k Triumph
Plan sponsors should carefully examine their 401k plans if they currently exclude part-time employees from participation. If the plan does not have a fail-safe to assure that the plan will comply with Code §410(a), the sponsor should consider amending the plan.
The employer could regain the provision by including fail-safe language for the condition where the employee works more than 1,000 hours of service during a plan year. The plan can exclude part-time employees as a classification until they meet the year of service requirement, even though full-time employees enter immediately.
Want to retire with $1,127,376.04? With more than two decades of operational and management experience Lawrence Groves has developed a sharp eye for how businesses get clobbered with retirement plan fees and how they can retool for a sleeker, smoother, strategically focused retirement plan.
Why the Attack ?
As 401(k) plans have matured, newly recruited employees are no longer willing to wait the traditional 1000 hour, one-year eligibility period to begin participating. Many employers are liberating their traditional 401k plans of a 1000 hrs year wait by allowing immediate eligibility, at least for the deferral portion of the plan.
Other employers, while permitting immediate eligibility, wish to also avoid covering part-time employees because of :
(1) the negative effect on the ADP test as part-timers seldom contribute and will be counted as a zero.
(2) the administrative costs of adding and deleting new employees and
(3) the part-timers zero balance will prescribe a top heavy contribution.
Employers are now looking to provide immediate deferral entry and simultaneously exclude part-timers as a classification .
The Problem:
Treas. Reg. §1.410(a)-3 notes that a service condition requiring more than one thousand hours year of service is invalid. In other words what matters is that the plan as written, could have a service requirement in excess of the Code §410(a) limits, which is enough to disqualify the plan. Therefore, as a class part-timers can not be excluded.
IRS additionally addressed this issue in the following:
1.A 1994 Field Directive instructed IRS examiners to challenge plans which had these service requirements.
2.The IRS modified Publication 794, which accompanies determination letters, added the following :
A determination letter may not be relied on with respect to whether a plans exclusion classifications, if any, violate the minimum age or service requirements of section 410 by indirectly imposing an impermissible age or service requirement.
3.A 2002 Recurring Issue Focus (RIF) told IRS examiners that this would be an audit issue, not a determination letter matter.
IRS 401k Attack
Effective with the February 14, 2006 QAB the IRS examiners will again challenge 401k plans with the part-time exclusions. Examiners will not ,however, be challenging an exclusion classification that is defined without reference to hours of service (e.g., hourly paid employees). The QAB states:
Specialists should take note that the issue of whether a plan is providing a direct or indirect service requirement is not limited to part-time or seasonal employees. Any exclusion classification, whether it be part-time, seasonal, temporary, or any other classification of employees, should be closely scrutinized. Specialists should require that any such classification be clearly defined.
Employers 401k Triumph
Plan sponsors should carefully examine their 401k plans if they currently exclude part-time employees from participation. If the plan does not have a fail-safe to assure that the plan will comply with Code §410(a), the sponsor should consider amending the plan.
The employer could regain the provision by including fail-safe language for the condition where the employee works more than 1,000 hours of service during a plan year. The plan can exclude part-time employees as a classification until they meet the year of service requirement, even though full-time employees enter immediately.
Want to retire with $1,127,376.04? With more than two decades of operational and management experience Lawrence Groves has developed a sharp eye for how businesses get clobbered with retirement plan fees and how they can retool for a sleeker, smoother, strategically focused retirement plan.
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