Tags: Retirement Planning
Recently the IRS issued written guidance(1) that significantly impacts all qualified plans and the benefits received under those plans by individuals who have entered into a same‐sex marriage. Among other things, this new guidance impacts 401(k) nondiscrimination testing, the definition of highly compensated employees, beneficiary designations, hardship distributions, participant loans, qualified joint and survivor annuities, rollovers, required minimum distributions, and the overall requirements for a retirement plan to remain “qualified” under the Internal Revenue Code.
These new same‐sex rules affect all sponsors of qualified retirement plans including for‐ profit, non‐profit, governmental, churches, denominations, and para‐church organizations. Furthermore, these rules affect all qualified retirement plans including 401(k), profit sharing, defined benefit, ESOP, money purchase, cash balance plans, etc., as well as ERISA and non‐ERISA 403(b) plans.
On June 26, 2013 the United States Supreme Court issued a landmark ruling (called the Windsor decision) that invalidated Section 3 of the Defense of Marriage Act (DOMA)(2) which stated that for a marriage to be valid under federal law it had to be between a man and a woman.
Following the Windsor decision, the IRS issued guidance(3) on August 29, 2013 (which applied prospectively as of September 16, 2013) which stated that for tax purposes the federal government would determine one’s legal marital status based upon the state of celebration, not the state of residency.
John and James live in Colorado but were married in New Jersey, one of the 16 states that recognize samesex marriage. Although Colorado does not recognize samesex marriage, the federal government considers John and James to be married and entitled to the same federal tax treatments afforded a heterosexual couple.
This IRS Revenue Ruling stated that future IRS guidance would explain how these new rules may impact qualified retirement plans retroactively. IRS Notice 2014‐19, issued April 5, 2014, provides the clarity that we have needed with respect to the Windsor decision.
Summary of IRS Notice 201419
For a retirement plan to remain a “qualified” retirement plan under Section 401(a) of the Internal Revenue Code, the retirement plan must grant a samesex spouse the same rights it would an oppositesex spouse. More specifically, a qualified plan’s operations must reflect the Windsor decision retroactively as of June 26, 2013. However, such plans only have to recognize the above‐referenced state of celebration rule from September 16, 2013 forward.
Impact of Disqualification
A retirement plan that does not comply with these rules will face disqualification by the IRS meaning that, for the period of disqualification, the Plan Sponsor (usually the employer) generally would lose its tax deductions for all contributions to the plan and would potentially need to amend past tax returns and pay additional taxes and penalties. Furthermore, the investment trust account of the retirement plan would lose its tax‐exempt status and have to file Form 990‐T and pay taxes on any trust earnings. Any distributions from this plan would be ineligible for rollover to an IRA or qualified plan, and possibly the account balances of the “highly compensated4” employees would immediately become taxable.
ABC Christian Ministry, which has a personnel policy of not hiring any employee engaged in a samesex relationship, maintains a qualified Money Purchase retirement plan. John, who works for ABC Christian Ministry, unbeknownst to his employer, was married to Steve in New Jersey. On December 1, 2013 John terminated employment with ABC Christian Ministry and received a $100,000 lump sum distribution from the plan without Steve’s written spousal consent, as required by federal law.
This retirement plan has violated the terms of federal law and upon investigation could become disqualified by the IRS. Steve could initiate a claim against the qualified plan and enforce such an action with the assistance of the Department of Labor and IRS. If the plan is unable to recover its lump sum distribution from John, it may need to purchase a Joint and Survivor Annuity with Steve as the spousal, surviving beneficiary.
XYZ ForProfit Company maintains a 401(k) plan with an employee loan provision. Sandy, one of the plan participants, has a samesex spouse. She requests a $25,000 loan from the 401(k) plan (which requires spousal consent for all participant loans) but does not obtain a spousal consent signature for the loan. XYZ ForProfit Company must deny this loan until Sandy provides a written consent from her samesex spouse.
Joe and Bill have a samesex marriage. Joe owns Joe’s Crab Shack and Bill works for him as an employee earning $25,000/year. Once Joe and Bill are determined to have a samesex marriage, Bill is a “highly compensated employee” (HCE) because of the spousal attribution rules, despite the fact that he only earns $25,000/year. This new HCE designation will affect the 401(k) plan’s nondiscrimination testing, ADP test, and many other aspects of the plan’s administration.
Steps Plan Sponsors Should Take:
Obtain new Beneficiary Designation forms from all plan participants, with an explanation of the change in DOMA. It is important that the Plan Sponsor (or a designee of the Plan Sponsor) know who is married, whether in a heterosexual or same‐sex marriage.
Review all plan distribution and loan activity from June 26, 2013 to the present. (This date may change to September 16, 2013 depending on when the plan implemented the state of celebration rule. If the plan discovers that it processed loans or distributions without the required consent of a same‐sex (or opposite sex) spouse, the plan needs to take corrective action with the assistance of an ERISA expert or attorney.
Change policies and procedures so that employees are aware that they must disclose the fact that they are engaged in a same‐sex marriage.
1 IRS Notice 2014‐19.
2 Passed by both houses of Congress, and signed into law by President Clinton on September 21, 1996.
3 Rev. Rul. 2013‐17.
4 Generally anyone who owns more than 5% of the employer or anyone who earns more than $115,000.
Stig Nybo, President of Pension Sales and Distribution at Transamerica Retirement Solutions, in conjunction with Liz Alexander have written a must-read book on retirement entitled, Transform Tomorrow, Awakening the Super Saver In Pursuit of Retirement Readiness. The book calls attention to the looming retirement crisis in the United States and suggests some fundamental changes to how the retirement industry should present this issue to employees.
Here are some startling statistics:
80% of people surveyed said they thought they had enough money saved for retirement and expected to be “very comfortable,” despite the fact that the average 401(k) account balance stood at that time at just $67,000 (2010).
The total retirement savings for individuals in their 60s, including IRAs and 401(k) balances, at the end of 2010 was only $275,517.
At retirement, employees need about 20 times their pre-retirement salary to avoid out-living their retirement savings.
Retirement should not even be a consideration for participants unless
Their mortgage is paid off
They have no credit card debt
No adult children or grandchildren are living with them, and
They are not responsible for any big-ticket items like a college education
Between the ages of 50 and 81, which is the average life expectancy of most 50-year-olds today—we are likely to run up bills totaling $1.4 million.
People in their eighties spend 57% more on health insurance that their counterparts who are in their fifties.
69% of older Baby Boomers (born 1945-1964) are financially ill-prepared for retirement, and many of them don’t even realize it.
In summary, Nybo states, “The average American worker has a front row seat on the Titanic, headed for a retirement iceberg.”
This book is available at Amazon.com.
Tags: Retirement Planning
IRS Announces New 2014 Limits
October 31, 2013
Today, the IRS announced the 2014 cost of living adjustments for dollar limitations on qualified retirement plan benefits and contributions.
For many, retiring with a million dollars would be a dream come true. However, for a highly paid professional, a million dollar retirement nest egg may only be a third or fourth of what is actually needed. Numerous studies have shown that key to a successful retirement is the management of the annual withdrawal rate. Industry professionals recommend withdrawing no more than five percent of your retirement savings in any year. Therefore, a million dollar retirement nest egg will only provide a $50,000 annual retirement income, two million would provide an annual retirement income of $100,000, and so on. Essentially, one takes the desired annual retirement income and divides that number by 5% (.05).
Where Does Retirement Savings Stand in the United States?
The Employee Benefits Institute of America recently surveyed employees in their 60s and found that when including both IRAs and 401(k) balances, the average retirement savings stood at only $275,517[i]. Using the above formula, such an amount will provide annual retirement income of only $13,775 ($275,517 X 5%). A similar study in the same year (2010) found that the average balance of (all working) Americans’ 401(k) accounts was just over $60,000 at the end of 2010[ii].
Many doctors and professionals emerge from school saddled with debt. Then there is the cost of starting or buying in to the practice, the house, the kids’ college education, and needed vacations. Retirement is only an idea, a distant event.
Sometime in the late 40’s, financial reality hits and the professional realizes that he or she has a relatively short period of time to accumulate several million dollars.
Employee contributions to a 401(k) plan are limited to $17,500/year ($23,000 if over age 50). Add to that amount employer matching or profit sharing and the contributions can be as high as $51,000 ($56,500 if 50 or older). However, with the addition of a Cash Balance retirement plan, someone age 55 could add another $180,000/year in retirement savings!
A Cash Balance plan has the look and feel of a defined contribution plan (such as a 401(k)) with the high funding limits of a defined benefit plan. Any type of business can establish one, but it works best if it accompanies a specifically designed 401(k)/Profit Sharing plan. Such a retirement plan is ideal when the owners and key employees:
- Need to save more than would be allowed via a 401(k) plan
- Are about 8-10 years older than the rank and file employees
- Need additional federal and state tax savings
- Earn over $250,000 and have discretionary income
Of course, such a retirement plan usually must benefit, to some extent anyway, the rank and file employees. However, the federal and state tax savings generated by this retirement plan often funds the contributions to these employees on a three or four to one ratio.
Let’s explain that once again. The illustration below shows the total employer contributions to the two doctors of $252,000, contributions to the employees of $37,082 and total tax savings of $153,480. In other words, the tax savings generated by the retirement plans is funding the required contributions to the employees on a ratio of 4.14 to 1 ($153,480/$37,082).
Cash Balance plans are not for everyone since they are a form of a Defined Benefit plan and do require annual employer contributions over the life of the plan, which generally should be at least three years. In addition, they are more expensive since they require the services of an actuary and an experienced retirement plan administrator. However, given the right situation they just may solve your retirement riddle.
Nathan Carlson, President of Retirement Planning Services, Inc. has 28 years of ERISA consulting experience.