Some Obama administration retirement proposals, like automatic IRA enrollment, still await Congressional action. In the meantime, the administration is taking actions designed to promote retirement savings. The Internal Revenue Service (IRS) released a package of new guidance over the Labor Day weekend to encourage smaller company plans to take action that will encourage savings. The guidance does not offer any radically new approaches, but does contain some useful clarifications and easy-to-use sample amendments.
This advisory offers a brief overview of the key areas covered by the guidance—including automatic retirement savings enrollment and increases, paid time off (PTO) contributions, and rollover eligibility notices—and provides links to the related IRS documents.
Automatic enrollment/automatic increases
One of the most successful mechanisms to get employees to save has been automatic enrollment, where eligible employees are enrolled for salary deferrals at a set rate unless they opt out or change their deduction. This approach has been adopted by many larger 401(k) plans. To encourage small and mid-size firms to use it too, the IRS guidance includes two simple and similar model amendments.
The first is an automatic contribution arrangement (ACA), the type that has been available for years. The second is an eligible automatic contribution arrangement (EACA) under the 2006 law that includes a refund feature for participants who opt out in the first 90 days. Both include options to set a default percentage and to automatically increase the percentage in later years. (Please see IRS Notice 2009-65: Adding Automatic Enrollment to Section 401(k) Plans – Sample Amendments.)
The package also includes a ruling clarifying that automatic increases linked to increased compensation are allowed in an ACA, and that mid-year changes in the default deferral percentage are allowed in an EACA or qualified automatic contribution arrangement (QACA). (Please IRS Rev. Rul. 2009-30: Automatic Contribution Increases under Automatic Contribution Arrangements.)
Besides these tools for 401(k) plans, the package also includes guidance and a model amendment to add automatic contributions to a SIMPLE plan of a small employer that is funded with IRAs. The amendments would need to be adopted by the IRA sponsor and each implementing employer. (Please see IRS Notices 2009-66 and 2009-67: Automatic Enrollment in SIMPLE IRAs, and Adding Automatic Enrollment to SIMPLE IRA Plans – Sample Amendment.)
Contribution of PTO
Two more rulings make it easier to contribute unused PTO to qualified plans. The first ruling deals with PTO policies that allow unused PTO to be carried over, up to a certain limit; unused PTO is either forfeited or cashed out annually. If the unused PTO would be forfeited, the plan can be amended so that it is contributed to the plan as an employer contribution instead. Of course, this would be an added expense to the employer. These employer contributions are subject to all the usual qualified plan rules; in particular, since excess PTO will vary from person to person with no relationship to compensation, the contributions may need to be tested for nondiscrimination. If the PTO policy instead provides that excess unused PTO is cashed out after the end of each year, the ruling makes clear that the plan can allow employees the election to defer it to the 401(k) plan. Again, all the usual limits apply to the total amount deferred during the year. (Please see IRS Rev. Rul. 2009-31: Annual Paid Time Off Contributions.)
The second ruling applies to unused PTO that is forfeited or cashed out at termination of employment. Some states, such as California, require that all unused PTO be cashed out at termination. Under the recently revised Section 415 regulations, such cash-outs can be treated as compensation under the plan if paid within 2.5 months of termination or by the end of the year. The new ruling makes it clear that a plan can allow participants to make 401(k) contributions from PTO cash-outs. Where unused PTO would be forfeited under state law and an employer’s PTO policy, the ruling allows a plan to convert it to an employer contribution. In both cases, the contributions are subject to all the usual limits on salary deferral or employer contributions for the year in which they are contributed. (Please see IRS Rev. Rul. 2009-32: Paid Time Off Contributions at Termination of Employment.)
Updated safe harbor rollover explanation
The most universally useful part of the package is the long-awaited update to the notice that plans must give when a distribution is eligible for rollover (also known as the “402(f) notice”). It was last issued in 2002, but since then there have been numerous changes in the law, such as rollovers to Roth IRAs and rollovers by non-spouse beneficiaries. Employers and administrators were on their own to update the notice until now.
There are actually two versions of the new notice, one for rollovers from Roth accounts and one for all other rollovers; a plan should send a participant requesting a distribution the appropriate notice (both if the participant has both types of accounts). (Please see IRS Notice 2009-68: Safe Harbor Explanation – Eligible Rollover Distributions.) Notices should still be tailored to fit the plan, such as by eliminating discussion of employer stock. We have Microsoft Word versions of the notices available for our clients or can work with you to prepare a tailored version. Please contact Kim Kaald if you would like a Microsoft Word version.
On a related note, the IRS separately released a ruling explaining how a rollover from a pre-tax account to a Roth IRA will be treated as a taxable distribution. Starting in 2010, such rollovers will be available to anyone, without the income limitations that existed in the past. Participants who can take distributions in 2010 may be interested in a rollover to a Roth account, because account values are still depressed after 2008 and future appreciation will be tax-free within the Roth IRA. The tax due a conversion can also be paid over a two-year period. (Please see IRS Notice 2009-75: Rollovers from Employer Plans to Roth IRAs.)