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Wednesday, October 6, 2010

Federal Government Launches Initiatives to Spur Retirement Savings

On September 5, 2009, the Obama administration announced several new initiatives intended to make it easier for employees to save for their retirement.

Automatic Enrollment

Under automatic contribution arrangements (ACAs), employers may automatically enroll employees in their 401(k) plans and deposit a default percentage of an employee's compensation in a retirement account unless the employee affirmatively opts out. Automatic enrollment can be a valuable tool in increasing participation in 401(k)s, which not only benefits employees who might not otherwise participate but also helps the plan pass nondiscrimination tests. Further, increasing participation makes it more likely that highly compensated employees who so desire can make contributions to the plan up to the annual limits without risking the plan's qualified status.

Retirement plan sponsors typically seek IRS approval of plan amendments adopting automatic enrollment, potentially delaying implementation. To streamline the process, the IRS issued Notice 2009-65, which provides two sample amendments that plan sponsors can adopt with automatic IRS approval. The first amendment can be used to add an ACA to a 401(k). The second can be applied to add an eligible automatic contribution arrangement (EACA) to a 401(k). EACAs provide employees with a 90-day withdrawal period from the date of the first default contribution. Employees can withdraw contributions during that period without incurring early withdrawal penalties.

Automatic Increases

The administration also noted that automatic increases in employee contributions over time can be an effective method for increasing retirement savings. Automatic increase provisions might, for example, earmark a portion of employees' pay raises to retirement savings or require that a higher default percentage of compensation be saved each year. Revenue Ruling 2009-30 explains how 401(k)s can use such an automatic increase feature. It considers scenarios involving automatic increase provisions in an ACA and in an EACA.

The IRS ruled that automatic increases in the default contribution percentage in plan years after the first year of participation, based in part on increases in compensation, are permissible under an ACA. The IRS noted, though, that EACAs are subject to some additional requirements that don't apply to ACAs.

In particular, under an EACA, a plan must satisfy the uniformity requirement - the default contribution must be a uniform percentage of compensation for all eligible employees. The IRS ruled that a plan doesn't fail to satisfy this requirement merely because the default contribution percentage varies based on the number of years (or portions of years) that an employee has participated in the plan. As long as every eligible employee with equal tenure is subject to the same contribution percentage, it doesn't matter that the percentage is more or less than the percentage for employees with shorter or longer tenures.

The IRS also made clear that an EACA may automatically increase the default contribution percentage for all eligible employees on a date other than the first day of a plan year (typically January 1st) without violating the uniformity requirement. An employer, for example, may prefer to implement the increase on the day that pay raises take effect every year. The IRS deemed such increases acceptable because they apply in the same manner to all eligible employees for whom the same number of years has elapsed since default contributions were first made for them.

Notice 2009-65 provides sample language for adopting an automatic increase feature. Both of the amendments for automatic enrollment include language that can be used to establish annual increases in the default percentage until the percentage reaches a predetermined level.

Automatic Enrollment and Increases for Small Businesses

The IRS also released guidance permitting small businesses to implement automatic enrollment and increases for their Savings Incentive Match Plan for Employees (SIMPLE) IRAs. The new initiatives now allow automatic enrollment in the SIMPLE IRA plans offered by small businesses, as long as employees are free to opt out.

Notice 2009-66 provides guidance on how small business employers can add automatic enrollment, including the notice requirements. It also permits automatic increases based on the number of years (or portions of years) for which default contributions have been made for the employee. Notice 2009-67 provides sample automatic contribution language that a SIMPLE IRA plan sponsor can adopt with automatic IRS approval.

Contributions of Unused Leave Pay to 401(k) Plans

Two new Revenue Rulings detail how employers can allow employees to contribute their pay for unused vacation time or similar leave to their 401(k)s without being taxed on the contribution until it's distributed. The rulings also provide employers the option of making their own contribution of these amounts to the employees' plans.

Revenue Ruling 2009-31 addresses annual contributions of unused paid time off (PTO), whether under an arrangement where the PTO would otherwise be forfeited or an arrangement where the PTO would otherwise be cashed out. Revenue Ruling 2009-32 addresses contributions of unused PTO at the termination of employment.

Bear in mind that any contribution under an arrangement where the PTO would otherwise be forfeited will be subject to testing for nondiscrimination to ensure that the amount of contributions made on behalf of rank-and-file employees is proportional to those on behalf of owners and managers. Further, both rulings are based on several specific assumptions. Careful consideration of an employer's individual circumstances is necessary before adding a plan amendment for contributions of unused PTO.

A Road Map for Rollovers

Employers are required to provide departing employees with a notice describing the tax consequences of taking a lump-sum distribution from their retirement plans, their ability to roll over funds into another retirement plan and other tax rules. But the language in these disclosures is technical, and employees changing jobs and receiving lump-sum payments from a retirement plan can easily become confused. To help alleviate any confusion and increase the likelihood that employees will keep their savings in tax-favored employer-sponsored retirement plans or IRAs until they retire, the IRS issued Notice 2009-68.

The notice provides a plain-English roadmap for rollovers of lump-sum payments to tax-favored plans in the form of two model notices that plans can present departing employees. Both notices explain the choices available to employees receiving an eligible rollover distribution. One applies to a distribution from a traditional account, and the other applies to a distribution from a designated Roth account.

Upcoming Initiatives

The administration is also urging Congress to adopt proposals that automatically enroll employees without retirement plans in IRAs through deposit contributions at the workplace. The contributions would be voluntary and matched by a tax credit for eligible low- and middle-income families. Finally, beginning in 2010, taxpayers can instruct the IRS to use their income tax refunds to purchase U.S. savings bonds. Taxpayers need only check a box on their tax returns; they don't need a bank or Treasury account. Beginning in 2011, taxpayers can use their refunds to purchase bonds co-owned with others, such as their children and grandchildren.

The Retirement Horizon

The new initiatives should make it easier for employers to enroll their employees in 401(k) plans and help employees build their retirement savings and make wise choices when switching jobs. Contact your financial advisor to discuss the best options for you and your employees in light of your individual circumstances.


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