PAYROLL DEDUCTION PROGRAMS FOR INDIVIDUAL RETIREMENT ACCOUNTS
By Cynthia L. Shupe
In June, the United States Department of Labor reissued guidance on the
circumstances under which employers may provide a payroll deduction program
allowing employees to contribute to IRA accounts without the program being
treated as a qualified retirement program subject to the participation,
vesting and funding obligations, the reporting and disclosure requirements,
the fiduciary duties, or participant enforcement rights otherwise applicable
to qualified plans under ERISA and the Internal Revenue Code. This guidance
came in the form of Interpretive Bulletin 99-1, issued on June 18, 1999.
While specifically
drafted with smaller employers in mind (who may provide no pension coverage
at all), the Department of Labor bulletin provides an interesting and
potentially inexpensive planning opportunity for employers who sponsor
401(k) plans, but who have elected not to permit voluntary after-tax contributions
because of an inability to pass the discrimination testing required for
after-tax contributions to qualified plans.
Here are some factors
for an employer looking for an inexpensive and uncomplicated way to help
employees save after tax dollars on a tax deferred basis to keep in mind:
1. Aren't
IRA Contributions Tax-Deductible? How Would IRA Contributions Provide
a Substitute for After-Tax Contributions to a 401(k) Plan?
IRA contributions
are generally tax deductible. However, while individuals who are eligible
to participate in an employer's qualified plan and whose adjusted gross
income exceeds $40,000 if single or $60,000 if married, may make IRA contributions,
such IRA contributions are not deductible.
An employer who provides
a 401(k) plan for employees and whose work force generally earns adjusted
gross income in excess of these limits may choose not to permit after-tax
contributions to its 401(k) plan because of the expense and burden of
testing particularly where after-tax contributions are more heavily used
by highly compensated employees (generally those who earn in excess of
$80,000 annually). These tests do not apply to IRA contributions, and
while employees could open IRAs to make substitute after-tax contributions
on their own, they may well appreciate the convenience of making such
contributions through payroll deductions.
2. What
Are the Contribution Limits for "After-Tax" IRA Contributions?
The contribution
limits are the same as for regular IRAs: an annual limit of the lesser
of $2,000 or a person's compensation for the year. This limit applies
whether an individual opens his own IRA independently or opens an IRA
through an employer payroll deduction program. A payroll deduction program
will not increase or change this annual limit.
3. Are
There Any Special Tax Consequences Associated with "After-Tax"
IRA Contributions?
An individual who
makes "after-tax" IRA contributions must report the non-deductible
contributions each year on a Form 8606 filed with his or her annual federal
income tax return. This reporting is required so that when the individual
takes distributions from the IRA, the amount of the distribution which
is attributable to a return of previously taxed contributions can be calculated.
If an individual has IRAs which hold both deductible and non-deductible
contributions, this filing is also required to determine how much of any
distribution from any IRAs will be treated as a return of previously taxed
non-deductible contributions.
Specifically, if
an individual makes any "after-tax" IRA contributions and simultaneously
has any pre-tax IRA contributions, a portion of any future IRA distributions
will be treated as a return of basis even if the distribution are taken
from an IRA to which only pre-tax contributions have been made.
4. What Steps
Must an Employer Take to Ensure that a Payroll Deduction IRA Program Is
Not Treated as an Employer Plan?
- An IRA will not be considered an employer pension plan if
- there are no employer contributions
- employees participate in the program on a completely voluntary basis
- the employer maintains neutrality with respect to the IRA sponsor in its communication of the program to employees
- the employer receives no consideration for providing the program, although the employer may impose a reasonable charge for services actually rendered in connection with the processing of the payroll deductions
5. How "Neutral" Must an Employer Be?
Neutrality as interpreted by the Department of Labor does not preclude an employer from encouraging employees to save for retirement by providing the payroll deduction program and educational materials about how the program works including the advantages of contributing to an IRA and of supplementing retirement savings.
Neutrality can be achieved by communication materials that make it clear that the program is completely voluntary, the employer does not endorse or recommend either the IRA sponsor or the investment alternatives available from the IRA sponsor, that other IRAs are available to employees outside the payroll deduction program, and that the tax consequences of contributions to an IRA through a payroll deduction program are no different than the tax consequences of contributing to an IRA outside the payroll deduction program.
The Bulletin specifically provides that an employer would not be viewed as neutral if one of the purposes of the IRA program were to provide a medium for investing in the securities of the employer or if a significant investment alternative offered by the IRA sponsor included employer stock.
6. How Much Assistance Can an Employer Give Employees Who Participate in an IRA Payroll Deduction Program?
An employer can answer employees' specific questions about the mechanics of an IRA payroll deduction program and provide informational materials and retirement savings counseling, including materials with the employer's name or logo, provided that the material or assistance does not suggest that the employer is other than neutral with respect to the IRA sponsor and its products.
The publication of the Interpretive Bulletin is clearly intended to facilitate the use of payroll deductions to encourage employee savings for retirement. Employers wishing to enhance existing benefits programs for employees may well find it an opportune vehicle to do just that.