Under
Construction! WARNING! I NEED TO UPDATE THIS FOR THE NEW TAX
LAW PASSED IN 1997 !!! Under
Construction! WARNING! I NEED TO UPDATE THIS FOR THE NEW TAX
LAW PASSED IN 1997 !!!
EMail Bob Parrish CPA:
Longboat Key & Sarasota FL Office - BMSarasota@worldnet.att.net
Odessa TX Office - BMOdessa@aol.com
To return to the top (introduciton) page for selecting new departments click on the HOME key in the heading. To go back to the department that you came to here from, click on your "back" button on your browser.
Read Related Documents:
IRS Notice 97-6
Following is a table showing you the major information about individual retirement plans:
| Item | IRA | SIMPLE IRA | SEP-IRA | SIMPLE 401K | 403B | Roth IRA | SAR-SEP |
| Premature distribution penalty for Pre- 59 1/2 distributions. | Yes. 25% penalty applies to distributions taken from account two years from date of first contribution. Applies to distributions taken after 59 1/2 and 70 1/2 | ||||||
| Averaging on distributions? | NO | ||||||
| Rollover and plan-to-plan transfers | YES. Roll to an IRA or SIMPLE IRA. Rollover within 2 years of start allowed to SIMPLE IRA without penalty. Not rollable to qualified plan. | ||||||
| Mandatory withholding? | NO. Withholding at discretion of individual. If not directed, trustee may withhold 10%. | ||||||
| Loans. See notes. | Results in taxation of entire account. | ||||||
| Annual tax return required form 5500? | No | ||||||
| Investment Vehicles | Directed by individual. Document may restrict investment choice. No permanent life insurance. Annuities OK. | ||||||
| Paired plans or maintain another plan? | Not Allowed! | ||||||
| Trustee | Designated Trustee required: bank, insurance company, or third party approved by IRS. | ||||||
| Subject to ERISA 404(c)? | NO | ||||||
| Third Party Administrator Required? (TPA) | No | ||||||
| Approximate annual cost | $10 - $25 per participant | ||||||
| Bonding required? | No | ||||||
These notes are an integral part of the tax summary table attached hereto. The notes must be read carefully in context with the matrix. In addition, the 1997 Tax Act made some changes for distributions and penalties. I will update those changes in the very near future.
QUALIFIED PLAN NOTES
I. Premature Distributions - A 10 percent penalty is imposed on premature distributions ~ qualified plans, 403(1,), SEP and IRAs. Early withdrawal is withdrawal before age 59 112; some exceptions apply. In the case of a premature distribution, the employee's income tax is increased by an amount equal to 10 percent of the amount of the distribution includible in gross income.
A. Exceptions to penalty for Profit Sharing, Money Purchase, 401(k) and Defined Benefit include: death, disability, retirement after age 55, substantial and equal periodic payments, distributions resulting from Qualified Domestic Relations Order (QDRO), return of excess contributions, medical expenses, and quali4ing adoption expenses.
B. Exceptions to penalty for IRAs, SEPs, SARSEPs and SIMPLE IRAs include: death) disability, substantial and equal periodic payments, qualifying adoption expenses and certain health Insurance premiums for self-employed.
C. For a complete listing of exceptions, see IRC section 72t
D. 403(b) plans have different exceptions, see IRC section 72q.
2. Excess Distributions
A. Determined annually
An individual who receives an excess distribution is subject to a 15 percent nondeductible excise tax on the amount of the excess. The tax imposed is reduced by the amount of any early distribution tax attributable to the excess distributions.
Penalty waived on distributions made In 1997,1998 and 1999.
In general, an excess distribution is the excess of an individual's total retirement distributions for a calendar year over $160,000.
B. Determined for Lump Sum Distributions
In making the determination of whether a lump-sum distribution results in an excess distribution, instead of using the $160,000 annual limit, the limit is equal to five times the annual amount which equals $800,000 for 1997.
If an employee's accrued benefit as of August 1, 1986, exceeds $562,500 and if the employee made a grandfather election on a return filed for a taxable year ending before 1989, no excise tax is imposed on the portion of the grandfathered amount.
3. Lump-Sum Distributions
A. Forward Averaging
(1) Five-year
The taxable portion of a qualified plan lump-sum distribution is taxable as ordinary income. The taxpayer may elect special tax treatment using five-year averaging:
(a) On account of employee's separation from service;
(b) After employee attains the age of 59 1/2; or
(c) After employee has been a participant in the plan for five years.
A distribution can qualify as a lump-sum distribution only if the entire balance is distributed within one taxable year. To get the benefits of five-year averaging, the recipient must elect lump-sum treatment. Only one lump-sum election per individual can be made.
Five-year averaging may not be elected on distributions made after 1999.
14
2) 10-Year
A participant in a qualified plan who reached age 50 before 1986 can elect, with respect to a lump-sum distribution, capital gain treatment and special averaging. This election is available only one time. If 10-year averaging is elected, the applicable tax is determined using 1986 rates.
B. Rollovers
No tax is due on distributions rolled over to another qualified plan or IRA within 60 days of receipt. The employee can "roll over" part or all of the distribution, but if only part is rolled over, the employee must include the retained portion in income. Once a rollover is made, the taxpayer loses the right to have the distribution taxed under the five-year or ten-year averaging rules. After 12/31/92, all qualified plan distributions are subject to 20 percent withholding. See Lump-Sum Kit for more details.
4. Death before Required Beginning Date (RBD) - proceeds must be distributed within five years or an election must be made to annuitize within one year of death of account holder. Exceptions:
Spouse
is beneficiary - proceeds can be rolled to surviving spouse's IRA and treated as their own IRA. If proceeds are not rolled over, spouse can treat the IRA as decedent's IRA. Spouse must start distribution after deceased would have turned 70 1/2. Section 401(a)(9)(B)(iv).Nonspouse beneficiary - rollover not allowed. Section 219(a)(4). If beneficiary
is a non-person, i.e., estate or trust, the annuity election is not available.5. Death after RBD - distribution must be at least as rapid as under the method in effect prior to death.
Example: Owner elects minimum distributions based on 16-year life expectancy and dies after 10 years. Remaining interest will be paid out in equal installments over a period not greater than 6 years. Benefits can be accelerated. Section 401 (a)9(b)(i).
Timing of distributions impacted by election to use recalculation method or non-recalculation method for minimum distribution calculation. If recalculation is used, beneficiary may be required to take distributions within one year of death. Non-recalculation method allows the beneficiary to continue taking distributions at least as rapidly as the owner had been taking distributions prior to death.
RBD for items 4 and 5 means April 1 of the year following the year the account owner turns 70 ½.
6. Cap on Compensation - compensation limited to $160,000 for calculation of contributions. Only $160,000 of income can be considered as compensation for contribution purposes. For SEPs, the new individual limit
is $24,000 ($160,000 x 15%).7. Discrimination Tests
A. 401(k) Discrimination Tests - one type of 401(k) discrimination test is the Average Deferral Percentage (ADP). Additional discrimination tests may apply. The ADP of the Non-Highly
Compensated Employees (NHCE) as a group will limit the deferrals of the Highly Compensated Employees (HCE) as a group based on the following ranges:
O%-2% ADI', HCE can defer additional 200%.
2%-8% ADP, HCE can defer two times the NHCE ADP.
Over 8% ADP, HCE can defer additional 125%.
Example: If the ADP of the NHCE is 5%, the HCEs as a group can dos combined deferral of 7%.
B. SARSEP Discrimination Test -a similar ADP test is performed on SARSEP plans. The ADP of the Non-Highly Compensated Employees (HCE) 55 a group will limit the individual deferrals of die Highly Compensated Employees (HCE). The HCEs are able to individually do an additional 125% more than the NHCE.
Example: If the ADP for the NHCE is 5%, the HCEs individually can do a6.25% deferral. ADP for years starting in 1997 is based on compensation without reduction for salary deferral arrangements.
8. Vesting schedules allow the employer to reward long-term employees by restricting employees with shorter service from receiving their entire benefit from the retirement plan. Employers requiring one year of service for eligibility in the retirement plan may use vesting schedules. Employers requiring two years of service for eligibility may not use vesting schedules. Vesting schedules are as follows:
A. Top-heavy plans are plans where 60% or more of the benefits accrue to the Key Employees. Top-heavy plans are subject to the following vesting schedules:
3-year cliff - allows for no vesting of benefits for employees who terminate within the first three years of service. After the employee has completed the third year of service, the employee is 100% vested, which means the employee is entitled to all of the money the employer has put aside in the retirement account on behalf of the individual employee.
6-year graded vesting - results in no vesting for the first two years of service. After completion of the second year of service, the employee vests 20% per year until
100% vested after completion of the sixth year of service.
B. Non-top-heavy plans are plans where less than 60% of the benefits accrue to the Key Employees. Non-top-heavy plans allow for the following vesting schedules:
5-year cliff- allows for no vesting of benefits for employees who terminate within the first five years of service. After the employee has completed the fifth year of service, the employee is 100% vested, meaning the employee is entitled to all of the money the employer has put aside in the retirement account on behalf of the individual employee.
7-year graded vesting - results in no vesting for the first three years of service. After completion of the third year of service, the employee vests 20% per year until 100% vested after completion of the seventh year of service.
9. Plan loans
A. Payments are made at least quarterly and repaid within five years (special exception for purchase of primary residence).
B. Loan limited to lesser of $50,000 or 50% of vested benefit reduced by outstanding loan balance. Must use reasonable interest rate.
C. Loan policy must be written, and the plan must allow for loans.
D. ERISA prohibited transaction rules restrict sole proprietors, partners and 5% S-corporation shareholders from taking loans from the retirement plan. Loans must be offered to employees on a nondiscriminatory basis.
10. Fiduciary responsibility is defined in ERISA Section 404. Fiduciaries must follow the following guidelines when investing retirement plan assets:
A. Prudent man rule - investments offered under the plan would be selected by another person acting in a similar capacity who has knowledge of such investments.
B. Diversified - plan assets must be adequately diversified based on asset category.
C. Liquid - plan assets must have enough liquidity to meet plan liabilities.
11. Bonding is required on all plan fiduciaries. A bond equaling 10% of plan assets with the minimum amount being $1,000 and the maximum amount being $500,000.
Taxpayer Relief Act of 1997
SIMPLE IRA CHANGES
SIMPLE IRA contributions (Act section 1601(d)(1), Code section 408(p)(8)
Prior Law. Participants in a SIMPLE IRA may make elective contributions of up to $6,000 per year. Employers may match the contribution or make a nonelective contribution of2 percent of the compensation of each eligible employee. Uncertainty existed due to the general $2,000 ceiling applicable to traditional IRAs.
NewLaw. The $2,000 IRA ceiling is expanded for a SIMPLE IRA such that an employee may make elective contributions of up to $6,000 (and the employer may match the $6,000 contribution for a total annual contribution of$12,000).
Matching Contributions for self-employed Individuals (Act section 1501(a), Code section 402(g)(9))
Prior Law. Matching contributions to a defined contribution plan on behalf of a self-employed individual are treated differently from matching contributions for an employee. Matching contributions on behalf of a self-employed individual, such as a partner in a partnership, are treated as additional elective contributions by the self-employed individual who receives the matching contribution. As a result, matching contributions for a self-employed individual are subject to the section 402(g) exclusion limit ($9,500 in 1997). It was not clear whether contributions to a SIMPLE IRA on behalf of a self-employed person were treated as elective employer contributions subject to the $6,000 limit.
New Law. The Act provides that matching contributions on behalf of self-employed individuals are not treated as elective employer contributions. The provision is effective for years beginning after December 31, 1997.
Savings Incentive Match Plans for Employees (SIMPLE).
Beginning in 1997, certain employers can set up SIMPLE retirement plans. A SIMPLE plan can
be set up by an employer who had no more than 100 employees who received at least $5,000
in compensation from the employer last year. Generally, the SIMPLE plan must be the only
retirement plan of the employer.
SIMPLE plans are written qualified salary reduction arrangements that allow an employee to
elect to reduce his or her compensation by a certain percentage each pay period and have
the employer contribute the salary reductions to the SIMPLE plan on behalf of the
employee. For 1997, the amount of the employee's salary reductions cannot exceed $6,000.
Employers are also required to make contributions to the SIMPLE plan on behalf of eligible
employees. Contributions to a SIMPLE plan are not subject to income tax until they are
distributed.
SIMPLE plan can be set up either as an IRA or as part of a qualified cash or deferred arrangement (401(k) plan). SIMPLE plans are not subject to the nondiscrimination rules that generally apply to qualified plans. For more information on this new plan, get Publication 560, Retirement Plans for the Self-Employed.
What is an individual retirement arrangement (IRA)? An individual retirement arrangement (IRA) is a personal savings plan that offers you tax advantages to set aside money for your retirement. Two advantages are that you may be able to deduct your contributions to your IRA in whole or in part, depending on your circumstances, and, generally, amounts in your IRA, including earnings and gains, are not taxed until they are distributed.
If you work for yourself, you may be able to deduct contributions to a Simplified Employee
Pension (SEP), which involves the use of IRAs (SEP-IRAs), or the new SIMPLE plan, which
can be set up in the form of an IRA (SIMPLE retirement account). You may also be able to
deduct contributions to other retirement plans for the self-employed (sometimes called
Keogh or HR-10 plans). Only self-employed individuals can deduct such contributions. For
details, get Publication 560.
SIMPLE Retirement Plans
A SIMPLE plan is a written salary reduction arrangement that allows a small business (an
employer with 100 or fewer employees) to make elective contributions to a simple
retirement account on behalf of each eligible employee. An eligible employer is not
allowed to maintain another retirement plan.
Setting Up a SIMPLE Plan
If an employer has 100 or fewer employees (who received at least $5,000 of
compensation from the employer for the preceding year), the employer may be able to set up
a SIMPLE retirement plan on behalf of eligible employees. The plan can be either:
• an IRA for each eligible employee, or
• part of a qualified cash or deferred arrangement (a 401(k) plan).
The SIMPLE plan must be the only retirement plan of the employer to which
contributions are made, or benefits are accrued, for service in any year beginning with
the year the SIMPLE plan becomes effective.
Under the qualified salary reduction arrangement the employer's
contributions on behalf of the employee (elective deferrals) are stated as a percentage of
the employee's compensation and are limited to $6,000. The dollar limit is indexed for
inflation in $500 increments.
TIP: The terms emphasized here are defined later in detail.
Under the qualified salary reduction arrangement the employer is also required to make
either a matching contribution to the simple retirement account on behalf of each employee
who elects to make elective deferrals, or a nonelective contribution to the simple
retirement account on behalf of each eligible employee.
These two methods for determining the employer contribution formula are
explained under Dollar-for-dollar employer matching contributions and 2% nonelective
contributions.
Contributions to a SIMPLE Plan are deductible by the employer and are
excluded from the gross income of the employee.
Definitions
Simple retirement account. The simple retirement account of an eligible employee
is an individual retirement plan that can be either an individual retirement account or an
individual retirement annuity, as described in Publication 590, Individual Retirement
Arrangements (IRAs). Employees' rights to the contributions cannot be forfeited.
A SIMPLE plan can also be set up as a 401(k). See SIMPLE 401(k), later.
Qualified salary reduction arrangement. An employee eligible to participate in the SIMPLE
plan may elect (during the 60-day period before the beginning of any year) to have the
employer make contributions (called elective deferrals) to the simple retirement account
on his or her behalf. An employee who so elects may also stop making elective deferrals at
any time during the year. The employer is required to match the employee's contributions
or to make nonelective contributions. No other types of contributions are allowed under
the qualified salary reduction arrangement.
Eligible employer.
Any employer who has 100 or fewer eligible employees in any year can
establish a SIMPLE plan provided the employer does not maintain another employer-sponsored
retirement plan.
Eligible employee.
Any employee who receives at least $5,000 in compensation during any 2
years preceding the plan year can elect to have his or her employer make contributions to
a simple retirement account under a qualified salary reduction arrangement. The employee
must be expected to earn at least $5,000 during the calendar year.
Excludable employee.
Excludable employees include certain nonresident aliens and employees
whose retirement benefits are covered by a union agreement. See Definitions under
Simplified Employee Pension (SEP), earlier.
Compensation.
Compensation for employees is the total amount of wages required to be
reported on Form W-2, plus elective deferrals. For the self-employed individual,
compensation is the net earnings from self-employment (without regard to any contribution
made to the SIMPLE plan for the self-employed individual).
TIP: Any SIMPLE elective deferrals relating to an
employee's wages under a salary reduction arrangement are included in the Form W-2 wages
for social security and Medicare tax purposes only.
Contribution Limits
Contributions are made up of employee elective deferrals and employer contributions. The
employer is required to satisfy one of two contribution formulas: the matching
contribution formula or a two-percent nonelective contribution. No other contributions can
be made to the SIMPLE plan. These contributions, which are deductible by the employer,
must be made timely.
Employee elective deferral limit. The amount that the employee elects to have the employer
contribute to a simple retirement account on his or her behalf (elective deferrals) must
not exceed $6,000 for any year and must be expressed as a percentage of the employee's
compensation.
Dollar-for-dollar employer matching contributions. The employer is
required to match all eligible employees' elective contributions, on a dollar-for-dollar
basis, up to 3% of the employee's compensation.
CAUTION: If the employer elects a matching contribution
that is less than 3%, the percentage must not be less than 1%. The employer must notify
the employees of the lower match within a reasonable time before the employee's 60-day
election period for the calendar year. A percentage less than 3% cannot be elected for
more than two years during a five-year period.
2% nonelective contributions. In lieu of the dollar-for-dollar matching
contributions, the employer may elect to make nonelective contributions of 2-percent of
compensation on behalf of each eligible employee. Only $150,000 of the employee's
compensation can be taken into account to figure the contribution limit.
CAUTION: If the employer elects this 2% contribution
formula, he or she must notify the employees timely (within the employee's 60-day election
period described earlier).
Time limits for contributing funds.
The employer is required to contribute the employee's deferral to the
SIMPLE account within 30 days after the end of the month for which the payments to the
employee were deferred. The employer's matching contributions to the SIMPLE plan, however,
are required to be made by the tax return filing deadline, including extensions, for the
taxable year that begins with or within the calendar year for which the contributions are
made.
Distributions (Withdrawals)
Distributions from a SIMPLE retirement account are subject to IRA rules and are
includible in income when withdrawn. Tax-free rollovers can be made from one SIMPLE
account into another SIMPLE account or into an IRA. Early withdrawals generally are
subject to a 10% (or 25%) penalty.
See Publication 590 for information about IRA rules, including those on
the tax treatment of distributions, rollovers, required distributions, and income tax
withholding.
Exceptions.
A rollover to an IRA can be made tax free only after a 2-year
participation in the SIMPLE plan. A 25% penalty for early withdrawal applies if funds are
withdrawn within 2 years of beginning participation.
Reporting and Disclosure Requirements
The trustee of a SIMPLE account is required to:
• Annually provide the employer with a summary description
containing basic information about the plan.
• Furnish each SIMPLE plan participant an account statement for the
calendar year within 30 days after each calendar year.
• Furnish an annual report to the IRS.
Employee notification.
The employer who sets up a SIMPLE plan must notify each eligible employee
of his or her opportunity to make contributions under the plan. The employer must also
notify all eligible employees of the contribution alternative that was chosen. This
information must be provided before the beginning of the employee's 60-day election
period.
SIMPLE 401(k) plan
A SIMPLE plan can also be adopted as part of a 401(k) plan. The SIMPLE 401(k)
plan must satisfy all the rules that usually apply to 401(k) plans, except for the
following qualification rules for which a safe harbor is provided. See Keogh Plan
Qualification Rules, later.
Safe harbor provisions. A SIMPLE 401(k) plan that satisfies the
contribution requirements and the vesting rules of a SIMPLE IRA does not have to meet the
nondiscrimination rules that apply to employee elective deferrals and employer matching
contributions.
The SIMPLE IRA contribution rules that must be met are:
1) $6,000 limit on employee deferrals,
2) Dollar-for-dollar employer matching contributions, up to 3% of compensation; or,
3) Alternative 2% of compensation nonelective contribution, and
4) No other contributions are made to the SIMPLE 401(k) plan.
Note. The employer cannot reduce the matching percentage below 3% of
compensation for the SIMPLE 401(k) plan.
However, the safe harbor is not satisfied for any year in which (for
service for that year) the employer makes contributions to, or benefits are accrued under,
any retirement plan of the employer on behalf of employees eligible to participate in the
SIMPLE 401(k) plan (other than SIMPLE 401(k) plan contributions discussed above).
In addition, the SIMPLE 401(k) plan is not subject to the top-heavy rules of qualified plans if the safe harbor is satisfied.