5 Signs of 401(k) Trouble

A recent report highlights five key 401(k) risk areas that advisors might want to keep an eye on.

The report by ThinkAdvisor was based on an assessment of 19 “red flags” gleaned from Form 5500 filings by Judy Diamond Associates.

Here are the five warning signs:

Inadequate Fidelity Bond Coverage:

More than 70,000 sponsors of 401(k) plans are carrying insufficient levels of fidelity bond insurance, according to data mined from Judy Diamond Associates Retirement Plan Prospector tool. It was, in fact, the top red flag in JDA’s most recent analysis, according to the ThinkAdvisor.  A recent NAPA Net reader poll found that just over half (53%) of respondents said that fiduciary insurance/coverage levels were not only a factor in their current RFP process, but were a growing one.  About a quarter (27%) said that it was a factor, while the remaining 20% said it wasn’t.

Reduced Employer Contributions:

The JDA analysis noted that 32,354 plans experienced reduced employer contributions, noting that when employers reduce, or eliminate matching contributions, it is often an indication that the sponsor is in financial trouble, though there are certainly any number of alternative, less gloomy rationales for that result.

Corrective Distributions:

According to the most recent available data from the Labor Department, a significant portion of the 401(k) universe (57,410 plans, according to Judy Diamond) issued a corrective distribution under the IRS’s nondiscrimination test, which ensures that elective and matching contributions for rankandfile employees are proportional to contributions from business owners, managers and other highly compensated employees. While it might not be signs of a real problem, it might suggest an opportunity for a better scrutiny on an interim basis, so that HCEs aren’t forced to deal with the complications frequently associated with these corrective distributions.

A History of Corrective Distributions:

Having to make a corrective distribution one year is one thing – but doing so on an ongoing basis could be indicative of a more serious problem. The JDA analysis noted that 28,251 plans showed a “history” of having to make corrective distributions.

Retirees Leaving Money in the Plan:

Arguably this is not necessarily a problem – indeed, the Labor Department has suggested that this would be a positive outcome from the fiduciary regulation, and researchers have opined that this would, in fact, be a consequence. That said, Judy Diamond notes that 56,275 plans had a “high percentage” of retirees with assets still in the plan, which the report notes means that the plan continues to pay administrative costs on those assets, which can increase overall plan expenses.

Source: NAPA Net

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Using a Qualified Retirement Plan or IRA to Buy Real Estate

Thinking of using a Qualified Retirement Plan or IRA to invest in a rental property?  It may not be the best option.  If you borrow to finance the property, you’ll run into the unrelated business taxable income rule, which could require you to pay hefty taxes on your rental income on profits as they are earned inside the Plan/IRA.  And you’ll be prohibited from claiming landlord-friendly tax breaks for depreciation, property taxes, and other expenses.  Instead, consider investing in a real estate investment trust (REIT) in your Plan/IRA.  REITs are required to return at least 90% of taxable income to shareholders, so dividends are typically generous.

 

SOURCE: Kiplinger’s Personal Finance Advisor, November 2016

Money Purchase Plan Loan Questioned by EBSA

According to EBSA, the SeaBoard Management money purchase plan trustees breached their fiduciary duties by failing to take action to recover funds owed to the plan, which were loaned in violation of ERISA.

SeaBoard Management Inc., a company based in Stevenson, Maryland, is facing a court challenge from the Department of Labor’s (DOL) Employee Benefit Security Administration (EBSA) for breaching the Employee Retirement Income Security Act (ERISA).

According to EBSA, the SeaBoard Management money purchase plan trustees Larry Porter and Susan Porter breached their fiduciary duties to the plan by failing to take action to recover funds owed to the plan, which were loaned in violation of ERISA. To date, principal and interest owed to the plan on this loan is approximately $332,544, according to EBSA.

“The trustees failed to take action to recover funds owed to the plan that were loaned to Waskey Investments, a real estate partnership in which Larry Porter owned a 50% share, in violation of the Employee Retirement Income Security Act,” the complaint states. “To date, principal and interest owed to the plan on this loan is approximately $423,486.”

EBSA is asking the U.S. District Court for the District of Maryland to restore all related losses, including interest or lost opportunity costs to the plan, which occurred as a result of the defendants’ breach of their fiduciary obligations. Further, EBSA wants to permanently enjoin Larry Porter and Susan Porter from serving as a fiduciary, administrator, officer, trustee, custodian, agent, employee, representative, or having control over the assets of any employee benefit plan subject to the ERISA—and to appoint an independent fiduciary at the Porters’ expense.

Source: http://www.plansponsor.com/Money-Purchase-Plan-Loan-Questioned-by-EBSA/

IRS has Opened Up an Employee Plan Compliance Project on SIMPLE IRAs

The IRS has opened up an employee plan compliance project on SIMPLE IRAs; it’s eyeing whether employer with SIMPLE IRAs are eligible small businesses…those with 100 or fewer employees.  The agency is mailing questionnaires to firms that both sponsor SIMPLE IRAs and filed over 100 W-2s for at least two consecutive years between 2012 and 2014.  Failing to respond to the letters could lead to an audit.

Source: The Kiplinger Letter, November 18, 2016

Big Changes to the IRS’s Determination Letter Process

Big changes are coming to the IRS’s employee plans ruling program next year.  Under current procedures, sponsors of individually designed employee plans can seek a determination letter from the IRS every five years to ensure the plan is in compliance with all current laws and regulations.  This helps give sponsors certainty that their plans are up-to-date and continue to meet the rules from employee plan qualification.

The IRS will generally stop ruling on amendments to individually designed plans beginning in 2017, absent special circumstances such as significant law changes and new approaches to plan design.  Sponsors will only be allowed to request determination letters from the IRS on the plan’s initial qualification and upon termination.  After these restrictions were first announced last year, retirement plan professionals pleaded with the IRS to backtrack on the changes, but to no avail.

Source: The Kiplinger Tax Letter, July 29, 2016

Wonder What IRS Agents Look for When They Audit Retirement Plans?

Large participant loans are a key examination issue.  During an audit, IRS checks how plans handle loans, such as the time they allow for repayment, and what happens upon default.  Agents ask for copies of signed loan agreements and promissory notes, as well as documentation to substantiate residential loans.  Generally, plan loans are tax-free if the total doesn’t exceed the smaller of $50,000 or 50% of the account balance.  Excess loans are treated as taxable distributions.  Among the most common plan loan failures: loans over $50,000; Nonresidential loans in which repayment exceeds five years; and loan defaults, in which the participant fails to make the payment.

Source: The Kiplinger Tax Letter, June 17, 2016

One of the Best Retirement Deals 9 Out of 10 People Ignore

By Carla Fried

There are some easy decisions around 401(k)s. Contributing enough to trigger the highest possible matching contribution from your employer, for example, is one of them.

Contributing to a Roth 401(k) should be another. But it’s not. Eight years after retirement savings plans were allowed to offer the option, which can help many people boost their retirement funds, more than half added it. Yet just 11 percent of savers with access to the account use it, according to benefits consultant Aon Hewitt.

Roth 401(k)s are much like your garden variety 401(k). The big difference is that you contribute after-tax money, not pre-tax dollars like with the standard 401(k). Later in life when you want to tap that Roth money you won’t pay income tax on it — not a penny, as long as you’ve held the account for five years and are 59 ½.

The conventional wisdom is that the Roth 401(k) makes the most sense if your current income tax rate is lower than what you expect to pay in retirement. Opting for the Roth 401(k) essentially prepays your tax bill. Granted, deciding if the Roth route makes sense for you is tougher than deciding whether to contribute enough to get the company match. But the lack of broad buy-in suggests many 401(k) savers are missing out on an important way to build retirement security.

NOW VS. LATER

With a traditional 401(k) you delay the tax bill and your money compounds over time. You get an upfront break that reduces taxable income. The tradeoff: Your later withdrawals get taxed as ordinary income. Stands to reason that prepaying — as you do with a Roth account — makes sense when you’re in a low tax bracket, especially for younger workers yet to reach peak earnings.

An analysis by T. Rowe Price found that a 30-year-old saving in a Roth 401(k) would have 17 percent more spendable income in retirement even if his pre- and post-retirement tax rates were the same. If his retirement tax rate is 5 percentage points higher, the Roth 401(k) will generate 25 percent more income than the after-tax money from a traditional 401(k). A future tax rate 10 percentage points higher will generate nearly 35 percent more spendable income in retirement compared to the traditional, courtesy of the time factor of tax-free (not tax-deferred) compounding.

While the young get the greatest benefit, even middle-agers who anticipate a lower tax rate in retirement would likely be better off saving via a Roth 401(k). “Unless you’re planning for a steep lifestyle change in retirement, what’s likely is that at best you might drop into a tax rate a few percentage points lower,” said Stuart Ritter, a senior financial planner at T. Rowe Price.

For example, the tax bracket for a 45-year old married couple with taxable income of $200,000 is 28 percent. If they retired today, that income would have to drop below $74,000 to fall into the 15 percent tax bracket. More likely, they’d be in the 25 percent bracket, which tops out at $148,500 for married couples filing jointly. T. Rowe Price estimates that even if they pay a tax rate in retirement just three percentage points lower, the Roth 401(k) will leave them with 8 percent more spendable income in retirement than a traditional 401(k).

Only if the future tax rate is more than 10 percentage points lower than the initial tax rate does the traditional 401(k) becomes a better deal for the 45-year-old couple. That would be a large lifestyle haircut even if federal tax rates merely stay steady.

TAX RATES TEST

For 55-year-olds the traditional 401(k) becomes the smarter choice when the future tax rate is at least 8 percentage points lower. A married couple in the 35 percent federal tax bracket today (so income between $405,101 and $457,600) would need to get by on income of no more than $226,850 (the top of the 28 percent federal tax bracket) to pull that off.

Higher-income earners need to carefully navigate potential short-term tradeoffs. For example, two fifty-somethings can each defer up to $23,000 this year in a traditional 401(k). That’s a lovely $46,000 reduction in taxable income. Put that in the Roth 401(k) and you lose that upfront tax break, which could wreak alternative minimum tax havoc.

And remember, if you opt for the traditional 401(k), the IRS will come knocking at age 70 ½, expecting you to start taking annual required minimum distribution (RMDs) — forced taxable withdrawals — from your savings. RMDs are taxable income and make it harder to generate a steeply lower tax rate.

If you don’t think you’ll rely heavily on your 401(k) savings in retirement, a Roth 401(k) looks even better. Roll it into a Roth IRA before age 70 ½ and you won’t suffer forced withdrawals. That can help manage taxable income in retirement and give you the latitude to keep more of your retirement funds growing tax-free for heirs.

SOURCE: http://www.bloomberg.com/news/2014-05-08/one-of-the-best-retirement-deals-9-out-of-10-people-ignore.html