Practice Management
One of the incentives for adopting and participating in an employer-sponsored qualified plan are tax benefits for employees and employers. A Feb. 9 ASPPA webinar focused on tax credits for small employers that adopt plans and for participants with modest incomes.
In “Working with Qualified Plans Can Be Taxing,” American Retirement Association Director of Technical Education Robert M. Kaplan, CFP, CPC, QPA, QKC, QKA, addressed not only tax credits, but also tax penalties.Saver’s Credit
Kaplan emphasized that the Saver’s Credit is a tax credit, not a deduction. It serves as a dollar-for-dollar offset, he noted, while a deduction lowers taxable income. “Are most participants aware of this? We don’t know,” he remarked, adding that most people who are eligible for the credit don’t have a tax advisor and that if they make no contribution, “do-it-yourself” software may not mention it. “In one-on-one meetings, we should mention this to individuals,” Kaplan suggested.
A taxpayer, or they and their spouse if filing jointly, may take the credit for:
- contributions other than rollovers to a traditional IRA or a Roth IRA;
- elective deferrals to a 401(k), 403(b), 457(b), SIMPLE or SARSEP;
- voluntary after-tax contributions to a qualified plan or 403(b) (including the Federal Thrift Plan);
- contributions to a 501(c)(18)(D) pension trust (created before June 25, 1959 and funded by member contributions only); and
- contributions to an ABLE account (funding of disability expenses).
Taxpayers eligible for the credit include those who are:
- age 18 or older;
- not claimed as a dependent on another person’s tax return; and
- not a student (meaning that one has not been a student in any part of five calendar months, is not enrolled as a full-time student and did not take a full-time, on-farm training course).
When using the credit, Kaplan reminded, one should adjust for distributions for the last three years (up to the due date for filing the tax return, including extensions) from:
- IRAs (traditional, Roth or MyRA);
- ABLE accounts; and
- qualified retirement plans, including 401(a), 401(k), 403(b), 457(b), SEP, SIMPLE and the Federal Thrift Savings Plan.
However, Kaplan said, do not include distributions from:
- rollover or trustee-to-trustee transfers;
- in-plan Roth conversions;
- a qualified plan to a Roth IRA;
- loans treated as a distribution;
- excess contributions or excess deferrals;
- inherited IRA by non-spouse beneficiary;
- military retirement plans; and
- dividends paid by an ESOP.
Employer Tax Credit
Remember that 2020 plans may still be created in 2021, but for employer contributions only, Kaplan said. For plans created before Dec. 31, 2019, the credit is limited to the lesser of 50% of startup costs or $500; under the SECURE Act, after Dec. 31, 2019, the credit is limited to lesser of (1) 50% of startup costs or, (2) the greater of either: (i) $500, or (ii) the lesser of either $250 X NHCEs or $5,000.
And there are other considerations, as Kaplan outlined:
- The employer may deduct expenses that exceeded the credit.
- “New plan” means not maintaining one for the prior three years.
- If the plan started before 2020, one may still use the new limit if the three years has not expired. “Just because it started at one dollar limit does not mean it cannot use a new dollar limit,” Kaplan said.
- One must have at least one NHCE in order to use the credit.
- The credit applies to a qualified plan, SEP or SIMPLE.
Distributions
Kaplan addressed distributions from a variety of perspectives, as well.
10% Additional Tax on Early Distributions. The fact that there are penalties means that early distributions can be really expensive, Kaplan said. However, he reminded, the tax is not applicable if:
- the recipient is age 59½ or older;
- there was a separation of service during or after the year age 55 is attained (applicable for qualified plans only, not for IRAs);
- the early distribution was a permissive EACA withdrawal or nondiscrimination testing corrective distribution;
- the distribution is to the beneficiary of a deceased participant;
- the person taking the distribution has a total and permanent disability;
- there are substantially equal payments for the life of employee (or joint lives of employee and beneficiary;
- the distribution is in the form of ESOP dividends;
- there is a tax levy;
- there are unreimbursed medical expenses of more than 10% of AGI;
- there are QDRO payments to an alternate payee;
- it is from an IRA for health insurance premiums for unemployed individuals or for post-secondary education expenses;
- it is a qualified reservist distribution for someone who has been activated for at least 180 days;
- the early distribution is an in-plan Roth rollover;
- it is from an IRA for a first-time home purchase (note: limited to $10,000); or
- it is a qualified birth or adoption distribution (note: limited to $5,000).
And there are other special exceptions, Kaplan said: COVID-19 distributions (as provided for under the CARES Act) and qualified disaster distributions under the Consolidated Appropriations Act, 2020. He also noted that distributions from governmental 457(b) are not subject to the 10% additional tax, except for rollovers from plans that are subject to it. And early distributions from a SIMPLE IRA incur a 25% additional tax instead if made in the first two years of participation.
Failure to Take an RMD. There is a 50% penalty for failing to take required minimum distribution, Kaplan noted. He offered suggestions regarding steps to consider if such a penalty is imposed:
- Pay the tax.
- Request a waiver.
- If one is a beneficiary, consider withdrawing the entire balance by end of 10th year following the owner’s death (or 5th year if death was before 2020).
- Remember that now the lifetime stretch can only apply to a spouse, one who is chronically ill or disabled, or those less than 10 years younger.
- Use EPCRS for plan operational errors.
- Make sure it does not happen again.
Roth Distributions. Kaplan reminded attendees that Roth distributions are subject to the RMD rules. In addition, they can be used for a direct rollover from one Roth to another or to a Roth IRA, but there may not be a rollover from a Roth to a traditional IRA or pre-tax retirement account. And a partial rollover of a nonqualified distribution is treated as consisting first of the untaxed portion (thus not pro-rated).
Available on Demand
The ASPPA webinar “Working with Qualified Plans Can Be Taxing” is available on demand. Information is available here.
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