Uncle Sam wants you to save for retirement. And this time he really means it.
Alert: The IRS has issued new guidance on retirement savings in a series of rulings. These offerings clarify the existing rules, enhance others and generally provide incentives for socking away more money for retirement.
Here’s a roundup of the latest developments in this area.
Automatic enrollment plans
The automatic enrollment feature encourages greater participation among the rank-and-file because it requires employees to proactively opt out of the plan instead of the other way around. As a side benefit, increasing participation makes the plan more likely to meet the strict nondiscrimination tests in the law. This feature has been adopted by numerous 401(k) plans in recent years.
Now the IRS has released a Notice encouraging automatic enrollment as long as the plan provides adequate notice and otherwise complies with the regulations. The Notice also provides a sample for employers to use and guidance on how employees can avoid early withdrawal penalties if they elect to receive a default distribution. (IRS Notice 2009-65)
Similarly, a companion Notice explains how employers can install the automatic enrollment feature in a SIMPLE-IRA. (IRS Notice 2009-67) A SIMPLE (Savings Incentive Match Plan for Employees) is available to employers with 100 or fewer employees earning more than $5,000 a year. Caveat: If your company offers a SIMPLE to employees, it can’t provide any other type of qualified retirement plan.
The IRS also allows an employer with an automatic enrollment plan to gradually increase the default contributions over time. (IRS Revenue Ruling 2009-30)
Unpaid leave time
Does your company permit its employees to bank or carry over unused leave time—vacation days, sick days and the like—to the next year? If it does, it may compensate someone for the unpaid leave time if he or she should terminate employment.
Another new IRS ruling explains how a departing employee can contribute the dollar-equivalent of unused leave time to a qualified retirement plan. Typically, any unused leave time may be forfeited and contributed to the plan or the participant may contribute any part of the dollar-equivalent of unused paid time that can’t be carried over. The dollar-equivalent is determined as the number of hours of unused paid time off multiplied by the hourly rate of compensation for the pay period when employment is ended. (IRS Revenue Ruling 2009-31)
The IRS clarifies the tax treatment when contributions of unused leave time are paid to a plan after termination of employment. In brief, such contributions are treated as employer contributions to the plan. Reminder: Taxpayers taking a pre-age-59½ distribution of the dollar-equivalent of unused leave time will be hit with a 10% penalty for early withdrawals unless a special exception applies. (IRS Revenue Ruling 2009-32)
Beginning with 2009 returns, you will be able to check a box allocating part or all of a personal federal income tax refund to the purchase of Series I U.S. Savings Bonds. Series I Bonds are part of Uncle Sam’s stable of inflation-linked investment products. You aren’t taxed on the earnings until you cash in the bonds or they mature.
At first, this option will be available only for I Bonds you buy in your own name or the joint names of you and your spouse if you’re a joint filer. But the IRS has announced it plans to expand this feature to co-owners for 2010 returns filed in 2011. It intends to post answers to frequently asked questions (FAQs) about the I Bond option at www.irs.gov.
At long last, the IRS has provided guidance on rollovers from 401(k) plans, Roth IRAs and other retirement plans. (IRS Notice 2009-68) Significantly, it updates the safe-harbor rules issued back in 2002 prior to the recent spate of legislative changes. The Notice also describes the distribution options available to employees in “plain English” (see box below). Finally, it explains the rules for distributions paid to surviving spouses and other beneficiaries.
Tip: The IRS will probably continue to encourage retirement savings through future pronouncements.
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