Winter, 2005 Edition

• Late Deposit of 401(K) Contributions
• IRS Announces Cost of Living Increases
• Long Term Care as a Fringe Benefit
• Social Security in the Spotlight
• Retirement Savings Proposals

 

Late Deposit of 401(K) Contributions

Over recent years, the Department of Labor (DOL) has focused much of its 401(k) compliance efforts on the late deposit of 401(k) employee contributions.

The general rule for depositing employee 401(k) deferrals is that once funds are deducted from an employee's paycheck, they must be invested in the Plan at the earliest possible date that the funds can be reasonably segregated from the employer assets, but no later than the 15th business day following the month of deferral. Some employers have mistakenly interpreted this rule to mean that all contributions can wait until the "15th day" deadline. The DOL has made it clear that this is not the case and that all employee contributions must be deposited to the Plan investment accounts as soon as administratively feasible. How soon is administratively feasible? This will be different for all employers. For most, however, once the paycheck is issued, the 401(k) contributions should be mailed or wired within the next day.

Late 401(k) contributions are required by law to be disclosed on the Plan's Form 5500 return. And, as might be suspected, this is a "red flag," increasing your Plan's chances of being audited by the DOL. This involves having to go through a tedious/time-consuming process, making additional contributions to replace lost earnings and dealing with prohibited transaction and fiduciary responsibility issues.

The best way to avoid the wrath of the DOL and keep your 401(k) running smoothly is to send in 401(k) contributions on a timely basis and to do it consistently.

Back to Top

 

IRS Announces Cost of Living Increases

The IRS has announced the plan limit cost of living increases for 2005.

	2004	2005
Taxable Wage Base	$87,900	$90,000
Includable Compensation Limit	$205,000	$210,000
401(k)/403(b) Deferral Limit	$13,000	$14,000
401(k)/403(b), 457 Catch-up Limit	$3,000	$4,000
Defined Contribution 415 Limit	$41,000	$42,000
Defined Benefit 415 Limit	$165,000	$170,000
SIMPLE Deferral Limit	$9,000	$10,000
SIMPLE 401(k) & IRA Catch-up Limit	$1,500	$2,000
Highly Compensated Employee	$90,000	$95,000
SEP Compensation Limit	$450	$450
457 Deferral Limit	$13,000	$14,000

 

Back to Top

 

Long Term Care as a Fringe Benefit

Many professional practices and small companies have been establishing Long-Term Care Insurance programs as a fringe benefit for their key employees and family members.

Under current law, Long-Term Care Insurance premiums are tax-deductible within certain guidelines when paid by "C" corporations. When such an entity establishes Long-Term Care coverage for an owner or key employee (and the spouse, if desired), the tax situation is akin to that of health insurance. The premium can be deducted on the corporation's tax return and any benefits paid out to the insured individual (employee or spouse) are received free of federal income tax.

There is no requirement that Long-Term Care coverage be provided to all employees. Thus, it can be limited to professionals, executives, and/or owners if desired.

Given the sharp rise in the cost of providing nursing home care, as well as hiring licensed aides to provide care in the home, Long-Term Care Insurance has become a very important consideration for many professionals, executives, and business owners in their late forties and beyond. Locking in a premium at a relatively early age and having it paid on a tax-deductible basis by one's employer, provides an extremely efficient way to carry this important coverage.

Back to Top

 

Social Security in the Spotlight

Back in our Fall of 1996 edition of The Mid-Atlantic Messenger, we included an article entitled "Saving Social Security," which presented ideas and options aimed at fixing the Social Security program. We speculated that the next President (Clinton) and Congress would "oversee the most radical changes to the Social Security program in its 60-year history." A little late perhaps, but it is clear now that Social Security reform is in the spotlight and at the top of President Bush's domestic agenda.

Why is there a problem with Social Security?

This question can be answered with one word - demographics. Since Social Security is run on a pay-as-you-go basis where workers and employers support those receiving benefits, when the dollars paid to recipients exceeds the amount being contributed into the system, you have a problem. When Social Security was first enacted, there were 16 workers supporting each recipient. Since then the ratio of the working to the retired has steadily decreased. Currently, there are just over 3 workers to every recipient. As the baby boom generation retires, the ratio will be further reduced to a 2-to-1 level.

Currently, Social Security collects more in taxes than it pays out in benefits, and thus runs at a surplus. Given the changing demographics, however, it is estimated that the system will begin paying out more than it receives in 2018 and that full promised benefits will not be able to be paid around 2042. The system at that time would only be able to pay 73% of such benefits.

Private Accounts

Although the exact details have not been given, the centerpiece of President Bush's reform proposal is the creation of private accounts for workers under age 55. The idea is to take a portion of the payroll taxes that a worker currently pays into the system (up to 4%) and allow them to invest those funds in a private investment account. In exchange, the promised benefit from Social Security itself would be reduced, with the potential for the private accounts to make up the reduced benefits and hopefully result in a larger overall benefit with positive investment results. Supporters of private accounts believe that it will lead to a more stable system that does not depend as heavily on demographics, provide individuals the opportunity to earn a higher return than what is currently provided by Social Security, and provide an ownership aspect that can be passed on to future generations.

Would the creation of private investment accounts solve the Social Security dilemma? Well, no. Detractors of the idea point out that private accounts would do nothing to solve the future funding woes and may increase the problem since funds would be diverted from the Social Security Trust Fund currently paying benefits. In the short-run, the government would have to borrow heavily to pay current recipients as well as the implementation costs associated with private accounts. Opponents of private accounts also believe that Social Security should remain a social insurance program. Creation of investment accounts inherently pose the risk that individuals may do worse than the current system and thereby erode the safety net that Social Security provides.

Benefit Cuts and Tax Increases

Whether or not there are private accounts, changes that will sustain Social Security will most likely still involve a combination of benefit cuts and tax increases. Two significant changes that are being discussed are "price indexing" of benefits and increasing the earnings that are subject to tax, called the "taxable wage base."

Price indexing would involve a change in how benefits are calculated. Currently, benefits for retirees are based on the rises in wages over a worker's lifetime. With price indexing, the change would be made to calculate benefits based on the rises in prices rather than wages. Since prices generally do not increase as fast as wages, benefits would effectively be reduced.

For 2005, payroll taxes are only paid on earnings up to the taxable wage base, which is now $90,000 and is increased annually. Increasing the amount of earnings subject to tax would provide a significant increase in funds available to the system, as well be a large tax increase to those affected.

Over the coming months, expect to hear more details about the President's proposals and other alternatives. Our newsletter will be updated to keep you informed.

Back to Top

 

Retirement Savings Proposals

While Social Security has been getting all of the attention, it should not be overlooked that sweeping retirement plan proposals are included in the President's 2006 budget. These proposals have been debated for the past two years (see our Winter 2002 & Winter 2003 Newsletters), but with the Republican gains made in Congress, the likelihood for at least some of the ideas to become law has increased.

The proposals would replace replace existing retirement savings vehicles such as IRA's and Roth IRA's, with new accounts, the Retirement Savings Account (RSA) and Lifetime Savings Account (LSA) as well as consolidate different types of retirement accounts - 401(k), 403(b), 457, SIMPLE, SARSEPS - into an Employer Sponsored Savings Account (ERSA).

The Retirement Savings Account (RSA) is a tax sheltered account that would allow for non-deductible contributions of up to $5,000 annually. Distributions would be excluded from income if made after age 58.

The Lifetime Savings Account (LSA) is another tax sheltered account that could be used for any purpose, non just retirement. As with the RSA, non-deductible contributions could be made up to $5,000 annually. The difference is that distributions could be made tax-free at any time.

With the Employer Sponsored Savings Account (ERSA), you would have the same type of retirement plan regardless of whether you worked in the private sector, state government or public schools. The ERSA would be modeled after 401(k) plans , but many of the complex rules that are inherent in these different types of plans would be simplified.

When these proposals were first brought forth a couple of years ago, there was significant apprehension from both parties for a variety of reasons, including the long-term impact on the federal deficit and the potential for small employers to exclusively use the RSA and LSA savings accounts and shy away from providing retirement plans for their employees. Since then, adjustments have been made to address some of these concerns, increasing the likelihood of passage. Early indications are that there is more support for the RSA and LSA than for the ERSA.

Back to Top

 

This publication is not meant to provide legal or other professional advice. It is suggested that a tax advisor be contacted to review applicable areas discussed herein. All rights reserved.