What Is It?
A payroll deduction IRA plan is really nothing more than a special type of program that you can establish to allow your employees to contribute to their own IRAs via payroll deduction. It can be offered to your employees as an alternative to a more conventional employer-sponsored retirement plan [such as a 401(k) plan], or in addition to such a plan. With a payroll deduction IRA plan, each of your employees who chooses to participate maintains his or her own separate IRA. The IRAs can be either traditional IRAs or Roth IRAs.
Each participant elects to have a certain amount per pay period deducted from his or her compensation on an after-tax basis (rather than receiving that amount in cash). That amount is then deposited into the participant's designated IRA.
Tip: Aside from being funded through payroll deduction, the IRAs are subject to the same rules that normally apply to IRAs (traditional and Roth).
What Is the Employer's Role?
A payroll deduction IRA program is funded with employee payroll deductions. This means that there are no employer contributions to participants' IRAs. In fact, as the employer, your role is generally limited to: (1) setting up the program with an IRA sponsor (e.g., a bank, credit union, mutual fund company, or insurer), (2) providing potential participants with enrollment materials, information, and educational materials about the program, and (if desired) retirement savings counseling, and (3) processing the payroll deductions and delivering those amounts to the IRA sponsor to be invested in participants' IRAs. Payroll deduction IRA programs meeting these requirements are not pension plans under ERISA Title I, so ERISA's administrative, record-keeping, and other requirements do not apply.
Caution: To ensure that a payroll deduction IRA program will not be treated as an ERISA-covered plan, the following conditions must apply: (1) there are no employer contributions to the program, (2) employees participate in the program on a completely voluntary basis, (3) the employer is neutral with respect to the IRA sponsor when giving employees information about the program, and (4) the employer receives no benefit for offering the program, although a reasonable charge may be assessed for the service of processing payroll deductions.
Tip: According to DOL Reg. Sec. 2509.99-1, an employer may demonstrate its neutrality with respect to an IRA sponsor in a variety of ways, including (but not limited to) by clearly and prominently stating, in language reasonably calculated to be understood by the average employee, that: (1) the payroll deduction IRA program is completely voluntary (employees may not be automatically enrolled, even if permitted to "opt out" of the program), (2) the employer does not endorse or recommend either the sponsor or the funding media, (3) other IRA funding media are available to employees outside the program, (4) an IRA may not be appropriate for all individuals, and (5) the tax consequences of contributing to an IRA through the program are generally the same as the consequences of contributing to an IRA outside the program.
When Can It Be Used?
In general, any type of employer with one or more employees can set up and offer a payroll deduction IRA program. However, this type of program is generally most appropriate for employers that: (1) cannot afford to match employee contributions or otherwise fund employees' retirement, and (2) do not have the time and resources to manage a full-fledged retirement program, such as a SEP, SIMPLE, or 401(k) plan. This may be the case with some small and medium-size companies. Despite their resource limitations, many such employers would still like to help their employees save for retirement on a regular basis. A payroll deduction IRA program can provide a way to do just that. This type of program may also appeal to employers that have a 401(k) or other retirement plan, but want to give employees the opportunity to supplement their retirement savings.
Tip: The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) created a new retirement vehicle called "deemed IRAs." Deemed IRAs allow employees to keep their IRA assets in the employer's tax-qualified retirement plan as a separate account (traditional IRA, Roth IRA, or both) within the plan. This may be more attractive than a payroll deduction IRA plan for employers that maintain a qualified plan governed by ERISA because the deemed IRA assets (like other qualified plan assets) are eligible for unlimited protection from the employee's creditors under federal law, regardless of whether the employee has declared bankruptcy (some exceptions apply). Regular IRAs, by contrast, are not eligible for ERISA protection, although they are protected under federal law up to an aggregate limit of $1,362,800 (scheduled for adjustment in April 2022) in the event of the employee's bankruptcy. (SEP IRAs, SIMPLE IRAs, and amounts rolled over to an IRA from an employer qualified plan or 403(b) plan, plus any earnings on the rollover, aren't subject to this dollar cap and are fully protected.) State law may provide additional protection, including protection from creditors outside of bankruptcy. Employers are not required to offer deemed IRAs.
Advantages of Payroll Deduction IRA Plans
Whether offered in addition to or instead of another retirement plan, a payroll deduction IRA program can have certain benefits for both you and your participating employees.
Advantages for Employer
- This type of program is easy to set up and maintain, with little or no administration and expense.
- The program is funded solely with employee payroll deductions.
- This type of program is not subject to the reporting, nondiscrimination, top-heavy, and other requirements that apply to qualified retirement plans.
- This type of program generally does not interfere with your ability to establish another type of retirement plan for your business, or maintain an existing plan.
- Participating employees are responsible for choosing their own IRA investments and allocating their money among investments, and you are not liable for how those investments perform.
- Like other retirement plan arrangements, this type of program may be considered a valuable employee benefit, and may help promote employee loyalty and productivity.
Advantages for Employees
- Because of the payroll deduction feature, this type of program offers a convenient and reliable way for employees to systematically save for retirement. Without the payroll deduction feature, an IRA owner may be more likely to fund the account inconsistently and/or not as fully.
- Employee participation in these programs is strictly voluntary.
- Each participant decides what amount to contribute to his or her account each pay period. However, total contributions for the year cannot exceed the annual IRA contribution limit — see below.
- Participants generally have the flexibility to start, stop, and restart contributions to the program at their discretion.
- Participants are always 100% vested in their accounts under this type of program.
- Although the payroll contributions are made on an after-tax basis, all or part of a participant's IRA contribution may be tax deductible on his or her federal income tax return. (Roth IRA contributions are never tax deductible, while deductibility of traditional IRA contributions depends on several factors.)
- Some participants may qualify for a partial income tax credit for contributions to an IRA (traditional or Roth), in addition to any tax deduction that might apply.
- As with 401(k)s and other retirement plans, IRA dollars grow tax deferred. In other words, any investment earnings are not taxable until distributed from the IRA (and Roth IRAs may generate tax-free distributions).
- Depending on the program, participants may have a number of investment alternatives to choose from.
Are There Any Disadvantages?
From your perspective as the employer, because it is so easy and inexpensive to have a payroll deduction IRA program, there is no perceivable disadvantage to doing so — other than the fact that you do not receive any income tax deduction, but that is only because you are not contributing anything to the plan. For your participating employees, however, there are a few potential drawbacks, especially if this is the only type of retirement program that you offer:
- The program is entirely employee-funded, so participants receive no employer dollars to supplement their own contributions. With other types of plans, employer contributions may boost employee morale and productivity.
- The annual contribution limit for IRAs is a relatively low $6,000 for 2020 (the same as in 2019). IRA owners age 50 or older by December 31 can contribute an additional $1,000 in 2019 and 2020. By contrast, in a 401(k) plan, a participant can defer up to $19,500 of salary in 2020 ($26,000 if 50 or older).
Caution: In the case of a Roth IRA, the contribution limit is phased out for individuals with adjusted gross income in excess of certain thresholds.
- A participant's tax deduction for IRA contributions may be limited or nonexistent, depending on the type of IRA and the participant's circumstances. By contrast, most employee salary deferrals to a 401(k) plan are made on a pre-tax basis.
- Participants are not allowed to take loans from their IRAs if they need money. By contrast, many employer-sponsored plans allow participants to borrow a portion of their vested benefits.
- Under federal law, funds held in a qualified retirement plan are fully protected from the participant's creditors. However, only $1,362,800 (scheduled for adjustment in April 2022) of traditional and Roth IRA assets (excluding amounts rolled over from certain employer plans) are protected under federal law, and only in the event of the participant's bankruptcy. Any additional protection from creditors is available only to the extent that state law provides such protection.
How Is It Implemented?
A payroll deduction IRA program is fairly easy to implement. Simply establish a payroll deduction program with a bank, mutual fund Company, or other financial institution. Each employee who chooses to participate in the program sets up his or her own IRA with the sponsoring institution. You then arrange for participating employees to make payroll deduction contributions to their IRAs.
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