Definition of employer plan participant
What is the definition of a 401k plan “participant” for purposes of the income limitations for deductibility of IRAs. Does plan participant mean eligible for the 401k plan, or actually participating in the plan?
Permalink Submitted by Martin Helmer on Wed, 2009-04-08 22:18
For purposes of the IRA rules, an active participant in a 401(k) plan is someone who’s had some amount allocated to his account. It can be $1 of employee elective deferrals, employer profit sharing, or a forfeiture. Merely being eligible without any allocation does not result in the pension box being checked on Form W-2. Another wrinkle is that the determination is based on the plan year end. So if the plan year is from July 1, 2007 to June 30, 2008 and you defer $1 on July 15, 2007 and then discontinue making any more contributions, you would be an active participant for 2008. A 401(k) is a type of defined contribution plan. It’s a defined benefit plan where merely being eligible nets you a check in the pension box. If a person is eligible for a 401(k) and chooses not to contribute, that person does count as being covered by the plan for purposes of the minimum coverage requirements. See Notice 87-16 for details on the active participant rules.
Permalink Submitted by mk foss on Wed, 2009-04-08 20:41
The 401k plan has special rules. If someone is eligible for the plan but decides not to defer income into it, they are considered to be participating with a zero deferral percentage. That makes them a plan participant.
The retirement plan box will be checked on Form W-2 and IRA deductions will be limited to those available to plan participants.
Permalink Submitted by Alan Spross on Wed, 2009-04-08 23:56
Since many 401k plan providers also maintain a DB plan as well, a W-2 would show plan participation in the box for the DB plan and the employee may think this is coming from the 401k, when it is not. It only takes one plan covering an employee for one day a year to trigger the W-2 check off. In addition, if a 401k is the only plan, and is set up for all employees in the event of a supplemental profit share match when the employee does not elect any deferrals, the employer can not be able to provide an accurate answer to the participation question early in the year.
In the event of an unpleasant surprise following an IRA contribution, there are several choices:
1) Recharacterize to a Roth contribution if income is within limits for a Roth
2) If not, accept the non deductible TIRA contribution and file Form 8606. This works well if there are high earnings in the IRA account to be protected.
3) Withdraw the contribution under return of contribution rules. Do not take a deduction, and report any income included in the distribution. Early withdrawal would apply to the income unless an exception applies.
Permalink Submitted by mk foss on Thu, 2009-04-09 02:01
We’ve found that the IRS routinely disallows IRA deductions when the retirement plan box is checked. Unfortunately the IRA deduction could be made before the taxpayer is eligible for the employer plan and doesn’t realize the problem until they receive Form W-2.