A Closer Look at Payroll Deduction IRAs

Employer payroll deduction IRAs are coming back into vogue, an expert at last week’s NTSA Summit argued.

“Employer IRAs are not new—they’re just getting a resurgence because of the MEP and PEP rules,” said Sue Diehl, President of PenServ Plan Services, a Pennsylvania-based TPA and recordkeeper. Employer IRAs are “totally open to employers however they want to use them,” she said. It’s no surprise if IRAs are more widespread among employers that offer 403(b)s, Diehl indicated, remarking that “The IRA world works better with the 403(b) world than 401(k)s.” That, she said, is “because there are so many advisors in the 403(b) world.”

Diehl outlined some of the particulars concerning them and how they work.  

How They Work. Under a payroll deduction IRA, an employee establishes an IRA (either a traditional IRA or a Roth IRA) with a financial institution. 

Eligibility. Any employee who performs services for an employer is eligible to be included in a payroll deduction IRA. In general, if an employer offers such an arrangement to any employee, then it should offer it to all employees.

The Employer’s Role. Payroll deduction IRAs are not a heavy lift for employers, Diehl indicated. After an employee establishes one, the employer is responsible for transmitting the employee’s authorized deduction to the financial institution. But after that:

• There is no annual filing or reporting requirement.
• The employee’s Form W-2 will not reflect the contributions and will indicate that the employee is not a participant in a retirement plan.
• No separate statements need to be provided to the employees.

Contributions. The contribution rules are as follows:

• Employees fund their own payroll deduction IRAs through payroll withholding.
• Contributions to each employee’s account is limited to the IRA contribution limit—for 2022, that’s $6,000 (plus $1,000 if age 50+).
• Payroll deduction IRA contributions are sent to each financial institution; employers have no further responsibility for the amounts contributed.

Investments. Each employee can move their IRA assets from one IRA to another; the financial institutions selected manage the funds.

Vesting. Each employee is always 100% vested in the contributions to their payroll deduction IRA.

Compliance. Diehl identified nine compliance areas of concern for trustees, custodians and issuers:

1. Plan document or agreement (custodial/trust agreement or IRA annuity) 
2. Plan disclosure statement 
3. Amendments to plan or disclosure
4. Forms 1099-R 
5. Forms 5498
6. Fair market value statements 
7. Required minimum distribution statements
8. Withholding responsibilities, notices and elections 
9. Compliance with the Securities and Exchange Commission’s fiduciary rule when it is finalized, as well as certain state rules

“You will hear more about employer IRAs,” Diehl told attendees. 

Deemed IRAs

Deemed IRAs also have become increasingly popular, Diehl told attendees. With a deemed IRA: 

• Contributions can be made to a qualified plan, 403(b), or governmental 457(b) under the same rules that apply to traditional or Roth IRAs, as long as the employer allows it.
• The employer must keep separate account records and report in the same way that it does IRAs [Forms 1099-R (separate) and 5498].
• SEP or SIMPLE contributions cannot be made, effective in 2003 under EGTRAA and IRS guidance in Revenue Procedure 2003-13 and Treas. Reg. §1.408(q)-1.
• A separate trust is not required but separate accounting is required for deemed IRA portion, with the traditional and Roth accounts maintained separately.
• The trustee must be a bank.
• Governmental entities may become IRS-approved non-bank trustees for their own 457 and QP plans. “This means you will see them in rollovers,” said Diehl, adding, “some already have.”/li>
• Disqualification issues may not spill into the IRA portion or the plan portion if separate trusts are maintained.
• Each portion may have different eligibility.
• It is treated as a separate entity from other parts of plan for purposes of Code Sections 401(a)(9) and 72(t) and ERISA protection. 
• IRA rules apply to the deemed IRA portion, and 403(b) rules apply to the other sources of monies.

Deemed IRAs will help prevent leakage, Diehl said, if employees can roll over the funds after separation from service into a deemed IRA. And they can be used as an IRA for missing participants.