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Deemed IRAs face an uphill battle in gaming acceptance by employers and employees alike. Proposed Regulations regarding these elusive IRAs offer clarification and guidance, however which may increase their popularity. This article summarizes the requirements for Deemed IRAs under the Internal Revenue Code (IRC) and the Employee Retirement Income Security, Act of 1974, as amended (ERISA), taking the Proposed Regulations into account.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) authorized the establishment of individual retirement accounts (IRAs) within employer-sponsored retirement plans. These accounts--known as deemed individual retirement accounts (Deemed IRAs)--became available on January 1, 2003. (1) Deemed IRAs are separate accounts (or annuities) established by an employer on behalf of eligible employees under its qualified retirement plan that are treated as Traditional individual retirement accounts (Traditional IRAs) or Roth individual retirement accounts (Roth IRAs) rather than as qualified plan accounts. Generally, this means that contributions to and distributions from Deemed IRAs are subject to the federal income tax rules that apply to Traditional and Roth IRAs, and not to the federal income tax rules that apply to qualified retirement plans.
To date, few employers have permitted employees to establish Deemed IRAs and few qualified retirement plan providers (e.g., banks, mutual funds, and other financial institutions) have added Deemed IRAs to their retirement product offerings. Employers and qualified retirement plan providers may be delaying rollout of Deemed IRAs due to a lack of regulatory guidance regarding the structure and administration of the accounts.
Some employers and qualified retirement plan providers, however, may not be interested in Deemed IRAs. Although the additional assets that might accumulate in Deemed IRAs might lower overall plan fees, a Deemed IRA feature would require qualified plan administrators to integrate a different--and perhaps unfamiliar--set of federal income tax rules into their administrative procedures.
Moreover, it is unclear whether Deemed IRAs would be sufficiently popular among employees to make an effort to add the Deemed IRA feature worthwhile for plan sponsors. Cost and convenience are thought to be the primary attractions of Deemed IRAs for employees. By allowing an employee to establish an IRA under his or her employer's qualified retirement plan, the employee may be able to take advantage of the lower fees and expenses generated by the larger qualified retirement plan asset pool than might otherwise apply if the employee were to establish a separate IRA. In addition, an employee otherwise uninterested in contributing to an IRA because of the time and expense associated with shopping for and establishing the IRA, might be induced to contribute to the ready made Deemed IRA, to which contributions can be made through the convenience of payroll reduction. (2) These advantages seem marginal at best and it is not surprising that many employers might conclude that Deemed IRAs provide little value to employees.
For those employers and qualified retirement plan providers who may be interested in Deemed IRAs, but have been reluctant to pursue them for lack of regulatory guidance, the guidance provided by the Internal Revenue Service (IRS) in recently proposed regulations (Proposed Regulations) (3) may be sufficient and may trigger a rollout of Deemed IRA products in the near future.
APPLICABILITY OF TRADITIONAL AND ROTH IRA RULES
Deemed IRA contributions and distributions are subject to the rules generally applicable to IRAs, and not to the rules generally applicable to qualified retirement plans. This separate treatment applies for all purposes, including eligibility, participation, funding, vesting, disclosure, nondiscrimination, contributions, distributions, investments, and plan administration.
Deemed IRAs may be either Deemed Traditional IRAs or Deemed Roth IRAs. Deemed Traditional IRAs are subject to the rules generally applicable to Traditional IRAs and Deemed Roth IRAs are subject to the rules generally applicable to Roth IRAs.
Thus, for example:
* Deemed Traditional IRA contributions may or may not be deductible to the employee, depending upon whether the employee is an active participant in an employer-sponsored retirement plan and what the employee's adjusted gross income is. Deemed Roth IRA contributions are not deductible.
* Distributions from Deemed Traditional IRAs are subject to federal income tax (except for distributions of nondeductible Deemed IRA contributions). Distributions of Deemed Roth IRA contributions are not subject to federal income tax. Distributions of Deemed Roth IRA earnings generally are not taxable if they are made after the employee has had a Roth IRA for at least five years and following the employee's death, disability, or attainment of age 591/2.
* Deemed IRA contributions are not subject to the limit on 401(k) contributions ($12,000 for 2003) or the annual addition limit under IRC Section 415 (the lesser of 100 percent of compensation or, for 2003, $40,000).
* Contributions to any combination of Traditional or Roth IRAs (including Deemed IRAs) may not exceed the annual IRA contribution limit ($3,000 for 2003). …