Payroll Deduction IRA

What Is A Payroll Deduction IRA?

A payroll deduction IRA is a “no fuss” arrangement that any business can easily set up and operate to help employees save for retirement. The arrangement is not subject to employer reporting and fiduciary requirements, as long as the employer keeps its involvement to a minimum. Even if an employer is not in a position to adopt a traditional retirement plan for its employees, it may choose a payroll deduction IRA as a way to facilitate employee saving.

Here are some Payroll Deduction IRA facts:

  • There are no employer filing requirements.
  • There are no employer contributions. The employee makes all contributions. By making regular payroll deductions, employees can to contribute smaller amounts each pay period to their IRAs, rather than having to come up with a larger amount all at once.
  • There is no requirement that an employer have a certain number of employees to set up a payroll deduction IRA.
  • There is little administration cost. The employer and IRA sponsor may absorb the costs of the payroll deduction program but not the regular costs of setting up and maintaining IRAs.
  • Generally, if this arrangement is offered to any employee, the employer should offer it to all employees.

The payroll deduction IRA is a simple and direct way for employees to save for their retirement. Some employees may find it helpful to save more retirement money through an automatic payroll deduction.

Providing a payroll deduction IRA for employees may assist an employer to attract and retain quality employees.

Like its more complicated counterparts, a payroll deduction IRA has four stages in its life cycle: choosing, establishing, operating, and terminating.

CHOOSING

Since all retirement plans have important tax, business, and other considerations for an employer and its employees, the employer may wish to discuss any proposed retirement savings arrangements with a financial advisor. Publication 3998 Choosing a Retirement Solution for Your Small Business” can also assist the employer with this decision.

The payroll deduction IRA is one of the most simple retirement arrangements an employer can provide. The employer merely withholds from pay the amounts requested by employees and promptly

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deposits these amounts into the employees’ IRAs. Employee participation is completely voluntary, and the employer may limit the number of IRA sponsors it will work with.

Basically, by establishing a payroll deduction IRA, the employer has chosen a program that makes each employee responsible for funding their own IRA. The employee has also assumed some responsibility for saving for their own retirement.

ESTABLISHING

Since the payroll deduction IRA is one of the most simple retirement savings arrangements that a business can have, it is easy to set up and operate.

The employee establishes either a traditional or a Roth IRA with a financial institution. Then they authorize the payroll

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deductions. All the employer needs to do is to withhold the payroll deduction amounts that the employee has authorized and promptly transmit the funds to the financial institution. After doing so, the employer has no further responsibility for the amounts contributed. Since the employer has no filing requirements for the program, the administrative costs are kept to a minimum.

OPERATING

Participation in this arrangement is voluntary. Generally, any employee who performs services for the business (or “employer”) is eligible to participate in the payroll deduction IRA arrangement. The employees should understand that they have the same opportunity to contribute to an IRA outside the payroll deduction program. An employee’s participation in the payroll deduction IRA just may be their only source of retirement savings. Each employee determines the amount. Participants are always 100% vested in (they own) all the funds in their IRAs.

There are no employer filing requirements.

There are no participant loans permitted. Withdrawals are permitted anytime and they will be subject to income taxes (except for certain distributions from nondeductible IRAs and ROTH IRAs) and, in some cases, also to a 10% additional tax if the employee is under age 59 �.

Contribution limits are:

  • $ 3,000 in 2004
  • $4,000 in 2005-2007
  • $5,000 in 2008

Additional “catch-up” contributions are permitted for an employee who is age 50 or over. This special catch-up amount is $500 per year for the years 2004 and 2005 and $1,000 for 2006 and beyond.

Employees control where their money is invested. The financial institution the employee has selected to hold their IRA will manage the funds. However, an employee may move their IRA assets from one IRA to another. Depending on the offerings of the financial institution, IRA contributions may be invested in several types of investments – e.g., stocks or mutual funds. Again, the employee is always 100% vested in their

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funds. IRA Information for Individuals has information to get you started on learning about investing your

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IRA funds.

Watch Managing Your IRA for more ideas about investing your IRA (Text version)

The employer must be a neutral party with respect to an IRA sponsor and investment choices. The employee should also be made aware that the employer does not guarantee or promise any rate of return. The employer is merely acting as a conduit.

TERMINATING

If the employer decides that a payroll deduction IRA no longer suits its business needs, the employer simply notifies the payroll department that the program is being terminated. The employer may need to notify the IRA sponsor(s) that the employer

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will no longer be making such deposits.

The payroll deduction IRA can be terminated at any time provided the employees have been notified. No notice of the termination is sent to the IRS.


RESOURCES

Additional information on payroll deduction IRAs is available on the IRS’s and U.S. Department of Labor’s (DOL’s) Employee Benefits Security Administration Web sites, http://www.irs.gov/ep and www.dol.gov/ebsa. For the IRS, go to the IRS Web address and click on “More Topics” in the “Topics” section and then click on “Types of Retirement Plans”. For DOL, go to the DOL Web address and click on “Compliance Assistance for Small Employers.”

Related materials available from the IRS:

Publications

  • Publication 3998 Choosing a Retirement Solution for Your Small Business provides an overview of retirement plans available to small businesses.
  • Publication 560 Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans),
  • Publication 590 Individual Retirement Arrangements (IRAs)
  • Publication 4118 Lots of Benefits, discusses the stages involved in the Retirement Plan Life Cycle.

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