401(k) puzzles (former employee)

[GoodbyeYellow]

We are aiming to drive down 2022 MAGI for ACA purposes. I am retired but DW intends to resign either Dec 31 2021 (Scenario 1) or within 2 weeks following that date (S2).

In either scenario she will be paid for the last 2 weeks of December (in January) with that amount hitting her W2 for 2022. If she works some days in Jan then a bit more pay for that also. Finally, the 2021 bonus will get paid in March 2022.

Question 1:
We are uncertain what happens to the 401(k) deduction and employer match in either scenario. If S1 and the paycheck comes in Jan (and she is already an ex-employee at this point), does the deduction get taken out of that check? If yes, does it get taken out of the bonus check? I guess basically the question is, once an employee goes into "Former" status, does 401(k) activity (contribution, employer match) cease?

Question 2:
To further reduce MAGI, we plan to contribute the max to both our IRAs in 2022, $7K each, so $14K. Does this amount need to be reduced by any 401(k) deduction above, either in S1 or S2? Or can we still do the entire $14K?

I hope someone has experience with this sort of thing as we may need to adjust plans based on the answers. Experience has shown that HR/Payroll are incredibly difficult to get a hold of and in any case, as she has not announced her resignation, not sure I want to ask this question at this time. She will provide the customary (though not obligatory) 2 weeks when the time comes.

 

[gauss]

I do have some experience with this in that my DW retired at the end of a calendar year (2018).

She received in the following year (2019) two checks. One for the 2018 bonus and one for a severance payment. She did not work anytime during 2019.

I am quite sure that I was able to make IRA contributions for the 2019 based on this.

As a "kicker", the W2 "covered by retirement box" was not checked in the following years (2019) W2 so that increased the amount of the possible IRA deduction. A single W2 was issued in 2019 that covered both of these payments (which I guess is not surprising).

This would line up more with your scenario 1 since there were no "wages" earned in the following year (2019.)

Also in this case, the final paycheck which was dated 12/31/2018 included the final 401k contribution.

-gauss

p.s. 401k and IRA contributions never interact. The rules for 401k contributions are not effected by IRA contributions and vice-versa. You can contribute to both as long as you meet their respective requirements. As such I think the answer to your Q2 is straight forward - no need to reduce IRA contributions because of 401k.

 

[Dash man]

IRAs are separate from a 401k. As long as you have enough earnings for the IRA, you can contribute.
The 401k contribution will be the date of the paystub.

 

[cathy63]

Question 1:
We are uncertain what happens to the 401(k) deduction and employer match in either scenario. If S1 and the paycheck comes in Jan (and she is already an ex-employee at this point), does the deduction get taken out of that check? If yes, does it get taken out of the bonus check? I guess basically the question is, once an employee goes into "Former" status, does 401(k) activity (contribution, employer match) cease?

Unfortunately, the only ones who know the answer to this question are the payroll/benefits people at your wife's employer. They will be governed by the plan documents and their own internal policies, so she needs to be persistent and ask them what will happen with each type of payment. Also, is she 100% sure she will get the bonus if she's already resigned? The employer doesn't have to pay it, even if it's based on 2021 performance, unless she has an actual contract, and many (most?) won't.

Question 2:
To further reduce MAGI, we plan to contribute the max to both our IRAs in 2022, $7K each, so $14K. Does this amount need to be reduced by any 401(k) deduction above, either in S1 or S2? Or can we still do the entire $14K?

As a couple, you can't contribute more than your combined earned income. If you and your wife will earn at least $14K, then you can each contribute $7K to your IRAs. Her contribution will not be fully deductible if she earns more than $105K because she has a 401(k) plan at work. Your contribution will not be deductible if she earns more than $198K. (I'm assuming you don't have a W-2 job with a 401(k) plan.)

Your wife could also consider maximizing her 401(k) contribution for 2022 by setting the contribution to 100% of salary, or whatever amount her employer will allow. This could actually be more than the IRA contribution.

 

[SecondCor521]

Question 1:

I would expect the fact that she is a former employee at the point those last two checks are issued would not matter, and her 401(k) contribution and any employer match would occur.

I would look to what happened with her 2020 bonus check received in March 2021 (i.e., 7 months ago) to see what to expect. Maybe her employer treats bonus checks differently; I think some companies do.

Question 2:

Between the two of you, you can generally contribute up to the total of your box 1 wages (plus net SE income if that applies). I think box 1 wages typically excludes any employee 401(k) deferral, so you'd only be able to contribute up to essentially the net of her paychecks.

You can probably look back at her paystubs from December 2020 and January 2021 and her 2020 W-2 to see whether her 401(k) contributions are included in box 1 or not.

Note that if her W-2 income is less than $14K, then you would not be able to max out your IRAs - you would be limited to her W-2 box 1 wages (again, plus any net self-employment income, if applicable).

Also, if your 2022 income is going to be relatively low, you may want to consider making a Roth contribution instead of a traditional IRA contribution. Same tax deferral, but no tax deduction. In a low income year, you may actually want to report the income and pay the taxes.

Finally, I worked for a large company, and I was cagey with HR for a while until I realized that nobody in HR was going to spill back to my management chain that I was considering retiring. I still only talked with one person in HR, and I still couched things conditionally, but towards the end I was pretty much saying "OK, assume I retire on date X, what happens to my stock options?" It never got back to my chain of command. But that was in a large corporation; if your wife works for a smaller employer it may be a less advisable idea.

 

[PaunchyPirate]

You will really need to contact HR and hope they are knowledgeable enough to accurately answer your questions or you will have to wait and see. It will vary with different employers.

I retired on December 14, 2018. Since I gave advance notice, I received all of my regular due income (hours worked and vacation payout) via check on my last day of work. It was sent to my home via FedEx. Normal 401k amounts were withheld.

I had a bonus that was due to be paid on January 15. They paid it on time via check. No 401k deductions were taken from the amount. That bonus was $4600. So for 2019, I only had $4600 in earned W2 income. Therefore I could only contribute $4600 to an IRA in 2019. So that’s what I did.

To make the story longer and more interesting, I put the money in my Roth IRA right away. Unfortunately, later in the year, I rather unexpectedly sold a lot of stock which put my income way above the Roth threshold. So I had to reverse the Roth contribution and put it in my Traditional IRA instead. I was able to take a tax deduction for the contribution because I was not covered by a work retirement plan. The W2 for the $4600 properly showed no check mark in the retirement plan box. That reversal was a bit of a pain that I had to deal with in December. My advice is to wait until the year’s end before doing your IRA contribution, just to see what happens in your first year of retirement.

 

[gauss]

As a couple, you can't contribute more than your combined earned income. If you and your wife will earn at least $14K, then you can each contribute $7K to your IRAs. Her contribution will not be fully deductible if she earns more than $105K because she has a 401(k) plan at work. Your contribution will not be deductible if she earns more than $198K. (I'm assuming you don't have a W-2 job with a 401(k) plan.)

If the wife retires at the end of the year, then I believe the following year's W2 will not have the box 13 "covered by retirement plan" box checked. Just having a 401(k) is not sufficient for the employer to check this box and subject the deductible IRA contributions to income limits.

The W2 instructions to the employer specifically cover this on page 22. They also refer to common employer W2 mistakes earlier in the instructions including checking box 13 inappropriately.

The year after my DW retired we were able to make a deductible IRA contribution that was not effected by our income because her MegaCorp employer correctly did not check the box --- even though she had both a 401k and a DB pension that she was drawing from.

Our plan documents clearly state that only active employees are able to participate in the pension and 401k plan. I don't have the actual plan documents in front of me, but I seem to recall that "participate" was synonymous with "contribute".

The [-]devil[/-] angel is in the details on this one. YMMV

IRS W2 employer instructions - page 22 - box 13
Retirement plan. Check this box if the employee was
an “active participant” (for any part of the year) in any of
the following.
1. A qualified pension, profit-sharing, or stock-bonus
plan described in section 401(a) (including a 401(k) plan).
2. An annuity plan described in section 403(a).
3. An annuity contract or custodial account described
in section 403(b).
4. A simplified employee pension (SEP) plan
described in section 408(k).
5. A SIMPLE retirement account described in section
408(p).
6. A trust described in section 501(c)(18).
7. A plan for federal, state, or local government
employees or by an agency or instrumentality thereof
(other than a section 457(b) plan).
Generally, an employee is an active participant if
covered by (a) a defined benefit plan for any tax year that
he or she is eligible to participate in, or (b) a defined
contribution plan (for example, a section 401(k) plan) for
any tax year that employer or employee contributions (or
forfeitures) are added to his or her account. For additional
information on employees who are eligible to participate in
a plan, contact your plan administrator. For details on the
active participant rules, see Notice 87-16, 1987-1 C.B.
446; Notice 98-49, 1998-2 C.B. 365; section 219(g)(5);
and Pub. 590-A, Contributions to Individual Retirement
Arrangements (IRAs). You can find Notice 98-49 on
page 5 of Internal Revenue Bulletin 1998-38 at
IRS.gov/pub/irs-irbs/irb98-38.pdf.

 

[cathy63]

If the wife retires at the end of the year, then I believe the following year's W2 will not have the box 13 "covered by retirement plan" box checked. Just having a 401(k) is not sufficient for the employer to check this box and subject the deductible IRA contributions to income limits.

The W2 instructions to the employer specifically cover this on page 22. They also refer to common employer W2 mistakes earlier in the instructions including checking box 13 inappropriately.

The year after my DW retired we were able to make a deductible IRA contribution that was not effected by our income because her MegaCorp employer correctly did not check the box --- even though she had both a 401k and a DB pension that she was drawing from.

Our plan documents clearly state that only active employees are able to participate in the pension and 401k plan. I don't have the actual plan documents in front of me, but I seem to recall that "participate" was synonymous with "contribute".

The [-]devil[/-] angel is in the details on this one. YMMV

If the employer actually takes a contribution to the 401(k) plan from a check that is delivered in January, then my understanding of the IRS definition of "active participant" that you bolded is that they are supposed to check the box. It doesn't matter whether the money was earned in 2021 or 2022, just when it was added to the account.

I agree if they don't permit a contribution in 2022, then they definitely should not check box 13. There's just no way for us to know whether they will or won't take the contribution.

Since OP is talking about minimizing MAGI, I guess that they're not likely to be close to the limit for deductibility anyway though, so whether or not the box is checked probably doesn't make a difference in their tax situation.

 

[GoodbyeYellow]

Wow, such a wealth of information so soon... I am grateful!. Gonna try to answer specific points but all the info was avidly consumed.

IRAs are separate from a 401k. As long as you have enough earnings for the IRA, you can contribute.
The 401k contribution will be the date of the paystub.

The income will be less than $40K and, assuming bonus is paid, will be at least $24K (gross). Bit more if adding worked days in January but the thresholds have been passed with the above.

I had a bonus that was due to be paid on January 15. They paid it on time via check. No 401k deductions were taken from the amount. That bonus was $4600. So for 2019, I only had $4600 in earned W2 income. Therefore I could only contribute $4600 to an IRA in 2019. So that’s what I did.

I am beginning to think more and more that 401k will not be deducted from the bonus check, like your case.

If the wife retires at the end of the year, then I believe the following year's W2 will not have the box 13 "covered by retirement plan" box checked. Just having a 401(k) is not sufficient for the employer to check this box and subject the deductible IRA contributions to income limits.

Our plan documents clearly state that only active employees are able to participate in the pension and 401k plan. I don't have the actual plan documents in front of me, but I seem to recall that "participate" was synonymous with "contribute".

I believe she will also not have box 13 checked.

The bonus policy states "Eligible for Success Bonus – (if) Active on the payroll on 12/31 of the performance year"

Cathy63, correct on the MAGI assumption/calc you made.

 

[RetiredAt55.5]

My advice is to wait until the year’s end before doing your IRA contribution, just to see what happens in your first year of retirement.

The OP can wait even longer (April 15th) of the following year. By that time, all the year end W2's and other tax docs will be available.