We are taking a few days off. Thank you to all who have served our country, and we remember those who gave their lives.
The last topic we'll address that stems from the fact that LOSAP assets are municipal assets and not participant assets is the idea of investment direction by the participant.
Most are familiar with a typical 401(k), 457 or IRA account, where a menu of investment options are available for the participant to select. Some plans even offer target funds, or actively managed options. So we often get questions about Defined Contribution LOSAP accounts, and if participants can direct the investment of his/her LOSAP account.
As a preface, it must be said that we cannot find any formal guidance from the IRS on this issue. We have done a lot of research and digging and are not able to locate anything. So our understanding is based on other types of guidance available, including commonly accepted practice. We strongly suggest you seek advice from an attorney with expertise with the Internal Revenue Code.
That said, it appears the answer is no, a participant cannot actually direct the investment of his/her DC LOSAP account balance. This seems logical, because the assets are sponsor assets. But again, our research comes up empty in terms of formal guidance from the IRS.
HOWEVER - there seems to be an accepted "workaround" for this. How it must be structured is that the participant selects hypothetical investment options provided by the sponsor. The documentation must be clear that these are hypothetical options, and the sponsor is not under any obligation to actually invest the money in a manner constant with that hypothetical investment.
So for example, let's say the hypothetical investment option was Apple stock. To keep the bookkeeping easy, the sponsor would then actually invest the account balance in Apple stock, even though it is technically not obligated to do so. This thin veil seems to be acceptable.
Typically, including the option for a participant to direct his/her own account balance would result in additional administration fees. Plus, the Trust Document/Agreement would have to be specially drafted to include the proper language. A plan sponsor should carefully consider these additional fees, and get advice from their own legal counsel, before allowing participants to direct the investment of their LOSAP accounts.
We continue to look at the different ramifications of the fact that the assets reserved for LOSAP benefits are municipal assets and not firefighter assets.
Given the last few discussions, this one may seem obvious, but a participant cannot take a loan against his/her LOSAP account balance either.
This is an easy answer first because the NY State law does not allow it. The reason it isn't allowed is because again, the assets are not participant assets. So any kind of loan would be akin to the municipality loaning money to an individual.
We've recently been discussing the ramifications of the fact that the assets of a LOSAP are not participant assets, but municipal assets.
Another ramification is that the benefits paid cannot be rolled over to an IRA. There are other tangential reasons as well, but a main reason why is that the assets are not the participants to control.
Let's consider a defined contribution plan to keep it simple. A firefighter has accumulated a $20,000 balance. This firefighter turns the entitlement age and is eligible to be paid this $20,000 on 1/1/2019. Therefore, on 1/1/2019 the $20,000 is made available to the participant, and so it is taxable (we are just tackling Federal income tax for now). Thus, it is distributed to the participant. Prior to 1/1/2019, the $20,000 was not taxable because it was municipal assets and subject to forfeiture (if the municipality were to become insolvent, or bankrupt).
In a rollover situation, a participant transfers his/her own account balance (one that the participant owns 100%) to another qualified retirement plan. But since the LOSAP account is not owned by the participant, this type of transfer cannot take place - it is not from a participant-owned pre-tax account to another participant-owned pre-tax account.
There are similar situations in the qualified plan world. For example, if you inherit an IRA from someone other than your spouse, you are not allowed to roll it over into your own IRA. In addition, required minimum distributions are not eligible for rollover.
Please consult with your own tax adviser about the taxation of receiving your LOSAP distribution. This article is not legal or tax advice.
Benefits paid from a LOSAP are subject to federal income tax as of the date this blog post is being written.
In general, any form of compensation is taxable in the year in which it is earned, unless the the Internal Revenue Code specifically exempts it. One of those exemptions are contributions into 401(k) - the Code allows an individual to defer taxation of compensation by depositing that compensation into a qualified 401(k) plan. Similarly, an individual can make contributions into an IRA and subtract those contributions (up to a certain limit) from the individual's taxable gross income.
Benefits accrued in a LOSAP are a form of compensation, and the Code does not contain any provision to exempt it from federal tax. NY State law stipulates, in summary, that the LOSAP benefits should not be taxable to the participants until it is paid.
In order to prevent a participating volunteer from paying federal income tax on the LOSAP benefits as they are accrued rather than when they are paid, two stipulations are made on the Trust assets:
1) Trust assets are assets of the municipal sponsor.
2) Trust assets are subject to the creditors of the sponsor in the case of insolvency.
Stipulation #2 in particular means that it is possible that a participating volunteer will not be paid the accrued benefit, because the sponsor could, in theory, become insolvent and the Trust assets would be accessed by the sponsor's creditors. This is enough of a stipulation that the benefit is not taxable until it is made available to be paid to the participant. In New York, once it is made available to be paid, it is paid.
Note: this post is not meant to be an exhaustive explanation of all of the nuance of the federal taxability of LOSAP benefits. Please contact your own IRS tax specialist or contact our office for additional details.