[Federal Register Volume 69, Number 140 (Thursday, July 22, 2004)]
[Rules and Regulations]
[Pages 43735-43741]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-16594]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9142]
RIN 1545-BB58


Deemed IRAs in Qualified Retirement Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final regulations providing guidance 
under section 408(q) regarding accounts or annuities that are part of 
qualified employer plans but are to be treated as individual retirement 
plans. These regulations reflect changes made to the law by the 
Economic Growth and Tax Relief Reconciliation Act of 2001 and by the 
Job Creation and Worker Assistance Act of 2002. This document also 
contains temporary regulations under section 408(a) providing a special 
rule for governmental units seeking approval to serve as nonbank 
trustees of individual retirement accounts for purposes of section 
408(q). These regulations affect administrators of, participants in, 
and beneficiaries of qualified employer plans.

DATES: Effective Date: These regulations are effective July 22, 2004.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.408(q)-1(i) and 1.408-2T(e)(8)(iv).

FOR FURTHER INFORMATION CONTACT: Linda Conway at (202) 622-6090 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507) 
under control number 1545-1841. Responses to this collection of 
information are required for taxpayers who want to include individual 
retirement plans as part of a qualified employer plan.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    The estimated annual burden per respondent/recordkeeper is 50 
hours.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, 
SE:W:CAR:MP:T:T:SP, Washington, DC 20224, and to the Office of 
Management and Budget, Attn: Desk Officer for the Department of the 
Treasury, Office of Information and Regulatory Affairs, Washington, DC 
20503.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR Part 1) under section 408(q) of the Internal Revenue Code (Code). 
On May 20, 2003, a notice of proposed rulemaking (REG-157302-02) was 
published in the Federal Register (68

[[Page 43736]]

FR 27493) under section 408(q). No public hearing was requested or 
held. Written comments responding to the notice of proposed rulemaking 
were received. After consideration of all the comments, the proposed 
regulations are adopted as amended by this Treasury decision.
    This document also contains an amendment to the regulations under 
section 408(a) regarding the approval of nonbank trustees of individual 
retirement accounts. Section 1.408-2(e)(5)(v)(A) of the regulations 
currently provides that a person seeking approval to serve as a nonbank 
trustee must demonstrate that, except for investments pooled in a 
common investment fund, the investments of each account will not be 
commingled with any other property. Because section 408(q)(1) expressly 
provides that deemed IRAs need not satisfy the requirements of section 
408(a)(5) regarding the commingling of IRA and plan assets, Sec.  
1.408-2(e)(5)(v)(A) is modified to reflect the statutory rule.
    In addition, this document contains a temporary amendment to the 
regulations under section 408(a) regarding the approval of nonbank 
trustees. This temporary amendment modifies the requirements for 
approval as a nonbank trustee for certain governmental units that 
intend to serve as the trustees of individual retirement accounts 
subject to section 408(q).

Explanation of Provisions and Summary of Comments

A. Overview

    Section 408(q) provides that, if a qualified employer plan allows 
employees to make voluntary employee contributions to a separate 
account or annuity established under the plan and under the terms of 
the qualified employer plan the account or annuity meets the applicable 
requirements of section 408 or section 408A for an individual 
retirement account or annuity, then the account or annuity is treated 
for purposes of the Code in the same manner as an individual retirement 
plan rather than as a qualified employer plan. It further provides that 
contributions to such a ``deemed IRA'' are treated as contributions to 
the deemed IRA rather than to the qualified employer plan. Section 
408(q) also expressly provides that the requirements of section 
408(a)(5) regarding the commingling of IRA assets with other property 
shall not apply to deemed IRAs.
    In general, the proposed regulations provided that a qualified 
employer plan and a deemed IRA would be treated as separate entities 
under the Code and that each entity would be subject to the rules 
generally applicable to that entity for purposes of the Code. Thus, a 
qualified employer plan (excluding the deemed IRA portion of the plan), 
whether it is a plan under section 401(a), 403(a), or 403(b), or a 
governmental plan under section 457(b), would be subject to the rules 
applicable to that type of plan rather than to the rules applicable to 
IRAs under section 408 or 408A. Similarly, the deemed IRA portion of 
the qualified employer plan would generally be subject to the rules 
applicable to traditional and Roth IRAs under sections 408 and 408A, 
respectively, and not to the rules applicable to plans under section 
401(a), 403(a), 403(b), or 457.

B. Separate Trusts

    Section 1.408(q)-1(f)(2) of the proposed regulations provided that 
any trust holding deemed individual retirement account assets must be 
separate from the trust holding the other assets of the qualified 
employer plan. The separate trust rule was intended to ensure better 
compliance with the IRA requirements and limit confusion of IRA and 
plan assets. The proposed regulations also provided a comparable rule 
for deemed IRAs that are individual retirement annuities.
    Several commentators argued that a separate trust for deemed 
individual retirement accounts should not be required where the assets 
of the qualified employer plan are already held in a trust. They argued 
the plan's trust could satisfy the requirement of section 408 that the 
individual retirement account be held in a trust and that separate 
accounting would ensure compliance with the IRA requirements and avoid 
any confusion of IRA and plan assets. They also argued the requirement 
of a separate trust would unduly complicate the administration of the 
plan and lead to potentially higher costs for the plan sponsor. In 
response to these comments, the final regulations provide that a 
separate trust is not required in those cases in which the qualified 
employer plan maintains a trust but only if separate accounting is 
maintained for each deemed IRA. Revenue Procedure 2003-13 (2003-4 
I.R.B. 317), which includes sample amendments providing for separate 
trusts for deemed IRAs, does not apply to the extent it provides to the 
contrary.
    The regulations specify that if deemed IRAs are held in a single 
trust that includes the qualified employer plan, the trustee must 
maintain a separate account for each deemed IRA and the qualified 
employer plan.
    Permitting deemed IRAs that are individual retirement accounts to 
be held in a single trust that includes the qualified employer plan 
raises the issue of whether, if the qualified employer plan portion of 
the trust invests in life insurance contracts, the deemed IRA would be 
considered to have violated section 408(a)(3), which provides that ``no 
part of the trust funds will be invested in life insurance contracts.'' 
The regulations clarify that, in that case, section 408(a)(3) is 
treated as satisfied if no part of the separate account of any of the 
deemed IRAs is invested in life insurance contracts,
    Section 408A(b) and the regulations thereunder set forth rules 
under which a Roth IRA must be clearly designated as a Roth IRA. 
Pursuant to the regulations under Sec.  1.408A-2, Roth IRAs that are 
individual retirement accounts must be trusts separate from traditional 
IRAs. These final regulations permit a departure from these rules for 
deemed Roth IRAs, allowing them to be held in a single trust with 
deemed traditional IRAs, provided that the trustee maintains separate 
accounts for the deemed Roth IRAs and deemed traditional IRAs of each 
participant, and each of those accounts is clearly designated as such. 
Thus, the rules under Sec. Sec.  1.408A-2 and 1.408A-4 of the 
regulations, regarding designation and redesignation of IRAs as Roth 
IRAs, apply to deemed IRAs as if the separate accounts maintained for 
the deemed Roth IRAs and deemed traditional IRAs were separate trusts.
    The requirements for separate accounts within a trust as described 
above are not meant to imply that a trust that includes deemed IRAs and 
a qualified employer plan (or Roth and traditional IRAs) can be 
segmented for other purposes. For example, where a qualified employer 
plan and deemed IRAs are included in the same trust, there cannot be 
separate trustees for each account, and the trustee for the trust must 
be either a bank or a nonbank trustee that satisfies the requirements 
of section 408(a)(2) and the regulations thereunder.
    The proposed regulations included a rule for individual retirement 
annuities similar to that for individual retirement accounts. Under the 
proposed regulations, separate annuity contracts were to be maintained 
for individual retirement annuities when the qualified employer plan 
also maintains annuity contracts. However, unlike the rules applicable 
to deemed individual retirement accounts which provide for separate 
accounts and not separate

[[Page 43737]]

trusts, section 408(q)(1)(A) expressly provides that a separate annuity 
is to be established for a deemed individual retirement annuity. 
Accordingly, these final regulations retain the rule in the proposed 
regulations that a separate annuity is to be established under the plan 
with respect to deemed individual retirement annuities.

C. Disqualification

    Section 1.408(q)-1(g) of the proposed regulations provided that the 
failure of any of the deemed IRAs maintained by the plan to satisfy the 
applicable requirements of section 408 or 408A caused the plan as a 
whole to fail to satisfy the plan's qualification requirements. The 
proposed regulations further provided that, if the qualified employer 
plan failed to satisfy its qualification requirements, the deemed IRA 
portion would no longer be a deemed IRA because section 408(q) does not 
apply if the plan is not a qualified employer plan. The proposed 
regulations provided, however, that although the account or annuity 
that was intended to be a deemed IRA was no longer a deemed IRA, it 
could still be treated as a traditional or a Roth IRA if it satisfied 
the applicable requirements of section 408 or 408A (including the 
requirements regarding the commingling of assets under section 
408(a)(5)).
    Several commentators objected to this rule as inconsistent with the 
general rule that the qualified employer plan and the deemed IRA 
portion of the plan are separate entities and with the requirement that 
the deemed IRA assets and the other assets of the qualified employer 
plan must be maintained in separate trusts. Some commentators objected 
in particular to the rule that the failure of the qualification of a 
deemed IRA could result in the failure of the qualification of the plan 
as a whole. They stated that various aspects of the operation of deemed 
IRAs are not within the control of the employer.
    The final regulations provide that the failure of either the 
qualified employer plan portion or the deemed IRA portion of the plan 
to satisfy the applicable qualification rules of each will not cause 
the other portion to be automatically disqualified. This rule applies, 
however, only if the deemed IRA portion and the qualified employer plan 
portion are maintained as separate trusts (or separate annuity 
contracts, as required in the case of individual retirement annuities). 
If both the deemed IRA portion and the qualified plan portion are 
included in separate trusts and the qualified employer plan is 
disqualified, the IRA portion cannot be a deemed IRA under section 
408(q) but it will not fail to satisfy the applicable requirements of 
section 408 or 408A if it satisfies the applicable requirements of 
those sections, including, with respect to individual retirement 
accounts, the requirements of section 408(a)(5). However, if the IRA 
assets and the non-IRA assets have been commingled (except in a common 
trust fund or common investment fund as permitted by section 
408(a)(5)), the IRA portion will fail to satisfy the requirements of 
section 408(a).\1\ Likewise, if the IRA assets and the non-IRA assets 
are commingled (except as permitted by section 408(a)(5), and the IRA 
is disqualified, the plan will also be disqualified.
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    \1\ The Department of Labor has advised the IRS and Treasury 
that consistent with section 4(c) of the Employee Retirement Income 
Security Act (ERISA), accounts and annuities (and contributions 
thereto) established in accordance with section 408(q) of the Code 
are not to be treated as part of the pension plan under which such 
accounts and annuities are allowed (or as a separate pension plan) 
``for purposes of any provision of [title I of ERISA] other than 
Sec.  403(c), 404, or 405 (relating to exclusive benefit, and 
fiduciary and co-fiduciary responsibilities) and part 5 (relating to 
administration and enforcement).'' Accordingly, fiduciaries need to 
take appropriate steps to ensure that they satisfy any fiduciary 
duties associated with implementation and operation of a deemed IRA 
feature that is related to a plan covered under title I of ERISA. 
These duties may include, but are not limited to, a duty to monitor 
the activities of holders of deemed IRAs in order to prevent 
disqualification of the deemed IRA feature and/or the qualified 
employer plan where the plan is intended to be maintained as a tax-
qualified plan.
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D. Governmental Units as Nonbank Trustees

    As noted above, the proposed regulations provided that a qualified 
employer plan and a related deemed IRA are generally treated as 
separate entities under the Code and each is subject to the rules 
applicable to that entity. Thus, under the proposed regulations, an 
individual retirement account that is a deemed IRA would be required to 
satisfy the requirements of section 408(a) except for the commingling 
limitations of section 408(a)(5). Consistent with this general rule, 
Sec.  1.408(q)-1(f)(1) of the proposed regulations provided that the 
trustee or custodian of an individual retirement account must be a bank 
or other person that receives approval from the Commissioner to serve 
as a nonbank trustee pursuant to Sec.  1.408-2(e) of the regulations.
    Several commentators noted that because the nonbank trustee 
criteria were designed to test private entities, it is difficult, if 
not impossible, for most state and local governments to satisfy them. 
They also argued that, although it may be possible for a state or local 
government to appoint a bank or an approved nonbank trustee for the 
deemed IRA portion of the plan, this would impose unnecessary costs and 
administrative hardships on these governments that would outweigh any 
corresponding benefit and that such an appointment may contravene state 
law.
    Several commentators argued that governments should be exempt from 
the nonbank trustee requirements, but the IRS and Treasury continue to 
believe that governments, like private entities, must demonstrate to 
the satisfaction of the Commissioner that the manner in which the 
government will administer the deemed IRA will be consistent with the 
requirements of section 408(a). Accordingly, the final regulations 
adopt the rule of the proposed regulations that the trustee of the 
deemed IRA must be a bank or a nonbank trustee approved by the 
Commissioner. The IRS and Treasury acknowledge, however, that Sec.  
1.408-2(e) of the regulations sets forth several criteria that 
governments may have difficulty satisfying. Accordingly, this document 
temporarily amends Sec.  1.408-2(e) to provide that a governmental unit 
may serve as the trustee of any deemed IRA established by that 
governmental unit as part of its qualified employer plan if that 
governmental unit establishes to the satisfaction of the Commissioner 
that the manner in which it will administer the deemed IRA will be 
consistent with the requirements of section 408. The temporary 
amendment also provides special rules regarding the application of 
Sec.  1.408-2(e) to governmental units.

E. Other Comments

    Other comments included one noting that the proposed regulations 
require that the plan document of the qualified employer plan must 
contain the deemed IRA provisions and that Revenue Procedure 2003-13 
provides that the deemed IRA provisions must address every applicable 
point in the IRA Listing of Required Modifications. The commentator 
suggested that plan sponsors be permitted to incorporate by reference 
the terms of separate IRA agreements or annuities. Although 
incorporation by reference may be possible in some circumstances, it is 
not possible where the IRA document is inconsistent with the provisions 
of the plan. For example, assuming the deemed IRA is to provide for 
commingling as allowed under section 408(q), it is not possible to 
incorporate an IRA document that prohibits such commingling.
    Various comments were received relating to administrative issues 
such as

[[Page 43738]]

reporting and withholding rules and whether the separate rules 
applicable to qualified employer plans and IRAs were to be applied. As 
indicated in Sec.  1.408(q)-1(c) of the proposed regulations, except as 
otherwise provided in the regulations, the qualified employer plan and 
the deemed IRA are treated as separate entities under the Code and they 
are subject to the separate rules applicable to qualified employer 
plans and IRAs, respectively. Accordingly, the reporting and 
withholding rules on plan and IRA distributions apply separately 
depending on whether the distributions are made from the deemed IRA or 
the qualified employer plan. Thus, for example, the reporting rules for 
required minimum distributions apply separately for the two portions of 
the plan. Similarly, a total distribution of amounts held in the 
qualified employer plan portion and the deemed IRA portion is reported 
on two Forms 1099-R, ``Distributions from Pensions, Annuities, 
Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.'', 
one for the distribution from the deemed IRA portion and one for the 
rest of the distribution. Also, the 20% withholding rules of section 
3405(c) do not apply to a distribution from the deemed IRA portion but 
would apply to a distribution from the qualified employer plan portion, 
and section 72(t) applies separately to the two portions.
    Questions were also raised regarding who may participate in a 
deemed IRA. For example, one commentator, noting that the term employee 
is not defined by section 408(q) or by the proposed regulations, asked 
whether that term includes self-employed individuals. Although employee 
is not defined by section 408(q), section 408(q)(3)(B) defines a 
voluntary employee contribution, in part, as a contribution by an 
individual ``as an employee under a qualified employer plan which 
allows employees'' to elect to make contributions to a separate account 
under the plan. Thus, these regulations provide that to the extent a 
self-employed individual is an employee for purposes of the qualified 
employer plan, that individual will be treated as an employee for 
purposes of section 408(q). In the case of a qualified plan under 
section 401(a) and a qualified annuity plan under section 403(a), 
employee includes self-employed individuals as defined in section 
401(c). The only circumstance under which a self-employed individual 
may participate in a section 403(b) plan is when a self-employed 
minister described in section 414(e)(5) participates in a retirement 
income account as described in section 403(b)(9). In contrast, section 
457(e)(2) permits independent contractors as well as employees to 
participate in a section 457 plan. However, since section 408(q) 
permits only employees to make contributions to a deemed IRA, only 
employees (including self-employed individuals) may be permitted to 
participate in a deemed IRA maintained by a governmental section 457 
plan.
    Another commentator asked whether an employee can participate in a 
deemed IRA if he or she does not participate in the qualified employer 
plan, or even if the employee is not eligible to participate in the 
qualified employer plan. Again, as noted above, the deemed IRA and the 
qualified employer plan are generally treated as separate entities 
under the Code. Section 408(q) does not impose a requirement that an 
employee must participate in both portions of the plan or that an 
employee must be eligible to participate in both portions of the plan. 
Accordingly, the two portions of the plan may have different 
eligibility requirements.
    One commentator asked whether the automatic enrollment principles 
applicable to section 401(k), 403(b), and 457 plans under Revenue 
Rulings 2000-8 (2000-1 C.B. 617); 2000-35 (2000-2 C.B. 138); and 2000-
33 (2000-2 C.B. 142), apply to deemed IRAs. These revenue rulings 
specify the criteria to be met in order for an employee's compensation 
to be automatically reduced by a certain amount where that amount is 
contributed as an elective deferral to these three types of plans. The 
IRS and Treasury agree that the automatic enrollment principles 
applicable to section 401(k), 403(b), and 457 plans in the cited 
revenue rulings may also be applied to deemed IRAs.
    With respect to the requirements for approval as a nonbank trustee, 
one commentator noted that Sec.  1.408-2(e)(5)(v) requires that an 
applicant must demonstrate that, except for investments pooled in a 
common investment fund, the investments of each account will not be 
commingled with any other property. The commentator noted that this 
requirement is inconsistent with the provisions of section 408(q)(1), 
which provide that the requirements of section 408(a)(5) regarding 
commingling do not apply to deemed IRAs. Accordingly, this document 
amends Sec.  1.408-2(e)(5)(v) to provide that an applicant that intends 
to serve as a nonbank trustee need not satisfy this requirement with 
respect to any assets held in a deemed IRA.
    Finally, these regulations provide that neither the assets held in 
the deemed IRA portion of the qualified employer plan, nor any benefits 
attributable thereto, shall be taken into account for purposes of 
determining the benefits of employees and their beneficiaries under the 
plan (within the meaning of section 401(a)(2)) or determining the 
plan's assets or liabilities for purposes of section 404 or 412. The 
Pension Benefit Guaranty Corporation (PBGC) has advised the IRS and 
Treasury that a deemed IRA feature that is related to a qualified 
employer plan is not covered by Title IV of ERISA. The PBGC has further 
advised that the deemed IRA feature is treated as a separate entity 
from the qualified employer plan for purposes of Title IV. For example, 
neither the assets in, nor the benefits attributable to, the deemed IRA 
are taken into account in determining the amount of the PBGC's 
variable-rate premium, and an individual who is a participant in the 
deemed IRA but who is not a participant in the qualified employer plan 
is not included in the PBGC's flat-rate participant count. In addition, 
for purposes of Title IV, the deemed IRA will be treated as separate 
from the qualified employer plan in the event of termination of the 
qualified employer plan, and the fiduciary of the deemed IRA would 
continue to be responsible for the continued operation, transfer, or 
termination of the deemed IRA. The PBGC would allocate the assets of 
the qualified employer plan to the priority categories under section 
4044 of ERISA without regard to any assets in, or benefits attributable 
to, the deemed IRA, and the PBGC would not serve as trustee of the 
deemed IRA. Termination of a deemed IRA would not be subject to the 
rules governing plan termination under Title IV of ERISA.

Effective Date

    The regulations apply to accounts or annuities established under 
section 408(q) on or after August 1, 2003.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required.
    It is hereby certified that the collection of information in these 
final regulations will not have a significant economic impact on a 
substantial number of small entities. The collection of information in 
the regulations is in Sec.  1.408(q)-1(f)(2) and consists of the 
optional requirement that deemed IRAs may be held in trusts or annuity 
contracts separate from the trust or annuity contract of the qualified 
employer plan. This certification is

[[Page 43739]]

based on the fact that the burden of reporting these separate trusts 
and annuity contracts is small, particularly for small entities. 
Therefore, a Regulatory Flexibility Analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to 
section 7805(f) of the Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.
    It has also been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations. For the applicability of the Regulatory Flexibility 
Act (5 U.S.C. chapter 6) to the temporary regulations, refer to the 
Special Analyses section of the preamble to the cross-referencing 
notice of proposed rulemaking published in this issue of the Federal 
Register. Pursuant to section 7805(f) of the Code, the notice of 
proposed rulemaking preceding the final regulations was submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on their impact on small business. The temporary regulations 
will also be submitted to the Chief Counsel for Advocacy for such 
comment.

Drafting Information

    The principal authors of these regulations are Robert Walsh of the 
Tax Exempt and Government Entities Division and Linda Conway, Office of 
Division Counsel/Associate Chief Counsel (Tax Exempt and Government 
Entities). However, other personnel from the IRS and Treasury 
participated in the development of these regulations

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements

26 CFR Part 602

    Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Sec.  1.408-2 also issued under 26 U.S.C. 408(a) and 26 U.S.C. 
408(q). * * *
    Sec.  1.408(q)-1 also issued under 26 U.S.C. 408(q). * * *


0
Par. 2. In Sec.  1.408-2, paragraph (e)(5)(v)(A) is revised and (e)(8) 
is added to read as follows:


Sec.  1.408-2  Individual retirement accounts

* * * * *
    (e) * * *
    (5) * * *
    (v) Custody of investments. (A) Except for investments pooled in a 
common investment fund in accordance with the provisions of paragraph 
(e)(5)(vi) of this section and for investments of accounts established 
under section 408(q) on or after August 1, 2003, the investments of 
each account will not be commingled with any other property.
* * * * *
    (8) [Reserved]. For further guidance, see Sec.  1.408-2T(e)(8).

0
Par. 3. Section 1.408-2T is added to read as follows:


Sec.  1.408-2T  Individual retirement accounts (temporary).

    (a) through (e)(7) [Reserved]. For further guidance, see Sec.  
1.408-2(a) through (e)(7).
    (8) Special rules for governmental units. (i) A governmental unit 
that seeks to qualify as a nonbank trustee of a deemed IRA that is part 
of its qualified employer plan must demonstrate to the satisfaction of 
the Commissioner that it is able to administer the trust in a manner 
that is consistent with the requirements of section 408. The 
demonstration must be made by written application to the Commissioner. 
Notwithstanding the requirement of Sec.  1.408-2(e)(1) that a person 
must demonstrate by written application that the requirements of 
paragraphs (e)(2) to (e)(6) of that section will be met in order to 
qualify as a nonbank trustee, a governmental unit that maintains a plan 
qualified under section 401(a), 403(a), 403(b) or 457 need not 
demonstrate that all of these requirements will be met with respect to 
any individual retirement accounts maintained by that governmental unit 
pursuant to section 408(q). For example, a governmental unit need not 
demonstrate that it satisfies the net worth requirements of Sec.  
1.408-2(e)(3)(ii) if it demonstrates instead that it possesses taxing 
authority under applicable law. The Commissioner, in his discretion, 
may exempt a governmental unit from certain other requirements upon a 
showing that the governmental unit is able to administer the deemed 
IRAs in the best interest of the participants. Moreover, in determining 
whether a governmental unit satisfies the other requirements of 
Sec. 1.408-2 (e)(2) to (e)(6), the Commissioner may apply the 
requirements in a manner that is consistent with the applicant's status 
as a governmental unit.
    (ii) Governmental unit. For purposes of this special rule, the term 
governmental unit means a State, political subdivision of a State, and 
any agency or instrumentality of a State or political subdivision of a 
State.
    (iii) Additional rules. The Commissioner may in revenue rulings, 
notices, or other guidance of general applicability provide additional 
rules for governmental units seeking approval as nonbank trustees.
    (iv) Effective date. This special rule is applicable for written 
applications made on or after August 1, 2003, or such earlier 
application as the Commissioner deems appropriate.

0
Par. 4. Section 1.408(q)-1 is added to read as follows:


Sec.  1.408(q)-1  Deemed IRAs in qualified employer plans.

    (a) In general. Under section 408(q), a qualified employer plan may 
permit employees to make voluntary employee contributions to a separate 
account or annuity established under the plan. If the requirements of 
section 408(q) and this section are met, such account or annuity is 
treated in the same manner as an individual retirement plan under 
section 408 or 408A (and contributions to such an account or annuity 
are treated as contributions to an individual retirement plan and not 
to the qualified employer plan). The account or annuity is referred to 
as a deemed IRA.
    (b) Types of IRAs. If the account or annuity meets the requirements 
applicable to traditional IRAs under section 408, the account or 
annuity is deemed to be a traditional IRA, and if the account or 
annuity meets the requirements applicable to Roth IRAs under section 
408A, the account or annuity is deemed to be a Roth IRA. Simplified 
employee pensions (SEPs) under section 408(k) and SIMPLE IRAs under 
section 408(p) may not be used as deemed IRAs.
    (c) Separate entities. Except as provided in paragraphs (d) and (g) 
of this section, the qualified employer plan and the deemed IRA are 
treated as separate entities under the Internal Revenue Code and are 
subject to the separate rules applicable to qualified employer plans 
and IRAs, respectively. Issues regarding eligibility, participation, 
disclosure, nondiscrimination, contributions, distributions, 
investments, and plan administration are generally to be resolved under 
the separate rules (if

[[Page 43740]]

any) applicable to each entity under the Internal Revenue Code.
    (d) Exceptions. The following exceptions to treatment of a deemed 
IRA and the qualified employer plan as separate entities apply:
    (1) The plan document of the qualified employer plan must contain 
the deemed IRA provisions and a deemed IRA must be in effect at the 
time the deemed IRA contributions are accepted. Notwithstanding the 
preceding sentence, employers that provided deemed IRAs for plan years 
beginning before January 1, 2004, (but after December 31, 2002) are not 
required to have such provisions in their plan documents before the end 
of such plan years.
    (2) The requirements of section 408(a)(5) regarding commingling of 
assets do not apply to deemed IRAs. Accordingly, the assets of a deemed 
IRA may be commingled for investment purposes with those of the 
qualified employer plan. However, the restrictions on the commingling 
of plan and IRA assets with other assets apply to the assets of the 
qualified employer plan and the deemed IRA.
    (e) Application of distribution rules. (1) Rules applicable to 
distributions from qualified employer plans under the Internal Revenue 
Code and regulations do not apply to distributions from deemed IRAs. 
Instead, the rules applicable to distributions from IRAs apply to 
distributions from deemed IRAs. Also, any restrictions that a trustee, 
custodian, or insurance company is permitted to impose on distributions 
from traditional and Roth IRAs may be imposed on distributions from 
deemed IRAs (for example, early withdrawal penalties on annuities).
    (2) The required minimum distribution rules of section 401(a)(9) 
must be met separately with respect to the qualified employer plan and 
the deemed IRA. The determination of whether a qualified employer plan 
satisfies the required minimum distribution rules of section 401(a)(9) 
is made without regard to whether a participant satisfies the required 
minimum distribution requirements with respect to the deemed IRA that 
is established under such plan.
    (f) Additional rules--(1) Trustee. The trustee or custodian of an 
individual retirement account must be a bank, as required by section 
408(a)(2), or, if the trustee is not a bank, as defined in section 
408(n), the trustee must have received approval from the Commissioner 
to serve as a nonbank trustee or nonbank custodian pursuant to Sec.  
1.408-2(e). For further guidance regarding governmental units serving 
as nonbank trustees of deemed IRAs established under section 408(q), 
see Sec.  1.408-2T(e)(8).
    (2) Trusts. (i) General rule. Deemed IRAs that are individual 
retirement accounts may be held in separate individual trusts, a single 
trust separate from a trust maintained by the qualified employer plan, 
or in a single trust that includes the qualified employer plan. A 
deemed IRA trust must be created or organized in the United States for 
the exclusive benefit of the participants. If deemed IRAs are held in a 
single trust that includes the qualified employer plan, the trustee 
must maintain a separate account for each deemed IRA. In addition, the 
written governing instrument creating the trust must satisfy the 
requirements of section 408(a) (1), (2), (3), (4), and (6).
    (ii) Application of section 408(a)(3). If deemed IRAs are held in a 
single trust that includes the qualified employer plan, section 
408(a)(3) is treated as satisfied if no part of the separate accounts 
of any of the deemed IRAs is invested in life insurance contracts, 
regardless of whether the separate account for the qualified employer 
plan invests in life insurance contracts.
    (iii) Separate accounts for traditional and Roth deemed IRAs. The 
rules of section 408A(b) and the regulations thereunder, requiring each 
Roth IRA to be clearly designated as a Roth IRA, will not fail to be 
satisfied solely because Roth deemed IRAs and traditional deemed IRAs 
are held in a single trust, provided that the trustee maintains 
separate accounts for the Roth deemed IRAs and traditional deemed IRAs 
of each participant, and each of those accounts is clearly designated 
as such.
    (3) Annuity contracts. Deemed IRAs that are individual retirement 
annuities may be held under a single annuity contract or under separate 
annuity contracts. However, the contract must be separate from any 
annuity contract or annuity contracts of the qualified employer plan. 
In addition, the contract must satisfy the requirements of section 
408(b) and there must be separate accounting for the interest of each 
participant in those cases where the individual retirement annuities 
are held under a single annuity contract.
    (4) Deductibility. The deductibility of voluntary employee 
contributions to a traditional deemed IRA is determined in the same 
manner as if they were made to any other traditional IRA. Thus, for 
example, taxpayers with compensation that exceeds the limits imposed by 
section 219(g) may not be able to make contributions to deemed IRAs, or 
the deductibility of such contributions may be limited in accordance 
with sections 408 and 219(g). However, section 219(f)(5), regarding the 
taxable year in which amounts paid by an employer to an individual 
retirement plan are includible in the employee's income, is not 
applicable to deemed IRAs.
    (5) Rollovers and transfers. The same rules apply to rollovers and 
transfers to and from deemed IRAs as apply to rollovers and transfers 
to and from other IRAs. Thus, for example, the plan may provide that an 
employee may request and receive a distribution of his or her deemed 
IRA account balance and may roll it over to an eligible retirement plan 
in accordance with section 408(d)(3), regardless of whether that 
employee may receive a distribution of any other plan benefits.
    (6) Nondiscrimination. The availability of a deemed IRA is not a 
benefit, right or feature of the qualified employer plan under Sec.  
1.401(a)(4)-4.
    (7) IRA assets and benefits not taken into account in determining 
benefits under or funding of qualified employer plan. Neither the 
assets held in the deemed IRA portion of the qualified employer plan, 
nor any benefits attributable thereto, shall be taken into account for 
purposes of:
    (i) Determining the benefits of employees and their beneficiaries 
under the plan (within the meaning of section 401(a)(2)); or
    (ii) Determining the plan's assets or liabilities for purposes of 
section 404 or 412.
    (g) Disqualifying defects--(1) Single trust. If the qualified 
employer plan fails to satisfy the qualification requirements 
applicable to it, either in form or operation, any deemed IRA that is 
an individual retirement account and that is included as part of the 
trust of that qualified employer plan does not satisfy section 408(q). 
Accordingly, any account maintained under such a plan as a deemed IRA 
ceases to be a deemed IRA at the time of the disqualifying event. In 
addition, the deemed IRA also ceases to satisfy the requirements of 
sections 408(a) and 408A. Also, if any one of the deemed IRAs fails to 
satisfy the applicable requirements of sections 408 or 408A, and the 
assets of that deemed IRA are included as part of the trust of the 
qualified employer plan, section 408(q) does not apply and the plan 
will fail to satisfy the plan's qualification requirements.
    (2) Separate trusts and annuities. If the qualified employer plan 
fails to satisfy its qualification requirements, either in form or 
operation, but the assets of a deemed IRA are held in a separate trust 
(or where a deemed IRA is an individual retirement annuity), then the 
deemed IRA does not

[[Page 43741]]

automatically fail to satisfy the applicable requirements of section 
408 or 408A. Instead, its status as an IRA will be determined by 
considering whether the account or the annuity satisfies the applicable 
requirements of sections 408 and 408A (including, in the case of 
individual retirement accounts, the prohibition against the commingling 
of assets under section 408(a)(5)). Also, if a deemed IRA fails to 
satisfy the requirements of a qualified IRA and the assets of the 
deemed IRA are held in a separate trust (or where the deemed IRA is an 
individual retirement annuity), the qualified employer plan will not 
fail the qualification requirements applicable to it under the Code 
solely because of the failure of the deemed IRA.
    (h) Definitions. The following definitions apply for purposes of 
this section:
    (1) Qualified employer plan. A qualified employer plan is a plan 
described in section 401(a), an annuity plan described in section 
403(a), a section 403(b) plan, or a governmental plan under section 
457(b).
    (2) Voluntary employee contribution. A voluntary employee 
contribution is any contribution (other than a mandatory contribution 
within the meaning of section 411(c)(2)(C)) which is made by an 
individual as an employee under a qualified employer plan that allows 
employees to elect to make contributions to deemed IRAs and with 
respect to which the individual has designated the contribution as a 
contribution to which section 408(q) applies.
    (3) Employee. An employee includes any individual who is an 
employee under the rules applicable to the qualified employer plan 
under which the deemed IRA is established.
    (i) Effective date. This section applies to accounts or annuities 
established under section 408(q) on or after August 1, 2003.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 5. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805. * * *

0
Par. 6. In Sec.  602.101, paragraph (b) is amended by adding the 
following entry in numerical order to the table to read as follows:

 
------------------------------------------------------------------------
                                                          Current OMB
  CFR Part or section where identified and described      control no.
------------------------------------------------------------------------
 
                              * * * * * * *
1.408(q)-1...........................................          1545-1841
 
                              * * * * * * *
------------------------------------------------------------------------


    Approved: July 14, 2004.
Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
Gregory F. Jenner,
Acting Assistant Secretary of the Treasury.
[FR Doc. 04-16594 Filed 7-21-04; 8:45 am]
BILLING CODE 4830-01-P