What Is a Deemed IRA and How Does It Work?

A deemed Individual Retirement Account (IRA) represents a unique retirement savings vehicle, blending characteristics of both employer-sponsored retirement plans and traditional individual retirement arrangements. It allows employees to make voluntary contributions to a separate account or annuity established within their employer’s qualified retirement plan. This structure enables individuals to benefit from the convenience of payroll deductions and potentially lower investment fees often associated with larger employer plans, while adhering to the established rules governing IRAs. The creation of deemed IRAs offers a flexible option for employees seeking to enhance their retirement savings beyond typical employer plan contributions.

Understanding Deemed IRAs

A deemed IRA is an individual retirement plan, which can be either a traditional or Roth IRA, that exists as a separate component within a qualified employer-sponsored retirement plan. Introduced under Internal Revenue Code Section 408(q), a deemed IRA operates independently and must satisfy all the specific requirements of a traditional IRA under Section 408 or a Roth IRA under Section 408A. This means its contributions, distributions, and operational aspects are governed by IRA rules, not the rules of the overarching employer plan.

The primary intent behind establishing deemed IRAs was to offer employees greater flexibility and access to individual retirement savings benefits directly through their workplace. This hybrid design allows individuals to take advantage of the administrative efficiencies of an employer plan, such as simplified contributions via payroll deductions, while still benefiting from the investment choices and portability typically associated with standalone IRAs. Deemed IRA’s assets may be commingled for investment purposes with the qualified employer plan’s assets, but distinct recordkeeping is always mandated for the deemed IRA assets.

While a deemed IRA is part of an employer’s retirement plan, it is treated as a separate entity under the Internal Revenue Code. This separation means that a failure in the qualification of the employer’s main plan does not automatically disqualify the deemed IRA, provided the deemed IRA’s assets are held in a separate trust or annuity. Similarly, issues related to the deemed IRA generally do not impact the qualified status of the employer’s plan. This clear distinction ensures that the specific rules for IRAs, including those for eligibility, contributions, and distributions, apply directly to the deemed IRA portion of the overall retirement program.

The dual nature of a deemed IRA differentiates it from a standard employer-sponsored plan, such as a 401(k), and a standalone IRA. Unlike contributions to a 401(k), which are subject to specific employer plan limits and rules, contributions to a deemed IRA adhere to the separate, individual IRA contribution limits. While a standalone IRA is established and managed solely by the individual, a deemed IRA is established by the employer, which assumes the administrative burden of setting up and maintaining the IRA accounts on behalf of its employees. This structure can simplify the retirement saving process for employees.

Establishing a Deemed IRA

For a qualified employer-sponsored plan to offer a deemed IRA feature, specific structural and administrative requirements must be met. The employer’s plan document must explicitly include provisions allowing for the establishment of deemed IRAs. This requires an affirmative election by the plan sponsor to adopt the deemed IRA feature. The Internal Revenue Service (IRS) has provided guidance which outlines how plans can incorporate this feature.

The deemed IRA portion must be held in a separate account or annuity for the exclusive benefit of the employee and their beneficiaries. While the assets of the deemed IRA and the qualified employer plan can be commingled for investment purposes, the plan administrator must maintain separate records for the deemed IRA assets to ensure clear accounting and compliance with IRA-specific rules. The trustee or custodian for the deemed IRA assets must be a bank or other entity approved by the IRS to serve as an IRA custodian.

Once an employer-sponsored plan offers deemed IRAs, an employee can choose to participate. Employee contributions to a deemed IRA must be voluntary and explicitly designated as deemed IRA contributions. The election process typically involves informing their employer of their intent to contribute to the deemed IRA. Contributions are then commonly initiated through payroll deductions, offering a convenient and consistent method for saving.

The employer is not obligated to offer a deemed IRA, as it remains an optional provision within qualified employer plans. The decision to establish a deemed IRA program rests with the employer, who takes on the administrative responsibility of setting up and maintaining these accounts. For the individual, the process focuses on understanding the terms of the deemed IRA offered by their employer and making an informed election to direct voluntary contributions to this specific retirement savings vehicle.

Contribution and Distribution Rules

Contributions to a deemed IRA strictly adhere to the rules governing traditional or Roth IRAs, rather than those of the underlying employer-sponsored plan. This means annual contribution limits, including catch-up contributions for individuals aged 50 and over, are dictated by IRC Section 219 for traditional IRAs and IRC Section 408A for Roth IRAs. These IRA contribution limits are entirely separate from, and do not affect, the contribution limits applicable to the employer’s qualified plan, such as 401(k) elective deferrals. An individual can contribute the maximum to their 401(k) and also contribute the maximum allowable to their deemed IRA.

The tax treatment of contributions depends on whether the deemed IRA is structured as a traditional or Roth IRA. Contributions to a traditional deemed IRA may be tax-deductible, depending on the taxpayer’s income level and whether they are an active participant in an employer-sponsored retirement plan, following the deductibility rules for traditional IRAs. Contributions to a Roth deemed IRA are made with after-tax dollars and are not tax-deductible. The tax-free growth and qualified distributions of a Roth deemed IRA are contingent upon meeting specific criteria, mirroring the rules for standalone Roth IRAs.

Distributions from a deemed IRA also follow the rules applicable to traditional or Roth IRAs. For a traditional deemed IRA, distributions are generally taxable income in retirement, and required minimum distributions (RMDs) typically begin at specific ages, as outlined by IRA rules. Early withdrawals before age 59½ may be subject to a 10% penalty tax, in addition to regular income tax, unless an exception applies. For a Roth deemed IRA, qualified distributions, which include those made after age 59½ and after a five-year holding period, are entirely tax-free.

Tax reporting for deemed IRAs aligns with that of other individual retirement arrangements. Contributions to a deemed IRA are typically reported to the IRS on Form 5498, “IRA Contribution Information.” Distributions from a deemed IRA are reported on Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.,” and are subject to the same withholding rules as distributions from other IRAs.