In-Service Non-Hardship Withdrawal
I understand the employer needs to allow for in-service transfers in 401k plan document. However, does the IRS limit this type of withdrawal to people only 59.5 or older or can a person of any age transfer part of a 401k if plan doc allows?? Does anyone know where I can find this in writing??
Permalink Submitted by Alan Spross on Sat, 2008-09-06 02:36
The plan provision determines if an in service distribution is allowed. The IRS does not restrict it, but most plans will not allow it prior to age 59.5, if then. Plans like to retain assets as it helps lower the total expense ratio of operating the plan, and plans will have to better disclose exactly what those expense ratios are.
Permalink Submitted by Martin Helmer on Sat, 2008-09-06 05:04
For purposes of this issue, think of the employee’s account as potentially being comprised of two types of dollars. Type I dollars are those electively deferred by the employee and also employer qualified matching contributions and employer qualified nonelective contributions. Also included in type I are the earnings attributable to the above.
Type II dollars are those not included in type I. The 401(k) elective deferral feature is virtually always contained within the larger structure of a profit sharing plan. If the employer makes profit sharing contributions, these will often if not always count as type II dollars.
There are two different sets of distribution requirements. The type I money is more restricted as to when it can be distributed. Section 401(k)(2) of the Internal Revenue Code is where it gives the short list of occasions for which it’s permissible to distribute type I money. The list includes severance from employment, termination of the plan, hardship, or attainment of age 59 1/2. The plan can allow type I distributions in service if the participant is at least 59 1/2 but is not required to allow these in service distributions.
On the other hand, the plan can opt to distribute type II money in service upon the occurrence of the following: attainment of a stated age, passage of a fixed number of years, or any named event. See Internal Revenue Regulation section 1.401-1(b)(1)(ii).
In Revenue Ruling 68-24, the IRS said it’s ok to distribute to a person who’s been a plan participant for 5 years.
In Revenue Ruling 71-295, the IRS said it’s ok to distribute after the given dollars have been in the plan for at least 2 years.
On its web site, the IRS provides various LRMs (Listing of Required Modifications). These are sample plan provisions a plan sponsor can use in order to help properly draft a plan document. If you google CODA LRM, the second hit or so should link you to the IRS page where all the LRMs are listed. Just short of halfway down this LRM list is the link to the CODA LRM. Once you get to the CODA LRM, look at provision number XVI, “Distribution Limits.” A CODA refers to the 401(k) feature, a cash or deferred arrangement–the employee has a choice between receiving the money in his paycheck or deferring it into the plan. The CODA LRM also includes definitions for qualified matching contributions and qualified nonelective contributions.
Permalink Submitted by Lisa Brumfield on Sat, 2008-09-06 14:11
Thank you! very helpful responses.
On a similar note, my client is concerned that if he doesn’t allow for in-service transfers, he (a small business owner) has some liability for how the market performs. A financial planner came to his business and told him there are many law suits currently where employees are suing employers because of poor 401k choices?! I hadn’t heard this but did find some things on google – not sure of accuracy of source though. Any insight?
Permalink Submitted by Alan Spross on Sun, 2008-09-07 01:13
I think most of those suits are for bad performance of employer stock shares when the employees are not allowed to diversify out of such stock. These are known as “stock drop” suits and typically the basis is that the employer knows negative developments but does nothing to stop the accumulation of such shares by employees or provide them with an ability to sell the shares.
The next area of litigation is for fund choices that grossly underperform their benchmarks and/or have high expense ratios that further dampen returns. These are typical of bear markets particularly now in the financial services industry since that is by far the worst performing market sector.
But to put this is perspective, if these suits get out of hand, it could damage the defined contribution structure enough to compromise it as a retirement savings vehicle. Therefore, the negligence on the part of the employer must go far beyond just poor market results to have a serious legal exposure.
Providing investment and divesification choices within the plan would seem to be the usual method for addressing this exposure rather than allowing in service distributions for multiple reasons. I am not aware of a flood of in service distribution options due just the exposure of a bear market and negative returns.