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Is a participant eligible for a distribution if he terminates but resu


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Is a participant eligible for a distribution if they terminate and resume employment within 6 months? The Plan allows for distributions to terminated participants however, this plan was in blackout status because it was being moved to a new service provider and the distribution forms were never furnished to the participant.

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Although some would argue otherwise, I think this is permissible so long as there was a bona fide separation from service and the plan document does not preclude payouts if the participant is reemployed before the distribution occurs. You need to be careful so that you do not make an impermissible in-service distribution but, on the other hand, the plan document clearly gives the participant a right to a distribution upon termination and most documents do not address what happens upon reemployment. We asked an IRS agent his opinion, and he agreed a distribution was permissible if the separation was bona fide. Of course, you can't rely on that.

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The plan document usually dictates when a terminated participant should be paid, usually in a "reasonable" time frame after either the valuation date or, with the advent of daily valuations, termination. The only thing to note is that you may have an issue if there are forfeitures involved. If the person was paid, they would be entitled to their forfeitures back if they paid back the employer money. If the person was 0% vested and forfeited, the company would have to reinstate his balance, either out of accumulated forfeitures or through a company contribution. Either way, it's a messy thing.

Bottom line, if the person hasn't been paid, and you know they will be rehired, the best course may be to not distribute.

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Under the 411(d)(6) regulations, there's no employer discretion allowed regarding distributions: the employer must follow the plan document. Therefore, assuming again that it was a bona fide distribution, the employer could get into trouble for not honoring a distribution request.

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Essentially what happened in this situation is that the person never filled out the distribution forms during the time they were not employed. Since the Plan is silent with regard to this issue, I was hoping to find a code section or a Reg that addressed this issue.

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are you actually saying that if the employee terminates (bona fide) and returns to work prior to completing a request for a distribution, he is still entitled to the distribution even though he is an currently an active participant with an account balance? is there a cite for that?

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Yes, that's what I'm saying for contributions made prior to termination of employment, assuming that allowing a distribution to a terminated employee who's been rehired is also consistent with the plan document. There's not a specific cite, but look at IRC 401(k)(2)(B)(i)(I) and you'll read that elective deferrals may be distributable after separation from service, without any mention of that distribution occurring prior to rehire.

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See also Treas. Reg. Section 1.401(k)-1©, Nonforfeitability requirement. The last sentence of Section 1.401(k)-1©(1)(i) provides that "A contribution that is subject to forfeitures or suspensions permitted by section 411(a)(3) does not satisfy the requirements of this paracgraph ©."

On its face, Section 411(a)(3)(B) applies to the suspension of benefits after commencement; however, see DOL Regulation Section 2530.203©, which refers to suspension of payments that have commenced or would have commenced if the employee had not returned to work (This is not in accordance with the statue in my opinion, but perhaps there is something in the legislative history indicates that indicates that was the intent). Although the DOL provisions are applicable to defined benefit plans, it seems reasonable to conclude that defined contribution plans should be treated similarly, particularly in today's environment when defined contribution plans are often the only retirement plan available.

Although it has never been clear to me as to the correct interpretation of Section 1.401(k)-1©, I have -- somewhat reluctantly -- concluded that a fair interpretation is: (1) A defined contribution plan may provide for suspension of distributions attributable to any contributions other than 401(k) elective deferrals. (2) A participant who had a separation from service and is reemployed retains the right to distribution of 401(k) elective deferrals attributable to periods prior to rehire. (3) If the plan is silent as to what happens upon rehire, all amounts attributable to periods prior to rehire remain eligible for distribution. Many plans that I have submitted to the Service have contained provisions (1) and (2) above and have never been challenged. Although others have contained only (1) above, and the Service has not challenged that either!

Anyone had any direct experience with the Service on this issue?

[This message has been edited by Wessex (edited 02-28-2000).]

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A distribution to an employee/participant is allowed under certain rules. Generally a loan or a hardship. Unless your document contains such language as stated by WESSEX, we would not permit a distribution and require the participant to obtain legal opinion to the contrary.

In the documents mentioned by WESSEX, was that particular language specifically pointed out to the reviewer or just buried. Unless specifically identified, and the IRS later disagrees, the LOD is worthless. OTOH, if specifically identified in the submission the LOD is good until rescinded no matter what the IRS wants, so past practice is protected.

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I disagree with the interpretation of "separation from service" that says that you're entitled to a payment if you've ever separated from service, even though you are not currently separated from service.

I would interpret the rule as saying that you can get a payment if you are currently separated from service.

The analogy is hardship - if you could prove that you had a hardship 3 years ago (maybe you bought a house), but at that time you didn't get around to request a hardship payment, could you do so now, based on the argument that the hardship event had occurred, and that the payment was being made no earlier than that event.

As a plan administrator I would avoid this interpretation for a number of reasons: 1. you've opened up the plan to arguments that persons terminated in the past and now they're entitled to payment, 2. you encourage people to leave - however briefly - in order to get their money, 3. it's too easy to get into questionable situations - what will you do when the boss comes in and says I need $20,000 now - I'm going to quit for a while (I'll be in Aruba at my winter place for a month or so)? And then lo and behold he's back at the end of the month with a nice tan and looking for his $20k, and 4. I don't think the IRS will buy it - how can you say that someone has separated from service when they're at their desk right now?

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Good points, dowist.

I was expressly assuming that the termination of employment was bona fide, so the boss terminating for one month (wink, wink) while vacationing in Aruba isn't the situation I was addressing.

Also, the situation where the employee terminated, was rehired, and now 3 years later wants a distribution is different from what I was thinking. If you've got a situation like that, then you probably want to look at some rulings under 72(t) addressing what constitutes a distribution upon separation from service upon attaining age 55. At some point in time, the distribution ceases to be because of the separation from service. Sure, it involves some difficult linedrawing with the plan administrator interpreting the document, but it seems the best resolution to me.

What would trouble me is the garden variety case where the participant really was terminated, the distribution process got started, the participant was rehired, and now the plan sponsor or trustee refuses to pay the distribution because the participant is now rehired. Unless the document addresses this situation, that's probably employer discretion in violation of what's in the plan document and also in violation of the 411(d)(6) regulations.

I don't think I can point to any authority to more definitively back up this view.

[This message has been edited by MWeddell (edited 03-01-2000).]

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  • 1 month later...

Here's the text of Q&A 44 from the 2000 Enrolled Actuaries Meeting Questions to IRS/Treasury and Summary of Their Responses (the "gray book"). It's a pretty muddy answer and not an official cite, but may help anyone still interested in the topic raised by this thread:

"A 401(k) participant incurs a bona fide separation from service. Two years later she returns to employment with the sponsor before having elected a termination distribution of her 401(k) account. Can the plan allow her to take a distribution of her pre-separation balance before she again separates, attains age 59 1/2 or encounters a "hardship"? If the plan is silent, may she demand a right to withdraw those amounts?

RESPONSE

A distribution may be made once a bonafide triggering event has occurred. However, if the person does not elect the distribution within a reasonable time frame, it is interpreted that the person chose to leave the value of her account on deposit. Once reemployed, the individual would need a second triggering event in order to be able to receive a distribution. The plan could provide that the distribution is not available if requested while the plan sponsor currently employs the individual. If the plan is not clear, the Plan Administrator would be responsible for the interpretation of the plan."

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quote:

Originally posted by MWeddell:

Once reemployed, the individual would need a second triggering event in order to be able to receive a distribution."

That certainly makes it sound as if reemployment negates the distributable event. How would you handle this situation:

A terminated participant received a check for a portion of his total 401(k) balance in a balance-forward, non-union plan, with the remaining amount to be paid after the next quarterly valuation date. Prior to the next valuation date, the participant is rehired by the same company as a union employee and there is a union plan. What should be done with the amount remaining in the non-union plan?

Should the remaining amount be distributed since the distribution was elected and had been partially completed? Or does the rehire immediately negate the distributable event so that the money has to be left in the plan?

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I don't think one can quote only one sentence from the IRS response. While a portion of the IRS response does seem to say that reemployment negates the distribution event, another portion seems to imply that it depends on whether the participant has had a reasonable time frame in which to elect to take a distribution prior to reemployment and yet another portion of the IRS response seems to say that the issue is ambiguous and is within the Plan Administrator's power to interpret the plan document.

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Guest JWBrown

Can anyone provide guidance on what a bona fide termination of employment would be? I know that terminating employment to get retirement benefits, then being rehired would not be a real termination of employment. But I can't find any cites or guidance to support this.

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  • 7 months later...

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