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Impermissible in-service withdrawal


Belgarath

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So, the 100% owner, who is over age 65 which is NRA, takes a distribution from the plan. Problem is that the plan does NOT permit in-service distributions, even at NRA.

I THINK this overpayment can be corrected under SCP with a retroactive amendment to conform plan terms to the operation of the plan. I haven't delved deeply into Rev. Proc. 2021-30 yet - just going from memory. But I wondered if anyone had dealt with this recently and had an opinion? Thanks.

P.S. it does appear that it would otherwise be allowable under 6.06(4)(a), which refers you to 4.05. Under 4.05(2)(a)(i) and (ii) - it appears it satisfy (i). My only "squeamish" issue is whether it satisfies (ii) since it is due to the impermissible distribution to a HCE. It would be available to NHCE's as well, but the only current correction would be for a HCE.

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What sort of in-service distribution, lump sum, ad-hoc partial withdrawal? DC or DB? If DB, was plan sufficiently funded?

What about having owner repay the distribution, then amend the plan to allow for 2022? I know this still involves a level of self correction but takes retro amendment benefiting an HCE off the table. 

Kenneth M. Prell, CEBS, ERPA

Vice President, BPAS Actuarial & Pension Services

kprell@bpas.com

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3 minutes ago, Belgarath said:

Repayument does sound like a better option - I'll have to reconsider in greater detail.

Do it soon.  1099's are due out in two weeks.

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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The requirements under Rev. Proc. 2021-30 for a retroactive amendment to correct an operational failure are in 4.05(a):

Correction of Operational Failure by plan amendment for a Qualified Plan or § 403(b) Plan. A Plan Sponsor of a Qualified Plan or § 403(b) Plan may correct an Operational Failure by plan amendment in order to conform the terms of the plan to the plan’s prior operations only if the following conditions are satisfied:

(i) The plan amendment would result in an increase of a benefit, right, or feature.

(ii) The provision of the increase in the benefit, right, or feature to participants is permitted under the Code (including the requirements of §§ 401(a)(4), 410(b), 411(d)(6), and 403(b)(12), as applicable), and satisfies the correction principles of section 6.02 and any other applicable rules of this revenue procedure.

I think your main issue is going to be 401(a)(4). Under Treas. Reg. 1.401(a)(4)-5, whether the retro amendment is discriminatory is a facts and circumstances determination. The individual in question is the owner, which doesn't help. But assuming the amendment to permit in-service distributions at NRA is not temporary and their are other employees who could qualify, it seems like you should be OK. Seems silly to think you can fix only by doing essentially the same thing with extra steps (repayment followed by amendment followed by redistribution). Presumably, if a retro amendment to permit an in-service distribution has an (a)(4) problem under EPCRS it should also have the same problem outside EPCRS, as just a discretionary amendment, but the history highlights the issue in a way that it would not be if the plan had been amended first.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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3 hours ago, Belgarath said:

BG - assuming the repayment takes place after the 1099 date, I'd think it would be reported as a taxable distribution, and repayment would represent basis. Agree/disagree?

That.  Or a revised 1099?  I don't think I've ever had anyone repay anything.

Remember the entire withdrawal needs to be repaid; not just the check amount.

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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"Remember the entire withdrawal needs to be repaid; not just the check amount."  Yup.

I gets even better. The owner/Trustee withdrew the funds, and didn't withhold anything! Pooled account plan, so we didn't discover that there was a distribution until a couple of days ago, when reviewing the fund numbers for 1099 due to a QDRO distribution last year. Fun times!

We have sometimes (rarely) had a repayment, but only of relatively small amounts. Those (small amounts) are also the ones where the employer is likely to say it isn't worth the hassle, and just repays it with interest, 'cause they don't want to fight with the employee.

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If taxpayer had constructive receipt of the funds in 2021 but repays in 2022, is there some guidance allowing you to adjust the 2021 Form 1099-R to reflect the repayment? I always thought repayment in a subsequent tax year requires the taxpayer to claim the income in year of receipt and claim an itemized deduction in the year of repayment.

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