May a plan provide an in-service distribution only to those who will roll it over?

[Peter Gulia]

Hypothetical: A profit-sharing retirement plan has never before allowed an in-service distribution. The plan sponsor might like to add an in-service distribution (including before age 59½ from amounts not attributable to 401(k) deferrals) but only if the participant’s claim includes his or her instruction to pay the distribution as a direct rollover into an eligible retirement plan (including an IRA). The plan sponsor cares about this because it wants to permit an in-service distribution only if the participant will use it to preserve retirement savings. (Yes, I’m aware that nothing precludes an IRA holder from taking a distribution from the IRA a day later.)

Can a plan provide this without violating any relevant ERISA or Internal Revenue Code provision?

If this can’t be done, why not?

If the plan provision is possible, is there another reason why a plan sponsor shouldn’t want to do this?

[Belgarath]

Interesting question. I can see why an employer would want to do this (not for the reason you stated, but in order to avoid messing with 20% withholding.)

I recommend a great deal of caveat emptor, 'cause I'm just winging it, not having done any type of research. I'm not aware of anything that would automatically preclude such a provision. But there might be operational issues. First, does the document allow it? Second, this obviously could not apply for distributions that are not "eligible rollover distributions." Third, depending upon circumstances, there might possibly be a nondiscrimination issue if a NHC wanted to take a small amount. Finding an institution to handle a small amount might be difficult or impossible, and there might be surrender charges. I don't know if this might be considered a "significant detriment" or not - seems like kind of a stretch, but the DOL can be funny that way.

If document doesn't permit it, you could always put it in and apply for a determination letter to see if IRS approves. I'll be interested to see what experience other folks might have with this issue, or what opinions they might have.

[Peter Gulia]

The plan sponsor would amend the plan and other documents, and would apply for an IRS determination. Also, the plan would provide that an in-service distribution is payable only as a single sum.

[Kevin C]

1.401(a)(31)-1 Q&A 1 looks relevant.

Q-1: What are the direct rollover requirements under section 401(a)(31)?

A-1: (a) General rule. To satisfy section 401(a)(31), added by UCA, a plan must provide that if the distributee of any eligible rollover distribution elects to have the distribution paid directly to an eligible retirement plan, and specifies the eligible retirement plan to which the distribution is to be paid, then the distribution will be paid to that eligible retirement plan in a direct rollover described in Q&A-3 of this section. Thus, the plan must give the distributee the option of having his or her distribution paid in a direct rollover to an eligible retirement plan specified by the distributee. For purposes of section 401(a)(31) and this section, eligible rollover distribution has the meaning set forth in section 402©(4) and §1.402©-2, Q&A-3 through Q&A-10 and Q&A-14, except as otherwise provided in Q&A-2 of this section, eligible retirement plan has the meaning set forth in section 402©(8)(B) and §1.402©-2, Q&A-2.

[Peter Gulia]

The plan provision would allow an in-service distribution as long as the claim specifies a direct rollover to any eligible retirement plan.

[Everett Moreland]

1.401(a)(31)-1 Q&A-9:

Q-9: Must the plan administrator permit a distributee to elect to have a portion of an eligible rollover distribution paid to an eligible retirement plan in a direct rollover and to have the remainder of that distribution paid to the distributee?

A-9: Yes, the plan administrator must permit a distributee to elect to have a portion of an eligible rollover distribution paid to an eligible retirement plan in a direct rollover and to have the remainder paid to the distributee. However, the plan administrator is permitted to require that, if the distributee elects to have only a portion of an eligible rollover distribution paid to an eligible retirement plan in a direct rollover, that portion be equal to at least a specified minimum amount, provided the specified minimum amount is less than or equal to $500 or any greater amount as prescribed by the Commissioner in revenue rulings, notices, and other guidance published in the Internal Revenue Bulletin. See Sec. 601.601(d)(2)(ii)(b) of this chapter. If the entire amount of the eligible rollover distribution is less than or equal to the specified minimum amount, the plan administrator need not allow the distributee to divide the distribution.

[Bird]

As I see it, the cites provided are about permitting rollovers, not precluding lump sums. I don't think it can be done, and in any event, the plan sponsor is deluded if he thinks this accomplishes anything.

[Peter Gulia]

Thanks, everyone, for the feedback, all of which is helpful.

As I mentioned in the originating post, I’m aware that nothing precludes an IRA holder from taking a distribution from the IRA a day later. But some plan sponsors see value in a symbolic plan provision.

Several practitioners have said that they believe that an extra condition to getting an in-service distribution (which a plan sponsor isn't required to provide) can't be done. The idea of an unusual condition seems unsettling, but no one has explained why it's not allowed. Any takers?

[kgr12]

Just reading the regulation posted by Everett Moreland (without looking into it any further or in any broader context), it seems to me that you must give the distributee the option of receiving some or all of the distribution directly rather than having it paid to an eligible retirement plan.

". . . the plan administrator must permit a distributee to elect to have a portion of an eligible rollover distribution paid to an eligible retirement plan in a direct rollover and to have the remainder paid to the distributee."

Doesn't this at least suggest that if the distributee elects to have zero paid in a direct rollover, the plan "must" pay the remainder to the distributee pursuant to that election?

[jpod]

There are only two reasons to permit the type of in-service distributions you described, at least as far as I've ever seen.

1. The employer simply doesn't care (e.g., the employer doesn't care or isn't concerned about the effect of distributions to non-keys on top heavy status), and its attitude is that it's the employee's money, so why should it care.

2. The employer does not want people to quit in order to get their hands on their qualified plan money.

Given those reasons, what exactly is the value of the so-called symbolism?

[Peter Gulia]

Some participants have expressed an interest in Roth-izing existing accumulations under the plan's matching and nonelective accounts. The employer is okay with an in-service distribution that a participant chooses because she wants to make a rollover into an IRA. This view is based on the employer's belief that the Roth-izing some participants want can't be accomplished within the employment-based plan. But the employer doesn't want to allow an in-service distribution for someone who merely wants to take money. The employer is aware that a clever person could choose the rollover and take a distribution from the IRA a day later. Understanding this, the employer nonetheless believes that the plan provision I've described is a valuable symbol that communicates to the retirement plan's participants the employer's view on what is or isn't an appropriate use of a pre-retirement distribution.

[KJohnson]

A number of years ago I had a profit sharing plan that provided that a particpant, even a terminated participant, must wait until NRA if he/she wanted to receive a distribution in anything other than a direct rollover. A direct rollover was available to a terminated participant at the end of the plan year following termination of employment. That plan received a determination letter.

[Kevin C]

To me, Q&A 9 that Everett quoted clearly says you can't require the entire distribution to be rolled over.

I wouldn't be surprised if you could get a determination letter with the provision your client wants. Disappointed, yes, but not surprised.

One of our clients recently hired a law firm to write a document for them. The new document has a provision where the employer decides each year what total amount of in-service distributions, if any, will be paid. If the distributions requested for the year are more than the amount the employer decides to pay, everyone's requested in-service distribution is reduced proportionally. I pointed out that 1.411(d)-4, Q&A 4 prohibits employer discretion being used to deny a distribution the participant would otherwise be entitled to receive. The attorney's response was that they do it all the time and always get determination letters.

[Peter Gulia]

Kjohnson, thank you for the helpful news.

For those who feel that the employer's idea is out of place, recognize that it at least signals the importance of preserving retirement savings as retirement savings, and does so with no discretion in the plan's administration.

For everyone who contributed information or an outlook, thank you.