Direct Rollover Gone Stale: Taxable Distribution?

[Guest 1950]

Strange, but true: Former HCE requested direct rollover distribution from plan to conduit IRA. Balance much > $5K. Check properly written and sent to custodian (small bank), but 6 months later not cashed. TPA cancels payment on stale check and reissues payable to custodian of IRA FBO Mr. HCE, as originally requested and remails. Check returned a month later by post office: Addressee unknown. (The custodian was aquired, changed names or went away -- we don't know.) Sent certified letters to former HCE asking what's up/what to do. Green cards come back, but no response. He's not missing, just not talking. (Probably just to mess with me.)

TPA says it's a taxable distribution because it missed the 60-day window on rollovers. Proposes to send 1099R for 2000 (date of original check) and put funds into plan's forfeiture account and offer to restore account if/when requested.

That seems wrong to me. Before you get to the question of whether 60-day limit applies to direct rollover, you have to decide if there has been a "distribution to the distributee". If not, there can't be taxable income and money should go back (or stay??) in former HCEs account and remain invested per his prior instructions, subject to plan rules, etc. I say there's been no distribution because (1) he didn't actually receive the money (check wasn't payable to him and he didn't receive it), (2) no constructive receipt (we can't make him take and he hasn't asked), and (3) no payment to/for his benefit or receipt by his agent or assignee, etc.

Problem: TPA has been using that procedure on NHCEs and is loath to change it now just because we noticed it on a much bigger amount.

If anyone's got some guidance here, please bring it on.

[Michael Devault]

Wow... what a thorny problem!

You might take a look at Letter Ruling 8833043. In that ruling, the 60 day period began when the taxpayer received the distribution, even though the check was issued 10 months earlier but delivery was delayed due to an incorrect address.

Also, Letter Ruling 8804014 held that the 60 day time period began when the client signed the registered mail delivery receipt. The distribtion was sent while the taxpayer was away from home, so he took delivery some time after the date the distribution was made.

If you can't get the guy to respond, I bet I can find several volunteers to take the money:)

Hope this helps. Good luck!

[Guest Hans Moleman]

I think you are absolutely right in your analysis of the situation. For the TPA to do this in the past is flat wrong. It is not something that should be repeated simply because it was done in the past.

[david rigby]

Common sense (oops, that is usually not relevant) would say that the participant should not be penalized due to the error of another, the best example of which is a check lost in the mail. This seems to be especially true when there is an easy remedy of voiding the distribution.

[Disco Stu]

I also agree with your take. The fact that the participant was never in constructive receipt of the distribution means that there was no taxable distribution.

I find it a little difficult to believe that your TPA suggested putting this money into the plan's forfeiture account. What would you do with the forfeitures at the end of the year? Reallocate it to the other participants?

Until you can get the participant to respond, I guess I'd just put the money back into his account in the same fashion that it came out. Although I will say that I think the trustee would be within their discretion in putting the money into the plan's fixed income type investment or something else that he/she felt was prudent.

Once this guy starts getting statements from your plan and notices all of his money in the fixed income account, I'd bet he'd respond fairly quickly.

[Guest 1950]

Thanks for all the input. Couple of follow-up thoughts: Yes, the TPA was serious. And this is a big TPA that we all know and that usually gets it right. That's why I wanted a reality check. Always vigilant against rampant common sense.

Suggest y'all check the fine print 'cause my understanding is that this is not an uncommon procedure for stale distribution checks among big TPAs. And it's probably ok in the case of many/most stale distribution checks (i.e., payable and taxable to the participant and delivered to him/her), but not on these facts. The problem is there is no procedure to sort the sheep from the goats. (By the way: I understand it's common for the money, pending the check clearing, to set in the TPA's clearing account earning "credits" against the TPAs bank service charges. Not sure of the implications of that. Seems like plan assets to me.)

Devault: Good cites. Nothing much closer I can find.

Disco: Nope, we have confirmed that the guy has gotten statements. That's why it's strange, but true.

Thanks again. Off to figure out what it'll take to restore this guy's account -- and where the money for the lost earnings is going to come from.

[Disco Stu]

Lost earnings? For whom?

[Guest 1950]

Lost earnings for the participant. I.e., this whole ugly story has taken almost a year from the date the first check was written and went astray. All that while, the participant's account balance has been $0 'cause his vested, accrued benefits were transferred out of his selected investments and into a checking account the TPA uses to clear distributions. (If the clearing account earns interest, the TPA applies it reduce bank service charges on the clearing account, which seems odd to me, but that's how the big TPAs do it, I'm told.) Anyhow, now that we've played out the string on trying to get his money into a rollover IRA per his request, it's time to restore his account (i.e., bring the cash back from the TPA's clearing account and put it back in his account) pending participant's future request for a distribution.

So, the issue is: do we just have to restore just the amount taken out, or do we have to jack it up for income/gain he would have had if the money had been left in his investment selection? I.e., do we have to leave him in the same circumstance he'd be in if his money had just remained invested, rather than having sat idle in the clearing account over the last year? (His investment selection actually would have netted him gain, lucky guy.)

My current thought is that we should NOT have to impute lost earnings. The rules on imputing lost earnings, but not lost "losses" (if his investment selections had gone down in the interim), used in Rev. Proc. 2001-17 (for correcting compliance failures) doesn't seem fair. The participant did lose the chance to have his money invested while it was sitting idle in the clearing account, but that's hard to blame on the plan. Seems like he should NOT get the benefit of having started this fiasco and not having done anything to help stop or fix it. On the other hand, this money is "plan assets" ('cause it's never left the plan), and plan assets should not be invested for the benefit of the TPA, hence, they should have been earning something for the participant and, if so, how to determine that. Using his old investment selection does have some merit and is easy, but is a windfall to this guy. You dig?

[Jean]

I agree with your analysis of the TPAs procedure. I think you have found the fault with the approach they want to take with this check. I would also escalate the issue within the TPA. Talk to the supervisor / manager until someone acts on your request. Finally, if that does not work, I would have the authorized plan respresentative / sponsor send a certified letter to the head of the unit demanding that the funds be returned to the participant's account.

[Guest 1950]

Jean: Not to worry. I'm not bashful, plus they aren't refusing to restore the money taken from the account, it's just that originally they told me I was wrong. I think we're about to get beyond that problem -- with y'all's help (thanks again). But current heartburn is: (1) should the participant get his theoretical "lost earnings" restored, too, (2) if so, how computed, and (3) who pays it. I don't want the employer to suffer. I don't even want to take it out of the TPA's hide -- not their fault our participant originally started this mess and now won't respond to letters or help. Seems to me the participant ought to just get his account restored for the amount taken out originally and nothing more. On the other hand, while the cash was sitting in the TPA's checking account, it (the TPA) got the benefit of "credits" (much like interst) that reduce the bank service charges on its clearing accounts with the bank. Since that feels like income and this money is still plan assets, maybe the participant ought to get some interest (from the TPA) on his money while it was idle.

By the way: Does it bother anyone out there that the mutual fund companies (which is our TPA here) commonly use one common clearing account for clearing all contributions and distributions (not a separate account just for our plan or retirement plans, but for all investors) and that the banks offset the account service charges by "credits", which are essentially interest income on the average daily account balance of the account? Seems like plan assets of various qualified plans are being used to benefit someone other than participants.

[Disco Stu]

This distribution was initiated at the participant's direction and the participant took no action to mitigate his investment losses once things went bad. I can't imagine anyone in this situation that would be willing to pony up for investment losses on this guy's chosen funds during his period of inaction.

Your point about the TPA benefitting from this transaction is well taken though. Maybe they'd be willing to restore some sort of money market type gains based on the time they had the money, but even that seems generous to me.

I'd certainly defer to someone more knowledgable on this subject, but I'm not so sure that these funds have been plan assets all this time. It sounds like this has gone on for a while...were these funds counted as plan assets on the last 5500?

This clearing account you refer to...it sounds like that isn't a plan account. Is it one big account in the name of the mutual fund company that it uses for all of its clients? If so, there's probably a decent arguement that these are not plan assets. At least not until they are put back into the plan's accounts.

[Jean]

My experience with lost earnings is that they are paid when the instruction provided by the participant was not followed correctly. It appears that they were, and not knowing the time frame for how long they have been distributed, I would agree that he is entitled to 100% of the original distribution. Earnings usually are based on a consistent factor (i.e., the average return of the fund during the time you are correcting). Based on the markets, he may have lost money. Who pays is usually determined by who made the mistake -- the employer or the TPA. I think your example indicates that the only one who did is the employee.

I believe the bank account "credits" are very common and they are usually disclosed in the service agreement as being used to pay administrative fees associated with the distributions and other bank service charges.

[Guest]

I agree with Disco Stu, This does not appear to be a taxable distribution at all. If the distribution is made payable to the IRA custodian, then the taxpayer can not negotiate the check and no distribution-actual or constructive has occured.

As the tax manager for a Bank Trustee, we would not treat this as a taxable distribution

[Guest 1950]

Jean and Disco: You are right -- the participant caused this mess. Hard to see that we have an "operational failure" requiring imputing any income to him.

Disco: Yes, it's one big clearing account through which all trades for all customers of the mutual fund company clear. So, on some days "credits" earned on our plan's float is being bled off to the reduce operating expenses for other (non-plan) investors. And sometimes, the tide will go in our favor. I think Jean has correctly expressed the current thinking on this issue (and was glad to see some company on that point): the TPA is not a fiduciary, so it can keep money from a third party (here, their bank) even if earned by plan assets, so long as the TPA discloses the arrangement and the amounts (or an estimate of the amounts, I forget) to the plan. This is in synch with the so-called "Aetna" letter.

Interesting issue about whether they are plan assets. The 5500 for PY2000 hasn't been done yet. Seems to me that if this was NOT a distribution of benefits to participant -- which everyone seems to agree -- then they have to be plan assets. Not only seems logical result, but the tally on the 5500 won't work out otherwise: if not distributed then have to be left in plan assets to make it foot. But it's ok for 'em to be plan assets. See preceding paragraph.

Jean: There are times other than when the participant's investment instruction aren't followed that he/she gets imputed earnings, e.g., late deposit of elective deferrals. And the correct rate at which to impute earnings in such a case is to look to the investment return on the investments the affected participant's money would have gone into for the period of time the deposit was delinquent if you know (e.g., he/she has investment pick in place). If not, then you can use average return on investments or, for convenience, you can use the highest available yield on any investment in the plan for the period of the failure. This seems to be the mirror image. But I agree with the crowd: this gap in time/investment return wasn't our fault, hence no operational failure, hence no duty to impute earnings.

I think this horse is done. Thanks to all of y'all.