What qualifies a distribution for rollover treatment?

[Guest Joel Frank]

IRC section 402©4 defines an "eligible rollover distribution" as "any distribution"............etc.

Yet the IRS is taking the position that only early/taxable distributions under 403(B)(7)(A)(ii) and (11) are eligible for rollover treatment from 403(b)arrangements. This position was sustained by The Court of Appeals for the second circuit in FRANK V. ARRONSON (CA 2nd 96-9456).

403(B)8 and (10) are the eligible rollover distribution provisions of section 403(B) while paragraphs (7)(A)(ii) and (11) are the early/taxable distribution provisions. Contrary to the Court's decision they do not conflate.

By conflating them the Court has rendered the REPEAL OF THE SPECIFIC TRIGGERING EVENTS UNDER 403(B)8 that needed to be satisfied for distributions to be afforded rollover treatment MEANINGLESS. This repeal was authorized by the Unemployment Compensation

Ammendments of 1992, effective 1-1-93.

IF THE CODE REQUIRES THE SATISFACTION OF A TRIGGERING EVENT FOR DISTRIBUTIONS TO BE AFFORDED ROLLOVER TREATMENT WHY ARE THESE TRIGGERING EVENTS NOT ENUMERATED IN THE REGULATORY DEFINITION OF AN "ELIGIBLE ROLLOVER DISTRIBUTION????

They are not enumerated because the 102nd Congress wanted to eliminate the Code's restrictions for distributions to be afforded rollover treatment. The 106th Congress should clarify that the early/taxable distribution provisions do not apply to rollover amounts; and in the absence of the Plan Document requiring a triggering event, the plan participant has the statutory right to effectuate an eligible rollover distribution at his or her personal discretion.

[This message has been edited by Joel Frank (edited 03-05-99).]

[david shipp]

Welcome back Brooksdaletsa.

. . . the 102nd Congress wanted to eliminate the Code's restrictions for distributions to be afforded rollover treatment. . .

This is a correct statement and Congress did, in fact, make rollovers easier. As we have discussed before, however, a distribution has to be permitted before it can be made. The easing of rollover rules did not, and was not intended to liberalize distribution restrictions.

What specifically are you being prohibited from doing? If you could indicate what your ultimate goal is with respect to your TSA, the assembled knowledge on this site might be able to fashion a solution for you.

[For the benefit of others, this is a continutation of a discussion held on the 403(B) board under the title "Rollover transactions]

[This message has been edited by david shipp (edited 03-06-99).]

[Guest Joel Frank]

Hi David,

I am not looking for advice!

I am simply pointing out how the Court has thawarted the will of the 102nd Congress. The Congress realized that a rollover transaction DOES NOT CHANGE THE TAX-DEFERRED STATUS OF THE FUNDS DISTRIBUTED. (THEREFORE, THEY REPEALED THE TRIGGERING EVENTS SOLELY FOR ROLLOVER PURPOSES). The Congress realized that the satisfaction of a triggering should only be imposed for taxable or early distributions. (THEREFORE, THEY RETAINED THE TRIGGERING EVENTS FOR DISTRIBUTIONS WHICH ARE PREMATURE,EARLY AND AND THUS, TAXABLE. A TAXABLE DISTRIBUTION, FOR EVER, CHANGES THE TAX-DEFERRED STATUS OF THE FUNDS DISTRIBUTED.)

The Court has erroneously applied the triggering events for taxable distributions to also govern rollover eligibility.

David, have you read IRC Section 402©4 before and after the UCA '92? The definition of an eligible rollover distribution was changed dramatically. Prior to 1-1-93 in order for a distribution to be afforded rollover treatment it had to be at least half of the account balance and be triggered by an event, like age 59.5, etc. Subsequent to 12-31-92, these restrictions have been eliminated.

The regulatory definition of an "eligible rollover distribution" does not include the triggering events of 403(B)(7)(A)(ii) and (11) because 402©4 governs rollover eligibility and the specified triggering events under 402©4 were repealed, effective 1-1-93.

FRANK V AARONSON et. al; has, indeed, caused much concern. A SIMPLE STATUTORY CLARIFICATION IS LONG OVERDUE.

[david shipp]

Joel,

I would suggest that operation as you propose would negate triggering events altogether. Once an amount is rolled to an IRA there are no restrictions on withdrawal.

Part of the "deal" for tax qualified treatment of retirement plans is that the benefits are to be primarily for retirement, therefore there are restrictions on when benefits can be withdrawn. Allowing distributions at any time, simply because they are not taxable at the time of distribution due to a rollover, would open plan benefits to unrestricted access . . . simply roll a distribution over and then take it from the IRA.

Your argument that a change in the conditions that apply in determining rollover eligibility also changed the availability of distributions under a qualified plan is incorrect. The restriction on distributions comes from reg. 1.401-1(B) for section 401(a) plans and (as you point out) section 403(B)(11) for TSAs. These provisions fit in with the tax "deal" and there is no way Congress is going to modify it in the way your suggest. It wasn't their intention at the time of the amendment and it won't happen in the future.

The committee report for UCA talks about making rollovers easier, it doesn't deal with the issue of eligibility for distributions. The pre-UCA impediments to rollovers were removed to allow retirement benefits to be maintained as retirement benefits (i.e., rolled over) when distributed from a plan at permissible times.

I've got no snappy close to this discussion, it's just a matter of statutory construction. I think we may have to agree to disagree.

[Guest Joel Frank]

Good morning Dave:

A rollover from a 403(b)to an IRA is simply a CHOICE given in the Code.

This is the FLEXIBILITY that the 102nd Congress intended. While 403(B) imposes triggering events for TAXABLE Distributions and the IRA statute does not; 403(B) permits loans while the IRA does not. That is why the Congress has left it up to the participant to decide which type of plan fits his circumstances best.

I grant you that it is administratively

easier to make taxable distributions from an IRA than a 403(B). In either case, however, the 10% pre-mature distribution penaly tax is due.

Dave, surely you agree that a rollover from a 403(B) to an IRA PRESERVES AND MAINTAINS THE TAX-DEFERRED STATUS OF THE ROLLOVER DISTRIBUTION.

The ANALYSIS goes like this:

Q. Does the participant INTEND to use the funds for retirement by maintainin and preserving the tax-deferred status of the funds? There are only two possible answers. Answer 1. no: Therefore, restrictions apply to the distribution. Answer 2. yes: Therefore, no restrictions apply to the distribution.

Permit me to "attack" the Court's logic in another way.

Assumptions: PRE UCA'92, age 61, active employee. The participant wants to ROLLOVER his entire account balance to an IRA. He may do this because he is more than 59.5 years of age. Q. IS HE 59.5 UNDER PARAGRAPHS (7)(A)(ii) and/or (11),0R (and this is a big "or")is he 59.5 under 403(B)8? According to the Court's logic he is must be at least 119 years old. First, he must QUALIFY FOR a TAXABLE DISTRIBUTION under paragraphs (7)(A)(ii) and/or (11) and SECONDLY, FOR ROLLOVER TREATMENT UNDER 403(B)8.

ALL WHO AGREE WITH THE COURT'S DECISION MUST AGREE WITH THE ABOVE EXAMPLE, NOT WITHSTANDING ITS UTTER ABSURDITY.!!

The "example", I trust, PROVES that the Court MISAPPLIED THE EARLY DISTRIBUTION PROVISIONS OF PARAGRAPHS (7)(A)(ii) and (11) to a rollover transaction.

THE IRS'POSITION WAS UNFORTUNATELY RUBBER-STAMPED BY THE COURT OF APPEALS.

[This message has been edited by Joel Frank (edited 03-08-99).]

[david shipp]

Joel,

I'll try one more time then I have to move on. It has been a pleasure debating with you, however.

The basic model under both 401(a) plans and TSAs is that distributions are taxable. In addition, distributions are restricted unless certain events occur.

To preserve the retirement nature of distributions, rollovers are permitted as an exception to taxability.

Pre-UCA, in addition to requiring a distributable event for the intial ability to distribute, there were also "impediments" to rollovers in the nature of conditions which had to be met if a distribution was to be rolled over.

Congress decided that it was not good pension policy to restrict rollovers. If an individual qualified for a distribution, why put roadblocks in his way if he wished to roll it over to preserve it for retirement. Hence, UCA removed most but not all rollover restrictions.

You will recognize that this is a restatement of your "absurdity" and I think most will agree that it is not absurd from a pension policy standpoint.

. . . Q. Does the participant INTEND to use the funds for retirement by maintainin and preserving the tax-deferred status of the funds? There are only two possible answers. Answer 1. no: Therefore, restrictions apply to the distribution. Answer 2. yes: Therefore, no restrictions apply to the distribution. . .

Tax policy doesn't live on intentions. If the distribution of benefits is limited to specified events, the fact that an individual could thwart those restrictions by simply stating an intention to leave assets in an IRA after a rollover isn't good policy. Now, if you were to impose pension-like restrictions on the IRA, the tax policy arguement would go away (to be replaced by other arguements about access to benefits while still employed.)

Joel, this is as lucid an arguement as I can marshall (and a darn good one if I do say so myself). If you don't buy this one, then I would have to say you would have gone down with the Titanic muttering "this ship can't sink." :-)

Again, thanks for opportunity to discuss the issue with you.

[jlf]

From the inception of 403(b) in 1959 until 12-31-88 there were no restrictions on taxable distributions from 403(b)1 annuities. The Code did not provide a rollover provision until 1-1-79. Effective 1-1-79, upon satisfying a triggering event one could effectuate a rollover.

Thus, from 1-1-79 until 12-31-88 a 403(b)1 particpant needed to satisfy a triggering event to effectuate a rollover distribution; but was permitted to make taxable distributions at will.(THESE UNRESTRICTED TAXABLE DISTRIBUTIONS JEOPARDIZED THE TAX-DEFERRED STATUS OF THESE ANNUITY CONTRACTS). Efective 1-1-89 the Code imposed, for the first time, triggering events for taxable distributions on 403(b)1 annuity contracts.

Thus, from 1-1-89 until 12-31-92,the Code required triggering events for both kinds of distributions,tax-free rollovers and taxable withdrawals.

With the UCA'92 the Congress finally got it right: It realized that to require triggering events for rollover amounts serves no purpose. It, therefore, repealed triggering events for rollover purposes only.

Effective 1-1-93, it is indeed a misapprension of the relevant Code provisions to require triggering events for distributions to be afforded rollover treatment.

[jlf]

Dear Dave, I'm addressing you because you have been the only one to respond to this topic.

Assumptions: Pre-UCA'92, a hardship distribution is made under paragraphs (7)(A)(ii) and or (11) of IRC section 403(b).The distribution represents at least half of the account balance.

Q. Is this distribution permitted to be rolled over to another 403(b)/IRA? Remember, this is a pre-UCA case.

[This message has been edited by jlf (edited 03-16-99).]

[jlf]

The answer is NO!!!!!

Prior the the UCA'92 "hardship" was not one of the triggering events under "403(B)8 Rollover Amounts".

It was only after UCA'92 when the 403(B) industry, for obvious reasons, decided to utilize paragraphs (7)(A)(ii) and (11) to ALSO govern rollover eligibility that hardship distributions qualified for rollover treatment. This industry practice was erroneously rubber stamped by the IRS and the Courts. This is added proof that the 102nd Congress (UCA'92) had absolutely no intention of REPLACING the the repealed triggering events of 403(B)8 with the triggering events of 403(B)(7)(A)(ii)and (11).

As I stated earlier the statutory definition of an "eligible rollover distribution" is "any distribution......". The Court, therefore, erroneously ruled when it decided to limit rollover treatment only to those specific distributions that qualify for early distribution under 403(B)(7)(A)(ii) and (11).

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[This message has been edited by jlf (edited 03-29-99).]

[jlf]

Committee Reports on P.L. 102-318 (Unemployment Compensation Amendments of 1992)states the following:

".0013 Rollover and Withholding on non-periodic pension distributions (secs. 511-513 of the bill and secs.402 and 3405 of the Code.)"

"Present Law:"

"Distributions from tax-qualified pension plans (secs. 401(a)), qualified annuity plans (sec.403(a)), and tax-sheltered annuities (sec. 403(B)) generally are includable in gross income in the year paid or distributed under the rules relating to the taxation of annuities. A total or partial distribution of the balance to the credit of the employee under a qualified plan, a qualified annuity plan or a tax-sheltered annuity may, under certain circumstances, be rolled over tax free to another plan or annuity or to an individual retirement arrangement (IRA). A rollover of a partial distribution is permitted if (1) the distribution equals at least 50% of the balance to the credit of the employee, (2) the distribution is not one of a series of periodic payments, (3) the distribution is made on account of death, disability, or separation from service, and (4) the employee elects rollover treatment................."

"Reasons for Change:"

"The complexity of the present-law rollover rules create needless problems for individual taxpayers. For example, the restrictions on rollovers lead to inadvertent failures to satisfy the rollover requirements. Liberalization of the rollover rules will increase the flexibility of taxpayers in determining the time of the income inclusion of pension distributions and will encourage taxpayers to use pension distributions to provide retirement income.........."

The above quotations from the Committee Reports shows, without any doubt whatsoever, that the lawmakers clearly intended to repeal restrictions for distrbutions to be eligible for rollover treatment.

The Court's decision is a simple case of judicial usurpation of Legislative authority. The 106th Congress should once again clarify that eligible rollover distributions are not subject to the early distribution restrictions of 403(B)(7)(A)(ii) and (11).

Is there anyone out there that believes the second circuit made the wrong the decision?

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[This message has been edited by jlf (edited 04-01-99).]

[This message has been edited by jlf (edited 04-01-99).]

[This message has been edited by jlf (edited 04-07-99).]

[Guest TYounkin]

Joel, you asked me to join in this debate so here I am. I read the above posts and I can tell you that I am probably in over my head. But here is what I at least think I know and would advice.

When terminating a job you can roll over your 403(B) or 401(k) account into your Traditional or sometimes called conduit IRA. This should be a direct rollover and you should not have to pay any taxes. I would recommend this conduit IRA be separate from any other IRA's you may already have. Once you have transferred your old jobs retirement plan into your conduit IRA you can even convert that into a Roth IRA (if your AGI<$100,000 limit) but in turn you will have to pay taxes.

You can elect to cash out your retirement plan upon leaving however there may be penalties imposed in addition to a hefty tax bill. Cashing out is rarely recommended.

When my wife left her previous job she rolled over her 403(B) plan into a no load Trad. IRA without any problems. She kept her retirement plan contributions still tax deferred and did not have to pay any taxes because of the rollover.

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