Terminated employee rollovers

[Guest wjr]

Is there anything that would prohibit a 401(k) plan from offering former participants,with vested deferred accounts, the opportunity to roll other accounts into the plan such as IRAs?

I realize an employer may not want to deal with former participants, but is there anything that would prohibit rollovers. I know you could have a loan policy that allows former participants to continue or start a loan.

[Brian Gallagher]

Sure. A plan can be set up that doesn't allow rollovers in. I have several plans that do that now. It's actually a selection on the Adoption Agreement.

[Brian Gallagher]

Sorry, I meisread your question. I missed the salient point about FORMER ee's. I'm sure you want current ee's to be allowed to roll in.

I'm sure something could be written into an IDP, but I deal mostly with prototypes. That's no help I know. Sorry about that.

[Kirk Maldonado]

The IRS has ruled that a plan cannot permit employees to make contributions prior to the date on which they are eligible to share in employer contributions. Whether this same result would apply in the case of a former employee, I don't know.

[Guest Harry O]

Kirk,

Can you identify the ruling?

I know of a number of plans that would run afoul of this ruling (mostly 401(k) plans that allow employee elective deferrals immediately but require 1 year of service to become eligible for the employer matching contribution; also plans that permit new employees to make rollover contributions but require 1 year of service before becoming eligible to make elective deferrals and receive matching contributions).

[david rigby]

Does the exclusive benefit rule have a bearing?

[QDROphile]

Elective deferrals are employer contributions.

[Guest Harry O]

QDRO makes a good point on elective deferrals. Nevertheless I have also seen plans that permit after-tax employee contributions immediately.

I have never heard of this IRS ruling and am interested in finding out more.

[Kirk Maldonado]

Rev. Rul. 68-651, 1968-2 C.B. 167

Sec. 401

IRS Headnote

The qualified status of an employees' profit-sharing plan will be adversely affected if it is amended to permit employees to make voluntary contributions prior to the time they become eligible to share in the employer's contributions.

Full Text

Rev. Rul. 68-651

Advice has been requested whether the qualified status of an employees' profit-sharing plan is adversely affected by an amendment to the plan permitting certain employees to make voluntary contributions in the manner described below.

A corporation established a profit-sharing plan and trust that was held to qualify under section 401(a) of the Internal Revenue Code of 1954. All employees were eligible to participate in the plan upon completion of three years of service. Voluntary employee contributions of up to ten percent of compensation were also permitted under the plan. Distributions from the trust were to be made in cash.

The plan was amended to provide that any employee who had completed six months of service may make voluntary contributions to the plan in the same manner as the plan participants. However, such an employee remains ineligible to share in the employer's contributions until he has conpleted three years of continuous service.

A plan will qualify under section 401(a) of the Code if it is a pension, profit-sharing, or stock bonus plan that meets all the applicable requirements of that section.

Section 1.401-1(b)(1)(ii) of the Income Tax Regulations provides that a profit-sharing plan is a plan established and maintained by an employer to provide for the participation in his profits by his employees or their beneficiaries. The plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants and for distributing the funds accumulated under the plan.

In this case the amended plan permits employees with less than three years of service to make contributions thereunder but does not provide for the requisite participation by those employees in the employer's profits. Instead, the plan is now a mere savings plan with respect to those employees.

A pension plan can meet the requirements of section 401(a) of the Code even if only employee contributions are made thereunder. See Rev. Rul. 66-205, C.B. 1966-2, 119. However, a profit-sharing plan cannot meet the requirements of section 401(a) if only employee contributions are made thereunder. See section 1.401-1(b)( 1)(ii) of the regulations requiring that a profit-sharing plan be a plan for the participation by the employees in the employer's profits.

Accordingly, the qualification of this plan is adversely affected by the amendment permitting employees to make voluntary contributions prior to the time they become entitled to participate in the employer's profits.

Furthermore, since neither contributions nor benefits under the plan are definitely determinable and since distributions from the trust are to be in cash, this plan also does not satisfy the definitions of a pension plan or a stock bonus plan. See section 1.401-1(b)(1)(i) and (iii) of the regulations.

[mbozek]

Kirk: I dont think the IRS enforces that ruling any more. I have received favorable determination letters for plans which permit employees to make tax free rollovers into the plan before becoming eligible to participate in the plan. Also since former employees are participants they should be permited to make tax free rollovers under the BRF provisions.

[KJohnson]

I would be interested in this as well.

I have an option in my volume submitter where the employer may select whether to allow only participants to rollover amounts into the plan or whether to also include any employee who would be a participant but/for meeting the age and service requirements of the plan. The IRS had no problem with this language.

I think this is a very common provision incorporated into a number (most?) prototypes.

Of course, jut because everyone is doing it doesn't make it correct.

[g8r]

Interesting issue. I know this provision is numerous prototype and volume submitter plans. While that doesn't make it right, to the extent an employer has reliance on the opinion or notification letter, the employer is protected.

I think that due to legislative changes, you can at least make an argument that the revenue ruling no longer applies. The ruling relies on the fact that a profit sharing plan must be established for sharing in profits of the employer. Since the law has changed, that position is no longer true.

Of course, that's just an argument. The best position is the first point I made -- reliance on the terms of the plan means it is O.K. with respect to that plan.

[Guest Harry O]

Thanks, Kirk.

My initial reaction was the same as g8r - that recent legislation may have made this ruling obsolete. I also wonder what the policy behind such a ruling was.

[GBurns]

Remember that this ruling was before 401(k) and even before pre-tax salary reductions were allowed.

[Kirk Maldonado]

Absent legislation that specific changes the result, I don't think that Revenue Rulings are automatically repealed.

I'm not arguing that the old Revenue Ruling is good policy; I'm just pointing out an issue.

I think that people are foolish to believe that if a lower level employee at the IRS does not object to (or even catch) some objectionable language in a plan document, that automatically signifies that the entire IRS has rejected all of the existing precedent on a point. That is nothing more than wishful thinking.

I only feel comfortable if the policy change is embedded in an important document that has been reviewed at senior levels of the IRS and Treasury, such as a regulation or at least a revenue ruling. Even a private letter ruling isn't sufficient authority in my book; there are plenty of erroneous PLRs out there.

I'm not saying that the person that received the ruling can't rely on it; I'm just saying that others can't rely upon it.

[GBurns]

Is there a difference between "employer's contribution" and "employer's profit"?

Is there a difference between the employee's elective deferral and the employer's contribution?

Are the above treated differently or have different definitions in a 401(k) from in a PS pension plan?

[mbozek]

Under Rev. Rul 96-48 a plan can accept rollovers from employees prior to the date they are eligible to participate in the 401(k) plan.

[Kirk Maldonado]

Upon reading the ruling, I concur with MBozek.