Can in-service withdrawals avoid 20% withholding by direct rollover or

[John A]

Is there any reason that in-service withdrawals (that are not hardship withdrawals)cannot avoid the mandatory 20% withholding by being directly rolled over to a traditional IRA? Or does the 20% withholding always apply to in-service withdrawals (that are not hardship withdrawals)? Can in-service withdrawals be rolled over after the 20% withholding?

[Guest Mr. X]

There is no stipulation that an in-service withdrawal is treated any differently than if the participant terminated employment. It is eligible for rollover, so the 20% withholding would apply if the participant chose not to roll it over. As for your second question, they can if it is within 60 days of receiving the distribution. Additionally, the participant can choose to "make-up" any amounts withheld for taxes.

[Guest Tim Howard]

I'd be careful here to check the plan document as far as what source is available for ISW. In particular, if some sources, but not all, are available for ISW, then the distribution would not qualify as a "lump sum distribution" available to be rolled over.

For example, a Profit Sharing Plan may permit a non-hardship ISW on the vested employer balance only (for funds that have been in the Plan for 2 years), but no employee 401(k) deferrals are available for the ISW. An in-service distribution would not qualify as a lump sum distribution, so the mandatory 20% withholding would not be applicable. The participant would have to be offered the voluntary tax withholding, which I beleive is 10%.

Unless the ISW consists of the entire account balance it is not an eligible distribution, so it may not be rolled over.

What is the nature of the plan / ISW in question?

In general, many plans do not offer ISWs because they are not consistent with the plan's original intent which is to provide retirement benefits.

[KJohnson]

I'm not on board with Tim Howard's analysis. There is no longer a requirement that a rollover be a lump sum distribution. The distribution simply must not be a distribution that is one of a series of substantially equal payments over a period of ten years or more. If someone simply "cleans out" their profit sharing and matching accounts with an in-service distribution leaving their elective deferral accounts, I think that you still could "roll" this in-service distribution. See 1.402©-2 Q&A 5 and Q&A6.

[This message has been edited by KJohnson (edited 05-08-2000).]

[david shipp]

IAWKJ

[pjkoehler]

The definition of "eligible rollover distribution" (for distributions after 12/31/98) set forth in section 402©(4)excludes 3 types of distributions: (1) the periodic sort discussed by KJohnson, (2) any distribution required under the minimum distribution rules set forth in section 401(a)(9), and (3) "hardship distributions described in section 401(k)(2)(B)(i)(IV)." Minimum distributions don't require in-service distributions except in the case of 5% owners, so any distribution to a non-5% owner (even if less than 100% of the participant's vested interest in the plan) that is not among the other two categories of distributions can be rolled over, i.e. the plan would be required to withhold at the mandatory 20% federal rate, unless the distribution qualifies as a direct rollover.

[jlf]

Tim: The rollover rules including the definition of an eligible rollover distribution were substantially amended by the Unemployment Compensation Amendments of 1992. WHERE HAVE YOU BEEN?? Thanks to all for the in depth correction.

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yes

[Guest Tim Howard]

Oops. Thanks for the clarification.

I still, of course, would stand by the point of checking the plan document as far as what accounts are eligible for ISWs.

While it has been a while (actually, pre-92) since I actually had to approve a partial account ISW, I recall that the process can become quite convoluted. My recollection is that the Plan document's provisions were unnecessarily complex, especially when pro-rata amounts from after-tax accounts were included.

After reading the follow-up responses, I agree its OK, if the plan permits ISWs, to roll them to a traditional IRA to avoide the 20% tax withholding.

Thanks again for the correction.