Participant wants to change distribution election

A plan participant in a 401(k) plan elected a lump sum distribution upon termination of employment. However, he has changed his mind and now wants an annuity payout option offered by the plan. He has not cashed his distribution check. It seems that since the check was not cashed that these are still plan assets and he should be entitled to make another distribution election. However, I can also argue that once the election is made its final. Any thoughts.

Interesting question - but think of it this way - has the 60 day rollover period started?  The participant has control of the funds - and can cash the check at any point in time - so I would argue yes, it has.  Our position is that "from the plan's position" - once the check is cut, the distribution is complete and we do not allow changes in the form of distribution.  This would be especially important if the original check was cut in December, and the request to change it came in January.  When is it taxable.

Assets have been liquidated, assets have (arguably) been removed from the trust and put into a distribution (checking) account, and it's done.

The participant can still roll it over into an annuity (and IRAnnuity) or into any IRA and then annuitize it. 

1 hour ago, MoJo said:

The participant can still roll it over into an annuity (and IRAnnuity) or into any IRA and then annuitize it. 

But will have to make up any withholding if he wants it as a tax-neutral transaction.

22 minutes ago, BG5150 said:

But will have to make up any withholding if he wants it as a tax-neutral transaction.

That's the participant's problem.  S/he can rollover the net or make up the amount withheld (or anything in-between) and then when they file their tax return receive a credit for the amount withheld.

Still not the plan's/service provider's issue....

Thank-you for your responses!!!

18 hours ago, MoJo said:

has the 60 day rollover period started

Can a former participant make an indirect rollover to a 401k? Or, would they be required to make this rollover into an IRA?

It would surprise me if this question is not already answered in the plan document.

Not sure about DCP language, but in DBPs you generally cannot change your benefit election after your "annuity starting date".

We had this issue come up a few times.  There was one time where we believed the participant received bad information from an employer source and we allowed the election to be un-done, but otherwise no.  In our Plan, the election of an optional form of benefit can only be made during the benefit election period, which is 180 days prior to the annuity starting date.  And the annuity starting date is the first period for which an amount is payable as an annuity under the Plan or, if not an annuity,  the first date on which all events have occurred which entitle the participant to a benefit.  Since the check has already been cut it would appear that all the required events have occurred, so if your plan has similar language you can point to it when you refuse the participant's request.

On 8/25/2022 at 1:51 PM, Ananda said:

 It seems that since the check was not cashed that these are still plan assets and he should be entitled to make another distribution election.

This is most likely not true from a tax perspective.  There is a tax doctrine known as the 'Constructive Receipt" doctrine. It says once a person has constructive receipt or control of income it is taxable to them.

Think of it this way.  You send the check to this person in last 2021 and they don't cash it until 2022.  When is it taxable to them?  It is 2021.  You would send a 1099-R in Jan of 2022.  This is because the person had control of the check.  They can't say it was still a plan assets until 2022 and they shouldn't get a 1099-R until Jan of 2023.  They don't get to pick their tax year.  It is simply in their hands.  It is their income and their asset to do as they wish at this point. 

Yes, I know there is debate about what happens if a check isn't cashed when a plan terminates are all the assets gone or not.  But that is allowing an odd exception to destroy the rule and I don't think the IRS will have any of it.

We would recommend refusing to any of our clients with one exception noted next. 

The only way you could get our firm to recommend to a client to undo a payment would be if somewhere along the way the participant's election was ignored or handled incorrectly so they did not get what they asked for of no fault of their own.  You can then make the case the plan has an obligation to make the person whole and the way the should have been if done right.  Once again a narrow exception whose basis can be found in the law. 

Ananda, assuming you don't want to buck a Revenue Ruling, I think Rev. Rul. 2019-19 settles the issue for you on whether you can cancel the uncashed check and start over. Can't. Says the individual is taxable. I think the only gray area would be if the participant had moved, not received the check, or something like that. You can argue that Rev. Rul. 2019-19 relies on traditional notions of "constructive receipt," i.e. taxpayer can't turn his/her/their back on income.