How do you handle that a participant’s account changes from less than $1,000 to more than $1,000?

The sponsor of a retirement plan that yet has no provision for an involuntary distribution desires to provide an involuntary distribution if a participant is severed from employment and her balance is no more than $1,000.

The sponsor prefers to limit the plan’s involuntary distribution to the amount specified in Internal Revenue Code § 401(a)(31)(B)(i)(I) because the sponsor/administrator is unwilling to provide for a default-rollover IRA, which would be required if an involuntary distribution is more than $1,000 and the participant/distributee furnishes no different instruction.

The plan’s provision would look to whether a participant’s whole account, including her rollover-contributions subaccount, is no more than $1,000.

The plan’s governing document uses no IRS-preapproved document. The sponsor would amend the document to state its desired provision (except to the extent a provision would tax-disqualify the plan).

Assume all amounts are 100% nonforfeitable.

The plan provides participant-directed investment, with a broad range of investment alternatives. Account balances are recomputed every New York Stock Exchange day.

For simplicity (and to not resume a June 2020 BenefitsLink discussion), assume the plan incurs no fee for processing a distribution, and a participant’s account incurs no charge that could result in a distribution amount less than the participant’s before-charge account balance.

What happens if, between the time the plan’s administrator sends a § 402(f) notice and the form for instructing a direct rollover and the time the administrator would process an involuntary distribution, the participant’s changes from less than $1,000 to more than $1,000? Must the administrator cancel the distribution?

What happens if, on the day the involuntary distribution would be processed, the participant’s account balance changes from $999 (based on the preceding day’s funds’ shares’ prices) to $1,001 (based on the funds’ shares’ prices on which shares would be redeemed)?

Must the administrator cancel the distribution? How does a recordkeeper do that? If looking to the preceding day’s balance is good enough and the distribution is not canceled, what does the recordkeeper with the breakage between $1,000 and the funds’ shares’ redemption value?

How do plans’ administrators and, perhaps more important, recordkeepers deal with this in the practical real world?

Is there a similar issue if the plan’s involuntary distribution is set for no more than $5,000?

What happens if yesterday’s balance was $4,999 and today’s is $5,001?

One hopes some smart recordkeeper has methods for situations in which a tolerance (whether $1,000, $5,000, or something else) would have been met when a distribution was anticipated, but is not met when investments would be redeemed to pay the distribution.

Is it really as simple as canceling the anticipated distribution?

Peter,

I understand what you are driving at with respect to your first post. Could you perhaps look at it in the following way: if the participant's account balance does not exceed the specified dollar amount threshold as of the last day of the plan year, then the involuntary cashout provision is invoked. What happens subsequently (with respect to investments) should not cause the account to be precluded from being cashed out. Also, in an involuntary cashout scenario, you mentioned the 402(f) notice. My understanding is that, in that scenario, the account balance is simply distributed to the participant in the form of a single sum.

Regarding your second post, since the participant is entitled to elect whether or not to do a direct rollover to another eligible retirement plan to the extent the account exceeds $1,000 but does not exceed $5,000, I could see that that would take slightly longer a period of time between the end of the plan year and when the distribution/rollover is actually implemented. However, if the account balance as of the close of the plan year does not exceed $5,000, the plan could still implement the distribution/direct rollover, in spite of interim investment gains.

Maybe not quite on-point, but an example from a defined benefit plan we terminated a few years ago.  Participant's estimated lump sum when distribution election forms were handed out was less than $5,000, so spouse consent form was not included.  When final distributions were processed, lump sum distribution was more than $5,000.  Plan termination was audited by the PBGC.  They asked why there wasn't a spouse consent for this participant.  Explained timeline of what happened, and they said OK and didn't ask for anything else.

I'd look at it similar to an RMD, the determination value is fixed to the anniversary date, you can't chase the minimum fractional value throughout the distribution period.  If this is a question and you have an IDP doc, stick that aspect into the provision.   It's definitely determinable and if strictly followed would be non-discriminatory. 

That an involuntary distribution is no more than $1,000 does not deprive it of treatment as an eligible rollover distribution. A plan’s administrator must permit such a distributee to elect a direct rollover if her eligible rollover distributions during a year total at least $200. 26 C.F.R. § 1.401(a)(31)-1/Q&A-11 https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR6f8c3724b50e44d/section-1.401(a)(31)-1. Or has tax law changed from what I remember?

Internal Revenue Code of 1986 § 401(a)(31)(B)(i)(I), which sets $1,000 as the most a plan may distribute without providing a default rollover for a distributee who does not elect a different rollover or no rollover, refers to “a distribution . . .”, not an account balance or an accrued benefit.

The last day of a plan year might not be a relevant measure. Some plans that provide an involuntary distribution look to a different time. Some plans provide involuntary distributions more often than yearly. Some do it quarter-yearly, or monthly. Some provide an involuntary distribution timed from each participant’s severance from employment. For example, an employer/administrator might include a § 402(f) notice and the form for specifying a rollover with employment-exit papers. For an involuntary severance from employment, some employers furnish a retirement plan’s notices and forms when the employer presents its proposed release and severance agreement.

Yet, if the concept is that it’s good enough that a distributee’s account is no more than the specified amount on a relevant date that reasonably precedes the involuntary distribution, that concept might apply no matter what internals or timing the plan uses.

Thank you, all, for the suggestions about providing for a determination date.

And thank you for your information about practical experiences.

Likewise, I don’t doubt there are IRS-preapproved documents one could read as allowing an involuntary distribution more than $5,000 if the accrued benefit at some relevant earlier date was no more than $5,000 (or the plan’s specified amount). At least one recordkeeper’s IRS-preapproved document mandates the involuntary distribution if the amount does not exceed $5,000 (or the other specified amount) “at the time” the participant or beneficiary “becomes entitled” to a distribution.

Because, without an IRS determination, I am responsible for my advice about whether the plan’s governing document and written procedures state a tax-qualified plan, I’ll advise the plan’s sponsor and administrator about the opportunities and risks.

Oops, intervals.

I've thought of this from time to time myself. Surprised there is not guidance on it, but to the best of my knowledge, there is not. My guess at what the rule should be is that if the account is under the applicable threshold at a point in time, you can distribute even if above the amount is over the threshold at the date of distribution, as long as the distribution occurs as soon as administratively feasible (probably within a few days, right?) of the date when the decision to distribute is made. IOW, if it's under the threshold and you initiate distribution, the fact that the amount transferred, or the check, is slightly higher is probably not a problem, as long as the increase occurs after the employer or its agent has taken the appropriate action to initiate the distribution, such that it will occur thereafter without any further action on the part of the plan administrator.

That's my guess at the right rule. I have no doubt that even a somewhat longer, but reasonable, delay, as in the case that chc93 recounts, will typically work in an exam reviewing an individual situation.

Personally, I'd prefer to have all force-outs go to a default IRA.  Cash-outs are notorious for going uncashed, which creates the headache of stale checks, withheld taxes, and so on.  For purposes of this discussion I'm not going to go into the constructive receipt issue.

It is very simple to select a default IRA provider these days, and they do most of the heavy lifting for you.  It's also often at no cost to the sponsor.

@Peter Gulia is the client concerned about liability for selecting and monitoring the default IRA provider?  Or is there another reason for wanting to stay away from them?

1 hour ago, RatherBeGolfing said:

Personally, I'd prefer to have all force-outs go to a default IRA.  Cash-outs are notorious for going uncashed, which creates the headache of stale checks, withheld taxes, and so on.  For purposes of this discussion I'm not going to go into the constructive receipt issue.

It is very simple to select a default IRA provider these days, and they do most of the heavy lifting for you.  It's also often at no cost to the sponsor.

@Peter Gulia is the client concerned about liability for selecting and monitoring the default IRA provider?  Or is there another reason for wanting to stay away from them?

A number of our clients reduced the IRA force-out threshold to $0.01 in their Cycle 3 restatement to address this issue. I think it's a good idea. 

The suggestion for a cash-out provision, of any kind, is not mine, and has no grounding in any advice I provided or would provide. Considering a nonlawyer pension consultant’s reason for suggesting the provision is beyond the scope of my engagement.

The plan’s sponsor/administrator is not worried about liability for selecting or monitoring a default-IRA provider. Rather, it has different reasons for preferring not to put anyone in a default IRA. (And considering those reasons is beyond my scope.)

The plan’s sponsor/administrator also has no worry about abandoned-property administration or other difficulties regarding unnegotiated payments. Likewise, no worry about having tax-reported, and withheld income taxes from, an involuntary distribution.

Luke Bailey, thank you for suggesting a possible interpretation, and that an IRS examiner might show some tolerance. I don’t have that luxury. What my client asks for is my advice on the correct reading of the statute. Absent a court decision, a Treasury rule, IRS subregulatory guidance, or another “[t]ype[] of authority” mentioned in 26 C.F.R. § 1.6662-4(d)(3)(iii), I could advise a substantial-authority tax position “only by [my] well-reasoned construction of the applicable statutory provision.” 26 C.F.R. § 1.6662-4(d)(3)(ii).

26 C.F.R. § 1.6662-4(d) (Substantial authority) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR1d0453abf9d86e0/section-1.6662-4#p-1.6662-4(d).

I’ll advise the plan’s sponsor and administrator about the opportunities and risks.

I am considering a good-enough if the individual’s account was no more than $1,000 as of the daily valuation that immediately precedes the administrator’s final instruction on the day investments allocable to the individual’s account are redeemed—even if, because of changes in funds’ shares’ prices that day, the overnight redemption and next morning’s payment is more than $1,000.

That necessity reasoning might be little or no more than that the plan’s administrator cannot know what redemption would result before the administrator must conclude the instruction for the recordkeeper and directed trustee to process the distribution.