When can a participant receive a distribution from a retirement plan while still working?
It depends. A plan may (but is not required to) allow participants to receive in-service distributions. In addition, certain conditions must be satisfied which are set forth under the Internal Revenue Code, regulations and IRS guidance.
Are the rules different depending upon the type of contributions?
Yes. Elective deferrals (i.e. 401(k) and Roth contributions) can only be distributed while a participant is still working under limited circumstances. The following in-service distributions are permissible, if provided for under the plan document:
Hardship distributions (this generally does not include related earnings)
Distributions on or after the date a participant has attained age 59 ½
Qualified reservist distributions
Distributions after a participant has become disabled (as defined under the terms of the plan)
Safe harbor nonelective and matching contributions may only be distributed upon attainment of age 59 ½ or disability. This also holds true for QNEC and QMAC account balances.
Profit sharing and employer matching contribution account balances may be distributed upon attainment of a stated aged (which may be less than age 59 ½), after the contributions have accumulated (or “aged”) in the plan for at least 2 years, after an employee has been a plan participant for at least 5 years, or in the event a participant becomes disabled.
Rollover and voluntary after-tax (non-Roth) contribution account balances may be distributed at any time.
Different rules apply to pension plan balances, which generally may not be distributed to an active employee prior to attainment of age 62.
Are in-service distributions eligible for rollover?
Generally, yes. With the exception of hardship distributions, any of the in-service distributions described above are eligible for rollover.
Are in-service distributions subject to the additional 10% income tax for early withdrawals?
Unless the participant has attained age 59 ½, the taxable portion of the distribution is generally subject to the additional 10% income tax. There are exceptions to this rule if the participant is disabled (as defined under the Internal Revenue Code) or if the distribution is a qualified reservist distribution.
What qualifies as a “hardship” distribution?
The regulations provide “safe harbor” rules for hardship distributions, which most plans follow. Under these rules, hardship distributions may be made for the following reasons:
To prevent foreclosure or eviction from a participant’s principle residence
To purchase a participant’s principal residence (excluding mortgage payments)
To pay for post-secondary education for a participant, his spouse, children or dependents for the next 12 months
To pay for unreimbursed medical expenses that would otherwise be deductible (without consideration to the deduction limit) for a participant, his spouse, children or dependents
To pay for funeral expenses for a participant’s deceased parent, spouse, child or dependent
To pay for expenses necessary to repair a participant’s principle residence that would qualify as a casualty loss
Note that if a participant receives a hardship distribution, the participant is prohibited from making 401(k)/Roth contributions to the plan for the 6-month period following the distribution.
Are in-service distributions from Roth accounts taxable?
It depends. Roth contributions are not taxed when distributed, but the related earnings may be unless the distribution is a “qualified distribution”. In general, a distribution is a qualified distribution only if the distribution is being made on account of death, disability or attainment of age 59 ½ and the participant has had a Roth account under the plan for at least 5 years.
Distributions that are rolled over to a Roth IRA are not taxable.
What are “qualified reservist” distributions?
A plan can allow participants who have been called to active duty for a period of more than 179 days (or indefinitely) to receive a distribution of their elective deferrals.
Are distributions from voluntary after-tax accounts taxable?
Like Roth contribution account balances, the after-tax contribution portion of the account is not taxable but the related earnings are unless the distribution is rolled over to a traditional IRA. If rolled over to a Roth IRA, the related earnings are taxed.
If a plan allows in-service distributions, can the provisions be removed?
A plan can remove a hardship distribution feature at any time; it is not a protected benefit. The other types of in-service distribution options discussed above are protected under the law. What this means is that any of these provisions may be removed prospectively; however, the participant account balances as of the effective date of the change must continue to be eligible for in-service distribution under the plan’s prior provisions.
If an employee terminates and then is rehired, can he still receive a “termination” distribution?
No. After an employee has been rehired, he or she is no longer eligible to receive a termination distribution and would have to qualify for an in-service distribution under the terms of the plan.
What happens if a plan issues an in-service distribution to a participant who doesn’t qualify to receive one under the terms of the plan?
The bottom line is that the plan sponsor must take corrective actions; this is plan qualification issue. The good news is the IRS provides methods for correcting such mistakes under their Employee Plan Correction Resolution System (EPCRS). Generally, the employer must take steps to have the participant return the funds to the plan, along with related earnings, but there are other options as well.
How can I learn more about the in-service distribution rules?
If you are considering adding and in-service distribution feature to your plan, or would like to learn more, please contact us and we will be happy to assist you.