Plan Distributions from A to Z

1. Plan Distributions from A to Z Ilene H. Ferenczy, Esq. The Law Offices of Ilene H. Ferenczy (404) 320-1100  (404) 320-1105 (fax) ilene@ihflaw.com

2. Agenda • When are payments to participants permitted? • Amount of benefit payments from a plan • Withdrawals • In-service withdrawals from a profit sharing plan • Hardship withdrawals • Withdrawal pursuant to a QDRO

3. Agenda (cont’d.) • Distributions • Required distribution forms • Defined • Notice requirements • Alternate distribution forms • Distributions on employment termination • When no participant consent is needed

4. Agenda (continued) • Taxation • Rollovers • Withholding • Required minimum distributions

5. When Are Payments to Participants from the Plan Permitted?

6. When Are Payments Permitted? • Pension Plans • Distributions are permitted only upon: • a severance from service, • attainment of retirement age or, if earlier, age 62, • death, • disability • No in-service withdrawals (except in regard to above)

7. When Are Payments Permitted? • Profit Sharing Plans: payments to participants may occur upon: • Termination of employment • Death • Disability

8. When Are Payments Permitted? • Profit Sharing Plans: payments to participants may occur: • After a fixed number of years • 2 year/5 year rules • Attainment of stated age (e.g., age 59½) • Occurrence of a stated event (e.g., layoff, illness, hardship)

9. When Are Payments Permitted? • Special rule for 401(k) deferrals: may distribute only upon: • Retirement Age 59½ • Severance from Hardship Service Termination of • Disability plan if certain • Deathconditions are met

10. When Are Payments Permitted? • Designated Roth Contribution Accounts are subject to same rules as 401(k) deferrals: • Retirement Age 59½ • Severance from Hardship Service Termination of • Disability plan if certain • Deathconditions are met

11. When Are Payments Permitted? • Special situations: • A plan may (but is not required to) permit withdrawal anytime of: • After-tax employee contributions (other than designated Roth contributions) • If after-tax contributions are mandatory, withdrawal can cause forfeiture of employer contributions • Employee rollover contributions

12. When Are Payments Permitted? • Special situations: • Corrective payments • E.g., refunds of salary deferrals or payment of matching contributions due to exceeding limits or failure of nondiscrimination testing

13. Special 401(k) Plan Distribution Issues • There are two situations in which payments of salary deferrals may be problematic: • When the plan is terminated; and • When a subsidiary participates in a plan sponsored by the parent and the stock of the subsidiary is sold

14. Special Limitation on Distributions From Terminated 401(k) Plans • The rule: A terminated 401(k) plan may pay out 401(k) deferrals and qualified nonelective contributions only if there is no “alternative defined contribution plan”

15. Special Limitation on Distributions From Terminated 401(k) Plans • Alternative defined contribution plan: • Any DC Plan other than ESOP, SEP, SIMPLE, 403(b), 457 plan • Sponsored by same employer • In existence between date of termination and 12 months after distribution of all assets from the terminated plan

16. Alternative Defined Contribution Plan - Example • Chris’s Chiropractic Offices has two locations: one in Los Angeles and one in Atlanta • CCO sponsors two plans: a 401(k) plan for the L.A. office and a regular profit sharing plan for the Atlanta office

17. Alternative Defined Contribution Plan - Example • CCO decides to terminate the 401(k) plan and move all participants into the profit sharing plan • The profit sharing plan is an alternative defined contribution plan: • Sponsored by the same employer • Not a SEP, SIMPLE, ESOP, 403(b), or 457(b) plan

18. Alternative Defined Contribution Plan - Example • CCO cannot pay out the salary deferrals from the terminated 401(k) plan • The 401(k) plan must be frozen; or • The deferrals must be transferred to the profit sharing plan (and subjected to the 401(k)-style payout rules) • Note: the 401(k) plan may pay out profit sharing or matching contributions, so long as they are not QNECs or QMACs

19. Common M&A Problem When a Subsidiary Is Purchased • Example: • CCO sponsors its profit sharing plan for all employees • CCO acquires the stock of another chiropractic practice, Minnie’s Chiropractic Office (MCO), which sponsors a 401(k) plan for its employees • CCO would like to terminate the MCO plan and have the MCO employees participate in its profit sharing plan

20. Common M&A Problem When a Subsidiary Is Purchased • Example: • Because MCO is now part of the CCO controlled group, its plan is sponsored by the same “employer” • As a result, the profit sharing plan sponsored by CCO is an alternate defined contribution plan

21. Common M&A Problem When a Subsidiary Is Purchased • Example: • Result: the 401(k) plan may not make distributions of the salary deferrals or QNECs or QMACs of the MCO employees (except those who terminate employment) • Plan must freeze or accounts must be transferred

22. Some Ways to Get Out of the 401(k) Payout Problem … • Alternative defined contribution plan: • Sponsored by same employer • Determined on date of termination of the 401(k) plan • Date of termination is the date the action is taken to terminate the plan (usually Board resolution or plan amendment)

23. Some Ways to Get Out of the 401(k) Payout Problem … • Alternative defined contribution plan: • If a plan is terminated in anticipation of and before an acquisition of the sponsor by another company, no alternative defined contribution plan exists at the time of termination • E.g., if MCO had terminated its plan before CCO acquired the company, there would have been no alternative DC plan on the date of termination

24. Some Ways to Get Out of the 401(k) Payout Problem … • Alternative defined contribution plan: • Result: the termination may be processed and the deferrals and QNECs and QMACs may be paid to the participants, even if the actual payout occurs after the acquisition • Note: remember that payments from a terminated plan must occur within a reasonable time after the termination, or the plan is deemed to be frozen, not terminated

25. Another Way to Get Out of the 401(k) Payout Problem … • Exception to limitation on distributions from terminated plans: • 2% Rule: • Distribution is permitted if less than 2% of participants from old plan participate in the “alternative DC plan” during 24-month period beginning 12 months before plan termination • Permits distributions to people who will not participate in the alternative DC plan

26. 2% Rule Example • Going back to our original facts: CCO sponsors two plans, a 401(k) plan for L.A. and a profit sharing plan for Atlanta • CCO is really peeved at the L.A. office, because they are making no profit. As a result, they want to terminate the L.A. plan. The L.A. employees will not participate in the Atlanta plan.

27. 2% Rule Example • Note: the Atlanta plan will need to meet Section 410(b) coverage rules to exclude the L.A. people • Assume for purposes of this example that it can do so • It is not expected than anyone from L.A. will transfer to Atlanta

28. 2% Rule Example • Because: • No one (i.e., less than 2% of the participants) from L.A. participated in the Atlanta plan during the 12 months before the termination • No one (i.e., less than 2% of the participants) will transfer from L.A. to Atlanta in the 12 months after the termination, • The Atlanta Plan is not an alternative defined contribution plan

29. 2% Rule • On a practical basis, this rule usually does not help much • In an acquisition, it is more common for buyers to want the newly acquired employees to participate in their plans – part of integrating the new group

30. Latest Date for Plan-Initiated Distribution • Plans are required to permit distributions not later than the 60th day after the end of the plan year in which the latest of the following occurs: • Attainment of normal retirement age • The 10th anniversary of the participant’s plan entry date; or • The participant’s termination of employment

31. Normal Retirement Age • Latest permitted normal retirement age is the later of: • Age 65 • Fifth anniversary of plan entry date

32. Early Retirement Age • Not required to be in plan • Usually requires combination of attainment of a given age (e.g., 55) and completion of years of service (e.g., 10) • Usually provides for lower benefit than that available at normal retirement but sometimes greater than would be payable upon another termination of employment

33. Late (Delayed) Retirement Age • A participant may continue working past the normal retirement age, and begin taking distributions when actual retirement occurs • However, see rules for required minimum distributions later in presentation for limitations of ability of a participant (particularly a more-than-5% shareholder) to delay receipt of benefits

34. Amount of Benefits Payable from a Plan

35. Amount of Benefits Payable from a Defined Contribution Plan • Generally, the participant’s benefit is equal to the account balance times vested interest • All or a part of the benefit may be payable, depending on the event causing a distribution

36. Amount of Benefits Payable from a Defined Benefit Plan • Generally, the benefit is defined as an annuity payable monthly beginning at retirement, and usually for life • Vesting applies

37. Amount of Benefits Payable from a Defined Benefit Plan • Plan may permit benefit payment at other time or in different form • Value is the same as the benefit earned to date (“actuarial equivalent”) • The actual amount of the payment may be for only part of the benefit, depending on the reason for the payment

38. Amount of Disability Benefit • DC plan: usually 100% vest the account balance • DB plan: may be: • Accrued benefit (often 100% vested) payable at disability date • Benefit in addition to retirement benefit, to be paid during disability period until normal retirement, and then retirement benefit kicks in • Other

39. Amount of Death Benefits • DC plan: usually 100% vest the account balance • DB plan: see QPSA discussion below

40. In-Service Withdrawals from Profit Sharing Plans

41. Profit Sharing Plans May Permit Withdrawals • Stated age • E.g., age 59½ • Stated event • E.g., hardship, sale of the plan sponsor

42. Profit Sharing Plans May Permit Withdrawals • After a fixed number of years: • Contributions have been in the plan for two years; or • The individual has been a participant for at least 60 months

43. Hardship Withdrawals

44. Hardship Withdrawals • Must be permitted in the plan • Profit sharing plans permitted to have significant flexibility in defining what constitutes a “hardship” • 401(k) deferrals, however, cannot be distributed on hardship unless the hardship qualifies under special rules • All hardship rules must be applied in nondiscriminatory fashion

45. 401(k) Hardship Withdrawals • Must be applied uniformly • Subject to two-part test: • Must be a withdrawal to meet an immediate and heavy financial need (i.e., “events test”) • Withdrawal must be necessary to satisfy that need (i.e., “needs test”)

46. 401(k) Hardship Withdrawals • Event Test • General Standard: facts and circumstances requiring plan administrator investigation • Safe Harbor Standards: must be one of the following: • Payment of certain unreimbursed medical expenses for participant, spouse, dependents • Purchase of a primary residence for participant • Payment of post-secondary education expenses for the next year for participant, spouse, dependents

47. 401(k) Hardship Withdrawals • Event Test • Safe Harbor Standards (cont’d.): • Payments necessary to prevent eviction from or foreclosure on participant’s primary residence • Payments to repair casualty losses on home due to disaster • Funeral expenses

48. 401(k) Hardship Withdrawals • Needs Test • General Standard: • Facts and circumstances requiring plan administrator investigation • Amount cannot exceed hardship plus gross-up for taxes

49. 401(k) Hardship Withdrawals • Needs Test – General Standard • Plan administrator may accept participant certification that need cannot be met through: • Reimbursement by insurance or other compensation • Liquidation of employee’s assets • Cessation of 401(k) or after-tax contributions to the plan • Distributions or loans from plan • Loan from commercial lender under commercially reasonable terms • Note: this cannot be accepted as a proxy for facts and circumstances determination if the plan administrator has actual knowledge to the contrary

50. 401(k) Hardship Withdrawals • Needs Test • Safe Harbor Standards • Distribution meets amount requirements described above • Employee has obtained all other available plan distributions and available loans • Deferrals and after-tax contributions to this and any other employer plans are suspended for six months after hardship distribution is received