In Service / Non Hardship Election
There is literature out there discussing the ability of 401k plan participants to take “In Service distributions” of the employer contributions and associated earnings, as well as rolled over monies before the age of 59 1/2. None of it cites tax code or a PLR. Does anyone know where this comes from?
The actual code makes it pretty clear 401(k)(2) I think, that you must have a severance from employment, disability, do a 72(t) or be 59 1/2 to take the distribution and have it eligible for a rollover..
Maybe its the omission of certain language that allows for this loophole? Still i would think I could find some sort of PLR or something.
Also, this s often referred to as the “401k hidden escape hatch”.
Permalink Submitted by Martin Helmer on Tue, 2009-02-10 15:49
Two old Revenue Rulings provide guidance—-R.R. 71-295 for the 2 year rule and R.R. 68-24 for the 5 year rule.
Permalink Submitted by [email protected] on Tue, 2009-02-10 16:18
Thanks so much. I printed them out to review.
Permalink Submitted by Joseph Arsenault on Tue, 2009-02-10 19:55
Doesnt §401(k)(2)(B)(i) have authority over revenue ruling 71-295, making distributions from a 401(k) before one of the listed evens completely dissallowed?
(I) separation from service, death, or disability,
(II) an event described in paragraph (10) termination of a plan,
(III) in the case of a profit-sharing or stock bonus plan, the attainment of age 59 1/2, or
(IV) in the case of contributions to a profit-sharing or stock bonus plan to which section 402(a)(8 ) applies, upon hardship of the employee
So basically, wouldnt distributions of employer contributions not be allowed before a triggering event? Does the scope of §401(k)(2)(B)(i) not apply to the employer contributions becuase of 72-275 maybe??
Permalink Submitted by Martin Helmer on Tue, 2009-02-10 21:24
Section 401(k)(2) is dealing with only the dollars “attributable to employer contributions made pursuant to the employee’s election” (employee salary deferrals only). 401(k)(2) is describing a cash or deferred arrangement, which is PART OF a profit sharing plan. This leaves OTHER employer contributions, those not subject to the employee’s election, available to be distributed under stipulations such as the 2 year or 5 year rules.
The R.R. you cite in your last sentence predates the existence of section 401(k), so it doesn’t directly relate to your other question.
Permalink Submitted by Joseph Arsenault on Tue, 2009-02-10 22:19
Thanks for the response and interpretation martinhelmer.
Its very helpful.
The other question I would have then is in RR 71-295 it uses the term profit sharing plan. Is that used interchangeably with qualified plans subject to 401(a) for purposes of the interpretation?
I usually think of a profit sharing plan as it pertains to Reg. §1.401-1(b)(1)(ii) which is different than a 401(k). It seems in your explanation your saying a profit sharing plan and 401(k) are the same, or a 401(k) is part of a profit sharing plan. Maybe this is where my confusion is?
Permalink Submitted by mk foss on Wed, 2009-02-11 00:37
A 401k plan is a type of profit sharing plan. The 401k plans were created in the 1980’s; 1984 I believe. I haven’t read the 1971 ruling but you should be aware that it predates section 401k.
Permalink Submitted by Martin Helmer on Wed, 2009-02-11 01:18
The section 401(k) employee elective deferral option/cash or deferred arrangement is part of/a feature contained within the larger structure of a profit sharing plan. 401(k) could also be a feature in a pre-ERISA money purchase plan or in a couple of other types of plans though all of these nonprofit sharing types are rare. It’s possible for the 401(k) part of a plan to be out of compliance/disqualified while the rest of the plan, the profit sharing part, is still in good standing.
401(a) is a still larger classification. You could say it’s a synonym for ‘qualified plan.’ Profit sharing plans are distinguished from another type of qualified plan, the pension plan. The regulation at 1.401-1(b)(i) discusses characteristics of pension plans such as defined benefit, cash balance, or money purchase plans. A key phrase in the definition of pension plan is a plan that provides for “definitely determinable benefits.” The 2 and 5 year rules are not an option for a pension plan. The several revenue rulings that discuss in service distributions from a profit sharing plan are interpreting the definition of a PSP at 1.401-1(b)(ii).
It’s interesting to me that the public has a general awareness that a pension plan is different than a profit sharing/401(k) plan. Typically the public will think of a defined benefit plan when they think of a pension. Contrast this technical IRS definition of pension with the Department of Labor, whose statutory authority is primarily the 1974 ERISA legislation. Under ERISA there are only 2 types of employee benefits, pension and welfare. So under ERISA, all plans that defer compensation are pension plans.
Permalink Submitted by Joseph Arsenault on Wed, 2009-02-11 14:35
I guess I usually think of qualified plans as Defined Contribution plans and Defined Benefit plans. The profit sharing plans and 401(k)s fall under Defined Contribution plans but I never thought of them being used synonomous in the actual code (like in 1.401-1(b)(ii)).
“mgtf4cpa” mentioned that the R.R.s we have discussed predate section 401(k), but doesnt Final Reg 1.401 need to be taken into account as well?
So if it is broken down..
Most authoritative (Final Reg)- [i]sets general limits for any distributions made.[/i]
[b]1.401-1(b)(ii)[/b] – A profit-sharing plan is a plan established and maintained by an employer to provide for the participation in his profits by his employees or their beneficiaries. [b]The plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants and for distributing the funds accumulated under the plan after a fixed number of years, the attainment of a stated age, or upon the prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment.[/b] A formula for allocating the contributions among the participants is definite if, for example, it provides for an allocation in proportion to the basic compensation of each participant. A plan (whether or not it contains a definite predetermined formula for determining the profits to be shared with the employees) does not qualify under section 401(a) if the contributions to the plan are made at such times or in such amounts that the plan in operation discriminates in favor of officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees. For the rules with respect to discrimination, see §§1.401-3 and 1.401-4. A profit-sharing plan within the meaning of section 401 is primarily a plan of deferred compensation, but the amounts allocated to the account of a participant may be used to provide for him or his family incidental life or accident or health insurance.
So with that, the Revenue Rulings 71-295 and 68-24 provide guuidance to what a “fixed number of years” represents.
Then [b]401(k)(2)(B)(i) [/b]offers specific guidance on funds which are attributable to employer contributions made pursuant to the employee’s election, which [b]only[/b] includes the employees contributions.
So in summary, section 401(k) limits only employee contributions, Reg 1.401-1 allows for distributions after a fixed number of years or stated age, and Revenue Ruling 71-295 interprets the fixed number of years as 2. So by omission of specific limits on “employer contributions” in section 401(k) plans are able to have in-service distributions on those funds and remain qualfied.
Does that seem right? Thats our hidden escape hatch?