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When are safe harbor 401(k) employer contributions distributable?

“My client is age 47. Can he take a distribution of his safe harbor 401(k) plan matching contributions while he is still working?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Ohio is representative of a common inquiry involving safe harbor 401(k) employer contributions.

Highlights of discussion

  • No, safe harbor 401(k) employer contributions—either matching or nonelective—may not be distributed earlier than separation from service, death, disability, plan termination, or the attainment of age 59 ½ [IRC §§ 401(k)(12) and 401(k)(2)(B)]. This would include the earnings on such amounts as well.
  • IRS Notice 98-52, Section IV, H. provides further clarification on the distribution of safe harbor 401(k) employer contributions: “Pursuant to § 401(k)-(2)(B) and § 1.401(k)-1(d)(2)(ii), hardship is not a distributable event for 401(k) safe harbor contributions other than elective contributions.”
  • The distribution rules for safe harbor 401(k) employer contributions are different (more restrictive) than those for non-safe harbor 401(k) plans, where it may be possible, under the terms of the plan, to take an in-service withdrawal of employer matching or profit sharing contributions prior to age 59 ½.
  • Safe harbor 401(k) employer contributions must be fully vested when made. They cannot be subject to a vesting schedule as is the case with non-safe harbor 401(k) employer matching or profit sharing contributions.
  • The bottom line is to always refer to the provisions of the plan document or summary plan description for a definitive answer on when plan assets are distributable.

Conclusion

The IRS’ distribution rules for safe harbor 401(k) employer contributions are different (more restrictive) than those for non-safe harbor 401(k) plans. The soonest that a working participant would be able to request a withdrawal of safe harbor 401(k) employer  contributions would be age 59 ½.

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Can NUA in employer stock count towards an RMD?

“Can the portion of a distribution from a 401(k) plan that takes advantage of NUA tax treatment be used to satisfy the receiving participant’s RMD for the year?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Colorado is representative of a common inquiry involving net unrealized appreciation (NUA) and required minimum distributions (RMDs).

Highlights of discussion

  • Yes— amounts excluded from income at the point of distribution, such as NUA on employer securities, are amounts a plan participant may count toward satisfying an RMD under Internal Revenue Code Section (IRC §) 401(a)(9). (NUA is eventually included in the participant’s income as taxable long-term capital gains when the employer securities are eventually sold.)
  • According to Treas. Reg. 1.401(a)(9)-5, Q&A 9, with a few, limited exceptions, all amounts distributed from a qualified plan are amounts that are taken into account in determining whether an RMD is satisfied for a participant, regardless of whether the amount is includible in income.
  • For example, amounts that are excluded from income as recovery of “investment in the contract under IRC§ 72” (i.e., after-tax contributions) are taken into account for purposes of determining whether an RMD is satisfied for a year. Similarly, amounts excluded from income as NUA on employer securities are counted towards satisfying an RMD of the participant.
  • The following amounts are not taken into account in determining whether a participant’s RMD is satisfied for the year:
  1. Amounts returned to a participant to correct plan excesses;
  2. Loans treated as deemed distributions;
  3. The cost of life insurance coverage (i.e., PS 58 costs);
  4. Dividends on employer securities; and
  5. Other similar amounts as deemed by the IRS and published in the Internal Revenue Bulletin from time to time.

Conclusion                                                   

The IRS is clear that NUA on employer securities is a distribution amount that a plan participant may count toward satisfying his or her RMD for the year.

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How do the IRS and DOL determine whether a closed MEP exists?

“What criteria do the Internal Revenue Service (IRS) and Department of Labor (DOL) consider when determining whether a single multiple employer plan (MEP) exists for an association of employers?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Oregon is representative of a common inquiry involving multiple employer plans.

Highlights of discussion

  • A single MEP, otherwise known as a “closed MEP,” is a single employee benefit plan maintained by two or more employers that meets the requirements of Internal Revenue Code Section (IRC §) 413(c), where the employers are not related under IRC §414(b) (regarding a controlled group of employers), IRC §414(c) (regarding trades or businesses under common control), or IRC §414(m) (regarding affiliated service groups).
  • The IRS has put together a chart that indicates how specific IRC provisions apply to closed MEPs (Internal Revenue Manual, Part 7, Chapter 11, Section 7 Multiple Employer Plans).
  • The failure of one participating employer or the failure of the plan itself to satisfy an applicable qualification requirement will result in disqualification of the multiple employer plan for all participating employers [Treasury Regulation 1.413-2(a)(3)(iv)]. For example, the failure of any participating employer to satisfy the top-heavy rules disqualifies the entire multiple employer plan for all of the employers maintaining the plan (Treasury Regulation 1.416-1, Q&A G-2).
  • The DOL categorizes plans covering more than one employer as either a single employee pension benefit plan, or a combination of separate, individual plans. If the MEP is a single plan under ERISA (i.e., a closed MEP), then the plan administrator files a single Form 5500, which requires only one independent audit for the group. Similarly, the ERISA §412 fidelity bonding requirements for a closed MEP apply as if to a single plan, rather than independently as to a series of individual plans.
  • Pursuant to § ERISA §3(5) , the DOL requires that the employers in a closed MEP must be part of a bona fide group or association that has something in common besides cosponsoring one or more plans. It is the DOL’s view that where several unrelated employers merely execute identically worded trust agreements or similar documents as a means to fund or provide benefits, in the absence of any genuine organizational relationship between the employers, no employer group or association exists for purposes of ERISA §3(5).
  • In DOL Advisory Opinion 2012-04A , the DOL opined that determining whether a bona fide employer group or association exists for purposes of maintaining a closed MEP depends on all of the facts and circumstances involved. Relevant factors in judging whether a plan sponsor is a bona fide group or association of employers include the following:
  1. How members are solicited;
  2. Who is entitled to participate and who actually participates in the association;
  3. The process by which the association was formed,
  4. The purposes for which it was formed, and what, if any, were the preexisting relationships of its members;
  5. The powers, rights, and privileges of employer members that exist by reason of their status as employers; and
  6. Who actually controls and directs the activities and operations of the benefit program.
  • The employers that participate in a closed MEP must, either directly or indirectly, exercise control over the program, both in form and in substance, in order to act as a bona fide employer group or association with respect to the program.
  • Courts have ruled that the entity or group maintaining a closed MEP must be tied to the employees or the contributing employers by genuine economic or representational interests unrelated to the provision of benefits [MDPhysicians & Associates, Inc. v. State Bd. Ins., 957 F.2d 178,185 (5th Cir.), cert. denied, 506 U.S. 861 (1992) and Wisconsin Educ. Assoc. Ins. Trust v. Iowa State Bd., 804 F.2d 1059, 1063 (8th Cir. 1986)].
  • In DOL Advisory Opinion 94-07A the DOL emphasized it is the commonality of interest among the individuals that benefit from the plan and the party that sponsors the plan that forms the basis for sponsorship of a closed MEP.
  • As a rule of thumb, examples of employer associations that are likely to qualify to maintain closed MEPs include
  1. Well-established associations whose members are very similar (e.g., members of a particular trade possibly within a specific geographic region);
  2. Employers related by common ownership (but where ownership does not reach the level to require aggregation under the controlled group rules);
  3. Employers who regularly and closely cooperate in serving a particular group of clients (but do not aggregate under the affiliated service group rules); and
  4. Certain Professional Employer Organizations (PEOs).

Conclusion

Under the current regulatory framework, whether several independent employers represent a bona fide employer group or association that is eligible to maintain a closed MEP depends on the facts and circumstances of the particular situation, taking into consideration a number of factors as identified by the DOL in several of its advisory opinions on the topic.

 

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