Is the account balance of a 401(k) plan participant protected from an IRS tax levy?
ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with an advisor in Alabama is representative of a common inquiry involving 401(k) plans and IRS tax levies.
Highlights of Discussion
Unfortunately, no it is not. If the participant has an unpaid tax liability the IRS has the authority to levy against his or her 401(k) plan account balance [ Reg. § 1.401(a)-13(b)(2)]. In fact, any qualified retirement plan or IRA [including traditional, Roth, savings incentive match plan for employees (SIMPLE) or simplified employee pension (SEP) plan IRAs] may be subject to an IRS tax levy.
11.6.3 of the IRS’s Internal Revenue Manual (IRM) provides instructions and strict procedures when an IRS tax levy involves assets in retirement plans (as opposed to retirement income under 188.8.131.52 of the IRM). The IRM instructs agents to levy on retirement accounts only after considering the following questions.
1) Does the taxpayer have property other than retirement assets that may be available for collection first?
2) Has the taxpayer exhibited “flagrant” conduct? (See example next.)
EXAMPLE: Jake, who has an outstanding tax liability with the IRS, continues to make voluntary contributions to retirement accounts while asserting his inability to pay the amount he owes to the IRS. The IRS could deem this conduct as flagrant.
3) Are the retirement plan assets necessary to cover the tax payer’s essential living expenses?
4) Does the taxpayer have “present rights” to receive the retirement plan assets?
EXAMPLE: Amanda has money in a 401(k) plan, but cannot withdraw it until she experiences a distribution triggering event as listed in the plan document. An IRS levy may identify her 401(k) plan balance, but the money cannot be paid over until Amanda can withdraw it under the terms of the plan.
Logistically, the IRS will use Form 668-R, Notice of Levy on Retirement Plans for levying retirement plan assets. When money is withdrawn from a retirement account to satisfy an IRS levy the taxpayer would include any pre-tax amounts in his or her taxable income for the year. Fortunately, an exception to the 10% additional tax on early distributions for taxpayers under age 59 ½ applies if the money was withdrawn because of a notice of levy served on the retirement account.
In most cases, 401(k) plan assets are protected from creditors—unless the creditor is the IRS. However, IRS agents are instructed to levy against retirement plan assets only as a last resort. Any taxpayer addressing an IRS tax levy should seek guidance from an experienced tax professional or attorney experienced in this area.