Retirement Plan Fundamentals

Module 3: Distributions

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contained herein are intended for instruction only and are not a substitute for professional advice.
Module Overview
Unit 1: The Distribution Process
Unit 2: Termination of Employment
Unit 3: In-Service Withdrawals
Unit 4: Hardship Withdrawals
Unit 5: Required Minimum Distributions (RMDs)
Unit 6: Other Distributable Events
Unit 7: Employer Responsibility

Scenario
Shirley is hired to process distributions for USA Retirement Plan Services. One of the first tasks she is
responsible for is processing requests from participants who would like to withdraw money from their
accounts. The first request she receives is from a woman whose husband has passed away. The woman
would like to use their retirement savings for funeral and living expenses. She also receives a call from a
man who was told he must take money from his account, and he wants to know why. Then she has a call
from someone who quit her job and is confused as to why a large portion of her retirement savings was
withheld for taxes when she withdrew her money.

Shirley has many questions for her supervisor. When can people withdraw money from their accounts?
When must people take money from their accounts? How is the amount that a person may withdraw
determined, and how is it taxed?

Introduction
The assets that accumulate in retirement plans are meant to provide retirement plan savings for
participants, and are intended to be a long term investment. Participants do not have access to their
account balance in the same way they would a checking or savings account. The law restricts when
participants can take a distribution from the plan. At a minimum, plans are required to allow distribution
of assets upon certain events. These include reaching normal retirement age, death, termination of
employment, and termination of the plan. Some plans may allow distributions for additional reasons,
such as financial hardship. In addition, the law requires participants to start taking minimum distributions
when they reach a certain age.

This module explores the distribution process, starting with how an administrative service provider
determines whether a distribution is allowed, how to calculate the amount of the distribution, and
acceptable forms of payment. We then examine in more detail the most common distributable events.
Finally, we take a look at a few additional distribution situations and describe the employer’s
responsibility for distributions.

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Unit 1: Distribution Process

Scenario
Mark is an employee of Bidwell Manufacturing. He has been offered a job in another state and has
submitted a letter of resignation to his manager. Mark’s manager has alerted Bidwell’s HR director and
plan administrator, Joyce, that Mark no longer works for the company. Joyce is responsible for updating
the information with Bidwell’s plan provider, USA Retirement Plan Services. When the pay period ends,
Joyce submits a file to USA Retirement Plan Services. The file includes updates on the status of all
employees so that Mark will now be listed as a terminated employee.

As Mark prepares for the move, he wonders if he can use some of his savings in his retirement account to
cover the costs. He’s not sure what he needs to do to access the money, or whom to contact. He calls
USA Retirement Plan Services to find out what to do and talks with Shirley.

The first question Shirley should ask is, “Can the participant take money out?” Can money be withdrawn
from an account if the account holder has resigned? The next question Shirley asks is, “How much is
available for distribution?” Are there restrictions on what sources are eligible for distribution? Shirley also
needs to ask, “What payment types are available?” If Mark wants a lump sum of money to pay for moving
expenses, and would also like to roll over part of the money to his new employer 401(k), is this allowed?
Finally, Shirley must ask, “What is the amount reported as taxable income and the amount required to be
withheld?” If Mark made both pre-tax and after-tax contributions, then what taxation applies to the
distribution?

Guiding Questions
As you work through the material of this unit, look for answers to the following questions:

1. What considerations must be made before a distribution occurs?

2. How is the amount of the distribution calculated?
3. In what forms of payment might the distribution be provided?
4. What amount of the distribution is reported as taxable income?

Key Terms
Distributable Event: An event that gives a participant or beneficiary the right to receive a distribution from
the plan.

Normal Retirement Age (NRA): Upon reaching normal retirement age, participants must become fully
vested in their account balances or accrued benefits and be eligible to begin receiving distributions of
their retirement benefits. The plan document will define the plan’s NRA.

Retirement: When a participant has left employment of the employer and has met the plan’s definition of
NRA.

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Rollover: A plan distribution that is transferred to another retirement account or Individual Retirement
Account (IRA).

Unit Overview
The first step of the distribution process is determining whether or not the distribution is allowed. In
order to do this, Shirley must ask the following questions:

 Does the law allow for a distribution?

 Does the plan contain provisions for this type of distribution?
 Does the participant’s request meet the requirements of the plan and the law?

The plan document will determine when a participant can withdraw funds from a qualified plan and will
determine the form of the payment available to a participant. Therefore, whenever Shirley asks her
supervisor a question about distributions, she always receives the same response: “What does the plan
document say?” Shirley must be careful to ensure that distributions are permitted by the law and by the
provisions of the plan document.

Once Shirley has determined that the distribution is permitted, she must also calculate how much of the
participant’s account is available for the distribution, the form in which the amount will be paid, how the
distribution will be tax-reported and how much of the distribution is required to be withheld for tax
purposes.

“Distribution” vs. “Withdrawal”

What is the difference between a distribution and a withdrawal? The choice of wording is a
matter of perspective. The plan “distributes” assets to the participant, whereas the participant
“withdraws” the assets from the plan. Thus, a hardship withdrawal and a hardship distribution
refer to the same thing.

Can the Participant Take Money Out?

Only certain events trigger when a participant may receive money from a retirement plan. These events
are called distributable events. Distributable events allowed under all plans1 are:

 Reaching normal retirement age (NRA)

 Terminating employment, specifically:
o Terminations, layoffs and resignations
o Death
o Disability
 Terminating the plan

The terms of the plan document control which distributable events are available for a particular plan. The
terms of the plan document are often more restrictive than what is available under law. In addition, the
plan document may impose timing restrictions on when that distribution may be taken. Some plans may

1
With the exception of specific 401(k) contribution rules.

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also include various types of in-service withdrawals (withdrawals while still employed) and hardship
withdrawals.

Example 1
Shirley receives a request from Serge, 44 years old, who says that he was recently terminated
from his job and would like to withdraw money from his account. Shirley asks three questions to
answer “Can the participant take money out?”

1. Does the law allow for it?

Yes, the law permits distributions for participants who have terminated employment.

2. Does the plan allow for it?

Yes, all plans are required to allow distributions at termination of employment. The plan
document does not impose any additional timing restrictions and the distribution is immediately
available.

3. Does the participant meet the requirements?

Shirley checks her system but does not have a date of termination recorded for Serge. She calls
the plan administrator of Serge’s former company who verifies that Serge is no longer employed
by the company. Therefore, yes.

How Much Is Available for Distribution?

A participant may be able to take a distribution, but will often be restricted as to how much of their
account may be withdrawn. In a 401(k) and other defined contribution plans, the participant’s or
beneficiary’s account balance is used to determine how much money is available for distribution. Certain
types of distributions may place additional restrictions on the amount available.

Source Restrictions
Contributions made to retirement accounts are tracked separately based on their source, such as
employee pre-tax deferrals, employee Roth, nonelective and employer matching contributions. Rules on
what sources are available for the distribution depend on what the law allows and what the plan allows.
For instance, the law states that a participant who would like to take a hardship withdrawal cannot take
the withdrawal from qualified nonelective contributions (QNECs), qualified matching contributions
(QMACs), or safe harbor 401(k) contributions.2

Vesting Restrictions
Another factor that reduces the amount of a participant’s total account balance available for distribution
is vesting. Some employer sources of money place a vesting schedule on the account, while other sources
can never be subject to vesting. Sources that can be subject to vesting if chosen by the plans sponsors
are: employer matching and employer nonelective contributions. Sources that cannot be subject to a

2
For more information on contribution sources, see the RPF Contributions module. For more information on
hardship distributions, see Unit 4 of this module.

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vesting schedule and are always 100% vested are: employee money (salary deferrals, Roth and rollovers)
and safe harbor contributions, QNECs and QMACs.

Example 2
Serge was 40% vested when he terminated employment. Shirley must calculate the amount
available for distribution in Serge’s account.
Money Type Account Balance
Deferral $6,000
Rollover $12,000
Employer Matching $3,000
Employer Nonelective $2,000
Total $23,000

The deferral (salary deferral) and rollover money is employee money and is 100% vested. The
employer matching and nonelective sources are subject to vesting.

Employer Match: $3,000 x .40 (40%) = $1,200

Employer Nonelective: $2,000 x .40 (40%) = $800

$6,000 + $12,000 + $1,200 + $800 = $20,000

Serge can withdraw $20,000 of his account.

As in the example above, if a termination of employment occurs and the participant is not fully vested,
then the unvested portion of the participant’s account is forfeited. When a participant’s account is
forfeited, the money from the account returns to the plan and is used to provide a benefit to other plan
participants or is used to pay expenses that the plan incurs. The employer may not receive or benefit
from a forfeiture.

What Payment Types Are Available?

Once the amount available for distribution has been determined, the participant would elect the form of
distribution based on the options available in the plan. Most plans allow for a complete distribution of the
entire vested account balance, commonly known as a lump sum distribution, but may also provide for a
partial distribution, installment, or annuity.

Lump Sum
A lump sum payment is a distribution to a participant or beneficiary where the entire value of the account
is paid in a single sum. For example, a participant who terminated her account and wanted to roll it over
to another qualified plan would receive a lump sum payment.

Partial
A partial distribution has only a portion of the account balance withdrawn from the plan.

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Installment
An installment payment is a periodic payment (e.g. annual or monthly) over a specified period of time,
such as 10 years or the life expectancy of the participant.

Annuity
If an annuity is a form of payment on the plan, participants can purchase annuities with all or a portion of
their account balance. The annuity then provides payments similar to installments where payments are
made on an ongoing basis (usually monthly). Payments may be made over the lifetime of the participant
or the participant’s spouse or beneficiary.

A plan sponsor may include several forms of distribution options beyond what is required so participants
can select the best option to suit their individual needs. Depending on the type of plan, certain forms of
payments may be optional or may be required.

In the case of a pension plan (such as a defined benefit or money purchase plan) the plan is required to
offer annuity payment options, and a qualified joint and survivor annuity would be the required normal
form of distribution. 401(k) plans and other types of defined contribution plans cannot make annuities
payments directly from the plan, because the account balance of a particular participant will fluctuate
over time. Therefore, when a 401(k) or other type of defined contribution plan offers an annuity, it uses
the participant’s account balance to purchase an annuity contract from an insurance contract.

What Is the Amount Reported as Taxable Income?

Depending on the sources of the contributions, part of the distribution amount may not be subject to
taxation. For instance, after-tax contributions were reported as taxable income at the time they were
made. The account now consists of the basis, or contributed amount, and the earnings. In this case, the
basis is not reported as taxable income again. However, the earnings would be reported as taxable
income.

For pre-tax contributions, the entire amount (basis and earnings) is reported as taxable income. Neither
the basis nor the earnings of designated Roth contributions are reported as taxable income, provided
they meet certain criteria, which are discussed in unit 6.

Both the gross distribution and the participant taxable income are reported on the 1099-R form that is
provided to the participant at distribution.

Example 3
Brenda is 65 years old and is going to take a distribution from the plan. Her vested account
balance is $20,000: $10,000 is in employer contributions and $10,000 is in after-tax employee
contributions ($1,000 of the after-tax balance is attributable to earnings). When she receives the
distribution, $11,000 will be reported as taxable income to Brenda. The other $9,000, the basis, is
not considered income because Brenda paid taxes on the after-tax portion of her account when
she made the contributions to the plan.

The specific tax consequences and whether taxation on the distribution can be deferred also depend on
the distributable event, the form of distribution, and who is receiving the distribution. In the following
units, we will examine some of these variations in taxation as we explore different distribution situations.

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20% Withholding Rule
A mandatory 20% federal withholding tax applies on distributions over $200 from qualified plans if the
amount is eligible for rollover but is paid directly to the participant.

If the participant decides to roll over the distribution to an individual retirement account or to another
qualified plan, the rollover is not reported as taxable income and no withholding applies on the
distribution. If the distribution is not eligible for rollover, the mandatory 20% withholding doesn’t apply.
Rather, a 10% withholding applies and may be waived by the participant. If the amount of the
distribution is $200 or less, withholding is not required.3

Example 4
Emeril is 100% vested in his account balance of $100,000, and he is 60 years of age. Under the
mandatory 20% withholding rules, Emeril would receive a check for $80,000 and the plan would
make a $20,000 federal income tax deposit to the IRS representing the taxes withheld from the
distribution. The plan would issue a Form 1099-R to Emeril to report the distribution and taxes
withheld. The $100,000 would be reported as taxable income.

10% Premature Distribution Penalty

Generally, any withdrawal from a retirement plan before age 59½ is defined as an “early” or “premature”
distribution. When a participant who has not attained age 59½ receives a distribution from a qualified
retirement plan, the IRS imposes a 10% penalty (also referred to as “10% excise tax”) in addition to any
ordinary income taxes. Only the distributable amount that is included in income is subject to the 10%
penalty (amounts that are rolled over are not subject.) The 10% premature distribution penalty is not
withheld at the time of distribution but is assessed when the participant files their Federal Tax Return.

An exception to the 10% premature distribution penalty are distributions made upon death, disability,
and other termination of employment after attainment of age 55.4

Eligible Rollover Distributions

After receipt of the distribution, the participant can still roll over the account to another qualified plan
(including an IRA) to avoid having the distribution amount reported as taxable income. The participant
has 60 days to roll over the funds. The participant would have to use personal savings to make up for the
amount deposited to the IRS as withholding. The participant would then notify the IRS of the 60-day
rollover when filing that year’s personal tax return.

Example 5
Suppose Emeril took a $100,000 distribution from the plan. He receives a check for $80,000
October 1 st and $20,000 was withheld. On October 31st, he decides to initiate a 60-day rollover.
Withdrawing $20,000 from his personal savings, he deposits a total of $100,000 into an IRA.
Emeril later reports the 60-day rollover on his personal tax return so that the $100,000
distribution is not included as taxable income for that year.

3
See “20% Withholding for Federal Income Tax” chart under Resources for this module in My Learning Activities.
4
See “10% Additional Income Tax” chart under Resources for this module in My Learning Activities.

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All plan distributions are allowed to be rolled over EXCEPT for the following:

1. Certain Periodic Distributions. Distributions that are:

a. For substantially equal payments
b. For the life of the participant or the joint life of the participant and beneficiary
c. Over a period of at least 10 years.
2. Minimum Distributions. Once a participant or IRA holder reaches age 70½ they generally must
begin taking distributions from their retirement accounts.
3. Hardship Distributions. Some plans may allow participants to take hardship distributions in the
event that they have an immediate and heavy financial need.
4. Corrective Distributions. Distributions for excess deferrals, excess annual additions and failed ADP
or ACP tests.

Additional Taxation Considerations

In addition to any required federal income tax withholding, if a participant lives in a state that mandates
state income tax withholding and elects or is required to have federal tax withheld, state income tax is
also withheld. State tax can also be withheld for participants who live in a state that does not require
state income tax to be withheld if the participant elects state withholding as part of the distribution
request.

Depending on a participant’s individual tax situation, the required withholding may or may not cover tax
obligation on the distribution. Prior to taking a distribution, a participant should consult with a tax
advisor.

Summary
Processing distributions correctly is a serious responsibility. Someone new to the position, such as Shirley,
must be careful when determining whether or not a request is a distributable event. Shirley must
consider whether the event is allowed by the law, by the plan document, and whether the individual
meets the requirements.

Some amounts of the participant’s account may not be available for withdrawal, depending on the source
type, the distributable event, and other factors such as vesting. When the distribution is made, Shirley
must also consider the form of the payment available and what amount of the distribution is reported as
taxable income on the 1099-R form.

In the next unit of this module, we explore other distributable events due to termination of employment
and the particulars of each.

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Answers to Guiding Questions
Check your answers to the guiding questions by comparing them to the answers below.

1. What considerations must be made before a distribution occurs?

The distribution must be allowed by the law and the plan document, and the distribution request
must meet the requirements.

2. How is the amount of the distribution calculated?

The distribution may be restricted from certain sources, so only those sources that are allowed
can be factored in. Some sources may be subject to a vesting schedule. If vesting applies, only the
vested amount is included in the calculation.

3. In what forms of payment might the distribution be provided?

Distributions may take the form of a lump sum, partial distribution, installment, or annuity. Not
all forms are available for all distributable events or in all plans.

4. What amount of the distribution is reported as taxable income?

Distributions from qualified plans are included in gross income for the year in which the
distribution is received. The sources of the contributions as well as the participant’s basis in their
account balance and how they choose to take a distribution will impact the amount of a
distribution that is reported as taxable income. Taxation can be deferred by rolling over the
distribution into an IRA or another qualified plan. The amount subject to withholding will vary
based on the type of distribution event.

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Unit 2: Termination of Employment

Scenario
Shirley’s supervisor, Karen, knows that Shirley is going to encounter many types of requests for
distributions, and when she first begins work in this position, she will not know exactly what to do in
every situation. Karen provides Shirley with a set of questions for Shirley to ask in each situation. If at any
point Shirley is uncertain about the answer, Karen asks her to come to her and get clarification.

Shirley thinks of her first distribution request. Can money be withdrawn from an account if the account
holder has died? The next question Shirley asks is, “How much is available for distribution?” Are there
restrictions on what sources are eligible for distribution? Shirley also needs to ask, “What payment types
are available?” If the wife of the deceased participant wants a lump sum of money to pay for funeral
expenses now, and would also like to receive ongoing monthly payments to cover living expenses, is this
allowed? Finally, Shirley must ask, “What is the amount reported as taxable income and the amount
required to be withheld?” If the husband made both pre-tax and after-tax contributions, then what
taxation applies to the distribution?

Guiding Questions
As you work through the material of this unit, look for answers to the following questions:

1. How does the person processing the distribution request know that a termination event has
occurred?
2. What types of events are considered terminations of employment?
3. How is the amount available for distribution calculated, and what portions, if any, are reported as
taxable income and subject to withholding?

Key Terms
Separation from Service: A separation from service is when an employee resigns, retires, becomes
disabled, dies, or experiences a loss of job due to a reduction in force or layoff.

Termination of Employment: See “Separation from Service” above.

Unit Overview
A termination of employment (or separation from service) occurs when an employee retires, becomes
disabled, dies, resigns, or experiences a loss of job due to a reduction in force or layoff. In the previous
unit, we discussed termination of employment due to resignation, layoff, or termination. In this unit, we
discuss the other types of termination of employment. In situations where companies experience a
merger or acquisition, an employee’s termination status may not be as easily determined.

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Types of Distributable Events Due to Termination
The plan provider must be notified when an employee has terminated employment. In our example,
Joyce notified USA Retirement Plan Services that the deceased no longer worked for the company at the
end of the pay period when she submitted her payroll file. Notification to the plan provider typically
occurs when submitting payroll data, but may also occur by the employer or by the participant contacting
the plan provider, which would require employer verification.

Distributions upon Retirement

When a participant reaches the NRA, they become fully vested in their account, regardless of the vesting
schedule. Most qualified plans permit a participant to begin taking distributions upon reaching NRA,
whether or not the participant actually retires. The plan sponsor will define normal retirement age under
the plan document. For instance, one plan document may define normal retirement age as 65, whereas
another plan document may define it as the later of age 66 and 5 years of participation.

Although distribution may be permitted when the participant reaches NRA, the participant is not required
to take a distribution and may delay the distribution. Prior to reaching normal retirement age, the
participant is typically notified between 30 and 180 days prior to the date distributions will begin. The
notification includes descriptions of possible payment options.

Distributions upon Disability

In addition to allowing benefits at retirement, some plans provide benefits to participants who become
disabled and are no longer able to continue working. The plan document will define what constitutes
disability and what documentation is required to determine disability status. The Social Security Act
provides a definition of disability used to determine eligibility for Social Security benefits, and plan
sponsors are permitted to use this standard definition. However, many plans use the same definition as
their disability insurance plan which is typically more liberal.

While becoming disabled qualifies as a distributable event, the additional optional benefits provided
under the plan may be limited. The following options may be permitted, but are not required:

 The plan may provide for a participant’s vesting to be accelerated to 100%.

 The plan may waive any contribution or forfeiture allocation conditions, such as a last day or
1,000 hour requirement to receive a contribution for the year.5

The same withholding rules that apply to a participant upon termination of employment also apply to
termination due to disability. However, a distribution from the plan due to disability may provide some
tax benefits. If the participant meets the IRC’s definition provided under the Social Security Act, the
participant can avoid the 10 percent premature distribution penalty on early distributions.

Distributions upon Death

A termination of employment due to death also qualifies as a distributable event. As with termination of
employment upon becoming disabled, the plan may provide participants become 100% vested upon their
death.

5
For more information on allocations, see “Unit 3: Contribution Types” of the Contributions module.

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Upon the death of a participant, the beneficiary is entitled to a distribution of the account. To this
purpose, the plan administrator must maintain documents with the beneficiary designation. If there is not
a beneficiary designation on file, the plan document will provide default beneficiary language. The
distribution timing is determined by the provisions in the plan document. In general, death benefits are
available as soon as administratively feasible following death.

Different distribution options are available depending on whom the beneficiary is as defined by the plan
document. Spousal beneficiaries may take the distribution as a lump sum, take installment payments, roll
over the account balance to their own individual retirement account, or roll over the account to another
qualified plan, if allowed by the plan document. In most plans, nonspousal beneficiaries may take the
distribution as a lump sum or roll over the account balance to an inherited IRA.

Death benefits that are eligible for roll over and are rolled to an IRA or another qualified plan are not
subject to the 20% mandatory withholding rules. Amounts that are not rolled over are subject to the 20%
mandatory withholding, but the 10% tax penalty on early distributions does not apply.

Death distributions can be complex. Additional information relating to the required minimum distribution
rules and detailed information surrounding payment options are covered in advanced ASPPA courses.

Separation from Service versus Severance of Employment

A participant may not have a separation from service in situations involving a company-level transaction
such as a merger or acquisition, and accounts may not be eligible for distribution. The term severance of
employment is used to address situations when employees continue to perform the same job but become
employees of another company due to a merger or acquisition. In this case, participants may not be
eligible for a distribution from the plan. It is important to know that there are differences between having
a separation from service and severance of employment when determining if a participant has a
distributable event. Advanced ASPPA courses discuss severance of employment in more detail.

Amounts Available for Withdrawal

In our scenario, Mark had a distributable event (termination of employment) and has applied to take a
distribution from the plan. How much can Mark take from the plan?

Generally speaking, all sources within the account are available for distribution upon termination of
employment. Mark’s account must be reviewed to determine what types of money he has in the plan and
the plan document must be reviewed to determine what vesting schedule applies to his employer money.

Example 1
How much does Mark have available for distribution?

Name: Mark
Years of Service: 2
Pre-Tax Salary Deferrals: $20,000
Employer Match: $20,000
Employer Profit Sharing: $60,000

Employer Match Vesting Schedule Profit Sharing Vesting Schedule

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 Year Vesting Year Vesting
1 20% 1 0%
2 40% 2 0%
3 60% 3 100%
4 80%
5 100%

If the plan provided for 100% immediate vesting or if Mark has satisfied the required number of
years of service to become 100% vested, the entire $100,000 would be available for distribution.
However, portions of Mark’s accounts are vested, according to two different schedules.

Pre-Tax Salary Deferrals: $20,000 (Salary deferrals are always 100% vested)
Employer Match: $8,000 = $20,000 × .40 (40%) (2 year vesting for the match is 40%)
Employer Profit: $0 = $60,000 × .00 (0%) (2 year vesting for profit sharing is 0%)

Mark’s available distribution would be $28,000 = $20,000 + $8,000 + $0

If the participant is not 100% vested in the employer contributions, the unvested amounts are typically
forfeited at the time the distribution is taken from the plan. In the example above, $72,000 would be
forfeited, and the employer could then use those forfeitures to reduce future contributions or allocate
the amount to other plan participants. The plan document will state provisions for use of plan forfeitures.

Summary
When processing distribution requests for terminated participants, Shirley will normally be notified by the
plan administrator. If a participant contacts her directly, she must be careful to verify that a termination
has occurred before processing a distribution.

Shirley has already started a habit of checking the plan document to verify specifics related to each
request. For instance, she knows that normal retirement age may differ from plan to plan, and that some
plans provide for 100% vesting upon death or disability, but others may not. She also knows to look at the
plan document for the distribution options available in the plan (lump sum, installments, and annuity
options).

Answers to Guiding Questions

Check your answers to the guiding questions by comparing them to the answers below.

1. How do you determine whether a participant is eligible to receive a distribution as the result of a
termination event?
The employer must notify the plan provider when a termination occurs. If a participant contacts the
provider directly, the provider must verify that the participant has terminated employment. In some
situations, such as mergers or acquisitions, it may be less clear whether an actual termination of
employment has occurred.

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2. What types of events are considered terminations of employment?
Retirement, separation from service (quitting, being fired, or laid off), death, and disability are all
events in which employment is terminated.

3. How is the amount available for distribution calculated, and what portions, if any, are reported as
taxable income and subject to withholding?
Generally speaking, all sources within the account are available for distribution upon termination of
employment. Participants are always fully vested upon reaching normal retirement age and some
plan documents will provide for 100% vesting upon certain events (such as death, disability, or early
retirement). However, some sources may be subject to a vesting schedule and any applicable vesting
must be calculated.

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Unit 3: In-Service Withdrawals

Scenario
Shirley from USA Retirement Plan Services receives a distribution request from Rashid, an active
participant in the Bidwell Manufacturing Retirement Savings Plan. Rashid is 60 years old and has been
working at Bidwell Manufacturing for three years. He would like to withdraw all of his money from his
account. The plan has a five-year graded vesting schedule (20%, 40%, 60%, 80%, and 100%). Rashid has a
$50,000 account balance in the salary deferral source, $40,000 that was rolled over, and $20,000 in the
company match source. Can he withdraw money? If so, how much may be withdrawn? What information
does Shirley need in order to answer these questions?

Guiding Questions
As you work through the material of this unit, look for answers to the following questions:

1. Under what circumstances might in-service withdrawals be allowed?

2. How is the amount of an in-service withdrawal calculated?
3. In what forms can in-service withdrawals be paid?
4. How are in-service withdrawals tax reported?

Key Terms
Age 59½: Withdrawals taken before age 59½ incur an additional 10% tax for early distribution (some
exceptions apply). Some contributions cannot be withdrawn before a participant reaches age 59½.

Normal Retirement Age (NRA): Upon reaching NRA, participants must become fully vested in their account
balances or accrued benefits. The plan document will define NRA.

Unit Overview
Unit 2 of this module discussed the events that allow a participant to receive a distribution under a
qualified plan. While the purpose of a qualified plan is to supplement social security benefits to a
participant in the future, the plan may provide for withdrawals prior to termination of employment or
retirement. These types of withdrawals are called in-service withdrawals because they take place while
the participant is still in the service of the employer.

While the law permits plans to offer certain types of in-service withdrawals, they are not required by law.
Although not all plan sponsors choose to include them, provisions frequently do include them. In our
scenario, Shirley should ask, “Does the plan allow it?” before processing distributions. She must also
evaluate the request to see whether Rashid meets the requirements. The next question Shirley must ask
is, “How much is available for distribution?” Taking a withdrawal while still employed may be permitted
out of certain money sources, such as after-tax or rollover contributions, and sources may be subject to
vesting. Once she has determined the amount of the distribution, Shirley must consider what form of
payment will be made, and how the distribution must be tax reported.

16
In this unit, we discuss common types of in-service withdrawals, including the ability to withdraw money
from eligible sources, at age 59½, at normal retirement age, and after a certain period of service. Another
type of in-service withdrawal, a hardship withdrawal, is discussed in Unit 4. We will also discuss
notifications and tax reporting as they pertain to in-service withdrawals.

Source of Funds Withdrawals

Withdrawal rules vary depending on the source of the money, which is one reason why accounts are
tracked by source. Thus, Rashid may be able to withdraw some, but not all of his money from his account.
Two sources that may be eligible for withdrawal without requiring a distributable event are after-tax and
rollover contributions.

After-Tax Employee Contributions

If the plan permits after-tax employee contributions, most plans permit the withdrawal of the
contributions at any time. The contributions are always 100% vested, and the contributions (basis) are
not reported as taxable income and are not subject to the 10% premature distribution penalty upon
withdrawal. However, the earnings that accrue on the after-tax contributions are reported as taxable
income. Withdrawals of after-tax employee contributions generally must include an equal share of
earnings and contributions. In other words, participants cannot withdraw just their after-tax contributions
from the plan, pay no taxes on the distribution, and leave their earnings in the plan.

Rollover Contributions
If a qualified plan accepts rollover contributions from an IRA or another qualified plan, the plan may
permit the withdrawal of the rollover contributions at any time. Rollover money is always 100% vested
and has previously been distributed from a qualified plan or IRA. Most plans permit the withdrawal of the
rollover contributions at any time, without requiring the participant to attain a certain age or meet other
conditions.

Example 1
Name: Rashid
Age: 60
Salary deferrals: $50,000
Employer match: $20,000
Rollover: $40,000

Shirley checks the plan document and sees that the plan only permits the withdrawal of rollover
contributions, which are available at any time. Rashid may withdraw the $40,000 of rollover
money. He would not, however, be able to withdraw either the salary deferrals or employer
match money until an eligible distributable event occurred.

Event Withdrawals
In addition to being able to withdraw money from certain sources at any time (as allowed by the plan), a
participant may be able to withdraw money due to other events. Events that may allow for a withdrawal
while still employed include:

17
  Reaching normal retirement age;
 Reaching age 59½;
 Satisfying a certain term of service; or
 Certain employer contributions may be available if they are kept in the plan for a specified period
of time (aging requirement) or if a participant completes a specified number of years of service.
These employer contributions may also be available if a participant reaches a specified age, the
age specified can be less than 59½.

Normal Retirement Age

As discussed in Unit 2, the plan document will define NRA. Many qualified plans permit a participant to
begin taking distributions from all money sources upon normal retirement age, whether or not the
participant actually retires. Upon reaching normal retirement age, participants become fully vested in
their account. Depending on the options available in the plan, the participant may choose to take an in-
service withdrawal as a lump sum, partial distribution, installment payments or as an annuity. The
distribution will be reported as taxable income unless the distribution is eligible for rollover into an IRA or
another qualified plan, or the participant has basis in the contributions.

Example 2
Suppose Rashid’s plan allows in-service withdrawals at normal retirement age and defines normal
retirement age as 65. Rashid would not be allowed to take an in-service withdrawal for NRA since
he has not reached age 65.

Age 59½
A qualified plan may offer in-service withdrawals upon attainment of age 59½. Most plans do not permit
any in-service withdrawals prior to attainment of age 59½. This is because the 10% premature
distribution penalty applies to distributions taken before age 59½. In addition, salary deferrals, safe
harbor contributions, QMACs and QNECs are not permitted to be distributed prior to age 59½ while still
employed (unless the participant meets a hardship event). As with normal retirement age, the plan
document will specify the forms of distribution available when taking an in-service withdrawal. The
distribution will be reported as taxable income unless the distribution is rolled over.

Example 3
Name: Rashid
Age: 60
Salary deferrals: $50,000
Employer match: $20,000
Rollover: $40,000
Years of Vesting Service: 3
Vesting Schedule: 5 year graded
Year 1:20%
Year 2:40%
Year 3:60%
Year 4:80%
Year 5: 100%)

18
 Shirley checks the plan document and sees that withdrawals are allowed at age 59½. Rashid is
eligible for withdrawals at age 59½ since he is 60. Rashid may withdraw his salary deferrals
($50,000) and rollover ($40,000). According to the vesting schedule, Rashid is vested in $12,000
($20,000 × .60(60%)) of the employer match, which he could also withdraw. Rashid will not pay
the 10% early withdrawal penalty, but the distributable amount will be reported as taxable
income if he takes the distribution in cash.

Length of Service or Time

The plan may permit a participant to take a withdrawal of certain employer contributions while still
employed if the participant completes a fixed number of years of service or participation. In addition, a
plan may also allow the withdrawal of certain employer contributions if the contributions have remained
in the plan for a specified period of time. Safe Harbor contributions, QNECs and QMACs are not eligible
for this type of distribution.

 The period of service cannot be less than five years.

 The period of time that contributions must remain in the plan cannot be less than two years
(two-year aging requirement).

Example 4
Name: Kevin
Age: 40
Salary deferrals: $15,000
Employer match: $15,000
Years of Service: 7
Vesting Schedule: 5 year graded (20%, 40%, 60%, 80%, and 100%)

Kevin’s plan allows for withdrawal of matching contributions upon completing five years of
service. How much can Kevin withdrawal from the plan? Since Kevin has satisfied the service
requirement, he is able to take a distribution of his vested match account, $15,000. Remember,
salary deferrals are not allowed to be withdrawn prior to age 59½ while still employed, unless the
plan allows for hardship distributions.

Notification and Tax Reporting

Once Shirley has determined that Rashid can take money out and the amount that he may withdraw, she
must consider the notifications the participant must receive and how the distribution is tax reported. The
main difference between notifications for in-service withdrawals and distributable events due to
termination is the way in which the request is initiated. When a termination of employment happens, the
plan provider must be notified so the recordkeeping systems can be updated to reflect the termination
event and applicable notices can be sent out. However, when an employee meets an in-service
withdrawal event, the employee typically initiates the process by approaching their plan administrator
regarding options to take a distribution. At that time, the plan administrator will determine the
employee’s eligibility for distribution and provide them with the appropriate forms, including a Special
Tax Notice. Additional details regarding notices are provided in Unit 7 of this module.

19
In-service withdrawal events discussed in this unit are subject to the same withholding rules as
distributions upon termination of employment discussed in Unit 1. The IRC imposes a mandatory 20%
federal income tax withholding for any distribution over $200 that is eligible for rollover but paid directly
to the participant. A 10% premature distribution penalty may also apply to distributions taken prior to
attainment of age 59½.

Summary
In-service withdrawals can vary greatly from plan to plan. Whenever processing a distribution request,
Shirley is careful to review the plan document to see in what circumstances withdrawals are allowed and
whether the participant requesting the withdrawal meets the requirements. Shirley must also determine
whether any of the money is subject to vesting, and whether any withholding needs to be made for
taxation. Depending on the plan and the request, the distribution may be made as a lump sum, partial,
installment, or annuity payment.

Answers to Guiding Questions

Check your answers to the guiding questions by comparing them to the answers below.

1. Under what circumstances might in-service withdrawals be allowed?

Withdrawals from qualified plans may be permitted while a participant is still employed if:
 The participant has reached NRA
 The participant has attained age 59½
 The participant has completed certain service or participation requirements
 The employer contributions have remained in the plan for a specified period of time

2. How is the amount of an in-service withdrawal calculated?

As with other distributable events, the administrative service provider must determine what sources
are eligible for distribution for in-service withdrawals. Certain money types, such as after-tax and
rollover contributions, can be withdrawn at any time, if permitted by the plan. If vesting applies to a
source, only the vested amount is included in the calculation to determine how much is available.

3. In what forms can in-service withdrawals be paid?

The plan document specifies distribution options available in the plan (lump sum, partial distribution,
installments, or annuity options).

4. What tax withholding applies to in-service withdrawals?

Distributions from qualified plans are included in gross income for the year in which the distribution is
received. Taxation can be deferred by rolling over the distribution into an IRA or another qualified
plan. The IRC imposes a mandatory 20% federal income tax withholding for any distribution over
$200 that is eligible for rollover but paid directly to the participant.

20
Unit 4: Hardship Withdrawals

Scenario
Shirley receives a request from an employee of Bidwell Manufacturing. He would like to withdraw money
to rent an apartment following a separation from his spouse. The participant read in the summary plan
description that the plan allows for hardship withdrawals and he thinks that this qualifies. He’d like to
start withdrawing $900 a month from his account to cover the rent. Shirley hasn’t encountered this
situation before, so she asks Karen for guidance.

Guiding Questions
As you work through the material of this unit, look for answers to the following questions:

1. How might a plan define a hardship event?

2. How is the amount a participant can withdraw for a hardship determined?

3. What forms of payment are available?

4. How are hardship withdrawals tax reported and are they subject to withholding?

Key Terms
Events test: The test to determine whether a participant in a 401(k) plan has an immediate and heavy
financial need as applicable to hardship withdrawals.

Hardship withdrawal: A withdrawal due to an immediate and heavy financial need and is necessary to
satisfy that financial need.

Needs test: The test to determine the amount necessary to satisfy financial needs, as applicable to 401(k)
hardship withdrawals.

Safe harbor standard: Pre-approved IRS language using specifically named hardship events and stipulated
additional procedures for hardship withdrawals.

Unit Overview
If a participant is seriously struggling financially because of events out of their control and they have
resources in a 401(k) plan, the law provides a way for them to access those funds. This type of
distribution is called a hardship withdrawal. A plan document must specify whether hardship distributions
are allowed in the plan. Further, plan administrators must have objective criteria to be able to
consistently determine what types of events meet the standard to receive a distribution.

Plans may use a safe harbor standard to define hardships. This unit introduces the safe harbor hardship
rules. You will learn how to identify when a hardship distribution meets the requirements of the plan and

21
how to calculate the amount available for a hardship withdrawal when the feature is allowed in the plan.
Plans may use a more flexible hardship provision outside the safe harbor rules; these types of hardship
provisions are covered in other ASPPA courses.

Hardship Distributions by Plan

Not all 401(k) plans allow hardship distributions and it is up to the employer to determine whether they
allow participants to have access to hardship distributions. In addition, the hardship option is not a
protected benefit and a plan can be amended to add or remove the feature without consideration of
previous hardship options offered.

Example 1
Bidwell Manufacturing sponsors a 401(k) plan. The executive committee of the company wants as
many of its employees as possible to save for retirement. However, the committee also
understands that employees will choose to save less money if they are worried about being
unable to access the money for unexpected financial hardships like medical expenses. Therefore,
the committee votes to allow participants to take hardship distributions for certain events to
encourage overall plan participation, and the plan is amended to allow hardship distributions.

The plan document will indicate if hardship distributions are available. In addition, hardships are required
to be based on specific events. The plan must give the plan administrator objective criteria to determine
if an event qualifies as a hardship. The plan administrator must apply the hardship rules in a uniform and
nondiscriminatory manner. They cannot show favoritism for certain participants or choose on a whim
which events count as a hardship.

However, even after applying objective criteria to evaluate the hardship, it may still be unclear whether a
particular hardship instance counts as a hardship. In this case, the plan administrator has the authority to
approve or deny a hardship and must do so in a uniform and nondiscriminatory manner.

Example 2
Gene requests a hardship withdrawal from his 401(k) plan because he had an elective cosmetic
nose surgery procedure. Gene explains why he needed the surgery and supplies the medical bills
and his insurance denial. The 401(k) plan allows hardships for medical care that is not covered by
insurance. The plan administrator reviews the hardship policy and plan provisions and it is not
clear whether an elective procedure is covered. The plan administrator denies the hardship claim
because Gene’s surgery was cosmetic and not medically necessary. The plan administrator
updates their hardship policy to include the objective criterion that a procedure for plastic
surgery must be medically necessary as evidenced by a doctor note.

The Two Hardship Tests

When a 401(k) plan allows for hardship distributions, the plan must define what constitutes a hardship in
objective terms. The hardship request must pass two “tests:”

1. The hardship must be made on account of an immediate and heavy financial need (events test);
and

22
 2. A distribution must be necessary to satisfy the financial need (needs test).

For example, if the participant makes a hardship request to prevent foreclosure on her house in six
months, it does not pass the test of being an immediate financial need. The plan administrator should
request information and documentation from the participant to determine if the hardship meets the
plan’s criteria.

Example 3
Martha requests a hardship distribution to prevent eviction from her primary residence. The plan
administrator of Martha’s 401(k) plan requests that Martha provide documentation showing that
she is experiencing a financial need and the amount of the need. Martha provides the plan
administrator with a copy of her eviction notice showing how much she owes and when she has
to pay before she will be evicted. The information provided by the participant is reviewed by the
plan administrator to determine whether she meets the plan’s definition of a hardship.

The second test is to determine whether a hardship distribution is necessary to satisfy the financial need.
All other sources of money, including other withdrawal options from the plan to satisfy the financial need,
should be exhausted before the participant requests a hardship from the plan.

Example 4
Don is experiencing an immediate and heavy financial need and requests a hardship from the
plan. However, the plan allows for in-service distributions from the rollover source. Don must
request an in-service distribution of his rollover funds before he can request a hardship.

Safe Harbor Rules

Both tests just described have safe harbor rules that can be used to administer a hardship program. A
safe harbor means that if the plan provision meets certain criteria and those criteria are applied properly,
then the plan provision will be deemed to satisfy regulatory requirements.

In the case of a 401(k) hardship provision, the IRS has issued a safe harbor standard for both of the
hardship tests.

Safe Harbor for Events Test

There are six possible predefined hardship expenses under the safe harbor standard:

1. Medical care for the employee, the employee’s spouse or the employee’s dependents that is
not covered by insurance;
2. The purchase of the participant’s principal residence;
3. Payments for tuition, educational fees, and room and board expenses for the next 12 months
of post-secondary education for the employee, the employee’s spouse, the employee’s
children or the employee’s dependents;
4. Payments necessary to prevent eviction from the employee’s principal residence;
5. Payments for burial or funeral expenses for the employee’s deceased parent, spouse,
children or dependents;
6. Expenses for the repair of damage to the employee’s principal residence.

23
Under the safe harbor definition, the plan may allow requests for items 1, 3, and 5 to be made on behalf
of the participant’s primary beneficiary’s need. The beneficiary must be named as the participant’s
beneficiary at the time of the hardship request and the plan document must specifically allow for it.

Example 5
Paula’s sister needs a medical procedure that is not completely covered by her insurance. Paula’s
sister is the primary beneficiary of Paula’s 401(k) account. Paula requests a distribution for her
sister’s medical expenses and provides the necessary documentation to the plan administrator.
Since the plan document allows for hardship distributions based on the participant’s primary
beneficiary and provided appropriate documentation to support the hardship, the distribution is
approved.

Safe Harbor for Needs Test

If the following three conditions are met, then the hardship distribution is deemed to satisfy the needs
test:

1. The Amount of the Distribution Does not Exceed the Financial Need
A participant cannot request a hardship distribution for more than the amount required to satisfy
the financial need. However, the amount requested can be adjusted (grossed up) to account for
taxes and penalties.

Example 6
Martha needs $2,100 to avoid foreclosure. If the distribution is approved, Martha would have to
pay taxes on the $2,100 as income. She would need 30% in taxes (20% federal and state taxes
and 10% early withdrawal additional tax). She can request the hardship distribution for $3,000 so
that she has the money to pay the taxes on the distribution. 30% of that ($900) will be used for
taxation, and she will receive $2,100 to meet her need.

2. Loans and Other Distributions Must Be Taken First

The participant must take any available in-service distributions and loans from any plan of the
employer before requesting a hardship distribution. However, if taking a loan from the plan
would increase the financial need (due to the regular loan payments), then the plan administrator
may not require that the participant take a loan before receiving a hardship.

3. Deferrals Must Be Suspended for Six Months.

The participant is required to be suspended from making elective deferrals to any plan sponsored
by the employer for six months after the hardship. The plan then has the option to either
automatically reinstate the participant’s previous deferral election or to require the participant to
affirmatively elect a new elective deferral amount. An automatic enrollment plan may subject the
participant to automatic enrollment if they do not make a new affirmative election.
shghghghghgshgfdh

24
Special 401(k) Source Rules
Special rules apply to hardships taken from a participant’s 401(k) source. The participant may only receive
a hardship from the contributions they have made to the plan, called the basis. The earnings associated
with those elective deferrals are not available.

However, a hardship provision may allow hardships from other sources, such as employer contributions,
and the participant would be able to take the entire amount of the account.

Example 7
Zack’s 401(k) plan allows for hardship distributions only from the plan’s 401(k) deferral source.
How much may Zack withdraw from his account balance?

401(k) Deferral Contributions: $10,000

Total 401(k) Account: $13,000
Vested Employer Match Contributions: $5,000
Total Vested Employer Match Account: $6,500

Zack’s total 401(k) deferral account includes $3,000 in earnings (the difference between the total
account balance and the actual amount of his contributions) that may not be withdrawn. Nor can
Zack withdraw the employer match contributions. Zack may receive up to $10,000 for a hardship
distribution from his account.

Example 8
Suppose that instead, the plan allowed hardships from both the 401(k) deferrals and matching
source. In this case, Zack could receive a hardship distribution of up to $16,500 ($10,000 from
401(k) and $6,500 from the match account).

Other Hardship Restrictions

The plan may put additional restrictions on hardship distributions. Common restrictions include:

1. Limiting participants to one hardship per calendar year;

2. Restricting hardships to certain sources (e.g., only allowing hardships from 401(k) accounts);
3. Minimum amount restrictions (e.g., requiring at least a $500 hardship request);
4. Requiring 100% vesting (e.g., a hardship is allowed from a matching source only if it is 100%
vested).

Sources that are Never Allowed for Hardship Distributions

Safe harbor, QNEC and QMAC sources are never allowed for hardship distributions. In addition, money
purchase sources that were transferred into a 401(k) plan are never available for hardship.

25
Tax Reporting and Withholding of Hardships
Hardship withdrawals are a distribution that must be requested by the participant. Generally, the plan will
have a form the participant must fill out or will have an online request option. The participant must
always consent to a hardship request.

Hardship payments are provided as a lump sum; they may not be paid out as annuities. Also, hardship
distributions are not allowed to be rolled over into another plan or IRA. This has two important
consequences:

1. No Special Tax Notice is required to be provided.

2. The 20% federal withholding does not apply.

Since the 20% federal income tax withholding does not apply, the distribution defaults to a 10% federal
withholding amount. However, a participant may waive the 10% withholding amount or increase the
withholding as they see fit.

Regardless of the amount a participant decides to withhold at the time of the hardship distribution, the
distribution will still count as taxable income to the participant just as any other retirement plan
distribution. The participant will receive a Form 1099-R at the end of the year reporting the income. In
addition, if the participant is under age 59½, there will be the 10% additional early distribution penalty
added to the regular taxable amount of the distribution.

However, if a hardship distribution is taken from a Roth source, the amount contributed to the plan and
the amount subject to a qualified Roth distribution will not be taxable, because it is an after-tax source.

Summary
Shirley and Karen discuss the basics of hardship withdrawals. Hardship withdrawals are an optional plan
provision that allow participants to access money in their accounts under extenuating circumstances. The
plan document must specify whether hardships are allowed to be taken from the plan, whether the plan
uses the safe harbor standard to determine if a given event qualifies as a hardship and what sources are
available for withdrawal. A participant must demonstrate in their request that the financial need is
immediate and heavy, and that a hardship distribution is the only available option for meeting that need.
The requested amount must not exceed the amount required to cover the financial need (and related
taxation or penalties). Hardships are not eligible for rollovers, and therefore are not subject to the 20%
federal tax withholding. Instead, there’s a 10% default withholding that might be waived by the
participant.

Based on the safe harbor standard that Bidwell’s plan document uses, the employee is not eligible to
withdraw money for rent each month. However, if the employee’s situation were to escalate in severity
to the point that he were about to be evicted, he could present documentation showing the immediacy
of the need and the amount required to prevent eviction. Shirley has a good introductory understanding
of hardship withdrawals, but is aware that many unique situations may arise that will require her to
develop a more advanced knowledge of laws and procedures in order to accurately process requests.

26
Answers to Guiding Questions
Check your answers to the guiding questions by comparing them to the answers below.

1. How does a plan define what is or is not a hardship event?

Plans may adopt the safe harbor standard to determine whether or not a situation meets the criteria
of a hardship. The safe harbor standard allows participants to take hardship withdrawals for medical
care not covered by insurance, purchase of a principal residence, tuition payments, preventing
eviction, funeral expenses, or repair of damage to the principal residence.

2. How is the amount a participant can withdraw for a hardship determined?

The amount of the withdrawal cannot exceed the amount necessary to cover the financial need. The
amount is also limited by the available sources. Different plans will place restrictions on different
sources. 401(k) earnings, QMAC, and QNECs are never available for withdrawal. Nor are money
purchase sources that have been transferred into the plan.

3. What forms of payment are available?

Hardships are only paid out as lump sums and cannot be rolled over.

4. How are hardship withdrawals tax reported and are they subject to withholding?
Generally speaking, hardship withdrawals are reported as taxable income (except distributions of
Roth contributions and in certain cases earnings since they have already been taxed). The 20% federal
withholding is reduced to 10%, although the participant may choose to waive the withholding, or
increase it. Participants under age 59½ will have a 10% additional penalty applied for early
withdrawal.

Additional Resources
For more information on hardship withdrawals, see:

 “Retirement Topics – Hardship Distributions”

[Link]
Distributions

27
Unit 5: Required Minimum Distributions (RMDs)

Scenario
Shirley receives a call from Paul who just turned 70½ and was told by his financial advisor that he must
start taking distributions from his retirement plan. The first question Shirley needs to ask is if Paul is still
employed, and if he is a 5% owner of the company. He confirms that he is still employed, he does not
intend on retiring until age 73, and that he is not a 5% owner. Next, Shirley reviews the plan document
and sees it specified required minimum distributions (RMD) must start upon the later of attainment of
age 70½ or retirement. Paul is confused by the conflicting information and asks, “When do I need to start
taking an RMD? How much will my first RMD be? When I start to receive my distributions, what are my
distribution options?”

Guiding Questions
As you work through the material of this unit, look for answers to the following questions:

1. What is a required minimum distribution (RMD)?

2. By when must the first RMD be paid?

3. By when must the second and subsequent RMDs be paid?

Key Terms
Required beginning date (RBD): The date by which the first required minimum distribution must be made.

Required minimum distribution (RMD): Distributions that must be made after participants reach age 70½
and retire, or for 5% owners, after reaching age 70½.

Unit Overview
The rules surrounding retirement plans provide tax benefits for people to save for retirement. However, if
there were no requirements for money to be distributed from the plan, then retirement benefits could
accumulate indefinitely.

On the other hand, should a participant be required to take a retirement distribution from the plan when
he is still working and plans to retire in several years? The required minimum distribution (RMD) rules
define when participants (and beneficiaries) must start receiving distributions from their retirement
plans. Once participants or beneficiaries begin receiving RMDs, they must continue receiving them for the
rest of their lives.

Example 1
Ronald is 71 years old and begins to receive required minimum distributions. He receives a
portion of his account every year. The amount of the distributions is adjusted each year based on
the size of Ronald’s account and his life expectancy.

28
This unit provides an introduction to these rules and introduces the beginning steps to calculating basic
RMDs using the most common method used in 401(k) plans. More advanced RMD rules are covered in
other ASPPA courses.

Required Beginning Date

Depending on a participant’s age, employment, and ownership status, the law sets a date by which that
participant must start receiving RMDs. The date by which the first distribution must be made is called the
required beginning date (RBD). Generally, the required beginning date is April 1st of the year after
participants reach age 70½ and retire, or for 5% owners, after reaching age 70½. All plan documents will
define a specific required beginning date. However, this may be different from the statutory
requirements. It is important to check the plan document to verify the method used.

The following procedure is for plans that define the RBD as April 1st of the year after participants reach
age 70½ and retire, or for 5% owners, after reaching age 70½.

Steps to Determine the Required Beginning Date for RMDs

1. Will the participant be at least 70½ during the current calendar year? (Birth date + 70½)
2. Is the participant employed by the company? (Or when did the participant retire/leave
the company?)
3. Did the participant own more than 5% of the company during the calendar year?

29
If the participant meets the requirements this year, the participant will need to start receiving RMDs by
April 1st of the following year. When determining the required begin date, the only real calculation that
must be done is to determine the year in which the RMDs will begin, as the day of the year is always April
1st.

Example 2
Name: Anabelle
DOB: 2/7/1946
Employment status: Terminated (retired) 12/31/2009
Ownership status: 0%

1. The plan document provides that RMDs for non-5% owners are not required until after
they terminate employment.
2. Will the participant be at least 70½ during the current calendar year?
Yes – Annabelle turns 70½ on 8/7/2016
3. Is the participant employed by the company?
No, Anabelle retired 12/31/2009

Answer: Anabelle is no longer employed by the company, so her RBD is 4/1 after she turns 70½.
In this case, her RBD is 4/1/2017.

Example 3
Name: Bert
DOB: 10/11/1945
Employment status: Active
Ownership status: 25%

1. The plan document provides that RMDs for non-5% owners are not required until after
they terminate employment.
2. Will the participant be at least 70 ½ during the current calendar year?
Yes – Bert turns 70½ on 4/11/2016
3. Is the participant employed by the company?
Yes – Bert is still an active employee
4. Did the participant own at least 5% of the company during the calendar year?
Yes – Bert own 25% of the company

Answer: Although Bert is still employed by the company, he is at least a 5% owner, so he

must begin receiving RMDs by April 1st after the year he turns 70½, which is 4/1/2017.

April 1st of the following year is the latest the participant may receive the distribution. However, it is
common for participants to take their first RMD in the calendar year before the RBD.

Returning to our scenario, when does Paul need to take an RMD? Shirley explains to Paul that since he is
not a 5% owner, he does not need to take his RMD until he retires.

30
When is the Second RMD Due?
If participants get their first RMDs on April 1st , the second RMD is due by December 31st of the same year
of their required beginning date. Thus, if participants postponed their first payment until up to April 1st of
the year following their required beginning date, they will receive two payments that first year. However,
since every required beginning date is 4/1, the first RMD will be due in the same year as the second.

Why does the law allow for a delay until April 1st rather than requiring the first payment by 12/31?
Consider the following example:

Example 4
Catherine is 73 years old, is still employed, and does not own any of the company for which she
works. Unexpectedly, late in December of 2015, Catherine leaves the company because her
husband becomes sick. Her termination of employment triggers a required minimum distribution.
If her required beginning date was 12/31/2015, right when she left the company, she may not
have time to receive a distribution.

By extending the RBD to 4/1/2016, there is enough time to request and receive the first distribution.

Determining a 5% Owner
The term “5% owner” really means “greater than 5% owner.” In determining 5% ownership, family
attribution must be taken into consideration. That is, ownership is not only calculated by individual, but is
added together for certain relationships. Thus, a parent’s ownership is added to the child’s ownership and
vice versa. Ownership is also attributed from spouse to spouse and grandchild to grandparent (though
not from grandparent to grandchild).6 Brothers, sisters, aunts, and uncles are not included for attribution
purposes.7

Example 5
Who is a 5% owner?

6
IRC §318.
7
For more information on attribution and ownership, see Unit 1: Highly Compensated Employees of the RPF
Modules: Testing.

31
 1. Val is a 12% owner, since the 3% ownership from each of her daughters is attributed to
her, and 2% from her granddaughter.
2. Wilomena is a 7% owner, since her mother’s ownership is attributed to her.
3. Yvonne is a 9% owner, since she her mother’s ownership and her daughter’s ownership
are attributed to her.
4. Zuri owns 5% (but is not a “5% owner”), since only her mother’s ownership is attributed
to her.

Answer: Val, Wilomena, and Yvonne are 5% owners.

A Note on 403(b) Plans and IRAs

Individual Retirement Accounts (IRAs) and 403(b) plans have slightly different RMD rules than qualified
(401(k) and profit sharing) plans.

IRAs
There are three main differences in the IRA RMD rules verses 401(k) RMD rules. First, all RMDs from an
IRA must start after the individual turns 70½, regardless of employment status. In other words, there is no
postponement in an IRA for being actively employed.

However, the required beginning date for an IRA is always April 1st, just like it is for a 401(k) plan.

Second, unlike a 401(k) plan, an individual may aggregate their IRAs and the RMD can be taken from one
of many accounts. However, each participant in a 401(k) plan must take an RMD from each of his or her
retirement plans. In other words, there is no RMD aggregation for 401(k) plans.

Example 6
Mary has three separate RMDs at three different financial institutions: Alpha Brokerage, Best
American Stocks, and Conservative Bond Investments. Mary may take the aggregate balances of
each account to determine her RMD amount and take the distributions only from her
Conservative Bond Investment account leaving her accounts with the other two financial
institutions untouched.

The third major difference is the treatment of Roth accounts for RMD purposes. Qualified Roth accounts
are not subject to RMDs in an IRA. However, they are subject to RMDs in a 401(k) or a 403(b) plan.
Therefore, there is an advantage to holding Roth funds in an IRA, especially if the individual is no longer
working or is an owner of the company because an individual still employed, is not required to start RMDs
until they stop working).

403(b) Rules
Similar to IRAs, some 403(b) accounts can be aggregated to in order to determine an individual’s RMD
amount. Also, 403(b) plans may provide that RMD distributions do not begin while they are still employed
by the employer.

32
Determining the RMD Amount – The Account Balance Method
The account balance method is the most common RMD method used in 401(k), 403(b) plans, and IRAs.
Using this method, the amount of the minimum distribution is found by dividing the vested account
balance (as of December 31st of the prior year) by a life expectancy factor (these can be found in tables
published by the IRS).8

The IRS table used for a particular RMD is based on the participant and the age of the spouse. The
following is the most commonly used IRS table.

Age Factor Age Factor Age Factor Age Factor

70 27.4 82 17.1 94 9.1 106 4.2

71 26.5 83 16.3 95 8.6 107 3.9

72 25.6 84 15.5 96 8.1 108 3.7

73 24.7 85 14.8 97 7.6 109 3.4

74 23.8 86 14.1 98 7.1 110 3.1

75 22.9 87 13.4 99 6.7 111 2.9

76 22.0 88 12.7 100 6.3 112 2.6

77 21.2 89 12.0 101 5.9 113 2.4

78 20.3 90 11.4 102 5.5 114 2.1

79 19.5 91 10.8 103 5.2 115 and 1.9

older

80 18.7 92 10.2 104 4.9

81 17.9 93 9.6 105 4.5

To determine the RMD amount:

Value of Account Balance / Life Expectancy Factor = Minimum Distribution

1. Determine the value of the participant’s account balance as of December 31 of the year prior
to the year for which the RMD is being made.
2. Determine the age of the participant as of their birthday in the year for which the RMD is
being made.
3. Use the age (step 2) to select the factor from the appropriate life expectancy table.
4. Divide the account balance (step 1) by the life expectancy factor (step 3).

Example 7
Name: Liam
DOB: 7/12/1932

8
[Link]

33
 Account balance as of 12/31/2014: $500,000

What is the amount of Liam’s RMD due 12/31/2015?

1. $500,000
2. 2015 – 1932 = 83
3. Age 83 = Factor 16.3
4. $500,000 (account balance) / 16.3 (life expectancy factor) = $30,674.84 (RMD amount)

This is not his first RMD, therefore Liam’s RMD amount due by 12/31/2015 is $30,674.84.

Example 8
Name: Nancy
DOB: 9/4/1944.
Employment status: Terminated
Ownership: 0%
Account balance as of 12/31/2014: $1,000,000
Account balance as of 12/31/2015: $1,010,000

When is Nancy’s required beginning date? What is the amount of her first distribution?

Nancy turns 70½ on 3/4/2015 (1944 + 70 years + 6 months). Her required beginning date is
4/1/2016 (April 1st following the year she is 70½).

1. Although she receives her first RMD in 2016, the RMD is for the 2015 calendar year.
Nancy’s account balance as of the last day of the prior year (2014) is used ($1,000,000).
2. Nancy turns 71 in 2015.
3. The factor used for her RMD is 26.5.
4. $1,000,000 (account balance) / 26.5 (life expectancy factor) = $37,735.85 (RMD amount)

Notice, Consent and Withholding Requirements

Plan administrators must provide a distribution notice to participants eligible for RMDs. Often this is a
special RMD notice that indicates the participant’s distribution options. Normally, consent is required
from any participant with a balance over $5,000 when issuing a distribution. However, in most cases,
consent is not required when distributing an RMD. Since RMDs are ineligible to be rolled over into
another qualified plan or IRA, a Special Tax Notice is not provided nor is the 20% withholding required.
Instead, RMDs are defaulted to have 10% federal tax withholding. However, a participant can choose to
have a different amount withheld.

Consequences of Not Taking an RMD

There are two types of consequences for not taking an RMD, one for the participant and one for the plan.

34
If a participant is required to take an RMD and does not, there is a 50% excise tax required in addition to
regular federal and state income taxes. The participant, or the plan administrator on behalf of a
participant, may ask the IRS to waive the excise tax.

The RMDs are a plan qualification requirement. Plans that fail to give RMDs to participants may be
disqualified. If it is discovered that a plan missed an RMD it was supposed to distribute, then the plan
administrator will need to correct the plan by going through an IRS correction program. Otherwise, the
IRS may disqualify the plan.

Summary
Shirley clarifies for Paul that since he is not a 5% owner, he will not need to take an RMD until after he
retires. She further explains to Paul that he may postpone the first RMD until April 1st of the year
following the year of his retirement (remember that he is already 70½). After that, he must continue to
receive an RMD by December 31st of each year. The calculation of his distribution is based on his life
expectancy factor (as obtained from a table provided by the IRS) and the amount of his account on the
last day of the year prior to the year for which he is receiving the RMD. Paul will not be able to roll over
the RMD into a qualified retirement plan or IRA. However, instead of the 20% mandatory withholding, the
distribution will be subject to only a 10% withholding, unless he elects a different amount.

Answers to Guiding Questions

1. What is a required minimum distribution (RMD)?
An RMD is a distribution that is required, ensuring retirement savings are paid out and are not
held in the plan indefinitely.

2. By when must the first RMD be paid?

If a participant is a 5% owner, the participant must take the first RMD by April 1st following the
year in which he or she turns 70½. If the participant is not a 5% owner, the participant does not
need to take an RMD until he or she retires, in which case it must be taken by April 1st following
the year in which he or she met both requirements (reaching age 70½ and retiring).

3. By when must the second and subsequent RMDs be paid?

The second RMD must be paid by December 31st of the year of the required beginning date.
RMDs then continue each year until the death of the participant.

Additional Resources
 “RMD Comparison Chart (IRA vs. Defined Contribution Plans)”
[Link]

 “IRA Required Minimum Distribution Worksheet”

[Link]

35
Unit 6: Other Distributable Events

Scenario
A few months go by since Shirley started processing distributions, and she’s still encountering new
situations:

 She has to process distributions for the former spouse of an employee.

 She has to return payments to employees who contributed too much money to the plan.
 She’s also had requests from divorced participants to split the account between them and their
former spouse.

In each case, Shirley goes through the process of asking the four questions related to withdrawing money
from a retirement plan. Each time she encounters a new situation, she checks with her supervisor, Karen,
to clarify any questions she can’t answer.

Guiding Questions
As you work through the material of this unit, look for answers to the following questions:

1. What other situations allow for a participant to withdraw money from a plan?
2. What is the best way to handle a new or unfamiliar request to withdraw money?

Key Terms
Qualified Domestic Relations Order (QDRO): A domestic relations order (such as is issued by the court as
the result of a divorce) that has been approved by the plan administrator, verifying that it meets the
requirements of the plan document.

Unit Overview
Every time Shirley thinks she understands distributions from the plan, a new situation comes up that she
has never encountered. This unit goes through some of the less common distributions that you may come
across. Like many rules in 401(k) plans, there are exceptions. The following four are worth reviewing and
understanding because they come up just often enough.

The Anti-Alienation Principal

One of the core tenets of retirement plans is that participants have a right to their own account balance.
If the employer goes out of business, then the company’s creditors cannot touch the employees’
retirement accounts. More so, if a participant files for bankruptcy or has outstanding debt, his or her
retirement account cannot be touched by those creditors.

In fact, there are very limited circumstances when any of the following can receive that person’s
retirement benefit:

1. The spouse, former spouse or dependent of a participant

36
 2. The federal government (but not a state government) for federal tax levies
3. Other participants if the participant forfeiting the funds was a fiduciary to the plan and acted
improperly

QDROs
The most common instance where a participant does not receive their account balance is after a divorce.
In order for a former spouse to receive money from the plan, he or she must have a qualified domestic
relations order (QDRO). There are two parts to a QDRO. The first step is to obtain a domestic relations
order (DRO). The DRO must be court-ordered relating to marital property or child support. A DRO
commonly takes place during the finalization of a divorce. The two parties will agree on how to separate
retirement accounts and the court will issue a formal DRO that explains how to split the account between
the former spouses. Distributions taken pursuant to the QDRO are not subject to the 10% additional
penalty.

In order for a DRO to become a QDRO, the DRO must be qualified. So, in addition to the formal DRO, the
QDRO must also comply with the rules of the plan document and must be formally approved by the plan
administrator to be a QDRO. The approval process is significant, because if a DRO is processed without
the Q (qualification approval), then the plan may be disqualified. This is why it is important for every
potential QDRO to be reviewed by an expert or an attorney.

Termination of the Plan

Even though retirement plans are meant to be permanent, at times they are terminated. When a 401(k)
plan terminates, all participants with an account balance are paid out. Anyone who is less than 100%
vested in any of their types of money becomes 100% vested.

Participants are given the option to receive a distribution, and if a participant does not respond to the
request, then the plan administrator will automatically process a distribution on their behalf either in cash
or into an IRA depending on their account balance.

Sometimes it is difficult to locate participants that have terminated many years ago. In this case, it is the
plan administrator’s responsibility to make a reasonable attempt to find the lost participant. The plan
administrator can attempt to find them using the last known address, conduct internet searches, or use a
commercial person locator to find the lost participant. During a plan termination, if the plan administrator
is unable to find the participant, he or she can automatically process a distribution for them.

Voluntary After-Tax and Roth Distributions

Voluntary after-tax and Roth seem similar but have very different tax consequences when they are
distributed from the plan. When a participant has a Roth account and takes a qualified distribution, the
distribution is tax-free.

In order to be a qualified distribution, the Roth account must:

1. Meet the five-year aging requirement

2. Be for a participant that is over 59½ or:

37
 a. The distribution is due to a disability, or
b. Death

Otherwise, the Roth distribution is treated the same way as a voluntary after-tax distribution.

A voluntary after-tax distribution is treated in two ways:

1. First, the amount that was contributed (the basis) is returned tax-free
2. Second, the earnings on the contributions (the gain) are taxed as income.

Example 1
Ben has an after-tax account of $15,000. He made contributions of $10,000, and the other $5,000 are
gains. When Ben takes a distribution, the $10,000 is returned tax-free and $5,000 is received as
taxable income.

Beatrice has a $25,000 Roth account. She is 65 years old and she has had the Roth account for 10
years. Her $25,000 distributions are entirely tax-free.

Differences in distribution rules such as this exemplify why it is important to maintain adequate records
on employee accounts, including contributions. Plans that allow for Roth must not only track separate
accounts for pre-tax, after-tax, and Roth contributions, but also the date of the first Roth contributions.
Plans that allow for voluntary after-tax contributions must keep track of both the basis and gain in order
to tax the distribution appropriately.

Summary
Shirley has learned the basics of distributions and is ready to handle many responsibilities. However, she’s
also learning that new situations arise that add complications to what at first may seem straightforward.
Shirley recognizes the seriousness of providing a distribution from the plan in error, and is careful to
contact her supervisor for clarification whenever she encounters a situation of which she is unsure.

Answers to Guiding Questions

Check your answers to the guiding questions by comparing them to the answers below.

1. What other situations allow for a participant to withdraw money from a plan?
Participants may receive distributions from the plan upon the plan’s termination, or due to a QDRO.

2. What is the best way to handle a new or uncertain request to withdraw money?
Processing a distribution that isn’t actually permitted puts the plan at risk. Anyone who is uncertain of
whether or not a distribution request should be approved should ask a supervisor for guidance.

Additional Resources
For more information on other distributable events, see:

 Roth Comparison Chart

[Link]

38
Unit 7: Employer Responsibility

Scenario
Joyce, the HR director and plan administrator of Bidwell Manufacturing, receives distribution requests in
which it is not obvious whether or not the participant should be permitted to take a distribution. Joyce
calls up Shirley at USA Retirement Plan Services. Who is responsible for making the decision as to whether
or not the participant may take a distribution, Joyce or Shirley?

Guiding Questions
As you work through the material of this unit, look for answers to the following questions:

1. Who is ultimately responsible for distribution of assets from the plan?

2. What notifications and forms must be provided for a distribution?
3. What is an involuntary cash-out provision?

Key Terms
Cash-out/force-out: When a Plan Administrator is allowed to make a plan distribution without participant
consent.

Fiduciary: Any person (individual or corporation) who exercises discretionary authority or control over the
management or disposition of plan assets.

Plan Administrator: The fiduciary named in the plan document responsible for the administration and
operation of the plan.9

Plan Sponsor: The employer or group of employers (or in some cases another entity such as an employee
organization, association, committee, or board of trustees) that establishes or maintains the plan.10

Unit Overview
It is the responsibility of a plan administrator, such as Joyce, to ensure that plan assets are only
distributed when appropriate: as allowed by the law and by the plan document. In this final unit of the
Distributions module, we explore the employer’s responsibility to provide certain notifications and forms,
withhold amounts for taxation when applicable, and to locate lost participants. We also examine the
ability to force small balances out from the plan in order to reduce administrative costs.

Employer Responsibility
The employer can take on several roles in a retirement plan. First, the employer makes a business
decision when deciding to sponsor a plan. 401(k) and other retirement plans are not required by law.
When an employer makes business decisions around a plan, like determining whether or not to allow

9
Adapted from the ERISA Outline Book.
10
Adapted from the ERISA Outline Book.

39
hardships, in-service distributions and setting the retirement age of participants, the employer does not
have a fiduciary responsibility towards the plan.

However, when these provisions are implemented, the operation of the plan becomes the fiduciary
responsibility of the person or organization in charge of operating the plan. A fiduciary is any person
(individual or corporation) who exercises discretionary authority or control over the management or
disposition of plan assets.

The employer takes on two distinct roles related to the retirement plan:
A. The Plan Sponsor – the employer that sponsors the plan and determines the provisions of the
plan
B. The Plan Administrator – the person or entity that is responsible for administering the provisions
of the plan

The employer can take on both roles in the plan or can select an outside administrator to have the
responsibility for administering the plan. In addition, the employer can select service providers to take on
specific responsibilities like administrating plan distributions.

When determining whether or not a participant may take a distribution, some discretion must be used to
determine whether or not an individual meets the requirements for a distribution as laid out by the law
and the plan document.

Consider the example from Unit 4 when Gene requested a hardship:

Example 2
Gene requests a hardship withdrawal from his 401(k) plan because he had an elective cosmetic
nose surgery procedure. Gene explains why he needed the surgery and supplies the medical bills
and his insurance denial. The 401(k) plan allows hardships for medical care that is not covered by
insurance. The plan administrator reviews the hardship policy and plan provisions and it is not
clear whether an elective procedure is covered.

The hardship policy in this case does not give a clear-cut definitive answer for Gene’s request. In these
cases, it is up to the Plan Administrator to either approve or deny the request. Of course, the Plan
Administrator can use outside resources or hire counsel to help make the decision. On the other hand,
Gene, as a participant in the plan, also has a right to make an ERISA claim.

It is a fiduciary responsibility to determine when assets may be distributed from the plan, and any action
taken to do so should be taken seriously. The employer may retain the responsibility for making these
decisions, or may assign responsibility to a service provider.

It can be tricky to tell if a service provider (such as a recordkeeper or TPA) is acting as a fiduciary. Some
providers may process distributions automatically without any affirmative approval. For other providers,
the employer or outside plan administrator must affirmatively approve distributions. It is also possible for
the recordkeeper to set up specific criteria for processing that are provided by the plan sponsor.

In general, the party ultimately responsible is the individual or organization with the authority and
discretion to approve distributions. This is not always easily determined. It is a best practice to identify
the responsible party in the plan document and the service contracts.

40
Notification and Distribution Timing
When an employee’s employment is terminated, the employee must be notified of his or her rights and
options under the plan. The timing of this may vary. In most cases, the plan is valued on a daily basis11 so
the employee is notified as soon as the plan receives the termination date.

To receive a payment of benefits, the plan’s mechanisms for processing distributions, as defined in the
plan document, come into play. These mechanisms are designed to comply with the IRC and ERISA
regarding timing of payments, options for choosing the amount and frequency of payments, application
of tax withholding or excise taxes, notification, reporting and disclosure requirements.

In order to start the distribution process, the participant or beneficiary must receive certain information.
Between 30 and 180 days prior to the distribution, participants, or beneficiaries entitled to a distribution
must be provided with a packet that contains the following documents and information:

 A Special Tax Notice (also referred to as 402(f) Special Tax Notice) explaining the taxation of
distributions, availability of direct rollover options, the 60-day rollover rule, the right to defer
a distribution and tax withholding information
 A distribution form that captures employee information, explains the benefits and payment
options available under the plan and provides for participant election of payment
 A withholding election form for income tax purposes (information may be provided on the
distribution form)
 Participant and/or spousal consent form (provided as part of the distribution form)

In today’s environment, most plans are valued daily and provide for an employee to take a distribution as
soon as administratively feasible following termination of employment. However, the plan document
dictates when a distribution is permitted. The plan is not required to allow a distribution at the time of
termination and may have restrictions requiring the participant to wait to receive the distribution until:

 The last day of the plan year during which a participant terminates employment
 The first valuation date following the participant’s termination
 The end of the calendar quarter following the termination of employment
 Attainment of normal retirement age, death or disability
 After the last employer contribution is made to the plan

For required minimum distribution notifications, consent and requirements, refer to Unit 5.

Prior to signing and submitting any distribution for processing, Joyce must refer back to the plan
document to determine if the participant can take a distribution immediately or if the participant needs
to wait based on the distribution timing stated in the plan.

Taxes and Tax Form Responsibility

When distributions are paid from a retirement plan, the IRS requires that the amount is reported to both
the IRS and to the participant. This is so the IRS can track an individual’s tax liability. Participants receive a

11
For more on valuation, see RPF Contributions module, Unit 4: Tracking Employee Account Information

41
tax form called a 1099-R which shows the amount of the distribution, how much is taxable and how much
was withheld from the distribution. The IRS also receives a copy of Form 1099-R.

Generally, the custodian (the entity that holds the actual assets of the plan) will automatically produce
Form 1099-R and all the IRS documentation. In addition to the individual tax forms, the IRS also requires
documentation that shows that a company withheld the right amount of income tax in total throughout
all of the distributions they processed.

Small Balances
Retirement plan administration can become especially burdensome when employees leave the company
and leave behind small retirement account balances. In order to reduce administrative costs, Plan
Administrators may process distributions for these participants without their consent. These are known
as cash-outs or force-outs.

$5,000 Rollover Limit

By law, this cash-out option is only available if participants have vested account balances that are $5,000
or less.

However, this is an optional plan feature, and if desired, the plan may require participant consent for all
distributions, or may choose a different force-out required amount such as $500. In this example, only
participants with balances below $500 may be forced out of the plan.

Example 1
Name: Uri
Salary Deferrals: $4,000
Employer Match: $2,000
Vested Percentage: 40%

Uri’s plan allows the employer to force-out balances under $5,000. Uri has an account balance of
$6,000. However, his vested employer match is only $800 ($2,000 x .40 (40%) = $800). His total
vested account balance is $4,800 ($4,000 + $800). Since the vested balance is under $5,000, his
account could be forced out.

Limited Notice and Consent Rules

Remember that since a cash–out distribution involves the payment of benefits to the participant, the
general notice and consent requirements applicable to plan distributions also apply.

When a plan does have a force-out requirement, participants with account balances less than the
required amount receive a slimmed down notice. The notice informs participants of their rollover
options; this differs from the full notice requirement in which consent is required.

$1,000 Cash-Out Limit

When the plan has a cash-out provision, vested account balances under $1,000 may be paid out in cash
as lump sum distributions. In other words, if the participant does not elect a rollover when they are first
due a distribution, then the plan will send the participant a check, and the entire amount of the
distribution will be taxable.

42
If the distribution amount is over $200, then there must be 20% withholding from the distribution.

When the plan has a cash-out provision for more than $1,000, participants with vested account balances
above $1,000 will have their accounts automatically rolled over into an IRA.

It is the plan administrator’s responsibility to select an IRA provider. The IRA provider must be selected
prudently and in the best interest of plan participants.

Include or Exclude Rollovers

The amount for cash-outs may include or exclude rollover balances. This information must be stated in
the plan document.

Example 2
Name: Maria
Salary Deferrals: $2,500
Rollover: $50,000

The Bidwell Manufacturing Company 401(k) Plan has a cash-out provision for participants that
have vested account balances of less than $5,000. The plan excludes rollovers in its cash-out
consideration. Maria leaves the company and does not respond to Bidwell’s distribution notice.
Bidwell processes a distribution for $52,500 and rolls it into an IRA on Maria’s behalf. She
receives a limited notice informing her about the distribution.

Example 3
Name: Peter
Salary Deferrals: $3,000
Rollover: $4,000

The Smith Consulting Group, Inc. 401(k) Plan has a cash-out provision for participants that have a
vested account balance of less than $5,000. The plan includes rollovers in its cash-out
consideration. Peter has a deferral account balance of $3,000 and a rollover account of $4,000.
Since Peter’s total vested account is greater than $5,000, Peter cannot be forced out of the plan.

43
Outstanding Small Balance Checks
In some instances, participants with accounts less than $1,000 are forced out, the plan sends them a
check, and the participant never cashes it. In this case, the plan administrator can roll the participant into
an IRA.

Lost Participants
At times, plan participants will move or leave the country and not notify their prior employer. At that
point, the plan administrator may be unable to contact the participant. However, the plan administrator
continues to have a responsibility to plan participants to ensure that their retirement accounts are
protected. The plan administrator has a responsibility to search for participants, and if they cannot be
found, process their distributions in specific ways.

The DOL published a Field Assistance Bulletin in 2014 outlining the steps a plan administrator is required
to take to find and distribute lost participant balances in defined contribution plans.12

Required Search Steps

When a participant is lost, a Plan Administrator must use the following search methods:

1. Send a notice via certified mail

2. Check with related plan and employer records
3. Check with any designated plan beneficiaries on file
4. Use free electronic search tools, like an Internet search

Additional Search Steps

A plan administrator may also use a commercial search service in order to try to find the participant. As a
plan fiduciary, the plan administrator must weigh the costs and benefits of using these services.

Distribution Options
Once a plan administrator has attempted to find a lost participant and cannot, the administrator must
decide how to handle the lost account. If the participant has a vested account balance below the plan’s
cash-out amount, then the plan can process a cash-out distribution.

However, if the participant has an account above the cash-out amount, then the administrator cannot
force the participant out of the plan without his or her consent.

In this case, one potential option for a plan administrator is to forfeit the account balance of the lost
participant. The plan administrator must take the proper steps (listed previously) before the account
balance is forfeited.

Once a forfeiture is processed, the plan must restore the participant’s account in full if the participant
ever comes back to the plan and inquiries about his or her account balance. Additionally, the participant
remains on a list of the plan’s terminated participants who are still due a vested benefit from the plan13,
because the participant’s account balance was never distributed from the plan.

12
[Link]
13
Form SSA-8955

44
Rollovers to IRAs
In the event that the plan is in the process of terminating and there are lost participants, then the plan
should not forfeit their accounts. Instead, the preferred distribution method is an automatic distribution
to an IRA account.

Alternate Distribution Options

If the plan administrator does not roll over the account balance, the plan administrator may decide to
process a distribution to a Federally Insured Bank Account, or process the funds to Unclaimed State
Property, depending on the state of the plan.

Unacceptable Distribution Options

The plan administrator may not use 100% Federal Income Tax Withholding as a distribution option. This
would be an improper distribution from the plan.

Summary
Who is responsible for making decisions as to whether an individual may take a distribution or not? Is it
Shirley, the administrative service provider, or Joyce, the plan administrator? Ultimately, Joyce, as a
fiduciary to the plan, is responsible for the assets of the plan. She may have delegated some of these
responsibilities to a service provider to act as a fiduciary. However, if Joyce did designate USA Retirement
Plan Services as a fiduciary for the plan, it should be clearly stated in writing, either in the plan document
or the contract she signed with USA Retirement Plan Services. Shirley should be careful not to make
discretionary decisions if she has not been assigned the responsibility.

In addition to making discretionary decisions regarding plan distributions, it is also the responsibility of
the employer as a plan administrator to provide the correct notices and forms in a timely manner.

The plan administrator is also responsible for account balances of participants who are no longer in the
service of the company. If the employee is lost, the plan administrator has a duty to try and locate the
participant, and must complete a series of steps to do so. However, if the participant’s balance is under
$5,000 and the plan document includes a cash-out provision, the plan administrator may force out the
balance, either distributing it as a lump sum (if the balance is under $1,000) or rolling it over to an IRA (if
greater than $1,000).

Answers to the Guiding Questions

Check your answers to the guiding questions by comparing them to the answers below.

1. Who is ultimately responsible for distribution of assets from the plan?

The employer as plan sponsor is ultimately responsible, but any party who exercises discretion over
distribution of plan assets is accountable as a fiduciary. It is a best practice to record the responsible
party (whether an individual or entity) in the plan document or service contract.

2. What notifications and forms must be provided for a distribution?

Required notifications and forms include the Special Tax Notice, a distribution form, a withholding
election form, and participant or spousal consent, provided from 30 to 180 days prior to the
distribution. The participant is also given Form 1099-R so the IRS can track the individual’s tax liability.

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3. What is an involuntary cash-out provision?
Terminated participants with account balances less than $5,000 may have their assets forced out of
the plan (if the plan document allows). Balances under $1,000 may be paid as cash; balances greater
than $1,000 may be rolled into an IRA.

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