If you've ever had the pleasure of crabbing on the Oregon Coast, you probably know that a good crab trap has multiple entry points (sometimes called "doors"), allowing as many unsuspecting crabs as possible to enter the trap easily. These "doors" swing in only one direction, preventing the larger crabs from exiting the trap once they've eaten their fill. Many retirement plans have similar designs, as it is generally much easier to put money into the plan than to take it out once it's there. Plan distributions encompass a number of issues relating to plan qualification, taxation of the participant, plan administration and reporting to the IRS and Oregon Department of Revenue. This article reviews a few of the issues surrounding plan distributions.
Distribution Events. Generally, a qualified plan may permit distributions at any time following a participant's termination of employment, retirement, disability or death. With respect to each of these events, the plan document may impose certain restrictions on timing. For example, a plan may provide that upon a participant's termination of employment, his or her vested account balance may be distributed following the end of the plan year in which the termination took place. As restrictions on timing often vary from plan to plan, it is important to review your plan document prior to processing a distribution request in order to ensure compliance. A plan may also permit in-service distributions while the participant is still employed. Specifically, a profit sharing plan may provide for in-service distributions upon the occurrence of a stated event, including attainment of a specified age, completion of a minimum period of participation in the plan, or the occurrence of a hardship (as defined by the plan). If the profit sharing plan contains IRC '401(k) provisions, the in-service distribution options for that portion of the plan are more limited. A money purchase pension plan or defined benefit plan (including a cash balance plan) generally may not allow in-service distributions unless the participant has attained the plan's normal retirement age, although recent law changes have provided some exceptions. As with the timing restrictions noted above, in-service distribution provisions vary from plan to plan. If your plan allows them (this distribution option is not required), an understanding of the specific provisions in your document is critical before processing a distribution request.
Methods of Payment and Consent Requirements. Most qualified plan documents provide for lump-sum distributions (either in cash or as a roll-over to another qualified plan or IRA), although installment payments and annuity distributions are also available (assuming the plan document provides those options). If the participant's vested account balance exceeds $1,000, the participant must consent to the method of payment (lump-sum, installments, etc.), the timing of the distribution, and any forfeiture resulting from the distribution. Money purchase pension plans must provide a qualified joint and survivor annuity, either as a mandatory distribution method or as an optional distribution method. This rule applies even if the money purchase pension plan has been merged into a profit sharing plan. A participant's spouse must consent to the distribution if the joint and survivor annuity requirements apply to the participant, the plan is making distribution in a form other than the qualified joint and survivor annuity, and the participant's vested account balance exceeds $5,000. In order to memorialize the participant's consent (as well as the consent of the participant's spouse, if required), it is important to use appropriate distribution forms. At a minimum, appropriate forms must describe the tax consequences of a participant's distribution options and will include the applicable federal and state income tax withholding rates applicable to lump-sum cash distributions. A plan sponsor should never approve a cash distribution without confirming that the appropriate income taxes have been withheld from the amount to be paid to the participant.
Required Minimum Distributions. Notwithstanding the distribution events noted above, a qualified plan must commence distributions consistent with the Required Minimum Distribution (RMD) rules of the Internal Revenue Code. Those rules provide that the participant's required beginning date is April 1 following the calendar year in which the participant attains age 702 or the calendar year in which the participant actually retires, whichever is later. A participant must begin taking minimum distributions from his or her plan account upon reaching his or her required beginning date. For a participant who is a 5% or more owner of the plan sponsor, the required beginning date is April 1 following the calendar year in which the participant attains age 702, without regard to his or her actual retirement. As the penalty for missing a required minimum distribution is large (up to 50% of the required distribution), plan sponsors should exercise good oversight as participants age. While the RMD rules were suspended for the plan year beginning in 2009, that suspension was only applicable for one year.
The comments above represent a sampling of some of the rules and requirements surrounding plan distributions. A number of other laws, regulations, and exceptions exist, even in this sampling. This should not prevent plan sponsors from funding their plans and saving for retirement, but does require a level of care in authorizing and processing distributions.