ESOP Distribution Timing: Mandatory Distributions

Posted by Aaron Juckett, CPA, CPC, QPA, QKA on Mon, Feb 01, 2010
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We have been discussing the ESOP distribution timing rules and the distribution timing rules applicable to all qualified plans. The Internal Revenue Code provides that a qualified plan may process distributions of $5,000 or less without the written consent of the participant.

IRC Section 411(a)(11) – Minimum vesting standards – Restrictions on certain mandatory distributions

§ 411. Minimum vesting standards

(11) Restrictions on certain mandatory distributions

(A) In general

If the present value of any nonforfeitable accrued benefit exceeds $5,000, a plan meets the requirements of this paragraph only if such plan provides that such benefit may not be immediately distributed without the consent of the participant.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) amended the Internal Revenue Code to provide that, effective March 28, 2005, involuntary cash-out distributions of more than $1,000 must be automatically rolled over to an IRA. Check your plan document to see if your plan has these plan provisions.

The safe harbor rollover language was incorporated into the 2009 Safe Harbor Notice of Tax Treatment (402(f) Notice):

Unless you elect otherwise, a mandatory cashout of more than $1,000 (not including payments from a designated Roth account in the Plan) will be directly rolled over to an IRA chosen by the Plan administrator or the payor. A mandatory cashout is a payment from a plan to a participant made before age 62 (or normal retirement age, if later) and without consent, where the participant's benefit does not exceed $5,000 (not including any amounts held under the plan as a result of a prior rollover made to the plan).

29 CFR 2550.404a-2 - Safe harbor for automatic rollovers to individual retirement plans establishes a safe harbor under which a fiduciary will be deemed to have satisfied the fiduciary duties associated with an automatic rollover of a mandatory distribution. IRS Notice 2005-5 - Automatic Rollover provides some additional guidance.

IRC Section 401(a)(31) – Qualified pension, profit-sharing, and stock bonus plans – Requirements for qualification - Direct transfer of eligible rollover distributions

§ 401. Qualified pension, profit-sharing, and stock bonus plans

(a) Requirements for qualification

A trust created or organized in the United States and forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall constitute a qualified trust under this section—

(31) Direct transfer of eligible rollover distributions.—

(A) In general.— A trust shall not constitute a qualified trust under this section unless the plan of which such trust is a part provides that if the distributee of any eligible rollover distribution—

(i) elects to have such distribution paid directly to an eligible retirement plan, and

(ii) specifies the eligible retirement plan to which such distribution is to be paid (in such form and at such time as the plan administrator may prescribe),

such distribution shall be made in the form of a direct trustee-to-trustee transfer to the eligible retirement plan so specified.

(B) Certain mandatory distributions.—

(i) In general.— In case of a trust which is part of an eligible plan, such trust shall not constitute a qualified trust under this section unless the plan of which such trust is a part provides that if—

(I) a distribution described in clause (ii) in excess of $1,000 is made, and

(II) the distributee does not make an election under subparagraph (A) and does not elect to receive the distribution directly, the plan administrator shall make such transfer to an individual retirement plan of a designated trustee or issuer and shall notify the distributee in writing (either separately or as part of the notice under section 402 (f)) that the distribution may be transferred to another individual retirement plan.

(ii) Eligible plan.— For purposes of clause (i), the term "eligible plan" means a plan which provides that any nonforfeitable accrued benefit for which the present value (as determined under section 411 (a)(11)) does not exceed $5,000 shall be immediately distributed to the participant.

(C) Limitation.— Subparagraphs (A) and (B) shall apply only to the extent that the eligible rollover distribution would be includible in gross income if not transferred as provided in subparagraph (A) (determined without regard to sections 402 (c), 403 (a)(4), 403 (b)(8), and 457 (e)(16)). The preceding sentence shall not apply to such distribution if the plan to which such distribution is transferred—

(i) is a qualified trust which is part of a plan which is a defined contribution plan and agrees to separately account for amounts so transferred, including separately accounting for the portion of such distribution which is includible in gross income and the portion of such distribution which is not so includible, or

(ii) is an eligible retirement plan described in clause (i) or (ii) of section 402 (c)(8)(B).

(D) Eligible rollover distribution.— For purposes of this paragraph, the term "eligible rollover distribution" has the meaning given such term by section 402 (f)(2)(A).

(E) Eligible retirement plan.— For purposes of this paragraph, the term "eligible retirement plan" has the meaning given such term by section 402 (c)(8)(B), except that a qualified trust shall be considered an eligible retirement plan only if it is a defined contribution plan, the terms of which permit the acceptance of rollover distributions.

Topics: ESOP distributions, distributions

Aaron Juckett, CPA, CPC, QPA, QKA
Written by Aaron Juckett, CPA, CPC, QPA, QKA

Aaron is President and Founder of ESOP Partners and provides implementation, administration, and consulting services to hundreds of companies. He is a member of The ESOP Association (TEA) and the National Center for Employee Ownership (NCEO).

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