Chapter 7...
Rollovers
Rollovers from a Previous Employer's Plan or Rollover IRA
Rollovers by Terminating Employees
Processing Rollovers
-- New Employee Rollover from a Previous Employer
-- A Terminating Employee's Rollover into an IRA or Another 401k
-- Processing Rollovers Via the "Activity" Window
-- Ex-Employee Accounts
A rollover is a tax-free transfer of all or part of a distribution from a qualified retirement plan to another qualified retirement plan or to a traditional IRA. A new employee might want to roll over money from a previous employer’s 401k plan or from a rollover IRA into your plan. Or a current employee, upon leaving your company, might want to roll over money from his or her 401k account at your company into another qualified plan or into a traditional IRA.
Your plan administration software's Asset Transfers-in Pac explains the policy for rolling over all or part of a distribution from a previous employer’s plan into your plan and provides the forms for doing so. Also, the 401k Distribution Pac (accessed via Reports, Forms--Outgoing Assets, 401k Distribution Pac) contains a Special Tax Notice that advises participants of important tax implications of their rollover decisions. You should review these documents with employees considering rollovers to ensure that the employees understand what is involved.
401k Fact:
Distributions from a 401(k) plan may qualify for optional lump–sum distribution treatment or rollover treatment as long as they meet the respective requirements. Many 401(k) plans allow employees to make a hardship withdrawal because of immediate and heavy financial needs. Generally, hardship distributions from a 401(k) plan are limited to the amount of the employee's elective deferrals only, and do not include any income earned on the deferred amounts. Hardship distributions are not treated as eligible rollover distributions. Target Labs, a small California-based employer
(www.targetlab.com) , has a very successful 401(k) loan program for its employees.
Rollovers from a Previous Employer's Plan or Rollover IRA
There are two significant benefits to the participant in rolling over his or her retirement savings into your company’s 401k plan:
• Combining retirement funds in the 401k will increase its dollar value and thus the amount the participant can borrow should a loan become necessary. Under current rules, borrowing from an IRA or ex-employer’s pension plan is not allowed.
• Combining assets in the 401k allows the participant to develop and implement a comprehensive long-term investment strategy and then track its performance.
IMPORTANT!!!Contributory IRAs cannot be rolled over into your 401k plan. Only IRAs that have only 401k assets can be rolled over. These latter plans, called rollover IRAs (also known as conduit IRAs), are ones whose only assets have come as a result of a participant’s termination from a qualified retirement plan. Contributory IRAs, by contrast, contain pre-tax funds elected by the participant to go into the IRA.
To initiate a rollover, the new participant requests an Asset Transfers-In Pac. He or she uses this form when the assets remain in the former employer’s plan or when they have been transferred to a rollover IRA as an interim measure. In this case, the employee never “sees” the money; the transfer is handled by the affected trusts.
The employee also uses the form if he or she took a lump sum distribution upon leaving the former employer. In this case, a mandatory 20% was withheld for tax purposes. The employee may roll over the remainder within 60 days after he or she receives the distribution. The employee may also make up the 20% that was withheld, depositing the full amount in your 401k plan. In this case, the 20% will not be included in the employee’s taxable income for the year.
If the employee’s assets remain with the former employer, he or she completes page 4 of the Asset Transfers-In Pac and sends it to the former employer. This page instructs the custodian to liquidate the account(s) and send the proceeds directly to you, the Plan Administrator, for deposit into the participant’s new 401k account. This transaction is tax-free and no backup withholding occurs.
IMPORTANT!!!Invalid rollover contributions can potentially result in disqualification of the plan that accepts them. However, a recent regulation offers you, the Plan Administrator, relief from this potentiality. You must “reasonably determine” that the rollover is valid on receipt, but you do not have to have a copy of a determination letter to do so. Additionally, if you find out later that the contribution was invalid, you must distribute it, along with earnings, to the employee within a reasonable period of time.
The employee completes pages 2 and 3 of the Pac and sends them to you. These pages tell you how he or she wants the rollover invested when it arrives. The participant can choose to have the rollover invested in accordance with his or her current options, or can select new investments.
If the employee is transferring assets from a lump sum distribution, he or she completes pages 2 and 3 and returns them to you. A check in the proper amount made out to the 401k plan trust should accompany the form.
Rollovers by Terminating Employees
The other occasion for a rollover is when a participant terminates employment with your company. The 401k Distribution Pac, is used in this case. The form discusses the distribution options, including rolling over the money into another employer’s 401k plan or into a traditional IRA. The IRA rollover can be a direct automatic rollover of the participant’s existing investment accounts into an IRA with the same investment account company or a rollover to a different IRA custodian.
A terminating employee can also elect to take a cash distribution and roll the money over into a new employer’s 401k plan or a traditional IRA within 60 days. This is handled by you as a distribution as described in Chapter 6; the mandatory 20% withholding, as explained in the Distribution Pacs, applies even if the employee says he or she intends to roll over the distribution.
If a participant dies and his or her spouse is the beneficiary, the surviving spouse can roll over the account balance into an IRA, but not into another qualified plan; if the beneficiary is a former spouse pursuant to a qualified domestic relations order (QDRO), he or she has the same options as the participant. Named beneficiaries other than spouses cannot roll over the distribution.
Rollover rules and the basic tax consequences of each on the recipient are explained in the Special Tax Notice within the Distribution Pacs. It is a good idea for the Plan Administrator to become familiar with the Special Tax Notice, but should always recommend employees take specific tax questions to a professional tax advisor.
New Employee Rollover from a Previous Employer
When you, the Plan Administrator, receive the distribution from a new employee’s rollover IRA or former 401k plan, you can process it immediately, or wait until you do the monthly processing of employee contributions.
The sequence is as follows:
1. Deposit the distribution check into the 401k trust bank account.
2. Determine the employee’s investment choices from his/her completed Asset Transfers-In Pac.
3. Complete the rollover transmittal using either the Rollover or Deposit to an Existing Account form (if the account has already been established) or Rollover or Deposit to a New Account form (if a new account is to be opened). Attach a check in the proper amount from the 401k trust bank account and send it to the investment account company.
4. Enter the rollover transaction into your plan administration software as described at the end of this chapter.
A Terminating Employee's Rollover into an IRA or Another 401k
For a terminating employee who wishes to roll over his or her 401k plan assets into a rollover IRA or a new employer’s 401k plan, the sequence is as follows:
1. The employee receives and completes the “Election for Distribution of 401k Benefits” in the 401k Distribution Pac.
2. If the employee chooses an automatic IRA, the Plan Administrator gives him or her an IRA application supplied by the investment account company. (It is a good idea to request multiple IRA applications from the investment account company and keep them on hand.) The signed and completed IRA application and signed IRA Rollover Authorization are sent to the investment account company. When the rollover is complete, the amount that was rolled over is entered as a distribution into your plan administration software as described at the end of this chapter.
3. If the employee chooses a rollover to a newly appointed custodian, when you, the Plan Administrator, receive the properly filled in and signed authorization for direct transfer, send a signed Asset Liquidation Authorization to the investment account company. When the check is received from the investment account company, deposit it into the 401k trust bank account, and issue a check out of the trust bank account to the newly-appointed custodian. The transaction is entered into your plan administration software as a distribution as described below.
Processing Rollovers Via the "Activity" Window
Rollovers into and distributions out of your plan administration software are entered through the “Activity” window for each employee. To access the “Activity” window, click on Employee Information in the “Welcome...” window. Highlight the employee’s name and click on Activity.
Choose New. The Entered On date will be today’s date (month, day, 4-digit year). The Posted to date is the month in which you want the transaction to take place (2-digit month and 4-digit year). Posted to Investment Account is the month it will be so posted.
Choose from the pull-down menu for Type what you are entering (rollover into or distribution out of the employee’s account). For Portfolio, enter the investment account choice, and enter the account number (if one is in the system it will automatically pop up). Then enter the dollar amount. If this is a distribution, use the minus (-) sign before entering the amount.
If the information is correct, click Post. The transaction is then posted, and you are ready to enter another.
By law, participants with balances over $5000 can leave their money in your 401k plan after they terminate employment with the company. A person who does so, however, may cause many unintended problems, including moving without giving you a forwarding address. They may also have difficulty changing investments. You, on the other hand, have the responsibility of trusteeing a former employee’s property indefinitely. For these reasons, we suggest you strongly encourage automatic IRA rollovers. “Your Money Is Still in Our 401k” can be sent as a reminder, along with a copy of the 401k Distribution Pac.
Terminated employees with LESS than $5000 in their 401k account can be cashed out, at the employer's discretion, without express written notice by the terminated employee. As of 2002, any portion of the employee's account balance that came from a rollover into the plan should NOT be considered in determining the $5000 balance.
An innovative retirement plan, the 401(k) is the primary savings vehicle for more than 20 million Americans having more than $500 billion for their safe and secure retirement. By 2006, this total is predicted to grow to $2 trillion.
Like others, you're counting on your 401(k) to make your retirement comfortable and secure. Yet, you likely have concerns about the most advantageous way to handle distribution of your 401(k) without paying unnecessary tax penalties.
For example, John and Betty (an actual couple, but fictitious names) are in the 50- to 60-year-old age group. They both participate in tax-sheltered programs where they work. And, they're concerned about having enough funds for retirement. John has a tax-deferred 403(b) program with his educational institution employer, and Betty has a 401(k) with hers. As they evaluate their retirement plans at this point in their lives, they plan to leave their tax-sheltered funds in their employers' programs when they retire.
Betty explains, "My main concern is simple: having enough to draw on, if possible, without using up the principal to supplement social security and my pension and still provide a level of income close to what I now have."
Before making decisions affecting taxation of your 401(k) money, review your options with a qualified tax adviser. And, the following frequently asked questions about 401(k) withdrawal options, and the responses, can help you make an informed decision as you retire and, perhaps, save you money.
When I retire what happens with my 401(k) program?
What distribution options are available for my 401(k)?
What is a taxable lump sum distribution?
Can I withdraw funds from my 401(k) if I retire before I reach age 59˝, say at age 55?
Is a lifetime annuity advisable for my 401(k)?
Is it possible to continue 401(k) participation when I retire?
What if I decide on an IRA (individual retirement account) rollover for my 401(k)?
Do I have to withdraw all of my 401(k) savings when I reach age 70˝?
What is the penalty if I do not withdraw funds at age 70˝?
When I retire what happens with my 401(k) program?
When you retire anytime after age 59˝, you can withdraw all the money in your 401(k) account subject to your plan's vesting schedule. Review and understand the options that may be available for distribution of your 401(k).
What distribution options are available for my 401(k)?
Not every 401(k) plan offers every option. In fact, in many 401(k) programs, the retiree must take a lump sum distribution. John and Betty are fortunate that their employers' programs don't require them to withdraw their funds when they retire. Other plans may offer a lifetime annuity, continued participation in the program after retirement, or an IRA rollover.
What is a taxable lump sum distribution?
If your plan requires you to take your 401(k) in a lump sum distribution, or if you elect to take a lump sum, you will owe income taxes on the full amount. No matter what your tax bracket, 20% of your distribution will be withheld for federal taxes. If you are younger than age 59˝, you may have to pay a 10% early withdrawal penalty. However, after age 59˝, you may, under current tax laws, be able to lower your tax rate by using "five-year averaging."
Your tax adviser can explain how five-year averaging may benefit your particular tax situation.
Can I withdraw funds from my 401(k) if I retire before I reach age 59˝, say at age 55?
The truth is, you can withdraw funds from your 401(k) anytime you leave a company no matter what your age. You will, however, owe withholding and, if you are younger than age 55, a 10% withdrawal penalty. If you are age 55, leave the company, and take a lump sum distribution, you will pay no penalty, only the income tax. The tax code says that no penalty applies to distributions "made to an employee after separation from service after attainment of age 55."
Is a lifetime annuity advisable for my 401(k)?
Some 401(k) plans offer the option of receiving your distribution as a lifetime annuity, purchased from a private insurance company. This annuity will pay you a monthly benefit for your lifetime. If you have established a joint-and-survivor annuity, you and your spouse will receive the monthly payment for your lifetimes. You cannot change the annuity once you start it.
Though an annuity provides a guaranteed lifetime benefit that could amount to more than you paid into your account, it is a fixed benefit with purchasing power reduced each year by inflation. Further, once you and your spouse (if joint-and-survivor annuity) die, the annuity ceases, leaving nothing for any beneficiaries of your estate.
Annuity payments are subject to ordinary income tax. For example, if your annuity pays you $1,000 a month beginning January 1, 2000, you will owe taxes on the $12,000 annuity income for the year.
Additional non-profit websites that include relevant unbiased information about 401k plans include: www.401k-laws.com
Is it possible to continue my 401(k) participation when I retire?
If your plan doesn't require you to take a lump sum distribution when you retire, you may decide to leave your funds in the program and continue to participate until you reach 70˝, when you must begin withdrawing funds. Or you may decide to withdraw only part of your money. You will have to pay withholding taxes only on the amount you withdraw. As a rule, most plans require that you have at least $3,500 vested in your account to continue to participate when you retire.
Continued participation in your employer's 401(k) program is a sensible choice if you like the investment options it offers and if the plan allows you to withdraw funds as often as you need after you retire.
What happens if I decide on an IRA (individual retirement account) rollover for my 401(k)?
If you decide to roll your 401(k) into an IRA, your money will continue to be sheltered in a tax-deferred account and will avoid the 20% federal withholding. You can withdraw money as you need it, subject to the IRA minimum distribution rules, and pay income tax only on the amount you withdraw. This IRA must be a special account intended only for the rollover of your 401(k). Do not put your 401(k) money into your existing IRA account.
This distribution option is the most flexible because you can invest your IRA however you wish and still have your money tax-deferred.
Do I have to withdraw all of my 401(k) savings when I reach age 70˝?
When you reach age 70˝, you're required to withdraw a minimum amount depending on your life expectancy. An actuarial table showing life expectancies is available from the Internal Revenue Service (IRS). You must begin receiving these payments by April 1 of the calendar year following the year you turn 70˝.
To determine your required minimum distribution, divide your 401(k) account balance by the number of years remaining in your life or by the remaining joint life expectancy of you and your spouse. Try the calculation both ways. You may find it more advantageous to determine your mandatory withdrawal amount by using both life expectancies instead of yours alone.
You may have to recalculate this mandatory distribution amount each year because of your account balance and life expectancy.
What is the penalty if I do not withdraw funds at age 70˝?
If you do not withdraw the mandatory minimum amount beginning at age 70˝, your 401(k) may lose its tax benefits and you will have to pay a 50% tax penalty on the required distribution.
Is it possible to continue to participate in my 401(k) program after I'm 70˝?
After age 70˝, if you're still working for your employer sponsoring the plan, you are eligible to participate. You may continue to participate even though you're subject to mandatory minimum withdrawals.
Is it wise to continue contributing after I reach 70˝?
If your employer matches your contributions, it can be worthwhile for you to continue participation.
How long must I wait to receive my 401(k) money after I retire?
Legally, sponsors of your 401(k) plan must give you the money in your 401(k) account within 60 days of the end of the plan year in which you leave your employer after you reach retirement age.
The administrator must value your account before distribution can take place. As a rule, it takes six to eight weeks for valuation and approximately two weeks to pay the benefit.
These IRS publications might be helpful as you decide what to do about your 401(k) distributions when you retire:
Publication 575C Pension and Annuity Income
Publication 590C Individual Retirement Arrangements rrp
