IRS Issues Guidance on Distributions from Qualified Plans, 403(b) and 457 Plans

EVANSTON, Ill. - Oct. 7, 2014 - PRLog -- On September 18, the IRS issued Notice 2014-54 (http://www.irs.gov/pub/irs-drop/n-14-54.pdf), which clarifies that a single distribution of both pre-tax and post-tax savings from an ERISA-qualified retirement plan, 403(b), or governmental 457 plan can be distributed to different retirement accounts without proration.

OVERVIEW

Generally, when an employer-sponsored participant’s qualified plan, 403(b) or governmental 457 plan includes both pre-tax and after-tax amounts, the distribution from those plans is made on a pro-rata basis.  For example, if a participant made pre-tax and post-tax contributions to a retirement plan, then directly transferred part of his account and took a cash distribution of another portion, both the amount that was directly rolled over and the cash distribution had to contain a pre-tax and after-tax amount on a pro-rata basis.

However, some plan sponsors and record-keepers have allowed qualified plans (such as a 401k), 457 deferred compensation, and 403(b) plan participants to transfer pre-tax and post-tax dollars to different destinations, in spite of the wording in the IRS's model rollover notice.  This was allowed because retirement plan participants, with a bit of legwork, could achieve the same result by taking a lump-sum distribution, then roll over the pre-tax amount into a Traditional IRA within 60 days. The post-tax dollars could then be rolled into a Roth IRA or be kept as cash.

AFTER-TAX ALLOCATION

Under Notice 2014-54, which takes effect January 1, 2015 all concurrent distributions from qualified retirement plans, 403(b), and governmental 457 plans will be treated as a single distribution. In other words, retirement plan participants can now direct pre-tax and post-tax dollars to separate accounts without prorating the amounts directed to each account.

"The new IRS Notice definitely makes things a lot easier for plan sponsors, administrators, and participants.  It eliminates a lot of unnecessary paperwork" say's Sev Meneshian, CFP® - owner of Public Retirement Planners, LLC.

However, plan sponsors, administrators, and retirement plan participants should be aware of the following rules:

1) If the pre-tax part of the distribution is less than the amount the participant chooses to directly transfer, then the entire pre-tax amount will be allocated to the direct transfer. If retirement plan savings will be directly rolled over to more than one account, the plan participant can choose the pre-tax allocation between the direct rollover destinations by notifying the plan administrator in advance.

2)  If the pre-tax part of the distribution is in excess of the amount the participant chooses to transfer directly, any pre-tax dollars remaining are subject to 60-day rollover rules (i.e. non-direct rollovers).  If pre-tax retirement dollars are transferred to two or more accounts, the participant can choose how the pre-tax amounts are allocated between the 60-day rollover destinations.  Any pre-tax dollars remaining after any direct rollovers and 60-day rollovers (i.e. cash distributions) must be included in the participant’s gross income for the tax year of the distribution.


CONCLUSION

The guidance issued in Notice 2014-54 takes effect on January 1, 2015. Before January 1, 2015 the Notice permits a reasonable interpretation of the statutory rollover rules, which would include allowing pre-tax and after-tax amounts to be directed to separate accounts without proration. Plan sponsors and administrators using the IRS model rollover notice or similar notice should consider updating their rollover notices to reflect the new guidance.

More 457 plan information can be found at www.PublicRetirementPlanners.com