In light of increased fee disclosure, most employers would benefit from reviewing their retirement plan documents to determine when employees are eligible to receive a distribution of their benefit and possibly rollover a distribution to an IRA to obtain greater investment control.

For example, an employee goes to the HR department and requests a distribution of their benefit. The individual is 45-years-old, saw a news program touting that one-third of participant accounts are being eaten away with internal asset charges over an employee's lifetime, and he requests an immediate distribution of his or her benefits. Can an employer make a distribution?

To answer that question, the plan document must be evaluated. Distributions generally may occur from a participant's account upon:

* A separation from service.

* Reaching age 591/2 (in a 401(k) plan).

* Age 55 in the form of substantially equal annuity payments.

* A Qualified Domestic Relations Order before or after age 50 (depending upon an employer's document).

* Death.

Despite the rules, employees periodically demand distributions. But there is another alternative. An old, often-forgotten rule in qualified retirement plans is that if employer profit-sharing contributions have been in a plan for two years or an individual has been a participant in a plan at least five years, an in-service distribution is permitted. This rule doesn't apply to employee salary deferral or matching contributions. Thus, if the 45-year-old employee has been working for his employer since age 35 and has a considerable profit sharing account in a profit sharing and/or section 401(k) plan, the plan may be amended to permit an employee to elect to receive an in-service distribution.

 

Restricting distributions

The plan may also restrict the in-service distribution to a rollover to an IRA, if an employer wishes to prevent employees from misspending their retirement assets. Despite such paternalistic intentions, after the funds have been rolled over, the individual may always take a withdrawal from an IRA, subject to income taxes and a 10% excise tax if funds are withdrawn before age 591/2.

In reviewing plan documents, employers should carefully consider the advantages and disadvantages of allowing greater employee access to profit-sharing accounts. Advantages include greater employee satisfaction with fund access and fewer employee complaints regarding the withdrawal process. The disadvantages are that plan assets may be liquidated, reducing an employer's retirement plan assets and buying power with 401(k) recordkeeping and investment vendors. As well, participants may pay higher fees outside of an employer-negotiated retirement plan. Another potential disadvantage is going against the increasing government focus on avoiding retirement leakage and encouraging more annuity forms of distributions, rather than lump-sum distributions.

The ultimate decision about whether to permit in-service distributions should be carefully considered by each employer. Most employers use prototype plan documents in the form of standardized or nonstandardized adoption agreements. Under these documents, if a box may be checked to elect an in-service distribution, the provision may be added by execution of an amendment or a new adoption agreement. For employers whose vendors do not permit in-service distributions (which is common), an individually designed plan document or a new vendor might be required to implement an in-service distribution provision.

Employers need not take any action to allow greater access to funds. However, they should review their plan provisions and make conscious decisions about whether to provide greater access and/or control of future retirement benefits.

Contributing Editor Frank Palmieri, CPA, JD, LL.M (Taxation) is a partner with the law firm of Palmieri & Eisenberg, with offices in Princeton, N.J. and Alexandria, Va.

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