Plan sponsors are required to provide a written explanation of plan distribution options and tax consequences to participants who qualify to take a distribution from the plan that is eligible to be rolled over. This distribution notice (called a “402(f)” notice) must generally explain:
- Rollover rules
- Special tax treatment for certain lump-sum distributions
- Direct rollover options (and any default procedures)
- Mandatory 20% withholding rules
- How distributions from the plan receiving the rollover may have different restrictions and tax consequences than the plan from which the rollover is made
The IRS provides model notices that plan sponsors may use to satisfy the notice requirement. One version of the IRS model notice applies to distributions that include designated Roth contributions. Another version is designed for distributions that do not include designated Roth contributions. The IRS recently updated its model notices to include changes made by the SECURE Act including:
- The exception to the 10% early distribution tax for qualified birth or adoption distributions, and
- The increase to age 72 for RMDs for participants born after June 30, 1949.
Plan service providers typically update and prepare the 402(f) notice for plan sponsors. But plan sponsors may want to confirm their provider has updated their 402(f) distribution notices to include these changes and that the updated versions will be used as soon as possible.
New Guidance on “Qualified” Plan Loan Offsets
Despite the temporary relaxation of retirement savings distribution rules in response to the pandemic, Congress and regulatory agencies are generally concerned about the leakage of plan assets prior to participants’ actual retirement. One way leakage can occur is when plan loans are defaulted. To help participants restore defaulted plan loans, the Tax Cuts and Jobs Act of 2017 (TCJA) provided an extended rollover period for “qualified” plan loan offsets (QPLO). The IRS recently proposed regulatory guidance to help plan sponsors implement this law change in compliance with the plan loan rules.
If a participant defaults on a loan and is eligible to take a distribution, the plan may offset the loan. A plan loan offset cannot occur prior to a distributable event. For example, if a participant has an outstanding loan and severs employment with the plan sponsor, the plan sponsor may choose to offset the loan immediately or wait until the participant requests a distribution or rollover. When the plan is ready to offset the loan, the plan account balance will be reduced (or offset) by the outstanding loan amount and the remaining balance in the account may be distributed. Because the loan offset is treated as an actual distribution, it is eligible to be rolled over—even though the participant doesn’t receive the cash in hand as part of the distribution. (They received it back when the plan loan was initially taken.) This means the participant must come up with the loan offset amount out-of-pocket if they wish to roll it over to another plan or an IRA and avoid being taxed on that amount for the year. Typically, the participant has 60 days to complete this rollover.
Effective January 1, 2018, the TCJA extended the amount of time a participant has to complete a rollover of a plan loan offset if it is considered a QPLO. A QPLO only occurs when the loan is in good standing and the default occurs solely because the:
- Retirement plan is being terminated or
- Participant failed to meet the repayment terms of the loan after severing employment with the employer.
A QPLO must occur within 12 months of the default event.
If the offset is qualified, the participant has until their tax return due date, including extensions, for the tax year the offset occurred to complete the rollover. This gives participants more time to come up with the funds so they can preserve the assets for retirement and avoid taxation.
This material was prepared by LPL Financial, LLC.
This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation.
Securities offered through LPL Financial. Member FINRA/SIPC. Investment advisory services offered through LMC Financial Advisors, a registered investment advisor. LMC Financial Advisors and LPL Financial are separate non-affiliated entities.