Back to 401(k) Plans

401(k) Requirements

  • 3778. What are the requirements for a SIMPLE 401(k) plan?

    • Of all the types of qualified plans that are permitted under the IRC, the SIMPLE 401(k) may be the least attractive to a plan sponsor. These plans retain all the eligibility, documentation, and reporting requirements of a qualified plan but are subject to the lower limits and other restrictions of a SIMPLE IRA. A SIMPLE 401(k) plan allows an eligible employer to satisfy the actual deferral percentage test for 401(k) plans (Q 3802) by meeting the plan design requirements described below, instead of performing annual ADP testing.1 For a comparison of the features of a SIMPLE 401(k) plan to those of a safe harbor 401(k) plan, see Q 3777.

      An eligible employer is one that had no more than 100 employees earning at least $5,000 of compensation from the employer for the preceding year.2 An eligible employer that establishes a SIMPLE 401(k) plan for a plan year and later ceases to be eligible generally will be treated as eligible for the following two years. If the failure to remain eligible was due to an acquisition, disposition, or similar transaction, special rules apply.3

      In addition to all the requirements of IRC Section 401(k), a SIMPLE 401(k) plan must meet the contribution and other requirements of SIMPLE IRAs. Those requirements include a contribution requirement, an exclusive plan requirement, and a vesting requirement (Q 3706, Q 3709).4

      The SIMPLE 401(k) contribution requirement includes the following: (1) eligible employees must be able to make salary deferral contributions to the plan, (2) the amount to which the election applies may not exceed $14,000 (in 2022), and (3) the employer must make matching contributions or nonelective contributions under one of the formulas described below.5

      A SIMPLE 401(k) plan also may permit catch-up salary deferral contributions by participants who have attained age 50 by the end of the plan year.6 The limit on catch-up contributions to SIMPLE 401(k) plans is the same as for SIMPLE IRAs. The maximum catch-up contribution is the lesser of $3,000 (in 2015-2022) or the excess (if any) of the participant’s compensation over any other elective deferrals for the year made without regard to the catch-up limits.7

      A SIMPLE 401(k) plan must satisfy a universal availability requirement for availability of catch-up contributions (Q 3761).8

      Under the matching formula option for SIMPLE 401(k) plans, the employer must match employee salary deferral contributions dollar-for-dollar up to 3 percent of the employee’s compensation.9 (Earlier guidance stated that matching of catch-up contributions was not required.)10

      Under the second option, the employer makes a contribution of 2 percent of compensation on behalf of each employee who is eligible to participate and who has at least $5,000 in compensation from the employer for the year, provided notice of the election is given prior to the 60-day election period.11

      The plan also must provide that no other contributions (other than rollover contributions) may be made to the plan other than those described above.12 This is the “exclusive plan requirement.” This requirement is met if no contributions were made, or no benefits accrued, for services during the year under any qualified plan of the employer on behalf of any employee eligible to participate in the cash or deferred arrangement, other than the contributions made to the SIMPLE 401(k) plan.13 The receipt of a reallocation of forfeitures under another plan of the employer will not cause a SIMPLE 401(k) participant to violate this requirement.14

      All contributions to a SIMPLE 401(k) plan must be nonforfeitable.15

      Employees generally must have the right to terminate participation at any time during the year, although the plan may preclude the employee from resuming participation until the beginning of the next year.16 Furthermore, each employee eligible to participate must have 60 days before the first day of any year (and 60 days before the first day the employee is eligible to participate) to elect whether to participate in the plan or to modify his or her deferral amount. The foregoing requirements are met only if the employer notifies each eligible employee of such rights within a reasonable time before the 60 day election period.17

      A SIMPLE 401(k) plan that meets the requirements set forth in IRC Section 401(k)(11) is not subject to the top-heavy rules (Q 3917) provided that the plan allows only the contributions required under IRC Section 401(k)(11).18 SIMPLE 401(k) plans are subject to the other qualification requirements of a 401(k) plan, including the $305,000 compensation limit (as indexed for 2022, $290,000 in 2021, $285,000 in 2020, $280,000 in 2019), the IRC Section 415 limits (Q 3728, Q 3868), and the prohibition on state and local governments operating a 401(k) plan (Q 3753).19 The IRC Section 404(a) limit on the deductibility of contributions to 25 percent of compensation (Q 3750) is increased in the case of SIMPLE 401(k) plans to the greater of 25 percent of compensation or the amount of contributions required under IRC Section 401(k)(11)(B).20


      1. See IRC Sec. 401(k)(11); Treas. Reg. §1.401(k)-4(a).

      2. IRC Secs. 401(k)(11)(D)(i), 408(p)(2)(C)(i).

      3. See IRC Secs. 408(p)(10), 401(k)(11)(D)(i), 408(p)(2)(C)(i)(II); Treas. Reg. §1.401(k)-4(b)(2).

      4. IRC Secs. 401(k)(11)(A), 401(k)(11)(D)(i).

      5. IRC Sec. 401(k)(11)(B); Notice 2021-61.

      6. See IRC Sec. 414(v).

      7. IRC Sec. 414(v)(2)(A); Notice 2017-64, Notice 2018-83, Notice 2019-59, Notice 2020-79, Notice 2021-61.

      8. IRC Sec. 414(v)(3)(B); Treas. Reg. §1.414(v)-1(e).

      9. Treas. Reg. §1.401(k)-4(e)(3).

      10. See REG-142499-01, 66 Fed. Reg. 53555 (Oct. 23, 2001).

      11. IRC Sec. 401(k)(11)(B)(ii); Treas. Reg. §1.401(k)-4(e)(4).

      12. IRC Sec. 401(k)(11)(B)(i)(III); Treas. Reg. §1.401(k)-4(e)(1).

      13. IRC Sec. 401(k)(11)(C); Treas. Reg. §1.401(k)-4(c).

      14. Treas. Reg. §1.401(k)-4(c)(2).

      15. IRC Sec. 401(k)(11)(A)(iii).

      16. Treas. Reg. §1.401(k)-4(d)(2)(iii).

      17. IRC Secs. 401(k)(11)(B)(iii), 408(p)(5)(B), 408(p)(5)(C); Treas. Reg. §1.401(k)-4(d)(3).

      18. IRC Sec. 401(k)(11)(D)(ii); Treas. Reg. §1.401(k)-4(h).

      19. Rev. Proc. 97-9, 1997-1 CB 624; Notice 2018-83, Notice 2019-59, Notice 2020-79, Notice 2021-61.

      20. IRC Sec. 404(a)(3)(A)(ii).

  • 3779. What are the requirements of a Roth 401(k)?

    • A Roth 401(k) feature combines certain advantages of the Roth IRA with the convenience of 401(k) plan elective deferral-style contributions. The IRC states that if a qualified plan trust or a Section 403(b) annuity includes a qualified Roth contribution program, contributions to it that the employee designates to the Roth account, although not being excluded from the employee’s taxable income, will be treated as an elective deferral for plan qualification purposes.1 A qualified plan or Section 403(b) plan will not be treated as failing to meet any qualification requirement merely on account of including a qualified Roth contribution program.2

      A qualified Roth contribution program means a program under which an employee may elect to make designated Roth contributions in lieu of all or a portion of elective deferrals that the employee is otherwise eligible to make.3 For this purpose, a designated Roth contribution is any elective deferral that would otherwise be excludable from the gross income of the employee, but that the employee designates as not being excludable.4 Final regulations set forth the following requirements for designated Roth contributions:

      (1) The contribution must be designated irrevocably by the employee at the time of the cash or deferred election as a designated Roth contribution that is being made in lieu of all or a portion of the pre-tax elective contributions the employee is otherwise eligible to make under the plan.

      (2) The contribution must be treated by the employer as includable in the employee’s gross income at the time the employee would have received the amount in cash, if the employee had not made the cash or deferred election (i.e., it must be treated as wages subject to applicable withholding requirements).

      (3) The contribution must be maintained by the plan in a separate account, as provided under additional requirements set forth below.5

      A plan with a Roth contribution feature must provide for separate accounts for the designated Roth contributions of each employee and any earnings allocable to the account.6 Gains, losses, and other credits and charges associated with the Roth accounts must be separately allocated on a reasonable and consistent basis to the designated Roth account and other accounts under the plan. Forfeitures of any accounts may not be reallocated to the designated Roth account. No contributions other than designated Roth contributions and rollover Roth contributions (as described below) may be allocated to the Roth account. The separate accounting requirement applies from the time the designated Roth contribution is made until the designated Roth contribution account is completely distributed.7

      The maximum amount an employee may claim as a designated Roth contribution is limited to the maximum amount of elective deferrals permitted for the tax year, reduced by the aggregate amount of elective deferrals for the tax year for which no designation is made.8 Only one limit can be split between the Roth and salary deferrals of the employee each calendar year.

      Designated Roth contributions generally must satisfy the rules applicable to elective deferral contributions. Thus, for example, the nonforfeitability requirements and distribution limitations of Treasury Regulation Sections 1.401(k)-1(c) and (d) must be satisfied for Roth contributions. Designated Roth contributions are treated as elective deferral contributions for purposes of the Actual Deferral Percentage (“ADP”) test.9

      A designated Roth account is subject to the minimum distribution requirements of IRC Section 401(a)(9) (Q 3891 to Q 3909).10 A payment or distribution otherwise allowable from a designated Roth account may be rolled over to another designated Roth account of the individual from whose account the payment or distribution was made or to a Roth IRA of the individual.11 Rollover contributions to a designated Roth account under this provision are not taken into account for purposes of the limit on designated Roth contributions.12 Funds in a Roth IRA are not subject to the lifetime minimum distribution requirements that apply to Roth accounts in a qualified plan (Q 3686).

      The IRC states that any qualified distribution from a designated Roth account is excluded from gross income.13 A qualified distribution for this purpose is defined in the same manner as for Roth IRAs except that the provision for “qualified special purpose distributions” is disregarded (Q 3673).14 The term qualified distribution does not include distributions of excess deferrals (amounts in excess of the IRC Section 402(g) limit) or excess contributions (under IRC Section 401(k)(8)), or any income on them.15

      Nonexclusion period. A payment or distribution from a designated Roth account will not be treated as a qualified distribution if it is made within the five-year nonexclusion period. This period begins with the earlier of (1) the first taxable year for which the individual made a designated Roth contribution to any designated Roth account established for that individual under the same retirement plan, or (2) if a rollover contribution was made to the designated Roth account from another designated Roth account previously established for the individual under another retirement plan, the first taxable year for which the individual made a designated Roth contribution to the previously established account.16

      The IRC states that notwithstanding IRC Section 72, if any excess deferral attributable to a designated Roth contribution is not distributed on or before the first April 15 after the close of the taxable year in which the excess deferral was made, the excess deferral will not be treated as investment in the contract and will be included in gross income for the taxable year in which such excess is distributed.17 Furthermore, it adds that “Section 72 shall be applied separately with respect to distributions and payments from a designated Roth account and other distributions and payments from the plan.”18

      Planning Point: Even though designated Roth contributions are not excluded from income when contributed, they are treated as elective deferrals for purposes of IRC Section 402(g). Thus, to the extent total elective deferrals for the year exceed the 402(g) limit for the year, the excess amount can be distributed by April 15 of the year following the year of the excess without adverse tax consequences. However, if the excess deferrals are not distributed by that time, any distribution attributable to an excess deferral that is a designated Roth contribution is includible in gross income (with no exclusion from income for amounts attributable to basis under Section 72) and is not eligible for rollover. If there are any excess deferrals that are designated Roth contributions that are not corrected prior to April 15 of the year following the excess, the first amounts distributed from the designated Roth account are treated as distributions of excess deferrals and earnings until the full amount of those excess deferrals (and attributable earnings) are distributed.19


      1. As defined in IRC Sec. 402(g).

      2. IRC Secs. 402A(a), 402A(e)(1).

      3. IRC Sec. 402A(b)(1).

      4. IRC Sec. 402A(c)(1).

      5. Treas. Reg. §1.401(k)-1(f)(1).

      6. IRC Sec. 402A(b)(2).

      7. Treas. Reg. §1.401(k)-1(f)(2).

      8. IRC Sec. 402A(c)(2).

      9. See Treas. Reg. §1.401(k)-1(f)(3).

      10. Treas. Reg. §1.401(k)-1(f)(3).

      11. IRC Sec. 402A(c)(3).

      12. See IRC Sec. 402(A(c)(3)(B).

      13. IRC Sec. 402A(d)(1).

      14. IRC Sec. 402A(d)(2)(A). See IRC Sec. 408A(d)(2)(A)(iv).

      15. IRC Sec. 402A(d)(2)(C).

      16. IRC Sec. 402A(d)(2)(B).

      17. IRC Sec. 402A(d)(3).

      18. IRC Secs. 402A(d)(3), 402A(d)(4).

      19. TD 9324, 2007-2 IRB (May 29, 2007).

  • 3780. How are qualified distributions from a designated Roth 401(k) or 403(b) account taxed?

    • A designated Roth account is an option that is available under a 401(k) or a 403(b) plan to which designated Roth contributions (Q 3779) are made.1 Where a distribution from the designated Roth account satisfies certain requirements (referred to as a “qualified distribution,” see below), distributions from the account are free of income tax, even if not rolled over. For details on the requirements of a Roth 401(k) feature, see Q 3779.

      Qualified distributions. The taxation of a distribution from a designated Roth account depends on whether the distribution constitutes a qualified distribution. A qualified distribution generally is a distribution received after a five-taxable-year period and that meets any of the following qualified purposes for this rule:

      (1) It is made after the employee reaches age 59½.

      (2) It is attributable to the employee’s being disabled within the meaning of IRC Section 72(m)(7).

      (3) It is made after the employee’s death.2

      This definition is the same as that used for Roth IRAs except that the provision for “qualified special purpose distributions” is disregarded (Q 3673).3

      The term qualified distribution does not include distributions of excess deferrals that arise in correction of either an excess deferral under the IRC Section 402(g) limit or an excess contribution under IRC Section 401(k)(8), or any income attributable to such a distribution.4


      1. See IRC Sec. 402A(b)(2)(A); Treas. Reg. §1.402A-1, A-1.

      2. See IRC Sec. 402A(d)(1), Treas. Reg. §1.402A-1, A-2.

      3. IRC Sec. 402A(d)(2)(A). See IRC Sec. 408A(d)(2)(A)(iv).

      4. IRC Sec. 402A(d)(2)(C).

  • 3781. How are nonqualified distributions from a designated Roth 401(k) or 403(b) account taxed?

    • A nonqualified distribution from a designated Roth account generally is partially nontaxable. The portion of the distribution that constitutes the employee contribution is not taxable, and the portion that relates to earnings on those contributions is taxable.1 A nonqualified distribution may be rolled over to a Roth IRA. The funds in a designated Roth account are not subject to the ordering rules that determine the tax treatment of Roth IRA distributions (Q 3673) unless they are rolled over to a Roth IRA.2

      The preamble to the proposed regulations illustrated the pro rata treatment of nonqualified distributions as follows: If a nonqualified distribution of $5,000 is made from an employee’s designated Roth account when the account consists of $9,400 of designated Roth contributions and $600 of earnings, the distribution consists of $4,700 of designated Roth contributions (that are not includible in the employee’s gross income) and $300 of earnings (that are includible in the employee’s gross income).

      Amounts not treated as qualified. Certain amounts that are not eligible rollover distributions never can be treated as qualified distributions, and always will be currently includible in income. These include corrective distributions of excess deferrals, excess contributions and attributable income (Q 3808), deemed distributions resulting from violations of the plan loan requirements (Q 3954), and the cost of current life insurance protection (Q 3948).3


      1. See Treas. Reg. §1.402A-1, A-3; IRC Sec. 72(e)(8).

      2. See Treas. Reg. §1.408A-10, A-1.

      3. See Treas. Reg. §§1.402(g)-1(e)(8)(iv), 1.402A-1, A-2(c), 1.402A-1, A-11.

  • 3782. How is the five-year holding period of qualified distributions from designated Roth 401(k) or 403(b) accounts determined?

    • A Roth contribution is deemed to be made on the first day of the first taxable year for which the employee first made any designated Roth contributions. Thus, for a calendar year plan, all contributions in the first year would be deemed made on January 1 of that year. Starting with that date, the five-year period ends at the end of the fifth consecutive taxable year following that date. The beginning of the five-year period for a designated Roth account does not change even if the employee receives a distribution of the entire account and subsequently makes additional designated Roth contributions under the plan.

      If an employee makes deferrals to designated Roth accounts under more than one plan, the employee will have two or more separate five-year periods of participation that are calculated independently of one another unless the employee makes a direct rollover of a Roth distribution from one plan to another plan.1 If a direct rollover occurs, the five-year holding period for the receiving plan is deemed to begin on the earlier of beginning of the five-year holding period for the distributing plan or the beginning of the five-year holding period for the receiving plan. This calculation differs from the five-year period calculation under a Roth IRA in which the five year period starts with the date a Roth contribution was made to any Roth IRA (Q 3673).

      Planning Point: A client planning to make deferrals to a designated Roth account for the next year should begin deferrals in the current year. This will begin the five-year period one year earlier, so qualified distributions can be made one year earlier.


      1. Treas. Reg. §1.402A-1, A-4.

  • 3783. Can the owner of a designated Roth 401(k) or 403(b) account roll those funds into another retirement account?

    • A rollover of a designated Roth account distribution that is not includable in income may be made only to another designated Roth account of the individual from whose account the payment or distribution was made or to a Roth IRA of the individual either through a sixty-day rollover or a direct rollover. A plan receiving a designated Roth account rollover must agree to separately account for the amount that is not includable in income. Furthermore, if such a rollover is made to another plan, it must be made as a direct rollover to assure that there is proper accounting in the recipient plan. In other words, a rollover to a plan is not available if the distribution has been made directly to the employee. In that case, however, an employee would have the option of rolling over the distribution to a Roth IRA within sixty days.1

      If a rollover is made from a designated Roth account under another plan, the five-year period for the receiving plan begins on the first day that the employee made designated Roth contributions to the other plan, if earlier.2

      If a rollover is made from a designated Roth account to a Roth IRA, the period that the rolled over funds were in the designated Roth account does not count toward the five taxable year period for determining qualified distributions from the Roth IRA. If the Roth IRA was established in an earlier year, the five-year period for determining qualified distributions from the Roth IRA applies to distributions of rolled over amounts.3 Furthermore, the entire amount of any qualified distribution rolled over to a Roth IRA is treated as basis in the Roth IRA. As a result, a subsequent distribution from the Roth IRA of that amount would not be includable in the owner’s gross income.4

      Planning Point: A client who does not have a Roth IRA and anticipates rolling over an amount from a designated Roth account to a Roth IRA should consider establishing a Roth IRA before the year the rollover is anticipated. This will start the five-year holding period.


      1. See IRC Sec. 402A(c)(3); Treas. Reg. §1.402A-1, A-5.

      2. Treas. Reg. §1.402A-1, A-4(b).

      3. Treas. Reg. §1.408A-10, A-4.

      4. See Treas. Reg. §1.408A-10, A-3(a).

  • 3784. What should a taxpayer consider when deciding whether to roll funds from an employer-sponsored 401(k) into an IRA?

    • For a taxpayer who has reached age fifty-five, but has not yet reached age 59½, the tax advantages of allowing the funds to remain in the 401(k) are clear. If the taxpayer were to roll the funds into an IRA, a 10 percent penalty tax would apply to any withdrawals made before the taxpayer reaches age 59½ (in addition to the otherwise applicable ordinary income tax rate), unless another exception such as disability or a series of substantially equal periodic payments applies. A taxpayer who leaves employment once reaching age fifty-five can withdraw funds from the 401(k) without incurring the 10 percent penalty for early withdrawals.1

      If a taxpayer plans to work past the age when distributions become mandatory (age 72), the taxpayer can avoid the required distributions by leaving the funds in the employer-sponsored 401(k). Unless the plan requires earlier distributions, as long as the taxpayer continues to work and does not own 5 percent or more of the company, he or she can avoid taking distributions from a 401(k). Distributions from an IRA are required to begin when the taxpayer turns 72, regardless of whether he or she has actually retired.2

      Further, if a taxpayer holds stock in the employer within the 401(k) plan, the taxpayer may qualify for favorable tax treatment if the stock is left in the 401(k). After distribution from the 401(k) to a non-qualified account, a sale of the employer stock may qualify for taxation at the taxpayer’s long-term capital gains tax rate under the net unrealized appreciation rules, rather than the ordinary income tax rate that would apply to the appreciation on the stock if it was rolled into the IRA and later sold and the sales proceeds distributed. (See Q 3972.)

      Taxpayers may wish to keep funds in an employer-sponsored 401(k) after leaving employment because it may be possible to borrow against those funds, though these loans are limited and must be repaid relatively quickly. A loan against an IRA balance is not an option (penalties and taxes would apply to the IRA as though it were a distribution). Using an IRA as collateral for a loan is also treated as a distribution, subject to taxes and penalties.

      If the 401(k) offers attractive investment options, the taxpayer may wish to keep the funds invested in the 401(k). Further, if the 401(k) has lower fees than available in an IRA, the taxpayer may benefit from leaving the funds in the 401(k). Because recently enacted disclosure rules require 401(k) plan sponsors to disclose administrative expenses and fees to participants, there is evidence to suggest that 401(k) fees may be decreasing.


      1. IRC Sec. 72(t).

      2. Treas. Reg. §1.408-8, A-3.

  • 3785. What is the separate accounting requirement applicable to a designated Roth 401(k) or 403(b) account?

    • For a designated Roth account, the plan must maintain separate accounts and recordkeeping for each employee’s designated Roth contributions and any earnings that are allocated to the contributions.1 The separate accounting requirement is violated by “any transaction or accounting methodology involving an employee’s designated Roth account and any other accounts under the plan or plans of an employer that has the effect of directly or indirectly transferring value from another account into the designated Roth account.” A transaction that merely exchanges investments between accounts at fair market value will not violate the separate accounting requirement.2


      1. IRC Sec. 402A(b)(2).

      2. Treas. Reg. 1.402A-1, A-13(a).

  • 3786. What in-plan rollovers are permitted with respect to designated Roth 401(k) or 403(b) accounts?

    • Section 402A(c)(4) allows plans to permit rollovers from Section 401(k) plans to designated Roth accounts in the same plan (“in-plan Roth rollovers”). The rollover may be accomplished by a direct rollover or a sixty day rollover.1 Amounts can be rolled over even if they would not otherwise be distributable.2

      In-plan Roth direct rollovers simply change the plan account in which the amount is held and the tax character. They are not treated as a distribution for situations involving plan loans, spousal annuities, participant consent before an immediate distribution of an accrued benefit in excess of $5,000, and elimination of optional forms of benefit.3

      A qualified distribution is included in gross income as if it were not rolled over to a designated Roth account. The taxable amount of the in-plan Roth rollover is the amount that would be includible in a participant’s gross income if the rollover were made to a Roth IRA. This amount is equal to the fair market value of the distribution reduced by any basis the participant has in the distribution.4 The taxable amount of a distribution that an individual rolls over in an in-plan Roth rollover generally is includible in gross income in the taxable year in which the distribution occurs.

      Prior to 2018, a rollover to a Roth IRA could be unwound. This option was eliminated by the 2017 tax reform legislation. An in-plan rollover could never be unwound (recharacterized) because the recharacterization rule in Section 408A(d)(6) applied only to contributions to IRAs.5 In-plan Roth direct rollovers are not subject to the otherwise mandatory 20 percent withholding and cannot be withheld for voluntary withholding.6

      A written explanation of the in-plan Roth feature must be provided to the participant with the written explanation that the plan provides to individuals receiving an eligible rollover distribution.7


      1. Notice 2010-84, Q&A-1.

      2. Notice 2013-74, Q&A -1.

      3. Notice 2010-84, Q&A-4.

      4. See Notice 2009-75, 2009-35 I.R.B. 436.

      5. Notice 2010-84, Q&A-6.

      6. Notice 2013-74, Q&A-4.

      7. Notice 2010-84, Q&A-5.

  • 3787. What rules apply to Roth 401(k) rollovers?

    • Since 2013, funds from traditional 401(k) accounts may be rolled over into Roth 401(k) accounts without a penalty tax (even if they are not otherwise distributable without penalty).

      The amount that a plan participant can roll over is not limited. Any amount rolled over pursuant to this provision is treated as a distribution that was contributed in a qualified rollover contribution within the meaning of IRC Section 408A. This provision applies to 401(k) plans, 403(b) plans and governmental 457(b) plans.1

      As under prior law, the amount that is rolled over from a traditional 401(k) into a Roth 401(k) is included in gross income. The taxable amount of the Roth rollover must be included in the participant’s gross income. The taxable amount of an in-plan Roth rollover is the amount that would be includible in a participant’s gross income if the rollover were made to a Roth IRA. This amount is equal to the fair market value of the distribution reduced by any basis the participant has in the distribution.2 The taxable amount of a distribution that an individual rolls over in an in-plan Roth rollover generally is includible in gross income in the taxable year in which the rollover occurs.

      The expanded rollover treatment is optional, so that plan administrators have discretion as to whether to adopt an amendment permitting expanded use of this type of rollover. The amendment must be made no later than the last day of the first plan year in which the amendment is to be effective.

      See Q 3789 for distribution restrictions that apply following a 401(k) to Roth 401(k) rollover.


      1. American Taxpayer Relief Act of 2012, Pub. Law No. 112-240, Sec. 902.

      2. Notice 2009-75, 2009-35 IRB 436; Notice 2010-84, 2010-51 IRB 872.

  • 3788. What is the difference between an after-tax 401(k) contribution and a Roth contribution? What should individuals understand when deciding whether to allocate their retirement funds to after-tax or Roth contributions?

    • Each year, individuals have the ability to defer up to the traditional annual pre-tax contribution limit to a 401(k) plan ($20,500 in 2022, or $27,000 for clients age 50 and over) and up to the individual limit to IRAs and Roth IRAs ($6,000 or $7,000 with the catch-up). The after-tax contribution rules allow the individual to defer more than the annual pre-tax limit (for a total of up to $61,000 in 2022, up from $58,000 in 2021, or 100 percent of compensation) to their traditional 401(k). While these contributions are made with after-tax dollars, they are not the same as Roth contributions (which also come from after-tax funds, and are discussed below). Like pre-tax contributions, after-tax contributions cannot be withdrawn from the 401(k) without penalty except according to the terms of the plan (which will typically allow for penalty-free distributions only in the event of the client reaching age 59½, dying, retiring, becoming disabled or upon the occurrence of certain hardships).

      The primary difference between the after-tax 401(k) contribution and the Roth contribution is the tax treatment of earnings on the investment. While all Roth contributions are permitted to grow on a tax-free basis (i.e., the entire amount of the withdrawal will generally be tax-free), earnings on after-tax contributions will eventually be taxed at ordinary income tax rates. As a result, only individuals who are already contributing the maximum pre-tax and Roth amounts to their retirement accounts should consider the after-tax contribution option (generally, these will be high net worth clients seeking to amass a larger retirement nest egg).

      Individuals should also consider maximizing their Health Savings Account (HSA) contributions (which are contributed on a pre-tax basis, grow tax-free and can be withdrawn tax-free to cover medical expenses) before considering after-tax 401(k) contributions. This is because the actual benefit of the aftertax contribution is tax-deferred investing and the eventual ability to move the after-tax funds into a Roth account, from which point they will grow tax-free. Both Roth accounts and HSAs allow the funds to grow tax-free from the beginning, which will maximize the value of the contribution through compounded earnings over time. For high net worth clients, however, the after-tax 401(k) option can be valuable because all of the earnings are tax-deferred—conversely, with traditional taxable accounts (such as a mutual fund), the individual will have to pay taxes on appreciation each year, albeit usually at the lower capital gains rate. This group of taxpayers may benefit from the ability to allow all of their investment and earnings to grow tax-deferred over a period of many years. These individuals must keep in mind that they may not be able to withdraw their after-tax 401(k) contributions freely and without penalty, however.

      Importantly, under relatively new IRS regulations, at retirement the taxpayer can now bifurcate the funds in his or her 401(k), transferring after-tax funds into a Roth IRA (from that point, the after-tax funds grow tax-free) and the earnings into a traditional IRA (because those earnings had never been taxed, they will eventually be subject to ordinary income tax rates).

  • 3789. Are amounts rolled over to a Roth 401(k) subject to distribution restrictions after the rollover?

    • Yes. Although the American Taxpayer Relief Act of 2012 expanded the rules to allow rollovers from traditional 401(k) accounts to Roth 401(k) accounts of otherwise nondistributable amounts, the IRS has issued guidance providing that distribution restrictions will still apply after such amounts are rolled over.

      Any amount that is rolled over from a traditional 401(k) to a Roth 401(k) remains subject to the same distribution restrictions that applied to the amounts before the rollover.1 As a result, if an individual makes a rollover from a traditional 401(k) to a Roth 401(k) before reaching age 59½, for example, the rolled over amounts cannot be withdrawn from the Roth 401(k) on a penalty-free basis unless one of the other events described in IRC Section 401(k)(2)(B) has occurred (i.e., unless he or she reaches age 59½ or there has been a separation from service, death or disability).


      1. Notice 2013-74, 2013-52 IRB 819.

  • 3790. Are otherwise nondistributable amounts that are rolled over from a 401(k) to a Roth 401(k) subject to withholding?

    • The withholding requirements of IRC Section 3405 do not apply to otherwise nondistributable amounts that are rolled over from a traditional 401(k) into a Roth 401(k) because such a rollover must be accomplished through a direct rollover.1

      Further, because a nondistributable rollover cannot, by definition, be distributed to the taxpayer, a taxpayer is not permitted to voluntarily elect that a portion of the distribution be subject to withholding for purposes of meeting the taxpayer’s tax obligations with respect to the rollover. As a result, IRS guidance specifically advises that a taxpayer who elects to roll 401(k) funds into a Roth 401(k) may wish to increase withholding or make estimated payments in order to avoid an underpayment penalty.2


      1. Notice 2013-74, 2013-52 IRB 819.

      2. IRC Sec. 3402(p); Notice 2013-74, 2013-52 IRB 819.

  • 3791. What is the exception to the 401(k) required minimum distribution (RMD) rules that can apply when a plan participant has reached age 70½, but continues to work?

    • While the general rules governing retirement accounts require nearly every individual account owner to begin taking RMDs by April 1 of the year following the year in which he or she turns 72 (70½ prior to 2020), an exception exists for employer-sponsored 401(k) accounts owned by employees who continue working past age 72. If the plan allows, a participant who leaves funds in the 401(k) can avoid RMDs if he or she remains employed with the employer who sponsors the plan (the participant can also continue to make contributions to the 401(k)).

      Importantly, the current employer must sponsor the 401(k)—a participant cannot change employers and defer RMDs beyond age 72 if a former employer sponsors the relevant 401(k). However, it does not appear that the IRS provides a concrete definition of what it means to continue working past age 72, so it may be possible for the participant to continue working on a reduced hours basis and still defer his or her RMDs past the traditional required beginning date.

      The exception does not apply if the plan is an IRA (whether a traditional, SEP or SIMPLE IRA (RMDs do not apply to Roth IRAs during the original account owner’s lifetime)). Additionally, because not all 401(k) plans permit this exception, the individual must be careful to ensure that his or her plan actually does allow the funds to remain in the plan to avoid steep 50 percent penalty that applies to missed RMDs.

      If the individual has more than one 401(k) and the plans allow for rollovers, it may be possible for he or she to roll all 401(k) funds into the 401(k) of a current employer and delay RMDs on all of the funds if the still working exception applies. Combining accounts will also simplify RMD planning once the participant stops working, because the RMD on each account would otherwise have to be determined separately.

      While a plan participant may generally avoid taking RMDs from his or her 401(k) as long as he or she continues working past age 72, many small business owners will not be able to take advantage of this exception. This is because the exception does not apply to participants who are five percent owners of the business sponsoring the retirement plan. Individuals who own a portion of the business sponsoring the 401(k) must also be aware of the constructive ownership rules that apply when determining whether he or she is a five percent owner. Ownership interests held by certain members of the participant’s family (i.e., a spouse, children, parents, etc.) and by certain entities in which the participant holds a controlling stake will be added to the ownership interest that the participant holds directly in determining whether the 5 percent threshold has been crossed.

  • 3792. Can a plan restrict the types of 401(k) contributions that can be converted to a Roth 401(k)?

    • Yes. A plan that adopts an amendment permitting in-plan rollovers from traditional 401(k) accounts to Roth 401(k) accounts can, subject to otherwise applicable nondiscrimination requirements, restrict the types of contributions that can be rolled over. Further, the plan amendment can limit the frequency of these rollovers.1

      For example, otherwise nondistributable amounts may be permissibly rolled over, it is up to the plan itself to determine whether it will allow these rollovers. For administrative convenience, a plan may provide that it will only permit rollovers of otherwise distributable amounts or that nondistributable amounts can only be rolled over at certain intervals.


      1. Notice 2013-74, 2013-52 IRB 819.

  • 3793. What is an eligible investment advice arrangement?

    • ERISA contains a general prohibition against providing services to a plan for a fee. It is a prohibited transaction unless exempted either in the law or by regulations. There is a statutory exemption for investment advice rendered by a fiduciary advisor under an “eligible investment advice arrangement.” These requirements are designed to allow the plan fiduciary to meet the obligations under ERISA in the hiring of an investment advisor.1 The provisions discussed here generally are effective with respect to advice provided after December 31, 2006.

      On October 25, 2011, the Employee Benefits Security Administration of the U.S. Department of Labor issued final regulations implementing a statutory exemption from ERISA’s prohibited transaction rules that allows fiduciary advisors to offer plan participants and beneficiaries investment advice for a fee under eligible investment advice arrangements.2 The exemption, discussed below, was mandated by the Pension Protection Act of 2006 and is available for transactions occurring on or after December 27, 2011 that provide sufficient safeguards to ensure there is no conflict of interest.

      The final rules do not affect the applicability of the DOL’s prior guidance on the application of the prohibited transaction rules and existing prohibited transaction exemptions to investment advice arrangements.

      The Final Regulations

      The statutory exemption allows fiduciary investment advisors to receive compensation from investment vehicles that they recommend if either (1) the investment advice is based on a computer model certified as unbiased which applies generally accepted investment theories, or (2) the advisor is compensated on a “level-fee” basis (i.e., fees do not vary based on investments selected by the participant). The final regulations provide detailed guidance to advisors on compliance with these conditions.

      The regulations also show advisors how to comply with other conditions and safeguards in the statutory exemption, including:

      •     requiring that a plan fiduciary (independent of the investment advisor or its affiliates) authorize the advice arrangement;

      •     imposing recordkeeping requirements for investment advisors relying on the exemption;

      •     requiring that computer models be certified in advance as unbiased and meeting the exemption’s requirements by an independent expert;

      •     establishing qualifications and a selection process for the investment expert who must perform the above certification;

      •     clarifying that the level-fee requirement does not permit investment advisors (including their employees) to receive compensation from any party (including affiliates) that varies on the basis of the investments that participants select;

      •     establishing an annual audit of both computer model and level-fee advice arrangements, including the requirement that the auditor be independent from the investment advice provider;

      •     requiring disclosures by advisors to plan participants.3

      Fee Disclosures

      In February 2012, the DOL issued final regulations on fee disclosure4 and provided a Sample Guide to Initial Disclosures.5 In its final rule, the DOL extended the deadline for disclosures to July 1, 2012. In May 2012, the DOL issued a Field Assistance Bulletin providing guidance on frequently asked questions about participant-level disclosure requirements.6

      See Q 3794 for information about establishing an eligible investment advice arrangement and Q 3795 for a detailed discussion of who is a fiduciary advisor for purposes of an eligible investment advice arrangement.


      1. IRC Secs. 4975(d)(17), 4975(f)(8).

      2. DOL Reg. §2550.408g-1.

      3. DOL Reg. §2550.408g-1.

      4. DOL Reg. §2550.408b-2.

      5. Available at https://www.dol.gov/sites/dolgov/files/EBSA/employers-and-advisers/plan-administration-and-compliance/retirement/sample-guide-for-service-provider-disclosures-under-408b2.pdf.

      6. Field Assistance Bulletin 2012-2 (May 7, 2012).

  • 3794. How is an eligible investment advice arrangement established?

    • An eligible investment advice arrangement may be established in either of two ways: (1) the arrangement may provide that any fees (including commissions or other compensation) received by the fiduciary for investment advice, or with respect to the sale, holding, or acquisition of any security or other property for purposes of investment of plan assets, do not vary depending on the basis of any investment option selected, or (2) the arrangement may use a computer model that meets specified criteria, described below, in connection with the provision of investment advice by a fiduciary advisor to a participant or beneficiary.1

      The use of either method requires the plan fiduciary to comply with the statutory requirements of this exemption. Those requirements include:

      (1) that the advisor must act as an independent fiduciary;

      (2) proper authorization to provide the services;

      (3) compliance with an audit requirement;

      (4) disclosure of all relevant information including meeting certain standards for presentation of information;

      (5) the maintenance of proper records; and

      (6) that the fees charged the plan are reasonable.2

      The fee leveling requirement is met if the fees, commissions, or any revenue sharing by the advisor do not vary based upon the recommendations provided. This applies to the affiliate of the advisor.3

      Computer Model

      The computer model must:

      (1) apply generally accepted investment theories that take into account the historic returns of different asset classes over defined periods of time;

      (2) use relevant information about the participant, such as age, life expectancy, retirement age, risk tolerance, other assets or sources of income, and preferences as to certain types of investments;

      (3) use prescribed objective criteria to provide asset allocation portfolios comprised of investment options offered under the plan;

      (4) operate in a manner that is not biased toward investments offered by the fiduciary advisor, or a person in material affiliation or contractual relationship with the fiduciary advisor; and

      (5) take into account all investment options under the plan in specifying how a participant’s account should be invested and not be inappropriately weighted with respect to any investment option.4

      The person who develops or markets the computer model or investment advice program may be treated as a fiduciary advisor under certain circumstances.5

      The utilization of the computer model must be certified by an “eligible investment expert” as meeting the foregoing criteria, and the only advice provided under the arrangement can be that generated by the computer model and any transaction requested by the participant.6 The arrangement also must be audited annually and must meet detailed written disclosure requirements. Records of compliance must be maintained for six years.7

      An eligible investment advice arrangement must be expressly authorized by a plan fiduciary other than the person offering the investment advice. Notifications required for participants and beneficiaries must be written in a clear and conspicuous manner, calculated to be understood by the average plan participant.8 The DOL is directed to issue a model form for this purpose.9


      1. IRC Sec. 4975(f)(8)(B).

      2. IRC Sec. 4975(f)(8)(D) through (I).

      3. IRC Sec. 4975(f)(8)(B)(i)(I).

      4. IRC Sec. 4975(f)(8)(C)(ii); DOL Reg. §2550.408g-1(b)(4).

      5. IRC Sec. 4975(f)(8)(J)(i).

      6. IRC Sec. 4975(f)(8)(C)(iii), 4975(f)(8)(C)(iv).

      7. IRC Sec. 4975(f)(8)(I).

      8. IRC Sec. 4975(f)(8)(H)(i).

      9. IRC Sec. 4975(f)(8)(H)(ii).

  • 3795. Who is a fiduciary advisor for purposes of an eligible investment advice arrangement?

    • A “fiduciary advisor” for purposes of this provision is a person who provides investment advice to the participant or beneficiary and is one of the following:

      (1) a Registered Investment Advisor (“RIA”) in the state in which the fiduciary maintains its principal office and place of business;

      (2) a bank or similar financial institution, but only if the advice is provided through a trust department that is subject to periodic examination and review by federal or state banking authorities;

      (3) an insurance company qualified to do business under the laws of a state;

      (4) a person registered as a broker or dealer under the Securities Exchange Act of 1934;

      (5) an affiliate of any of the persons described in (1) through (4); or

      (6) an employee, agent, or registered representative of a person described in (1) through (5) who satisfies the requirements of applicable insurance, banking, and securities laws relating to the provision of the advice.1


      1. IRC Sec. 4975(f)(8)(J)(i); DOL Reg. §2550.408g-1(c)(2)(i).

  • 3796. What is a combination defined benefit/401(k) plan?

    • For plan years beginning after December 31, 2009, an “eligible combined plan” (i.e., a combination defined benefit/401(k) plan) is available to employers with two to 500 employees.1

      The assets of the plan will be held in a single trust, and the defined benefit and 401(k) components generally will be subject to their already-existing qualification requirements. The plan will be required to file only one Form 55002 and will have a single plan document.3 The top heavy rules (Q 3916 to Q 3922) will be deemed satisfied for a combined defined benefit/401(k) plan, and the 401(k) portion will be exempt from ADP/ACP testing (Q 3753, Q 3802).4

      The plan’s design generally will be subject to the following requirements:

      (1) The benefit requirement for the defined benefit portion will be satisfied if the annual accrued benefit of each participant is not less than 1 percent of final average pay times up to twenty years of service, or if the plan is a cash balance plan providing pay credits not less than the percentage of compensation determined under the following formula:

      Participant’s age as of beginning of year

      Cash balance pay credit percentage ofcompensation

      30 or less

      2

      30 or over, less than 40

      4

      40 or over, less than 50

      6

      50 or over

      8

      For this purpose, “final average pay” is determined using up to five years during which the participant had the highest aggregate compensation from the employer.5

      (2) The contribution requirement will be met if the 401(k) plan provides for an automatic contribution arrangement (see below) and requires the employer to match 50 percent of elective deferrals of up to 4 percent of compensation.6 Nonelective contributions are not precluded but will not count toward satisfying this requirement.7

      (3) Employees must be 100 percent vested after three years of service with respect to the defined benefit portion of the plan. Matching contributions under the defined contribution portion must be nonforfeitable, including those in excess of the required match. Any nonelective contributions may be subject to a maximum three-year cliff vesting schedule.8

      (4) All contributions, benefits, rights, and features must be provided uniformly to all participants.9

      (5) The foregoing requirements must be met without taking into account permitted disparity and amounts under other plans.10

      These criteria are the only circumstances under which a combination defined benefit/401(k) plan may constitute a single plan and trust.

      A 401(k) plan will be treated as an automatic contribution arrangement if it provides a default elective contribution percentage of 4 percent and meets specific notice requirements. Employees must receive a notice explaining their right not to have contributions withheld, or to have them made at a different rate, and they must have a reasonable period of time after receipt of the notice to make such elections.11


      1. IRC Secs. 414(x)(2)(A), 4980D(d)(2).

      2. Regulations proposed in July 2016 (RIN 1210-AB63) are designed to modernize and improve the Form 5500 reporting procedures, and will generally be effective for the 2019 plan year, presumptively once they have been finalized.

      3. See IRC Secs. 414(x)(2), 414(x)(6).

      4. IRC Secs. 414(x)(3), 414(x)(4).

      5. IRC Sec. 414(x)(2)(B).

      6. IRC Sec. 414(x)(2)(C).

      7. IRC Sec. 414(x)(2)(C)(ii).

      8. IRC Sec. 414(x)(2)(D).

      9. IRC Sec. 414(x)(2)(E).

      10. See IRC Sec. 414(x)(2)(F).

      11. See IRC Sec. 414(x)(5).

  • 3797. What restrictions apply to distributions from 401(k) plans?

    • Amounts held by the trust that are attributable to employer contributions made pursuant to the election to defer may not be distributed to participants or beneficiaries prior to:

      (1) the employee’s death, disability, or severance from employment;

      (2) certain plan terminations, without the establishment or maintenance of another defined contribution plan;

      (3) in the case of a profit sharing or stock bonus plan, the employee’s reaching age 59½;

      (4) experiencing financial hardship (Q 3798) (for years beginning before January 1, 2019, limited to distributions from a profit sharing or stock bonus plan and not permitted from other plans);

      (5) in the case of a qualified reservist distribution, the date of the reservist’s order or call.1  or

      (6) Under the SECURE Act, withdrawals of up to $5,000 for up to one year following the birth or legal adoption of a child.  Adopted children generally include children under age 18, but can also include someone who has reached age 18 but is physically or mentally disabled and incapable of self-support.2

      These occurrences are referred to as “distributable events.” Amounts may not be distributable merely by reason of completion of a stated period of participation or the lapse of a fixed number of years.3

      The cost of life insurance protection as per Table 2001 or the insurer’s qualifying lower published term rates (Q 3948) provided under the plan is not treated as a distribution for purposes of these rules. Neither is the making of a loan that is treated as a deemed distribution even if the loan is secured by the employee’s elective contributions or is includable in the employee’s income under IRC Section 72(p).

      The reduction of an employee’s accrued benefit derived from elective contributions (i.e., an offset distribution) by reason of a default on a loan is treated as a distribution (Q 3953).4 The IRS has privately ruled that a transfer of 401(k) elective deferrals or rollovers to purchase service credits would not constitute an impermissible distribution from the plan and are not a violation of the separate accounting requirement.5

      Restrictions on distributions of elective contributions generally continue to apply even if the amounts are transferred to another qualified plan of any employer.6 Amounts transferred to a 401(k) plan by a direct rollover from another plan do not have to be subject to these restrictions.7 See Q 3780 for discussion of in-plan Roth distributions. See Q 3787 for a discussion of penalty-free rollovers from 401(k) plan accounts into Roth 401(k) accounts. Final regulations state that rollover amounts may be excepted from the timing restrictions on distributions applicable to a receiving plan, provided there is a separate accounting for such amounts.8

      If an eligible retirement plan separately accounts for amounts attributable to rollover contributions to the plan, distributions of those amounts are not subject to the restrictions on permissible timing that apply, under the applicable requirements of the Internal Revenue Code, to distributions of other amounts from the plan. Accordingly, the plan may permit the distribution of amounts attributable to rollover contributions at any time pursuant to an individual’s request.

      Thus, for example, if the receiving plan is a money purchase pension plan and the plan separately accounts for amounts attributable to rollover contributions, a plan provision permitting the in-service distribution of those amounts will not disqualify the plan.9


      1. See IRC Sec. 72(t)(2)(G)(iii); Q 3677. See IRC Sec. 401(k)(2)(B)(1); Treas.

      Reg. §1.401(k)-1(d)(1).

      2. IRC Sec. 72(t)(2)(H)(iii)(II).

      3. IRC Sec. 401(k)(2)(B).

      4. Treas. Reg. §1.401(k)-1(d)(5)(ii).

      5. Let. Ruls. 200335035, 199914055.

      6. Treas. Reg. §1.401(k)-1(d)(2).

      7. Treas. Reg. §1.401(k)-1(d)(5)(iv).

      8. Treas. Reg. §1.401(k)-1(d)(5)(iv); see also Rev. Rul. 2004-12, 2004-7 IRB 478.

      9. Rev. Rul. 2004-12, 2004-7 IRB.

  • 3798. What requirements apply to hardship withdrawals from a 401(k) plan?

    • Editor’s Note: The 2017 Tax Act created new rules governing hardship distributions made because of qualified 2016 disasters. See Q 3799 for details. The CARES Act further expanded hardship distribution eligibility in response to the COVID-19 pandemic in 2020.  See Q 3801.

      Hardship withdrawals may be made from a 401(k) plan only if the distribution is made on account of an immediate and heavy financial need and the distribution is necessary to satisfy the financial need.[1] The distribution may not exceed the employee’s maximum distributable amount. Hardship withdrawals generally may not be rolled over (Q 3998).[2] Not all plans provide for hardship withdrawals, and plan sponsors must first look to the plan documents before determining whether a hardship distribution can be made. The final regulations cited here took effect for plan years beginning on or after January 1, 2006.[3]

      The Pension Protection Act of 2006 called for regulations modifying the hardship requirements to state that if an event constitutes a hardship with respect to a participant’s spouse or dependent, it constitutes a hardship with respect to the participant, to the extent permitted under the plan.[4]

      An employee’s maximum distributable amount generally is equal to the employee’s total elective contributions as of the date of distribution reduced by the amount of previous distributions on account of hardship.[5] Early in 2018, Congress passed the Bipartisan Budget Act of 2018 (BBA 2018), which modified this rule to expand the amounts that may be withdrawn as hardship distributions. Beginning in tax years that begin after December 31, 2018, the following amounts may also be distributed as hardship distributions (1) amounts contributed by the employer to a profit sharing or stock bonus plan, (2) qualified nonelective contributions (QNECs), (3) qualified matching contributions (QMACs) and (3) earnings on any of these types of contribution.[6]


      Planning Point: The changes enacted by BBA 2018 are not all mandatory, meaning that plan sponsors have the option of modifying their plans to implement the new rules. Plan sponsors operating safe harbor 401(k)s may wish to proceed with caution in implementing the changes, as Treasury has yet to issue guidance on whether the regulatory safe harbor will be satisfied if the plan retains (1) the six-month waiting period for contributions following a hardship distribution or (2) the requirement that the participant first take a plan loan before a hardship distribution is available. Plans must also consider the “leakage” problem in allowing participants to withdraw QNECs or QMACs, or in permitting hardship distributions before plan loans (which must be repaid).


      The determinations of whether the participant has “an immediate and heavy financial need” and whether other resources are “reasonably available” to meet the need are to be made on the basis of all relevant facts and circumstances. Beginning for hardship distributions taken on or after January 1, 2020, the employee must provide a written representation stating that the employee does not have cash or other liquid assets reasonably available to satisfy the need (under BBA 2018). An example of “an immediate and heavy financial need” is the need to pay funeral expenses of a family member. A financial need will not fail to qualify as an immediate and heavy financial need merely because it was foreseeable or voluntarily incurred by the employee.[7]

      A distribution will be deemed to be made on account of “an immediate and heavy financial need” if it is made on account of any of the following:

      (1)  “medical expenses” incurred by the employee, spouse, or dependents that would be deductible as itemized deductions under section 213(d) without regard to the 7.5 percent (10 percent for in prior years[8]) of AGI floor;

      (2)  the purchase (excluding mortgage payments) of the employee’s principal residence;

      (3)  payment of tuition, related educational fees, and room and board expenses for the next twelve months of post-secondary education for the employee, spouse, children, or dependents (note that the educational expenses must be for education incurred in the following twelve months, the IRS has ruled that a participant cannot take a hardship distribution to repay student loans incurred for past education);

      (4)  payments necessary to prevent eviction of the employee from his or her principal residence or foreclosure on the mortgage on his or her principal residence;

      (5)  funeral or burial expenses for the employee’s parent, spouse, children, or other dependents (as defined prior to 2005); and

      (6)  expenses for the repair or damage to the employee’s principal residence that would qualify for the casualty deduction under IRC Section 165 (without regard to the 10 percent floor).[9]

      This list may be expanded by the IRS but only by publication of documents of general applicability.[10] Apparently, to be the taxpayer’s “principal residence” for this purpose, the home must be the residence of the employee, not merely that of his or her family.[11]


      Planning Point: While the rules governing plan hardship distributions were not directly changed by the 2017 Tax Act, many plans that follow safe harbor standards and allow participants to withdraw funds to cover losses that are deductible as casualty losses may need to reevaluate their plan provisions. This is because, for 2018-2025, individuals may only treat losses sustained in a federal disaster area as deductible casualty losses under IRC Section 165. Unless subsequent guidance is released to change the safe harbor rules governing hardship distributions, plans may need to change the terms of their plan to comply with the new Section 165 rules.


      A distribution is not necessary to satisfy such an immediate and heavy financial need (and will not qualify as a hardship withdrawal) to the extent the amount of the distribution exceeds the amount required to relieve the financial need. The amount of an immediate and heavy financial need may include any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution.[12]

      The distribution also will not be treated as necessary to satisfy an immediate and heavy financial need to the extent the need can be satisfied from other resources that are reasonably available. However, the BBA 2018 eliminated the requirement that a plan participant first take any available plan loan before the distribution could qualify as a hardship distribution.[13]

      A distribution may be treated as necessary if the employer reasonably relies on the employee’s representation that the need cannot be relieved:

      (1)  through reimbursement or compensation by insurance or otherwise,

      (2)  by reasonable liquidation of the employee’s assets,

      (3)  by cessation of elective contributions or employee contributions,

      (4)  by other distributions or nontaxable loans from any plans (the requirement that a participant first take any available plan loan was eliminated by the BBA 2018, but the requirement that the employee consider any ESOP dividend distributions was retained), or

      (5)  by loans from commercial sources.

      Notwithstanding these provisions, an employee need not “take counterproductive actions” (such as a plan loan that might disqualify the employee from obtaining other financing) if the effect would be to increase the amount of the need.[14]

      The final regulations governing hardship distributions also provide that with respect to employee representations of financial hardship, the employee can reasonably represent that he or she has no cash or liquid assets reasonably available to satisfy the relevant financial need if the only cash or liquid assets available to that employee are necessary to pay some other expense (such as rent) in the near future.[15] Employees can also make representations of financial need over the phone if the employer records the call.[16] Plan documents must be amended by December 31, 2021 to provide for the new written representation provision, although the rule is effective beginning in 2020.[17]

      Plan sponsors are also entitled to impose a minimum distribution amount for hardship distributions so long as the requirement is not found to be discriminatory.[18]

      Regulations state that a distribution will be deemed to be “necessary” to meet a financial need (deemed or otherwise) if the employee has obtained all other distributions and nontaxable loans (prior to 2019) currently available under all of the employer’s plans and, prior to 2019, the employee is prohibited from making elective contributions and employee contributions to the plan and all other plans of the employer for a period of at least six months after receipt of the hardship distribution.[19] The regulations have been modified to eliminate the prohibition on contributions during the six month period following receipt of a hardship distribution, although the final regulations have clarified that the new rule applies only to contributions to qualified plans. Plan documents must be amended by December 31, 2021 to account for this new rule, which became effective beginning in 2020.[20] Nonqualified plans, including those subject to IRC Section 409A, may continue to suspend deferrals for six months following the hardship distribution.[21]

      The IRS has released internal guidance that it will use when examining a 401(k) plan to evaluate whether hardship distributions have been properly substantiated. The new guidance clarifies that, as part of the verification process for determining whether the participant has an immediate and heavy financial need, the employer or plan sponsor must review either the source documents supporting that need (such as contracts or foreclosure notices), or a summary of those documents. If only a summary is provided, an IRS agent reviewing the case will look to whether a notice was provided to the withdrawing participant before he or she is entitled to the hardship withdrawal. The notice must contain a statement that provides the following information:

      (1)  the distribution is taxable,

      (2)  additional taxes could apply,

      (3)  the amount of the distribution cannot exceed the participant’s “immediate and heavy financial need”,

      (4)  the distribution cannot be made from earnings on elective contributions or qualified nonelective contributions or matching contributions (QNECs and QMACs) (the prohibition on making the distribution from QNECs, QMACs, and earnings was eliminated for tax years beginning after December 31, 2018)[22], and

      (5)  all source documents must be retained and provided to the employer or administrator upon request at any time.

      The guidance also provides that specific information should be obtained by the plan administrator to substantiate a summary. If the summary is incomplete or inconsistent on its face, the IRS examining agent may ask for source documents.[23]

       

      [1].     Treas. Reg. §1.401(k)-1(d)(3)(i).

      [2].     IRC Sec. 402(c)(4). See also IRC Sec. 401(k)(2)(B).

      [3].     See Treas. Reg. §1.401(k)-1(g).

      [4].     See Pub. L. 109-280, Sec. 826.

      [5].     Treas. Reg. §1.401(k)-1(d)(3)(ii).

      [6].     IRC Sec. 401(k)(14)(A).

      [7].     Treas. Reg. §1.401(k)-1(d)(3)(iii)(A).

      [8].     The year-end spending package that became law late in 2019 extended the 7.5% threshold through 2020.

      [9].     Treas. Reg. §1.401(k)-1(d)(3)(iii)(B).

      [10].   Treas. Reg. §1.401(k)-1(d)(3)(v).

      [11].   See ABA Joint Committee on Employee Benefits, Meeting with IRS and Department of Treasury Officials, May 7, 2004 (Q&A-18).

      [12].   Treas. Reg. §1.401(k)-1(d)(3)(iv)(A).

      [13].    IRC Sec. 401(k)(14)(B).

      [14].   Treas. Reg. §1.401(k)-1(d)(3)(iv)(C), (D).

      [15].    See Preamble to the Final Regulations, 84 FR 49651.

      [16].    See Preamble to the Final Regulations, 84 FR 49651.

      [17].    Rev. Proc. 2020-9.

      [18].    See Preamble to the Final Regulations, 84 FR 49651. See also Treas. Reg. 1.401(k)-1(d)(3)(iv).

      [19].   Treas. Reg. §1.401(k)-1(d)(3)(iv)(E).

      [20].    Rev. Proc. 2020-9.

      [21].    P.L. 115-123 (Bipartisan Budget Act), Section 41113.

      [22].    P.L. 115-123 (Bipartisan Budget Act), Section 41114.

      [23].    The substantiation guidelines are available at https://www.irs.gov/pub/foia/ig/spder/tege-04-0217-0008.pdf (last accessed September 16, 2020).

  • 3799. What special rules governing retirement plan distributions were implemented for 2016 and 2017 disaster areas?

    • Editor’s Note: The 2019 Tax Certainty and Disaster Relief Act extended the rules governing qualified disaster distributions from retirement accounts, discussed below for victims of disasters that occurred in 2018 through sixty days after enactment of the bill (December 20, 2019).  The distribution itself must be made within 180 days after enactment of the law to qualify.  See Q 3800. Also, see Q 3801 for a discussion of how the CARES Act expanded the retirement plan distribution rules for 2020 in response to the COVID-19 pandemic.

      The 2017 Tax Act,1 the 2017 Disaster Tax Relief and Airport and Airway Extension Act,2 and the Bipartisan Budget Act of 2018,3 include special tax relief for taxpayers affected by certain presidentially declared disasters that occurred in 2016 and 2017.

      A 2016 qualified disaster is a major disaster that was declared in 2016 by the president. A 2016 qualified disaster distribution is any distribution received from an eligible retirement plan in 2016 or 2017 if the recipient’s main home was located in a 2016 qualified disaster area and the recipient sustained an economic loss from the disaster.

      A 2017 qualified disaster is limited to Hurricane Harvey and Tropical Storm Harvey, Hurricane Irma, Hurricane Maria, and the California wildfires. To be a 2017 qualified disaster distribution, the following requirements must be met:

      1. The distribution was made:

      a. After August 22, 2017, and before January 1, 2019, for Hurricane Harvey or Tropical Storm Harvey (both referred to as Hurricane Harvey);

      b. After September 3, 2017, and before January 1, 2019, for Hurricane Irma;

      c. After September 15, 2017, and before January 1, 2019, for Hurricane Maria; or

      d. After October 7, 2017, and before January 1, 2019, for California wildfires.

      2. The recipient’s main home was located in a disaster area listed below on the date or any date in the period shown for that area.

      a. August 23, 2017, for the Hurricane Harvey disaster area.

      b. September 4, 2017, for the Hurricane Irma disaster area.

      c. September 16, 2017, for the Hurricane Maria disaster area.

      d. October 8, 2017 to December 31, 2017, for the California wildfire disaster area.

      3. The recipient sustained an economic loss because of Hurricane Harvey, Hurricane Irma, Hurricane Maria, or the California wildfires.

      None of the Acts define economic loss. Examples of economic loss include loss, damage, or destruction of real or personal property; loss related to displacement from a home; and loss of livelihood due to temporary or permanent layoff.4 There is no requirement that the amount of the qualified disaster distribution relate to the amount of the taxpayer’s economic loss from the disaster or be made on account of the disaster.

      The Acts provide special rules for distributions from retirement accounts (qualified plans, 403(a)s, 403(b)s, governmental 457(b)s, and traditional, SEP, SIMPLE, and Roth IRAs). Distributions from retirement accounts made because of a qualified disaster are exempt from the 10 percent early distribution penalty (or 25 percent early distribution penalty for certain SIMPLE IRA distributions) if the penalty would otherwise be imposed under IRC Section 72(t). Qualified disaster distributions are treated as meeting the applicable plan’s distribution requirements. The amount that may be treated as a qualified disaster area distribution is limited to $100,000 (the amount for any given year must be reduced by the amounts treated as 2016 disaster area distributions in prior years).

      If a taxpayer is affected by multiple qualifying disasters, the $100,000 limit is applied separately to each disaster distribution. Taxpayers may recognize income attributable to a qualified disaster distribution over a three-year period beginning with the year the qualified disaster distribution was made (unless an election to the contrary is made).

      In addition, taxpayers are also permitted a three-year period from the day after the distribution is received to make a repayment of qualified disaster distributions that is eligible for tax-free rollover treatment to an eligible retirement plan or made on account of a hardship. These repayments may be made at once or via a series of payments and will essentially be treated as though they were rollovers made within the 60-day window. A repayment to an IRA is not considered a rollover for purposes of the one-rollover-per year limitation for IRAs. The following types of distributions cannot be repaid:

      • Qualified disaster distributions received as a beneficiary other than as a surviving spouse

      • Required minimum distributions

      • Periodic payments other than from an IRA that are for 10 years or more, the recipient’s life or life expectancy or the joint lives or life expectancies of the recipient and their beneficiary.

      Plans that make such a distribution also are protected against potential disqualification. Plans that permit qualified 2016 disaster distributions must be amended by the last day of the plan year beginning on or after January 1, 2018. Plans that permit qualified 2017 disaster distributions must be amended by the last day of the plan year beginning on or after January 1, 2019.

      Taxpayers who received certain distributions from retirement plans to buy or construct a principal residence but did not buy or construct the residence because of Hurricane or Tropical Storm Harvey, Hurricane Irma, Hurricane Maria, or the California wildfires had the opportunity to recontribute the distributions to an eligible retirement plan. The distributions had to be repaid before March 1, 2018 for repayments as a result of a hurricane or July 1, 2018 for repayments due to the California wildfires. A distribution that was not repaid before the applicable date may be taxable for 2017 and subject to the 10 percent additional tax on early distributions (or the 25 percent additional tax on certain SIMPLE IRA distributions).

      Individuals affected by a qualified disaster (as extended by the 2019 law) qualify for relaxed rules on loans from qualified plans. The plan administrator may increase the regular $50,000 limit on plan loans to $100,000 and the 50 percent of vested benefit limit to 100 percent. For individuals affected by a hurricane, the loan must have been made between September 29, 2017 and December 31, 2018. For someone affected by the California wildfires, the loan must have been made during the period beginning February 9, 2018 and ending on December 31, 2018. In addition, loan payments due during a specified period ending on December 31, 2018 may be suspended for one year by the plan administrator. The period begins on:

      • August 23, 2017 if the recipient’s home was located in the Hurricane Harvey disaster area
      • September 4, 2017 if the recipient’s home was located in the Hurricane Irma disaster area
      • September 16, 2017 if the recipient’s home was located in the Hurricane Maria disaster area; or
      • October 8, 2017 if the recipient’s home was located in the California wildfire disaster area.

      Casualty losses associated with a qualified 2016 or 2017 disaster are deductible regardless of whether total losses exceed 10 percent of the taxpayer’s adjusted gross income (AGI), so long as the loss exceeds $500 per casualty. Taxpayers who do not itemize their deductions may
      increase their standard deduction by the net qualified disaster loss.


      1. Section 11028, 2017 Tax Act, P.L. 115-97.

      2. Title V, Disaster Tax Relief and Airport and Airway Extension Act of 2017, P.L. 115-63.

      3. Subdivision 2, Title I, Bipartisan Budget Act of 2018, P.L. 115-123.

      4. 2017 IRS Publication 976, Disaster Relief.

  • 3800. What special rules governing retirement plan distributions were implemented for 2018 and 2019 disaster areas?

    • The 2019 Tax Certainty and Disaster Relief Act (enacted in conjunction with the SECURE Act) extended the rules governing qualified disaster distributions from retirement accounts, discussed below, for victims of disasters that occurred in 2018 and through 60 days after enactment of the bill (December 20, 2019). With respect to this specific provision, distributions had to be made within 180 days after enactment of the law to qualify.

      However, the government has permitted similar relief in subsequent situations, including in response to the COVID-19 pandemic in 2020.

      Qualified disaster areas generally include any area the President declares as such. The term “qualified disaster area” does not include the California wildfire disaster area, as defined in the 2018 Bipartisan Budget Act.


      Planning Point: Relatedly, Section 7508A(d) was added to the Internal Revenue Code in 2019 to codify a 60-day postponement of certain tax-sensitive acts in situations involving a disaster.

      For this purpose, IRS final regulations released in 2021 clarify that a “federally declared disaster” includes both a major disaster and emergencies declared under Sections 401 or 501 of the Stafford Disaster Relief and Emergency Assistance Act.

      The regulations also clarify that “time-sensitive acts” include those acts that the Treasury secretary determines should be postponed.  In the case of certain pensions and employee benefit plans, they also include acts described in IRC Section 7508A(d)(4), such as contributions, distributions and rollovers.  The final regulations apply to federally declared disasters after December 21, 2019.


      In general, the benefits of taking a distribution under the SECURE Act’s expansion of the disaster relief option are:

      • The taxpayer is exempt from the penalty on early distributions,
      • The taxpayer is exempt from withholding requirements on the distribution,
      • The taxpayer can elect to treat the distribution as having been distributed over a three-year period (or within the single year of distribution, and
      • The taxpayer is able to repay the distribution within three years of receiving the distribution.[1]

      Individuals affected by a qualified disaster qualify for relaxed rules on loans from qualified plans. The plan administrator may increase the regular $50,000 limit on plan loans to $100,000 and the 50 percent of vested benefit limit to 100 percent.   These same benefits were provided for the 2020 tax year in response to the COVID-19 pandemic.

       

       

      [1].     The Taxpayer Certainty and Disaster Relief Act of 2019, Sec. 202.

  • 3801. What special rules governing retirement plan distributions were implemented for distributions related to the COVID-19 impact?

    • Editor’s Note: Many have been confused about whether the Consolidated Appropriations Act of 2021 (the CAA) extended the tax relief for coronavirus-related distributions (CRDs) discussed below. The law did not extend the CARES Act CRD provisions into 2021. The new law provides the same type of tax relief for non-COVID-19 disasters, such as wildfires and hurricanes. The CARES Act relief provided for qualified plan loans was also extended for victims of non-COVID-19 disasters.  Additionally, RMDs are back on the table for 2021—the year-end stimulus bill did not extend the RMD waiver into 2021. 2021 RMDs are calculated using the year-end account balance just like any other year.

      The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) allows taxpayers to take up to $100,000 in distributions from an employer-sponsored retirement plan (401(k), 403(b) or defined benefit plan) or an IRA without the distribution becoming subject to the 10 percent early distribution penalty (the 25 percent early distribution penalty that applies to early distributions from SIMPLE IRAs is also waived). Unless the participant elects otherwise, the coronavirus-related distribution (CRD) is included in income ratably over three years, beginning with the tax year of distribution.

      The actual amount of the CRD does not need to be tied to the amount the participant requires to satisfy the COVID-19-related financial need. The amount is also a per-taxpayer rule, not a per-plan rule, meaning that distributions from all plans must be considered when determining whether they qualify for favorable tax treatment.[1]


      Planning Point: Plan sponsors have discretion as to whether they choose to implement any of these CARES Act relief provisions. However, the employee can elect favorable tax relief on a personal tax return regardless of whether the employer chooses to implement these options.

      Note, however, that plans are not required to accept rollover contributions, which could create problems for participants who wish to take advantage of the three-year repayment option.


      The CARES Act also provides for repayment options to allow employees to repay eligible distributions during the three-year tax period beginning with the tax year of distribution (whether in a lump sum or installments over time). Although unclear from the law as written, the repayment seems to be repayable to any type of plan that will accept the repayment, in which case it will be treated as a nontaxable rollover via direct transfer. Only distributions that qualify for penalty-free distribution relief (i.e., amounts up to $100,000) are eligible for repayment. Distributions paid to account beneficiaries (except for surviving spouses) are not eligible for recontribution (although these distributions can be treated as qualifying coronavirus-related distributions).[2]


      Planning Point: Employer-sponsored plans, however, are only able to accept rollovers from participants (and sometimes new hires).  Therefore, if an employee takes their entire account balance as a CRD and later stops working for the employer, the person is no longer a participant or new hire.  That former employee would, therefore, be required to re-contribute the funds to an IRA or to a plan sponsored by a new employer that accepts rollovers.

      When the employee takes only part of the balance, employers should exercise more caution—because it’s unclear whether that former employee would continue to be treated as a plan participant. It’s important for the plan to have a non-discriminatory policy in place when deciding whether or not to accept these re-contributions (for example, by not accepting any rollovers from non-employees). The penalty waiver is effective for distributions made on or after January 1, 2020 and before December 31, 2020.


      The penalty waiver is effective for distributions made on or after January 1, 2020 and before December 31, 2020.

      The waiver is available for any “coronavirus affected individual”, which includes both those who have been diagnosed (or had a spouse diagnosed) with the virus and those who have suffered financial consequences caused by layoffs, work reduction, or being unable to work because of the need to provide child care.

      Later IRS guidance expanded the list of qualifying individuals to include:

      1. A plan participant whose pay was reduced due to COVID-19 (regardless of whether hours were reduced or whether the individual was laid off).
      2. A plan participant who was planning to start a new job and the start date was pushed back (or the offer was rescinded entirely) due to COVID-19.
      3. A plan participant whose spouse or member of the plan participant’s household has suffered a qualifying effect.[3]

      “Members of the participant’s household” should include roommates or anyone who shares the participant’s primary residence.  For example, if the participant’s live-in partner owned a business that was shut down due to COVID-19, the participant would be eligible for the plan distribution relief.

      Employers can rely upon employees’ certifications that they satisfy conditions related to the hardship distribution unless the employer has actual knowledge to the contrary. The IRS provided a sample employee certification document in Notice 2020-50.

      Similarly, plan loan rules are expanded to increase the available loan limit from $50,000 to $100,000 during the 180-day period beginning March 27, 2020. The due date for repaying loans taken before December 31, 2020 is delayed one year. RMDs for the 2020 tax year have also been waived.[4]


      [1]      Notice 2020-50.

      [2]      Notice 2020-50, see Section 2(D).

      [3]      Notice 2020-50.

      [4]     Pub. Law 116-136.