If your company has a 401(k) plan, one of the areas to understand is if your plan allows for different types of distributions, what they entail, and some key items to note regarding each type. The main types of distributions are hardships, termination/rollovers, and in-service.
Not all plans allow for hardship distributions; however if they do, there is criteria that must be met. These will vary based on how they are outlined by each plan document, but in general, there are some basic rules that are typical for a hardship distribution:
- There needs to be a financial need for the distribution and proof of this should be kept on file.
- Most plans will not allow for the distribution to exceed the amount of employee deferrals made to the plan.
- The plan may also indicate that prior to taking this type of distribution that all other forms of distributions have been exhausted, such as an in-service distribution or a loan.
Termination distributions are probably the most common distribution you will see. When an employee is terminated from the employer they can request a distribution in cash or they can have their balance rolled over into another individual retirement account. Some of the key things to look for in a termination distribution are:
- Paperwork should be kept on file indicating the termination date of the employee.
- A calculation should be complete to ensure that the employee can only receive the amount that they are currently vested in. Therefore, having accurate participant information in the system (regarding hire date) is important.
- If this is a lump-sum cash distribution, a calculation should be complete to determine that taxes were properly withheld. No taxes are necessary on rollover distributions as they are being transferred to another plan typically.
- After the distribution occurs, you will want to ensure that their balance is at $0 and there isn’t a small amount remaining (typically will occur due to earnings, if it does occur).
- If the distribution were for a rollover, proper request forms should be obtained indicating where the funds should be rolled over.
In-service distributions allow you to take a distribution up to 100% of the employee’s elective deferral, matching contribution, and any qualified non-elective contributions at the attainment of a specified age, (determined by the plan), but typically at the age of 59 ½. Employees will be taxed if taking out this distribution. To avoid this some individuals choose to rollover their balance as opposed to taking a distribution. Some key items to be aware of include:
- Proper employee information to determine that they have reached the age of 59 ½.
- A request form (online or paper).
There are, of course, other types of distributions but those listed above are the most typical distributions you will see. In all distributions it is important to ensure that there is a proper process in place to verify that the distribution was 1) requested, 2) in compliance with the plan, and 3) to ensure documentation is retained to show proof of these items.
By Brie C. Keckler, CPA