IRS Issues Safe Harbor Explanations on Certain Qualified Plan Distributions

© Barry C. Picker, CPA/PFS, CFP
www.BPickerCPA.com
Email: Barry@BPickerCPA.com

The Internal Revenue Service has issued Notice 2002-3, 2002-1 IRB 1, which obsoletes Notice 2000-11, 2000-6 IRB 572. Notice 2002-3 reflects changes made by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), P.L. 107-16. The Notice contains safe harbor language that can be used to satisfy the requirements of Internal Revenue Code Section 402(f).

Section 402(f) requires the plan administrator of plan qualified under Section 401(a), which includes a 401(k) plan, or Section 403(a) annuity, to provide a written explanation to any recipient of an "eligible rollover distribution". An "eligible rollover distribution" is defined as any distribution except a required distribution, a hardship distribution, or a distribution that is basically in the form of an annuity for a period of ten years or more, for the life of the recipient, or for the lives of the recipient and beneficiary.

The written explanation to the recipient is required to notify the recipient of his right to have the distribution directly transferred into an eligible retirement plan, that the employee is required to withhold income tax if the distribution is not directly transferred into an eligible retirement plan, that the recipient can avoid income tax on the distribution by transferring the distribution into an eligible retirement plan within 60 days of the date of the distribution, and if applicable, the availability of ten year averaging, capital gains treatment of pre 1974 account balances, and the capital gains treatment of net unrealized appreciation of employer securities. The regulations require the explanation to be given to the recipient no less than thirty days nor more than ninety days prior to the distribution.

EGTRRA added governmental Section 457 plans and Section 403(b) annuities to the list of eligible retirement plans that can receive a rollover distribution. Prior to EGTTRA, a distribution could only be rolled over into an IRA, a qualified trust, or a Section 403(a) annuity plan. EGTRRA also now permits distributions from a governmental Section 457 plan or a Section 403(b) annuity to be rolled over to an eligible retirement plan. EGTRRA amended Section 402(f) to require the written explanation to include information about when a later distribution from the receiving plan may be subject to restrictions and tax consequences that are different from the plan making the "eligible rollover distribution".

The Notice advises plan administrators or Section 403(b) annuity payors that any language in Notice that is not relevant to a particular plan can be eliminated.

The Notice explains the implications of rolling over after-tax contributions, which, under EGTRRA is now permitted. For example, one can roll over after-tax contributions to another plan or to an IRA. However, if one rolls over after-tax contributions to an IRA, those amounts will not be eligible to be rolled over to another plan. Similarly, the after-tax contributions can be rolled over into another plan only if the receiving plan will separately account for the after-tax amounts. Although rollovers can now be made into governmental Section 457 plans, you cannot roll over after-tax contributions into a 457. Also, after-tax contributions can only be rolled over to another plan in a direct rollover. You cannot utilize the 60 day rule to take the after-tax contributions and then roll them over to another plan, although you can use the 60 day rule to roll over after-tax contributions into an IRA.

The Notice itself is good source of information for the rules concerning distributions and rollovers. The safe harbor language is designed to be readable by lay people, so it should be readily understandable by tax pros.