QUESTION: Our company sponsors a 401(k) plan and is reviewing the plan’s rollover procedures. Could you review for us the definition of an eligible rollover distribution?
ANSWER: Generally, an “eligible rollover distribution” is any distribution to a participant, spouse beneficiary, spouse (or former spouse) alternate payee, or designated non-spouse beneficiary that is paid in a lump-sum payment or a series of installments over a period of less than ten years. Eligible rollover distributions can be moved, without taxation, from a 401(k) plan into another tax-advantaged retirement plan or individual retirement account (IRA).
If a distribution is an eligible rollover distribution, the plan must offer the participant, spouse beneficiary, or spouse (or former spouse) alternate payee the opportunity to choose a rollover that is made directly from the plan to another plan or IRA—which is called a direct rollover. For a designated non-spouse beneficiary, the direct rollover is available only to an IRA, not to another plan. To encourage participants and beneficiaries to elect direct rollovers, a mandatory 20% federal income tax withholding requirement applies to an eligible rollover distribution when a participant or beneficiary chooses not to use the direct rollover.
A plan is required to make a direct rollover distribution of an eligible rollover distribution to any eligible retirement plan designated by a participant, a spouse beneficiary, or a spouse (or former spouse) alternate payee, even if the eligible retirement plan is not a qualified plan. (An “eligible retirement plan” includes a qualified defined contribution plan, an IRA, a 403(b) plan, a 403(a) annuity plan, or an eligible 457 plan.) A plan also is permitted, but not required, to make direct rollover distributions to defined benefit plans.
While most 401(k) plan distributions are eligible rollover distributions, certain types of distributions that may be available in a plan are not and thus cannot be distributed in a direct rollover to another plan or IRA. The following types of distributions are specifically excluded from the definition of eligible rollover distribution:
a series of substantially equal periodic payments made not less frequently than annually and made over (1) the life of the participant (or the joint lives of the participant and the participant’s designated beneficiary), (2) the life expectancy of the participant (or the participant and the participant’s designated beneficiary), or (3) a specified period of ten years or more;
a required minimum distribution (RMD) (however, an amount that exceeds the RMD amount for the year is not an RMD and might qualify as an eligible rollover distribution);
a hardship distribution;
a corrective distribution of excess annual additions, excess deferrals, excess contributions, or excess aggregate contributions; and
a loan that is treated as a deemed distribution.
Special rules apply to distributions that include contributions made on an after-tax basis, such as Roth and after-tax contributions.
For more information, see EBIA’s 401(k) Plans manual at Sections XIV.B (“Defining an Eligible Rollover Distribution”), XIV.C (“Direct Rollover Distributions”), XIV.E (“Roth Rollovers to Roth Accounts in Other Plans or Roth IRAs”), and XIV.J.1 (“Income Tax and Withholding Rules on Eligible Rollover Distributions Not Rolled Over”).
Contributing Editors: EBIA Staff.