Plan Loans and Benefit Distributions

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Plan Loans and Benefit Distributions

• Karen D. Ng
• Thelen Reid Priest LLP
• San Francisco, CA
• kng_at_thelenreid.com

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Agenda

• Types of Distributions
• Distribution Forms
• General Distribution Rules
• Examples

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Types of Distributions

• Related to termination of employment
• Retirement
• Death
• Disability
• Termination of employment (e.g, voluntary quit,
  layoff, termination for cause, etc.)

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Types of Distributions

• In-Service Distributions
• Plan Termination
• Hardship Withdrawals
• Minimum Required Distributions
• In-Service Distributions by plan design
• QDROs
• Participant Loans

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Forms of Distribution

• Defined Contribution Plans
• Lump Sum
• Installment
• Defined Benefit Plans
• Qualified Joint and Survivor
• Term Certain
• Social Security Level Income
• Lump Sum

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Participant Consent

• General Rule Participants written consent is
  required for distributions
• Exceptions to General Rule
• Accrued benefit is less than 5,000
• Participant has attained normal retirement age
• Termination of plan where plan sponsor does not
  maintain another plan (other than an ESOP)

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Spouse Consent

• Spousal Consent Required if
• Plan is a pension plan (defined benefit, money
  purchase, target benefit, cash balance), and the
  participant elects a distribution form other than
  a qualified joint and survivor benefit.
• The terms of the plan document provide for
  spousal consent to distributions.

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Notice to Participants

• Written Notice
• Optional forms of payment available under the
  plan
• Ability to delay distribution until normal
  retirement age
• Ability to rollover distribution
• Special Tax Notice

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QJSA Notice

• Must Include
• Description of the QJSA
• Participants right to waive the QJSA and
  election another form of distribution
• Spouses consent rights regarding waiver of QJSA
• Relative values of optional forms of benefits

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Timing of Notice

• 30/90 Day Rule
• Notice must be given no later than 30 days prior
  to the date that the distribution commences
• Notice must be given no earlier than 90 days
  prior to the date that the distribution commences

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Commencement Date

• If the benefit is paid in the form of an annuity,
  then the distribution commences on the date of
  the first annuity payment
• Special rules for retroactive annuity starting
  dates
• If the benefit is paid in the form of an
  installment, then the distribution commences on
  the date of the first installment payment
• If the benefit is paid in the form of a lump sum,
  then the distribution date is the date that the
  lump sum is paid.

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Rollover Rules

• Eligible rollover distribution is a lump sum
  distribution or installment payments for a
  specified period of less than 10 years.
• Direct Rollover
• 60 Day Rollover
• Automatic Rollover
• Hardship Distributions

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Taxation of Benefits

• Tax deferred if benefit is rolled over to an IRA
  or eligible employer plan
• Ordinary income tax rates (exception for
  distributions made in the form of qualifying
  employer securities)
• 10 Additional Tax on Pre-Mature Distributions

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Restrictions on Distributions(Pension Plans)

• Pension Plans (includes defined benefit plans,
  money purchase plan, target benefit plans and
  cash balance plans) can only provide for
  distributions upon
• Retirement
• Termination of employment
• Disability
• Death

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Restrictions on Distributions(Pension Plans)

• In-service distributions permitted after
  attainment of normal retirement age
• Normal retirement age must be reasonable
• Phased retirement

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Restrictions on Distributions(Defined
Contribution Plans)

• Distributions may be made after the funds have
  accumulated in the trust for a fixed number of
  years (two years).
• Distributions may be made after a period of at
  least five years of participation (even if the
  amounts have not accumulated in the trust for two
  years).
• Distributions can be made in-service prior to
  attainment of normal retirement age.

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Restrictions on Distributions(401(k) Plans)

• Distribution of Elective Deferrals can only be
  made due to
• Severance from employment
• Death
• Disability
• Attainment of Age 59 ½
• Financial Hardship
• Termination of Plan

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Hardship Distributions

• Plan must define a hardship distribution in
  objective terms.
• Must be made on account of an immediate and heavy
  financial hardship
• Must not exceed the amount needed to satisfy the
  financial need
• Not eligible for rollover

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Hardship Distributions

• Safe Harbor Definition of Hardship
• Medical care
• Purchase of Principal Residence
• Post-Secondary Education
• Prevention of Eviction or Foreclosure
• Funeral Expenses
• Repair of Casualty Damage to Home

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Participant Loans

• Not Distributions So not subject to the
  distribution rules.
• Taxation to participant if loan does not comply
  with Section 72(p) of the Code
• Watch out for prohibited transaction rules

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Participant Loans

• Loans must be available to all participants on a
  reasonably equivalent basis
• Loans must be legally enforceable
• Loans must be adequately secured
• Loans must bear a reasonable interest rate

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Participant Loans

• Loan must provide for level amortization
• Loan must specify
• Amount of loan
• Term of loan and loan initiation date
• Repayment Schedule
• Exceptions for leaves of absence and USERRA

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Participant Loans

• Maximum Loan Amount
• Lesser of 50,000 (less highest loan balance in
  last 12 months) or
• Greater of 50 of the participants vested
  account balance or 10,000.
• Repayment Term
• Maximum of five years unless loan is for purchase
  of a primary residence

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Participant Loans

• Loan Default occurs
• Failure to make any payment when due in
  accordance with the terms of the note
• Loan amortization period exceeds maximum
  allowable period
• Cure Period
• End of calendar quarter following the calendar
  quarter in which the default occurred

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Participant Loans

• Deemed Distribution
• Amount of outstanding loan balance is includible
  in income
• Additional 10 pre-mature distribution tax could
  apply
• Not eligible for rollover
• Additional security required for new loans
  following a deemed distribution

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Example No.1

• Paris Marriott is a participant in the Simple
  Life Employees Plan. She has terminated service
  and calls you about receiving her benefit.
• What information do you need to know??

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Example No. 1 Cont.

• Is the plan a defined contribution plan or a
  defined benefit plan?
• The Simple Life Employees Plan is a defined
  benefit plan, and is subject to the qualified
  joint and survivor rules. The plan offers only a
  lump sum, life only annuity and 50 QJSA.
• Has Paris terminated service?
• She was fired because she repeatedly washed her
  car on company time.

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Example No. 1 Cont.

• Is Paris married?
• Paris has been married to Sam Marriott for five
  years.
• Has Paris reached retirement age under the plan?
• The plan provides for normal retirement at age
  65, and early retirement at age 55 with at least
  10 years of service. Paris is age 50 with 15
  years of service.

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Example No. 1 Cont.

• Conclusions
• Paris is not currently eligible to receive a
  distribution from the plan because she has not
  attained early or normal retirement age. She
  will be eligible to receive an early retirement
  benefit when she attains age 55 because she has
  more than 10 years of service.

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Example No. 1 Cont.

• If Paris elects an early retirement benefit, the
  benefit must be at least actuarially equivalent
  to her normal retirement.
• If Paris does not elect to receive early
  retirement benefits, she will begin to receive
  her benefit at normal retirement age.

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Example No. 1 Cont.

• Assuming that Paris is still married to Sam when
  she is eligible to commence benefit payment, the
  benefit will be paid in the form of a 50 joint
  and survivor benefit, unless Sam consents to
  Paris election to receive the lump sum payment
  or the life only annuity.

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Example No. 1 Cont.

• If Paris elects the lump sum payment, it will be
  eligible for rollover to an IRA or eligible
  employer plan.
• If Paris elects the 50 JS or the Life Only
  Annuity, benefit payments will not be eligible
  for rollover.

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Example No. 2

• Baylor Hicks is a participant in the American
  Idol Savings Plan, and has called you inquiring
  about his benefit.
• What do you need to know?

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Example No. 2 Cont.

• Is the plan a defined benefit plan or a defined
  contribution plan?
• The American Idol Savings Plan is a Section
  401(k) Plan (defined contribution plan).
• Has Baylor terminated service?
• No, Baylor is still employed by the company.

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Example No. 2 Cont.

• Does the plan provide for any form of in-service
  distributions?
• The plan provides for hardship withdrawals, but
  does not permit participant loans.
• Is Baylor eligible for a hardship withdrawal?
• Baylor wants to take a distribution to enroll in
  singing classes.

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Example No. 2 Cont.

• Conclusion
• Since singing lessons are unlikely to be
  considered a hardship, Baylor is not eligible to
  receive a distribution from the plan at this
  time.

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Example No. 2 Cont.

• Because he doesnt take singing lessons, Baylors
  first record sells 123 copies (friends and
  family) and he loses his recording contract.
• Because he loses his recording contract, he
  cannot afford to pay his rent, and request a
  hardship distribution. Since prevention of
  eviction is an acceptable hardship reason, he is
  eligible to receive a hardship distribution.

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Example No. 3

• Max Speed is a participant in the Formula One
  Profit Sharing Plan, and wants to buy a new race
  car. He contacts you about getting a
  distribution from the plan.
• What do you need to know?

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Example No. 3 - Cont.

• Is the plan a defined benefit plan or a defined
  contribution plan?
• The plan is a Section 401(k) plan (defined
  contribution plan) that only provides for
  elective deferrals (no employer contributions).
• Has Max terminated service?
• No, Max is still employed by the company.

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Example No. 3 Cont.

• Does the plan provide for any form of in-service
  distributions?
• The plan provides for hardship withdrawals,
  in-service distributions after attainment of age
  59 ½, and participant loans.
• Is Max eligible for a hardship withdrawal?
• No, the purchase of a race car does not qualify
  as a hardship.

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Example No. 3 Cont.

• Is Max eligible for an in-service distribution?
• Yes, he is age 60.
• His in-service distribution will not be subject
  to 10 pre-mature distribution tax because Max
  has attained age 59 ½.

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Example No. 4

• Anna Nicole Jones is a participant in the Scary
  Chick 401(k) Plan. The plan provides for up to
  three participant loans at any one time.
• Annas total account balance under the plan is
  200,000.
• Four months ago, Anna took out a participant loan
  in the amount of 20,000.

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Example No. 4 - Cont.

• Anna says she needs 10,000 in order to groom her
  dog, and wants to take out a second participant
  loan.
• What do you need to know?

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Example No. 4 Cont.

• Will the new loan exceed the maximum permissible
  loan amount?
• Lesser of
• 50,000 (less high loan balance in last twelve
  months) 50,000 - 20,000 30,000 or
• Greater of 50 of her vested account balance or
  10,000 100,000
• No, the maximum permissible loan amount is
  30,000.

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Example No. 4 - Cont.

• What is the status of Annas current loan?
• The last payment was due on January 15th, and she
  failed to make the payment before June 30th (the
  end of the calendar quarter following the
  calendar quarter in which the default occurred).
• Accordingly, Anna has a deemed distribution of
  her first loan.

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Example No. 4 Cont.

• How Does the Deemed Distribution of Annas First
  Loan Impact the Second Loan?
• Payroll withholding on the second loan will be
  required unless Anna agrees to provide additional
  security outside the loan.

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Example No. 4 Cont.

• Anna tells you that the dog grooming will now
  cost 40,000 (she has selected the deluxe
  grooming), and wants to change her loan amount to
  40,000. Is this permissible?
• No, this would exceed the maximum permissible
  loan amount (30,000). Even though there was a
  deemed distribution of the first loan, it is
  still treated as outstanding.

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Questions??

• Have a Great Day!!