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Practice Management

Select Topics on 403(b) Distributions

David Blask

There are important rules for the many aspects of distributions. Following is a discussion of how to handle those matters.

Distributions on Attainment of Age 59½

A frequent source of confusion when discussing permissible distributions from a 403(b) account is understanding the differences between the rules governing whether a participant is permitted to take a distribution, and the rules governing whether that distribution will be subject to a 10% premature distribution penalty.

Some questions arise in this vein:

  1. Can I take a 403(b) distribution if I am age 59 ½ or older?  Yes, assuming the plan document permits.
  2. Will the distribution be subject to a 10 percent penalty? No.
  3.  I will be turning age 59 ½ in November of this year. Can I take a distribution earlier in the year and avoid the penalty? No. You must have attained age 59 ½ as of the date of the distribution.

In order to ensure these rules are met, the TPA, product provider or plan sponsor should follow these administrative best practices:

  • Acceptable proof of age can be submitted to the product providers directly from the plan participants such as a driver’s license, passport, state photo ID or other acceptable identification with birth date.1
  • If providers have an acceptable record of participant’s date of birth in their records (as may have been required by FINRA or under the Patriot Act when establishing the account), the distribution request can be processed without any additional proof of age.1
  • If there is no TPA, then once the provider has confirmed that plan permits distributions at age 59½, employer authorization is not necessary. If there is a TPA involved, the authorization of whether the plan contains an age 59½ distributable event should be made by the TPA who then in turn authorizes the distribution.2

Severance of Employment

Unlike the rules for age 59½ distributions, taking a distribution after severance of employment from the plan sponsor is a distributable event but does not exempt the distribution from the 10% penalty unless one of the other permitted exemptions is met.

In order to ensure Severance of Employment rules are met, the TPA, product provider, or plan sponsor should follow these administrative best practices:

  • Employer is the best source for information on employment status. However, the only question that should be asked is whether or not the individual is still an employee of the employer. The name of the individual providing the information and the date of the contact should also be recorded. There is no need for additional authorizations, signatures, statements, disclaimers, etc. from the employer.
  • If a TPA is acting on behalf of the employer, the provider may get the information on employment status from the TPA unless the provider has been notified that the TPA will not provide that information. Generally, there will be no ‘TPA’ for safe harbor plans. However, if the employer is using an information coordinator, data aggregator or other similar organization to coordinate information from multiple product providers, then that party can act as the central source for the product providers. Note: This entity can actually be a “TPA”, but they will not be performing the typical TPA functions. The contract should only address the aggregator functions and authorization of the transactions must be done by the vendor.
  • Once the necessary confirmation is obtained, the provider should process the distribution request without requiring further proof or signature from the employer or TPA.
  • If the employer (or TPA) cannot or will not provide confirmation of “no employee” status, recommended best practices are:
  1. The provider should accept other reasonable proof, such as a letter from the retirement board to the participant, an income tax return showing no W-2 income from the employer, a COBRA notice or other documentation that demonstrates a lack of employment relationship between the parties.
  2. The provider should maintain a written or electronic record of its best efforts to obtain confirmation from the employer or TPA or written proof of severance from the participant.
  3. After reasonable efforts to obtain confirmation have failed, the provider may then process the distribution, though at that point the provider may make it clear to the participant that any tax consequences of an improper distribution will fall on the participant. Failure to timely process the distribution request unless there are extenuating circumstances is discouraged and in some cases may be a violation of state contract and/or federal securities laws.3

Death and Disability

Distributions made on account of the death or disability of the participant are subject to ordinary income tax but are not subject to the ten percent premature distribution penalty.

In the event of death, this exemption applies to cash distributions to beneficiaries and distributions made from a beneficiary IRA. It does not apply to account rolled over to a surviving spouse’s IRA in his or her own name (non-beneficiary IRA). Proof of death is typically a copy of a death certificate or reliance on another party as described below.

The standard of proof for disability and the definition of disability may be found in the plan document. For Elective Deferrals in all plans and any investments in mutual funds, the definition of disability is under section 72(m)(7) of the Internal Revenue Code and refers to “total and permanent disability”; under 403(b) annuities for Employer contributions, contracts will frequently use the Social Security definition of disability. Check the Employer’s Plan!

Following are best practices concerning death and disability distributions:

  • Most providers have standard procedures for acceptance of proof of death or disability. However, if the employer has delegated this responsibility to a TPA and the TPA notifies the provider(s) in writing that the TPA has provided the necessary confirmation, the provider should process the death or disability distribution request without additional review (assuming it is reasonable on its face).
  • If the TPA has made the determination that the distribution satisfies the requirements for a disability distribution, the participant remains responsible for supporting the claim to the satisfaction of the IRS to avoid the IRC Section 72(t) penalty. The provider need not impose an additional level of review if the TPA’s determination is reasonable on its face.
  • In a safe harbor plan non-ERISA 403(b) for a 501(c)(3) nonprofit employer, providers must use standard procedures to process death claims without employer signatures or confirmations. Necessary paperwork and signatures can be obtained from beneficiaries or estates of decedent participant. Employers may only provide factual information and perform ministerial tasks.4

Footnotes

1.-4.Best Practices For 403(b) and 457(b) plans. April, 2018, The American Retirement Association.

David Blask is a Senior Pension Consultant for Lincoln Investment.