IRS Offers Two New Due Diligence Safe Harbor Procedures for Accepting Rollovers into Qualified Plans

by Eversheds Sutherland (US) LLP
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On April 3, 2014, the Internal Revenue Service released Revenue Ruling 2014-9 (the Ruling), which provides guidance helpful to the administration of rollovers by tax-qualified retirement plans by:

  • Offering two new due diligence safe harbor procedures that allow a plan administrator to reasonably conclude that a rollover into the plan is a valid rollover contribution within the meaning of Internal Revenue Code (Code) § 401(a)(31). The new safe harbors are simpler than those described in prior guidance, and eliminate the need for any supporting documentation from the transferring plan for many rollovers;
  • Authorizing the payment of otherwise qualified rollover amounts via wire transfer or other electronic means, so long as the necessary information is communicated to the receiving plan administrator. In this respect, the Ruling approves common administrative practice; and
  • Providing that a plan administrator receiving a rollover from a qualified plan on behalf of a participant subject to the required minimum distribution (RMD) rules may presume that the RMD rules for the year of the rollover have been satisfied. This presumption does not extend to rollovers from an individual retirement account (IRA).

The Ruling will be welcome to the administrators of § 401(a) plans who permit rollover contributions into their plans, both from an administrative standpoint and as confirmation that the rollover contributions in these circumstances will not endanger the plan’s tax-qualified status. While not explicitly addressed, this guidance also appears applicable to rollovers into § 403(b), governmental § 457(b), or IRA arrangements.

Background

Normally, distributions from tax-qualified retirement plans and IRAs are taxable as ordinary income to the recipient of the distribution, with additional penalty taxes imposed on distributions made to a recipient before the recipient’s retirement. However, Code § 402(c) provides that, notwithstanding this general rule, a distribution will not be taxable to a recipient if the distribution is an “eligible rollover distribution.” In order to qualify as an eligible rollover distribution, the distribution must be rolled into another qualified plan or IRA within 60 days. Additionally, the distribution must not be an RMD, hardship withdrawal, or a distribution from an inherited IRA.

There is no requirement that a tax-qualified plan permit inbound rollovers, and plans may impose additional restrictions on any inbound rollovers, for example, by not allowing rollovers of after-tax or designated Roth contributions. If a plan does permit inbound rollovers or rollover contributions, in order to retain the plan's tax-qualified status, the plan administrator of the receiving plan must “reasonably conclude” that the rollover is an eligible rollover distribution from the transferring plan or IRA (a valid rollover contribution) and, if the plan administrator later learns that the rollover was not, in fact, a valid rollover contribution (an invalid rollover contribution), the plan administrator must distribute the rolled-over amount (plus any earnings) back to the participant within a reasonable amount of time.

The applicable guidance distinguishes between “rollovers,” which involve transfers directly from one trustee to another trustee for the benefit of the individual involved, and “rollover contributions,” in which the distribution is made directly to the individual, who pays it into an eligible retirement plan or IRA within 60 days of the distribution. Treas. Reg. § 1.401(a)(31)-1, Q & A-14(b); id. § 1.402(c)-2, Q & A-1. Either method of rolling over funds can qualify for tax-free treatment, and this Legal Alert uses the term “rollover” to mean either method.

However, the relevant guidance recognizes that the plan administrator of a receiving plan will not have direct knowledge of the facts necessary to determine whether a tendered rollover actually is a valid rollover contribution, i.e., one that meets all of the statutory and regulatory requirements of an eligible rollover distribution, in addition to any plan-imposed restrictions. Accordingly, the current guidance provides various due diligence procedures under which a plan administrator will be deemed to have “reasonably concluded” that a tendered rollover is a valid rollover contribution. (Current guidance is found in Treas. Reg. § 1.401(a)(31)-1, Q & A-14, ex. 1-4.) These procedures describe various fact patterns involving obtaining letters from the transferring plan or IRA regarding the transferring plan’s or IRA’s status, certain factual representations from the transferring participant regarding compliance with the applicable rules, and/or supporting documentation from the transferring plan or IRA. Absent facts to the contrary, a plan administrator who follows the procedures in the current guidance may treat an inbound rollover as a valid rollover contribution.

Revenue Ruling 2014-9

The Ruling sets forth two new factual scenarios in which a receiving plan administrator will be deemed to have completed the necessary due diligence and to have reasonably concluded that a tendered rollover is a valid rollover contribution.

In Scenario 1, Employee A rolls over funds from a prior employer’s tax-qualified plan into her new employer’s tax-qualified plan, which does not permit rollovers of Roth contributions or after-tax amounts. The transferring plan trustee gives a check to the employee, payable to the receiving plan “for the benefit of” the employee. The employee, in turn, gives the check to the plan administrator for the receiving plan, along with the name of the former employer. The check itself includes a check stub identifying the transferring plan as the source of the funds, and the employee certifies to the plan administrator that the amount of the check is derived wholly from pre-tax contributions. Finally, the plan administrator checks the transferring plan’s most recent Form 5500, publicly available on the Department of Labor website, and confirms that the transferring plan does not self-identify as a non-qualified plan.

In Scenario 2, the facts are the same except that Employee A rolls over funds from a traditional, non-inherited IRA into her employer’s tax-qualified plan. The IRA trustee issues a check directly to the employee, payable to the receiving plan “for the benefit of” the employee, who, in turn, gives the check to the plan administrator. The check stub identifies the source of the funds as the “IRA of Employee A,” and the employee certifies that the funds are derived from pre-tax contributions. The employee certifies further that she is not of an age that would trigger RMDs for the year of the transfer.

In both scenarios, the Ruling holds that, absent facts to the contrary, the receiving plan administrator may reasonably conclude that the tendered rollover is a valid rollover contribution. Under the Ruling’s reasoning, the following facts are relied upon:

Scenario 1:

  • The receiving plan administrator reviews the transferring plan’s most recent Form 5500 and that form does not indicate that the plan is a non-qualified plan, permitting the reasonable conclusion that the transferring plan is qualified.
  • The check is payable to the receiving plan “for the benefit of” the employee, permitting the reasonable conclusion that the transferring plan trustee treated the distribution as an eligible rollover distribution.

The Ruling notes that even if the receiving plan administrator knew that the employee was of an age that would trigger RMDs, the above facts would permit the reasonable conclusion that the transferring plan had complied with the RMD rules before making the eligible rollover distribution.

For this point the Ruling cites Treas. Reg. § 1.402(c)-2, Q & A-7, an ordering rule that provides that when a plan is required to make RMDs under Code § 401(a)(9) for a given year, any distributions made that year will be applied first to satisfying the RMD rules. After the RMD rules are satisfied, additional distributions may be treated as eligible rollover distributions.

Scenario 2:

  • The check is payable to the receiving plan “for the benefit of” the employee, permitting the reasonable conclusion that the transferring plan trustee treated the distribution as an eligible rollover distribution.
  • The check stub indicates the source of the funds is the “IRA of Employee A,” permitting the reasonable conclusion that the source of the funds is a traditional, non-inherited IRA.
  • The employee has certified that the amount rolled over contains no after-tax amounts.
  • The employee has certified that she will not reach age 70 ½ in the year of the transfer, permitting the reasonable conclusion that the RMD rules for IRAs would not apply.

Unlike the first scenario, the Ruling notes that under this second scenario, if the receiving plan administrator knew that the employee was of an age that would trigger RMDs, the plan administrator could not reasonably conclude that the rollover is a valid rollover until the plan administrator received additional information indicating RMDs for that year have been made.

In the IRA context, there is no ordering rule similar to Treas. Reg. § 1.402(c)-2, Q & A-7, for determining which part of an IRA distribution is treated as satisfying the RMD rules. Accordingly, under the facts of Scenario 2, the receiving plan administrator would need independent verification of compliance with the RMD rules.

Under both scenarios and as required under previous guidance, if the rollover is later determined to be an invalid rollover contribution, the amount rolled over, including any related earnings, must be distributed to the employee within a reasonable time.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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