401(K) Distributions and Portability

he modern workplace differs greatly from that of even a few years ago. Companies merge (or are gobbled up and taken over) with much more frequency. Employees tend to move around—they’re no longer wedded to one company for the duration of their careers.

Another difference in the work enviro nment has been the tremendous growth in the use of qualified cash or deferred compensation plans (also known as 401(k) plans) as a benefit offered to employees and the accompanying growth in the value and amounts invested in these plans. However, while their accounts have been reaping the benefits of a strong economy, employees’ access to and use of the money in these accounts has been limited.

Same-desk rule. In general, 401(k) plans have fairly restrictive distribution rules. Distributions can be made (without penalty) only if certain specified events occur: an employee’s death, retirement, reaching age 59 ¹ /2, disability or separation from service with the company that maintains the plan.

“Separation from service,” however, does not necessarily mean “severance from employment.” If, as a result of certain liquidations, mergers or consolidations, employees continue on the same job, but for a different employer, until recently the IRS considered such employees (although severed from employment) as not having separated from service. Instead, they were considered as having an ongoing relationship—working at the “same desk” and doing the same work as before. Thus, although the company maintaining the 401(k) plan no longer employed these workers, they could not receive their plan balances.

There were exceptions to this general rule. A 401(k) plan could make distributions to employees affected by a sale of a corporation’s subsidiary or of “substantially all” (at least 85%) of the assets of a trade or business. However, this exception typically did not apply unless the transaction was a sale, 85% of the assets were involved and the buyer was a corporation.

Effects of same-desk rule. This restriction on plan distributions had both good and bad implications. While it protected employees from receiving and spending their savings, the rule precluded those who had different employers but had been at the “same desk” from consolidating their accounts and investing their money in the more profitable plan of a current employer.

In addition, plan administrators typically did not have access to information on the activities of unrelated employers, so it could be difficult for them to determine whether and when a participant had been separated from service or whether the same-desk rule applied; and applying that rule required an administrator to make “judgment” calls (for example, whether the 85% requirement had been met).  

CURRENT DEVELOPMENTS

The IRS recently issued revenue ruling 2000-27, which seemed to abandon the same-desk rule. In it, the service allowed employees performing the same job for the buyer as they had for the seller to be considered separated from service after a less-than-85% sale of a trade or business, even though neither the buyer nor the seller was a corporation and the buyer was contractually bound (as part of the sale) to hire the transferred employees.

At the same time, Congress—concerned about the effects of the same-desk rule—proposed a legislative solution. The Retirement Security and Savings Act of 2000 (which has been passed by Congress, but not signed by the president as of this writing) would change the Internal Revenue Code to provide that 401(k) distributions may be made on severance from employment.

For a discussion of this and other developments in employee benefits and pensions, see “Current Developments (Part I),” by Peter Elinsky, Terrance Richardson and Betsy Rogers, in the November 2000 issue of The Tax Adviser.

—Nicholas Fiore, editor
The Tax Adviser