The final 401(k) regulations very clearly outline restrictions on distributions. In part five, we covered hardship distributions. In part six, we describe the rest of the distribution rules.

Final Regulations Part Six – Restrictions on withdrawals

Distributable Events for Elective Deferrals

The Final Regulations state the reasons that permit distribution of a participant’s elective deferrals:

Distributions upon plan termination -- Successor Plan Rules
A distribution from a 401(k) plan may not be made if the employer establishes or maintains an alternative defined contribution plan (a/k/a "successor" plan). In the case of mergers or acquisitions, the definition of the term “employer” is applied as of the date of plan termination, and a plan is an alternative defined contribution plan only if it is a defined contribution plan that exists at any time during the period beginning on the date of plan termination and ending 12 months after distribution of all assets from the terminated plan.

Prior to the final regulations, defined benefit plans (including cash balance plans), ESOPs and SEPs had been the only plans that could be established or maintained during the above period without violating the successor plan rule. The final rules add SIMPLE IRAs, 403(b) and 457(b) plans to the list of plans that do not constitute a successor defined contribution plan.

With the exception of the plans listed above, the employer may not maintain any other defined contribution plan during the period 12 months before and after the termination date of a 401(k) plan.

The 2% Exception to the Successor Plan Rule
However, if at all times during the 24-month period beginning 12 months before the date of plan termination, fewer than 2% of the employees who were eligible under the 401(k) plan as of the date of plan termination are eligible under the other defined contribution plan, that plan is not an alternative defined contribution plan and the successor plan rules would not be violated.

Plan-to-plan-Transfers require withdrawal restriction maintenance
In the event of a plan-to-plan transfer of assets, withdrawal restrictions on elective deferrals and qualified contributions must be maintained post-transfer by the receiving plan.

Distributions upon severance from employment
An employee has a severance from employment when the employee ceases to be an employee of the employer maintaining the plan. An employee does not have a severance from employment that would permit distribution if, in connection with the change of employment, the employee’s new employer continues to maintain the existing retirement plan with respect to the employee. For example, this would occur if the new employer assumes sponsorship of the plan or accepts a transfer of plan assets and liabilities (within the meaning of section 414(l)) with respect to the affected employee.

Change to leased employee status
If the employee's status changes from that of a common law employee to a leased employee and the individual still performs services for the same recipient employer, a severance from employment does not occur and this is not a distributable event. This result occurs because an individual who is a leased employee generally is treated as the employee of the recipient of the individual’s services for coverage purposes.

Excess Deferrals (Violation of Code Section 402(a) e.g. $14,000 per year limit for 2005)
Excess deferrals (plus earnings or net losses) may be distributed by April 15 of the year following the year of deferral. If they are not distributed by the deadline, the excess deferrals may not be distributed without a distributable event and will be subject to taxation a second time upon ultimate distribution. To see the MHCO excess deferral correction chart click here.

Deemed distributions
Certain transactions are not considered distributions of elective deferrals and are therefore not subject to the list of distributable events, such as: