In December 2019, the Bipartisan American Miners Act of 2019 (BAMA) was signed into law and allowed in-service distributions for plan participants to commence at age 59 ½. The previous age requirement to allow these distributions was age 62. This provision is voluntary for plan sponsors and must be reflected in the current plan document to allow for age 59 ½ distributions.
For a defined contribution plan, such as a 401(k) or 403(b), an in-service distribution at 59 ½ is a fairly straightforward process. However, in a defined benefit plan, such as a pension, an age 59 ½ in-service lump sum distribution must satisfy one of three thresholds before a Highly Compensated Employee or Highly Compensated Former Employee (as defined by the IRS) can receive their lump sum in-service distribution:
- After the payment of the lump sum, the value of the plan assets equals or exceeds 110% of the value of the plan’s current liabilities;
- The value of the benefits paid to the participants are less than 1% of the plan’s current liabilities; or
- The value of the benefits payable to a participant does not exceed $5,000.
These safeguards are in place to ensure that the plan has sufficient assets to pay out other plan participants in the event of a significant lump sum in-service distribution from an owner or principal within an organization. However, many owners or principals are not aware of this provision when they implement a new plan. They are expecting the option to take their lump sum in-service distribution at age 59 ½ with the ability to roll this benefit to their existing defined contribution plan or IRA, continue to defer taxation on these monies, and be able to invest this benefit as aggressively as they would like.
Since a defined benefit plan can be underfunded or overfunded at any specific point in time, most lump sum in-service distributions for Highly Compensated Employees are contingent on satisfying the 110% threshold mentioned above. In the event that the plan does not satisfy the “110% test”, the plan sponsor could make an additional plan contribution to get to the 110% threshold and allow the lump sum in-service distribution. Otherwise, the participant’s benefit will be restricted to an amount equal to the payments that would be made under the Single Life Annuity that is actuarially equivalent to the participant’s accrued benefit.
Contact the team at Watkins Ross with questions about whether or not your defined benefit plan and status qualify for lump sum distributions.