3 Retirement Account Rules to Know

Much of what you can and cannot do with retirement plan assets is governed by tax laws written by Congress and interpretations by the IRS and the U.S. federal court system. Understanding these rules and keeping up-to-date on these changes will help you ensure that your retirement account is operating within regulatory guidelines. Here is a review of some of the rules that are likely to affect your retirement account.

(See our tutorial: Retirement Planning Basics)

Cash-Out Rules

Some qualified plans include a provision that allows the plan to distribute your vested balance without your consent if the balance is less than $5,000. This is referred to as an involuntary cash-out.

The rules for involuntary cash-outs changed in 2005, and became effective for plan years that end after March 28, 2005. These rules require plan administrators to roll over your involuntary cash-out amounts between $1,000 and $5,000. This means that the plan administrator can't distribute amounts within this range to you, but must establish a Traditional IRA to which the amount must be rolled over. If the plan administrator does not want to establish an IRA for participants affected by the rules, the administrator must amend the qualified plan by reducing the involuntary cash-out amount to no more than $1,000. Under this option, the plan administrator cannot distribute your balance if the amount is over $1,000. Some plan administrators may even choose to reduce the cash-out amount to zero, thereby eliminating the cash-out provision from the plan.

“For participants who are no longer employees at the sponsoring company and have vested balances under $5,000, they may be subject to an involuntary cash-out if they are non-responsive in terms of communication about distributions. The third-party administrator must notify the participant of the decision to cash out the vested balance and allow a response from the participant how he or she would like the money distributed. For participants with vested balances of $1,000 or more, the plan must roll the assets over into an IRA of a designated trustee or issuer,” says Mark Hebner, founder and president, Index Fund Advisors, Inc., in Irvine, Calif., and author of “Index Funds: The 12-Step Recovery Program for Active Investors.”

What Counts as the 'Vested Account Balance'
When determining your vested account balance for the purpose of the cash-out rules, the plan administrator may disregard amounts you rolled over from another retirement plan. This means that the cash-out amount can be more than $5,000. For instance, say you rolled over $50,000 from a 401(k) plan you maintained with a former employer to your current 401(k) account, and your total balance is now $53,500. This entire amount may be cashed out because the amount accrued under the current plan is less than $5,000.

Be sure to check with your plan administrator to determine whether any cash-out rules apply to your plan balance. If so, take steps to confirm that the assets are distributed in accordance with your instructions. This will help to ensure that you keep track of your assets. (For further reading, see Keeping Track of Retirement Plan Assets.)

Roth 401(k) Plans

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which became effective for tax years beginning January 1, 2002, includes a provision that allows employers to add a Roth program to a 401(k) or 403(b) plan. This provision became effective January 1, 2006.

Under the Roth 401(k) or Roth 403(b) program, plan participants are allowed to make Roth contributions to their 401(k) plans or 403(b) accounts on an after-tax basis. Earnings on these contributions accrue on a tax-deferred basis, and are tax free if qualified.

The contribution limit to the Roth 401(k) and Roth 403(b) accounts is subject to the same limit as regular 401(k) and 403(b) salary deferrals. For instance, amounts contributed for 2017 cannot be more than $18,000, plus an additional $6,000 catch-up contribution for individuals who reach are age 50 or over. (For more on Roth 401(k) plans, see An Introduction to the Roth 401(k).)

Heroes Earned Retirement Opportunities (HERO) Act

Generally, combat-zone compensation earned by members of the Armed Forces is not considered eligible for making an IRA contribution because these amounts are not taxable income. The HERO Act redefined these amounts as compensation that counts in determining eligibility to contribute to an IRA, Roth IRA or the government's Thrift Savings Plan. (For further reading, see What pension benefits are available to military personnel?)

The Bottom Line

Keeping on top of these changes will help you ensure that your retirement assets are managed in accordance with any new rules. Failing to do so could result not only in penalties and loss of the tax-deferred status of those assets, but also missed opportunities and therefore loss of important benefits. Pay special attention if you're cashing out a 491(k) or other qualified plan that contains money you contributed from a previous employer's retirement plan. (For more, check out Top 10 Tips for a Financially Safe Retirement.)