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. In this article, we review some rules that are likely to affect your retirement account.
Tutorial: Retirement Planning
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 become effective for plan years that end after March 28, 2005. These rules now require plan administrators to roll over your involuntary cash-out amounts between $1,000 and $5,000. This means that the plan administrator can no longer distribute amounts within this range to you. Instead, the administrator 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.
A Note on What's Counted 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, whose 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, and if so, take steps to ensure 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 Your 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 2013 cannot be more than $17,500, plus an additional $5,500 catch-up contribution for individuals who reach age 50 by the end of the 2013 calendar year. (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 compensation that is 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. (For further reading, see Benefits for Members of the Armed Forces.)
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 assets, but also missed opportunities and therefore loss of important benefits. For instance, EGTRRA increased the amounts that can be contributed to an IRA each year. Individuals who are not aware of this provision may not be able to benefit by contributing larger amounts to their IRAs. (For more, check out Top 10 Tips For A Financially Safe Retirement.)