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Accepting Rollovers Into Your 401(K) Plan
May 2000

Most employers permit employees to rollover into the employer's tax qualified 401(k) or other defined contribution plan eligible rollover distributions received from plans maintained by prior employers. The Internal Revenue Code permits such a rollover so long as the prior employer's plan is tax qualified, the distribution is an eligible rollover distribution and the transfer is made directly to the recipient plan by the distributing plan (or is deposited in the recipient plan within 60 days after distribution to the employee). An eligible rollover distribution generally is a distribution to an employee participant before age 70 1/2 from an employer sponsored retirement plan, excluding: (1) amounts paid as an annuity or in installments over a period of ten years or more; and (2) 401(k) hardship distributions. Additionally, voluntary after tax contributions made under a prior plan cannot be rolled over.

A tax qualified retirement plan can also be drafted to accept rollovers from so-called conduit IRAs (either by direct transfer or transfer within 60 days of distribution). A conduit IRA is an IRA which contains no assets other than eligible rollover distributions previously rolled into the IRA from a prior employer's qualified plan in a tax free manner, plus the earnings thereon.

If an employer permits rollovers (directly or through a conduit IRA) from a prior employer's retirement plan and the prior plan is not tax qualified, there is a risk that the recipient plan may lose it's tax qualified status. To allay such concerns and enhance the portability of retirement plan distributions, the Internal Revenue Service has issued revised regulations providing expanded relief to plans that receive defective rollovers.

Under the regulations, a recipient plan that accepts a defective rollover will not lose its tax qualified status if before accepting the rollover it reasonably concluded that the rollover was proper and if after learning that the rollover was improper it promptly distributes the rollover amount and all earnings thereon.

In the case of a direct rollover transaction where assets are transferred directly from the prior plan to the recipient plan, the recipient plan will be deemed to have reasonably concluded that the rollover was proper if it receives a letter from the distributing plan stating that (1) the distributing plan has a favorable IRS determination letter; (2) the distributing plan is tax qualified; or (3) the distributing plan is intended to be tax qualified and the distributing plan administrator is not aware of any defect.

If the rollover contribution is received from the participant after he or she obtained a distribution, reasonable proof of rollover eligibility includes either of the three types of letters from the prior plan described above, coupled with a certification from the participant. That certification should state that (1) the participant received the distribution as an employee; (2) the distribution was not one of a series of equal payments; (3) the rollover is occurring within 60 days of the initial distribution; and (4) the distribution contains no after tax contributions.

If the rollover is coming from a conduit IRA the above items should be supplemented by a certification from the employee that the rollover to the IRA occurred within 60 days after the prior plan distribution, that no additional funds were contributed to the IRA, and that the transfer to the recipient plan is occurring within 60 days after the distribution from the IRA To backstop the employee's certification, the recipient plan should request and review copies of the employee's IRA statements to verify that no additional IRA deposits were made.

By following the above procedures, a plan sponsor can insure that the acceptance of rollovers from employees doesn't taint the recipient plan.