What Are the Withholding Rules for Small 403(b) Rollover Balances?

Q: Our ERISA 403(b) plan automatically cashes out small balances (less than $5,000) of terminated employees, with rollovers to an IRA for balances between $1,000 and $5,000. It is our understanding that these are all eligible rollover distributions subject to 20% withholding if not rolled over; however, our recordkeeper says that is not the case for distributions less than $200. Is our recordkeeper correct?

Kimberly Boberg, Taylor Costanzo, Kelly Geloneck and David Levine, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

A: For the most part, your recordkeeper is correct, thanks to a not-so-well-known IRS regulation that states that, if total distributions to a participant in a tax year are less than $200, such distributions are not subject to the 20% mandatory withholding. Also, the plan is not required to allow participants to make a direct rollover of such amounts (though the participant may complete an indirect rollover), and no withholding notice and election is required either. Therefore, we would clarify your recordkeeper’s assertion to note that if the participant has other distributions during the tax year that would cause the total of all the participant’s distributions to amount to $200 or more, then the normal withholding/rollover rules would apply.

There is also an IRS notice for eligible rollover distributions which contains the following language that summarizes these rules nicely, as follows (note that the language is slightly different for Roth distributions):

“If your payments for the year are less than $200 (not including payments from a designated Roth account in the Plan), the Plan is not required to allow you to do a direct rollover and is not required to withhold federal income taxes. However, you may do a 60-day rollover.”

NOTE: This feature is to provide general information only, does not constitute legal advice and cannot be used or substituted for legal or tax advice.

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