Seyfarth Synopsis: As previously reported here, on December 20, 2023, the IRS issued Notice 2024-2 (the “Notice”) providing guidance on several outstanding questions related to provisions under SECURE 2.0. This blog post summarizes the guidance under the Notice for in-service distributions to terminally ill employees that qualify for a waiver from the 10% early withdrawal tax that normally applies to early distributions from retirement plans. In the Notice, distributions qualifying for relief from the early withdrawal tax are referred to as “terminally ill individual distributions” (“TI Distributions”).
TI Distributions In General
- What is a TI Distribution? A TI Distribution is an in-service distribution to a “terminally ill individual.” Notably, there is no independent right to receive a TI Distribution. Rather, the participant must otherwise be eligible to receive an in-service distribution (e.g., an age 59½, disability or hardship withdrawal) under the qualified retirement plan. In order for the in-service distribution to qualify as a TI Distribution, it must also meet additional requirements described below.
- What is the advantage of having an in-service distribution classified as a TI Distribution? TI Distributions are exempt from the 10% early withdrawal tax. Also, participants have the right to repay TI Distributions as described below.
- If a plan does not provide for TI Distributions, may a participant treat an in-service distribution as a TI Distribution? Yes. If the participant receives an otherwise permissible in-service distribution, like a hardship withdrawal, and that participant meets the requirements for a TI Distribution, then the participant may treat the distribution as a TI Distribution on his or her tax return to avoid paying the 10% early withdrawal tax. In that situation, when filing his or her taxes, the employee will need to claim on Form 5329 that the distribution is a TI distribution and retain the physician’s certification (see below) in his or her tax records.
- Under which plans may a participant take advantage of the new TI Distribution rules? The guidance confirms that TI Distribution tax treatment will apply to in-service distributions from all “qualified retirement plans,” which include 401(k), 403(b) and defined benefit pension plans, as well as individual retirement accounts.
Terminally Ill Individuals and Certification
- Who is a “terminally ill individual”? A “terminally ill individual” is someone who has been certified by a “physician” as having an illness or physical condition reasonably expected to result in death within 84 months of the date of the “certification of terminal illness.”
- Who is a “physician”? A “physician” is a person who is State-qualified to practice medicine or osteopathy.
- What must be included in the “certification of terminal illness”? A physician’s “certification of terminal illness” must include several items, including:
- A statement that the participant has an illness or physical condition reasonably expected to result in death within 84 months after the date of certification;
- A summary of the evidence used to support such certification;
- The name and contact information of the physician;
- The date the participant was examined and the date of the certification; and
- The signature and attestation of the physician attesting to the information provided in the certification.
Self-certification by the participant is not permitted.
- When must a certification of terminal illness be made? In order for a distribution to qualify as a TI Distribution, the certification must be made and dated no later than the date of the distribution.
- What documentation must a participant give to the plan administrator to qualify for relief from the 10% tax on early withdrawals? In a plan that has been amended to provide for TI Distributions, a participant must provide the physician’s certification of terminal illness to the plan administrator. While the participant does not need to provide the underlying documentation, the participant should keep a copy of such documentation for their tax records. In a plan that is not amended to provide for TI Distributions, a participant does not need to provide the physician’s certification of terminal illness to the plan administrator.
- Is there a limit on the amount that may be distributed as a TI Distribution? No, not directly. But plans may impose a minimum or maximum distribution amount on in-service distributions (e.g., withdrawals at or after age 59½ or hardship distributions), or a limit on the number of in-service withdrawals taken by a participant. If a plan that puts such a limit on a permissible in-service distribution, those same limits would apply if the participant qualifies for a TI Distribution.
- Can a TI Distribution be repaid to the plan? Yes, if a plan adopts the TI Distribution rules, rules similar to those that apply to the recontribution of birth and adoption distributions apply to TI Distributions. For example, plans that provide for TI Distributions must accept repayments, even if the distribution did not come from that specific plan, as long as the participant is eligible to make rollover contributions to that specific plan. A special rule applies for distributions from a plan that does not specifically provide for TI Distributions. In that case, the participant may repay the distribution to an IRA. In any case, the repayment must be made during the 3-year period beginning on or after the date on which the distribution was received.
- If a plan chooses to recognize TI Distributions, does the plan have to be amended? Yes, the plan must be amended if the plan sponsor chooses to permit these distributions (and accept repayment).
- If a plan sponsor chooses to amend its plan to apply the special TI Distribution tax rules, what is the amendment deadline? The Notice provided an additional extension of the deadline to adopt SECURE, CARES and SECURE 2.0 amendments (including amendments for Terminally Ill Individual Distributions) to December 31, 2026 for non-governmental and non-collectively bargained plans (December 31, 2028 for collectively bargained plans, and December 31, 2029 for governmental plans).
As always, if you have any questions on how this impacts your retirement plan, please do not hesitate to reach out to your Seyfarth Employee Benefits attorney.