Permissive Withdrawals in Plans With Auto-Enrollment

Many employers offer workplace retirement savings vehicles, such as 401(k) plans, to help their workforce prepare for the future. To increase employee participation, companies frequently use an automatic enrollment feature. This approach defaults employees into the plan, meaning a portion of their wages is automatically directed into retirement savings unless they actively choose to opt out or select a different contribution amount.

The initial contribution rate for automatically enrolled employees is set by the plan, often starting at a modest percentage of pay, such as 3 percent. These contributions are taken from an employee’s paycheck on a pre-tax basis, reducing their taxable income for the year. If the employee does not select specific investments, the money is placed in a default investment option chosen by the employer, known as a Qualified Default Investment Alternative (QDIA).

Employers must provide employees with a notice before they are automatically enrolled. This notice explains the process, their default contribution rate, and their right to change their contribution level or opt out of participation entirely.

Defining Permissive Withdrawals in Auto-Enrollment Plans

A permissive withdrawal is a feature in certain automatic enrollment retirement plans that acts as a reversal mechanism. It allows employees who were automatically enrolled to withdraw the initial contributions that were deducted from their pay if they decide shortly after that they do not wish to participate.

This withdrawal option is found in plans that operate as an Eligible Automatic Contribution Arrangement, or EACA. For most retirement plans established before December 30, 2022, the feature remains optional. However, most newer plans that are required to include an automatic enrollment feature must also offer permissive withdrawals.

The withdrawal is an all-or-nothing event; an employee must withdraw the entirety of the automatic contributions made up to that point and cannot take a partial distribution. This feature applies only to the funds contributed through the automatic enrollment process.

Conditions for Making a Permissive Withdrawal

Several strict conditions must be met for an employee to execute a permissive withdrawal. An employee must make the election to withdraw the funds within a specific window, which is no more than 90 days from the date the first automatic contribution was deposited into their retirement account.

The funds eligible for this type of withdrawal are also narrowly defined. The distribution is limited to the amount of the employee’s contributions made through the automatic enrollment feature before the withdrawal election is finalized. It must also include any investment earnings or account for any losses attributable to those specific contributions. This option does not extend to any matching contributions made by the employer; if an employee withdraws their automatic deferrals, any associated employer match is forfeited.

The ability to take a permissive withdrawal depends on the specifics of the retirement plan, and the provision must be included in the plan’s official document. Employees can verify if their plan permits this by reviewing the Summary Plan Description (SPD), which outlines the plan’s rules. If the SPD is unclear, the employee should contact their company’s human resources department or the designated plan administrator.

Tax Treatment of Permissive Withdrawals

The tax consequences of a permissive withdrawal are straightforward. The entire amount of the distribution, which includes both the original pre-tax contributions and any associated earnings, must be included in the employee’s gross income for the tax year in which the withdrawal is received. The funds are subject to ordinary income tax at the employee’s applicable rate, and the plan administrator will report this distribution on Form 1099-R.

A defining characteristic of a permissive withdrawal is its favorable treatment regarding early distribution penalties. Withdrawals from a 401(k) plan before an individual reaches age 59½ are subject to a 10% additional tax on early distributions. However, permissive withdrawals taken under the specific rules of an EACA are explicitly exempt from this 10% penalty.

This tax treatment makes the permissive withdrawal a distinct event compared to other types of early distributions, such as hardship withdrawals, which are subject to both income tax and the 10% penalty. The exemption recognizes the unique nature of the withdrawal as a reversal of an automatic process rather than a typical early dip into retirement savings.

The Withdrawal and Repayment Process

To initiate a permissive withdrawal, an employee must first contact their plan administrator or human resources department. They will need to request the specific forms for a permissive withdrawal from an EACA to be processed correctly. The paperwork requires personal identification details, account information, and a clear election to withdraw the automatic contributions.

Once the form is completed, it must be submitted according to the plan’s procedures, which could involve uploading it to an online portal, mailing it to the recordkeeper, or returning it to the HR department. The plan may charge its standard distribution processing fee for the transaction. After the request is processed, the funds are sent to the employee via direct deposit or a physical check.

A unique aspect of permissive withdrawals is the potential option to repay the withdrawn amount. If the plan document allows for it, an employee who has taken a permissive withdrawal may later decide to contribute that money back into the plan. The amount that can be repaid is limited to the principal amount of the original withdrawal and is treated as a rollover contribution, meaning it is not subject to annual contribution limits.