What Are Permissible Section 414(w) Withdrawals?

A permissible withdrawal under Internal Revenue Code Section 414(w) is a feature for employees who are automatically enrolled in their workplace retirement plan. This provision provides a short window for an employee to reconsider this automatic participation and, if they choose, opt out and receive their initial contributions back.

The purpose of this rule is to give employees a chance to reverse the automatic enrollment decision without a significant financial penalty. It acknowledges that while automatic enrollment is beneficial for many, it may not be the right choice for every employee. This withdrawal option offers a grace period to evaluate personal finances before committing to the plan.

Eligibility Requirements for a Permissible Withdrawal

To be eligible for a permissible withdrawal, an employee’s situation must meet several criteria:

• The withdrawal is only available from a specific type of retirement plan known as an Eligible Automatic Contribution Arrangement (EACA). An EACA is a 401(k) or 403(b) plan that uniformly applies a default contribution percentage to all employees who are automatically enrolled.
• The employee must have been enrolled in the plan through the automatic process, not because they actively chose to sign up. If an employee affirmatively elected to contribute, they are not eligible for this withdrawal.
• The employee must make the election to withdraw their contributions within 90 days of the date the first automatic contribution was made. While the law sets a 90-day maximum, a plan can set a shorter election period, which must be at least 30 days.
• The employee must have received a notice from their employer explaining the terms of the EACA. This notice details the employee’s rights, including the right to make a permissible withdrawal and the deadline for doing so.

Calculating the Withdrawable Amount

The distribution is equal to the total amount of the automatic contributions that were deferred from paychecks up to the effective date of the withdrawal request. The withdrawal must also include any investment earnings or account for any losses attributable to those specific contributions.

The calculation excludes certain types of money within the retirement account. Any elective deferrals that the employee actively chose to make are not part of the withdrawal amount, nor are any employer contributions like profit sharing or safe harbor matches. The rule is narrowly focused on reversing only the automatic employee deferrals.

If the employer made any matching contributions based on the automatic deferrals being withdrawn, those matching funds must be forfeited. This forfeiture includes the employer’s matching contribution itself and any earnings that have accrued on that match.

The Process for Requesting the Withdrawal

An employee who wishes to make a withdrawal must initiate the process with their employer. The first step is to contact the plan administrator or the human resources department, who can provide the specific procedures and forms required.

The employee will need to complete the necessary paperwork. This involves a distribution form that captures personal information, acknowledges understanding of the consequences, and confirms the election. The form can be submitted through an online portal or as a paper document.

After the completed form is submitted, the plan administrator will process the request. The funds are delivered to the employee as a direct deposit into their bank account or as a physical check mailed to their address.

Taxation of Withdrawn Funds

The entire amount distributed, which includes both the employee’s original automatic contributions and any associated earnings, is considered taxable income. This total must be included in the employee’s gross income for the tax year in which the withdrawal is received.

The main tax benefit of this withdrawal is its exemption from the 10% additional tax on early distributions. Under Section 72(t), withdrawals from a retirement plan before age 59½ are subject to this penalty, but a permissible withdrawal is a specific statutory exception. This makes it much less costly than other early withdrawal options for those who qualify.

The plan administrator is responsible for reporting the distribution to the employee and the IRS on Form 1099-R. The form will show the gross distribution amount, and a distribution code will indicate that it is not subject to the early withdrawal penalty. The funds from a permissible withdrawal are also not eligible to be rolled over into another retirement account or IRA.