Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Planning Retirement Distributions
for Qualified Plans
•
•
•
complex rules
distinct federal income tax treatment
use careful planning to avoid adverse tax
consequences
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Helpful to consider questions:
1.
2.
3.
What distributions does plan allow?
Can and should distribution be rolled over?
If choose periodic payment, which form is best?
–
–
–
–
spousal consent needed?
early distribution penalty?
minimum distribution requirements?
how are payments taxed?
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Helpful to consider questions (cont’d):
4.
If lump sum payment is chosen
–
–
–
5.
eligible for 10 yr. averaging?
if so, is election beneficial?
how much tax payable?
What are the estate planning consequences of
payment choice?
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Plan Provisions:
Required Spousal Benefits
Federal law
–
–
protects the economic interest of the spouse
ensures that benefit changes affecting the spouse are
made with the spouse’s full knowledge and consent
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Plan Provisions:
Required Spousal Benefits
Two forms:
–
Qualified Pre-retirement Survivor Annuity [QPSA]
–
Qualified Joint and Survivor Annuity [QJSA]
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Plan Provisions:
Required Spousal Benefits
Stock bonus plans
Profit sharing plans
ESOPs
Generally do NOT need to provide survivorship benefits
for spouse IF participant’s nonforfeitable balance is
payable as a death benefit to that spouse
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Qualified Pre-Retirement Survivor Annuity
surviving spouse can have actual property rights in
deceased participant’s vested benefits
QPSA is an automatic provision, any change in
payout or beneficiary REQUIRES consent of
nonparticipant spouse
–
–
–
in writing
acknowledging effect of waiver
witnessed by plan representative or notary public
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Survivor Annuity in Defined Benefit Plans:
Amount that would have been paid under a QJSA IF
participant
–
or
–
retired on day before death (if < retirement age)
separated from service on the earlier of the actual time
of separation or death and survived to the plan’s earliest
retirement age, then retired with an immediate joint and
survivor annuity
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Survivor Annuity in Defined Contribution Plans:
Annuity for life of the surviving spouse that is the
actuarial equivalent of at least 50% of the participant’s
vested account balance, determined as of the date of
death
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Qualified Joint and Survivor Annuity
Provides annuity for life of participant and survivor
annuity for life of surviving spouse
Survivor annuity must not be < 50% nor > 100% of
annuity payable during the joint lives of the participant
and spouse
Survivor annuity continues if spouse remarries
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Qualified Joint and Survivor Annuity
Waiver of QJSA REQUIRES nonparticipant spouse
consent
–
–
–
in writing
acknowledging effect of waiver
witnessed by plan representative or notary public
90 day period after ‘annuity starting date’ to waive QJSA
Can revoke waiver during same 90 days
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Plan Provisions:
Other Benefit Options
Qualified plans can offer wide range of distribution
options
In practice, employers limit options
–
–
more choice → more administrative costs
IRS makes it difficult to change choices
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Other Benefit Options for
Defined Benefit Plans
Automatic options
joint and survivor annuity (if married)
life annuity (if single)
Options
period certain annuity – 10 or 20 years
joint annuity with someone other than spouse
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Other Benefit Options for
Defined Contribution Plans
Money purchase plans, target benefit plans, Section
403(b) tax deferred annuity plans subject to ERISA
must meet pre-retirement and joint and survivor annuity
rules
Other defined contribution plans do not have to meet
these rules if
–
–
there is no annuity option
the plan participant’s account balance is available to
surviving spouse at participant’s death
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Other Benefit Options for
Defined Contribution Plans
•
If purchase an annuity, the joint and survivor options
apply
•
Lump sum distribution
•
Non-annuity distributions
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Tax impact
Nontaxable and Taxable Amounts
Taxes reduce participant’s financial security; need to
minimize
Retirement plan distributions subject to federal, state
and local income tax laws
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
To determine tax, first determine participant’s cost basis
in plan benefit; basis can include…
–
–
–
total after-tax contributions made by the employee to a
contributory plan
total cost of life insurance reported as taxable income by
participant
employer contributions previously taxed to employee
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Basis can also include…
–
–
certain employer contributions attributable to foreign
services performed before 1963
amount of any plan loans included as income in taxable
distribution
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
In-service (partial) distributions
Partial distributions containing both nontaxable and
taxable amounts is taxed as:
Nontaxable amount = distribution x employee’s cost basis
total account balance
‘Grandfather’ rule for pre-1987 after-tax contributions to the plan
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
In-service (partial) distributions
taxable in-service distribution may also be subject to an
early distribution penalty
in-service withdrawals generally subject to mandatory
20% withholding unless a direct rollover is used
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Total distributions
if begin annuity payments based on entire account
balance
Nontaxable amount = distribution x employee’s cost basis
total annuity payments
expect to receive
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Total distributions
taxable in-service distribution may also be subject to an
early distribution penalty
in-service withdrawals generally subject to mandatory
20% withholding unless a direct rollover is used
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Tax impact:
Taxation of Annuity Payments
Employee has no cost basis
include full amount of annuity as ordinary income
Employee has some cost basis
table values used to determine the excludable portion of
each monthly payment
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Tax impact:
Taxation of Lump Sum Distributions
lump sum distributions …
from some qualified plans are technically not ‘lump sum’ –
IRAs, SEPs, Sec. 403(b)
may be subject to early distribution penalty
generally subject to mandatory 20% withholding
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Tax impact:
Taxation of Lump Sum Distributions
‘Grandfather rules’ if age 50 before Jan 1, 1986
–
–
can use 10 year averaging at 1986 tax rates if take lump
sum distribution
pay capital gain rate of 20% for capital gain portion of
distributions (the portion attributable to pre-1974
accumulations, if any), if elect capital gain treatment; not
beneficial after recent tax law changes
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Tax impact: Taxation of Death Benefits
Generally taxed the same as lifetime benefits
For a lump sum distribution
if employee was age 50 before January 1, 1986, the
beneficiary can elect 10 year averaging even if participant was
not 59 1/2 at time of death
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Tax impact: Taxation of Death Benefits
Annuity distribution
–
taxation follows annuity rules
If death benefit paid under life insurance contract held by
qualified plan
–
–
pure insurance portion excluded from income tax
Table 2001 rates used to determine value of life insurance
after 2000; prior years use ‘P.S. 58’ rates
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Tax Impact: Federal Estate Tax
Entire value of a qualified plan death benefit is subject to
inclusion in decedent’s gross estate for federal estate
tax purposes
Only high-income plan participants subject to estate tax
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Tax Impact: Federal Estate Tax
Federal estate tax avoidance important if
–
–
estate very large
participant single OR married and unwilling to pay death
benefit to spouse
If spouse close to decedent’s age, delay but not avoid
federal estate tax
Use of life insurance to exclude death benefits from
decedent’s estate is questionable
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Loans
•
•
•
•
•
avoid 10% penalty tax on early distributions
increase administrative cost
deplete plan funds available for pooled investments
plan must specifically permit loans
IRAs and SEPs cannot have loans
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Loans
Exempt from prohibited transaction rules if
–
–
available to participants and beneficiaries on reasonably
equivalent basis
not available to highly compensated in amount greater
than amount made available to other employees
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Loans
• are made according to specific provisions in plan
• must bear reasonable rates of interest
• are adequately secured
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Loans
Code Section 72(p): To avoid tax, aggregate loans from
qualified plan to any individual plan participant cannot
exceed LESSER of
–
$50,000, reduced by excess of the highest outstanding loan
balance during the preceding one-year period over the
outstanding balance on the date when the loan is made
or
– one-half the present value of the participant’s vested
account balance (or accrued benefit if defined benefit plan)
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Loans
• can loan < $10,000 even if amount is more than 1/2 of
participant’s vested benefit
• repay within 5 years (unless for home purchase)
• interest treated as consumer interest
• interest deductions prohibited in special cases
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Qualified Domestic Relations Orders (QDROs)
A decree, order, property settlement under state law
relating to
–
–
–
child support
alimony
marital property rights
that assigns part or all of participant’s plan benefits to
spouse, former spouse, child, or other dependent of the
participant
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Qualified Domestic Relations Orders (QDROs)
• QDRO cannot assign a benefit the plan does not
provide
• cash settlements generally require equivalent cash to
ex-spouse while benefits remain with plan participant
• a spouse or former spouse receiving a distribution
under a QDRO can roll it over just as if he or she were
the participant
Copyright 2009, The National Underwriter Company
36
Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Penalty Taxes: Early Distribution Penalty
Early distributions from
–
–
–
–
qualified plans
Section 403(b) tax deferred annuity plans
IRAs
SEP’s
are subject to a 10% penalty withdrawal
Penalty for SIMPLE IRAs is 25% for first 2 years of
participation
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Penalty Taxes: Early Distribution Penalty
The penalty does NOT apply IF distributions
–
–
–
Made on or after attainment of age 59½
Made to the plan participant’s beneficiary or estate on or
after the participant’s death
Attributable to the participant’s disability
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Penalty Taxes: Minimum Distribution
Requirements and Penalty
Must begin no later than April 1 of calendar year following
latter of
–
–
the calendar year employee attains 70½
the year the employee retires
50% penalty if distribute less than should
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Penalty Taxes: Minimum Distribution
Requirements and Penalty
Special issues:
–
–
–
spouse > 10 years younger
at participant’s death, minimum distribution based on
remaining life expectancy
designated beneficiary for after death distributions
determined Sept 30 of year following year of participant’s
death
Copyright 2009, The National Underwriter Company
40
Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Retirement Plan Rollovers
When are rollovers used?
To defer tax on:
–
–
–
part or all of plan distribution
large lump sum from terminated plan
transfer of funds to different investment vehicle
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Retirement Plan Rollovers
Tax Treatment of Rollovers
1. Can roll over any distribution from “eligible retirement plan”
EXCEPT
–
–
–
required minimum distribution
series of substantially equal payments for > 10 years or life or life
expectancy of employee or employee and a designated
beneficiary, or
‘hardship’ distribution
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Retirement Plan Rollovers
Tax Treatment of Rollovers
2. If do not use direct rollover and fail to roll over in 60 days,
distribution subject to income tax
3. Distribution from rollover IRA not eligible for forward averaging
4. Distribution rules for rollover IRA same as for traditional IRA; early
distributions subject to 10% early withdrawal penalty
Copyright 2009, The National Underwriter Company
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Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Retirement Plan Rollovers
Tax Treatment of Rollovers
5. Loans not permitted
6. If participant dies before withdrawing all from rollover IRA, death
benefit subject to estate tax
7. Use of separate ‘conduit IRA’ to hold qualified plan funds for
transfer from one qualified plan to another no longer necessary
Copyright 2009, The National Underwriter Company
44
Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Retirement Plan Rollovers
Alternatives to Rollovers
Leave $ in existing qualified plan
Select an annuity payout if available
Copyright 2009, The National Underwriter Company
45
Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
True or False?
1. A profit sharing plan must have a qualified joint and survivor
annuity.
2. A participant’s cost basis in a qualified retirement plan can include
the amount of any plan loans included in income as a taxable
distribution.
3. The entire value of a qualified death benefit is always excluded
from the decedent’s gross estate for federal income tax purposes.
Copyright 2009, The National Underwriter Company
46
Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
True or False?
4. If a loan made from a qualified plan bears a reasonable rate of
interest and is adequately secured, it will probably avoid being
classified as a prohibited transaction rule.
5. A participant’s plan benefits cannot be part of the negotiable
assets in domestic disputes.
6. A plan distribution made at age 60 is subject to a 10% penalty for
early withdrawal because it was made before age 65.
Copyright 2009, The National Underwriter Company
47
Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
True or False?
7. A direct rollover is a rollover distribution that is paid directly to
another eligible retirement plan for the benefit of the distributee.
8. Distributions from a rollover IRA are eligible for 10 year averaging
tax treatment.
9. A hardship distribution from a qualified plan is eligible for a
rollover.
10. Loans from a rollover IRA are prohibited.
Copyright 2009, The National Underwriter Company
48
Qualified Plans:
Distributions and Loans
Chapter 8
Employee Benefit & Retirement Planning
Discussion Questions
•
•
•
Joe Walters, age 51, lost use of his left arm after a stroke, making
it impossible for him to continue working as an electrician with
Goodenuf Construction. Joe has a qualified retirement plan with
his employer.
What are the pros and cons of Joe taking an early distribution
from his qualified retirement plan to cover his living expenses for a
few months while he gets some training to try another line of
work?
How and why would your answer change if Joe was not disabled,
but only wanted the distribution to buy a new 4x4?
Copyright 2009, The National Underwriter Company
49