©2013, college for financial planning, all rights reserved. © 2012, college for financial...

©2013, College for Financial Planning, all rights reserved.

© 2012, College for Financial Planning, all rights reserved.

Module 8Retirement Plan Distributions

Chartered Retirement Planning CounselorSM Professional Designation Program

Learning Objectives

8–1: Describe the distribution options available before and after retirement.

8–2: Describe the pros and cons of rollover, and explain how they can be accomplished.

8–3: Discuss the tax issues involved in retirement distributions—forward averaging in particular.

8–4: Explain the IRS rules governing the timing and minimum required size of retirement distributions.

8–5: Describe four steps that should be taken in making the best distribution decision.

8–6: Discuss the issues relevant to survivors and beneficiaries of retirement plan participants.

8–7: Describe alternative investments for lump-sum distributions.

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Questions to Get Us Warmed Up

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Learning Objectives








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Qualified Retirement Plan Distributions

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One-Time Suspension on Required Minimum Distributions from Certain Plans for 2009 Only

• Effective for 2009 only, the Worker, Retiree, and Employer Recovery Act of 2008 imposed a moratorium (suspension) on required minimum distributions (RMDs) from individual retirement plans (IRAs) and defined contribution plans for 2009 only.

• This relief applied to life-time plan distributions to defined contribution plan participants, IRA owners, and after-death distributions to beneficiaries.

• It did not apply to pre-2009 and post-2009 RMDs and defined benefit plans.

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In-Service Withdrawals From Qualified Plans

Withdrawals Prior to Plan’s Normal Retirement Age• permitted in profit sharing/stock bonus and thrift/

savings plans

• permitted in pension plans once employee attains age 62

• plan may impose restrictions but is not required to do so

Withdrawals After Plan’s Normal Retirement Age• typically available in money purchase

and target benefit plans (defined contribution pension plans)

• generally not available in defined benefit plans due to complexity of record keeping

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In-Service Withdrawals From Qualified Plans

Amounts Available for Withdrawal• per plan provisions• usually vested portion of employer

contributions

Tax Treatment of In-Service Withdrawals• 10% early withdrawal penalty

(if under age 59½)• ordinary income tax treatment

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In-Service Hardship Withdrawals from Profit Sharing or Stock Bonus 401(k) Plans

Amounts Available for In-Service 401(k) Hardship Withdrawals• limited to funds attributable to elective

deferrals—no earningsTax Treatment of Hardship Withdrawals• 10% early withdrawal penalty

(if under age 59½)• ordinary income tax treatment

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In-Service Hardship Withdrawals from Profit Sharing or Stock Bonus 401(k) Plans

Required Conditions for Hardship Withdrawal

Participant must establish that:

• other resources are not “reasonably available,” (i.e., have exhausted other reasonably available resources) and

• there is an “immediate and heavy financial need”:o medical expenseso primary residence purchaseo college tuitiono housing costs to prevent

eviction or foreclosureo funeral expenses for dependents o principal residence repairs that

qualify for a casualty deduction

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Qualified Plan Loans: General Rules

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Qualified Plan Loans: Terms

Must be:

• available to all participants and beneficiaries on an equal basis

• evidenced by a legally enforceable agreement

• at a reasonable rate of interest

• secured by a participant’s vested account balance (or other collateral)

• made in accordance with plan provisions

Must not be: • available in greater proportions to highly compensated

employees than to nonhighly compensated employees

• a loan with a term exceeding five years (except for purchase of primary residence)

• Repayments must be made at least quarterly on a substantially

• equal level amortization basis

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Qualified Plan Loans: Amounts

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Vested Account Balance

Maximum Loan Amount

$10,000 or less Entire vested account balance*

$10,001 to $20,000 $10,000*

$20,001 to $100,000 50% of vested account

Over $100,000 $50,000*Additional collateral would be required if the loan exceeds 50% of the vested account balance. Most plans therefore limit loans to 50% of the vested amount

Qualified Plan Loans

To avoid characterizationas a prohibited transaction,a loan from a qualified plan must be:• available to all participants and

beneficiaries

• not available to highly compensated employees in greater proportions than to nonhighly compensated employees

• made in accordance with plan provisions

• at a reasonable rate of interest

• adequately secured

• legally enforceable

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Qualified Plan Loans

To avoid characterization as a taxabledistribution:

• loan term must not exceed five years (except home loans)

• loan amount must not exceedo the lesser of $50,000 or o half of the present value

of the employee’s nonforfeitable accrued benefit or other applicable limit

• loan repayments must be made quarterly on a level amortization basis

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Required Qualified Plan Survivor Annuities Provisions

Required for Pensions, optional for PSPs

• Annuity provides income for the life of a qualified plan participant and for the life of his or her surviving spouseo QJSA must provide survivor annuity for life of

spouse, with at least 50% of annuity payable during joint lives.

o QPSA must provide 50% survivor annuity for life of spouse, payable at participant’s death before retirement.

• The right to a QJSA can be waived:o in writing by the spouse, oro if participant and spouse were married less than one

year, or o if plan provides for full payment to surviving spouse

at participant’s death.

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Required Qualified Plan Survivor Annuities

Qualified Plans Subject to Survivor AnnuityRequirements

• Defined benefit plans, target benefit plans, and money purchase pension plans (qualified plans that are subject to minimum funding standards) must comply with the QJSA, QOSA, and QPSA requirements.

• Other defined contribution plans (profit sharing, stock bonus plans) are exempt from the requirement if three conditions are met:

1. vested accrued benefit is payable to spouse or alternate beneficiary at death or participant,

2. participant does not elect annuity form of payment, and

3. plan is not a transferee of a plan that was subject to survivor annuity requirements.

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Qualified Plan Payout Options

• The life annuity and joint and survivor annuity are just two of many payout options generally available.

• Another, the period certain annuity, provides regular monthly payments over a specified period, even if the recipient (and spouse) happens to die during the specified period. This ensures payments to a named beneficiary.

Example• Peter and his wife, Charlotte, have chosen a 20-year

period-certain annuity option for Peter’s retirement benefits.

• His plan administrator has told them that, given Peter’s benefit level and the interest assumption of the annuity, this option will provide payments of $1,800 each month for 20 years.

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Qualified Optional Survivor Annuity (QOSA)

Married participants in a pension plan must be permittedto elect payment in the form of a QOSA benefit.

• A QOSA is an annuity for the life of the participant with a survivor

• Annuity for the life of the spouse determined as follows:

• If the survivor annuity provided by the plan’s QJSA is less than 75% of the annuity payable during the joint lives of the participant and spouse, then the survivor annuity provided by the QOSA must be 75% of the annuity payable during the joint lives of the participant and spouse.

• If the survivor annuity provided by the plan’s QJSA is equal to or greater than 75% of the annuity payable during the joint lives of the participant and spouse, then the survivor annuity provided by the QOSA must be 50% of the annuity payable during the joint lives of the participant and spouse.

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Lump-Sum Distributions

Required Conditions

• Represents full amount credited to participant accounts

• Distributed in one taxable year

• Payable due to participant’s death, attainment of age 59½, or separation from service (common law employees only); or payable due to participant’s death, attainment of age 59½, or disability (self-employed’s option in place of separation from service)

• Made from a qualified pension, profit sharing, or stock bonus plan and all plans of the same type

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Tax Treatment of Stock Distributions Net

Unrealized Appreciation (NUA) A distribution of shares of employer stock that

qualify for NUA treatment (in lieu of rollover treatment) are

subject to the following tax treatment: • The recipient is immediately taxed on the cost,

or basis, of the securities received, and at ordinary income tax rates.

• The NUA is not taxed until the recipient actually sells the shares. When these shares are sold, the NUA is taxed as long-term capital gain.

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Learning Objectives








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Rollover Distributions

“Eligible rollover distributions” are distributions of all or any part of a qualified plan account, except:

• Nontaxable portion of distribution• Part of a series of substantially equal periodic payments over 10 years or relevant life

expectancy• Required minimum distribution (age 70½)• Corrective distributions from a 401(k) plan• Loan treated as a distribution• Dividends on employer securities in an ESOP• Cost of life insurance coverage• Hardship distribution

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pretax & after-

tax assets

Rollover Rules

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Traditional IRA

SIMPLE IRA

403(b)Plans

Gov’t457(b) Plans

403(a)Plans

QRPs401(a)

(after 2 years

of participation)

pretax assets

Tax Treatment of Rollover Distributions

• Rollovers enable funds to maintain tax-deferred growth.

• Funds rolled over become subject to tax treatment of the rollover vehicle (e.g., qualified funds rolled into a deductible IRA are subject to ordinary income tax, not forward averaging).

• A “conduit” IRA can preserve eligibility for forward-averaging tax treatment from another qualified plan.

• The 20% mandatory withholding requirement applies to “eligible rollover distributions” from qualified plans and TSAs if distribution is not a direct rollover.

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Six Types of Rollovers (or Transfers)

1. Conduit IRA2. Direct rollover (also known as a direct

transfer of eligible rollover distributions)3. Trustee-to-trustee transfer4. Indirect rollover5. Spousal beneficiary

rollover6. Nonspouse beneficiary

rollover

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Conversions & Rollovers to a Roth IRA

A Roth IRA may accept rollover assets from other retirementarrangements if the source of the rollover assets consists of a

rollover from:• a qualified plan

• 403(b) arrangement

• Section 457 government plan

• traditional IRA

• Roth 401(k) account

• Roth 403(b) account

• another Roth IRANote: for this purpose, there is no ceiling on a retirement arrangement owner’s (or that of the owner who files jointly) adjusted gross income.

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Lump-Sum Distribution

Four Conditions Required for Distribution to be Considered a Lump Sum

• Represents full amount credited to participant’s account (or benefit) from all qualified plans of the same type

• Distributed in one taxable year

• Payable due to participant’s death, attainment of age 59½, or separation from service (common law employees only); or payable due to participant’s death, attainment of age 59½, or disability (self-employed’s option in place of separation from service)

• Made from qualified pension, profit sharing, or stock bonus plan

Four Options for Treatment of Lump-Sum Distribution• Taxation: ordinary income rates

• Taxation: forward-averaging method, if available; special treatment available if age 50 before 1/1/86 (born before 1936)

• Deferral: roll the distribution over, deferring tax liability until a future date

• Net unrealized appreciation treatment for distributions of employer stock

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Learning Objectives








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Ten-Year, Forward-Averaging Tax Treatment

Advantages: Taxable amount is subject to possibly lower tax rate (tax is calculated on 1/10 of taxable amount, using 1986 tax tables, then multiplied by 10 to determine total tax).

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Qualified Plan Annuity or Periodic Payment Distribution

Taxed under annuity rules (IRC §72) at ordinary rates—exclusion ratio applied to each payment to determine excludible amount:

Also, basis recovery tables of SBJPA 96 + TRA 97

• Available in accordance with plan provisions

• Lifetime survivor benefits must be provided by qualified plans subject to minimum funding standards (e.g., defined benefit, money purchase, target benefit).

*A participant’s “investment in the contract” (basis) includes after-tax contributions, Table 2001 costs, and loans that were treated as taxable distributions

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.

return Expected

*contract the in Investment portionNontaxable

payment of

Calculating Nontaxable Portion of Installment Distributions

Single Life

• Use the method in the following example if payments are for one life such as a single life annuity; payments are from a qualified employee plan, a qualified employee annuity, or tax-sheltered annuity; and at the time payments began, individual was either under age 75 or entitled to fewer than five years of guaranteed payments. Divide cost basis by anticipated payments based on the schedule below.

Example

• Ron is age 67, retiring this year, and is entitled to receive his retirement benefits in the form of a single life annuity payable monthly. He has a cost basis in the annuity of $28,000. The nontaxable portion of the payments received by Ron will be $133 ($28,000/210).

Note: Once he has received 210 monthly payments, the rest are fully taxable.

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Calculating Nontaxable Portion of Installment Distributions

Joint LivesWhen there is more than one annuitant, such as a

joint and survivor annuity payable monthly over the lives of a husband and wife:

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payments of Numbertable in shown

basis Total each in Basis

paymentannuity

Premature Distributions from Qualified Plans & Exceptions to the 10% Penalty

Penalty does not apply to a qualified plan distribution that is:• attributable to death or permanent disability

• part of a series of substantially equal periodic payments over a qualified plan participant’s life expectancy following separation from service

• used for medical care up to amount deductible on participant’s inc. tax return (amounts over 7.5% of AGI)

• made to reduce excess plan contributions/deferrals – corrective distributions of excess contributions from IRAs are permitted

The following exceptions are for qualified plans only – not IRAs:• made following separation from service after age 55

• paid in accordance with a QDRO

• a dividend paid by employer stock held by an ESO

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Premature Distributions from IRAs & Exceptions to the 10% Penalty

Penalty does not apply to an IRA distribution that is:• attributable to death or permanent disability

• part of a series of substantially equal periodic payments over an IRA owner’s life expectancy

• used for medical care up to the amount deductible on the participant’s tax return (amounts over 7.5% of AGI)

• corrective distributions of excess contributions (corrective distributions of excess plan contributions/deferrals applies to qualified plans)

Exceptions for IRAs only – not qualified plans• used for first-time homebuyer expenses ($10,000 lifetime cap)

• used for qualified higher education expenses (tuition, fees, books, supplies required for attendance)

• used to pay health insurance premiums for qualifying unemployed individuals

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Exceptions to the 10% Early Withdrawal Penalty: Summary

Type of Plan Exception to Penalty

Qualified plans & IRAs

• Substantially equal payments from an IRA or following separation from service

• Death or disability• Medical expenses over 7.5% of AGI• Corrective distributions of excess qualified

plan contributions and/or deferrals -- corrective distributions of excess IRA contributions

Qualified plans only • Separation from service after age 55

ESOP only • Dividend paid by employer stock held by an ESOP

Qualified plans only • Qualified domestic relations order (QDRO)

IRAs only • First-time home purchase• Health insurance premiums while

unemployed• Higher education expenses

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Series of Substantially Equal Periodic Payment (SOSEPP)

Exceptions to the Premature Distribution Penalty

These methods qualify:

• Required minimum distribution method

• Fixed amortization method

• Fixed annuitization method

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SOSEPP Exception

Required Min. Distribution MethodThe annual payment for each year is determined by dividing the account balance for that year by the number from the chosen life expectancy table for that year. The account balance, the number from the chosen life expectancy table (representing the years of remaining life expectancy), and the resulting annual payments are recalculated for each year.

ExampleMr. Smith is age 50 this year and single.

• His SOSEPP RMD for this year is $14,260.

• $500,000 IRA account balance divided by 34.2, his life expectancy (Single Life Table)

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SOSEPP Exception

Fixed Amortization Method The annual payment for each year is determined by amortizing in level amounts the account balance over a specified number of years determined by using an IRS approved life expectancy table and interest rate. The account balance, life expectancy, interest rate, and resulting annual payment are determined once for the first distribution year and the annual payment is the same amount in each succeeding year.

ExampleMr. Smith, age 50, is single and has given the following information for purposes of calculating his SOSEPP payments under the fixed amortization method:

• His IRA account balance is $500,000.

• His life expectancy is 34.2 per the Single Life Table.

• 5.7% is a reasonable rate of interest per IRS requirements.

PV = $500,000; N = 34.2; I = 5.7. Solving for PMT = $33,537

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SOSEPP Exception

Fixed Annuitization MethodEach year’s annual SOSEPP payment is determined by dividing the account balance by an annuity factor that is the present value of an annuity of $1 per year beginning at the taxpayer's age and continuing for the life of the taxpayer (or the joint lives of the individual and beneficiary). The annuity factor is calculated by an actuary using an IRS approved mortality table and interest rate. Under this method, the account balance, the annuity factor, the chosen interest rate, and the resulting annual payment are determined once for the first distribution year and the annual payment is the same amount in each succeeding year.

ExampleMr. Smith, age 50, is a single individual. You have been given the following information for purposes of calculating his SOSEPP payments under the fixed annuitization method:

• his IRA account balance is $500,000, and

• the annuity factor for an individual age 50 is 15.1819 according to an actuary who using an IRS approved mortality table and interest rate.

• Dividing his $500,000 account balance by 15.1819 results in a series of fixed annual payments of $32,934 each.

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Qualified Plan & IRA 2008 and Post-2009 Distribution Requirements

Aggregation Rules IRS rules allow a certain amount of aggregation for purposes of the RMD rules. Each IRA’s RMD must be calculated separately. Total required minimum distribution can be taken from any one or all of these IRAs.

Every other type of plan, however, must individually make an RMD.

Example• Frank has three IRAs and participates in his company’s profit sharing plan.

• After figuring the RMD for each of the IRAs, he can take a distribution from one, two, or all three—as long as it matches or exceeds the RMD for his three IRAs.

• Frank must also take an RMD from his profit sharing plan. He cannot aggregate this plan with his IRAs when he makes the RMD calculation.

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Tax Treatment of Qualified Roth IRA Distributions

Distributions from a Roth IRA are either qualified or nonqualified. A distribution is qualified if it meetsthe five-year holding requirement (beginning with the first year for which a Roth contribution is made) and if it is made for any one of the following reasons: • after the owner’s attainment of age 59½,

• death of the owner,

• owner’s disability, or

• to an owner for a special purpose (meaning a first-time home purchase (maximum distribution of $10,000).

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Tax Treatment of Nonqualified Roth IRA Distributions

The tax treatment of nonqualified distributions from a Roth

IRA is determined by the ordering rules, which treat allamounts distributed as a distribution of after-tax contributions first and then as a distribution of

earnings. • Therefore, no portion of a distribution is treated as

ordinary income (taxable income) until the total of all prior distributions (after-tax contributions) exceeds the total of all prior contributions.

• Unless an exception applies, an earnings distribution to an under age 59½ Roth IRA owner is subject to the 10% early withdrawal penalty.

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Tax Treatment of Nonqualified Roth IRA Distributions

Example• For the past 10 years, Jonathan Meiklehorn, age 32,

contributed $2,000 each year to a Roth IRA.

• During the current year, he withdrew his entire account balance of $34,000 to buy a car.

• His account meets the five-year holding requirement, but he is not age 59½, deceased, or disabled, nor is he using the money to buy his first home.

Therefore, the distribution is not qualified:• He has contributed $20,000, and this

amount comes out first and is not taxable.

• The remaining $14,000 of the distribution is taxable and is subject to the 10% penalty.

• The portion of the distribution that is not taxed is not subject to the penalty.

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Tax Treatment of Roth IRA Distributions: Summary

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Learning Objectives








8-46

Qualified Plan Distribution Requirements

Commencement of Distributions

• Qualified plan must provide for retirement benefit distributions to begin within 60 days after the plan year-end in which the latest of the following occurs:o participant reaches age 65

(or normal retirement age specified in the plan, if earlier)

o participant has 10 years of plan participation

o participant terminates service with the employer

• Employee may elect other forms of distribution

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Qualified Defined Contribution Plan & IRA Distribution Requirements

Required Minimum Distributions (RMDs)

Qualified Plans: • Required beginning date (RBD) for qualified plan

distributions must begin by April 1 of the calendar year following the later of the calendar year in which:o employee attains age 70½, or o employee retires.

IRA Plans and greater than 5% business owner-participants:

• Required beginning date (RBD) for IRA distributions must begin by April 1 of the calendar year following the year in which:o the individual attains age 70½o whether working or not

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IRA Distribution Requirements

Required Beginning Date

Distributions must be made over the Uniform Table life expectancy of the participant or the Joint and Last Survivor Table life expectancies (see IRC Sec. 401(a)(9) regulations) of the participant and the participant’s spouse if the spouse is at least 10 years younger.

Penalty

Penalty for receiving less than the required minimum distribution is 50% of the difference between the amount that was distributed and the amount that should have been distributed.

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Qualified DC Plan & IRA Distribution Requirements Following Participant’s Death

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Qualified Domestic Relations Order (QDRO)

A QDRO is a court order issued in conjunction with a divorce proceeding in which all or part of a participant’s qualified plan

benefits may be made payable to the participant’s spouse, former

spouse, or dependents as alimony, marital property rights, or child

support. (QDRO rules do not apply to IRAs.)• Benefits paid under a QDRO to the plan participant's child

or dependent are treated as paid to the participant; hence, they are taxable to the participant.

• Benefits paid to a spouse or former spouse may be rolled over into a traditional individual retirement arrangement or another qualified retirement plan.

• Benefits that are not rolled over must be included in the spouse's or former spouse's income but are not subject to the 10% early distribution penalty.

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Learning Objectives








8-52

Investments for Lump-Sum Distributions Identifying Appropriate Financial Advisors

There are different “roofs” (financial advisors, trustees, custodians, and financial institutions) under which retirement plan lump-sum distributions can be placed and effectively managed. These roofs include: • banks,• brokerage firms, • insurance companies, • investment companies (mutual funds), and • private money managers.

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Many of the products and services appropriate for retirees are available from all or several of these vendors. As a result, differences between financial service vendors are often blurred. However, the decision about which roof (or roofs) should be governed by the client’s investment strategy and, in some cases, by distribution decisions already made.

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• A shrewd and experienced stock market investor who does most of her own research and is good at investing may be interested in a self-directed IRA offered by a large discount broker.

• A very wealthy client may seek the services of a someone who can develop and manage an individually crafted portfolio such as a private money manager or possibly a bank trust department or large broker-dealer.

• An individual with little experience or interest in investments who needs a higher investment return to maintain her standard of living should consider hiring a retirement counselor.

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• A retired executive of a major corporation who has an exceptionally large and complicated estate may need to get expert advice in three areas: distribution options, money management, and estate planning.

• An individual who is more interested in safety rather than higher returns and is concerned about outliving his retirement assets may be interested in consulting with an insurance company about an annuity.

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Question 1Clark Benson, age 65, is a 3% owner and an employee of Oak

Enterprises, Inc. He has accumulated $250,000 in Oak Enterprises’ profit sharing 401(k) plan during his 22 years of employment; to date, he has taken no distributions from the plan. He plans to take distribution of the full account when he retires at age 67.

Which of the following describe the tax consequences of Clark’s planned distribution schedule?

I. not subject to the 10% early withdrawal penalty

II. subject to 15% mandatory withholding

III. subject to 50% minimum distribution penalty

IV. eligible for 10-year forward averaging

a. I onlyb. II and III onlyc. III and IV onlyd. I, II, and III onlye. I, III, and IV only

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Question 2

At age 57, Anita Buford retired from PQR Corporation in January this year after 15 years of service. She received a check for the distribution of her account in the PQR Money Purchase Plan. Her account balance was $60,000 on her final day of employment.

Which of the following statements describe the income tax or penalty tax consequences of this distribution?

I. subject to 10% penalty

II. subject to mandatory 20% withholding

III. eligible for 10-year forward averaging

IV. exempt from the 10% early withdrawal penalty

a. I and II onlyb. II and III onlyc. II and IV onlyd. I, II, and III onlye. I, II, and IV only

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Question 3

In-service withdrawals prior to age 62 are not permitted from which of the following?

a. profit sharing plansb. cash balance plansc. stock bonus plansd. employee stock ownership plans (ESOPs)

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Question 4

Taxes may be deferred on a qualified plan distribution if it is rolled over to an IRA, TSA, SEP, governmental 457 plan, or to another qualified plan. All are true regarding rollovers except

a. they generally result in less money for retirement.

b. distributions must be transferred to a new account no later than 60 days after receipt.

c. noncash property must be transferred to the new account.

d. funds rolled over may lose the potential to use forward averaging.

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Question 5

Which of the following is not a requirement for ten-year forward averaging treatment?

a. the participant must have attained age 50 by January 1, 1986

b. forward averaging must be elected for all lump-sum distributions received during the year

c. the employee must have been a participant in the plan for at least eight years

d. the participant must be married

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©2013, College for Financial Planning, all rights reserved.

© 2012, College for Financial Planning, all rights reserved.

Module 8End of Slides

Chartered Retirement Planning CounselorSM Professional Designation Program

©2013, college for financial planning, all rights reserved. © 2012, college for financial...

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