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1 Retirement Planning and Employee Benefits for Financial Planners Chapter 7: Distributions from Qualified Plans
2 © 2007 ME™ - Your Money Education Resource™ Distributions:Pension Plan/Normal Retirement Age Joint and Survivor Annuity after retirement Annuity for participant and spouse Spouse: 50% - 100% of joint annuity Continues even if remarry Automatic for defined benefit plans Elect out Increase monthly payments Spouse must sign waiver When should this be done?
3 © 2007 ME™ - Your Money Education Resource™ Distributions:Pension Plan/Normal Retirement Age Annuities Period certain Survivor other than spouse If beneficiary is much younger, distribution must be more than RMD
4 © 2007 ME™ - Your Money Education Resource™ Distributions:Pension Plan/Normal Retirement Age Rollovers to IRA or other qualified plan Tax-free if within 60 days of distribution Subject to withholding tax of 20% Direct rollovers: trustee to trustee No withholding Lump sum distribution Present value of future benefits When would you take this? Life expectancy Interest rates: now use corporate bond rates
5 © 2007 ME™ - Your Money Education Resource™ Termination of Service Before Normal Retirement Age - Pension Plan Lump Sum Distribution if plan allows (many don’t) Rollover plan assets to IRA or other qualified plan, or Leave assets in plan. Value must be greater than $5,000 Forced payments between $1,000 - $5,000 must go to IRA
6 © 2007 ME™ - Your Money Education Resource™ Pension Plan Distribution Options At participant’s death before retirement: Qualified Preretirement Survivor Annuity (QPSA) An annuity benefit payable to the surviving spouse of a participant if the participant dies before attaining normal retirement age. Lump sum (if plan permits) Distributed to beneficiary Primary / Contingent Participant’s estate. At participant’s disability before retirement: Distributed to participant.
7 © 2007 ME™ - Your Money Education Resource™ Profit Sharing Plan Distribution Options May permit in-service withdrawals after two years of participation in the plan. 401(k) plans may permit loans. At termination of service: Lump sum distribution, Rollover plan assets to IRA or other qualified plan, or Purchase annuity.
8 © 2007 ME™ - Your Money Education Resource™ Taxation of Distributions from Pension and Profit Sharing Plans Ordinary income Except: Direct rollovers of plan assets to IRAs or other qualified plans, Adjusted basis in plan, Qualified Domestic Relations Orders (QDRO). Taxable distributions not in annuity form are subject to 20% income tax withholding.
9 © 2007 ME™ - Your Money Education Resource™ Rollovers to IRAs May expand investment options Individual stocks Reduce asset management fees? Rollover to Roth IRAs now permitted Taxed Causes a loss of: NUA Direct Rollover No income tax withholding. Indirect Rollover A distribution to the participant with a subsequent transfer to another account. Mandatory 20% income tax withholding. Have cash to rollover 100%?
10 © 2007 ME™ - Your Money Education Resource™ Adjusted Basis in Plan How? After-Tax Contributions. Taxed at distribution? Tax-free return of capital to the extent of adjusted basis. Ordinary income for remainder.
11 © 2007 ME™ - Your Money Education Resource™ Annuities Partially tax-free return of adjusted basis. Partially ordinary income: Determined by inclusion/exclusion ratio Exclusion Ratio = Cost basis in the annuity Expected Benefit
12 © 2007 ME™ - Your Money Education Resource™ Lump Sum Distributions Definition A distribution of the participant’s entire account balance or accrued benefit, Within one taxable year, On account of the participant’s death, attainment of age 59½, separation from service, or disability, and The employee participated in the plan for at least five years prior to the date of distribution.
13 © 2007 ME™ - Your Money Education Resource™ Net Unrealized Appreciation (NUA) Lump sum distribution of employer securities. Usually from ESOP or Stock Bonus Plan Any other assets in plan may be rolled over. Determination of NUA: Fair Market Value at Date of Distribution Less: Value of stock at Date of Employer Contribution Net Unrealized Appreciation
14 © 2007 ME™ - Your Money Education Resource™ Net Unrealized Appreciation (1 of 2) In year of distribution of employer stock: Value at date of Employer Contribution Ordinary income NUA Deferred Long-Term Capital Gain At date of sale of employer stock: Recognize deferred long-term capital gain. Any subsequent gain/loss short/long term capital gain based on holding period since date of distribution.
15 © 2007 ME™ - Your Money Education Resource™ Qualified Domestic Relations Order (QDRO) (1 of 2) Judicial order allowing ex-spouse to receive benefits from another individual’s qualified plan. Can be used for: Division of marital estate Child Support Divorce Nontaxable distribution as long as assets are deposited into an IRA or another qualified plan. QDRO must comply with regulations
16 © 2007 ME™ - Your Money Education Resource™ Qualified Domestic Relations Order (QDRO) (2 of 2) Two methods of distribution: Shared Payment Splits monthly payment between former spouses What if participant dies? What if second charming ex? QDRO can’t require payments not allowed by plan Separate Interest Defined Benefit: buyout spouse’s interest Value: interest rates; life expectancy Defined Contribution: Value: often income tax ignored Roll into IRA
17 © 2007 ME™ - Your Money Education Resource™ Plan Loans Permissible by any qualified plan Usually only found with CODA type plans. 28% of workers had borrowed from 401(k) as of December 2010 Loan may not exceed The lesser of: $50,000, or ½ of the participant’s vested account balance Exception, when vested account balance is <$20,000, the maximum loan is limited to the lesser of: $10,000, or The vested account balance. Reduced by the highest outstanding loan balance within the previous twelve month period.
18 © 2007 ME™ - Your Money Education Resource™ Repayment of Plan Loans (1 of 2) Five years Or up to 30 years if loan proceeds used to purchase principal residence. 75% default rate for those who leave job with outstanding loan balance Substantially level amortization of the loan is required over its term. Payments must be at least quarterly. Plan sponsors often apply additional rules and requirements.
19 © 2007 ME™ - Your Money Education Resource™ Repayment of Plan Loans (2 of 2) Failure to repay the loan as prescribed will consider the value of the loan a taxable distribution. Possibly subject to the 10% early distribution penalty. Termination from employment generally causes entire loan to become due.
20 © 2007 ME™ - Your Money Education Resource™ Distributions Prior to 59½ Subject to a 10% early withdrawal penalty unless on account of an exception: Death, Disability, Strict definition of disability (similar to Social Security) Separation from Service after the participant attains age 55 Qualified Domestic Relations Order.
21 © 2007 ME™ - Your Money Education Resource™ Distributions Prior to 59½ Subject to a 10% early withdrawal penalty unless on account of an exception: Substantially equal periodic payments after separation from service RMD amount Start small; get bigger Fixed periodic amount over life expectancy Payments must continue for later of 5 years or until 59 1/2 Medical expenses in excess of 7.5% of the participants AGI, or Don’t want this…crummy insurance
22 © 2007 ME™ - Your Money Education Resource™ Minimum Distributions First minimum distribution must begin by April 1 of the year following the year in which the participant attains the age of 70 ½. Exception: A participant who is still employed by the plan sponsor may delay the first minimum distribution until April 1 of the year after the participant terminates employment (a >5% owner cannot use the exception). RMDs are required for 2014 Requirement for RMDs was waived in 2009
23 © 2007 ME™ - Your Money Education Resource™ Minimum Distributions All other minimum distributions (after first year) must occur by December 31 of the year. Tax equal to 50% of RMD if not taken Does not apply to Roth 401(k); Roth IRA Must take RMD from all qualified plans IRAs: take one RMD for all IRAs
24 © 2007 ME™ - Your Money Education Resource™ Calculating the Required Minimum Distribution Required Minimum Distribution = Fair Market Value of Participant’s Account at December 31 of the preceding plan year* Distribution period determined based on participant’s age at December 31 of the distribution year. Generally divide by factor starts at 27.4 for age 70 (see page 324) 26.5 for age 71 Factor continues to decline When will account be liquidated?
25 © 2007 ME™ - Your Money Education Resource™ Distribution Period Participant alive: receiving payments Single or Spouse isn’t trophy (spouse not > 10 years younger) Use Uniform Lifetime Table: page 324. Trophy spouse (> 10 years younger) Use Joint Life Table on pages Reduces RMD
26 © 2007 ME™ - Your Money Education Resource™ Minimum Distributions After Death If RMDs have begun Must take RMD (if over 70 ½ required) in year of death
27 © 2007 ME™ - Your Money Education Resource™ Minimum Distributions After Death If beneficiary is charming spouse Can roll into spouse’s IRA and use her RMD calculations Trophy spouse Or just continue to receive distributions based on decedent’s RMD Older spouse
28 © 2007 ME™ - Your Money Education Resource™ Minimum Distributions After Death If beneficiary is not charming spouse, two choices Cash out the IRA within five years of owner’s death or… Or elect to have distributions made over their life expectancy starting now Take account balance/factor for your age Factor from Single Life Table for age 30: 53.3 Then factor decreases by 1 each year Joe Some, Deceased 12/15/11, IRA F/B/O Joe Some, Jr., Beneficiary If beneficiary dies before account liquidated, successor beneficiary takes distributions using original beneficiary’s factors
1 © 2007 ME™ - Your Money Education Resource™ See page 127 Defined Benefit: monthly check for remainder of life Even better if it: increases each year.
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