1. Copyright © 2007, The American College. All rights reserved. Used with permission. Planning for Retirement Needs Distributions from Retirement Plans Chapter 24

2. Copyright © 2007, The American College. All rights reserved. Used with permission. Chapter 24: Distribution Rules Tax treatment Rollovers and transfers Lump-sum distributions Minimum distribution rules

3. Copyright © 2007, The American College. All rights reserved. Used with permission. Tax Treatment of Distributions Generally subject to ordinary income tax Death-benefit distributions treated as income in respect of a decedent Plan benefits subject to federal estate tax Special lump-sum tax treatment Certain “basis” not taxed 10-percent Sec. 72(t) penalty tax

4. Copyright © 2007, The American College. All rights reserved. Used with permission. Sec. 72 (t) Tax 10-percent penalty applies to taxable portion of pre-59-1/2 distributions from qualified plans, IRAs, SEPs and 403(b) plans Special 25-percent penalty applies to SIMPLE in first 2 years

5. Copyright © 2007, The American College. All rights reserved. Used with permission. Exceptions Applying to All Plans Distributions after death of participant Distributions due to disability Substantially equal periodic payments (qualified plans must separate from service) Deductible medical expenses

6. Copyright © 2007, The American College. All rights reserved. Used with permission. Exceptions for IRAs $10,000 of first-time homebuying expenses Payment of higher education expenses Heath insurance premiums for qualifying individuals receiving unemployment

7. Copyright © 2007, The American College. All rights reserved. Used with permission. Other Exceptions Early retirement with qualified plan or 403(b) plan (not IRAs) Must separate service after age 55 All distributions exempt from penalty tax

8. Copyright © 2007, The American College. All rights reserved. Used with permission. Substantially Equal Payments With qualified plan, must separate from service Distributions must continue for longer of 5 years or attainment of age 59-1/2 Annuitization (same withdrawal each year) Account balance (PV) Interest assumption (i) Life expectancy (n) Amoritization (same withdrawal each year) Minimum distribution approach (recalculate each year) Same methodology as minimum distribution rules

9. Copyright © 2007, The American College. All rights reserved. Used with permission. Substantially Equal Payments Failure to continue payments for prescribed period means 10% penalty and interest on all distributions prior to 59 ½ Can change to the minimum distribution approach

10. Copyright © 2007, The American College. All rights reserved. Used with permission. Questions Does the 10% Sec.72(t) tax apply? What if the withdrawal was from an IRA? Case Study Question Cindy, age 45, tells you that she is taking $25,000 from her company’s 401(k) plan under the hardship provisions to pay for her son’s college education expenses.

11. Copyright © 2007, The American College. All rights reserved. Used with permission. Responses No applicable exception with a 401(k) so 10% tax applies. Education exception applies to IRAs (but not qualified plans or 403(b) annuities) Note education exception does not require tracking of funds

12. Copyright © 2007, The American College. All rights reserved. Used with permission. Questions How can she avoid the Sec 72(t) tax? What are the parameters for each of the options? Case Study Facts Marcia, age 56, is involuntarily retired. She has a $100,000 IRA and a $250,000 401(k) account. She needs some income from one of these plans.

13. Copyright © 2007, The American College. All rights reserved. Used with permission. Responses Since she’s retiring after age 55 distributions from 401(k) plan not subject to tax. Could be problematic if she needs a stream of income for a number of years, since plan will have limited distribution options. Use the substantially equal periodic payment exception –Methodology in Rev. Rul. 2002-62. –With $350,000 in IRA, based on 28.7 year single life expectancy, and a 4.2% interest rate (the maximum rate is 120 percent of the federal mid term rate) the maximum annual payment is $21,213. –Must pay for 5 years (or to age 59 ½ if later). –Can switch to the minimum distribution approach –Could get smaller distribution by using the joint life table, a lower interest rate or divide the account into separate IRAs.

14. Copyright © 2007, The American College. All rights reserved. Used with permission. Nontaxable Distributions Basis PS 58 Costs After-tax contribution to qualified plan Nondeductible contribution to IRA IRA distributions Unfavorable exclusion ratio—must aggregate all IRAs Cost basis/value of all IRAs PS 58 costs Must distribute the insurance contract Self-employed can not recover Rollovers from qualified plans Can recover cost basis if roll over all but the cost basis

15. Copyright © 2007, The American College. All rights reserved. Used with permission. Nontaxable Distributions Single-sum distributions Payments prior to the annuity starting date Pre-1987 can be withdrawn tax-free Post-1987 use exclusion ratio based only on value of the cost-basis account Annuity payments Amount excluded is based on cost basis divided by specified months Fully taxable once basis is recovered

16. Copyright © 2007, The American College. All rights reserved. Used with permission. Questions Can he roll the after-tax dollars into an IRA? What are the tax ramifications if he rolls $750,000 into the IRA? What happens if he rolls the whole amount then withdraws $50,000? Case Study Facts John is retiring with a 401(k) balance of $800,000. $50,000 represents after tax contributions from years ago.

17. Copyright © 2007, The American College. All rights reserved. Used with permission. Responses The current law does allow the rollover of after-tax contributions. If he rolled over $750,000 there would be no income tax consequences. The IRS has indicated that the first amounts withheld from the rollover will be treated as the non-taxable amount. If he rolled over the whole amount and withdrew $50,000 only $3,125 of the total is withdrawn tax-free –Calculation is $50,000 x $50,000/$800,000. –Note that if you have multiple IRAs you must aggregate them when determining the denominator of this equation.

18. Copyright © 2007, The American College. All rights reserved. Used with permission. Rollovers: Qualified plans/403(b)/457 Roll “eligible distributions” to any of these plans or IRA Eligible rollover—all distributions except –Required minimum distributions –401(k) hardship withdrawals –Periodic payments for 10 years or more Rollover –Within 60 days of distribution –Subject to 20% mandatory withholding Direct Rollover –Every participant must receive opportunity for direct rollover –Avoids 20% withholding requirement

19. Copyright © 2007, The American College. All rights reserved. Used with permission. Rollovers: IRAs Not subject to mandatory withholding Elect trustee to trustee transfer to avoid problems Opportunity to use funds for 60 days –Must meet 60 day rule –Can only roll once each year for each plan

20. Copyright © 2007, The American College. All rights reserved. Used with permission. Rollovers: Beneficiaries Spouses –May leave in decedent’s name (consider if spouse is not yet 59 ½) –Roll into spouse’s IRA oCan simply retitle oCan do this at any time Other beneficiaries –Receive benefit directly from qualified plan –Inherited IRA—held in name of decedent

21. Copyright © 2007, The American College. All rights reserved. Used with permission. Question Jean wants to know whether she roll the benefit into an IRA account? Case Study Facts Jean Jones calls to say she is receiving a life annuity from her former employer’s defined-benefit plan. This month, Jean doesn’t need the money.

22. Copyright © 2007, The American College. All rights reserved. Used with permission. Responses No. One distribution in a stream of life annuity payments can not be rolled over.

23. Copyright © 2007, The American College. All rights reserved. Used with permission. Unrealized Appreciation Rule Participant receives a lump sum from a qualified plan that includes stock (in kind) from the sponsoring company. The difference between the value when allocated to the participant’s account (cost basis) and the market value is referred to as net unrealized appreciation (NUA). If stock is not rolled into an IRA the cost basis is taxed as ordinary income (and possibly Sec. 72(t) tax). NUA is not taxed until stock is sold. At that time NUA is taxed as long-term capital gain (regardless of holding period). Additional gain on stock is taxed as short/long term gain (depending upon holding period).

24. Copyright © 2007, The American College. All rights reserved. Used with permission. Question Should Joe consider any options other than rolling the benefit into an IRA? Case Study Facts Joe retires at 62 and receives a lump-sum distribution from his 401(k) plan with current value of $700,000. This includes $200,000 of company stock that has a cost basis is $50,000.

25. Copyright © 2007, The American College. All rights reserved. Used with permission. Responses Joe should consider rolling the cash (worth $500,000) into an IRA but not rolling over the $200,000 of stock. At the time of the distribution, Joe will have to pay tax on the $50,000 cost basis. When he sells the stock, he will pay long-term capital gains on the $150,000 NUA, and will pay long-term gain on any subsequent appreciation (held for 12 months). If Joe is in the 35 per­cent federal income tax bracket, he pays 35 percent on the $50,000 distribution, but he pays only 15 percent on the rest of the gain. If he rolls the employer securities into an IRA, all subsequent distributions will be taxed at 35 percent. Note no step up in basis if he dies while still holding the stock.

26. Copyright © 2007, The American College. All rights reserved. Used with permission. Choosing NUA Case Study shows power of NUA Tax savings only when cost basis of the securities is significantly lower than the market value Good idea if you need cash now since ordinary income converted to capital gains (Section 72(t) tax only applies to ordinary income) Bad idea for a younger person planning to diversify retirement portfolio Projections of future tax rates have an impact

27. Copyright © 2007, The American College. All rights reserved. Used with permission. Grandfathered Tax Rules Who is eligible for 10-year averaging? Lump sum distribution from qualified plan Born before 1936 Who is eligible for capital gains treatment? Lump sum distribution from qualified plan Born before 1936 Portion of benefit accrued before 1974 Who should consider taking advantage of these rules? Distribution around $300,000 or less Calculate tax rate and compare to current tax rate

28. Copyright © 2007, The American College. All rights reserved. Used with permission. Minimum Distribution Rules What plans are subject to the rules? What is the required beginning date? What is the first distribution year?

29. Copyright © 2007, The American College. All rights reserved. Used with permission. On September 15, 2005, she turned 70½. The first required distribution from Shelley’s IRA is for the year ending December 31, 2005, but she has the option to take the distribution any time in 2005 or delay it up to the required beginning date of April 1, 2006. However, if she delays the distribution into 2006, she will still have to take a minimum distribution for the second distribution year by December 31, 2006. Required Beginning Date Example Shelley, who has an IRA, turned 70 on March 15, 2005. What is her required beginning date and what is her first distribution year?

30. Copyright © 2007, The American College. All rights reserved. Used with permission. Question Florence wants to know if her husband has to start taking minimum distributions since he is still working? Case Study Facts Florence calls you and says that her husband is turning 70 ½ this year. He is self-employed (unincorporated) and he has a 401(k) plan.

31. Copyright © 2007, The American College. All rights reserved. Used with permission. Responses Exception for qualified plans allows deferral of RMD until April 1 following the year of retirement--if later than age 70 ½. However, exception does not apply since it does not apply to 5% owners. Must take minimum for year in which he turns 70½ but can wait until next April 1.

32. Copyright © 2007, The American College. All rights reserved. Used with permission. Account Plans–Participant Attains RBD What is the general rule that applies to minimum distributions from an account plan while the participant is still alive? Example: Sally, an IRA participant, is aged 71 at the last day of the first distribution year (the year she attains age 70½). Her IRA balance at the end of the preceding year is $200,000. The first year’s required distribution is $200,000/26.5 = $7,547 (table 25-4). This is the required minimum regardless of the beneficiary unless Sally’s sole beneficiary is her spouse and he is more than 10 years younger than she. For the second distribution year the applicable distribution period is 25.6 (table amount for a 72-year- old participant).

33. Copyright © 2007, The American College. All rights reserved. Used with permission. Account Plans–Participant Attains RBD What is the exception that applies with a spousal beneficiary? Example: If Sally’s beneficiary was her 51- year-old spouse, the minimum distribution would be $200,000/34.2 = $5,848 (table 25-5). In this case, for the second distribution year the applicable distribu­tion period is 33.2—their joint life expectancy calculated at the end of that distribution year.

34. Copyright © 2007, The American College. All rights reserved. Used with permission. Account Plans–Participant Attains RBD How are minimum distributions calculated after the participant’s death? –Spouse –Non spouse –Non person

35. Copyright © 2007, The American College. All rights reserved. Used with permission. Annuity Payments How are the rules different when an annuity is purchased? Does a life annuity on the life of the participant always comply with the rules? Does a joint and survivor annuity always comply with the rules? Does a life annuity with a certain term always comply with the rules?

36. Copyright © 2007, The American College. All rights reserved. Used with permission. Pre-retirement Death Benefits 5-year rule Spousal exception Nonspouse exception

37. Copyright © 2007, The American College. All rights reserved. Used with permission. Other Issues Beneficiary rules Multiple plans Spousal rollovers Grandfathering provisions

38. Copyright © 2007, The American College. All rights reserved. Used with permission. Question Do the minimum distributions for each of the plans have to come out of each plan, or can these plans be aggregated under the minimum distribution rules? Case Study Facts Alejandro, age 73, has three of his own IRAs, a 401(k) plan benefit and one inherited IRA.

39. Copyright © 2007, The American College. All rights reserved. Used with permission. Responses After calculating the minimum distribution for each of the 3 IRAs, the minimum for all three can come out of one plan. The RMD for the inherited IRA has to come out of that IRA. The RMD for the 401(k) has to come out of the 401(k) plan. Next year determine if annuity satisfies the annuity rules (a joint and survivor annuity generally will).

40. Copyright © 2007, The American College. All rights reserved. Used with permission. Planning Payouts prior to the following Sept. 30 Good option for charity beneficiaries Separate accounts Must establish prior to end of year following death Can calculate minimum for each separate account Qualified Waivers Must name contingent beneficiaries in the plan Waivers must be timely Can use to stretch out IRA or meet estate planning objectives

41. Copyright © 2007, The American College. All rights reserved. Used with permission. Question What are the required distributions in the first few years for Al? Case Study Facts In the first distribution year Al is age 70 and Alice, his primary beneficiary, is age 65.

42. Copyright © 2007, The American College. All rights reserved. Used with permission. RMD First Years $600,000 Al age 7027.4$21,897 $620,1027126.5$23,400 $640,1097225.6$25,004 $659,9127324.7$26,717

43. Copyright © 2007, The American College. All rights reserved. Used with permission. Question Assuming that Alice rolls the benefit into her own IRA what are the minimum required distributions in the year of death and for the next several years. Case Study Facts Al dies at age 85. Alice is age 80.

44. Copyright © 2007, The American College. All rights reserved. Used with permission. RMD’s at Al’s Death $828,0468614.1$58,726 $827,2828117.9$46,216 $838,9758217.1$49,062 $848,6418316.3$52,063 $855,9828415.5$55,224

45. Copyright © 2007, The American College. All rights reserved. Used with permission. Question Assuming that the account is not divided, what are the minimum required distributions in the year of Alice’s death and for the next several years? Case Study Facts Alice dies at age 90 and leaves her children as beneficiaries. The oldest is age 64 at the end of the year that Alice dies.

46. Copyright © 2007, The American College. All rights reserved. Used with permission. RMD’s at Alice’s Death $839,1479011.4$73,609 $824,2786520$41,213 $840,7636619$44,250 $855,3666718$47,520 $867,7216817$51,042

47. Copyright © 2007, The American College. All rights reserved. Used with permission. Question How does this impact the calculation of the minimum distributions? Facts Let’s assume that Alice had sufficient assets at Al’s death and decided to disclaim benefits in favor of the children.

48. Copyright © 2007, The American College. All rights reserved. Used with permission. $828,0468614.1$58,726 $827,2825628.7$28,825 $856,3675727.7$30,915 $885,3975826.7$33,160 $914,2145925.7$35,572 RMD’s with Children

49. Copyright © 2007, The American College. All rights reserved. Used with permission. Questions How does this impact the calculation of the minimum distributions? Facts Let’s assume that Alice had sufficient assets at Al’s death and decided to disclaim benefits in favor of the grandchildren. The oldest grandchild is age 30 in the year following Al’s death.

50. Copyright © 2007, The American College. All rights reserved. Used with permission. $828,0468614.1$58,726 $827,2823053.3$15,521 $869,6713152.3$16,628 $913,9193251.3$17,815 $960,0783350.3$19,087 RMD’s with Grandchildren

51. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions A death beneficiary receiving a distribution from an IRA may get a deduction attributable to estate taxes paid by the estate of the plan participant. The Sec. 72(t) 10 percent excise tax on early withdrawals applies to the entire amount of the distribution. The Sec. 72(t) 10 percent excise tax will not apply to a withdrawal from a 401(k) plan to pay for a child’s college education.

52. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions The required minimum distribution for a participant aged 72 with a charity as the beneficiary will be much larger than the required distribution with a 22-year-old child as the beneficiary. A 100-percent joint and survivor annuity pays benefits to the participant for life, and after the participant dies, payments continue in the same amount to a surviving contingent annuitant for his or her remaining life. Under a variable annuity contract, if the assumed investment rate (AIR) is low, the chances of receiving an increasing stream of benefits payments increase.

53. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions After a participant’s death, distributions must always be paid out over a 5-year period. A person born before January 1, 1936, may elect to treat the portion of a lump-sum distribution attributable to pre-1974 plan accruals as capital gains, subject to a straight 20 percent tax rate. A life annuity beginning when the participant attains age 69 will satisfy the required minimum distribution rules for all future years.