Bryant - Course 5. Retirement Planning & Employee Benefits. 7. Lesson 7. Distribution Rules, Alternatives and Taxation

Question 1

Failing to properly plan for retirement distributions is like driving a top-of-the-line Porsche at 35 miles per hour. The ride may be smooth, but the car’s full potential is not being realized. In much the same way, many people utilize their retirement plan to save for retirement, but they very rarely consider the various distribution alternatives, thereby utilizing only some portion of the plan’s capabilities.

Decades of savings usually result in making retirement plan funds the single largest asset for most people. However, too many people neglect to plan for effective retirement distributions. But planning is required because, unfortunately, there is no one best way to receive retirement distributions. The options are many and the rules and regulations can be confusing. However, there are a number of important points to keep in mind when making these decisions, which will result in achieving maximum tax savings while receiving timely distributions.

The Distribution Rules, Alternatives and Taxation module, which should take approximately four hours to complete, will explain the options for taking distributions from retirement plan funds and their tax consequences.

Answer 1

Upon completion of this module, you should be able to:
* Explain the process of planning retirement distributions,
* Specify the required spousal benefits,
* List the various options for receiving distributions,
* State the taxation system for plan distributions,
* Distinguish between the advantages of lump sum and deferred payments,
* Enumerate the requirements for loans from plan funds,
* Describe the effect of qualified domestic relation orders on distributions,
* List the penalties applicable on distributions,
* Calculate the minimum distribution amount required, and
* State the advantages and alternatives of plan rollovers.

Question 2

Due to the complexity of retirement plan distribution rules, it is essential for a financial planning practitioner to know the regulations governing distributions in order to minimize tax consequences while planning retirement distributions. The Internal Revenue Service (IRS) allows several distribution and benefit options, including some required spousal benefits. The tax impacts of in-service partial distributions, death benefits, loans and rollovers must be understood in detail. While there are several options to choose from, there are also penalties incurred upon not meeting certain requirements.

Answer 2

To ensure that you have a solid understanding of distribution rules, alternatives and taxation, the following lessons will be covered in this module:
* Planning Retirement Distributions
* Plan Provisions - Required Spousal Benefits
* Plan Provisions - Other Benefit Options
* Tax Impact
* Lump Sum Versus Deferred Payments
* Loans
* Qualified Domestic Relations Orders (QDROs)
* Penalty Taxes
* Retirement Plan Rollovers

Question 3

Section 1 - Planning Retirement Distributions

The retirement plan distribution rules are astonishingly complicated. They are a maze of rules and regulations that have developed in the law over many years, with Congress and the IRS adding new twists and turns almost every year.

In advising clients who are plan participants, a clear understanding of the qualified plan rules is important. A qualified plan or other tax advantaged plan can allow employees to accumulate substantial retirement benefits. Even a middle-level employee may have an account balance of hundreds of thousands of dollars available at retirement or termination of employment.

Careful planning is important in order to make the right choices of payment options and tax treatment for a plan distribution, to obtain the right result in financial planning for retirement, and also to avoid adverse tax results or even a tax disaster.

Answer 3

To ensure that you have a solid understanding of planning retirement distributions, the following topic will be covered in this lesson:
* Important Questions

Upon completion of this lesson, you should be able to:
* List the questions that must be answered to develop a tax-effective retirement distribution plan.

Question 4

Retirement plans are required to provide the same distribution options. State True or False.
* False
* True

Answer 4

False
* Retirement plans may be different in regards to distributions.
* It is important to review the summary plan document (SPD) of a plan to identify the plan’s distribution options.

Question 5

Section 1 - Planning Retirement Distributions Summary

Advance planning of retirement distributions is essential because the rules are complex and tax treatment of each plan differs. Though some plans may allow employees to accumulate a lot of money in their retirement account, they may lose a large sum to taxation if they do not choose the right payment options.

Exam Tip: All qualified plans are tax advantaged, but not all tax advantaged plans are qualified.

Answer 5

In this lesson, we have covered the following:
* Important questions must be answered from the perspective of a plan participant who is about to retire. This will help a financial planner collect information and help the client make decisions regarding plan distributions.
* The decisions that must be made involve the options for lump sum or periodic payout, rollovers, payment schedules, taxation of payments and the potential estate tax consequences of distribution.

Question 6

Section 2 - Plan Provisions - Required Spousal Benefits

All qualified pension plans must provide two forms of survivorship benefits for spouses, the qualified preretirement survivor annuity and the qualified joint and survivor annuity. Both of these options represent an “annuity” payment, that is a check every month for life rather than a single amount paid out at once. Stock bonus plans, profit-sharing plans, and employee stock ownership plans (ESOPs) generally need not provide these annuity survivorship benefits for the spouse if the participant’s nonforfeitable account balance is payable as a death benefit to that spouse.

Answer 6

To ensure that you have a solid understanding of the required spousal benefits in plan provisions, the following topics will be covered in this lesson:
* Qualified Preretirement Survivor Annuity
* Qualified Joint and Survivor Annuity

Upon completion of this lesson, you should be able to:
* Describe the provision of qualified preretirement survivor annuity,
* State the requirements for elections instead of preretirement survivor annuity,
* Explain qualified joint and survivor annuity, and
* Specify the alternatives to joint and survivor annuity and their legal requirements.

Question 7

Neely participates in her retirement plan. She received a notice to elect a survivorship benefit, but never made the election. What is her automatic benefit?
* No preretirement survivor benefit
* Preretirement survivor benefit
* Nonspousal benefit

Answer 7

Preretirement survivor benefit
* The preretirement survivor annuity is an automatic benefit. If no other election is made, a preretirement survivor annuity is provided.

Question 8

Describe receiving the Qualified Joint and Survivor Annuity Benefit

Answer 8

As with the preretirement survivor annuity, a participant may elect to receive another form of benefit if the plan permits. However, as with a qualified preretirement survivor annuity, the spouse must consent in writing to the election.

An election to waive the joint and survivor form must be made during the 90-day period ending on the annuity starting date. This is the date on which benefit payments should have begun to the participant, not necessarily the actual date of payment.

The waiver can be revoked, that is, the participant can change the election during the 90-day period. Administrators of affected plans must provide participants with a notice of the election period and an explanation of the consequences of the election within a reasonable period before the annuity starting date.

The joint and survivor annuity must be the actuarial equivalent of other forms of benefit. Therefore, the participant may wish to increase the monthly pension by waiving the joint and survivor annuity and receiving a straight life annuity or some other form of benefit. Just as in the case of the preretirement survivorship benefit, the nonparticipant spouse’s consent to waiver of the joint and survivor annuity in favor of an optional benefit form selected by the participant must meet the following requirements:
* It must be in writing.
* It must acknowledge the effect of the waiver.
* It must be witnessed, either by a plan representative or a notary public.

Practitioner Advice:
* Before recommending that a spouse waive his or her right to a pre or postretirement annuity, the financial planner must be certain that the surviving spouse has enough assets and income to be financially secure.

Question 9

Section 2 - Plan Provisions - Required Spousal Benefits Summary

Survivorship benefits ensure that the spouse of a plan participant receives adequate annuity payments upon the death of the spouse, whether it takes place before or after retirement. All qualified pension plans are required to provide survivorship benefits.

In this lesson, we have covered the following:
* Qualified preretirement survivor annuity provides the surviving spouse with a right to payment if the plan participant dies before retirement. The amount payable under the defined benefit plan is calculated in different ways depending on whether the participant died before attaining the earliest retirement age. Under a defined contribution plan, the amount paid is an annuity for life actuarially equal to 50% of the participant’s vested account balance or more. These survivorship benefits are automatic, unless the participant elects some other form of survivor benefit, elects a beneficiary other than a spouse or elects out of the benefit to increase his or her postretirement benefits. Such elections must be done with the written consent of the nonparticipant spouse.

Answer 9

• Qualified joint and survivor annuity provides annuity payments to the participant after retirement. It also ensures annuity benefits to the participant’s spouse if the participant dies postretirement. The payment must be between 50% and 100% of the annuity payable during the joint lives of participant and spouse. If the participant elects to receive any other form of benefit instead of survivor annuity, it must be done with the written consent of the nonparticipant spouse.

Question 10

The waiver of the preretirement survivorship benefit in favor of an optional benefit has to be consented to by the nonparticipant spouse. The consent to waiver must meet which of the following requirements? (Select all that apply)
* It has to be in writing
* It must be certified by the plan administrator
* It must acknowledge the effect of the waiver
* It has to be witnessed by a plan representative or a notary public.

Answer 10

It has to be in writing
It must acknowledge the effect of the waiver
It has to be witnessed by a plan representative or a notary public.
* The consent of the nonparticipant spouse to waiver of the preretirement survivorship benefit in favor of an optional benefit form selected by the participant must be in writing, acknowledge the effect of the waiver and be witnessed, either by a plan representative or a notary public. There is no regulation about certification by a plan administrator.

Question 11

All qualified pension plans must provide two forms of survivorship benefits for spouses, the preretirement survivor annuity and the joint and survivor annuity. The plans that need not provide for such survivorship benefits for spouses, if the participant’s nonforfeitable account balance is payable as a death benefit to that spouse, are which of the following? (Select all that apply)
* Defined contribution pension plans
* Defined benefit plans
* Stock bonus plans
* Profit sharing plans
* Employee stock ownership plans

Answer 11

Stock bonus plans
Profit sharing plans
Employee stock ownership plans
* All qualified pension plans, including defined benefit plans and defined contribution plans, must provide two forms of survivorship benefits for spouses, the qualified preretirement survivor annuity and the qualified joint and survivor annuity. Stock bonus plans, profit sharing plans and ESOPs generally need not provide these survivorship benefits for the spouse if the participant’s nonforfeitable account balance is payable as a death benefit to that spouse.

Question 12

An election to waive the joint and survivor form must be made before the annuity starting date. The annuity starting dates commences after what time frame?
* 30 days
* 45 days
* 60 days
* 90 days

Answer 12

90 days
* An election to waive the joint and survivor form must be made during the 90-day period ending on the annuity starting date, that is, the date on which benefit payments should have begun to the participant.

Question 13

Section 3 - Plan Provisions - Other Benefit Options

A qualified plan can offer a wide range of distribution options. Participants benefit from having the widest possible range of options because this increases their flexibility in personal retirement planning. Although a large number of options provided by a plan are beneficial to the participants, a wide range of options also increases administrative costs. Also, the IRS makes it difficult to withdraw a benefit option once it has been established, though this anti-cutback rule has been eased somewhat for plan years beginning after December 31, 2001. Consequently, most employers provide only a relatively limited menu of benefit forms for participants to choose from.

In addition, a qualified plan generally must provide for direct rollovers of certain distributions. Failure to elect a direct rollover will subject the distribution to mandatory 20% withholding. Plan administrators must provide a written explanation to the distributee of his or her right to elect a direct rollover and the withholding consequences of not making the election.

Answer 13

To ensure that you have a solid understanding of other benefit options in plan provisions, the following topics will be covered in this lesson:
* Defined Benefit Plan Distribution Provisions
* Defined Contribution Plan Distribution Provisions

Upon completion of this lesson, you should be able to:
List the distribution provisions under defined benefit plans,
* Describe the period-certain option,
* Explain the process of choosing a beneficiary other than spouse,
* Enumerate the distribution provisions under defined contribution plans, and
* Distinguish between annuity and lump sum payments.

Question 14

Section 3 - Plan Provisions - Other Benefit Options Summary

Apart from the distribution options that a qualified plan must provide, such as preretirement survivor annuity and joint and survivor annuity, there are several other distribution options that a qualified pension plan may provide. The administration costs, however, increase with the number of options provided.

In this lesson, we have covered the following:
* Defined benefit plan distribution provisions include joint and survivor annuity for married participants and life annuity for unmarried participants. They also may provide a life with period-certain annuity option, which ensures annuity payments for a certain period. Even if the participant or spouse dies before the end of the period, the payments will continue for the participant’s heirs or specified beneficiaries for a specified period. Another option available is for a participant to choose a joint annuity with a beneficiary other than his or her spouse.

Answer 14

• Defined contribution plan distribution provisions can and sometimes must include options similar to defined benefit plans. Annuity is computed based on the participant’s plan account balance. As an alternative to annuity, the participant can also take a lump sum benefit at retirement or take out nonannuity distributions over the retirement years as needed.

Question 15

A qualified plan can offer a wide range of distribution options. Participants benefit from having the widest possible range of options, because this increases their flexibility in personal retirement planning. Which of the following is a disadvantage of having such a wide range of options?
* There are no disadvantages to having a wide range of options
* It increases administrative costs
* It reduces the total distribution amount
* It increases tax liability of the participant

Answer 15

It increases administrative costs

• A wide range of options increases administrative costs. Also, the IRS makes it difficult to withdraw a benefit option once it has been established, though this anti-cutback rule has been eased somewhat for plan years beginning after December 31, 2001. Consequently, most employers provide only a relatively limited menu of benefit forms for participants to choose from.

Question 16

Which of the following are distribution options provided by defined contribution plans? (Select all that apply)
* Lump sum distribution at retirement
* Lump sum distribution at termination of employment
* Annuity distribution over the retirement years
* Nonannuity distributions over the retirement years as necessary
* Annuity distributions before retirement as necessary

Answer 16

Lump sum distribution at retirement
Lump sum distribution at termination of employment
Annuity distribution over the retirement years
Nonannuity distributions over the retirement years as necessary
* Defined contribution plans provide a lump sum benefit at retirement or termination of employment or annuity over the retirement years. Defined contribution plans often also allow the option of taking out nonannuity distributions over the retirement years as they are needed. However, these annuity distributions cannot be made before retirement.

Question 17

Life with period-certain annuities does not provide payments for the life of the annuitant, but for a specified period of time, usually 10 to 20 years, in which of the following circumstances? (Select all that apply)
* If the participant dies before the end of the period
* Only if the participant does not die until the end of the period
* If the participant and spouse die before the end of the period
* Only if the participant and spouse do not die until the end of the period

Answer 17

If the participant dies before the end of the period
If the participant and spouse die before the end of the period
* Life with period-certain annuities provides payments for a specified period of time, usually 10 to 20 years, even if the participant, or the participant and spouse, both die before the end of that period. Thus, the life with period-certain annuity makes it certain that periodic benefits will continue for the participant’s heirs even if the participant and spouse die early.

Question 18

Section 4 - Tax Impact

For many plan participants, retirement income adequacy is more important than minimizing taxes to the last dollar. Nevertheless, taxes on both the federal and state levels must never be ignored, as they reduce the participant’s bottom line, financial security. The greater the tax on the distribution, the less financial security the participant has. The more tax you pay, the less real retirement income you will have.

A qualified plan distribution may be subject to federal, state and local taxes, in whole or in part. The federal tax treatment is generally the most significant, because federal tax rates are usually higher than state and local rates. Also, many state and local income tax laws provide a full or partial exemption or especially favorable tax treatment for distributions from qualified retirement plans.

Answer 18

To ensure that you have a solid understanding of tax impact on distribution, the following topics will be covered in this lesson:
* Nontaxable and Taxable Amounts
* Total Distributions
* Taxation of Annuity Payments
* Lump Sum Distributions
* Taxation of Death Benefits
* Federal Estate Tax

Upon completion of this lesson, you should be able to:
* Identify the taxable and nontaxable distribution amounts,
* Describe the tax implications of in-service distributions,
* Explain the taxation of annuity payments and total distributions,
* Specify the taxes and penalties applicable to lump sum distributions,
* Define the grandfathered rules for lump sum distributions,
* State the methods used for taxation of death benefits, and
* Describe how estate tax is affected by distributions.

Question 19

Employees that contribute after-tax money into their account will have to pay federal income taxes on those contributions when the money is withdrawn. State True or False.
* False
* True

Answer 19

False
* Employees that make after-tax contributions can receive these amounts free of federal income taxes, although the order in which they are recovered for tax purposes depends on the kind of distribution.

Question 20

Describe In-Service (Partial) Distributions

Answer 20

Many savings or thrift plans and other plans provide for in-service partial plan distribution. If a participant takes out a partial plan distribution before termination of employment, the distribution is deemed to include both nontaxable and taxable amounts. The nontaxable amount will be in proportion to the ratio of total after-tax contributions, that is, the employee’s cost basis, to the plan account balance. This is similar to the computation of the annuity exclusion ratio. Expressed as a formula, it looks like this:

Nontaxable Amount=Distribution × (Employee’s Cost Basis/Total Account Balance)

However, there is a grandfather rule for pre-1987 after-tax contributions to the plan. If certain previously existing plans include contributions made before 1987, it is possible to withdraw after-tax money first. That is, if a distribution from the plan is made that is less than the total amount of pre-1987 after-tax contributions, the entire distribution is received tax-free. This applies to distributions made at any time, even after 1987. Once a participant’s pre-1987 amount, if any, has been used up, the regular rule applies.

A taxable in-service distribution may also be subject to the early distribution penalty. In addition, in-service distributions generally will be subject to mandatory withholding at 20%, unless the distribution is transferred to an eligible retirement plan by means of a direct transfer rollover.

After-tax contribution timeline
* Pre-1987. If the plan includes after-tax contribution mode before 1987, it is possible to withdraw after-tax money first. That is, if a distribution from the plan is made that is less than the total amount of pre-1987 after-tax contributions, the entire distribution is received tax-free.
* Post-1987 contributions. For any after-tax contributions that are made after 1987, the distribution includes both nontaxable and taxable amounts. The nontaxable amount will be in proportion to the ratio of total after-tax contributions, that is, the employee’s cost basis, to the plan account balance.

Exam Tip:
* The mandatory 20% withholding applies to qualified plans, Section 403(b) plans, and Section 457 governmental plans.

Question 21

Which of the following are reasons why a participant would NOT want to take a lump sum distribution? Click all that apply.
* High tax bracket
* Late distribution penalty
* Mandatory 20% withholding
* Mandatory 10% withholding
* Early distribution penalty

Answer 21

High tax bracket
Mandatory 20% withholding
Early distribution penalty
* A participant may not want to take a lump sum distribution because he or she may be in a high tax bracket.
* In addition, he or she may be subject to the 20% mandatory withholding and early distribution penalties.

Question 22

Describe Net Unrealized Appreciation (NUA) stock within a qualified plan

Answer 22

Employer stock within a qualified plan may enjoy unique treatment under the tax code. Under certain conditions, distributions of employer stock may be subject to ordinary income tax on the basis of the stock, and long term capital gain treatment on gains above basis as of the date of distribution.

Here’s an example:
Geri Hiegal has worked for Qualco Corporation for over 25 years. She has contributed to the 401(k) plan since its inception, allocating 10% of her contributions to the Qualco common stock account. Additionally, Qualco matches employee contributions with Qualco stock. The current market value of the Qualco stock in her 401(k) plan is $103,000. The plan administrator of the plan has been keeping track of Geri’s basis in Qualco stock, i.e. what the value of the stock was when each share was contributed (that is, the deduction that the company took when the stock was contributed). The basis of Geri’s stock is $21,000.

Geri is retiring this year, at age 60 and is considering her options for the 401(k) plan, whose total balance is $423,000. If Geri meets the definition of a lump sum distribution she could take the entire balance of the stock from the plan, with a market value of $103,000, and owe ordinary income tax on $21,000 (basis). If and when she sells any of the stock, the gain above basis will be taxed as long term capital gains.

Practitioner Advice:
* If Geri meets the definition of a lump sum distribution, she could take the entire balance of the stock from the plan, with a market value of $103,000, and owe ordinary income tax on $21,000 (basis).
* If and when she sells any of the stock, the gain above basis will be taxed as long term capital gains.

Question 23

Section 4 - Tax Impact Summary

Distributions from qualified plans are subject to federal, state and local taxes. Sometimes part of the distribution is not taxed, depending upon the proportion of after-tax contribution made by the employee.

In this lesson, we have covered the following:
* Nontaxable and taxable amounts of qualified plan distribution are calculated on the basis of the amount of after-tax contributions that the employee initially made to the plan, called cost basis. A participant’s cost basis includes the employee’s total after-tax contributions, cost of life insurance reported as taxable income, employer contributions previously taxed to employee and plan loans included in taxable income. In-service partial distributions are deemed to include both taxable and nontaxable amounts. Therefore the nontaxable amount will be proportionate to the ratio of the employee’s cost basis to the plan account balance.
* Total distributions in the form of an annuity are taxed on the basis of the same ratio of total after-tax contributions to total expected annuity payments. A total distribution may also be subject to an early distribution penalty and mandatory withholding at 20% unless certain requirements are met.

Answer 23

• Taxation of annuity payments involves determination of the excludable portion of each monthly payment based on tables of anticipated annuity payments. If the employee has no cost basis, he or she must include as ordinary income the full amount of each annuity payment.
• Lump sum distributions may be eligible for certain favorable tax calculations. However, they may also be subject to an early distribution penalty and a mandatory withholding at 20%. Distributees who attained age 50 before 1986 may elect capital gain treatment if it produces a lower overall tax. They are also eligible for the 10-year averaging provision and can elect to treat pre-1974 plan accruals as long-term capital gain.
• Taxation of death benefits is governed by the same rules as lifetime benefits such as lump sum distribution or annuity payments. The pure insurance amount of a death benefit is excludable from income taxation if the death benefit is payable under a life insurance contract held by the qualified plan. A death benefit can also be rolled over to a spouse’s IRA.
• Federal estate tax must be paid on all property transferred at death, if unified credit or marital deductions are not available. This would normally include death benefits, unless they are life insurance proceeds in which the insured had no incidents of ownership.

Question 24

Grandfathered rules are applied to taxation of plan participants who attained age 50 before which date?
* January 1, 1974
* January 1, 1986
* July 1, 1986
* January 1, 1987

Answer 24

January 1, 1986

• Grandfathered rules related to after-tax contributions and 10-year averaging are applied to taxation of plan participants who attained age 50 before January 1, 1986.

Question 25

James Stewart, age 60, dies in July 2021 before retirement. He has elected his wife Anita as his beneficiary. Anita receives a lump sum death benefit of $250,000 from a life insurance policy held by a qualified plan. The insurance contract’s cash value was equivalent to $160,000 at James’s death. During his lifetime, James had reported an insurance cost of $25,000. What is the nontaxable amount of the $250,000 distribution?
* $250,000
* $225,000
* $135,000
* $160,000
* $115,000

Answer 25

$115,000
* The nontaxable amount is the total of the participant’s cost basis and the pure insurance amount.
* Therefore, it is calculated as follows: $250,000 (death proceeds) - $160,000 (cash value) = $90,000 (pure insurance amount) + $25,000 (cost basis) = $115,000 (nontaxable amount).

Question 26

Taxable part of a plan distribution is determined by the total cost basis divided by the total payout. The cost basis includes: (Select all that apply)
* After-tax contributions made by the employee.
* Rollovers to other plans.
* Cost of life insurance protection reported as taxable income by the participant.
* Employer contributions previously taxed to the employee.
* Plan loans included in income as a taxable distribution.

Answer 26

After-tax contributions made by the employee.
Cost of life insurance protection reported as taxable income by the participant.
Employer contributions previously taxed to the employee.
Plan loans included in income as a taxable distribution.
* The cost basis includes employee after-tax contributions, cost of life insurance reported as taxable income, employer contributions taxed to employee and plan loans included as taxable income.
* However, rollovers are not included in cost basis because they are not taxed at the time of being rolled over.
* They are generally made to defer tax until the time the funds are actually withdrawn from the plan

Question 27

Section 5 - Lump Sum Versus Deferred Payments

Often plan participants have a choice between a single lump sum plan distribution and a series of deferred payments. This requires a choice between competing advantages. The tax implications as well as several nontax effects of both types of payments must also be taken into consideration.

Practitioner Advice:
* An often overlooked option is to leave the retirement assets in the plan. There may be significant advantages offered by the retirement plan including but not limited to:
* Mutual funds with low institutional expense ratios
* Fund are regularly monitored and replaced if necessary
* Website support and assistance
* ERISA protection from creditors
* Post age 55 separation from service withdrawals without 10% penalty

Answer 27

To ensure that you have a solid understanding of lump sum distribution versus deferred payments, the following topics will be covered in this lesson:
* Advantages of Lump Sum Distributions
* Advantages of Deferred Payout
* Factors Involved in Determining Alternatives

Upon completion of this lesson, you should be able to:
* State the advantages of lump sum distributions,
* Describe the advantages of deferred payout, and
* List and explain the factors that must be considered in deciding the form of distribution.

Question 28

Pract: common to elect direct transfer; defer payout &tax, free 2 invest

What are the Advantages of Lump Sum Distributions vs

Answer 28

The plan participant can withdraw his entire retirement funds accumulated in the plan as a single lump sum distribution. The advantages of a lump sum distribution include:
* 10-year averaging for eligible distributions to an individual born before 1936, and
* The freedom to invest plan proceeds at the participant’s discretion instead of having to accept the plan administrator’s method and/or choice of investment.

Advantages of Deferred Payout
In contrast to a lump sum distribution, the plan participant can opt to take a deferred payout of the plan funds. The advantages of a deferred payout are:
* Deferral of taxes until money is actually distributed,
* Continued tax shelter of income on the plan account while money remains in the plan, and
* Security of retirement income.

Practitioner Advice:
* It is common to elect a direct transfer. This will defer the payout and thus the tax and provide the client with the freedom to invest plan proceeds at the participant’s discretion.

Question 29

Section 5 - Lump Sum Versus Deferred Payments Summary

The pros and cons of lump sum distributions and deferred payments must be understood before making a choice, as both have distinctive advantages.

In this lesson, we have covered the following:
* Advantages to lump sum distributions include provisions for 10-year averaging if born before 1936 and a choice of investment options.

Answer 29

• Advantages of deferred payout include tax deferral, tax shelter and security of income and if proceeds are rolled over, a choice of investment options.
• Factors involved in determining alternatives are not only tax considerations, but also age and health of the participant, return on investment, expected tax rates, income requirements and the size of the total amount of the benefit.

Question 30

Section 6 - Loans Overview

Due to the 10% penalty tax on early distributions from qualified plans, a plan provision allowing loans to employees may be attractive. This allows employees access to plan funds without extra tax cost. However, a loan provision increases administrative costs for the plan and may deplete plan funds available for pooled investments. Moreover, loans are also subject to penalties if they do not meet certain requirements of the code.

Answer 30

To ensure that you have a solid understanding of loans, the following topics will be covered in this lesson:
* Requirements of Code Section 4975(d)(1)
* Requirements of Code Section 72(p)

Upon completion of this lesson, you should be able to:
* List the loan requirements of Section 4975(d)(1)
* Enumerate the loan requirements of Section 72(p), and

Practitioner Advice:
* One of the reasons many 401(K) plans allow for loans is that it encourages the non-highly compensated employees to contribute to the 401(K) thus allowing the highly compensated employees to defer a bigger amount.

Question 31

Section 6 - Loans Overview Summary

Loans to participants are generally prohibited transactions, subject to penalties unless they are exempted from prohibited transaction rules by administrative exemption or they meet the requirements of Section 4975(d)(1) and/or Section 72(p).

In this lesson, we have covered the following:
* Requirements of Code Section 4975(d)(1) must be met for a loan to be exempted from penalties. These requirements ensure that loans are available to all participants on an equivalent basis and prevent discrimination in favor of highly compensated employees with regard to loan amounts. The loans must also bear reasonable rates of interest and be adequately secured.

Answer 31

• Requirements of Code Section 72(p) must be met by loans from qualified plans, otherwise they will be treated as a taxable distribution. The loan must be the lesser of $50,000 reduced by last year’s highest outstanding loan balance, or half the present value of the vested account balance. In any case a loan of up to $10,000 is allowed, but the loan must be repayable within five years except for loans used to secure a principal resident of the participant.
• Interest on loans secured by first and second homes and rental properties may be deductible interest, however, interest for personal loans (e.g. a 401k plan loan) is not deductible.

Question 32

For participants to borrow from a plan, the plan must specifically permit such loans. Loan provisions are most common in defined contribution plans, particularly profit-sharing plans. From which of the following plans are loans permitted? (Select all that apply)
* Section 403(b) plan
* Simple IRAs
* SEPs
* Section 401(k) plan

Answer 32

Section 403(b) plan
Section 401(k) plan
* Any type of qualified plan or Section 403(b) tax-deferred annuity plan may permit loans.
* However, if the plan is subject to ERISA, loans from Section 403(b) tax-deferred annuity plans are subject to the prohibited transaction rules and penalties.
* Section 401(k) plans are qualified plans and therefore allow loans. There are considerable administrative difficulties connected with loans from defined benefit plans because of the actuarial approach to plan funding.
* Loans from IRAs and SEPs are not permitted.

Question 33

Which of the following are the requirements of the Code Section 4975(d)(1)? (Select all that apply)
* Loans are made available to all participants on a reasonably equivalent basis.
* Loans are made in accordance with provisions in the plan.
* Loans of larger amounts in proportion to their contributions are made available to highly compensated employees.
* Loans made available bear reasonable rates of interest.
* Loans are adequately secure.

Answer 33

Loans are made available to all participants on a reasonably equivalent basis.
Loans are made in accordance with provisions in the plan.
Loans made available bear reasonable rates of interest.
Loans are adequately secure.
* The requirements of the Code are that loans are available to all participants on a reasonably equivalent basis and in accordance with specific provisions set forth in the plan. The loans must bear reasonable rates of interest and must be adequately secured. Loans must not be made available to highly compensated employees in an amount greater than the amounts made available to other employees.

Question 34

Loans can be given to employees from the 401(K) plan contributions made by them. However, interest on these loans is not tax-deductible by the employee unless which of the following?
* It is secured to take care of a family emergency.
* Loan interest from a 401(k) plan may be deductible if the loan is used to acquire the borrower’s primary residence.
* It is secured for taking care of the medical expenses of the plan participant and his or her dependent family.
* It is secured by a key employee.

Answer 34

Loan interest from a 401(k) plan may be deductible if the loan is used to acquire the borrower’s primary residence.
* The interest for 401(K) loans is typically not deductible but an exception does exist for primary residence loan interest.

Question 35

Section 7 - Qualified Domestic Relations Orders (QDROs)

A qualified domestic relations order (QDRO) is a ruling by state law, usually relating to child support, marital property rights, or alimony. It may assign all or part of a plan’s benefits to a spouse, child, or dependent of the participant. Thus, the plan benefits become part of the negotiable assets in the dispute.

Practitioner Advice:
* QDRO’s only apply to assets found in qualified plans and 403(b) plans.
* For IRA’s and IRA-based plans such as the SEP-IRA and SIMPLE-IRA, the QDRO does not apply.
* Instead, the custodian of those assets would respond to the terms of an approved Divorce Decree.

Answer 35

To ensure that you have a solid understanding of qualified domestic relations orders, the following topics will be covered in this lesson:
* Plans and QDROS
* Alternate Payee

Upon completion of this lesson, you should be able to:
* Describe the impact of a QDRO on plan distributions, and
* State the options available to an alternate payee of a plan distribution.

Question 36

Describe QDRO to an Alternate Payee

Answer 36

A QDRO may assign part or all of a participant’s plan benefits to an alternate payee. The alternate payee may be a spouse, former spouse, child, or another dependent of the participant. The recipient of the QDRO can roll over the distribution or can just take the money.

An alternate payee who is the spouse or former spouse of the participant and who receives a distribution by reason of a QDRO may roll over the distribution in the same manner as if he or she were the participant. If not rolled over, the recipient is subject to income tax on the distribution.

Exam Tip:
* Distributions from a QDRO will not be subject to the 10%, pre-59.5 early withdrawal excise tax.

Question 37

Section 7 - Qualified Domestic Relations Orders (QDROs) Summary

Qualified plans generally protect a participant’s retirement fund from attachment by creditors by preventing a participant from voluntarily or involuntarily assigning or alienating the benefit. An assignment enforced by a QDRO is an exception to this rule.

In this lesson, we have covered the following:
* A QDRO may specify that benefits from a plan be assigned to an alternate payee as a settlement. However, a QDRO cannot assign a benefit that the plan does not provide. It also cannot assign a benefit already assigned to someone else or a cash benefit when the participant has no right to cash payments.

Answer 37

• An alternate payee is a person who receives a distribution enforced by a QDRO, such as a spouse or former spouse of the participant. The recipient of the QDRO can roll over the distribution or can just take the money.

Question 38

Section 8 - Penalty Taxes

In addition to the complicated regular tax rules, distributions must be planned so that recipients avoid, or at least are not surprised by, tax penalties for withdrawals made too early or too late. There is also a certain amount of minimum distribution that must be taken at a particular time or penalties will apply.

Answer 38

To ensure that you have a solid understanding of penalty taxes, the following topics will be covered in this lesson:
* Early Distribution Penalty
* Minimum Distribution Requirements and Penalty

Upon completion of this lesson, you should be able to:
* State the conditions under which early distribution penalties apply,
* List the minimum distribution requirements, and
* Describe the simplified regulations for minimum distributions.

Question 39

When is the Early Distribution Penalty imposed?

Answer 39

Early distributions from qualified plans, Section 403(b) tax-deferred annuity plans, IRAs and SEPs are subject to a penalty of 10% of the taxable portion of the distribution.
In the case of Savings Incentive Match Plans for Employees (SIMPLE) IRAs, the penalty is increased to 25% during the first two years of participation.

The penalty does not apply to 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,
* That are part of a series of substantially equal periodic payments made at least annually over the life or life expectancy of the participant, or the participant and a designated beneficiary (separation from the employer’s service is required, except for IRAs),
* Made upon separation from service after attainment of age 55 (not applicable to IRAs),
* Made to a former spouse, child or other dependent of the participant under a qualified domestic relations order (not applicable to IRAs),
* To the extent of medical expenses deductible for the year under Code Section 213, whether or not actually deducted,
* To pay health insurance costs while unemployed (IRAs only),
* For higher education costs (tuition, fees, books, supplies and equipment) for the taxpayer, spouse, child or grandchild (IRAs only), or
* To pay acquisition costs of a first home of the participant, spouse, child, grandchild or ancestor of the participant or spouse, up to a $10,000 lifetime maximum (IRAs only).
* The SECURE Act of 2019 added an early-withdrawal penalty exception for distributions from retirement plans for individuals in the case birth of a child or adoption. The aggregate amount which may be treated as qualified birth or adoption distributions by any individual with respect to any birth or adoption shall not exceed $5,000.

In the case of the periodic payment exception, if the series of payments is changed before the participant reaches age 59½ or, if after age 59½, within five years of the date of the first payment, the penalty tax that would have been imposed, but for the periodic exception, is imposed, with interest, in the year the change occurs.

Practitioner Advice: Note that distributions from a 457 plan prior to age 59½ are not subject to the 10% excise tax.

Question 40

Describe Minimum Distribution Requirements and Penalty

Answer 40

Required minimum distributions (RMD) from qualified plans, Section 403(b) tax-deferred annuity plans, IRAs, SEPs, SIMPLE IRAs, and Section 457 governmental deferred compensation plans must begin not later than April 1 of the calendar year following the later of:
* The calendar year in which the employee attains age 73 (beginning January 1, 2023), or
* The calendar year in which the employee retires (in the case of an employer-sponsored plan).

A required minimum distribution is required for the year in which the participant attains age 73 or retires, even if the actual distribution is deferred until April 1 of the following year. However, all other required minimum distributions must be made during the year to which they apply.

For example, an individual who attains age 73 in 2023 and defers the initial required minimum distribution to April 1, 2024, must make two minimum distributions during 2024, which are the deferred 2023 distribution and the 2024 distribution. The 2024 distribution must be taken by December 31, 2024.

If the annual distribution is less than the minimum amount required, there is a penalty of 25% of the amount that should have been distributed but was not distributed. However, a participant can always take out more than the required minimum.

The required minimum distribution rules are designed to determine the rate at which income taxes must be paid on retirement accumulation. The minimum distribution amounts do not have to be spent by the participant but can be reinvested in a nonqualified investment medium.

Practitioner Advice: Although it is usually wise to defer taxation, it is not always the case. For instance, a financial planner needs to figure out the tax ramifications of deferring the first required minimum distribution to April 1 of the year following the participant turning 73. Why? Because the participant would have to take two distributions that year, the second distribution might be taxed at a much higher marginal tax rate

Question 41

Section 8 - Penalty Taxes Summary

The SECURE Act of 2019 made significant changes impacting distribution options after the death of the account owner. Under previous law, a beneficiary had the option to take RMD over the remaining life expectancy of the beneficiary. Under the SECURE Act, there are no yearly required minimum distributions, but the entire account balance must be distributed within 10 years following the year of death of the account owner. This new law has dramatically impacted the “stretch IRA” strategy under which distributions were spread out over several generations.

Exempted from the 10-year stretch provisions are surviving spouses, minor children up until the age of majority, individuals within 10 years of age of the deceased, the chronically ill, and the disabled. This significant change makes it imperative for financial planners to know the rules and review accounts with the client to determine the impact of the law change on the client’s objectives.

The IRS regulates plan distributions so that they are not made too early or too late. It also specifies a minimum amount to be distributed, though a participant can take out more. If these distribution requirements are not met, it may result in penalties.

Answer 41

In this lesson, we have covered the following:
* Early distribution penalty This excise tax is assessed on the taxable portion of an early distribution from a qualified plan. However, if the distribution is made after the participant’s attaining age 59½, death or disability, the penalty does not apply. There are also other exceptions such as distributions made under QDRO, if separation from service occurred after age 55 or if distributions are taken as a series of substantially equal periodic payments following separation from service.
* Minimum distribution requirements specify that the plan distributions must begin no later than April 1 of the calendar year following the year the participant attains age 73 or retires. The minimum distribution is calculated by dividing the account balance by a number specified in an IRS table called Table 1. The penalty for not meeting minimum distribution requirements is 50% of the amount not distributed as required.

Question 42

The early distribution will attract a penalty if: (Select all that apply)
* The participant has not attained the age of 59½.
* It is made to the plan participant’s beneficiary or estate before the participant’s death.
* It is made upon separation from service before attainment of age 55.
* It is made to pay health insurance costs while unemployed.

Answer 42

The participant has not attained the age of 59½.
It is made to the plan participant’s beneficiary or estate before the participant’s death.
It is made upon separation from service before attainment of age 55.
* The early distribution penalty does not apply to distributions made on or after attainment of age 59½. Early distribution will also not attract a penalty if it is made to the plan participant’s beneficiary or estate on or after the participant’s death. The penalty is also not applicable if it is made to pay health insurance costs while unemployed. However, the early distribution penalty is applicable if it is made upon separation from service before attainment of age 55.

Question 43

Early distributions from which retirement plan will attract a penalty of 25% during the first two years of participation in the plan?
* SIMPLE IRAs
* Section 403(b) tax-deferred annuity plans
* IRAs
* SEPs

Answer 43

SIMPLE IRAs

• Early distributions from qualified plans, Section 403(b) tax-deferred annuity plans, IRAs and SEPs are subject to a penalty of 10% of the taxable portion of the distribution. In the case of SIMPLE IRAs, the penalty is increased to 25% during the first two years of participation.

Question 44

Dave Miller is 75 and is part of his employer sponsored retirement plan. Dave does not have to take minimum distributions from his work plan or any other retirement plan that is subject to the minimum distribution rules.
* False
* True

Answer 44

False

• It is true that Dave does not have to take minimum distributions from the plan of his current employer, but he is required to take distributions from the plans of any prior employers or from any IRA accounts that he has.

Question 45

Section 9 - Retirement Plan Rollovers

With tax-deferred retirement accounts, taxes become due when the funds are distributed. However, taxes can be deferred further if the funds are redeposited in another tax-deferred retirement account within 60 days. This tax-free transfer of assets from one retirement plan to another is called a rollover.

Practitioner Advice:
* It is helpful to distinguish between a rollover from a plan which involves the participant taking possession of the assets and a direct transfer in which the assets are passed from the plan to another trustee. It’s not a question of who gets the distribution check, but rather, who it is made out to. When it is made out the participant, the rollover rules apply. When it is made out to a new trustee (For The Benefit of the participant) the direct transfer guidelines apply. In “real life” both are often referred to, generically, as a rollover but practitioners must be aware of the distinct and substantial differences between the two options.

Answer 45

To ensure that you have a solid understanding of retirement plan rollovers, the following topics will be covered in this lesson:
* When Are Rollovers Used?
* Tax Treatment of Rollovers
* Alternatives to Rollovers

Upon completion of this lesson, you should be able to:
* List the situations when rollovers may be useful in minimizing taxes,
* Explain how rollovers can be eligible for favorable tax treatment, and
* Describe the tax implications of alternatives to rollovers.

Question 46

When Are Rollovers Used?

Practitioner Advice: Although federal regulations allow the rollover of various types of plans to each other, the plan document of the receiving plan must specifically allow the acceptance of the various types of money. For example, a 401(k)’s plan document must specifically allow rollovers from 403(b) plans, or they will not be accepted.

Answer 46

Tax-free rollovers of distributions to and from qualified plans, Section 403(b) tax-deferred annuity plans, traditional IRAs, SEPs and eligible Section 457 governmental plans are specifically allowed by the IRC. Thus, rollovers between different types of plans are permitted, such as from a qualified plan to a Section 403(b) tax-deferred annuity.

A rollover of a distribution from a SIMPLE IRA during the first two years of participation may be made only to another SIMPLE IRA, except in the case of distributions to which the premature distribution penalty does not apply.

Rollovers may be used in different situations for a variety of purposes as follows:
* When a retirement plan participant receives a plan distribution and wants to defer taxes and avoid any early distribution penalties on part or all of the distribution.
* When a qualified retirement plan, Section 403(b) tax-deferred annuity plan or eligible Section 457 governmental plan is terminated by the employer, and an individual participant who will receive a large termination distribution from the plan has no current need for the income and wishes to defer taxes on it.
* When a participant in a qualified plan, Section 403(b) tax-deferred annuity plan, eligible Section 457 governmental plan or IRA would like to continue to defer taxes on the money in the plan, but wants to change the form of the investment or gain greater control over it.

Question 47

What are the Alternatives to Rollovers?

Practitioner Advice: For a client who has left employment after age 55 but before age 59 1/2 and who may need to supplement income prior to beginning social security at age 62, it may be prudent to keep money in the employer’s plan if withdrawals are anticipated (assuming the plan document allows discretionary withdrawals after separation from service). Unlike an IRA, these withdrawals would not be subject to the 10% excise tax for withdrawals made prior to age 59 1/2 .

Answer 47

In cases where a rollover IRA is an alternative to leaving the money in the existing qualified plan, it may not make much of a difference to leave the money in the plan. It may even be better to do so. This is especially true if the participant is satisfied with the qualified plan’s investment performance and the payout options available under that plan meet the participant’s needs.

Results similar to a rollover IRA can be achieved if the qualified plan distributes an annuity contract to a participant in lieu of a cash distribution. The annuity contract does not have to meet the requirements of an IRA, but the tax implications and distribution restrictions are generally similar.

Practitioner Advice: For a client who has left employment after age 55 but before age 59 1/2 and who may need to supplement income prior to beginning social security at age 62, it may be prudent to keep money in the employer’s plan if withdrawals are anticipated (assuming the plan document allows discretionary withdrawals after separation from service). Unlike an IRA, these withdrawals would not be subject to the 10% excise tax for withdrawals made prior to age 59 1/2 .

Question 48

Section 9 - Retirement Plan Rollovers Summary

A rollover is a provision made by the IRS for a person to transfer funds from one retirement plan or account to another on a tax-free basis. The plan participant will not have to pay tax at the time of transfer, but when taking out the money from the rollover account he or she will have to pay taxes as applicable.

In this lesson, we have covered the following:
* Rollovers are used to defer taxes on plan distributions, upon termination of employment resulting in a large distribution not currently needed, or to change the form of investment of the money in the plan.

Answer 48

• Tax treatment of rollovers the rollover is tax-free only if the distribution is from an eligible retirement plan and is rolled over within 60 days. If not, it will be subject to income tax. A distribution is not eligible for rollover if it is the required minimum distribution or a hardship distribution. Distributions from a rollover IRA are not eligible for 10-year averaging. They are subject to the same rules as all traditional IRA distributions. Loans from a rollover IRA are not permitted.
• Alternatives to rollovers are leaving the money in the plan or taking an annuity contract in lieu of a cash distribution, if the participant does not need the money and is satisfied with the investment performance of the plan.

Question 49

Failure to roll over the distribution within 60 days subjects it to income taxes, even if the employee may be eligible to elect 10-year averaging. Which of the following gives the Secretary of the Treasury the right to waive the 60-day rule? (Select all that apply)
* There has been a disaster in the locality of the plan participant.
* The participant instructed his or her employer regarding the rollover, but it was not done on time by the plan administrator.
* The participant has met with a disastrous accident.
* The taxpayer was given erroneous advice that caused the delay.

Answer 49

There has been a disaster in the locality of the plan participant.
The participant has met with a disastrous accident.
* The Secretary of the Treasury may waive the 60-day rule where it would be against equity or good conscience to enforce it, including cases of disaster, casualty or other events beyond the participant’s control. However, there is no legislative basis for waiving the 60-day rule for pre-2002 distributions, even where the delays were the result of erroneous advice or the inaction of third parties.

Question 50

Any distribution from an eligible retirement plan is eligible for rollover, except which of the following? (Select all that apply)
* A required minimum distribution.
* A distribution that is one of a series of substantially equal periodic payments payable for a period of ten years or more.
* A distribution that will be rolled from one 401(k) plan to another 401(k) plan.
A hardship distribution.

Answer 50

A required minimum distribution.
A distribution that is one of a series of substantially equal periodic payments payable for a period of ten years or more.
A hardship distribution.
* Any distribution from an eligible retirement plan is eligible for rollover, except a required minimum distribution, a distribution that is one of a series of substantially equal periodic payments payable for a period of ten years or more or for the life or life expectancy of the employee or the employee and a designated beneficiary, or a hardship distribution.

Question 51

If the direct rollover method is not chosen in the case of a distribution from a qualified plan, the distribution is subject to mandatory withholding. What is the percentage of the mandatory withholding?
* 10%
* 20%
* 30%
* 50%

Answer 51

20%

• If the direct rollover method is not chosen in the case of a distribution from a qualified plan, Section 403(b) plan or eligible Section 457 governmental plan, the distribution is subject to mandatory withholding at 20%. Distributions from a rollover IRA and employee stock option plan cannot be rolled over.

Question 52

Module Summary

A person who is planning to retire soon has to make a major financial decision regarding how to take distributions from his or her retirement plan. The best strategies for retirement distributions can be made only with a thorough knowledge of all the available options and their tax consequences.

The key concepts to remember are:
* Planning Retirement Distributions: Making the right choice of payment options will result in avoiding adverse tax treatment and in distribution of funds at the time when it is truly useful to the retiree. Questions regarding distribution options, payment schedules and tax consequences must be answered from the perspective of the client so that the retirement planning practitioner can formulate the best strategy.
* Plan Provisions - Required Spousal Benefits: The rules for distribution of plan benefits require that all qualified pension plans must provide two types of spousal benefits. The qualified preretirement survivor annuity provides the surviving spouse with the right to payment if the participant dies before retirement. The qualified joint and survivor annuity provides annuity payments to the participant after retirement until his or her death and thereafter to the surviving spouse until his or her death. Survivorship benefits must be at least 50% of the participant’s vested account balance, but can go up to a maximum of 100%. If the participant elects out of the benefit or elects some other form of survivor benefit, the written consent of the nonparticipant spouse is required.
* Plan Provisions - Other Benefit Options: A wide range of distribution options provides flexibility to the plan participant, but also increases administration costs. Apart from the joint and survivor annuity and life annuity options, a plan may also provide a life annuity with period-certain option whereby payment continues to heirs or specified beneficiaries for a certain period upon the death of the participant and spouse. Another option is a joint annuity with the provision to choose a beneficiary other than spouse. As an alternative to annuity, the participant can also choose to take a lump sum payment or take out nonannuity distributions over the retirement years as needed.
* Tax Impact: Plan distributions are subject to federal, state and local taxes, in whole or part. The nontaxable part of a total distribution is basically calculated in proportion to the ratio of the participant’s after-tax contribution to the plan account balance. The nontaxable portion of annuity payments is calculated based on a table of anticipated annuity payments. In addition to this, lump sum distributions are subject to an early distribution penalty if applicable and a mandatory withholding at 20%. The same rules apply to death benefits. Federal estate tax must be paid if required and death benefits will be includable unless they are insurance proceeds in which the decedent had no incidents of ownership.

Answer 52

• Lump Sum Versus Deferred Payments: Plan participants must make an important choice regarding taking a lump sum amount or deferred payments. A lump sum payment will result in a larger taxable amount and may push the participant into a higher tax bracket, but it also can provide certain advantages such as the 10-year averaging option and the freedom to choose investment options. On the other hand, deferred payments have the advantages of tax deferral, tax shelter and security of income. Apart from the tax considerations, the other factors involved in determining alternatives are the participant’s age and health, return on investment and income requirements.
• Loans: The provision of taking loans from accumulated plan funds at no extra tax cost is an attractive alternative to withdrawals. Loans to participants are generally prohibited transactions, subject to penalties unless they are exempted from prohibited transaction rules by administrative exemption or they meet the requirements of Section 4975(d)(1) and/or Section 72(p). These requirements ensure that loans are equally available to all participants, bear reasonable rates of interest and are adequately secured. The rules also specify the amount of tax-free loan to which a participant is eligible. Loans must be repayable within five years if it is not a loan for a primary residence. Interest on loans is generally not deductible.
• Qualified Domestic Relations Orders (QDROs): A QDRO may assign all or part of a plan’s benefits to an alternate payee, who may be a spouse, child or dependent of the participant. However, a QDRO cannot assign a benefit that the plan does not provide, a benefit already assigned or a cash benefit when the participant has no right to cash payments. A spouse or former spouse of the participant can roll over the distribution.
• Penalty Taxes: The early distribution penalty can be from 10% to 25% of the taxable portion of the distribution depending on the type of plan and number of years of participation. The exemption to this penalty are distributions made after attaining age 59 ½, upon death or disability, under a QDRO, (employer plans) for medical expenses, health insurance while unemployed (traditional and Roth IRAs only), age 55 and separated from service (employer plans only), systematic payments over the life expectancy of the participant, higher education (traditional and Roth IRAs only) and acquisition of a first home (traditional and Roth IRAs only). The penalty for not meeting the required minimum distribution amount is 50% of the amount not distributed as required.
• Retirement Plan Rollovers: A participant who separates from service has the option to leave their assets in the plan (assuming at least $5,000 of assets), arrange for a direct transfer of the assets to another plan or IRA or take a distribution of the funds. The option exists for the participant to rollover the distribution to a IRA account or another employer plan as long as it is accomplished within sixty days. However, since 20% was withheld for taxes, that must either be made up or taxes will be due on that portion if the rest if rolled into another IRA or employer plan. Distributions not eligible for rollover include those made as part of a mandatory minimum distribution, part of a series of substantially equal periodic payments or a hardship distribution.

Question 53

Lesson 7. Distribution Rules, Alternatives and Taxation

EXAM Lesson 7. Distribution Rules, Alternatives and Taxation

Course 5. Retirement Planning

Question 54

Each of the following statements regarding an in-service partial plan distribution made this year from a qualified plan is correct EXCEPT:
* In-service distributions generally will be subject to mandatory federal income tax withholding at 20%.
* An in-service distribution is not eligible for rollover.
* An in-service distribution is deemed to include both nontaxable and taxable amounts.
* A taxable in-service distribution may also be subject to the early distribution penalty.

Answer 54

An in-service distribution is not eligible for rollover.

• An in-service distribution may be transferred to an eligible retirement plan by means of a direct transfer rollover.

Question 55

A defined benefit plan typically provides an unmarried participant with which of the following as the automatic form of benefit?
* Life annuity
* Joint and survivor annuity
* Fixed payments to age 90
* Fixed payments for 10 years

Answer 55

Life annuity

• For an unmarried participant, a defined benefit plan’s automatic form of benefit is usually a life annuity, which is typically a series of monthly payments to the participant for life, with no further payments after the participant’s death.

Question 56

A defined benefit plan must provide a married participant with which of the following as the automatic form of benefit?
* Joint and survivor annuity
* Fixed payments for 10 years
* Life annuity
* Fixed payments to age 90

Answer 56

Joint and survivor annuity

• Defined benefit plans must provide a married participant with a joint and survivor annuity as the automatic form of benefit.

Question 57

Which of the following plans is NOT required to provide the qualified preretirement survivor annuity (QPSA) and the qualified joint and survivor annuity (QJSA) provision?
* Target Benefit Plan
* Money Purchase Pension Plan
* Section 401(k) Plan
* Cash Balance Plan

Answer 57

Section 401(k) Plan
* All pension plans are required to provide the qualified preretirement survivor annuity and the qualified joint and survivor annuity provision. A Section 401(k) plan is not a pension.

Question 58

A spouse waiver of the survivorship annuity benefit must meet all of the following requirements EXCEPT:
* It must be in writing.
* It must acknowledge the effect of the waiver.
* It must be witnessed, either by a plan representative or a notary public.
* It must not change the benefit payable to the participant.

Answer 58

It must not change the benefit payable to the participant.
* Electing out of the preretirement survivorship benefit will generally increase the participant’s benefit after retirement.

Question 59

Larry, age 50, has a vested account balance in a Section 401(k) plan of $300,000. He occasionally takes loans from the account to finance various purchases. Ten months ago, he borrowed $10,000 for a cruise and finished repaying the loan last month. Now, Larry wants to borrow the maximum amount from the plan to make a down payment on a new home.
What is the maximum loan Larry make take from the plan today?
* $40,000
* $50,000
* $150,000
* $300,000

Answer 59

$40,000

• The maximum loan Larry may take today is $40,000. IRC Section 72(p) provides that aggregate loans from qualified plans to any individual plan participant cannot exceed the lesser of:
• $50,000, reduced by the 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, in the case of a defined benefit plan.

Question 60

Which of the following is NOT a condition that must be satisfied for a distribution from a qualified plan to qualify as a lump-sum distribution?
* The distribution must include all of the participant’s assets from all plans of the employer.
* The distribution must be due to the participant’s death, disability, attainment of age 59 ½, or separation from service (common law employees only).
* All assets must be removed within the same year.
* The distribution must be transferred using a direct transfer rollover.

Answer 60

The distribution must be transferred using a direct transfer rollover.
* The distribution must be transferred using a direct transfer rollover.

Question 61

Patty is retiring this year and has a Section 401(k) account balance of $500,000, of which $200,000 is invested in employer stock. The employer basis in the stock when contributed was $50,000. If Patty dies before making the lump-sum distribution, what amount is subject to inclusion in her gross estate for estate tax purposes?
* $500,000
* $50,000
* $200,000
* $150,000

Answer 61

$500,000
* The entire value of a qualified plan death benefit is subject to inclusion in the decedent’s gross estate for federal estate tax purposes.

Question 62

Patty is retiring this year and has a Section 401(k) account balance of $500,000, of which $200,000 is invested in employer stock. The employer basis in the stock when contributed was $50,000. If Patty takes a lump-sum sum distribution from the plan and makes a net unrealized appreciation (NUA) election, what amount is taxed as long-term capital gain this year?
* $0
* $50,000
* $200,000
* $150,000

Answer 62

$0
* The employer basis in the stock is taxed as ordinary income in the year of the lump-sum distribution and the gain at the time of the distribution is taxed as long-term capital gain when the stock is subsequently sold.
* In this example, $50,000 is taxed as ordinary income this year and $150,000 is taxed as long-term capital gain when Patty sells the stock.
* The example does not state Patty sold the stock this year

Question 63

Which of the following correctly describes the payment structure of a life with a 10-year certain annuity?
* Payments are distributed for 10 years and then terminate.
* Payments are distributed for 10 years to the annuitant and then for life to the beneficiary.
* Payments are distributed for life to the annuitant and continue for the balance of 10 years if the annuitant does not survive 10 years from the commencement of the payments.
* Payments are distributed for life to the annuitant and then for 10 additional years to the beneficiary.

Answer 63

Payments are distributed for life to the annuitant and continue for the balance of 10 years if the annuitant does not survive 10 years from the commencement of the payments.
* A life with period-certain annuity provides payments for life, but if the annuitant dies before a specified period, usually 10 to 20 years, the beneficiary will continue to receive payments until the period is over.

Question 64

Larry, age 50, has a vested account balance in a Section 401(k) plan of $300,000. Larry has accepted a new job and is taking a lump-sum distribution from his Section 401(k) plan and has notified his plan administrator he intends to rollover the distribution within 60 days. What amount will Larry receive in the lump-sum distribution?
* $240,000
* $300,000
* $210,000
* $270,000

Answer 64

$240,000

• If the direct transfer method is not chosen in the case of a distribution from a qualified plan, Section 403(b) plan, or eligible Section 457 governmental plan, the distribution is subject to mandatory withholding at 20%. Larry will receive $240,000 and $60,000 with be withheld for federal income taxes.

Question 65

If a qualified plan participant has reached age 73 and commenced required minimum distributions (RMDs), what is the maximum possible penalty if less than the RMD amount is distributed?
* 10% of the RMD for the tax year.
* 100% of the RMD for the tax year.
* 25% of the difference between the RMD for the year and the amount distributed.
* 50% of the difference between the RMD for the year and the amount distributed.

Answer 65

25% of the difference between the RMD for the year and the amount distributed.
* If the annual distribution is less than the minimum amount required, there is a maximum penalty of 25% of the amount that should have been distributed but was not distributed.

Question 66

Patty is retiring this year and has a Section 401(k) account balance of $500,000, of which $200,000 is invested in employer stock. The employer basis in the stock when contributed was $50,000.
If Patty takes a lump-sum sum distribution from the plan and makes a net unrealized appreciation (NUA) election, what is the tax treatment of the distribution of the employer stock?
* $150,000 is taxed as ordinary income this year and $50,000 is taxed as long-term capital gain when Patty sells the stock.
* $200,000 is taxed as ordinary income this year.
* $150,000 is taxed as capital gain this year.
* $50,000 is taxed as ordinary income this year and $150,000 is taxed as long-term capital gain when Patty sells the stock.

Answer 66

$50,000 is taxed as ordinary income this year and $150,000 is taxed as long-term capital gain when Patty sells the stock.
* The employer basis in the stock is taxed as ordinary income in the year of the lump-sum distribution and the gain at the time of the distribution is taxed as long-term capital gain when the stock is subsequently sold.
* In this example, $50,000 is taxed as ordinary income this year and $150,000 is taxed as long-term capital gain when Patty sells the stock.

Question 67

Larry, age 50, has a vested account balance in a Section 401(k) plan of $300,000. Larry and his spouse are in the process of finalizing a divorce and 50% of Larry’s Section 401(k) plan balance will be transferred to his soon-to-be former spouse under a Qualified Domestic Relations Order (QDRO).
If Larry is in a 22% marginal income tax bracket, what is the total income tax and penalty will Larry owe on the distribution?
* $15,000
* $48,000
* $0
* $33,000

Answer 67

$0
* Larry is not subject to income tax or penalty for funds distributed under a QDRO. If not rolled over, the recipient is subject to regular income tax on the distribution but distributions under a QDRO are exempt from the 10% early withdrawal penalty tax.