Distribution Rules and Taxation Flashcards
1
Q
What are the different types of distrbituions for retirement plans?
A
- Annuitized distribtuions
- Forced payout
- Rollovers (direct or indirect)
- Conversions
- QDRO
- Lump-sum
- Substantially equal periodic payments
2
Q
What are the additional distributions options for QUALIFIED PLANS ONLY?
A
- Must be from a qualified plan AND
- Must be a LUMP SUM distribution
- Includes tax preferential treatment:
- 10-year forward averaging
- Pre-1974 capital gains treatment
- NUA treatment
3
Q
Annuitized Distribuitons - What is this
A
- Payments from the participant’s retirement accounts are annuitized and distributed thorugh a series of payments over a specified period of time
- Distribuiton can be fixed OR variable, depending on type of annuity
- Pension plans MUST OFFER QJSA
- Many profit sharing plans also offer annuity options
4
Q
Annuitized Distribuiton Stategy - Advantages
A
- Particiapnts know exactly how much and when they are receving payemnts
- QJSA lets spouses or bene’s to continue to receive payments after death of retiree
- QPSA provides benefits to spouses if annuitant dies BEFORE normal retirement age
- Although, FULL VALUE of distribution may be subject to ordinary income tax AND estate taxes
- Reduces longevity risk as payments can continue for as long as the participant lives
5
Q
Annuitized Distribuiton Stategy - Disadvantages
A
- Gives up control of cash flow stream to annuity issuer and cannot make discretionary withdrawals without penalties
- Payout may not mitigate risk of inflation over longer periods of time
- When annuitant, or both annuitiant and bene die, payments stop
- Which leaves no bequest at death
6
Q
Forced Payout Strategy
A
- When a participant with a pension plan termaintes employement BEFORE normal retirement age, they have the option to leave assets in the plan, roll over to an IRA, or to take a lump-sum distribuiton
- If indivdiuals have less than $5,000 in the plan, the plan may distribute the balance to the participant (forced payout)
- If the forced payout is between $1,000 and $5,000, particpant MUST directly roll it over to an IRA
7
Q
Rollover strategy - Eligilbity requirements of retirement plan rollovers
A
- All PRETAX contributions can be rolled over into an IRA or another retirement plan
- Can transfer some or all of the rolled-over IRA money to another employer-sponsored plan
- RMDs CANNOT be rolled over into an IRA
- Many qualified plans do NOT accept rollovers into their plans
- Thrift Savings Plans (made up of after-tax contributions) can be rolled over into an IRA
- However, these amounts CANNOT be rolloed back out of the IRA into a different retirement plan
- When qualified money is rolled over into a IRA, lose prefential tax treatment (10-year forward averaging, NUA, and pre 1974 capital gains)
8
Q
What are direct rollovers?
A
Trustee-to-trusee rollovers
No need for employee to receive money first and then invest
9
Q
Indirect rollovers strategy
A
- Have 60 days to transfer money to a new tax-advantaged account
- Employers are REQUIRED to withhold 20% for taxes
- Individuals MUST reinvest the FULL original account balance, INCLUDING the 20% withheld for taxes back into a tax-advantaged account before the 60 days are up
- 20% withheld by employer IS REFUNDED when:
- Individual files their taxes
10
Q
Indirect rollovers strategy - disadvantages
A
- Individual may not have sufficient assets to pay the additional 20% of taxes back into the tax-advantaged account before the end of the 60 days
- Loses out on potential returns that the money could have generated if 20% of the rollover was not withheld by employer
11
Q
IRA - IRA Rollover
A
- Indirect rollovers from IRA - IRA are NOT subject to the 20% withholding
- 60 days to transfer into a new IRA
- ONE indirect IRA to IRA rollover is permissable every 12 months
- Does NOT apply to direct rollover
12
Q
What is considered a lump-sum distribuiton?
A
- A COMPLETE withdrawal of assets from a retiremetn account in one taxable year
13
Q
In order to qualify for special tax treatment, a lump-sum distribuiton from a retirment plan must meet what criteria?
A
- Must be from a qualified plan
- Distribution must be the ENTIRE accrued benefit from a pension plan OR the ENTIRE account balance from profit sharing plan
- Distribuiton must be made either at:
- Participant’s death
- Age 59.5,
- Separation from service OR
- Disability
- Employee must have particpated in the plan FIVE YEARS PRIOR from the tax year in which the distribution was made
- Taxpayer MUST ELECT the lump-sum distribution treament on TAX RETURN
14
Q
When can a lump-sum distribution not be subjec to ordinary income taxes?
A
- If there are after-tax distributions made to the account OR
- If the distribution meets the guidelines for one of the following:
- Pre-1974 capital gains treatment
- 10-year forward averaging
- NUA
*
15
Q
NUA treatment guidelines
A
- Requires employer stock within the account
- Works well with employees that have LARGE GAINS on their employer stock
- Lump-sum distributions of the entire account allow for more favorable capital gains treament on the employer securities portion of the account
- The nonemployer securities portion is still taxed at ordinary income rates
- Entire account MUST be distributed, not just the employer securities
- Employee can DEFER realizing gain on the employer securities until a later date, when the employer securities are sold
16
Q
How to calculate NUA?
A
- FMV at date of lump-sum distribution - FMV of securiteis at date of contribution to the plan
- Cost of securities at date of contribution taxed at:
- Ordinary income rates (must be paid immediately)
- Remaning amount (NUA/gain) taxed at:
- Long-term capital gains rate
- Any gain earned AFTER distribuiton date will be taxed at:
- Short term or long term capital gains rate based on HOLDLING PERIOD (which starts on date of distribution)
17
Q
Who does NUA treatment benefit most?
A
- When the gain on an employee’s employer securities is relatively HIGH
- Otherwise, recipient may be paying too much in ordinary income taxes in one year and then would push them into a higher tax bracket potentially
18
Q
What is the 10-year forward averaging treatment
A
- For those born before January 2nd, 1936
- Does NOT mean paying tax over various year, ALL TAX IS STILL PAID IN THE YEAR OF DISTRIBUTION
19
Q
10-year forward calcualtion
A
- taxable portion of distribution / 10
- Look at 1986 individiual income rates and apply to that number
- Then multiply that by 10
- This equals total tax owed on distribution
20
Q
Pre-1974 capital gains treatment
A
- Applies to those born before January 2, 1936
- Amount of lump-sum attritable to particpation prior to 1974 can be treated as LONG TERM capital gains rather than ordinary income
- capital gains treatment = (months of participation before 1974 / total months of particpation) x lump-sum distribution
- REMAINING AMOUNT can then be used for 10-year forward averaging
21
Q
Explain Roth Conversion strategy
A
- Roth conversions are distributions from another qualified plan or a tradional IRA to a Roth IRA
- Roth conversions can also occur within plans when pretax assets within qualiifed plans are converted to Roth accounts WITHIN THE SAME PLAN (Roth 401k for example)
- Conversions are subject to ordinary income tax
- NOT SUBJECT to 10% penalty if plan allows it
- Roth recharacterizations ARE NOT ALLOWED ANYMORE
- Cannot convert to Roth and then convert back to traditional
22
Q
Roth Conversions - Benefits
A
- If individual is currently in low tax bracker and expects to be in higher tax bracker, they will benefit from conversion since tax liability will be a lot more in the future as income rises
- It is impossible to predict with accuracy if people will be in a higher or lower tax bracket in the future when they need to withdraw the money, so it’s good to have BOTH pre-tax AND after-tax retirement accounts
- Can generate effective tax diversificaiton benefits for the portfolio
- Can REDUCE amount of RMD from retiree’s portfolio
23
Q
Explain QDRO
A
- Qualified domestic relations order typically results from divorce
- Creates the right of a third party to receive benefits from a qualified plan
- Issuance of QDRO allows the benefit to be DIVIDED up between partiicapnt and nonparticipant
- Can divide either the actual benefit payments (such as monthly payment from pension) OR the account balance
- If assets are moved from a qualified plan into another qualified plan OR IRA due to a QDRO, NO tax or penalties are assessed
24
Q
What is the substantially equal periodic payment distribution method?
A
- Also called section 72(t)
- Distribuiton method to those to AVOID the 10% penalty for withdrawals before age 59.5
25
Q
Substanially equal periodic payments - Requirements
A
- Distribuitons must be made at least annualy for the life or life expectancy of the participant
- Payment must begin after sepration from service
- Payments must continue for the earlier of:
- 5 years OR
- attaining age 59.5
- If payments stop or change in any way:
- FULL ACCOUNT BALANCE will be seen as a distribution
26
Q
Substanially equal periodic payments - Calculations
A
- RMD method
- Same way as RMD and payment changes each year based on value of account
- Fixed amortization method
- Calulcated over person’s life expectancy at a reasonable interest rate
- Fixed annuitization method
- Distributions are taken over several years
- Distribution is determined by dividing account balance by an annuity factor using an interest rate/mortality table
- Payments will NOT change in the future years
27
Q
Exceptions to the 10% penalty for tax-advantaged retirement accounts
A
- Death
- Age 59.5
- Disability
- Medical expenses exceeding 10% of AGI (dependents only)
- Seperation from service only at age 55 or older (qualifeid plans only)
- Public safety employees who separate from age 50 can take withdrawals from qualified plans with no penalty
- COUNTS FOR IN THE YEAR THEY TURN 55
- up to 5k in born child/adopted child expenses (10k for MFJ)
- 100k for COVID YEAR
- Section 72t
- QDRO
- Tax levies
28
Q
Additional Exception to 10% penalty - FOR IRA ONLY
A
- First-time home purchase
- Higher-education expenses
- Health insurance premiums, if unemployed
29
Q
Remember if you take a distribution from your IRA for something….
A
- You can return that money within 60 days to avoid 10% penalty
30
Q
RMDs for those age 72 with employement
A
- If employee is still employed by the plan sponsor for their qualified plan, does NOT have to begin taking RMD on it
- UNTIL April 1st of the year following termination with employer
- If employee is more than a 5% owner of company, must take RMD as orginial rules
- Tradiitonal IRA owners also MUST take RMDs regardless of employment
31
Q
RMDs - Roth accounts
A
- NOT needed for Roth IRA
- REQUIRED FOR ROTH 401K and ROTH 403B
32
Q
Death of plan participant/IRA owner
A
- Counts for retirement plans including IRA (both traditional and Roth)
- Remaning account balance must be distributed to designated beneficiaries BEFORE end of 10th calendar year following the year of death of participant/owner
- Applies REGARDLESS of whether account owner began taking RMDs or not
33
Q
Exceptions to 10-year rule
A
- If desgnated bene is an ELIGIBLE bene, then reamining balance can be distributed over the bene’s:
- Remaining life expectancy
- Life OR
- Possibly stretched beyond 10 years
34
Q
Exceptions to 10-year rule - Eligible Beneficiaries
A
- Surviving spouse
- Can roll remaining balance into their own account and wait until age 72 to take RMD OR can start taking RMD over their lfie
- Children of account owner/partiicpant who has NOT reached age of majority
- Can take RMD for life expectancy
Once age of majority is reached, reaminign balance must be subject to 10-year rule
- Can take RMD for life expectancy
- Chronically ill person
- RMD over life expectancy
- Any other individual who is NOT MORE THAN 10 YEARS YOUNGER than account owner/participant
- RMD over life expectancy
