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Retirement Savings and Income Planning > Distribution Rules and Taxation > Flashcards

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
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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
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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
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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
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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
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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
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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)
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8
Q

What are direct rollovers?

A

Trustee-to-trusee rollovers

No need for employee to receive money first and then invest

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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
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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
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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
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12
Q

What is considered a lump-sum distribuiton?

A
  • A COMPLETE withdrawal of assets from a retiremetn account in one taxable year
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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
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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
      *
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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
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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
  1. taxable portion of distribution / 10
  2. Look at 1986 individiual income rates and apply to that number
  3. Then multiply that by 10
  4. 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
  1. 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
  2. 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
  3. Can generate effective tax diversificaiton benefits for the portfolio
  4. 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
  • 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

Retirement Savings and Income Planning (11 decks)

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