Distribution Rules and Taxation

Question 1

Circumstances where 10% early withdrawal penalty is not applied

Answer 1

• death of the employee
• disability of the employee
• a series of substantially equal periodic payments over the life or life expectancy of the employee or the employee and a beneficiary
• separation from service for early retirement in or after the year in which the employee reaches age 55.
• deductible expenses for medical care. Not available for the first 10% of AGI that is withdrawn
• payment is made to an alternate employee under a qualified domestic Relations Order (QDRO)
• Qualified higher education expense of the taxpayer, the taxpayers spouse, or any child or grandchild of the taxpayer or the taxpayers spouse
• qualifying first time home buying expenses for the individual, the spouse of the individual, or a child, grandchild, or ancestor of the individual or the individuals spouse, up to $10,000 (lifetime limit). This applies to IRA’s and Roth IRA’s only.

Question 2

Substantially Equal and Periodic Payments - Sec 72(t)

Answer 2

three methods to calculate the amount:

• the minimum distribution method
• the amortization method
• the annuity method

Question 3

Minimum Distribution Method - 72(t)

Answer 3

• distributions are calculated the same way lifetime distributions are calculated under IRC sec 401(a)(9).
• account value is determined at the years end and then divided by the distribution period for the owners age, as determined by IRS tables.

Question 4

The Amortization Method - 72(t)

Answer 4

• amortizes the account balance over either the life expectancy or joint life expectancy
• produces a benefit amount that is greater than the minimum distribution method.

Question 5

The Annuity Method - 72(t)

Answer 5

-the account balance is divided by the annuity factor

Question 6

SEPPS Timing

Answer 6

-payments beginning at age 51 must continue to age 59 1/2 and payments beginning at age 57 must continue to age 62. This is to ensure the 5 year minimum requirement is met.

Question 7

Separation from Service Exemption for Public Safety Employees

Answer 7

• there is a special 10% penalty exemption available for qualified public safety employees such as firefighters, law enforcement officers, and emergency medical personnel who are employees of states and political subdivisions
• distribution must occur after age 50
• a rollover to an IRA can jeopardize this exemption.

Question 8

Hardship withdrawals

Answer 8

• are not exempt from the 10% penalty
• the hardship must be for a heavy and pressing need due to illness, college expenses, mortgage, or to prevent eviction.
• all other resources must be exhausted in order for the withdrawal to be granted.

Question 9

In-Service Distributions

Answer 9

-defined benefit and money purchase pensions plans are authorized to make distributions to employees who are age 62 or older even if they have not yet separated from service.

Question 10

One Rollover Per Year Rule

Answer 10

• taxpayers are permitted only one IRA-to-IRA rollover per year
• applies to all taxpayers IRA’s in the aggregate
• while only one IRA-to-IRA rollover is permitted per year, any number of direct transfers can be made

Question 11

One Year IRA-to-IRA does not apply to

Answer 11

• rollovers from traditional IRAs to Roth IRA’s
• Trustee-to-Trustee transfers from another IRA
• IRA-to-qualified plan rollovers
• Qualified plan-to-IRA Rollovers
• Qualified plan-to-qualified plan rollovers

Question 12

20% withholding tax

Answer 12

• when a 60-day rollover is used to transfer assets from a qualified plan to an IRA, there is a mandatory 20% withholding tax requirement.
• to avoid this tax, the participant must place the entire amount (including the withholding amount) into the IRA within 60 days.

Question 13

Direct Transfers

Answer 13

-accomplished by the trustee making payment directly to another qualified plan or rollover IRA. If this method is used, there is not 20% withholding requirement.

Question 14

SIMPLE Plan Rollovers

Answer 14

-a rollover from a SIMPLE IRA may be made only to another SIMPLE IRA during the first two years of an employee’s participation, except for distributions not subject to the early withdrawal tax.

Question 15

Study Tip

Answer 15

• hardship distributions from a qualified plan cannot be rolled into another qualified plan
• distributions from a nongovernmental 457 plan can only be rolled over into another 457 plan.
• Government 457 plans can be rolled over into an IRA

Question 16

Qualified Plan-to-IRA Rollovers where there is basis in the account

Answer 16

• once the basis is rolled over, IRA taxation rules will apply, which require pro-rata distribution of pretax and after-tax amounts
• it is advantageous to separate the pretax and after tax amounts.

Question 17

RMD’s

Answer 17

• Distributions from 403(b) plans must begin by April 1 of the year following the later of: 1) the year the employee turns 70 1/2 2) the year the employee retires (if not a 5% owner)
• distributions from IRAs, SEPs, and SIMPLEs must begin by April 1 of the year following the year in which the employee turns age 70 1/2
• if no distribution is made until the year following the year the employee turns age 70 1/2, a second payment must also be made by december 31 of the same year. The result could push them into a higher tax bracket

Question 18

Calculating the RMD

Answer 18

If RMD is taken in the year they turn 70 1/2:

• use the factor for age 70 if the employee was born between jan 1 and june 30
• Use the factor for age 71 if born between july 1 and dec 31

Question 19

Spouse more than 10 years younger

Answer 19

-when the spouse is more than 10 years younger, use of the joint life and life survivor life expectancy table will allow a lower RMD than the uniform table.

Question 20

Tax for not making RMD

Answer 20

• a 50% excise tax is imposed if not RMD is made

- the tax equals 50% of the amount by which the RMD exceeds the actual amount distributed during the tax yeary.

Question 21

Qualified Longevity Annuity Contracts (QLACs)

Answer 21

• regulations permit retirees to allocate up to the lesser of 125k or 25% of the employee’s account balance to purchase a QLAC.
• prior to annuitization, the value of the QLAC is excluded from the account balance used to determine the RMD

Question 22

IRA Distributions Paid Directly to Charity

Answer 22

• $100,00 may be contributed directly to a charity and it is not required to be reported as income.
• the taxpayer does not get to claim the charitable deduction.

Question 23

No Beneficiary at death

Answer 23

• if an employee dies before the RMD date for distributions and has no designated beneficiary, the 5 year rule will apply instead of the life expectancy rule.
• the entire account balance must be distributed by the end of the fifth year after the year of the employee’s death.

Question 24

if a trust is named as beneficiary, the following rules must be met

Answer 24

• the trust must be legal under state law
• the trust must be irrevocable at the death of the IRA owner
• the beneficiaries must be clearly identifiable from the trust instrument
• a copy of the trust must be submitted to the plan administrator by October 31st of the year following the year of death.
• the trust is referred to as a Designated Beneficiary Trust (DBT)

Question 25

Qualified Joint and Survivorship Annuity - qualified plan

Answer 25

-must be available to the participants spouse and the payout is calculated based on the two lives. the payments continue either at 50% or 100% after the death of the plan participant.

Question 26

Qualified Preretirement Spouse Annuity - qualified plan

Answer 26

• must be available to a spouse when a qualified plan participant dies before retirement. Provides at least the same benefit at QJSA.
• ESOPs and Profit Sharing Plans do not have to provide these benefits
• a 403(b) plan will be subject to these rules if employer contributions are contained in the plan.

Question 27

Alienation of Benefits

Answer 27

• qualified plan benefits generally cannot be assigned or garnished under IRC sec 401(a)(13). Exceptions to the rule:
• the IRS can collect federal income taxes
• the participant may direct his or her benefits to be paid to a third party
• payments which are due to a beneficiary may be denied if a court rules that the beneficiary is ineligible.

Question 28

bankruptcy protection

Answer 28

-qualified plan assets are protected 100%
-IRAs are protected up to $1 MM
-inherited IRAs are not protected
-

Question 29

Net Unrealized Appreciation (NAU)

Answer 29

• allows the unrealized appreciation of employer stock distributed to an employee to be taxed as a long-term capital gain.
• a lump sum distribution is required (whole account must be liquidated in the same year)
• all assets other than the employer stock are rolled into an IRA and then the stock is put into a taxable brokerage account.
• if the participant dies before the stock is sold, the gain will be treated as income in respect of a decedent (IRD) and there will be no step up in basis