TOPIC 81: DISTRIBUTION RULES, ALTERNATIVES, AND TAXATION in .NET framework

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TOPIC 81: DISTRIBUTION RULES, ALTERNATIVES, AND TAXATION
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1 Premature distributions A Penalties (1) Distribution prior to age 591 2 (2) Subject to 10 percent nondeductible penalty and taxed as ordinary income (3) Exception: Distribution or payment from a SIMPLE IRA within two years of the opening of the SIMPLE IRA is subject to a 25 percent penalty tax (4) The participant always has 60 days to undo the distribution
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272 - Retirement Planning B Hardship withdrawal (1) For quali ed plans and 403(b) only: The participant must have a triggering event to qualify for a hardship withdrawal A triggering event has occurred when the participant has demonstrated to the plan administrator an immediate and heavy nancial need (2) The IRS has issued safe harbor guidelines that de ne what constitutes an immediate and heavy nancial need in order to give the employer guidance The following is a list of safe harbor triggering events: (a) Medical care for the participant, spouse, or any dependents of the participant (b) Purchase of principal residence applies only to the purchase, not mortgage payments (c) Tuition and related education fees must be for postsecondary education of participant, spouse, or children (d) Prevention of eviction or foreclosure (3) The client should understand that (1) he or she must still pay the 10 percent penalty, (2) the full distribution will be taxed as ordinary income, and (3) a six-month blackout exists on elective deferrals after a hardship withdrawal (4) The participant must exhaust all other options before taking out a hardship withdrawal C IRC Section 72(t) for quali ed plans The following is a list of allowable distributions that will exclude an individual from paying the 10 percent penalty tax under IRC Section 72(t) for quali ed plans only: (1) Distributions made on or after the date on which the participant attains age 591 2 (2) Distributions made to a bene ciary on or after the death of the participant (3) Distributions attributable to the participant s becoming disabled (4) Distributions that are part of a series of substantially equal periodic payments (not less frequently than annually) made for life (or life expectancy) of the participant or the joint lives of the participant and his or her designated bene ciary Distributions under this exception generally cannot be modi ed for ve years unless another exception applied to the distribution when it initially commenced (5) Distributions made to an employee after separation from service after attainment of age 55 (6) A payment to an alternate payee pursuant to a quali ed domestic relations order (QDRO) (7) Distributions used to pay quali ed higher education expenses (including graduate education expenses) for the individual, the individual s spouse, or any child or grandchild of either (8) Distributions made on account of an IRS levy (9) A dividend paid with respect to certain stock held by an ESOP (10) Amounts transferred to an IRA of a spouse or former spouse under a divorce or separation instrument (11) Corrective distributions D IRC Section 72(t) for tax-advantaged retirement plans Tax-advantaged plans (IRA, Roth IRA, SEP, and SIMPLE) do not need a triggering event for the owner to remove funds The owner can remove funds at anytime but is subject to a 10 percent penalty tax, in addition to the balance being taxed as ordinary income The following is a list of allowable distributions that will exclude an individual from paying the 10 percent penalty tax under IRC Section 72(t) for tax-advantaged retirement plans only: (1) Distributions made on or after the date on which the participant attains age 591 2
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Topic 81: Distribution Rules, Alternatives, and Taxation - 273 (2) Distributions made to a bene ciary on or after the death of the participant (3) Distributions attributable to the participant s becoming disabled (4) Distributions that are part of a series of substantially equal periodic payments (not less frequently than annually) made for life (or life expectancy) of the participant or the joint lives of the participant and his or her designated bene ciary Distributions under this exception generally cannot be modi ed for ve years unless another exception applied to the distribution when it initially commenced (5) Distributions for medical expenses in excess of 71 2 percent of adjusted gross income (6) Distributions for health insurance premiums made to an unemployed individual after separation from employment if the individual has received unemployment compensation for 12 consecutive weeks under any federal or state unemployment compensation law (7) Distributions used to pay quali ed higher education expenses (including graduate education expenses) for the individual, the individual s spouse, or any child or grandchild of either (8) Distributions made for a rst-time home buyer s expenses There is a lifetime maximum of $10,000 The distribution must be used within 120 days to buy, build, or rebuild the principal residence of the individual, his or her spouse, or any child, grandchild, or ancestor of either A person quali es as a rst-time home buyer if he or she had no present ownership interest in a principal residence during the preceding two years (9) Distributions made on account of an IRS levy (10) Amounts transferred to an IRA of a spouse or former spouse under a divorce or separation instrument (11) Corrective distributions E Substantially equal periodic payments (Section 72(t)) (1) There is no minimum age requirement (2) IRS does not require reason for taking withdrawals (3) Payments must be made at least annually (4) Three methods to calculate: (a) Life-expectancy method [eg, required minimum distribution (RMD)] i Results in the exact annual payment required ii Results in the smallest payment (b) Amortization method: The account balance is amortized over the participant s life expectancy (or joint life expectancy) using a reasonable interest rate (ie, expected investment return) (c) Annuitization method i Divide the account balance by an annuity factor that is based on a reasonable interest rate (eg, 8 percent) and mortality factors (UP-84 Mortality Table) ii Results in the largest payment (5) Payments must continue for ve years or until participant is age 591 2, whichever is longer If payment is changed (increased or decreased) prior to satisfying either condition, the 10 percent penalty is assessed back to dollar one plus interest (6) Accounts need not be aggregated to begin Section 72(t) distribution F The EGTRRA 2001 changed the operative phrase separation from service to severance from employment This allows distributions from plans that terminate after a merger or
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274 - Retirement Planning spin-off because the participant has severed his or her relationship with the original employer This repeals the same desk rule G Differences in comparing quali ed plans to IRAs under IRC Section 72(t) The following exceptions apply to IRAs, but not to quali ed plans under IRC Section 72(t): (1) IRAs allow distributions for health insurance premiums made to an unemployed individual after separation from employment if the individual has received unemployment compensation for 12 consecutive weeks under any federal or state unemployment compensation law (2) IRAs allow distributions made for a rst-time home buyer There is a lifetime maximum of $10,000 (3) IRAs allow distributions used to pay quali ed higher education expenses (including graduate education expenses) for the individual, the individual s spouse, or any child or grandchild of either H The following exceptions apply to quali ed plans, but not to IRAs under IRC Section 72(t): (1) Distributions made to an employee after severance from service after attainment of age 55 (2) A payment to an alternate payee pursuant to a QDRO (3) A dividend paid with respect to certain stock held by an ESOP 2 Election of distribution options A Lump sum distributions (1) Must satisfy four conditions: (a) Must be distributed in one taxable year (b) Must represent the full account balance to the participant s credit from all quali ed plans of a single type (c) Lump sum payable i For common-law employees, (ie, rank and le) Attainment of age 591 2 Death (available to designated bene ciary) Separation from service ( severance from employment ) ii For the self-employed owner Attainment of age 591 2 Death (available to designated bene ciary) Disability (d) Must be made from i Quali ed pension plan (money purchase plan, target bene t, DBP) ii Pro t sharing plan iii Stock bonus plan (2) Taxation of a lump sum distribution (a) Taxed as ordinary income (b) Taxed-deferred if distribution is rolled over i QRP to another QRP ii QRP to tradition IRA or conduit IRA
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Topic 81: Distribution Rules, Alternatives, and Taxation - 275 (c) May qualify for 10-year forward-averaging tax treatment if the participant was born before January 1, 1936 (ie, age 50 by January 1, 1986) if four conditions met: i Participant must be at least age 591 2 ii Forward averaging must be applied to all lump sum distributions received during the year iii Employee must have been a plan participant for at least ve years (waiver if distribution is due to death) iv Only one forward-averaging election is allowed in a lifetime B Annuity options (1) All quali ed pension plans must provide two forms of survivorship bene ts for spouses: (a) Automatic lifetime survivor bene t in the form of a quali ed joint and survivor annuity (QJSA) i Must provide annuity for life of the participant with a survivor annuity for the life of the participant s spouse ii Must provide survivor annuity that is not less than 50 percent nor greater than 100 percent of the annuity payable during the joint lives of the participant and spouse For example, if $1,000 per month is payable during the joint lives, the annuity to the surviving spouse can be any speci ed amount from $500 per month to $1,000 per month iii The spouse s annuity must continue even if the spouse remarries (b) Automatic lifetime survivor bene t in the form of a quali ed preretirement survivor annuity (QPSA) i Provides survivor bene t if participant dies before retirement ii The survivor annuity payable is the amount that would have been paid under a QJSA (2) Consent of nonparticipant spouse to waiver (or electing out) of QPSA and QJSA in favor of an optional bene t form selected by the participant must (a) Be in writing, (b) Acknowledge the effect of the waiver, and (c) Be witnessed, either by a plan representative or a notary public (3) Stock bonus, pro t sharing, and ESOPs generally are exempt from the QJSA and QPSA requirements if two conditions are satis ed: (a) There are no annuity options (b) The plan participant s account balance is payable to the participant s spouse in the event of the participant s death (4) Life annuity is an automatic form of bene t for an unmarried participant provides monthly payments for life (5) Period certain annuity is another form, as an option to joint or single life annuity period certain provides payments for a speci ed period of time (6) Other annuity bene t options (a) A wide range of options increases the administrative costs of a quali ed plan (b) The IRA makes it dif cult to withdraw bene t options once they are established (7) Taxation of annuity payments
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276 - Retirement Planning (a) Noncontributory basis (no cost basis) Full amount of bene t payment is includible in the participant s gross income and taxed as ordinary income (b) Contributory basis (taxable and nontaxable amount) The bene t payment consists of a taxable (includible) and a nontaxable (excludible) portion in gross income (c) The participant s cost basis includes: i Total after-tax contributions made by the employee ii Total cost of life insurance protection reported as taxable income by the participant, if plan distribution is received under the same contract that provides the life insurance protection iii Any employer contributions that were previously taxed to employee (nonquali ed plan later becomes quali ed) iv Amount of any plan loans included in income as a taxable distribution (d) In-service (partial) distribution Partial distribution taken out before termination of employment i Nontaxable and taxable amounts ii Nontaxable amount equals Distribution Employee s cost basis Total account balance
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iii Pre-1987 grandfathered rule after-tax money can be withdrawn rst (FIFO) iv Taxable in-service distribution may be subject to early distribution penalty, and a mandatory withholding at 20 percent, unless transferred to an eligible retirement plan as a direct rollover (e) Total distribution If an employee has a cost basis, one of two tables is used to determine the excludable portion of each monthly payment i For a single-life annuity, based on the age of the annuitant Age of Participant 55 and under 56 60 61 65 66 70 70 and over Number of Monthly Payments 360 310 260 210 160
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ii For a joint and survivor annuity, based on the ages of both annuitants Combined Ages of Both Participants Not more than 110 111 120 121 130 131 140 More than 140 Number of Monthly Payments 410 360 310 260 210
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(f) Once the cost basis is fully recovered, payments received subsequently are fully taxable If the participant dies before the cost basis is fully recovered, an income tax deduction for the unrecovered basis is allowed on the participant s nal income tax return
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Topic 81: Distribution Rules, Alternatives, and Taxation - 277 C Rollover (1) Participant has constructive receipt of the money (2) Beginning in 2002, amounts in Section 401(a) plans, Section 403(b) arrangements, or Section 457(b) plans maintained by a state or local government generally can be rolled over to another Section 401(a) plan, Section 403 (b) arrangement, Section 457 (b) plan maintained by state or local government, or IRA (3) Beginning in 2002, after-tax employee contributions can be rolled over to other plans and IRAs (4) Beginning in 2002, contributory IRA amounts can be rolled over to a Section 401(a) plan, Section 403(b) arrangement, Section 457(b) plan maintained by a state or local government, or another IRA (5) Surviving spouses can roll over distributions into their own 401(k), 403(b), IRA, or governmental 457 (6) After two years in a SIMPLE plan, it may be rolled over to a traditional IRA or SEP plan without penalty A SIMPLE to SIMPLE rollover is permitted at any time (7) A rollover must be completed within a 60-day period, unless waived by the IRS if it deems the account owner has undergone a personal or natural disaster beyond his or her control (8) Only one rollover per account per one year period is permitted (9) A rollover will be subject to 20 percent withholding if money is from QRP to participant (10) Distributions not eligible for rollover: (a) Amounts distributed to satisfy RMD (b) Amounts that are part of a series of equal periodic payments (c) Hardship withdrawals (d) Nontaxable portion of a distribution (e) Elective contributions that are returned as a result of Section 415 limitations (f) Corrective distributions of excess contributions and excess deferrals (g) Loans in default that are deemed distributions (h) Dividends on employer securities in an ESOP (i) Cost of life insurance coverage D Direct transfer (1) Transfer of QRP or IRA assets directly from custodian/trustee-to-custodian/trustee (2) Participant does not have constructive receipt of the funds (3) Avoids the 20 percent mandatory withholding (4) Multiple transfers are permitted via this method 3 Required minimum distribution (RMD) A Rules (1) RMD applies to quali ed plans, IRAs, SEPs, SIMPLE IRAs, and Section 457 government deferred compensation plans (2) Minimum distributions must begin no later than April 1 of the calendar year following the later of (a) The calendar year in which the employee attains age 701 2 (b) The employee retires (not available for 5 percent owners of business or for an IRA owner) (3) Use the balance as of December 31 of the year prior to the distributions year as the RMD calculation base
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278 - Retirement Planning (4) RMD is calculated separately for each IRA, but distributions can be taken from any account to satisfy the minimum B Calculations (1) Life expectancy method (a) The required minimum is determined by dividing the owner s account balance by the appropriate life expectancy (b) To satisfy RMD rules, the entire interest must be distributed by the required beginning date, or the interest must be distributed over one of the following periods: i Over the lifetime of the participant ii Over the joint and survivor lives of the participant and a designated bene ciary iii Over a period that does not extend beyond the life expectancy of the participant iv Over a period that does not extend beyond the joint and survivor life expectancy of the participant and a designated bene ciary (2) Three life expectancy tables (a) Uniform Lifetime Table i Table for determining minimum required distributions during the lifetime of the participant when the retirement bene t is in the form of an account balance ii Used in situations in which the employee s spouse is either Not the sole designated bene ciary Is the sole designated bene ciary but is not more than 10 years younger than the employee
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