Chartered Retirement Planning Counselor SM Professional Designation Program

Chartered Retirement Planning CounselorSM Professional Designation Program Module 8Retirement Plan Distributions

Learning Objectives 8–1: Describe the distribution options available before and after retirement. 8–2: Describe the pros and cons of rollover, and explain how they can be accomplished. 8–3: Discuss the tax issues involved in retirement distributions—forward averaging in particular. 8–4: Explain the IRS rules governing the timing and minimum required size of retirement distributions. 8–5: Describe four steps that should be taken in making the best distribution decision. 8–6: Discuss the issues relevant to survivors and beneficiaries of retirement plan participants. 8–7: Describe alternative investments for lump-sum distributions.

Questions to Get Us Warmed Up

Qualified Retirement Plan Distributions

One-Time Suspension on Required Minimum Distributions from Certain Plans for 2009 Only • Effective for 2009 only, the Worker, Retiree, and Employer Recovery Act of 2008 imposed a moratorium (suspension) on required minimum distributions (RMDs) from individual retirement plans (IRAs) and defined contribution plans for 2009 only. • This relief applied to life-time plan distributions to defined contribution plan participants, IRA owners, and after-death distributions to beneficiaries. • It did not apply to pre-2009 and post-2009 RMDs and defined benefit plans.

In-Service Withdrawals From Qualified Plans Withdrawals Prior to Plan’s Normal Retirement Age • permitted in profit sharing/stock bonus and thrift/savings plans • permitted in pension plans once employee attains age 62 • plan may impose restrictions but is not required to do so Withdrawals After Plan’s Normal Retirement Age • typically available in money purchase and target benefit plans (defined contribution pension plans) • generally not available in defined benefit plans due to complexity of record keeping

In-Service Withdrawals From Qualified Plans Amounts Available for Withdrawal • per plan provisions • usually vested portion of employer contributions Tax Treatment of In-Service Withdrawals • 10% early withdrawal penalty (if under age 59½) • ordinary income tax treatment

In-Service Hardship Withdrawals from Profit Sharing or Stock Bonus 401(k) Plans Amounts Available for In-Service 401(k) Hardship Withdrawals • limited to funds attributable to elective deferrals—no earnings Tax Treatment of Hardship Withdrawals • 10% early withdrawal penalty (if under age 59½) • ordinary income tax treatment

In-Service Hardship Withdrawals from Profit Sharing or Stock Bonus 401(k) Plans Required Conditions for Hardship Withdrawal Participant must establish that: • other resources are not “reasonably available,” (i.e., have exhausted other reasonably available resources) and • there is an “immediate and heavy financial need”: • medical expenses • primary residence purchase • college tuition • housing costs to prevent eviction or foreclosure • funeral expenses for dependents • principal residence repairs that qualify for a casualty deduction

Qualified Plan Loans: General Rules

Qualified Plan Loans: Terms Must be: • available to all participants and beneficiaries on an equal basis • evidenced by a legally enforceable agreement • at a reasonable rate of interest • secured by a participant’s vested account balance (or other collateral) • made in accordance with plan provisions Must not be: • available in greater proportions to highly compensated employees than to nonhighly compensated employees • a loan with a term exceeding five years (except for purchase of primary residence) • Repayments must be made at least quarterly on a substantially • equal level amortization basis

Qualified Plan Loans: Amounts

Qualified Plan Loans To avoid characterization as a prohibited transaction, a loan from a qualified plan must be: • available to all participants and beneficiaries • not available to highly compensated employees in greater proportions than to nonhighly compensated employees • made in accordance with plan provisions • at a reasonable rate of interest • adequately secured • legally enforceable

Qualified Plan Loans To avoid characterization as a taxable distribution: • loan term must not exceed five years (except home loans) • loan amount must not exceed • the lesser of $50,000 or • half of the present value of the employee’s nonforfeitable accrued benefit or other applicable limit • loan repayments must be made quarterly on a level amortization basis

Required Qualified Plan Survivor Annuities Provisions Required for Pensions, optional for PSPs • Annuity provides income for the life of a qualified plan participant and for the life of his or her surviving spouse • QJSA must provide survivor annuity for life of spouse, with at least 50% of annuity payable during joint lives. • QPSA must provide 50% survivor annuity for life of spouse, payable at participant’s death before retirement. • The right to a QJSA can be waived: • in writing by the spouse, or • if participant and spouse were married less than one year, or • if plan provides for full payment to surviving spouse at participant’s death.

Required Qualified Plan Survivor Annuities Qualified Plans Subject to Survivor Annuity Requirements • Defined benefit plans, target benefit plans, and money purchase pension plans (qualified plans that are subject to minimum funding standards) must comply with the QJSA, QOSA, and QPSA requirements. • Other defined contribution plans (profit sharing, stock bonus plans) are exempt from the requirement if three conditions are met: • vested accrued benefit is payable to spouse or alternate beneficiary at death or participant, • participant does not elect annuity form of payment, and • plan is not a transferee of a plan that was subject to survivor annuity requirements.

Qualified Plan Payout Options • The life annuity and joint and survivor annuity are just two of many payout options generally available. • Another, the period certain annuity, provides regular monthly payments over a specified period, even if the recipient (and spouse) happens to die during the specified period. This ensures payments to a named beneficiary. Example • Peter and his wife, Charlotte, have chosen a 20-year period-certain annuity option for Peter’s retirement benefits. • His plan administrator has told them that, given Peter’s benefit level and the interest assumption of the annuity, this option will provide payments of $1,800 each month for 20 years.

Qualified Optional Survivor Annuity (QOSA) Married participants in a pension plan must be permitted to elect payment in the form of a QOSA benefit. • A QOSA is an annuity for the life of the participant with a survivor • Annuity for the life of the spouse determined as follows: • If the survivor annuity provided by the plan’s QJSA is less than 75% of the annuity payable during the joint lives of the participant and spouse, then the survivor annuity provided by the QOSA must be 75% of the annuity payable during the joint lives of the participant and spouse. • If the survivor annuity provided by the plan’s QJSA is equal to or greater than 75% of the annuity payable during the joint lives of the participant and spouse, then the survivor annuity provided by the QOSA must be 50% of the annuity payable during the joint lives of the participant and spouse.

Lump-Sum Distributions Required Conditions • Represents full amount credited to participant accounts • Distributed in one taxable year • Payable due to participant’s death, attainment of age 59½, or separation from service (common law employees only); or payable due to participant’s death, attainment of age 59½, or disability (self-employed’s option in place of separation from service) • Made from a qualified pension, profit sharing, or stock bonus plan and all plans of the same type

Tax Treatment of Stock Distributions Net Unrealized Appreciation (NUA) A distribution of shares of employer stock that qualify for NUA treatment (in lieu of rollover treatment) are subject to the following tax treatment: • The recipient is immediately taxed on the cost, or basis, of the securities received, and at ordinary income tax rates. • The NUA is not taxed until the recipient actually sells the shares. When these shares are sold, the NUA is taxed as long-term capital gain.

Rollover Distributions “Eligible rollover distributions” are distributions of all or any part of a qualified plan account, except: • Nontaxable portion of distribution • Part of a series of substantially equal periodic payments over 10 years or relevant life expectancy • Required minimum distribution (age 70½) • Corrective distributions from a 401(k) plan • Loan treated as a distribution • Dividends on employer securities in an ESOP • Cost of life insurance coverage • Hardship distribution

Rollover Rules 403(a)Plans 403(b)Plans SIMPLE IRA (after 2 years of participation) QRPs401(a) Gov’t457(b) Plans pretax & after-tax assets pretax assets Traditional IRA

Tax Treatment of Rollover Distributions • Rollovers enable funds to maintain tax-deferred growth. • Funds rolled over become subject to tax treatment of the rollover vehicle (e.g., qualified funds rolled into a deductible IRA are subject to ordinary income tax, not forward averaging). • A “conduit” IRA can preserve eligibility for forward-averaging tax treatment from another qualified plan. • The 20% mandatory withholding requirement applies to “eligible rollover distributions” from qualified plans and TSAs if distribution is not a direct rollover.

Six Types of Rollovers (or Transfers) • Conduit IRA • Direct rollover (also known as a direct transfer of eligible rollover distributions) • Trustee-to-trustee transfer • Indirect rollover • Spousal beneficiary rollover • Nonspouse beneficiary rollover

Conversions & Rollovers to a Roth IRA A Roth IRA may accept rollover assets from other retirement arrangements if the source of the rollover assets consists of a rollover from: • a qualified plan • 403(b) arrangement • Section 457 government plan • traditional IRA • Roth 401(k) account • Roth 403(b) account • another Roth IRA Note: for this purpose, there is no ceiling on a retirement arrangement owner’s (or that of the owner who files jointly) adjusted gross income.

Lump-Sum Distribution Four Conditions Required for Distribution to be Considered a Lump Sum • Represents full amount credited to participant’s account (or benefit) from all qualified plans of the same type • Distributed in one taxable year • Payable due to participant’s death, attainment of age 59½, or separation from service (common law employees only); or payable due to participant’s death, attainment of age 59½, or disability (self-employed’s option in place of separation from service) • Made from qualified pension, profit sharing, or stock bonus plan Four Options for Treatment of Lump-Sum Distribution • Taxation: ordinary income rates • Taxation: forward-averaging method, if available; special treatment available if age 50 before 1/1/86 (born before 1936) • Deferral: roll the distribution over, deferring tax liability until a future date • Net unrealized appreciation treatment for distributions of employer stock

Ten-Year, Forward-Averaging Tax Treatment Advantages: Taxable amount is subject to possibly lower tax rate (tax is calculated on 1/10 of taxable amount, using 1986 tax tables, then multiplied by 10 to determine total tax).

Qualified Plan Annuity or Periodic Payment Distribution Taxed under annuity rules (IRC §72) at ordinary rates— exclusion ratio applied to each payment to determine excludible amount: Also, basis recovery tables of SBJPA 96 + TRA 97 • Available in accordance with plan provisions • Lifetime survivor benefits must be provided by qualified plans subject to minimum funding standards (e.g., defined benefit, money purchase, target benefit). *A participant’s “investment in the contract” (basis) includes after-tax contributions, Table 2001 costs, and loans that were treated as taxable distributions .

Calculating Nontaxable Portion of Installment Distributions Single Life • Use the method in the following example if payments are for one life such as a single life annuity; payments are from a qualified employee plan, a qualified employee annuity, or tax-sheltered annuity; and at the time payments began, individual was either under age 75 or entitled to fewer than five years of guaranteed payments. Divide cost basis by anticipated payments based on the schedule below. Example • Ron is age 67, retiring this year, and is entitled to receive his retirement benefits in the form of a single life annuity payable monthly. He has a cost basis in the annuity of $28,000. The nontaxable portion of the payments received by Ron will be $133 ($28,000/210). Note: Once he has received 210 monthly payments, the rest are fully taxable.

Calculating Nontaxable Portion of Installment Distributions Joint Lives When there is more than one annuitant, such as a joint and survivor annuity payable monthly over the lives of a husband and wife:

Premature Distributions from Qualified Plans & Exceptions to the 10% Penalty Penalty does not apply to a qualified plan distribution that is: • attributable to death or permanent disability • part of a series of substantially equal periodic payments over a qualified plan participant’s life expectancy following separation from service • used for medical care up to amount deductible on participant’s inc. tax return (amounts over 7.5% of AGI) • made to reduce excess plan contributions/deferrals – corrective distributions of excess contributions from IRAs are permitted The following exceptions are for qualified plans only – not IRAs: • made following separation from service after age 55 • paid in accordance with a QDRO • a dividend paid by employer stock held by an ESO

Premature Distributions from IRAs & Exceptions to the 10% Penalty Penalty does not apply to an IRA distribution that is: • attributable to death or permanent disability • part of a series of substantially equal periodic payments over an IRA owner’s life expectancy • used for medical care up to the amount deductible on the participant’s tax return (amounts over 7.5% of AGI) • corrective distributions of excess contributions (corrective distributions of excess plan contributions/deferrals applies to qualified plans) Exceptions for IRAs only – not qualified plans • used for first-time homebuyer expenses ($10,000 lifetime cap) • used for qualified higher education expenses (tuition, fees, books, supplies required for attendance) • used to pay health insurance premiums for qualifying unemployed individuals

Exceptions to the 10% Early Withdrawal Penalty: Summary

Series of Substantially Equal Periodic Payment (SOSEPP) Exceptions to the Premature Distribution Penalty These methods qualify: • Required minimum distribution method • Fixed amortization method • Fixed annuitization method

SOSEPP Exception Required Min. Distribution Method The annual payment for each year is determined by dividing the account balance for that year by the number from the chosen life expectancy table for that year. The account balance, the number from the chosen life expectancy table (representing the years of remaining life expectancy), and the resulting annual payments are recalculated for each year. Example Mr. Smith is age 50 this year and single. • His SOSEPP RMD for this year is $14,260. • $500,000 IRA account balance divided by 34.2, his life expectancy (Single Life Table)

SOSEPP Exception Fixed Amortization Method The annual payment for each year is determined by amortizing in level amounts the account balance over a specified number of years determined by using an IRS approved life expectancy table and interest rate. The account balance, life expectancy, interest rate, and resulting annual payment are determined once for the first distribution year and the annual payment is the same amount in each succeeding year. Example Mr. Smith, age 50, is single and has given the following information for purposes of calculating his SOSEPP payments under the fixed amortization method: • His IRA account balance is $500,000. • His life expectancy is 34.2 per the Single Life Table. • 5.7% is a reasonable rate of interest per IRS requirements. PV = $500,000; N = 34.2; I = 5.7. Solving for PMT = $33,537

SOSEPP Exception Fixed Annuitization Method Each year’s annual SOSEPP payment is determined by dividing the account balance by an annuity factor that is the present value of an annuity of $1 per year beginning at the taxpayer's age and continuing for the life of the taxpayer (or the joint lives of the individual and beneficiary). The annuity factor is calculated by an actuary using an IRS approved mortality table and interest rate. Under this method, the account balance, the annuity factor, the chosen interest rate, and the resulting annual payment are determined once for the first distribution year and the annual payment is the same amount in each succeeding year. Example Mr. Smith, age 50, is a single individual. You have been given the following information for purposes of calculating his SOSEPP payments under the fixed annuitization method: • his IRA account balance is $500,000, and • the annuity factor for an individual age 50 is 15.1819 according to an actuary who using an IRS approved mortality table and interest rate. • Dividing his $500,000 account balance by 15.1819 results in a series of fixed annual payments of $32,934 each.

Qualified Plan & IRA 2008 and Post-2009 Distribution Requirements Aggregation Rules IRS rules allow a certain amount of aggregation for purposes of the RMD rules. Each IRA’s RMD must be calculated separately. Total required minimum distribution can be taken from any one or all of these IRAs. Every other type of plan, however, must individually make an RMD. Example • Frank has three IRAs and participates in his company’s profit sharing plan. • After figuring the RMD for each of the IRAs, he can take a distribution from one, two, or all three—as long as it matches or exceeds the RMD for his three IRAs. • Frank must also take an RMD from his profit sharing plan. He cannot aggregate this plan with his IRAs when he makes the RMD calculation.

Tax Treatment of Qualified Roth IRA Distributions Distributions from a Roth IRA are either qualified or nonqualified. A distribution is qualified if it meets the five-year holding requirement (beginning with the first year for which a Roth contribution is made) and if it is made for any one of the following reasons: • after the owner’s attainment of age 59½, • death of the owner, • owner’s disability, or • to an owner for a special purpose (meaning a first-time home purchase (maximum distribution of $10,000).

Tax Treatment of Nonqualified Roth IRA Distributions The tax treatment of nonqualified distributions from a Roth IRA is determined by the ordering rules, which treat all amounts distributed as a distribution of after-tax contributions first and then as a distribution of earnings. • Therefore, no portion of a distribution is treated as ordinary income (taxable income) until the total of all prior distributions (after-tax contributions) exceeds the total of all prior contributions. • Unless an exception applies, an earnings distribution to an under age 59½ Roth IRA owner is subject to the 10% early withdrawal penalty.

Tax Treatment of Nonqualified Roth IRA Distributions Example • For the past 10 years, Jonathan Meiklehorn, age 32, contributed $2,000 each year to a Roth IRA. • During the current year, he withdrew his entire account balance of $34,000 to buy a car. • His account meets the five-year holding requirement, but he is not age 59½, deceased, or disabled, nor is he using the money to buy his first home. Therefore, the distribution is not qualified: • He has contributed $20,000, and this amount comes out first and is not taxable. • The remaining $14,000 of the distribution is taxable and is subject to the 10% penalty. • The portion of the distribution that is not taxed is not subject to the penalty.

Tax Treatment of Roth IRA Distributions: Summary

Qualified Plan Distribution Requirements Commencement of Distributions • Qualified plan must provide for retirement benefit distributions to begin within 60 days after the plan year-end in which the latest of the following occurs: • participant reaches age 65 (or normal retirement age specified in the plan, if earlier) • participant has 10 years of plan participation • participant terminates service with the employer • Employee may elect other forms of distribution

Qualified Defined Contribution Plan & IRA Distribution Requirements Required Minimum Distributions (RMDs) Qualified Plans: • Required beginning date (RBD) for qualified plan distributions must begin by April 1 of the calendar year following the later of the calendar year in which: • employee attains age 70½, or • employee retires. IRA Plans and greater than 5% business owner-participants: • Required beginning date (RBD) for IRA distributions must begin by April 1 of the calendar year following the year in which: • the individual attains age 70½ • whether working or not

IRA Distribution Requirements Required Beginning Date Distributions must be made over the Uniform Table life expectancy of the participant or the Joint and Last Survivor Table life expectancies (see IRC Sec. 401(a)(9) regulations) of the participant and the participant’s spouse if the spouse is at least 10 years younger. Penalty Penalty for receiving less than the required minimum distribution is 50% of the difference between the amount that was distributed and the amount that should have been distributed.

Qualified DC Plan & IRA Distribution Requirements Following Participant’s Death

Chartered Retirement Planning Counselor SM Professional Designation Program