Retirement Plans at Work

Sara C. Derrick

10 TIPS ON RETIREMENT ASSET DISTRIBUTIONS

1. There is a 10% penalty, in addition to the income tax payable, on any taxable distribution from a retirement plan received before age 59 1/2; however the penalty does not apply to (a) the estate of the employee, (b) the beneficiary(s) of the employee or (c) to alternate payees under QDROs. I.R.C. §72(t).
2. There is a 50% penalty, in addition to income tax, on the difference between the amount required to be distributed from a retirement plan during any calendar year and the lesser amount actually distributed. I.R.C. §4974.
3. I.R.C. §401(a)(9) and the Proposed Regulations issued thereunder and unchanged since July 27, 1987, set forth the requirements for distributions from retirement plans. The general rule is that the entire interest of an employee in a retirement plan must be distributed (a) in full by the employee's Required Beginning Date (April 1 of the calendar year following the calendar year during which the employee attains age 70 1/2), or beginning not later than on the Required Beginning Date over the life expectancy of the employee or over the life expectancy of the employee and a "Designated Beneficiary". I.R.S. §401(a)(9)(A).
4. If retirement plan distributions begin during the employee's lifetime and the employee dies after the Required Beginning Date, the benefit remaining at the employee's death must be distributed at least as rapidly as under the distribution method in effect at the date of death. I.R.C. §401(a)(9)(A)(i).
5. If the employee dies before the Required Beginning Date, the entire retirement plan interest must be distributed by December 31 of the calendar year in which the 5th anniversary of the date of death falls, but no distribution is required to be made before that date. This is called the "5 Year Rule".  I.R.C. §401(a)(9)(B)(ii). For example, if the employee died on 1/1/2004, no distribution is required to be made before 12/31/2009, one day short of 6 years after the date of death.
6. If an employee's retirement plan interest is payable to or for the benefit of a Designated Beneficiary and the distribution begins not later than December 31 of the calendar year following the year during which the date of death fell, the 5 Year Rule does not apply, and the distribution may be made over the life expectancy of the Designated Beneficiary. I.R.C. §401(a)(9)(B)(ii).
7. If the Designated Beneficiary of the employee is the surviving spouse of the employee, the 5 Year Rule does not apply, the retirement plan interest may be made over the life expectancy of the surviving spouse, and the surviving spouse is not required to take any distribution before the date on which the employee would have attained age 70 1/2. I.R.C. §401(a)(9)(B)(iv).
8. Who may be a Designated Beneficiary for purposes of I.R.C. §401(a)(9) and the Proposed Regulations? There are 2 possibilities: (a) an individual, and (b) a trust if, as of the later of the Required Date or the date on which the trust is named as a beneficiary:
   
     (1) The trust is valid under local law, or would be valid if it were funded,
     (2) The trust is irrevocable,
     (3) The beneficiaries of the trust are identifiable from the trust instrument, and
     (4) A copy of the trust instrument is provided to the plan administrator.
   
   Prop. Reg. §401(a)(9)-1D-5. A trust itself may not be a Designated Beneficiary; however, if the requirements set forth above are met, the beneficiary of the trust having the shortest life expectancy will be deemed to be the Designated Beneficiary. Prop. Reg. §1.409(a)(9)-1 E-5(a).
9. Engage in distribution planning!!! Retirement assets will be taxed more heavily than any other assets when estate tax is payable because retirement plan distributions constitute "income in respect of a decedent." I.R.C. §691. Accordingly, subject to the I.R.C. §691(c) deduction, retirement assets will be income taxed to the employee's beneficiary and estate taxed. The combined taxes could easily equal 70% of the value of the retirement assets.
   
   Tax-wise retirement asset beneficiaries may be named in the following order of preference:
   
     (a) Surviving spouse
     (b) Other individuals
     (c) QTIP marital deduction trust
     (d) Employee's estate
     (e) Credit shelter trust
   
   And don't forget about charity!
10. The nonparticipant spouse who predeceases the employee has no right to control the disposition of his/her community property interest in an ERISA qualified retirement plan. Boggs v. Boggs, 521 U.S. 1138 (1997), Ablamis v. Roper, 937 F.2d 1450 (9th Cir. 1991).

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