1 Retirement Planning and Employee Benefits for Financial Planners Chapter 7: Distributions from Qualified Plans

2 © 2007 ME™ - Your Money Education Resource™ Distributions:Pension Plan/Normal Retirement Age  Joint and Survivor Annuity after retirement Annuity for participant and spouse  Spouse: 50% - 100% of joint annuity Continues even if remarry  Automatic for defined benefit plans  Elect out Increase monthly payments Spouse must sign waiver When should this be done?

3 © 2007 ME™ - Your Money Education Resource™ Distributions:Pension Plan/Normal Retirement Age  Annuities Period certain Survivor other than spouse  If beneficiary is much younger, distribution must be more than RMD

4 © 2007 ME™ - Your Money Education Resource™ Distributions:Pension Plan/Normal Retirement Age  Rollovers to IRA or other qualified plan Tax-free if within 60 days of distribution  Subject to withholding tax of 20% Direct rollovers: trustee to trustee  No withholding  Lump sum distribution Present value of future benefits When would you take this?  Life expectancy  Interest rates: now use corporate bond rates

5 © 2007 ME™ - Your Money Education Resource™ Termination of Service Before Normal Retirement Age - Pension Plan  Lump Sum Distribution if plan allows (many don’t)  Rollover plan assets to IRA or other qualified plan, or  Leave assets in plan. Value must be greater than $5,000  Forced payments between $1,000 - $5,000 must go to IRA

6 © 2007 ME™ - Your Money Education Resource™ Pension Plan Distribution Options  At participant’s death before retirement: Qualified Preretirement Survivor Annuity (QPSA)  An annuity benefit payable to the surviving spouse of a participant if the participant dies before attaining normal retirement age. Lump sum (if plan permits)  Distributed to beneficiary Primary / Contingent Participant’s estate.  At participant’s disability before retirement: Distributed to participant.

7 © 2007 ME™ - Your Money Education Resource™ Profit Sharing Plan Distribution Options  May permit in-service withdrawals after two years of participation in the plan.  401(k) plans may permit loans.  At termination of service: Lump sum distribution, Rollover plan assets to IRA or other qualified plan, or Purchase annuity.

8 © 2007 ME™ - Your Money Education Resource™ Taxation of Distributions from Pension and Profit Sharing Plans  Ordinary income Except:  Direct rollovers of plan assets to IRAs or other qualified plans,  Adjusted basis in plan,  Qualified Domestic Relations Orders (QDRO).  Taxable distributions not in annuity form are subject to 20% income tax withholding.

9 © 2007 ME™ - Your Money Education Resource™ Rollovers to IRAs  May expand investment options Individual stocks Reduce asset management fees? Rollover to Roth IRAs now permitted  Taxed  Causes a loss of: NUA  Direct Rollover No income tax withholding.  Indirect Rollover A distribution to the participant with a subsequent transfer to another account. Mandatory 20% income tax withholding.  Have cash to rollover 100%?

10 © 2007 ME™ - Your Money Education Resource™ Adjusted Basis in Plan  How? After-Tax Contributions.  Taxed at distribution? Tax-free return of capital to the extent of adjusted basis. Ordinary income for remainder.

11 © 2007 ME™ - Your Money Education Resource™ Annuities  Partially tax-free return of adjusted basis.  Partially ordinary income: Determined by inclusion/exclusion ratio Exclusion Ratio = Cost basis in the annuity Expected Benefit

12 © 2007 ME™ - Your Money Education Resource™ Lump Sum Distributions  Definition A distribution of the participant’s entire account balance or accrued benefit, Within one taxable year, On account of the participant’s death, attainment of age 59½, separation from service, or disability, and The employee participated in the plan for at least five years prior to the date of distribution.

13 © 2007 ME™ - Your Money Education Resource™ Net Unrealized Appreciation (NUA)  Lump sum distribution of employer securities. Usually from ESOP or Stock Bonus Plan  Any other assets in plan may be rolled over.  Determination of NUA: Fair Market Value at Date of Distribution Less: Value of stock at Date of Employer Contribution Net Unrealized Appreciation

14 © 2007 ME™ - Your Money Education Resource™ Net Unrealized Appreciation (1 of 2)  In year of distribution of employer stock: Value at date of Employer Contribution  Ordinary income NUA  Deferred Long-Term Capital Gain  At date of sale of employer stock: Recognize deferred long-term capital gain. Any subsequent gain/loss short/long term capital gain based on holding period since date of distribution.

15 © 2007 ME™ - Your Money Education Resource™ Qualified Domestic Relations Order (QDRO) (1 of 2)  Judicial order allowing ex-spouse to receive benefits from another individual’s qualified plan. Can be used for: Division of marital estate Child Support Divorce  Nontaxable distribution as long as assets are deposited into an IRA or another qualified plan. QDRO must comply with regulations

16 © 2007 ME™ - Your Money Education Resource™ Qualified Domestic Relations Order (QDRO) (2 of 2)  Two methods of distribution: Shared Payment  Splits monthly payment between former spouses What if participant dies? What if second charming ex? QDRO can’t require payments not allowed by plan Separate Interest  Defined Benefit: buyout spouse’s interest Value: interest rates; life expectancy  Defined Contribution: Value: often income tax ignored Roll into IRA

17 © 2007 ME™ - Your Money Education Resource™ Plan Loans  Permissible by any qualified plan Usually only found with CODA type plans. 28% of workers had borrowed from 401(k) as of December 2010  Loan may not exceed The lesser of:  $50,000, or  ½ of the participant’s vested account balance  Exception, when vested account balance is <$20,000, the maximum loan is limited to the lesser of: $10,000, or The vested account balance. Reduced by the highest outstanding loan balance within the previous twelve month period.

18 © 2007 ME™ - Your Money Education Resource™ Repayment of Plan Loans (1 of 2)  Five years Or up to 30 years if loan proceeds used to purchase principal residence. 75% default rate for those who leave job with outstanding loan balance  Substantially level amortization of the loan is required over its term.  Payments must be at least quarterly.  Plan sponsors often apply additional rules and requirements.

19 © 2007 ME™ - Your Money Education Resource™ Repayment of Plan Loans (2 of 2)  Failure to repay the loan as prescribed will consider the value of the loan a taxable distribution. Possibly subject to the 10% early distribution penalty.  Termination from employment generally causes entire loan to become due.

20 © 2007 ME™ - Your Money Education Resource™ Distributions Prior to 59½  Subject to a 10% early withdrawal penalty unless on account of an exception:  Death,  Disability, Strict definition of disability (similar to Social Security)  Separation from Service after the participant attains age 55  Qualified Domestic Relations Order.

21 © 2007 ME™ - Your Money Education Resource™ Distributions Prior to 59½  Subject to a 10% early withdrawal penalty unless on account of an exception:  Substantially equal periodic payments after separation from service RMD amount  Start small; get bigger Fixed periodic amount over life expectancy Payments must continue for later of 5 years or until 59 1/2  Medical expenses in excess of 7.5% of the participants AGI, or Don’t want this…crummy insurance

22 © 2007 ME™ - Your Money Education Resource™ Minimum Distributions  First minimum distribution must begin by April 1 of the year following the year in which the participant attains the age of 70 ½. Exception:  A participant who is still employed by the plan sponsor may delay the first minimum distribution until April 1 of the year after the participant terminates employment (a >5% owner cannot use the exception).  RMDs are required for 2014  Requirement for RMDs was waived in 2009

23 © 2007 ME™ - Your Money Education Resource™ Minimum Distributions  All other minimum distributions (after first year) must occur by December 31 of the year. Tax equal to 50% of RMD if not taken  Does not apply to Roth 401(k); Roth IRA  Must take RMD from all qualified plans IRAs: take one RMD for all IRAs

24 © 2007 ME™ - Your Money Education Resource™ Calculating the Required Minimum Distribution Required Minimum Distribution = Fair Market Value of Participant’s Account at December 31 of the preceding plan year* Distribution period determined based on participant’s age at December 31 of the distribution year.  Generally divide by factor starts at 27.4 for age 70 (see page 324) 26.5 for age 71 Factor continues to decline When will account be liquidated?

25 © 2007 ME™ - Your Money Education Resource™ Distribution Period  Participant alive: receiving payments Single or Spouse isn’t trophy (spouse not > 10 years younger)  Use Uniform Lifetime Table: page 324. Trophy spouse (> 10 years younger)  Use Joint Life Table on pages Reduces RMD

26 © 2007 ME™ - Your Money Education Resource™ Minimum Distributions After Death  If RMDs have begun Must take RMD (if over 70 ½ required) in year of death

27 © 2007 ME™ - Your Money Education Resource™ Minimum Distributions After Death  If beneficiary is charming spouse Can roll into spouse’s IRA and use her RMD calculations  Trophy spouse Or just continue to receive distributions based on decedent’s RMD  Older spouse

28 © 2007 ME™ - Your Money Education Resource™ Minimum Distributions After Death  If beneficiary is not charming spouse, two choices Cash out the IRA within five years of owner’s death or… Or elect to have distributions made over their life expectancy starting now  Take account balance/factor for your age  Factor from Single Life Table for age 30: 53.3  Then factor decreases by 1 each year Joe Some, Deceased 12/15/11, IRA F/B/O Joe Some, Jr., Beneficiary If beneficiary dies before account liquidated, successor beneficiary takes distributions using original beneficiary’s factors