Retirement Planning and Employee Benefits for Financial Planners

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

2. 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. 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. 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. 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. 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. Profit Sharing PlanDistribution 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. 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. 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. 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. Annuities • Partially tax-free return of adjusted basis. • Partially ordinary income: • Determined by inclusion/exclusion ratio

12. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. Calculating the Required Minimum Distribution • 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. 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 327-327 • Reduces RMD