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Qualified Plan Distributions and Loans

Qualified Plan Distributions and Loans. Chapter 25. Distribution Prior to Retirement. In Service Distributions Prohibited in pension plans Profit-sharing plans, ESOPs may permit them 401(k), 403(b) may be allowed in case of financial hardship IRAs and SEPs allow withdrawals.

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Qualified Plan Distributions and Loans

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  1. Qualified Plan Distributions and Loans Chapter 25

  2. Distribution Prior to Retirement • In Service Distributions • Prohibited in pension plans • Profit-sharing plans, ESOPs may permit them • 401(k), 403(b) may be allowed in case of financial hardship • IRAs and SEPs allow withdrawals

  3. Distributions when changing Employers • Cash-out provision: lump-sum distribution for balances <= $5,000 • No cash-out provision: former employee’s funds are held

  4. Distribution of Benefits • Normal Form of Benefits: plan must specify the amount and form. DB plans: • straight life • lump-sum • life annuity with a period certain • Pension plan must provide a qualified-joint-and survivor annuity

  5. DC: annuity and lump sum • 10% tax penalty for early distribution • Exceptions for tax 10% penalty • On or after age 591/2 • Upon the participant’s death • Upon disability of participant • As part of series of periodic payments

  6. To pay health insurance costs while unemployed (IRA only) • To pay higher education costs (IRA only) • To pay acquisition costs of a first home (IRA only) • After separation from service for early retirement after age 55.

  7. Delaying Benefit Payments: payment of benefits no later than the 60th day after the latest of 3 dates: • age 65 or NRA (if earlier) • 10th anniversary of entry in the plan • Termination of service • Incidental Benefit Requirements: in case of death benefits will be paid to a beneficiary

  8. Federal Taxation of Distribution • Determine taxable amount= distribution • nondeductible contributions by employee • Employer contribution taxed to employee • cost of life insurance reported as taxable income • Installments: annuity rule Section 72 applies • Lump-sum: amount in excess of the cost basis is taxable as ordinary income • 5-year average if received on or after 591/2

  9. Minimum distribution rules • Required beginning date: April 1 of the year following the year in which the participant attains age 701/2 • Subsequent distributions must be made by December 31 of each year • Applicable Life Expectancy: minimum=balance divided by ALE for distribution year

  10. Loans from Qualified Plans • Loans are allowed if the plan document states • No loans from IRAs and SEPs • Loans to owner/proprietor are prohibited • Limit = Min[50,000, 1/2 PV accrued benefits] • Loan must be repayable in 5 years (unless used acquire first home) • Loans must be secured and have a reasonable rate

  11. Plan Installment, Administration Investment and Termination Chapter 27

  12. Plan Installation • Plan year = same as the employer’s taxable year • Advance Determination letter: application to IRS • Master, Prototype, and Pattern Plans: written document

  13. Plan Administration • Record-keeping, receipt and disbursement of funds, claim administration and investments • Plans not subject to ERISA requirements: • Government plans • Church plans • WC, UI and DI laws • Plan administrator must be named in the document

  14. Reporting and Disclosure: provide information to government and plan participants • SPD • Annual Report (Form 5500 series) • Report on termination, merger or other changes • Individual benefit statement

  15. Fiduciary Requirements of ERISA and IRC • Fiduciary: someone who holds and administers money or property that belongs to others. • Each plan must specify a named fiduciary • Duties of the fiduciary are stated in Section 404 • Prohibited transactions

  16. Investment Policy • Growth oriented strategies • DC plans: directed investment is allowed • DB: no such provision • ERISA rules are designed to avoid risk • Assets in retirement plans: about $3 trillion

  17. Plan Termination • Qualification rule: plan must be permanent • Asset reversion termination: DB to recapture excess assets if the plan is fully funded • Consequences of termination: immediate 100% vesting • DB: all accrued benefits • DC: 100% vested associated to employer contributions

  18. PBGC: ERISA requires mandatory insurance for DB plans (excluding government, church plans) • Basic benefits are insured (see requirements on page 639) • Cost: $19 /participant (2005)

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