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Lecture 26 Qualified Plan Distributions and Loans

Lecture 26 Qualified Plan Distributions and Loans. You are taxed on any distributions from qualified plans You are also subject to penalties if you take your money out: Too soon Too late Too little Too much Loans may be permitted. Too Soon.

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Lecture 26 Qualified Plan Distributions and Loans

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  1. Lecture 26Qualified Plan Distributions and Loans • You are taxed on any distributions from qualified plans • You are also subject to penalties if you take your money out: • Too soon • Too late • Too little • Too much • Loans may be permitted

  2. Too Soon • A 10% penalty applies to withdrawals from a qualified plan unless the employee is: • At least 59 1/2 years old • Dead • Disabled • Separated from service after age 55 • Separated from service and taking payments over lifetime (or joint and survivor) • Has deductible medical expenses (over 7.5% of AGI)

  3. Too Soon - Example • Earl Early, born 1/7/50, quits his job in 1999 and takes his 401(k) account of $150,000 in a lump sum. He is in the 28% Federal tax bracket. How much does he get to keep after taxes and penalties? • Answer: • Early distribution penalty: $15,000 • Tax: $42,000 • Amount remaining: $93,000

  4. Too Late/Too Little • Withdrawals must begin by April 1 of the calendar year following when the employee turns 70 1/2 (or the year of actual retirement if later) • Withdrawals must be in substantially equal payments over life of employee (or joint and survivor) • Applicable penalty: 50% of the minimum amount that should have been withdrawn

  5. Too Late/Too Little - Example • Carl Careless, born 1/4/30, has $300,000 in a qualified profit sharing plan. If he retired on 7/4/95, when does he need to begin withdrawing money from this account? • Answer: April 1, 2001 • If he forgets to take any withdrawals in 2001, what is his penalty? Assume his life expectancy at age 71 is 15 years. • Answer: 50% x (300,000/15) = $10,000

  6. Too Much • If annual withdrawals from qualified plans in total exceed $150,000 (or $112,500 indexed), then the excess is subject to a 15% penalty tax. This penalty is reduced by the 10% penalty (if any) on early withdrawals.

  7. Too Much - Example • Gene Goodinvestor, born 5/7/39, retires on 1/1/99 and takes his defined contribution pension plan as a life annuity. This pays him $250,000 in 1999. He is in the 35% Federal and 5% state tax bracket. How much does he get to keep after taxes and penalties? • Answer: • Excess distribution penalty: 15,000 • Taxes: 100,000 • Amount remaining: 135,000

  8. Loans • Restricted to hardship cases • Loans limited to lesser of: • $50,000 minus highest outstanding loan balance in preceding year • 1/2 the present value of the employee’s vested accrued benefit • Repayment terms • 5 years unless loan is for a principal residence

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