Early Distribution from Retirement Plans May Have a Tax Impact

Taxpayers may sometimes find themselves in situations when they need to withdraw money from their retirement plan early. What they may not realize is that that transaction may mean a tax impact when they file their return.

Here are 10 facts from the IRS about the tax implications of an early distribution from your retirement plan.

1. Payments you receive from your Individual Retirement Arrangement before you reach age 59 ½ are generally considered early or premature distributions.

2. Early distributions are usually subject to an additional 10 percent tax.

3. Early distributions must also be reported to the IRS.

4. Distributions you roll over to another IRA or qualified retirement plan are not subject to the additional 10 percent tax. You must complete the rollover within 60 days after the day you received the distribution.

5. The amount you roll over is generally taxed when the new plan makes a distribution to you or your beneficiary.

6. If you made nondeductible contributions to an IRA and later take early distributions from your IRA, the portion of the distribution attributable to those nondeductible contributions is not taxed.

7. If you received an early distribution from a Roth IRA, the distribution attributable to your prior contributions is not taxed.

8. If you received a distribution from any other qualified retirement plan, generally the entire distribution is taxable unless you made after-tax employee contributions to the plan.

9. There are several exceptions to the additional 10 percent early distribution tax, such as when the distributions are used for the purchase of a first home (up to $10,000), for certain medical or educational expenses, or if you are totally and permanently disabled.

10. For more information about early distributions from retirement plans, the additional 10 percent tax and all the exceptions, see IRS Publication 575, Pension and Annuity Income and Publication 590, Individual Retirement Arrangements (IRAs). Both publications are available at www.irs.gov or by calling 800-TAX-FORM (800-829-3676).
Links:

• Publication 575, Pensions and Annuities (PDF 227K)
• Publication 590, Individual Retirement Arrangements (IRAs) (PDF 449K)
• Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax Favored Accounts   (PDF 72K)
• Form 5329 Instructions (PDF 40K)

Source:  IRS Tax Tip 2012-34

Investing

“Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.”

Source:  Warren Buffett, Berkshire Hathaway Shareholder Letter, February, 25, 2012, page 17

IRS issues proposed regulations on purchase of longevity annuity contracts by plans

The IRS has issued proposed regulations relating to the purchase of longevity annuity contracts under defined contribution plans, 403(b) plans, IRAs, and eligible governmental section 457 plans. The proposed regulations are designed to open up the 401(k) and IRA market to longevity annuities by providing special relief from the minimum distribution requirements.

CCH Note: A longevity annuity (sometimes referred to as “longevity insurance” or a “deeply deferred annuity”) is an income stream that begins at an advanced age, such as age 85, and continues as long as the individual lives. Purchasing such annuities can help participants hedge the risk of drawing down their benefits too quickly and thereby outliving their retirement savings. However, the required minimum distribution (RMD) rules can be an impediment to the utilization of such annuities. Under current rules, prior to annuitization, the value of the annuity must be included in the account balance that is used to determine RMDs. If the remainder of the account has been depleted, the participant might have to begin distributions from the annuity earlier than anticipated in order to satisfy RMD requirements.

Qualifying longevity annuity contracts

The proposed regulations would modify the RMD rules in order to facilitate the purchase of deferred annuities that begin at an advanced age. Prior to annuitization, the value of these contracts, referred to as “qualifying longevity annuity contracts” (QLAC) would be excluded from the account balance used to determine RMDs.

The proposed regulations would apply to contracts that met certain requirements, including the requirement that distributions begin not later than age 85. In addition, the premiums paid for the QLAC could not exceed the lesser of $100,000 or 25% of the participant’s account balance on the date of the payment. The only permissible benefit payable after the participant’s death would be a life annuity, payable to a designated beneficiary. Thus, a contract that provided for distribution for a certain period, or that provided for a refund of premiums after the participant’s death, would not qualify as a QLAC. The proposed regulations provide that if the sole beneficiary of an employee under the contract is the employee’s surviving spouse, the only benefit permitted to be paid after the employee’s death is a life annuity payable to the spouse that does not exceed 100% of the annuity payable to the employee. If the employee’s surviving spouse is not the sole beneficiary, the only benefit permitted to be paid after the employee’s death is a life annuity payable to a designated beneficiary, the amount of which is not to exceed certain limits.

The definition of QLAC would also exclude certain other types of arrangements, such as a variable contract under Code Sec. 817, an equity-indexed contract, or a similar contract. The contract would not be allowed to provide any commutation benefit, cash surrender value, or other similar feature.

Specific rules would apply to QLACs purchased under IRAs, 403(b) plans, and 457(b) plans. Disclosure and annual reporting requirements would also apply to all QLACs.

Proposed effective date

The proposed regulations regarding reporting and disclosure requirements would be effective when the regulations are finalized. Otherwise, the regulations are proposed to be effective for contracts purchase on or after the date that final regulations are adopted and for determining RMDs for distribution calendar years beginning on or after January 1, 2013. The IRS advises that, until final rules are issued, taxpayers may rely on the proposed regulations and the existing rules under Code Sec. 401(a)(9) continue to apply.

Comments and hearings

Written or electronic comments on the proposed regulations are due by May 3, 2012. A public hearing has been scheduled for June 1, 2012.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

Source:  CCH® PENSION — 02/16/12

Proposed Guidance on “Lifetime Income” Options for 401(k)s

The Treasury Department issued on Thursday, February 2^nd proposed guidance on “lifetime income” options for employers on how best to integrate lifetime income products into 401(k)s and other employer-sponsored retirement plans.

Treasury guidance builds on comments received in response to Treasury and DOL’s joint request for information on the desirability and availability of lifetime income alternatives in retirement plans. The guidance, Treasury says, will help Americans meet their need for income during retirement by:

1. Encouraging Partial Annuity Options. Retirement plan participants are often confronted with a “cash or annuity” decision upon retirement. Given an all-or-nothing choice, many opt for a lump sum and decline the lifetime income stream because they are unaware they have the option to combine approaches. The proposed regulation changes a regulatory requirement to make it simpler for defined benefit pension plans to offer combinations of lifetime income and a single-sum cash payment. This is designed to encourage more retirees to consider partial annuities, which allow for retirees to receive a steady stream of income for the duration of their lifetimes while also keeping a portion of their savings invested in assets with the flexibility to respond to liquidity needs.
2. Removing a Key Obstacle to “Longevity” Annuities. Another proposed regulation expands on the combination approach by removing a regulatory impediment to purchasing a deferred “longevity” annuity. This change would make it easier for retirees to use a limited portion of their savings to purchase guaranteed income for life starting at an advanced age, such as average life expectancy. Annuities of this type would provide an efficient way for 65- or 70-year-olds (or even younger savers) to address the risk of outliving their assets by purchasing a predictable income stream starting at age 80 or 85. Once that risk is addressed, a retiree’s task of generating income from the remaining assets is more manageable because it is limited to a fixed period of time.
3. Clarifying Rules for Plan Rollovers to Purchase Annuities and Spousal Protection Rules for 401(k) Deferred Annuities. Two revenue rulings issued Thursday clarify how rules protecting employees and spouses apply when plan sponsors offer lifetime income options under their plans. The first ruling clarifies how the rules apply when employees are given the option to use a single-sum 401(k) payout to obtain a low-cost annuity from their employer’s defined benefit pension plan. The second ruling clarifies that employers can offer their employees the option to use 401(k) savings to purchase deferred annuities and still satisfy spousal protection rules with minimal administrative burdens. Both of these rulings would facilitate the availability of flexible options for employees so that they can better use their 401(k) savings to achieve financial security in retirement.

Additional information on these proposals is available in a fact sheet posted at http://www.treasury.gov. The proposed regulations announced today are also available at http://www.regulations.gov for public comment.

Source:  U.S. Department of Labor     Council of Economic Advisers

DOL Delays 401(k) Fee Disclosure

The U.S. Department of Labor’s (DOL) Employee Benefits Security Administration (ESBA) issued a final rule that will provide employers sponsoring pension and 401(k) plans with information about the administrative and investment costs associated with providing such plans to their workers. The department also announced a 3-month extension in the effective date of this rule, meaning service providers must be in compliance by July 1, 2012, for new and existing contracts or arrangements between Employee Retirement Income Security Act (ERISA)-covered plans and service providers.

A fact sheet on this 408(b)2  regulation is available on EBSA’s website at http://www.dol.gov/ebsa/newsroom/fs408b2finalreg.html.

Additional information about how the final rule announced today differs from the previously published interim final rule can be seen by visiting http://www.dol.gov/ebsa/408b2changes.html.

Sources:  U.S. Department of Labor     Council of Economic Advisers

Email Hack Attack? Be Sure to Notify Brokerage Firms and Other Financial Institutions

I am unable to accept trade instructions by voicemail or email.  I need to receive written instructions or talk to you directly.  Here’s a reason why…..

Anyone who has experienced an email account intrusion or “hacking” knows how frustrating it can be to deal with the aftermath—from telling friends in milder cases that you didn’t send the flurry of bogus emails they received to regaining access to a blocked account. In the most serious cases, a compromised email account can lead not only to identity theft, but also to theft of your money. That’s why one of the most important first steps you should take if your email account has been hacked is to notify your brokerage firm and other financial institutions.

FINRA has received an increasing number of reports involving investor funds being stolen by fraudsters who first gain access to the investor’s email account and then email instructions to the firm to transfer money out of the brokerage account. In addition to issuing a Regulatory Notice to firms, FINRA is issuing this Alert to warn investors about the potential financial consequences of a compromised email account and to provide tips for safeguarding your assets.

Source:  FINRA Investor Alert

IRS Reminds Parents of Ten Tax Benefits

Your kids can be helpful at tax time. That doesn’t mean they’ll sort your tax receipts or refill your coffee, but those charming children may help you qualify for some valuable tax benefits. Here are 10 things the IRS wants parents to consider when filing their taxes this year.

1. Dependents In most cases, a child can be claimed as a dependent in the year they were born. For more information see IRS Publication 501, Exemptions, Standard Deduction, and Filing Information.

2. Child Tax Credit You may be able to take this credit for each of your children under age 17. If you do not benefit from the full amount of the Child Tax Credit, you may be eligible for the Additional Child Tax Credit. For more information see IRS Publication 972, Child Tax Credit.

3. Child and Dependent Care Credit You may be able to claim this credit if you pay someone to care for your child or children under age 13 so that you can work or look for work. See IRS Publication 503, Child and Dependent Care Expenses.

4. Earned Income Tax Credit The EITC is a tax benefit for certain people who work and have earned income from wages, self-employment or farming. EITC reduces the amount of tax you owe and may also give you a refund. IRS Publication 596, Earned Income Credit, has more details.

5. Adoption Credit You may be able to take a tax credit for qualifying expenses paid to adopt an eligible child. If you claim the adoption credit, you must file a paper tax return with required adoption-related documents.  For details, see the instructions for IRS Form 8839, Qualified Adoption Expenses.

6. Children with earned income If your child has income earned from working, they may be required to file a tax return. For more information, see IRS Publication 501.

7. Children with investment income Under certain circumstances a child’s investment income may be taxed at their parent’s tax rate. For more information, see IRS Publication 929, Tax Rules for Children and Dependents.

8. Higher education credits Education tax credits can help offset the costs of higher education. The American Opportunity and the Lifetime Learning Credits are education credits that can reduce your federal income tax dollar-for-dollar. See IRS Publication 970, Tax Benefits for Education, for details.

9. Student loan interest You may be able to deduct interest paid on a qualified student loan, even if you do not itemize your deductions. For more information, see IRS Publication 970.

10. Self-employed health insurance deduction If you were self-employed and paid for health insurance, you may be able to deduct any premiums you paid for coverage for any child of yours who was under age 27 at the end of the year, even if the child was not your dependent. For more information, see the IRS website.

Forms and publications on these topics are available at www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

Source:  IRS Tax Tip 2012-15