Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

The penalty is not necessarily 10 percent of the total distribution. Rather, the 10 percent is calculated only with respect to “the portion of [the distribution] which is includible in gross income.” § 72(t)(1) ; Notice 87-16, 1987-1 CB 446, Question D9. To the extent the distribution is income tax-free because (for example) it represents the return of the participant’s own after -tax contributions ( ¶ 2.2.01 ), or because it is rolled over to another plan ( ¶ 2.6.01 ), it is also penalty- free. Here is how the 10 percent penalty applies to various types of distributions (and deemed distributions) to a participant who is under age 59½ if no exception ( ¶ 9.2 – ¶ 9.4 ) applies: A. Employer stock and NUA. An employee who receives employer stock in a lump sum distribution from a QRP is entitled to certain favorable tax treatment regarding the “net unrealized appreciation” in the stock; see ¶ 2.5. The penalty will apply to the portion of the distribution that is includible in the employee’s gross income. It will not apply to the NUA (because the NUA is excluded from income for purposes of § 72 ; § 402(e)(4)(A) , (B) ) or to the income resulting from later sale of the stock ( ¶ 2.5.01 ) (because that event is not a retirement plan distribution subject to § 72 ). B. IRA contributions withdrawn before return due date. If an IRA contribution for which no deduction has been taken is withdrawn from the account (together with the net earnings on that contribution) before the extended due date of the participant’s tax return for the year for which the contribution was made, the withdrawal of the contribution is not a taxable distribution ( ¶ 2.1.08 (D)) and accordingly is also not subject to the penalty. However, any earnings on the contribution that are included in the corrective distribution will be subject to the penalty. Notice 87-16, 1987-1 CB 446, Question C2; Hall , T.C. Memo 1998-336. According to the Instructions for IRS Form 5329 (2009) (line 23, p. 4), the penalty is reportable for the year the contribution was made ( i.e., the same year in which the income is reportable). C. Deemed distribution due to plan-owned life insurance. When a QRP purchases life insurance on the life of a plan participant, § 72(m)(3) generally requires that the cost of the insurance protection be included currently in the participant’s gross income. See ¶ 2.1.04 (H). This deemed income is not treated as a distribution for purposes of the 10 percent penalty. Notice 89-25, 1989-1 CB 662, A-11. D. Deemed distribution from failed plan loan. If an employee borrows, from a QRP, a loan that fails to meet the requirements of § 72(p) , the loan is treated as a taxable distribution rather than a loan; see ¶ 2.1.07 . The resulting gross income is subject to the penalty. Notice 87-13, 1987-1 CB 432, A-20; Plotkin , T.C. Memo 2001-71. E. Deemed distribution resulting from prohibited transaction. The penalty apparently applies to the deemed distribution resulting from a prohibited transaction ( ¶ 8.1.06 ); see Instructions for IRS Form 5329 (2009), line 1.

Enforcement of early distributions penalty

If an under-age 59½ participant takes money from a retirement plan, and does not qualify for any of the very precise and limited exceptions (see ¶ 9.2 – ¶ 9.4 ), the penalty is imposed, regardless of the taxpayer’s ignorance of the rules, good intentions, or other excuse. Surprisingly