Life and Death Planning for Retirement Benefits

Chapter 2: Income Tax Issues

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G. No tax on distribution of annuity contract. The distribution of an annuity contract (to either the participant or the beneficiary) is nontaxable, provided the annuity contract complies with the minimum distribution rules and is nonassignable by the recipient. Reg. § 1.402(a)-1(a)(2) ; see PLR 2006-35013. This includes a variable annuity contract; PLR 2005-48027. Instead, the recipient pays income tax on distributions received under the contract.

H. Return of IRA contribution. See ¶ 2.1.08 (D), (F), regarding special income tax treatment for IRA contributions that are returned to the contributor.

I. Income tax deduction for certain beneficiaries . A beneficiary taking a distribution from an inherited retirement plan is entitled to an income tax deduction for federal estate taxes paid on the benefits, if any. ¶ 4.6.04 – ¶ 4.6.08 .

J. Distribution to charitable entity. If the beneficiary is income tax-exempt it will not have to pay income tax on the distribution. See ¶ 7.5.01 – ¶ 7.5.04 , ¶ 7.5.08 .

K. Qualified Health Savings Account Funding Distributions (QHSAFD). An IRA owner is permitted, once per lifetime, to transfer funds tax-free directly from an IRA to a Health Savings Account (HSA). § 223 , § 408(d)(9) . The individual can make such a transfer from his own IRA, or from an inherited IRA he holds as beneficiary. Notice 2008-51, 2008-1 IRB 1163. The QHSAFD does not increase the amount that can be contributed to the HSA. See ¶ 2.2.09 (C) for the effect of a QHSAFD on basis. While HSAs are a tax-favored form of savings account (contributions are deductible from adjusted gross income; distributions are tax-free if used to pay medical expenses), the ability to transfer funds directly to the HSA from an IRA will be of use to few participants. Most IRA owners will benefit more by contributing to the HSA from their taxable account thereby getting an above-the-line income tax deduction (the HSA contribution reduces adjusted gross income; it is not an itemized deduction). L. QDROs and divorce-related IRA divisions. An individual can transfer all or part of his qualified retirement plan benefits to his spouse without being liable for income taxes on the transfer if the transfer is pursuant to a “qualified domestic relations order” (QDRO). § 402(e)(1) , § 414(p) . § 408(d)(6) allows similar tax-free division of an IRA between spouses in case of divorce or legal separation. In both cases, the statutory requirements applicable to the state court order must be strictly followed. It is not clear whether the QDRO/408(d)(6) procedures for tax-free division of retirement benefits between spouses can be used for inherited benefits. This book does not cover divorce-related divisions of retirement plans; see, instead, Chapter 36 of The Pension Answer Book ( Appendix C ).

Plan loans: Income tax treatment, RMDs, etc.

A participant cannot borrow money from his IRA; such a loan would be a “prohibited transaction” ( ¶ 8.1.06 ), triggering a deemed distribution of the account. § 408(e)(2)(B) . Qualified retirement plans (QRPs) are permitted to make loans to employees from their plan accounts provided various requirements are met regarding the maximum amount of the loan