Life and Death Planning for Retirement Benefits

Chapter 2: Income Tax Issues

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withholding) if the beneficiary does not choose a direct rollover; see ¶ 4.2.04 . § 402(f)(2)(A) . However, distributions to a beneficiary that is not a “Designated Beneficiary” cannot be rolled over and therefore are not subject to mandatory withholding. A required minimum distribution (RMD; see Chapter 1 ) is not an “eligible rollover distribution” ( ¶ 2.6.03 ) and accordingly it is not subject to mandatory income tax withholding; however, be prepared for the fact that not every plan administrator really knows the rules on this. IRA distributions are not subject to the mandatory 20 percent withholding rule; an IRA distribution cannot be an “eligible rollover distribution” for withholding tax purposes even if it is eligible to be rolled over. That’s because § 3405(c)(3) references § 402(f)(2)(A) for its definition of eligible rollover distribution, and § 402(f)(2)(A) refers only to distributions from qualified plans, 403(b) arrangements, and § 457 plans. § 408 (governing IRAs) is not referenced in § 402(f) . The distinction between periodic payments and nonperiodic distributions is a little vague, but is not terribly important. Both types are subject to withholding by all types of plans, and with both types the recipient can elect out of having anything withheld (unless the distribution is an eligible rollover distribution). The only difference is the rate of withholding that applies if the recipient does not opt out of withholding (same-rate-as-for-wages for periodic payments, flat 10% for nonperiodic payments). The more significant distinction is between “eligible rollover distributions” and other payments, because 20% withholding from an eligible rollover distribution is mandatory unless the distribution is sent by direct rollover to another retirement plan. The mandatory withholding on eligible rollover distributions does not pose a problem if someone simply wants to get the money out of the QRP without simultaneously paying any income tax on the distribution. All such person has to do is have his distribution transferred directly (a “direct rollover”) into an IRA, so the qualified plan does not have to withhold anything; and then take the money out of the IRA (electing out of withholding on the IRA distribution). The person for whom “mandatory withholding” is truly mandatory is the person who wants to take a lump sum distribution from a QRP in order to qualify for special averaging treatment ( ¶ 2.4.06 ). This person cannot roll over any part of the distribution, and so will be forced to pay 20 percent income tax on it through withholding. He can get a refund when he files his tax return for the year of the distribution, if his total tax payments (including this withholding) exceed his actual tax liability. D. Roth conversion of eligible rollover distribution. Under § 3405(c)(2) , as long as the recipient elects (under § 401(a)(31) ) to have the eligible rollover distribution sent directly to an “eligible retirement plan,” there is no required income tax withholding. “...[A]n eligible retirement plan is a trust qualified under section 401(a), an annuity plan described in section 403(a), or an individual retirement plan (as described in Sec. 1.402(c) -2, Q&A- 2 of this chapter).” Reg. § 31.3405(c)-1 , A-1(a). The referenced section states that eligible retirement plan includes an individual retirement account under § 408(a) . Notice 2008-30, 2008-1 CB 638, A-1, A-6, makes clear that Roth IRAs are also eligible to receive direct rollovers, and that a direct rollover to a Roth IRA is not subject to the 20 percent mandatory income tax withholding: “ ...[A]n eligible rollover distribution that a distributee elects, under § 401(a)(31)(A) , to have paid directly to an eligible retirement plan (including a Roth IRA) is not subject to mandatory withholding, even if the distribution is