Life and Death Planning for Retirement Benefits

Chapter 2: Income Tax Issues

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Through the years, the Code has provided a special gentle treatment for “lump sum distributions” (LSDs) from qualified retirement plans (QRPs). A person who wishes to obtain this special treatment is confronted with some of the most convoluted requirements known to post- ERISA man.

Introduction to lump sum distributions

Congress changed the rules on LSD treatment so often that the IRS was unable to keep pace with regulations. There are only assorted proposed and temporary regulations issued in 1975– 1979 (under old Code § 402(c)), that became obsolete before they could be finalized. The instructions for IRS Forms 4972 and 1099-R are often the best indication of the IRS’s interpretation of the LSD rules. From 1992 through 1999, the definition of LSD was found in § 402(d); after 1999, it went back to its pre-1992 home, § 402(e) . One special LSD deal, five-year forward averaging, ceased to be available for distributions after 1999. To achieve the favorable tax treatments still available for LSDs, the taxpayer must clear various “hurdles,” many of which are surrounded by hidden-issue “land mines.” The requirements that must be met in order for a distribution to qualify as an LSD are summarized at ¶ 2.4.02 – ¶ 2.4.05 . If a distribution clears those hurdles it is an LSD. That doesn’t mean much, however, unless it meets further tests to qualify for particular favorable tax treatments:  If the LSD meets additional tests, it can qualify for special averaging treatment (unusual now). See ¶ 2.4.06 .  If the LSD includes employer stock, see ¶ 2.5 . The following aspects of LSDs are not treated here: LSDs in connection with a QDRO ( § 402(e)(4)(D)(v) , (vii) ); interplay with the § 691(c) deduction ( ¶ 4.6.04 ); an LSD paid to multiple recipients; and distribution of annuity contracts as part of an LSD. Only distributions from § 401(a) “qualified plans” (pension, profit-sharing, or stock bonus) can qualify as LSDs. Both corporate plans and self-employed (“Keogh”) plans can give rise to LSDs, but a distribution from an IRA, SEP-IRA, SIMPLE, or 403(b) plan can never qualify for LSD treatment. § 402(e)(4)(D)(i) . Once money or stock has been “rolled” into an IRA, any special LSD or NUA deal is permanently lost. PLR 2004-42032. First hurdle: Type of plan

Second hurdle: “Reason” for distribution

The distribution must be made following a triggering event. § 402(e)(4)(D)(i) , I–IV . The triggering events are slightly different depending on whether the participant is a “common law employee” or is self-employed (“employee within the meaning of section 401(c)(1)”).

If the participant is a common-law employee, the distribution must be made either:

 On account of the employee’s death; or  After the employee attains age 59½; or  On account of the employee’s “separation from service.” § 402(e)(4)(D)(i) , I–III .