Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

A treatise could be written on the subject of what constitutes “separation from service.” “An employee will be considered separated from the service within the meaning of section 402(e)(4)(A) of the Code, only upon the employee’s death, retirement, resignation or discharge, and not when the employee continues on the same job for a different employer as a result of the liquidation, merger or consolidation, etc., of the former employer.” Rev. Rul. 79-336, 1979-2 C.B. 187. See, e.g. , PLRs 9844040, 1999-27048, 2001-48077. See PLR 2000-38050 holding that an executive employee who transitioned to being a consultant (independent contractor) had “separated from service” for LSD purposes. Defining “separation from service” is beyond the scope of this book. See instead The Pension Answer Book ( Appendix C ). The frustrating technicalities of the term “separation from service” caused Congress to change to a different term—“severance from employment”—in defining when an elective deferral account may properly be distributed from a 401(k) plan (a subject not covered in this book); see § 401(k)(2)(B)(i)(I) , effective for distributions after 2001. Unfortunately, Congress did not similarly amend § 402(e) , so “separation from service” is still the term applicable in the definition of LSD. Most cases and rulings on the meaning of separation from service dealt with 401(k) plans; see, e.g. , PLR 2001-27053. Post-2001 401(k) pronouncements will no longer help on this question, since the two Code sections now use different terms. (b) Landmine: “on account of” Occasionally taxpayers have had problems asserting that a particular LSD was made “on account of” a triggering event. For example, where the employee died leaving his QRP benefits to his surviving spouse, then she died after taking some distributions from the plan, the children who inherited the remaining QRP benefits at her death were not entitled to LSD treatment, because the payments to them were not “on account of” the employee’s death (they were on account of the surviving spouse’s death). Gunnison , 461 F.2d 496, 499 (7th Cir. 1972). But see PLR 2003-02048, in which a distribution received 10 years after taxpayer’s separation from service was ruled to be “on account of” the separation from service. If the triggering event is reaching age 59½, or becoming disabled, then the distribution does not have to be “on account of” the triggering event; it merely has to be “after” it. PLR 8541089. The treatment is available for someone who has attained age 59½ even if he has not terminated employment; see PLR 2004-10023. 2.4.04 Third hurdle: Distribution all in one taxable year For the distribution to qualify as an LSD, the employee’s entire balance must be distributed to him in one calendar year. As the Code puts it, there must be a “distribution or payment within one taxable year of the recipient of the balance to the credit of ...[the] employee...” from the plan. § 402(e)(4)(D)(i) . The “balance to the credit” includes all the participant’s accounts in that plan— employ ee contribution, employ er contribution, rollover, and designated Roth! LSD treatment is NEVER available for a partial distribution. See PLRs 2006-34017 through 2006-34022. For exceptions to the all-in-one-year rule, see ¶ 2.4.05 . This hurdle is surrounded by land mines. Clearly, if an employee takes out, say, one-third of his plan balance in Year 1 and leaves two-thirds in the plan, the distribution of the one-third portion in Year 1 does not qualify for LSD treatment because it is not a distribution of the entire balance. Now suppose the employee takes out the remaining two-thirds of his balance in Year 2.