Life and Death Planning for Retirement Benefits

CHAPTER 2: INCOME TAX ISSUES How federal income taxes apply to retirement benefits, including special income tax deals such as NUA and LSD, rollovers, and tax withholding rules.

This Chapter examines all aspects of the federal income tax treatment of retirement benefits payable under defined contribution plans, except the following: “Income in Respect of a Decedent” (IRD; see ¶ 4.6); fiduciary income taxes (¶ 6.5, ¶ 7.4); the tax on “unrelated business taxable income” (¶ 8.2) ; and IRA losses ( ¶ 8.1.02 ). This book does not cover state income taxes or income tax treatment of qualified or nonqualified annuities. 2.1 Income Tax Treatment: General & Miscellaneous Tax-sheltered investment accumulation is the main attraction of retirement plans. Chapter 1 explained how long that tax-sheltered accumulation can last. We now turn to how benefits are subjected to federal income tax once they are distributed (or deemed distributed) from a qualified There are exceptions to the General Rule: For how a retirement benefit can be taxable even without a distribution’s occurring, see ¶ 2.1.04 . Regarding who is liable for the tax, see ¶ 2.1.05 . For distributions that are nontaxable, or that are taxed more favorably than as “ordinary income,” see ¶ 2.1.06 . Here is how we arrive at the General Rule. § 402(a) governs income taxation of distributions from qualified retirement plans (QRPs). § 402(a) provides that, except as otherwise provided in § 402 , “any amount actually distributed to any distributee by any employees’ trust described in section 401(a) ...shall be taxable to the distributee, in the taxable year of the distributee in which distributed, under section 72 (relating to annuities).” Emphasis added. § 408(d)(1) provides similarly for distributions from IRAs, as § 403(b)(1) does for 403(b) plans. If cash is distributed, the amount of cash distributed is the “amount actually distributed.” If property is distributed, the “amount ...distributed” is generally the fair market value of the property. Reg. § 1.402(a)-1(a)(1)(iii) ; Notice 89-25, 1989-1 C.B. 662, A-10. For exceptions, see ¶ 2.1.06 (G) (annuity contract) and ¶ 2.5 (employer stock). If the distribution occurs after the participant’s death, it is also subject to the rules of § 691 , governing “income in respect of a decedent” (IRD); see ¶ 4.6 . The General Rule A distribution from a retirement plan is taxable as ordinary income to the participant whose plan it is or (in the case of distributions after the participant’s death) to the beneficiary who receives such distribution. § 402(a) . retirement plan (QRP), IRA, or 403(b) plan (¶ 8.3) . 2.1.01 Plan distributions taxable as ordinary income