Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

§ 72 is one of the most complicated sections of the Code. It has lengthy rules dealing with: taxation of distributions (and deemed distributions) from annuity contracts, employer plans, life insurance contracts, and modified endowment contracts; how the owner’s “investment in the contract” (basis) is apportioned among distributions; and various penalties. This ¶ 2.1 covers only nonannuity distributions from QRPs, IRAs, and 403(b) plans, so there is no need to tackle most of the intricacies of § 72 . The only parts of § 72 covered in depth in this book are: how to compute the participant’s “investment in the contract” (basis) that may be distributed tax-free (¶ 2.2) ; and As this book goes to press, several federal income tax increases are scheduled. One change is expiration of lower tax rates that were enacted in 2001; see “A.” The others are part of the Patient Protection and Affordable Care Act of 2010, including the “reconciliation” provisions enacted with it, imposing new taxes on certain types of income; see “B” and “C.” A. Expiration of EGTRRA tax cuts. At the end of 2010, the so-called “Bush tax cuts” enacted as part of EGTRRA in 2001 and in 2003 are scheduled to expire. The effect will be to increase the highest marginal income tax bracket from 35 percent (as of 2010, effective for taxable income in excess of $373,650) to 39.6 percent (effective beginning at a lower level of taxable income). The maximum tax rate on long-term capital gain will increase from 15 percent to 20 percent; on qualified dividends, from 15 percent to 39.6 percent. These tax increases only indirectly impact retirement benefits. EGTRRA’s many changes in the retirement plan rules will not expire at the end of 2010, because they were made permanent by the Pension Protection Act of 2006. The indirect effect of these tax increases will be to increase the incentive for Roth conversions while today’s lower rates still apply (see ¶ 5.8.02 (B)), and to increase the relative attractiveness of investing inside a retirement plan (tax-deferred or tax-free) compared with investing outside a plan. B. “Medicare” surtax on compensation income. The “Medicare” tax rate prior to 2013 is 2.9 percent (including both the “employer” and “employee” shares, with the “employer” share being tax-deductible for the employer), imposed on all wages and self-employment income. Beginning in 2013, an additional .9 percent surtax must be paid (by the employee or self-employed individual) on wages and self-employment income in excess of $200,000 ($250,000, in the case of married taxpayers filing a joint return). C. 3.8% surtax on investment income. Another tax increase is captioned the “Unearned Income Medicare Contribution.” It is a 3.8 percent surtax applied to certain income of “high-income” taxpayers. See § 1411, effective for years after 2012. The surtax applies to “net investment income” of individuals whose modified adjusted gross income (MAGI) exceeds a certain “threshold amount.” Investment income includes “interest, dividends, annuities, royalties, and rents” and “net gain” attributable to the disposition of property. The “threshold amount” is $250,000 for “A taxpayer making a joint return ...or a surviving spouse ....” The threshold is half that amount for a married taxpayer filing separately; and $200,000 “in any other case.” the penalty for certain distributions before age 59½ (see Chapter 9). 2.1.02 Post-2010 tax increases; surtax on investment income