Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

Though retirement plan distributions are generally taxable to the recipient, upon receipt, as ordinary income ( ¶ 2.1.01 ), there are exceptions. Here are the situations in which a distribution may be wholly or partly tax-free or may be taxed more favorably than as ordinary income: A. Roth plans. Qualified distributions from a Roth retirement plan are tax-free. ¶ 5.2.03 , ¶ 5.7.04 . B. Tax-free rollovers and transfers . Distributions can be “rolled over” tax-free to another retirement plan, if various requirements are met. See ¶ 2.6 for rollovers by the participant, ¶ 3.2 for rollovers by the surviving spouse, and ¶ 4.2.04 for rollovers by other beneficiaries. See ¶ 2.6.08 for why certain IRA-to-IRA transfers are not taxable because they are not considered to be distributions at all. C. Life insurance proceeds, contracts. Distributions of life insurance proceeds from a QRP (after the participant’s death) are partly tax-free; distribution of a life insurance policy on an employee’s life to that employee may be partly tax-free as a return of basis. See ¶ 11.2.06 . D. Recovery of basis. If the participant has made or is deemed to have made nondeductible contributions to his plan account or IRA, these become his “basis” in the retirement benefits. This basis is nontaxable when distributed to the participant or beneficiary. See ¶ 2.2 . E. Special averaging for lump sum distributions . Certain QRP lump sum distributions of the benefits of individuals born before January 2, 1936, are eligible for reduced tax. ¶ 2.4.06 . F. Net unrealized appreciation of employer securities (NUA) . Certain distributions of employer stock from a QRP are eligible for deferred taxation at long-term capital gain rates rather than immediate taxation at ordinary income rates. See ¶ 2.5 . G. No tax on distribution of annuity contract. The distribution of an annuity contract (to either the participant or the beneficiary) is nontaxable, provided the annuity contract complies with the minimum distribution rules and is nonassignable by the recipient. Reg. § 1.402(a)-1(a)(2) ; see PLR 2006-35013. This includes a variable annuity contract; PLR 2005-48027. Instead, the recipient pays income tax on distributions received under the contract. H. Return of IRA contribution. See ¶ 2.1.08 (D), (F), regarding special income tax treatment for IRA contributions that are returned to the contributor. I. Income tax deduction for certain beneficiaries . A beneficiary taking a distribution from an inherited retirement plan is entitled to an income tax deduction for federal estate taxes paid on the benefits, if any. ¶ 4.6.04 – ¶ 4.6.08 . J. Distribution to charitable entity. If the beneficiary is income tax-exempt, it will not have to pay income tax on the distribution. See ¶ 7.5.01 – ¶ 7.5.04 , ¶ 7.5.08 .