Life and Death Planning for Retirement Benefits

Chapter 2: Income Tax Issues

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K. Qualified Health Savings Account Funding Distributions (QHSAFD). An IRA owner is permitted, once per lifetime, to transfer funds tax-free directly from an IRA to a Health Savings Account (HSA). § 223 , § 408(d)(9) . The individual can make such a transfer from his own IRA, or from an inherited IRA he holds as beneficiary. Notice 2008-51, 2008-25 IRB 1163. See ¶ 2.2.10 (C) for the effect of a QHSAFD on basis. While HSAs are a tax- favored form of savings account (contributions are deductible from adjusted gross income; distributions are tax-free if used to pay medical expenses), the ability to transfer funds directly to the HSA from an IRA will be of use to few individuals. Most individuals will benefit more by contributing to the HSA from their taxable account, thereby getting an above-the-line income tax deduction (the HSA contribution reduces adjusted gross income; it is not an itemized deduction). The QHSAFD does not increase the amount that can be contributed to the HSA. L. QDROs and divorce-related IRA divisions. An individual can transfer all or part of his qualified retirement plan benefits to his spouse without being liable for income taxes on the transfer if the transfer is pursuant to a “qualified domestic relations order” (QDRO). § 402(e)(1) , § 414(p) . § 408(d)(6) allows similar tax-free division of an IRA between divorcing spouses. In both cases, the statutory requirements applicable to the state court order must be strictly followed. It is not clear whether the QDRO/408(d)(6) procedures for tax-free division of retirement benefits between spouses can be used for inherited benefits. This book does not cover divorce-related divisions of retirement plans; see, instead, Chapter 36 of The Pension Answer Book ( Appendix C ). 2.1.07 Income tax, RMD, and estate planning aspects of plan loans A participant cannot borrow money from his IRA; such a loan would be a “prohibited transaction” ( ¶ 8.1.06 ), triggering a deemed distribution of the account. § 408(e)(2)(A) . Qualified retirement plans (QRPs) are permitted to make loans to employees from their plan accounts provided various requirements are met regarding the maximum amount of the loan and the repayment terms. § 72(p)(2) . For explanation of these requirements, see Chapter 14 of The Pension Answer Book ( Appendix C ). Benefits in certain plans may not be used as security for a plan loan to the employee unless the spouse consents. § 417(a)(4) ; see ¶ 3.4.02 . A plan loan that meets the requirements of § 72(p)(2) is not treated as an income-taxable distribution at the time it is made. However, a plan loan can generate a “deemed distribution” or an “offset distribution.” These two types of distributions have very different consequences; when the “distribution” results from a default under the loan it is not always clear which type it is (deemed or offset). A. Deemed distribution caused by “flunking” § 72(p) . If the loan does not meet the requirements of § 72(p) (either from the beginning, or because the employee later fails to meet the statutorily required repayment terms) the loan (or, if the problem is that the loan exceeded the permitted amount, the excess part of the loan) is treated as a deemed distribution to the employee. § 72(p)(1)(A) . If, after the loan was treated as a deemed distribution, the employee does in fact repay the loan, then such repayments to the plan are treated as after-tax contributions to the plan for purposes of computing the employee’s