Life and Death Planning for Retirement Benefits

404 / 507

404 Life and Death Planning for Retirement Benefits
by the Tax Reform Acts of 1984 and 1986, and the Unemployment Compensation Amendments
of 1992. To read about what the differences used to be, see Reg. § 1.401(e). For those that remain,
see “B” below; note that some of the differences are applicable to all “self-employed persons”
while others apply only to the “owner-employee.”
A. Definitions. A self-employed person is an individual who has self-employment income
In contrast, a “common law employee” (or, as the Code calls it, “an individual
who is an employee without regard to ) is an employee of someone else (not
himself).
An owner-employee is the sole proprietor of an unincorporated business, or a partner “who
owns more than 10 percent of either the capital interest or the profits interest” in the partnership.
The author has found no rule as to when the 10 percent test for determining owner-
employee status is applied; do we test only at the end of the plan year? Or must we determine
whether the individual owned more than 10 percent of the capital at any time during the year? And
is the test applied yearly? Or is the individual considered forever an owner-employee if he was
ever an owner-employee?
B. How they differ from other QRPs. Here are the differences that still remain between
Keogh plans and other QRPs that may matter from the self-employed individual’s personal
planning perspective.
Contributions subject to self-employment tax: The self-employed individual’s
contributions to his Keogh plan are not deductible for purposes of computing his self-employment
tax; this is in contrast to employer contributions to a corporate QRP (other than elective deferral
contributions; see , which are excluded from the definition of “wages” for FICA tax
purposes.
Lump sum distributions: A lump sum distribution (LSD) may qualify for special tax
treatment. The definition of LSD is slightly different for self-employed persons vs.
common law employees. See
Premature distributions: A distribution from a QRP made to an employee “after separation
from service after attainment of age 55” is exempt from the 10 percent “premature distributions”
penalty. Although does not exclude the self-employed from using this exception,
it is not clear what would constitute “separation from service” for a sole proprietor. Also see
regarding the penalty exception for IRA distributions to pay health insurance premiums
during unemployment.
Life insurance: If a QRP maintains a life insurance policy on the life of a plan participant,
the participant must include the cost of the current insurance protection in his income each year.
See H). Unlike other participants, an owner-employee does not get to treat the
accumulated cost that he has paid tax on as an “investment in the contract” for income tax purposes.
Reg.
Money purchase plan. See ¶ 8.3.10.
8.3.10 Pension plan
A pension plan is a type of QRP under which the employer is obligated to make annual
contributions, or, as the Code puts it, it is a plan “subject to the funding standards of section 412.”