May an IRA beneficiary transfer the IRA to a different custodian
following the death of the IRA owner?
January 19, 2000
Question: My mother inherited my father's IRA. My brother
and I each were named 50% beneficiaries. My mother died in 1995
and we kept the IRA intact, taking distributions yearly based on
my life expectancy. We would like to transfer the IRA to a different
brokerage house and divide it, one half to me; one half to brother
and continue to take the yearly distributions as before. This way
we could each manage our own account. Can this be done?
Answer: Yes. The IRS routinely allows beneficiaries to split
and transfer a deceased owner's IRA to a different custodian. See,
for example, Private Letter Rulings 9106044, 9106045 and 9623037.
Two words of caution, though. · The transfers of assets should go
directly from the existing IRA custodian to the new custodian, without
a check being written or assets distributed to you or your brother.
· The new IRAs should be opened in the name of "Mary Smith [Mother],
deceased, for the benefit of Jane Smith [Child #1]" and "Mary Smith
[Mother], deceased, for the benefit of John Smith [Child #2]."
What are the non-spousal beneficiary's options
at the death of the IRA owner?
December 1999
Question: If the plan participant dies and leaves a nonspouse
as the beneficiary of his retirement plans (He had money in an
SEP,
IRA and 401K plan). Can this money be rolled over into an IRA without
being taxed? If not, will the nonspouse have to pay any tax penalties?
Would the nonspouse qualify for the 5-year income averaging?
Answer: You've asked three separate questions. Here are the
answers:
Since the beneficiary was not the plan participant's surviving
spouse (this includes nonspouses), you may not roll over any of
these plan funds into an IRA. IRC sections 402(c)(9) and 408(d)(3)(C)
only allow surviving spouse beneficiaries to do tax-free rollovers.
The beneficiary will have to pay income tax as and when they
take plan distributions, at whatever their income tax bracket
is at the time of distribution, but they will not have to pay
any penalty taxes even if the plan participant was under age 59-1/2.
IRC section 72(t)(2)(A)(ii) excuses post-death distributions from
the penalty tax regardless of the beneficiary's or participant's
age.
Distributions from the SEP and the IRA are not eligible for
5-year averaging. A lump sum distribution from the 401(k) plan
might be eligible for income averaging if the plan participant
was born before 1936 and a number of other requirements (described
on IRS Form 4972) are met.
Unless the plan documents require a lump sum distribution, the best
option may be to spread taxable distributions over the beneficiaries'
life expectancy (or a shorter period), rather than taking them all
in one year. It is likely that the SEP and IRA will allow this and
that the 401(k) plan will not. But it is probably necessary for the
beneficiary to begin distributions by the end of the year that follows
the year in which the plan participant died, if the beneficiary wishes
to take advantage of this ability.
Under what circumstances does a trust as IRA beneficiary
trigger a taxable event?
December 1999
Two answers to that. The trust doesn't in itself trigger a taxable
event. But unless specifically qualified, it can force an accelerated
distribution because it is not a "designated beneficiary."
However, specially designed trusts can be "looked through"
and treated as an individual beneficiary, permitting stretch-out of
distributions.
What are the most common planning mistakes in the
IRA distribution arena?
December 1999
Not being in possession of a current beneficiary designation
Not correcting a beneficiary designation for death or divorce
Naming the estate rather than individuals as the beneficiaries
Failure by beneficiary to elect a life payout in a timely fashion
when the owners dies before the required beginning date
Failing to start minimum distributions by 12/31 of the year
following owner's death where the death occurs after the required
beginning date
Acceptance by the beneficiary of a check from the bank or other
distribution for the entire account, destroying the deferral opportunity.
What is the taxation of lump sum distributions?
November 24, 1999
Question: With the repeal of lump sum distribution averaging,
are all lump sum distributions of cash from profit sharing plans
now
taxed at ordinary income rates, unless rolled over?
Answer: Due to a grandfather rule, participants born before
1936 might still be eligible for 10-year averaging or 20% tax on pre-'74
account balances. See Section 1401(a) of SBJPA '96.
If the participant made after-tax contributions to the plan, or otherwise
had a tax basis in the plan, that portion of his distribution would
not be taxable. IRC 72(f). If the participant rolls over all or any
portion of the taxable amount of his distribution, the portion rolled
over would not be taxable yet. IRC 402(c).
If the participant had received appreciated employer securities instead
of cash, the taxation of the net unrealized appreciation in those
securities could be delayed until their sale and then taxed as capital
gain. IRC 402(e)(4). Otherwise, distributions from the qualified plan
are treated as ordinary income.
Who pays off a participant loan after the death
of the plan participant?
November 24, 1999
Question: What happens to the loan balance in a 401(k) plan
when the participant dies and the account is to be split between
two non-spouse beneficiaries?
Answer: If the participant's estate repays the loan, then the
full account is split between the two beneficiaries (presumably 50-50,
although your question does not say). If the estate does not repay
the loan, then what happens next depends on whether the account balance
was used as security for the loan. If it was, as is the case with
most qualified plans, then the trustee must offset the account balance
by the principal and accrued interest after the estate has passed
its grace period. At that point, only the net account (net of the
unpaid loan balance) is available to split between the two beneficiaries.
May a qualified plan participant make annual elections
to defer distributions after age 70-1/2?
November 24, 1999
Question: In 1997 an employee who participates in a 401(k)
plan is required to receive a minimum distribution. In 1998, he is
provided an election form to receive or defer the next payment of
the required minimum distribution. Can he now, in 1999, elect to
defer
the next minimum distribution? He is still employed by the employer
and is not a 5% owner.
Answer: The answer depends on the terms of the plan. Nothing
in IRC section 401(a)(9) (the minimum distribution rule) precludes
the participant from annually electing to take or defer otherwise
required distributions as long as he has not yet retired (and is not
a 5% owner). However, the plan document may be written, for purposes
of administrative convenience, to make the distribution/deferral election
a permanent one. Note that if, due to a prior election, he is receiving
a distribution he does not want, he can roll it over to an IRA if
he has not yet retired.
An alert reader has added the following question: A follow up to question
194. If a plan still requires a non-5% active employee to receive
a distribution as if it were a required minimum distribution, would
the employee be able to roll over the distribution since the amount
of the distribution would be calculated based on periodic distributions
over the employee's life time?
If the distribution is determined to be part of "a series of
substantially equal periodic payments" as defined in Reg. 1.402(c)-2,
Q&A 5, then it would nonetheless not be eligible for rollover even
though made before the participant's required beginning date.
What are the required minimum distributions from
a 403(b) annuity following the death of the annuity owner?
November 16, 1999
Question: Scenario: 403(b) annuity owner, age 75, is taking
required minimum distributions based on the joint life expectancy
recalculation with his spouse as the beneficiary (age 70). The participant
dies. The custodian gives the spouse beneficiary two options: (1)Lump
sum distribution and rollover to an IRA, or (2) annuitize the contract.
The surviving spouse elects to annuitize the contract for a period
certain that does not exceed her life expectancy (16 years), and
names
her 2 adult children as beneficiaries. The surviving spouse dies
5 years later. The TSA custodian gives the beneficiaries the option
to continue annuity payments for the remaining 11 years. Has the TSA custodian violated the "irrevocable" RMD
election by extending the TSA payments beyond both the participant
and his
spouse's life expectancies -- in effect changing the method of RMD
calculation from recalculation to non-recalculation?
Answer: I understand from your question that the participant
had elected, as of his required beginning date, to recalculate the
life expectancies of both himself and his spouse. That means the entire
balance of the annuity would have to be distributed by the end of
the year following the year of the surviving spouse's death pursuant
to Prop. Treas. Reg. 1.401(a)(9)-1, Q&A E-8(a). It appears that the
403(b) annuity is in violation of the minimum distribution rules by
continuing distributions for another 10 years.
If, on the other hand, the participant had elected to recalculate
his own life expectancy but not the life expectancy of his spouse-beneficiary
(i.e., by reduce her life expectancy for calculation purposes by exactly
1.0 each following year), then the proposed distribution method might
satisfy the minimum distribution rules.
What rollover or minimum distribution options are
available to a participant after his designated beneficiary's death?
November 11, 1999
Question: Husband, age 85, has been receiving 401(k) distributions
since age 70-1/2, based upon the joint life expectancy of himself
and his wife (one year younger). Recalculation of their life expectancies
was not elected. The wife died in March 1999, before the plan's required
minimum distribution for 1999 had been paid. Husband wants to roll
over his 401(k) account into three IRAs, and name a different child
as the beneficiary of each. What are his options regarding the 1999
minimum distributions? Must he use life expectancies (minus 1 each
year) based on the 401(k) account's balance at 12/31/98? Can he wait
until the account is rolled over into the IRAs before taking the
1999
required minimum distribution? What life expectancies may he use
in 2000?
Answer: I assume H no longer works for the 401(k) plan sponsor.
H's required 401(k) distribution for 1999, the year of his beneficiary's
death, continues to be based on their joint life expectancy for 1999.
Her death does not affect the minimum distribution calculation until
2000. See Prop. Treas. Reg. 1.401(a)(9)-1, Q&A E-5(e)(2).
Because H hasn't taken his 1999 minimum distribution, he must determine
that amount and then refrain from rolling over that amount. A required
distribution amount cannot be rolled over. IRC section 402(c)(4)(B).
Once he has completed the rollovers of the balance of the 401(k) account
in 1999, his required distributions from the IRAs begin in 2000. Prop.
Treas. Reg. 1.401(a)(9)-1, Q&A G-2(a).
His required distributions from the IRAs must be based on his single
life expectancy, no matter whom he names as beneficiary of the IRAs.
This is because he must use the shorter of the distribution periods
determined under the distributing plan (the 401(k) plan) or the receiving
plan (the IRAs). Prop. Treas. Reg. 1.401(a)(9)-1, Q&A G-2(b). (But
he can avoid this result by converting the IRAs to Roth IRAs, if that
is otherwise permissible and desirable. Treas. Reg. 1.408A-6, Q&A
14.
What are the minimum distribution requirements where
a surviving spouse treats her deceased husband's IRA as her own?
November 10, 1999
Question: Husband and wife are over age 70-1/2 and have
been receiving required minimum distributions for several years.
Both have IRA accounts. In April, 1999, husband died without having
received
his 1999 required minimum distribution. Spouse was husband's designated
beneficiary and elected to claim husband's IRA as her own and rolled
over the balance in husband's IRA to a new IRA established to receive
the rollover. She named her children beneficiaries of the rollover
IRA. Spouse now has two IRAs. She will take the required minimum
distribution
from her original IRA in 1999. The first question is: Is the spouse
required to take a distribution from the rollover IRA in 1999, the
year the rollover IRA was established, or in 2000, the year after
the rollover was established. The second question is: Should a required
minimum distribution have been distributed from the husband's IRA
before the account balance was rolled over into the IRA established
by the spouse?
Answer: No distribution was required as a result of the surviving
spouse electing to treat her late husband's IRA as her own even though
it was a "distribution calendar year" for the husband and
he had not taken a distribution. This was the position taken by the
IRS in PLR 9807029.
The IRS has taken the position that where an IRA is first created
by a surviving spouse after she has reached her usual required beginning
date, her required beginning date for this new IRA is December 31
of the year following the year her new IRA is created. (PLR 9848042)
So in this case, where the new IRA was created in 1999, the surviving
spouse's required beginning date is not until December 31, 2000, and
no distribution is required in 1999.
The surviving spouse then took another step in 1999. She rolled over
her late husband's IRA (now being treated as her own) to another IRA
in her name. Since 1999 was not a "distribution calendar year"
for this IRA, rollover of the entire IRA was permissible. It should
be noted that an effectively different result would occur if her husband's
account was in an employer plan rather than an IRA.
Incidentally, the spouse may have a good planning opportunity beginning
in 2000. Expressed as a percentage, her required distributions from
her original IRA will be greater than her required distributions from
her new IRA, since her original IRA presumably had her husband as
designated beneficiary, but her new IRA has her (younger) children
as designated beneficiaries. She is permitted under IRS Notice 88-38
to aggregate the required distributions from both IRAs and take the
total amount from just one of them. She might want to do this, taking
both her required distributions from the original IRA, thus preserving
the new IRA which carries with it significantly better tax deferral
opportunities, particularly after her death.
How can I avoid penalty tax on retirement plan distributions
before age 59-1/2?
November 5, 1999
Question: I have been employed with the same company for
28 years. I am 46 years old. I would like information on an IRS rule
called 72(t). I would like to retire early, age 50 or 55. I have
a
profit sharing plan that I fully vested in and a retirement plan
under a defined contribution.
Answer: Section 72(t) of the Internal Revenue Code imposes
a 10% penalty tax on distributions from a qualified plan or IRA before
age 59-1/2. There is a popular subsection of 72(t), called Section
72(t)(2)(A)(4), that allows you to take IRA distributions at any age
without the 10% penalty as long as they are taken in "substantially
equal periodic distributions." But you must stick with your distribution
scheme at least until age 59-1/2 (or 5 years if longer), or face a
high recapture tax under 72(t)(4). You can also use this distribution
method to avoid the 10% penalty tax on distributions from an employer's
qualified plan, as long as distributions begin after you have terminated
employment, but that usually doesn't work as well as an IRA, which
you control. So the way to take advantage of this provision is to
take lump sum distributions from your employer's plans (if they are
offered), directly roll them over to one or more IRAs, and begin taking
"substantially equal periodic distributions" from one or
more of your IRAs.
To actually work out how to apply this technique to your own plan
accounts, I suggest you consult a qualified accountant or financial
planner. Moreover, I strongly suggest you consult an accountant or
financial planner to determine whether you can afford to retire early.
An interested reader has asked for elaboration on this answer as follows:
In response to question 175, you indicated that 72(t) distributions
from qualified plans don't usually work as well as those from IRA's.
Could you please elaborate on why they don't work as well? I have
about 2/3 of my retirement assets in qualified plan and 1/3 in an
IRA. At age 56 I hope to begin substantially equal periodic distributions
from both sources using the annuity method. I have another IRA that
has a small $50K asset base that I will retain as an emergency back
up.
There are two reasons that the substantially equal periodic payment
method usually works better in IRAs than in qualified plans. First,
not all qualified plans are so flexibly written as to offer distribution
methods that qualify for this exception to the 10% penalty tax. Second,
an IRA offers an advantage not available with a qualified plan: Before
you begin the substantially equal periodic payments, you can transfer
a portion of your IRA balance to another IRA and only take the periodic
payments from the first IRA. This leaves a portion of your retirement
benefits in reserve for future treatment under IRC 72(t)(2)(A)(iv),
giving you the opportunity to increase your distributions again (from
the second IRA) before you reach age 59-1/2 (and 5 years has passed)
without incurring the 10% penalty. Please note in your case, since
you are age 56, if you terminated employment with the employer sponsoring
your qualified plan after reaching age 55, you qualify for a different
exception to the 10% penalty tax, and you don't have to meet the restrictive
requirements for substantially equal periodic payments for distributions
coming out of the qualified plan.
Must IRAs be aggregated to calculate substantially
equal periodic payments?
November 4, 1999
Question: I have multiple IRAs. When taking substantially
equal periodic payments from an IRA prior to age 59-1/2, do I need
to aggregate all my IRAs for the purpose of calculating the required
distribution amount, or can I segregate one IRA for purposes of determining
the required distribution amount?
Answer: The IRS has been liberal in allowing IRA owners to
determine the proper amount of substantially equal periodic payments
from an IRA, for purposes of meeting the exception to the 10% penalty
tax on distributions before age 59-1/2 contained in IRC 72(t)(2)(A)(iv)
-- the amount can be determined separately for one IRA without regard
to another IRA owned by the same owner. See, for example, PLRs 9824047
and 9747039. By separating an IRA into two separate IRAs, you can
reduce the required distribution amount.
Non-spouse beneficiary of IRA - what are my distribution
options after death of IRA owner before 70-1/2?
October 10, 1999
Question: What distribution options does a non-spouse beneficiary
have when inheriting an IRA following the death of a parent before
the parent was taking his minimum age 70-1/2 distributions?
Answer: If the IRA owner died before his required beginning
date (i.e., before April 1 following the year he would have reached
age 70-1/2), the non-spouse beneficiary should keep the IRA in the
name of the deceased parent (but continuing for the benefit of ("f/b/o"
the child), and either (1) take distribution of all funds by the end
of the fifth year following the year of the parent's death, or (2)
begin taking distributions the year after the year of the parent's
death, and take an amount each year based on the child's remaining
life expectancy. The second approach is usually better because it
preserves the tax-free build-up in the IRA for a longer period.
Should the value of an immediate annuity be included
in the minimum distribution calculation?
October 8, 1999
Question: Should the value of an immediate annuity be included
in the minimum distribution calculation? Additionally, does the income
received count towards reducing the required minimum distribution?
Answer: The distribution of an annuity contract from a plan
is not treated as a distribution for purposes of the minimum required
distribution rules. See Prop. Treas. Reg. 1.401(a)(9)-1, Q&A H-6.
Rather, distributions from the annuity contract itself count toward
the plan's distribution requirements (Q&A F-4).
Rollover of QDRO
August 5, 1999
Question:
I understand
that a spousal beneficiary can only roll over an account balance
over into an IRA and not their own qualified
plan. If a spouse who is an "alternate payee" receives
a distribution pursuant to a qualified domestic relations order,
can
he or she roll over that payment into his or her employer's qualified
plan?
Answer: A QDRO distribution from a qualified plan to the spouse
or former spouse of the participant can be rolled over to an IRA
or
into another qualified plan that will accept the rollover. Similarly,
a QDRO distribution from a 403(b) plan to a spouse or former spouse
can be rolled over to an IRA or to a 403(b) plan in which the spouse
participates.
Charitable remainder trust as plan beneficiary
June 1, 1999
Question: I know that a charity can be named as the beneficiary
of an IRA or Qualified Plan. When the participant dies, the charity
receives the proceeds in a lump sum. Assuming a qualified charity
is named, no income tax is due, thus eliminating the Income in Respect
of a Decedent (IRD) problem in a decedent's estate. I read in the
November issue of Trusts & Estates (pp. 80-81) that a trust can be
named a designated beneficiary (DB) of an IRA if certain conditions
are met. One of those conditions is that all beneficiaries of the
trust must be individuals (no estates, corporations or charities).
Yet, at a recent seminar on charitable gift giving, the speaker stated
that he believed a Charitable Remainder Annuity Trust or Unitrust
could be named.
Since the remainder beneficiary is not an individual, I am now confused.
Can a Charitable Remainder Unitrust or Annuity Trust be named as
a
beneficiary of an IRA or qualified plan? If so, is the IRD "bled
out" to the individual beneficiaries each year in the form of
ordinary income as part of the percentage payout until the total
IRA/IRD
is satisfied? Or, does only the first year percentage payout to the
individual beneficiaries pass out part of the IRD and the remainder
of the IRD becomes immediately taxable to the trust and tax paid
(even
though the charities are exempt) because not all the beneficiaries
are individuals?
Answer: It would help to answer your question in small pieces:
1. Nothing in the federal law would prevent a participant from naming
a Charitable Remainder Trust as IRA beneficiary. Under most qualified
plans, however, the spouse must consent to the naming of the Charitable
Remainder Trust as beneficiary; if the spouse does not consent, then
the spouse must usually be the beneficiary.
2. If a Charitable Remainder Trust is named as beneficiary, then
required minimum distributions during the participant's life must
be made over
the participant's single life expectancy. If the participant dies
before his required beginning date, then distribution to the Charitable
Remainder Trust must be made in full within 5 years after the end
of the year of death. If the participant dies after his required
beginning
date, then distribution must be made to the Charitable Remainder
Trust over the balance of the participant's life expectancy (which
would
be zero if the participant was recalculating his life expectancy
each year).
3. Since the Charitable Remainder Trust necessarily includes a non-individual
beneficiary (the charity) the non-charitable beneficiaries' life
expectancies
cannot be used to determine required minimum distributions. This
is what is meant when the IRS says that the Charitable Remainder
Trust
may not be a "designated beneficiary" (which is a very
confusing term for the IRS to have chosen).
4. If a Charitable Remainder Trust receives the entire IRA distribution
in one year, the Trust pays no tax on that distribution; however
the
otherwise taxable income attributable to that distribution continues
to be taxed to the non-charitable beneficiaries as Trust distributions
are made even though those distributions are paid out of the Trust
in later years.
Springing cash value insurance
May 21, 1999
Question: I need to find out about valuing springing cash
value life insurance. What's in IRS Notice 89-25?
Answer: Notice 89-25 includes guidance in question and answer
format on a number of subjects. Here is an excerpt from Notice 89-25
dealing with springing cash value life insurance:
Q-10: What amount is included in a plan participant's gross income
when the participant receives a distribution from a qualified plan
that includes a policy issued by an insurance company with a value
substantially higher than the cash surrender value stated in the
policy?
A-10: Subject to certain exceptions not here applicable, section
402(a) of the Code provides that the amount actually distributed
by a qualified
employees' trust shall be taxable to a plan participant in the year
in which so distributed under section 72 (relating to annuities).
Section 1.402(a)-1(a)(1)(iii) of the regulations provides that the
amount includible in a plan participant's gross income by reason
of
the distribution of property by the plan shall be the fair market
value of such property. Life insurance contracts constitute property
within the meaning of this section. Section 1.402(a)-1(a)(2) of the
regulations provides that a distributee must include in gross income
the cash value of any retirement income, endowment, or other life
insurance contract at the time of the distribution. Section 1.72-16(c)(2)(ii)
of the regulations indicates that the reserve accumulation in a life
insurance contract constitutes the source of and approximates the
amount of such cash value.
Individuals who receive an insurance policy as a distribution from
a qualified plan use the stated cash surrender value of the policy
as its fair market value for purposes of determining the amount includible
in their gross income under section 402(a) of the Code. However,
this
practice is not appropriate where the total policy reserves, including
life insurance reserves (if any) computed under section 807(d), together
with any reserves for advance premiums, dividend accumulations, etc.,
represent a much more accurate approximation of the fair market value
of the policy than does the policy's stated cash surrender value.
These circumstances are illustrated by the following example.
A is a participant in a qualified noncontributory defined benefit
plan. On January 1, 1986, $400,000 of plan assets were used to purchase
an insurance policy. The policy was distributed to A on January 1,
1988, two years after the date of purchase.
The policy provides a stated cash surrender value for each of the
first five policy years, as set forth in the table below. The total
end of year reserves held by the insurance company for the policy
also are set forth in the table. These reserves may include life
insurance
reserves and any reserves for advance premiums, dividend accumulations,
etc. Life insurance reserves, if any, are calculated using the rules
in section 807(d) of the Code, which provides rules for determining
the amount of those reserves for purposes of calculating the tax
liability
of the insurance company issuing the policy.
As the total reserves
for the policy at the end of year two, $426,597, substantially exceed
the policy's cash surrender value, $112,360, the reserves represent
a much more accurate approximation of the fair market value of the
policy when distributed than does the policy's cash surrender value.
Accordingly, the amount includible in A's gross income by reason
of the distribution of the policy at the end of year two is an amount
equal to the $426,597 reserve, not the $112,360 stated cash surrender
value at that date.
In the case of a distribution in excess of A's accrued benefit,
as defined in section 1.411(a)-7(a)(1) of the regulations, resulting
from valuing the policy at $112,360 rather than $426,547, the distribution
would not be treated as a distribution to A from a qualified plan
and, depending upon the facts and circumstances of the case, could
be treated as a reversion to the employer. Of course, depending
on the facts and circumstances, such distributions could disqualify
the plan because they raise a number of qualification issues under,
for example, section 415 of the Code, limitations on benefits and
contributions, section 401(a) requirements that benefits be definitely
determinable, and section 401(a)(4), discrimination in contributions
and benefits, particularly if A was a member of the group of employees
in whose favor discrimination is prohibited and other employees
were not provided with similar distributions.
Section 457 plan distribution
April 26, 1999
Question: I have a client who participates in a Section
457 plan and is changing jobs. The plan's accumulated value (about
$50,000) will belong to him when he terminates his current employment.
What options does my client have for distribution of the assets?
Answer: Your client's distribution options will be determined
by the terms of the plan. The Internal Revenue Code allows
the plan
to offer a lump sum (or other form of) distribution, but the
employer is not required to offer a distribution at termination
of employment.
The plan might require him to wait, e.g., until age 65.
If the plan offers a lump sum, he may not wish to take it at
this time. Unfortunately there is no provision for a tax-free
rollover
from a 457 plan to any other type of plan, including another
457 plan or an IRA. The IRS has, however, allowed plan-to-plan
transfers
if the new employer is eligible to sponsor a 457 plan, it does
in fact sponsor one, and both the old and the new plans allow
for the
transfer.
Life insurance in Rabbi trust
April 9, 1999
Question: An insurance salesman has suggested "swapping" the
vested nonqualified deferred compensation currently inside a
rabbi trust for a split dollar arrangement. He explained that the
tax paid on distribution would only be on the economic benefit
received which is much lower than what would be paid on the distribution
of the entire benefit. I understand that there is no ruling from
the IRS on this matter, however, is there any basis for the opinion
that the only amount which would be taxable is the lower economic
benefit cost?
Answer: If all the employee receives and has a right to receive
from a rabbi trust is a life insurance policy, then the employee
will be taxable on the value of the policy. However, valuing
the
policy is not always simple, especially if it is of a type that
has come to be called "springing cash value policies."
Your question raises some unanswered questions. What happened
to the employee's vested benefit? If he had earned a right to
$20,000,
shouldn't he insist that the policy he accepts from the trust
be worth $20,000?
And why should the employee's benefit be distributable in the
form of a policy? Most rabbi trusts provide benefits distributable
in
cash; but the trustee decides what investments to buy to fund
that cash obligation. Rabbi trustees sometimes buy life insurance
policies
due to their ability to grow their inside build-up in value tax-free.
But then when the employee is entitled to a distribution, rather
than distribute the policy in kind, the trustee typically borrows
against the cash value to provide the cash flow needed to fund
the
employee's benefit.
Allowable rollovers from tax sheltered annuities
March 25, 1999
Question: Do you think the Second Circuit was wrong in
Frank v. Aaronson in holding that the liberalized rollover rules
now contained in IRC Section 403(b)(8) do not permit direct rollovers
where distributions are prohibited by IRC Section 403(b)(7) or
403(b)(10)?
Answer: No, I would have reached the same conclusion that
the Second Circuit reached in that case.
Both before and after its amendment by UCA in 1992, IRC Section
403(b)(8) governed (and still governs) whether a tax-free rollover
may be effected with respect to a given distribution. That section
says nothing about whether a distribution is allowable under
the
plan or under the law. It only says what can be done with the
distribution once it is made from the plan.
IRC Section 403(b)(10) and 403(b)(7)(A)(ii), on the other hand,
govern when distributions may be made in the first instance.
A similar
situation applies in the more familiar area of qualified pension
plans. Pension plans are subject to the same liberal rollover
rules;
but they, too, remain subject to regulations that preclude them
from allowing distributions except under certain limited circumstances.
