11.7 Distributions

• Library: A Lawyer's Guide to Estate Planning: Fundamentals for the Legal Practitioner (ABA) (2018 Ed.)

11.7 Distributions

11.71 Distributions during Lifetime

The tax consequences of a distribution from a qualified retirement plan, 401(k), IRA, SEP, or any of the other tax-deferred retirement plans is relatively simple. The distributions are taxed when received.⁴⁹ Thus, a participant who is receiving periodic installments pays income tax on those installments in the year received. In the situation in which the participant's installments include both employer and employee contributions, the employee's contribution is returned tax free, as it was made with after-tax contributions, and the remainder of the installments are subject to income tax. Because most retirement plans do not permit after-tax employee contributions, this complication is seldom a factor.

In some situations, an individual elects a lump-sum distribution. This alternative was more appealing under earlier tax law provisions, which at one time permitted a favorable 10-year income averaging. Generally, those rules no longer apply.⁵⁰

Planning Pointer 6

A lump-sum distribution from a qualified plan can be rolled into an IRA within 60 days of the distribution.⁵¹ When this is done, the income tax continues to be deferred and the premature distribution penalty is avoided.

Caution: The distribution must be a trustee-to-trustee transfer to avoid the imposition of a 20% income tax withholding.⁵²

The determination of whether to receive a lump sum or installment payment of benefits is not the difficult choice it used to be. The current minimum distribution rules permit a longer payout term, thus increasing the possibility that the tax-deferred earnings on the retirement account will continue to increase the size of the account that is available to be distributed at the individual's death...