Tax Planning for Retirees

Tax-Favored Employer Retirement Plans: Part 2

Disregard of an Early Retirement that Lacks Substance. – Though a participant may be entitled to a pension benefit upon early retirement, the IRS has ruled that it will disregard an arrangement allowing a participant to “retire” and immediately thereafter resume employment. (Ltr. Rul. 201147038.) See Chapter 2 of the treatise.

Registered Domestic Partners in Certain Community Property States. – In a few community property states, community rules are also available for registered domestic partners. For those taxpayers, federal tax law generally treats their community income as earned one-half by each partner.

Unfortunately, though, it is not clear whether distributions from the qualified retirement plans of such taxpayers should be treated as community income or separate income for federal tax purposes. That is, the rationale for federal preemption of community property rules otherwise applicable to plan distributions to married individuals does not appear to apply to registered domestic partners. (Ltr. Rul. 201021048; CCA 201021050; Boggs v. Boggs, 520 U.S. 833, 117 S. Ct. 1754, 138 L. Ed. 2d 45 (1997); IRS Publication 555.) See Chapter 2 of the treatise.

Effect of Certain Life Annuity Elections on Spousal Annuity Requirements. – A qualified retirement plan may be required to provide a participant’s surviving spouse with an annuity payable over the spouse’s lifetime. However, the spousal annuity requirement generally does not apply to a participant in a profit-sharing or stock bonus plan if (1) any nonforfeitable benefit accrued at death is payable to the surviving spouse and (2) the participant has not elected a life annuity. The IRS has now ruled that a revocable election to invest in a contract providing a life annuity at retirement does not nullify this spousal annuity exception if ultimate annuity payments are based on the account balance and actuarial assumptions at the annuity starting date.

However, given the emphasis in the ruling on the revocability of such an election, it seems likely the IRS would deny the spousal annuity exception for this type of contract if the election were irrevocable. (Rev. Rul. 2012-3, 2012-1 C.B. 383.) See Chapter 2 of the treatise for a discussion of required spousal annuities.

Employer Securities Traded Only on the OTCBB Are Not Subject to Diversification Elections. – A retiree in a defined contribution plan generally may elect to diversify out of employer securities and into other investment alternatives in the plan. However, the tax law does not require the diversification election for plans that do not hold publicly traded employer securities if neither theemployer nor its parent corporations have issued any publicly traded stock.

For this purpose, the IRS has now ruled that securities are not publicly traded merely because they are traded on the Over-the-Counter Bulletin Board (the OTCBB). (Ltr. Rul. 201238031.) See Chapter 2 of the treatise for a discussion of employer securities in qualified plans.

Refinancing to Cure a Default on a Five-Year Qualified Plan Loan. – In CCA 201736022, the IRS demonstrated how a retiree could cure a default on a five-year qualified plan loan by refinancing and folding the defaulted payments into the replacement loan. In such a case, though, the retiree must comply with difficult statutory dollar limitations applicable to the refinancing of loans, unless the term of the replacement loan ends no later than the five-year term that was available for the old loan. The retiree must also refinance before expiration of the period during which the retiree could cure the default by making late payments. See Chapter 2.

Extended Rollover Period for Some Loan-Offset Distributions Made by Tax-Favored Plans. –Normally, a retiree has only 60 days after a qualified plan makes a loan-offset distribution (i.e., an offset of a plan loan against plan funds) to roll over the distribution to another plan or IRA. Congress has now provided that a retiree may roll over some such distributions any time before the due date (including extensions) of the tax return for the year of the distribution. This extended rollover period is available only for loan-offset distributions after the year 2017, and only if the distribution is due to termination of the distributing plan or failure to satisfy repayment terms because of severance of the participant’s employment. (IRC § 402(c)(3)(C); Tax Cuts and Jobs Act, Pub. L. No. 115-97, § 13613.) See Chapter 2 and Chapter 4 of the treatise.

More Liberal Hardship Distributions from 401(k) Plans. –Before 2019, 401(k) plans could make hardship distributions only from elective deferrals. After 2018, a 401(k) plan may also make hardship distributions from qualified nonelective contributions, qualified matching contributions, and plan earnings. Also after 2018, a retiree need not exhaust plan loans before taking a hardship distribution. Note though that hardship distributions may be subject to the 10 percent additional tax on early withdrawals, unless an exception to the additional tax applies to the distribution. (IRC § 401(k)(14).) See Chapter 2 of the treatise.

“Lifetime Income Investments” Can Be Distributed or Transferred. – Occasionally, a so-called “lifetime income investment” ceases to be an authorized option under a 403(b) plan, an eligible state/local plan, or a qualified plan that is a defined contribution plan. After 2019, if the plan so provides, the trustee of such a plan may transfer a lifetime income investment to the trustee of another qualified plan or IRA, if certain conditions are met. Alternatively, a plan may simply distribute a lifetime income investment to a participant in the form of an annuity contract. For this purpose, lifetime income investments include optional annuities payable over the life of the participant, or the joint lives of the participant and his or her designated beneficiary. They also include optional investments that guarantee a minimum level of income for the life of the participant, or for the joint lives of the participant and his or her designated beneficiary. (The SECURE Act of 2019, Pub. L. No. 116-94, § 109.) See Chapters 2 and 4 of the treatise.

In-Service Distributions from Eligible State/Local Government Plans at Age 59½. – In-service distributions from an eligible state/local government plan may now begin at age 59½. In years before 2020, such distributions could not begin until age 70 ½. (IRC § 457(d)(1)(A)(i).) See Chapter 4 of the treatise.

A Taxpayer May Not Use Credit Cards to Take Out Qualified Plan Loans. – In years before 2020, a qualified plan or eligible state/local plan could make qualified plan loans through a credit card arrangement. After 2019, the tax law does not allow a credit card arrangement. (The SECURE Act of 2019, Pub. L. No. 116-94, § 108.) See Chapter 2 and 4 of the treatise.