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403(b)
Plans: Distributions
Generally, amounts received by an employee as a distribution
from a 403(b) account is taxable as ordinary income to the employee. If the
distribution occurs while the employee in under age 59 ½, the amount is
subjected to a ten-percent early-distribution penalty, unless the employee
qualifies for an exception.
While most plans allow 403(b) account owners to begin taking distributions when
he or she reaches normal retirement age, many 403(b) plans provide for earlier
payments under certain circumstances. For example, a 403(b) plan's rules may
allow employees to receive payment of benefits after terminating employment,
even if this is before the employee reaches retirement age.
Qualified
Joint and Survivor Annuity (QJSA)
In a Title 1 403(b) plan, the retirement benefit payment generally must occur in
series of equal, periodic payments over the lifetime of the employee, and the
payments must continue to the employee's spouse for the rest of his or her life
if he or she survives the employee. The periodic payment to the surviving spouse
must be at least 50 percent but not more than 100 percent of the periodic
payment received by the participant while he or she was alive. This form of
payment is called a qualified joint and survivor annuity (QJSA), and the plan
must provide an explanation of the QJSA in a timely manner.
If the plan provides other forms of benefit payment, the employee and his/her
spouse can elect to waive their rights to receive the QJSA and select one of the
other payment options available. The waiver must be made in writing within
certain time limits and be witnessed by a notary or plan representative.
Triggering Event
Generally, distributions cannot be made until one of the following occurs:
- The employee
reaches retirement age as defined under the plan.
- The employee
becomes disabled.
- The employee
dies, at which time the beneficiary is eligible for distributions.
- The employee
separates from service (experiences severance from employment).
- Reaches age 59
½.
- The plan is
terminated and is not replaced by another defined contribution plan.
- The employee
who gives
salary reduction contributions encounters financial hardship.
These are
referred to as triggering events.
Tax on
Early Distributions
If a distribution is made to an employee under the plan before he or she reaches
age 59½, the employee may have to pay a ten-percent additional tax on the
distribution. This tax applies to the amount received, which the employee must
include as income.
The ten-percent tax will not apply before age 59½, however, if the following
occurs:
- The
distribution is made to a beneficiary on or after the death of the employee.
- The
distribution is made because the employee acquires a qualifying disability.
- The
distribution is made as part of a series of substantially equal periodic
payments beginning after separation from service and made at least annually
for the life or life expectancy of the employee or the joint lives or life
expectancies of the employee and his or her designated beneficiary. (The
payments under this exception, except in the case of death or disability, must
continue for at least five years or until the employee reaches age 59 ½,
whichever is the longer period.)
- The
distribution is made to an employee after separation from service if the
separation occurred during or after the calendar year in which the employee
reached age 55.
- The
distribution is made to an alternate payee under a qualified domestic
relations order (QDRO).
- The
distribution is made to an employee for medical care up to the amount
allowable as a medical expense deduction (determined without regard to whether
the employee itemizes deductions).
- The
distribution is timely made to reduce excess contributions.
- The
distribution is made because of an IRS levy on the plan.
Withholding on Eligible Rollover Distributions
Distributions from a 403(b) account are subject to a mandatory federal
withholding of 20 percent if the distribution exceeds $200 for the year and is
an
eligible rollover distribution. Distributions that are not eligible rollover
distributions are not subjected the mandatory 20-percent withholding.
Eligible rollover distributions are distributions of all or any part of an
employee's balance in a 403(b) plan, except if the distribution is any of the
following:
- A required
minimum distribution.
- Any of a
series of substantially equal payments made at least once a year over any of
the following periods:
- The
employee's life or life expectancy.
- The joint
lives or life expectancies of the employee and beneficiary.
- A period of
ten years or longer.
- A hardship
distribution.
- A corrective
distribution of excess contributions or deferrals and any income allocable to
the excess, or a corrective distribution of excess annual additions and any
allocable gains.
- Loans treated
as distributions.
- The cost of
life insurance coverage.
An employee may
avoid the 20-percent withholding by having the distribution processed as a
direct rollover to an eligible retirement plan. In a direct rollover, the assets are made payable to the
trustee or custodian of the receiving retirement plan.
Required
Distributions
For implementing the required minimum distributions (RMD), a 403(b) plan must
ensure that either of the following occurs:
- Each
participant will receive his or her entire interest (benefits) in the plan by
the required beginning date.
- Each
participant will begin to receive regular periodic distributions by the
required beginning date. The distributions are annual amounts calculated so
that the participant's entire interest is distributed over his or her life
expectancy or over the joint life expectancy of the participant and the
designated beneficiary.
If an employee
maintains more than one 403(b) account, the RMD for each account may be
calculated separately for each account, or a combined amount may distributed
from one 403(b) account. This is similar to the Traditional IRA
rules but unlike qualified
plan rules, whereby an employee who participates in more than one qualified
plan must calculate and distribute the RMD for each plan separately.
Required Beginning Date
Generally, each participant must begin receiving RMD by April 1st of the year
following the calendar year he or she reaches age 70 ½. This is referred to as
the required beginning date (RBD). If the plan allows and the employee is still
employed after he or she reaches age 70 ½, the RBD could be delayed until April
1st following the year the employee retires. The option to delay the RBD after
April 1st following the calendar year in which the employee reached the 70 ½
birthday is not available to employees who own at least five percent of the
business.
Subsequent RMD amounts must be distributed by December 31 of each year.
Excess
Accumulation Penalty
Employees who do not take their RMD by the prescribed deadline will owe the IRS a 50-percent excess-accumulation penalty. The 50 percent is assessed on
the amount not distributed.
Example:
Jane's RBD is April 1, 2003. Her RMD for 2002 is $40,000 and for 2003,
her RMD is $38,000.
Jane distributed her 2002 RMD of $40,000 on March 1, 2003. By December
31, 2003 she distributed an additional $20,000.
For 2003, Jane was $18,000 short from meeting her RMD, so she owes the
IRS $9,000 ($38,000 - 20,000 = $18,000; $18,000 x 0.5= $9,000). |
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Jane must pay the
excess accumulation penalty when she files her federal
tax return. If she feels that the failure was due to reasonable
circumstance, she may write to the IRS and request that the penalty be waived.
If the request is approved, the IRS will return the payment to Jane.
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