Distributions

March 13, 2024

4089 / Are distributions from a tax sheltered annuity subject to withholding?

<div class="Section1"> With respect to distributions other than eligible rollover distributions ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4007">4007</a>), amounts will be withheld from periodic payments at the rates applicable to wage payments and from other distributions at a 10 percent rate. An employee may elect not to have income tax withheld from these payments. Tax will not be withheld on amounts distributed where it is reasonable to believe they will not be includable in income.<a href="#_ftn1" name="_ftnref1">1</a> Any eligible rollover distribution made after December 31, 1992 is subject to mandatory income tax withholding at the rate of 20 percent unless the distributee elects to have the distribution paid by means of a direct rollover.<a href="#_ftn2" name="_ftnref2">2</a> This mandatory withholding applies even if the employee’s employment terminated prior to January 1, 1993, and even if the eligible rollover distribution is part of a series of payments that began before January 1, 1993.<a href="#_ftn3" name="_ftnref3">3</a> For distributions after 1992 but before October 19, 1995, slightly different rules may be applicable under temporary regulations ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4000">4000</a>). <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 3405; Temp. Treas. Reg. § 35.3405-1T, A-20. <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 3405(c); Treas. Reg. § 31.3405(c)-1, A-1(a). <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 31.3405(c)-1, A-1(c)(1)(i). </div></div>

March 13, 2024

4091 / Are death benefits paid to an employee's beneficiary under a tax sheltered annuity subject to withholding?

<div class="Section1"> With respect to distributions other than eligible rollover distributions ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4007">4007</a>), payments to a surviving spouse or beneficiary are subject to income tax withholding unless the spouse or beneficiary elects not to have withholding apply. Amounts need not be withheld on any part of the distribution where it is reasonable to believe those amounts will not be includable in gross income. Annuity payments are subject to withholding at the rate applicable to wages; other payments are subject to withholding at a 10 percent rate.<a href="#_ftn1" name="_ftnref1">1</a> In the case of an eligible rollover distribution, a surviving spouse or other beneficiary is subject to the same mandatory withholding rules as the employee ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4088">4088</a>). <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 3405; Temp. Treas. Reg. §§ 35.3405-1T, A-17; 35.3405-1T, A-28. </div></div>

March 13, 2024

4090 / How is a death benefit under a tax sheltered annuity taxed to an employee's beneficiary?

<div class="Section1"> A death benefit under a tax sheltered annuity generally is taxed in the same way as a death benefit under a qualified pension, qualified plan or profit sharing plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3974">3974</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3976">3976</a>). In the case of a single sum payment where no life insurance is involved, all amounts received by a beneficiary are taxable as ordinary income except that the beneficiary may exclude from gross income the employee’s unrecovered cost basis, if any. If a death benefit consists of life insurance proceeds, the amount of the proceeds in excess of the cash surrender value of the policy immediately before the insured’s death is excludable from gross income under IRC Section 101(a)(1). For the rule under the final regulations restricting the availability of life insurance in 403(b) arrangements, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4034">4034</a>. Cash surrender value is taxable as ordinary income to the extent that it exceeds the portion of the premiums taxed to the employee as being the cost of life insurance protection (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4061">4061</a> regarding the proper measure of the value of current life insurance protection), and any other unrecovered cost basis of the employee.<a href="#_ftn1" name="_ftnref1">1</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC §§ 403(c), 72(m)(3)(C); Treas. Reg. § 1.72-16(c). </div></div>

March 13, 2024

4082 / What is the minimum distribution incidental benefit requirement with respect to tax sheltered annuities?

<div class="Section1"> The minimum distribution incidental benefit (“MDIB”) requirement constitutes a second set of minimum distribution rules that must be considered in determining the minimum amount required to be distributed during a participant’s lifetime.<a href="#_ftn1" name="_ftnref1">1</a> The MDIB rules apply to the pre-1987 account balance as well as the post-1986 balance. The reason they apply to the pre-1987 account balance, while the minimum distribution rules under IRC Section 401(a)(9) do not, is that unlike those requirements, the incidental benefit rule existed in regulations for many years before it was enacted into the IRC in 1986 and amounts accumulated before 1987 were subject to its requirements. Regulations under IRC Section 403(b) required that the death benefit under a tax sheltered annuity be merely incidental to its primary purpose of providing retirement benefits. In 2007, regulations under Section 403(b) were finalized that briefly addressed the application of the older MDIB rule. These regulations took effect after 2008.<a href="#_ftn2" name="_ftnref2">2</a> They generally restated rules contained in earlier regulations, to the effect that the post-1986 balance is subject to the IRC Section 401(a)(9) regulations and that both the pre-1987 balance and the post-1986 balance are subject to the MDIB rule ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4075">4075</a>).<a href="#_ftn3" name="_ftnref3">3</a> The 2007 regulations do not interpret the old MDIB rule but describe two ways it can be satisfied. First, distributions attributable to the pre-1987 account balance are treated as satisfying the MDIB requirement if all distributions from a Section 403(b) contract, including distributions attributable to the post-1986 account balance, satisfy the requirements of Treasury Regulation Section 1.401-1(b)(1)(i) (which the regulations cite as authority for the old MDIB rule) without regard to whether distributions under the 2002 regulations and distributions from the post-1986 account satisfy the requirements of IRC Section 401(a)(9).<a href="#_ftn4" name="_ftnref4">4</a> Second, and in the alternative, distributions attributable to the pre-1987 account will be treated as satisfying the MDIB requirement if all distributions from the contract, whether pre-1987 or post-1986 amounts, satisfy the regulations under IRC Section 401(a)(9).<a href="#_ftn5" name="_ftnref5">5</a> Under much earlier rulings, the old rule generally was interpreted as requiring a distribution arrangement under which the present value of the aggregate payments to be made to the participant must be more than 50 percent of the present value of the total payments to be made to the participant and his or her beneficiaries.<a href="#_ftn6" name="_ftnref6">6</a> The old rules generally required that distributions commence by age 75.<a href="#_ftn7" name="_ftnref7">7</a> It would appear that the old rules may continue to apply in determining distributions required from the pre-1987 balance.<a href="#_ftn8" name="_ftnref8">8</a> Of course, nothing would prevent a participant from choosing to apply the Section 401(a)(9) rules.<a href="#_ftn9" name="_ftnref9">9</a> Final 2002 regulations state that if distributions are made in accordance with the individual account rules set forth therein ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4078">4078</a>), the MDIB requirement will be satisfied.<a href="#_ftn10" name="_ftnref10">10</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 403(b)(10); Treas. Reg. § 1.401-1(b)(1)(i). <a href="#_ftnref2" name="_ftn2">2</a>.  TD 9340, 72 Fed. Reg. 41128 (July 26, 2007). <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 1.403(b)-3, A-2, A-3; Treas. Reg. § 1.403(b)-6(e)(6). <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.403(b)-3, A-3; Treas. Reg. § 1.403(b)-6(e)(6)(vi). <a href="#_ftnref5" name="_ftn5">5</a>.  Treas. Reg. § 1.403(b)-3, A-3; Treas. Reg. § 1.403(b)-6(e)(6)(vi). <a href="#_ftnref6" name="_ftn6">6</a>.  Rev. Rul. 72-241, 1972-1 CB 108; Rev. Rul. 73-239, 1973-1 CB 201; Let. Ruls. 8642072, 7843043, 7825010. <a href="#_ftnref7" name="_ftn7">7</a>.  Let. Ruls. 9345044, 7825010. <a href="#_ftnref8" name="_ftn8">8</a>.  Let. Rul. 9345044. <a href="#_ftnref9" name="_ftn9">9</a>.  Treas. Reg. § 1.403(b)-3, A-3; Treas. Reg. § 1.403(b)-6(e)(6)(vi). <a href="#_ftnref10" name="_ftn10">10</a>.  Treas. Reg. § 1.401(a)(9)-5, A-1(d). </div></div>

March 13, 2024

4084 / How are the minimum distribution requirements met after the death of a tax sheltered annuity participant?

<div class="Section1"> Editor’s Note: Post-SECURE Act, it was widely expected that the minimum distribution rules would no longer vary based upon whether the participant dies before or after his or her required beginning date. However, under regulations proposed in 2022, a beneficiary will be required to take annual RMDs during the new ten-year distribution period if the original account owner died on or after his or her required beginning date. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3902">3902</a> for details. A tax sheltered annuity must satisfy the minimum distribution requirements set forth in IRC Section 401(a)(9) for qualified plans.<a href="#_ftn1" name="_ftnref1">1</a> Most of the requirements were explained in regulations published in 2002.<a href="#_ftn2" name="_ftnref2">2</a> Regulations governing annuity payouts from defined benefit plans were finalized in 2004 ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4078">4078</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3754">3754</a>), and regulations addressing additional matters were finalized under IRC Section 403(b) in 2007.<a href="#_ftn3" name="_ftnref3">3</a> The 2002 regulations simplified the calculation process and included longer life expectancy tables. The final regulations took effect for required minimum distributions in 2003 and later years ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3896">3896</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4078">4078</a>). Pre-SECURE Act, after the death of a tax sheltered annuity participant, the application of the minimum distribution requirements depended on whether he or she died before or after his or her required beginning date. For this purpose, distributions generally were treated as having begun in accordance with the minimum distribution requirements under IRC Section 401(a)(9)(A)(ii), without regard to whether payments had been made before that date.<a href="#_ftn4" name="_ftnref4">4</a> If distributions irrevocably, except for acceleration, began prior to the required beginning date in the form of an annuity that meets the minimum distribution rules, the annuity starting date was treated as the required beginning date for purposes of calculating lifetime and after death minimum distribution requirements.<a href="#_ftn5" name="_ftnref5">5</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 403(b)(10). <a href="#_ftnref2" name="_ftn2">2</a>.  TD 8987, 67 Fed. Reg. 18988 (4-17-02). <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 1.403(b)-6. <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.401(a)(9)-2, A-6(a). <a href="#_ftnref5" name="_ftn5">5</a>.  Treas. Reg. § 1.401(a)(9)-6, A-10, A-11. </div></div>

March 13, 2024

4087 / How is the designated beneficiary of a tax sheltered annuity determined after the participant's death?

<div class="Section1"> To be a designated beneficiary, an individual must be a beneficiary on the date of the participant’s death. The determination of the existence and identity of a designated beneficiary for purposes of minimum distributions is made as of the date of the participant’s death for tax years beginning in 2020 and thereafter. Pre-SECURE Act, the determination was made on September 30 of the calendar year following the year of the participant’s death.<a href="#_ftn1" name="_ftnref1">1</a> Exceptions may apply if the account is payable as an annuity, or if a surviving spouse beneficiary dies after the participant but before distributions have begun. Pre-2020, the September 30 deadline was imposed so that a distribution may be calculated and made by the deadline of December 31 following the year of the participant’s death. Consequently, an individual who was a beneficiary as of the date of the participant’s death, but was not a beneficiary as of September 30 of the following year, such as because he or she disclaims entitlement to the benefit or because he or she receives the entire benefit to which he or she is entitled before that date, was not taken into account for purposes of determining the distribution period for required minimum distributions after the participant’s death.<a href="#_ftn2" name="_ftnref2">2</a> Note that the SECURE Act did not change the definition of designated beneficiary. Instead, the Act created a new class of beneficiaries called eligible designated beneficiaries. Post-SECURE Act, only an eligible designated beneficiary is entitled to rely upon the life expectancy method of distribution. Non-eligible designated beneficiaries must empty the account under the new ten-year rule. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3902">3902</a> and <a href="https://www.thinkadvisor.com/tax-facts/2020/01/28/3903-01-what-is-an-eligible-designated-beneficiary-how-does-this-designation-impact-the-rules-governing-retirement-plan-distributions-after-an-account-owners-death/">Q 3903</a> for details. Under the 2002 regulations, special rules apply if more than one beneficiary is designated as of the date on which the determination is made. Generally, the beneficiary with the shortest life expectancy will be the designated beneficiary for purposes of determining the distribution period.<a href="#_ftn3" name="_ftnref3">3</a> If a surviving spouse beneficiary dies after the participant, but before distributions to the spouse have begun, the 10 year rule, the five year rule and the life expectancy rule described above for surviving spouses will be applied as though the surviving spouse were the participant.<a href="#_ftn4" name="_ftnref4">4</a> This provision will not allow a new spouse of the deceased participant’s surviving spouse to delay distributions under the surviving spouse rules of IRC Section 401(a)(9)(B)(iv).<a href="#_ftn5" name="_ftnref5">5</a> The 2007 regulations provide that the special rule allowing a surviving spouse to treat an IRA interest as the spouse’s own<a href="#_ftn6" name="_ftnref6">6</a> does not apply to a Section 403(b) contract, even if the spouse is the sole beneficiary.<a href="#_ftn7" name="_ftnref7">7</a> If a beneficiary is not an individual or a permitted trust ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3904">3904</a>), the participant will be treated as having no beneficiary. A participant’s estate may not be a designated beneficiary.<a href="#_ftn8" name="_ftnref8">8</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.401(a)(9)-4, A-4(a). <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 1.401(a)(9)-4, A-4(a). <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 1.401(a)(9)-5, A-7(a). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 401(a)(9)(B)(iv)(II); Treas. Reg. § 1.401(a)(9)-3, A-5. <a href="#_ftnref5" name="_ftn5">5</a>.  Treas. Reg. § 1.401(a)(9)-3, A-5. <a href="#_ftnref6" name="_ftn6">6</a>.  Treas. Reg. § 1.408-8, A-5. <a href="#_ftnref7" name="_ftn7">7</a>.  Treas. Reg. § 1.403(b)-6(e)(4). <a href="#_ftnref8" name="_ftn8">8</a>.  Treas. Reg. § 1.401(a)(9)-4, A-3. </div></div>

March 13, 2024

4083 / How are the minimum distribution incidental benefit (MDIB) rules that apply to tax sheltered annuities satisfied if the benefit is payable as an annuity?

<div class="Section1"> If a participant’s benefit is payable in the form of a life annuity for the life of the participant that satisfies the requirements of IRC Section 401(a)(9), the MDIB requirement will be satisfied.<a href="#_ftn1" name="_ftnref1">1</a> If a participant’s sole beneficiary as of the annuity starting date is the participant’s spouse, and the distributions satisfy IRC Section 401(a)(9), the MDIB requirement will be satisfied.<a href="#_ftn2" name="_ftnref2">2</a> Payments under the annuity must be nonincreasing, except as explained at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4078">4078</a>.<a href="#_ftn3" name="_ftnref3">3</a> If distributions begin under a particular distribution option that is in the form of a joint and survivor annuity for the joint lives of the participant and a nonspouse beneficiary, the MDIB requirement will not be satisfied as of the date distributions begin unless the distribution option provides that annuity payments to be made to the participant on and after his or her required beginning date will satisfy the conditions set forth in Treasury Regulation Section 1.401(a)(9)-6, A-2(c). Under those provisions, the periodic annuity payment payable to the survivor must not at any time on and after the participant’s required beginning date exceed the applicable percentage of the annuity payment payable to the participant using the RMD MDIB Joint and Survivor Annuity Table.<a href="#_ftn4" name="_ftnref4">4</a> The applicable percentage is based on how much older the participant is than the beneficiary as of their attained ages on their birthdays in the first calendar year for which distributions to the participant are required. For example, if a beneficiary is 10 or fewer years younger, the survivor annuity may be 100 percent. If the age difference is greater than 10 years, the maximum survivor annuity permitted is less than 100 percent. If there is more than one beneficiary, the age of the youngest beneficiary is used.<a href="#_ftn5" name="_ftnref5">5</a> If a distribution form includes a life annuity and a period certain, the amount of the annuity payments payable to the beneficiary need not be reduced during the period certain, but in the case of a joint and survivor annuity with a period certain, the amount of the annuity payments payable to the beneficiary must satisfy the foregoing requirements after the expiration of the period certain.<a href="#_ftn6" name="_ftnref6">6</a> The period certain for annuity distributions commencing during the life of a participant with an annuity starting date on or after his or her required beginning date generally may not exceed the applicable distribution period for the participant ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4078">4078</a>) for the calendar year that contains the annuity starting date. If the participant’s spouse is his or her sole beneficiary and the annuity provides only a period certain and no life annuity, the period certain may last as long as the joint and survivor life expectancy of the participant and spouse, if that period is longer than the applicable distribution period for the participant.<a href="#_ftn7" name="_ftnref7">7</a> If distributions commence after the death of the participant under the life expectancy rule ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3900">3900</a>), the period certain for any distributions commencing after death cannot exceed the distribution period determined under the life expectancy provisions of Treasury Regulation Section 1.401(a)(9)-5, A-5(b). The amount required to be distributed generally is the greater of the MDIB or the regular RMD amount ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3892">3892</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3908">3908</a>). If the amount required to be distributed exceeds the amount distributed, the shortfall is subject to a 50 percent excise tax, levied on the individual, not the plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>).<a href="#_ftn8" name="_ftnref8">8</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.401(a)(9)-6, A-2(a). <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 1.401(a)(9)-6, A-2(b). <a href="#_ftnref3" name="_ftn3">3</a>.  Rev. Proc. 2003-10, 2003-1 CB 259; Notice 2003-2, 2003-1 CB 257. <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.401(a)(9)-6, A-2(c)(2). <a href="#_ftnref5" name="_ftn5">5</a>.  Treas. Reg. § 1.401(a)(9)-6, A-2(c)(1). <a href="#_ftnref6" name="_ftn6">6</a>.  Treas. Reg. § 1.401(a)(9)-6, A-2(d). <a href="#_ftnref7" name="_ftn7">7</a>.  Treas. Reg. § 1.401(a)(9)-6, A-3(a). <a href="#_ftnref8" name="_ftn8">8</a>.  IRC § 4974. </div></div>

March 13, 2024

4088 / Are payments received under a tax sheltered annuity taxable income to the employee?

<div class="Section1"> Yes, except to the extent the amounts are a recovery of the employee’s investment in the contract including the amount of a defaulted loan or to the extent the employee rolls over an eligible distribution to another tax sheltered annuity, a qualified retirement plan, an eligible governmental 457 plan, or a traditional individual retirement plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4007">4007</a>). Where an annuity contract without life insurance protection is used for funding, all payments received normally are taxable in full as ordinary income to the employee. This is the result regardless of whether contributions were made by the employer as additional compensation to the employee, were derived from a reduction in the employee’s salary, or were paid in part by deductible voluntary employee contributions. Because salary reduction contributions have not been previously taxed to the employee, where they have come within the overall limit, they cannot be treated as a cost basis for the contract.<a href="#_ftn1" name="_ftnref1">1</a> In some instances, however, the employee will have a cost basis for the contract. An employee’s cost basis consists of any nondeductible contributions the employee has paid and any portion of the contributions made by the employer on which the employee has paid tax, except that excess salary reduction amounts not distributed from the plan by April 15 of the year following the contribution are not included in basis even though they were included in income ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4047">4047</a>). The value of a non-distributed defaulted loan is also included in the employee’s cost basis. Where a life insurance policy is used ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4034">4034</a>), the sum of the annual one year term costs that have been taxed to the employee are included in the employee’s cost basis.<a href="#_ftn2" name="_ftnref2">2</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4061">4061</a> regarding the proper measure of the value of current life insurance protection. Similarly, any portion of an employer’s premiums that have been included in an employee’s gross income because they exceeded the employee’s overall limit are included in the employee’s cost basis ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4042">4042</a>). The amount of any policy loans included in income as a taxable distribution ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4063">4063</a>) also constitutes part of the employee’s cost basis. Once a loan is deemed distributed under IRC Section 72(p), the interest that accrues thereafter on that loan is not included in income for purposes of determining the amount that is taxable under IRC Section 72. In addition, neither the income that results from the deemed distribution nor the interest that accrues thereafter increases the participant’s investment or cost basis in the contract under IRC Section 72. To the extent that a participant repays by cash any portion of a loan that has been deemed distributed, the participant acquires a tax basis in the contract in the same manner as if the repayments were after-tax contributions.<a href="#_ftn3" name="_ftnref3">3</a> If an employee takes an account balance in a single lump sum cash payment, the full amount received will be ordinary income to the employee in the year of receipt unless the employee has a cost basis, except as provided in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4057">4057</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4059">4059</a>.If the employee has a cost basis, the amount in excess of the cost basis will be ordinary income.<a href="#_ftn4" name="_ftnref4">4</a> Amounts received before the annuity starting date, that is, in-service distributions, by an employee who has a cost basis are taxed under a rule that provides for pro rata recovery of cost.<a href="#_ftn5" name="_ftnref5">5</a> An employee excludes that portion of the distribution that bears the same ratio to the total distribution as the employee’s investment in the contract bears to the total value of the employee’s accrued benefit as of the date of the distribution. Amounts received prior to July 2, 1986 were taxed under a cost recovery rule permitting recovery of basis before taxing any of the distribution as interest.<a href="#_ftn6" name="_ftnref6">6</a> The annuity starting date is the first day of the first period for which an amount is received as an annuity under a contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="536">536</a>).<a href="#_ftn7" name="_ftnref7">7</a> If a plan on May 5, 1986 permitted in-service withdrawal of employee contributions, the pro rata recovery rules do not apply to investment in the contract prior to 1987. Instead, investment in the contract prior to 1987 will be recovered first and the pro rata recovery rules will apply only to the extent that amounts received before the annuity starting date, when added to all other amounts previously received under the contract after 1986, exceed the employee’s investment in the contract as of December 31, 1986.<a href="#_ftn8" name="_ftnref8">8</a> If an employee who has a cost basis for his or her contract receives life annuity or installment payments, the payments are taxed as discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="613">613</a>, depending on the annuity starting date. Where the 403(b) annuity contract or custodial account is solely liable for the payment of investment expenses, the direct payment of investment advisor fees from a participant’s annuity or account is not treated as a distribution.<a href="#_ftn9" name="_ftnref9">9</a> Likewise, where an annuity contract consists of different subaccounts for which a financial advisor provides asset allocation advice, if the annuity contract expenses are assessed directly against the contract value itself, those payments then are expenses of the contract itself and, therefore, are not distributions from the contract includable in gross income. Furthermore, assessing expenses against a contract in this manner does not cause the contract to lose its qualified status under IRC Section 403(b).<a href="#_ftn10" name="_ftnref10">10</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 403(b)(1). <a href="#_ftnref2" name="_ftn2">2</a>.  Rev. Rul. 68-304, 1968-1 CB 179. <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. §§ 1.72(p)-1, A-19(a), 1.72(p)-1, A-21(a). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 72(e)(5). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 72(e)(8). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 72(e)(5)(D). <a href="#_ftnref7" name="_ftn7">7</a>.  IRC § 72(c)(4). <a href="#_ftnref8" name="_ftn8">8</a>.  IRC § 72(e)(8)(D). <a href="#_ftnref9" name="_ftn9">9</a>.  Let. Ruls. 9332040, 9316042, 9047073. <a href="#_ftnref10" name="_ftn10">10</a>.  Let. Rul. 9845003. </div></div>

March 13, 2024

4085 / How are the minimum distribution requirements met after the death of a tax sheltered annuity participant who died before the required beginning date?

<div class="Section1"> The SECURE Act now requires non-eligible designated beneficiaries to deplete the entire account balance within ten years of the original account owner’s death.  Eligible designated beneficiaries can continue to use the life expectancy method discussed below or can opt to follow the ten-year distribution rule.  Under regulations proposed in 2024, post-SECURE Act, a beneficiaries subject to the ten-year rule are required to take annual RMDs during the ten-year distribution period if the original account owner died on or after his or her required beginning date. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3901">3901</a> for details. See Q 3903 for the definition of “eligible designated beneficiary” post-SECURE Act. Pre-SECURE Act, if a participant died before his or her required beginning date, distributions were made under one of two methods: (1)  Under the five year rule, the entire interest must be distributed within five years after the death of the participant regardless of who or what entity receives the distribution.<a href="#_ftn1" name="_ftnref1">1</a> To satisfy this rule, the entire interest must be distributed by the end of the calendar year that contains the fifth anniversary of the date of the participant’s death.<a href="#_ftn2" name="_ftnref2">2</a> (2)  Under the life expectancy rule, if any portion of the interest is payable to, or for the benefit of, a designated beneficiary, that portion must be distributed over the life or life expectancy of the beneficiary, beginning within one year of the participant’s death.<a href="#_ftn3" name="_ftnref3">3</a> To the extent that the interest is payable to a non-spouse beneficiary, distributions must begin by the end of the calendar year immediately following the calendar year in which the participant died.<a href="#_ftn4" name="_ftnref4">4</a> The non-spouse beneficiary’s life expectancy for this purpose is measured as of his or her birthday in the year following the year of the participant’s death. In subsequent years, this amount is reduced by one for each calendar year that has elapsed since the year immediately following the year of the participant’s death.<a href="#_ftn5" name="_ftnref5">5</a> If the sole designated beneficiary is the participant’s surviving spouse, distributions must begin by the later of the end of the calendar year immediately following the calendar year in which the participant died or the end of the calendar year in which the participant would have reached age 73 (72 for 2020-2022, 70½ pre-2020).<a href="#_ftn6" name="_ftnref6">6</a> The payout period during the surviving spouse’s life is measured by the surviving spouse’s life expectancy as of his or her birthday in each distribution calendar year for which a minimum distribution is required after the year of the participant’s death.<a href="#_ftn7" name="_ftnref7">7</a> After the surviving spouse’s death, the distribution period is based on his or her remaining life expectancy. This is determined using the age of the surviving spouse in the calendar year of his or her death, reduced by one for each calendar year that has elapsed after the calendar year of the surviving spouse’s death.<a href="#_ftn8" name="_ftnref8">8</a> The 2002 regulations set forth tables containing single and joint and survivor life expectancies for calculating required minimum distributions, as well as a Uniform Lifetime Table for determining the appropriate distribution periods.<a href="#_ftn9" name="_ftnref9">9</a> Unless a plan adopts a provision specifying otherwise, if distributions to a participant have not begun prior to his or her death, they must be made automatically either under the life expectancy rule described above or, if there is no designated beneficiary, under the five year rule.<a href="#_ftn10" name="_ftnref10">10</a> A plan may adopt a provision specifying that the five year rule will apply after the death of a participant, or a provision allowing participants or beneficiaries to elect whether the five year rule or the life expectancy rule will be applied.<a href="#_ftn11" name="_ftnref11">11</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 401(a)(9)(B)(ii), Treas. Reg. § 1.401(a)(9)-3, A-1(a). <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 1.401(a)(9)-3, A-2. <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 401(a)(9)(B)(iii); Treas. Reg. § 1.401(a)(9)-3, A-1(a). <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.401(a)(9)-3, A-3(a). <a href="#_ftnref5" name="_ftn5">5</a>.  Treas. Reg. § 1.401(a)(9)-5, A-5(c)(1). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 401(a)(9)(B)(iv); Treas. Reg. § 1.401(a)(9)-3, A-3(b). <a href="#_ftnref7" name="_ftn7">7</a>.  Treas. Reg. § 1.401(a)(9)-5, A-5(c)(2). <a href="#_ftnref8" name="_ftn8">8</a>.  Treas. Reg. § 1.401(a)(9)-5, A-5(c)(2). <a href="#_ftnref9" name="_ftn9">9</a>.  Treas. Reg. § 1.401(a)(9)-9. <a href="#_ftnref10" name="_ftn10">10</a>.  Treas. Reg. §§ 1.401(a)(9)-1, A-3(c), 1.401(a)(9)-3, A-4(a). <a href="#_ftnref11" name="_ftn11">11</a>.  Treas. Reg. §§ 1.401(a)(9)-3, A-4(b), 1.401(a)(9)-3, A-4(c). </div></div>

March 13, 2024

4078 / What minimum distributions must be made under Section 401(a)(9) from a tax sheltered annuity during the life of the participant?

<div class="Section1"> If a post-1986 account balance is not totally distributed to a participant by the required beginning date, distributions of the balance must begin by that date and must, at a minimum, be distributed over one of the following periods: the life of the participant, the lives of the participant and the beneficiary, or a period not extending beyond the life expectancy of the participant or the life expectancy of the participant and a designated beneficiary.<a href="#_ftn1" name="_ftnref1">1</a> If the issuer or custodian of the account does not keep adequate records to distinguish between pre-1987 and post-1986 balances, the entire account will be treated as subject to IRC Section 401(a)(9).<a href="#_ftn2" name="_ftnref2">2</a> The minimum distribution requirements include regulations finalized in 2002.<a href="#_ftn3" name="_ftnref3">3</a> Additional regulations finalized in 2004 govern annuity distributions under Section 403(b) plans.<a href="#_ftn4" name="_ftnref4">4</a> Regulations finalized in 2007 apply to distributions after 2008.<a href="#_ftn5" name="_ftnref5">5</a> The Pension Protection Act of 2006 called for regulations that would provide that governmental plans are subject to a reasonable, good faith interpretation of the minimum distribution requirements.<a href="#_ftn6" name="_ftnref6">6</a> This same standard is applicable under earlier guidance and compliance with the 2002 regulations, the 2001 regulations, or the 1987 regulations will be considered to meet that standard.<a href="#_ftn7" name="_ftnref7">7</a> A participant's required beginning date is April 1 of the calendar year following the later of the calendar year in which the participant attains age 73 (72 in 2020-2022) or the calendar year in which the participant retires.<a href="#_ftn8" name="_ftnref8">8</a> For any part of a Section 403(b) contract that is not part of a government plan or church plan, regulations state that the required beginning date for a 5 percent owner is April 1 of the calendar year following the calendar year in which the employee reaches age 73.<a href="#_ftn9" name="_ftnref9">9</a> Under 2002 regulations (as under earlier guidance), a plan is permitted to provide that the required beginning date for all participants is April 1 of the calendar year following the calendar year in which the participant attains age 72.<a href="#_ftn10" name="_ftnref10">10</a> Governmental or church plan participants are permitted under the IRC to delay distributions until April 1 of the calendar year following the later of the year in which the participant retires or turns 72; consequently, this provision is not applicable to them.<a href="#_ftn11" name="_ftnref11">11</a> A distribution for the calendar year a participant becomes age 73 or retires, if applicable, must be made by April 1 of the following calendar year. The distribution for each calendar year after the year the participant becomes 73 or retires, if applicable, must be made by December 31 of that year. Thus, it is possible that distributions for the calendar year in which a participant becomes 73 or retires and the following calendar year will be made in the same calendar year. Account Balance For purposes of calculating minimum distributions, the account balance is determined as of the last valuation date in the immediately preceding calendar year, that is, the valuation calendar year. The account balance does not include the value of any QLAC held under the plan on or after July 2, 2014.<a href="#_ftn12" name="_ftnref12">12</a> Distributions in excess of the amount required in one year may not be used to reduce the amount required in subsequent years.<a href="#_ftn13" name="_ftnref13">13</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC §§ 403(b)(10), 401(a)(9). <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 1.403(b)-3, A-2(b); Treas. Reg. § 1.403(b)-6(e)(6)(ii). <a href="#_ftnref3" name="_ftn3">3</a>. TD 8987, 67 Fed. Reg. 18988 (4-17-02). <a href="#_ftnref4" name="_ftn4">4</a>. TD 9130, 2004-26 IRB 1082. <a href="#_ftnref5" name="_ftn5">5</a>. TD 9340, 72 Fed. Reg. 41128 (July 26, 2007). <a href="#_ftnref6" name="_ftn6">6</a>. P.L. 109-280, § 823. <a href="#_ftnref7" name="_ftn7">7</a>. Rev. Proc. 2003-10, 2003-1 CB 259; Notice 2003-2, 2003-1 CB 257. <a href="#_ftnref8" name="_ftn8">8</a>. IRC § 401(a)(9)(C); Treas. Reg. § 1.403(b)-6(e)(3). <a href="#_ftnref9" name="_ftn9">9</a>. Treas. Reg. § 1.403(b)-6(e)(3). <a href="#_ftnref10" name="_ftn10">10</a>. Treas. Reg. § 1.401(a)(9)-2, A-2(e). <a href="#_ftnref11" name="_ftn11">11</a>. IRC § 401(a)(9)(C). <a href="#_ftnref12" name="_ftn12">12</a>. Treas. Reg. § 1.401(a)(9)-5, A-3(a). <a href="#_ftnref13" name="_ftn13">13</a>. Treas. Reg. § 1.401(a)(9)-5, A-2. </div>