Internal Revenue Code (“IRC”) Section 403(b) annuities, Section 401(k) plans, and Section 408 individual retirement arrangements, whether individual retirement accounts or simplified pension plans, are popular, tax-favored means of saving for retirement. If an employer purchases a Section 403(b) annuity for an employee, the employee is not currently taxable on the annuity premium(s), or on income accrued within the annuity, if any. But distributions from the annuity are fully taxable to the distributee, whether the employee or a beneficiary after the employee’s death.[1]
An employee is not currently taxable on income deferred (contributed) to the employee’s account in a qualified retirement plan sponsored by his or her employer.[2] Nor is the employee currently taxable on employer matching contributions to the qualified, defined contribution retirement plan. Income accrued in a qualified defined contribution retirement plan is exempt from income tax.[3] Distributions from a 401(k) account are fully taxable to the distributee, whether the employee or a beneficiary, after the employee’s death.[4]
An individual can make tax-deductible contributions to the his or her individual retirement account, subject to limits.[5] An individual is not currently taxable on income accrued in his or her individual retirement account.[6] Distributions from an individual retirement account are fully taxable to the distributee, whether the employee or a beneficiary after the employee’s death.[7]
The minimum required distribution rules of IRC Section 401(a)(9) limit the tax deferral of stock bonus, pension, and profit-sharing plans qualified under IRC Section 401(a), annuity contracts described in IRC Section 403, and ndividual retirement accounts described in IRC Section 408.[8] IRC Section 401(a)(9) provides that the entire interest of an employee must be distributed not later than the required beginning date, or that it will be distributed, beginning not later than the required beginning date, in accordance with regulations, over the life of the employee or over the lives of the employee and a designated beneficiary (or over a period not extending beyond the life expectancy of the employee and a designated beneficiary).[9]
Life expectancies for this purpose are determined using the Single Life Table in Treasury Regulations Section 1.401(a)(9)-9(b).[10] If the surviving spouse of the employee is the employee’s sole beneficiary, the applicable distribution period is measured by the surviving spouse’s life expectancy using the surviving spouse’s birthday for each distribution calendar year after the calendar year of the employee’s death up through the calendar year of the spouse’s death. For calendar years after the calendar year of the spouse’s death, the applicable distribution period is the life expectancy of the spouse using the age of the spouse as of the spouse’s birthday in the calendar year of the spouse’s death, reduced by one for each calendar year that has elapsed after the calendar year of the spouse’s death.[11] In other words, the surviving spouse’s life expectancy is redetermined annually.
If the employee’s beneficiary is other than the employee’s spouse, the applicable distribution period measured by the beneficiary’s remaining life expectancy is determined using the beneficiary’s age as of the beneficiary’s birthday in the calendar year immediately following the calendar year of the employee’s death. In subsequent calendar years, the applicable distribution period is reduced by one for each calendar year that has elapsed after the calendar year immediately following the calendar year of the employee’s death.[12] In other words, if the employee’s beneficiary is other than the employee’s spouse, the beneficiary’s life expectancy, one determined, is not redetermined.
The required beginning date is April 1 of the calendar year following the later of—
- the calendar year in which the employee reaches age 72, or
- the calendar year in which the employee retires.
But (ii) above does not apply—
- where the employee owns or is deemed to own more than 5 percent of the voting power of the employer which is a corporation, or more than 5 percent of the capital or profits interest of the employer which is not a corporation; or
- to an individual retirement account or annuity.[13]
Where an employee dies, the minimum required distribution rules that apply depend on whether distributions from the plan have begun during the employee’s lifetime. If distributions have begun during the employee’s lifetime, distribution of the balance in the plan at the employee’s death must be distributed at least as rapidly as under the distribution method elected by the employee during his lifetime.[14] If distributions have not begun during the employee’s lifetime, then the entire interest of the employee in the plan at his or her death must be distributed within five years after the employee’s death, except that if the employee’s designated beneficiary is an “eligible designated beneficiary,” then the employee’s interest in the plan may be distributed over the eligible designated beneficiary’s life expectancy, provided the distributions begin not later than one year after the employee’s death.[15] If an eligible designated beneficiary dies before the his or her interest in the plan is completely distributed, the remaining balance of his or her interest in the plan must be distributed within 10 years after the eligible designated beneficiary’s death.[16]
“Eligible designated beneficiary” means, with respect to any employee, a designated beneficiary who is—
- the surviving spouse of the employee;
- a child of the employee who has not reached the age of majority;
- disabled;
- chronically ill; or
- an individual not described in (i)-(iv) above who is not more than 10 years younger than the employee.[17]
A “designated beneficiary” is any individual designated as a beneficiary by an employee.[18]
Thus it is far better for a married employee to designate his or her spouse as primary beneficiary of his or her retirement plan than a trust for the spouse’s benefit.
[1] IRC
[2] Reg. § 1.401(k)-1(a)(4)(iii).
[3] IRC §§ 501(a), 401(a).
[4] IRC § 402(a).
[5] IRC § 219.
[6 IRC § 408(e)(1).
[7] IRC § 408(d)(1).
[8] Reg. § 1.401(a)(9)-1, A-1; Reg. § 1.408-8, A-1.
[9] IRC § 401(a)(9)(A)(i), (ii).
[10] Reg. § 1.401(a)(9)-5, A-6.
[11] Reg. § 1.401(a)(9)-5(c)(2).
[12] Reg. § 1.401(a)(9)-5(c)(1).
[13] IRC § 401(a)(9)(C)(ii)(I), (II).
[15] IRC § 401(a)(9)(B)(ii), (iii).
[16] IRC § 401(a)(9)(H)(iii).
[17] IRC § 401(a)(9)(E)((ii).
[18] IRC § 401(a)(9)(E)(i).