Lecture 26Qualified Plan Distributions and

Loans• You are taxed on any distributions from

qualified plans• You are also subject to penalties if you take

your money out:– Too soon– Too late– Too little – Too much

• Loans may be permitted

Too Soon• A 10% penalty applies to withdrawals from a

qualified plan unless the employee is:– At least 59 1/2 years old– Dead– Disabled– Separated from service after age 55– Separated from service and taking payments over

lifetime (or joint and survivor)– Has deductible medical expenses (over 7.5% of AGI)

Too Soon - Example• Earl Early, born 1/7/50, quits his job in 1999 and

takes his 401(k) account of $150,000 in a lump sum. He is in the 28% Federal tax bracket. How much does he get to keep after taxes and penalties?

• Answer: – Early distribution penalty: $15,000– Tax: $42,000– Amount remaining: $93,000

Too Late/Too Little• Withdrawals must begin by April 1 of the

calendar year following when the employee turns 70 1/2 (or the year of actual retirement if later)

• Withdrawals must be in substantially equal payments over life of employee (or joint and survivor)

• Applicable penalty: 50% of the minimum amount that should have been withdrawn

Too Late/Too Little - Example

• Carl Careless, born 1/4/30, has $300,000 in a qualified profit sharing plan. If he retired on 7/4/95, when does he need to begin withdrawing money from this account?

• Answer: April 1, 2001

• If he forgets to take any withdrawals in 2001, what is his penalty? Assume his life expectancy at age 71 is 15 years.

• Answer: 50% x (300,000/15) = $10,000

Too Much

• If annual withdrawals from qualified plans in total exceed $150,000 (or $112,500 indexed), then the excess is subject to a 15% penalty tax. This penalty is reduced by the 10% penalty (if any) on early withdrawals.

Too Much - Example• Gene Goodinvestor, born 5/7/39, retires on 1/1/99 and

takes his defined contribution pension plan as a life annuity. This pays him $250,000 in 1999. He is in the 35% Federal and 5% state tax bracket. How much does he get to keep after taxes and penalties?

• Answer:– Excess distribution penalty: 15,000– Taxes: 100,000– Amount remaining: 135,000

Loans

• Restricted to hardship cases

• Loans limited to lesser of:– $50,000 minus highest outstanding loan

balance in preceding year– 1/2 the present value of the employee’s vested

accrued benefit

• Repayment terms– 5 years unless loan is for a principal residence