Distributions

Amounts paid to plan participants from a qualified plan are called distributions. Distributions may be nonperiodic, such as lump-sum distributions, or periodic, such as annuity payments. Also, certain loans may be treated as distributions. See Loans Treated as Distributions in Publication 575.

Required Distributions

A qualified plan must provide that each participant will either:

• Receive his or her entire interest (benefits) in the plan by the required beginning date (defined later), or
• Begin receiving regular periodic distributions by the required beginning date in annual amounts calculated to distribute the participant's entire interest (benefits) over his or her life expectancy or over the joint life expectancy of the participant and the designated beneficiary (or over a shorter period).

These distribution rules apply individually to each qualified plan. You cannot satisfy the requirement for one plan by taking a distribution from another. These rules may be incorporated in the plan by reference. The plan must provide that these rules override any inconsistent distribution options previously offered.

Minimum distribution. If the account balance of a qualified plan participant is to be distributed (other than as an annuity), the plan administrator must figure the minimum amount required to be distributed each distribution calendar year. This minimum is figured by dividing the account balance by the applicable life expectancy. For details on figuring the minimum distribution, see Tax on Excess Accumulation in Publication 575.

Minimum distribution incidental benefit requirement. Minimum distributions must also meet the minimum distribution incidental benefit requirement. This requirement ensures the plan is used primarily to provide retirement benefits to the employee. After the employee's death, only "incidental" benefits are expected to remain for distribution to the employee's beneficiary (or beneficiaries). For more information about other distribution requirements, see Publication 575.

Required beginning date. Generally, each participant must receive his or her entire benefits in the plan or begin to receive periodic distributions of benefits from the plan by the required beginning date.

A participant must begin to receive distributions from his or her qualified retirement plan by April 1 of the first year after the later of the following years.

1. Calendar year in which he or she reaches age 70 1/2.
2. Calendar year in which he or she retires.

However, your plan may require you to begin receiving distributions by April 1 of the year after you reach age 70 1/2 even if you have not retired.

If the participant is a 5% owner of the employer maintaining the plan or if the distribution is from a traditional or SIMPLE IRA, the participant must begin receiving distributions by April 1 of the first year after the calendar year in which the participant reached age 70 1/2. For more information, see Tax on Excess Accumulation in Publication 575.

Distributions after the starting year. The distribution required to be made by April 1 is treated as a distribution for the starting year. (The starting year is the year in which the participant meets (1) or (2) above, whichever applies.) After the starting year, the participant must receive the required distribution for each year by December 31 of that year. If no distribution is made in the starting year, required distributions for 2 years must be made in the next year (one by April 1 and one by December 31).

Distributions after participant's death. See Publication 575 for the special rules covering distributions made after the death of a participant.

Distributions From 401(k) Plans

Generally, distributions cannot be made until one of the following occurs.

• The employee retires, dies, becomes disabled, or otherwise separates from service.
• The plan ends and no other defined contribution plan is established or continued.
• In the case of a 401(k) plan that is part of a profit-sharing plan, the employee reaches age 59 1/2 or suffers financial hardship. For the rules on hardship distributions, including the limits on them, see section 1.401(k)-1(d)(2) of the regulations.

Certain distributions listed above may be subject to the tax on early distributions discussed later.

Qualified domestic relations order (QDRO). These distribution restrictions do not apply if the distribution is to an alternate payee under the terms of a QDRO, which is defined in Publication 575.

Tax Treatment of Distributions

Distributions from a qualified plan minus a prorated part of any cost basis are subject to income tax in the year they are distributed. Since most recipients have no cost basis, a distribution is generally fully taxable. An exception is a distribution that is properly rolled over as discussed next under Rollover.

The tax treatment of distributions depends on whether they are made periodically over several years or life (periodic distributions) or are nonperiodic distributions. See Taxation of Periodic Payments and Taxation of Nonperiodic Payments in Publication 575 for a detailed description of how distributions are taxed, including the 10-year tax option or capital gain treatment of a lump-sum distribution.

Rollover. The recipient of an eligible rollover distribution from a qualified plan can defer the tax on it by rolling it over into a traditional IRA or another eligible retirement plan. However, it may be subject to withholding as discussed under Withholding requirement, later.

Eligible rollover distribution. This is a distribution of all or any part of an employee's balance in a qualified retirement plan that is not any of the following.

1. A required minimum distribution. See Required Distributions, earlier.
2. Any of a series of substantially equal payments made at least once a year over any of the following periods.
   1. The employee's life or life expectancy.
   2. The joint lives or life expectancies of the employee and beneficiary.
   3. A period of 10 years or longer.
3. A hardship distribution from a 401(k) plan. (No hardship distribution made after December 31, 2001, will qualify as an eligible rollover distribution.)
4. The portion of a distribution that represents the return of an employee's nondeductible contributions to the plan. See Employee Contributions, earlier.
5. A corrective distribution of excess contributions or deferrals under a 401(k) plan and any income allocable to the excess, or of excess annual additions and any allocable gains. See Correcting excess annual additions, earlier, under Limits on Contributions and Benefits.
6. Loans treated as distributions.
7. Dividends on employer securities.
8. The cost of life insurance coverage.

More information. For more information about rollovers, see Rollovers in Publications 575 and 590.

Withholding requirement. If, during a year, a qualified plan pays to a participant one or more eligible rollover distributions (defined earlier) that are reasonably expected to total $200 or more, the payor must withhold 20% of each distribution for federal income tax.

Exceptions. If, instead of having the distribution paid to him or her, the participant chooses to have the plan pay it directly to an IRA or another eligible retirement plan (a direct rollover), no withholding is required.

If the distribution is not an eligible rollover distribution, defined earlier, the 20% withholding requirement does not apply. Other withholding rules apply to distributions such as long-term periodic distributions and required distributions (periodic or nonperiodic). However, the participant can still choose not to have tax withheld from these distributions. If the participant does not make this choice, the following withholding rules apply.

• For periodic distributions, withholding is based on their treatment as wages.
• For nonperiodic distributions, 10% of the taxable part is withheld.

Estimated tax payments. If no income tax is withheld or not enough tax is withheld, the recipient of a distribution may have to make estimated tax payments. For more information, see Withholding Tax and Estimated Tax in Publication 575.

Tax on Early Distributions

If a distribution is made to an employee under the plan before he or she reaches age 59 1/2, the employee may have to pay a 10% additional tax on the distribution. This tax applies to the amount received that the employee must include in income.

Exceptions. The 10% tax will not apply if distributions before age 59 1/2 are made in any of the following circumstances.

• Made to a beneficiary (or to the estate of the employee) on or after the death of the employee.
• Made due to the employee having a qualifying disability.
• 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 5 years or until the employee reaches age 59 1/2, whichever is the longer period.)
• 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.
• Made to an alternate payee under a qualified domestic relations order (QDRO).
• 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).
• Timely made to reduce excess contributions under a 401(k) plan.
• Timely made to reduce excess employee or matching employer contributions (excess aggregate contributions).
• Timely made to reduce excess elective deferrals.
• Made because of an IRS levy on the plan.

Reporting the tax. To report the tax on early distributions, file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. See the form instructions for additional information about this tax.

Tax on Excess Benefits

If you are or have been a 5% owner of the business maintaining the plan, amounts you receive at any age that are more than the benefits provided for you under the plan formula are subject to an additional tax. This tax also applies to amounts received by your successor. The tax is 10% of the excess benefit includible in income.

5% owner. You are a 5% owner if you meet either of the following conditions at any time during the 5 plan years immediately before the plan year that ends within the tax year you receive the distribution.

• You own more than 5% of the capital or profits interest in the employer.
• You own or are considered to own more than 5% of the outstanding stock (or more than 5% of the total voting power of all stock) of the employer.

Reporting the tax. Include on Form 1040, line 58, any tax you owe for an excess benefit. On the dotted line next to the total, write "Sec. 72(m)(5)" and write in the amount.

Lump-sum distribution. The amount subject to the additional tax is not eligible for the optional methods of figuring income tax on a lump-sum distribution. The optional methods are discussed under Lump-Sum Distributions in Publication 575.

Reversion of Plan Assets

A 20% or 50% excise tax is generally imposed on the cash and fair market value of other property an employer receives directly or indirectly from a qualified plan. If you owe this tax, report it in Part XIII of Form 5330. See the form instructions for more information.

Notification of Significant Benefit Accrual Reduction

For plan amendments taking effect after June 6, 2001, the employer or the plan will have to pay an excise tax if both the following occur.

• A defined benefit plan or money purchase pension plan is amended to provide for a significant reduction in the rate of future benefit accrual.
• The plan administrator fails to notify the affected individuals and the employee organizations representing them of the reduction in writing. Affected individuals are the participants and alternate payees whose rate of benefit accrual under the plan may reasonably be expected to be significantly reduced by the amendment.

A plan amendment that eliminates or significantly reduces any early retirement benefit or retirement-type subsidy significantly reduces the rate of future benefit accrual.

The notice must be written in a manner to be understood by the average plan participant and provide enough information to allow each individual to understand the effect of the plan amendment. It must be provided within a reasonable time before the amendment takes effect or September 7, 2001, whichever is later.

The tax is $100 per participant or alternate payee for each day the notice is late. It is imposed on the employer, or, in the case of a multi-employer plan, on the plan.

There are certain exceptions to, and limitations on, the tax. The tax does not apply in any of the following situations.

• The amendment takes effect after June 6, 2001, and notice was provided before April 25, 2001, to participants and beneficiaries adversely affected by the amendment (or their representatives) to notify them of the nature and effective date of the amendment.
• The person liable for the tax was unaware of the failure and exercised reasonable diligence to meet the notice requirements.
• The person liable for the tax exercised reasonable diligence to meet the notice requirements and provided the notice within 30 days starting on the date the person knew or would have known that the failure to provide notice existed.

If the person liable for the tax exercised reasonable diligence to meet the notice requirement, the tax cannot be more than $500,000 during the tax year. The tax can also be waived to the extent it would be excessive or unfair if the failure is due to reasonable cause and not to willful neglect.