May Focus: Plan
increasing number of plan participants are taking loans from their
qualified plan accounts such as 401(k)s, profit sharing plans, pension
plans and their 403(b) accounts. This has brought the question of whether
it makes good financial sense to take loans from these plans to the
forefront of the minds of financial professionals and participants alike.
But like most decisions about retirement plan assets, the answer depends
on the specific facts and circumstances that apply to the participant.
When making the decision to take a loan from a retirement account, the
following are some of the points that should be considered:
- The purpose of the loan:
If the loan is being used towards the down payment of a home, or to
prevent foreclosure on a home, the loan may make good financial
sense. Of course, the foreclosure issue can be viewed from two
points. (1) It may help the participant to keep the home and the
equity that has accrued. (2) On the other hand, if the same issues
that caused the foreclosure to come about still exist, it could
result in just throwing good money after bad, thus increasing the
amount the participant will lose.
loan is being used to pay off credit card balances, the loss of
tax-deferred earnings vs the interest that would be repaid on the credit
card balances should be compared. Using a qualified plan loan to pay off
credit card balances, only to have those card balances increased again
afterwards, will result in the participant being worse off. They will
have an additional loan to repay and a reduction in their plan balance at
the same time resulting in a loss of earnings.
ability to repay the loan. If circumstances arise that
result in the participant's inability to repay the loan, the
outstanding loan balance could be treated as a taxable distribution.
This would cause the participant to not only permanently lose the
benefit of tax-deferred growth on the amount, but to be stuck with a
tax-bill based on the outstanding loan amount and possible early
- Change of
jobs may mean a distribution: Most plan sponsors require
participants who leave their employment to repay outstanding loan
amounts shortly after termination of employment. For those who are
unable to pony-up the cash to pay the outstanding loan balance, the
outstanding loan balance could be treated as a taxable distribution.
Again, this amount could be subject to income tax and the early
distribution penalty. If the amount is offset against the
participant's account balance, the participant has 60-days to
rollover the amount to an IRA or other eligible retirement plan so
that the amount is not taxable.
argue that taking a loan is a double negative as (1) the amount disbursed
as a loan no longer has the benefit of accruing tax-deferred earnings in
the account, and (2), the loan repayments are made with funds that are
already taxed and those amounts will be taxed again when withdrawn from
the account. But the truth of the matter is that loans do not result in a
double negative in all circumstances. For instance, if the amount is used
towards the purchase of a home and the property significantly increases
in value, the return on investment in the property can offset or (even)
negate the negative impact of loss of tax-deferred growth and repaying
with already taxed dollars. For some, the intrinsic value of the loan far
outweighs any negative financial impact.
Now that money is
cheap participants should explore other loan options before
leaning on their retirement savings. For those who have no option but to
take loans from their retirement accounts, loan repayments should be made
as quickly as possible so as to restore the amount to the plan. At a
minimum, participants must pay at least what is required under the
amortization schedule so as to prevent the amount from being treated as a
Explanations of the rules that govern IRAs are usually provided in Ed Slott's IRA Advisor Newsletter. If you are not
already a subscriber and want to get an idea of what the newsletter
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of the Month
An individual submitted a request for a distribution of $10,000 and
elected to have 5% withheld for federal taxes. However, the custodian
withheld 10% and insists that 10% is the minimum amount they can
withhold. Is that true?
It depends. The withholding requirements depend on whether the amount is
a periodic payment, non-periodic payment, and if the amount is a rollover
eligible distribution from a qualified plan (such as a 401(k), profit
sharing or pension plan), 403(b) or 457(b) plan.
For this purpose, periodic payments are defined as payments from a pension
plan that are spread out over more than one year (periodic payments).
Non-periodic payments are ad-hoc one-time distributions or distributions
paid within one-year.
For periodic payments from a pension or annuity, the withholding amount
is calculated using the same method that is used to determine withholding
salaries and wages, and the participant would simply instruct the payer
on how much to withhold.
For non-periodic payments, the following applies:
- If the
account is a Traditional, SEP or SIMPLE IRA, the amount withheld for
federal tax must be zero, or any amount that is at least 10%. If the
IRA owner elects to have federal taxes withheld and indicates an
amount less than 10% of the gross distribution amount, the custodian
is required to increase the amount to 10%.
the account is a qualified plan (such as a 401(k), profit sharing or
pension plan), 403(b) or 457(b) plan, the following withholding
- If the
amount is rollover eligible, and is processed as a direct rollover
to an eligible retirement plan, no withholding applies
- If the
amount is rollover eligible, and is paid to the participant,
instead of being processed as a direct rollover, the payer is
required to withhold at least 20% for federal taxes.
- If the
amount is not rollover eligible, the IRA withholding rules apply,
which means the minimum withholding amount is 10%, unless the
participant elects zero withholding.
eligible distributions are defined in IRS Publication 575, available
mind that some payers also perform withholding for state taxes. The
withholding rules for states are different from the withholding rules for
federal tax; further, the withholding rules vary among states. For
instance, a state rule may require withholding only if federal taxes are
withheld, one may require withholding only if requested by the
participant or IRA owner, some have different withholding rules for IRAs
and qualified plans, and the withholding percentages differ.
Special rules apply to amounts that are sent overseas. These are
explained in IRS Publication 515, available at www.irs.gov
Rulings and Other Updates
- TC Memo
2008-93: Issues (1) Whether a 2002 distribution of $25,000 from a
Simplified Employee Pension Individual Retirement Account (SEP-IRA)
is includable in the SEP-IRA owner’s taxable income and (2)
whether the 10 percent early distribution penalty applies to the
Highlights: SEP-IRA owner made a
withdrawal of $25,000 from his SEP-IRA and deposited the amount into his
company's account. Within 60-days, he instructed his bookkeeper to send a
check for the amount to his broker to be deposited as a rollover
contribution to his IRA. The broker did not receive the funds. The
SEP-IRA owner did not include the amount in income, because he thought
the rollover was completed within the 60-day period. He stated that he
was unaware that the rollover was not completed, until he received a
notice from the IRS. He further stated that when he contacted the IRS
(via telephone) for information about how to handle the matter, he was
not provided with information about the IRS’ ability to extend the
60-day period, and was given incorrect information.
The tax court ruled that the amount was includable in income and subject
to the 10% early distribution penalty. Part of their reasoning was that
he should have noticed that the amount was not taken from the company's
200814029: The IRS extended the 60-day rollover period,
for an individual who failed to meet the 60-day deadline, due to
mental impairment. They ruled that the mental impairment adversely
affected her ability to make sound financial decisions and to
understand the consequences of her actions.
Facts/Highlights: Submitted medical
documentation indicated that the IRA owner began to receive treatment for
an irreversible neurological disease two years before the distribution
was made from the IRA. This disease affected her ability to understand
the rollover rules for a matured certificate of deposit (CD), as
explained by her financial institution. The amount was not used for any
purpose, other than the distribution and subsequent rollover. The
rollover, minus her required minimum distribution (RMD) amount, was completed
after the 60-day deadline.
A PLR cannot be cited as precedence or legal reference.
Retirement Planning Tip
When restorative payments are sent to IRAs, be sure to have the IRA
custodian treat the amounts as non-reportable transactions. That is, they
should not be reported on IRS Form 5498 as any type of contribution.
Payments Defined: For
this purpose, restorative payments are amounts paid to the IRA to restore the IRA
balance to what it (by estimation) would have been, had the action from
which the restorative payment resulted did not occur. Examples include a
broker or financial institution being required to reimburse an IRA for
mismanagement of the IRA.
If you send restorative payments to IRA custodians, include as much of
the related documentation as possible, so as to prove that the funds
belong to the IRA. In addition, attach a note explaining the source and
include specific instructions to treat the amount as a non-reportable
credit to the IRA. Leave nothing to chance, and do not assume that the
person who will handle the deposit is familiar with these requirements.
from Ed Slott's IRA Advisor Newsletter - May 2008 Issue
The May 2008 issue of Ed Slott's IRA Advisor is now available online. The
areas covered include the following:
- How A
Stretch IRA was Saved—Even When RMDs were Missed. In this
piece, we discussed the following:
- Facts of
the private letter ruling that was issued by the IRS on the case
background and basic information
- The 50%
excess accumulation penalty
of penalty no longer required with the filing of Form 5329
- Why the
PLR was requested
- Why the
50% excess accumulation penalty was paid
action plan for similar scenarios
Investment Insights: In this piece, this month's guest IRA expert,
Harry S. Dent, Jr., Harvard MBA of the HS Dent Foundation in Tampa,
for the long haul
the portfolio, and he provides
advisor action plan
to review the May issue and post your questions on our message board at http://www.irahelp.com/phpBB/index.php?area=,
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