Payments from Qualified Pension Plans - What are the Choices?

Posted on Thu, Jun 04, 2015 ©2021 Drucker & Scaccetti


As defined contribution plans (e.g., 401(k) plans) continue to grow in popularity, it’s easy to forget that another type of retirement plan exists; the noncontributory qualified defined benefit plan (e.g., pension plan).  Regardless of their age, employees who are fortunate enough to be covered by a defined benefit plan (“DBP”) should know how and when they, their spouses, or other beneficiaries will be entitled to receive benefits under the plan. Here's an overview of some of the essential rules.

 

When Payments May Commence

Distributions from a DBP typically are made in the form of an annuity.  Distributions to an employee generally are allowed only after the employee has either (1) retired, or (2) reached "normal retirement age" (typically age 65, but could be earlier).

 

An employee, who has a vested interest in a DBP but leaves before retirement, typically will have to wait to receive his annuity benefit until he attains the plan's normal or early retirement age.  A vested interest simply means the amount of benefits the employee is entitled to under the DBP.  However, some plans will make a lump-sum payment to departing employees instead of making them wait until a certain age to collect benefits. This lump-sum distribution can generally be rolled over tax free to an eligible retirement plan (including an IRA).

 

If the DBP allows lump-sum distributions, the lump sum must be equal to the present value (“PV”) of the future annuity to which the participant is entitled.  The Internal Revenue Code contains the specifics of how the PV must be calculated.  Generally, lower interest rates translate to higher lump payments under these rules.

 

Survivor Annuities

Which plans must provide survivor annuities?

The survivor annuity requirements of the Internal Revenue Code generally apply to all DBPs. However, certain exceptions exist such as certain money purchase plans that are part of an employee stock ownership plan.

 

Qualified joint and survivor annuity (QJSA)

Under this form of benefit, retirement benefits are paid as a life annuity to the participant and as a survivor annuity to the participant’s surviving spouse over the life expectancy of that spouse following the participant's death.  The monthly survivor benefit must be at least 50% of the joint benefit.  Payments may also be made to a former spouse, child or dependent who must be treated as a surviving spouse under a qualified domestic relations order (“QDRO”).

 

Qualified pre-retirement survivor annuity (“QPSA”)

DBPs must provide a QPSA payable to the participant's surviving spouse if the vested participant dies before the annuity starting date and has a surviving spouse.  A QPSA is a form of death benefit paid as a life annuity to the surviving spouse of a participant who (a) was vested in his or her retirement plan benefits, (b) died before retirement, and (c) was married to the surviving spouse generally for at least a year.  Similar to the QJSA, the life annuity can be paid to a former spouse, child or dependent that would be treated as a surviving spouse under a QDRO.

 

Qualified optional survivor annuity (QOSA)

Both qualified survivor annuities discussed above must offer participants an election to have benefits paid in the form of a QOSA.  A plan participant may elect (with spousal consent, if married) to waive the QJSA form of benefit, the QPSA form of benefit, or both.  A participant electing to waive a QJSA or QPSA, must be allowed to timely elect a QOSA.

 

A QOSA is an annuity for the life of the participant's spouse that is equal to a specified percentage of the amount of the annuity that is (1) payable during the joint lives of the participant and the spouse, and (2) the actuarial equivalent of a single life annuity for the life of the participant (or a distribution option having the effect of such an annuity).  The benefit amount under the QOSA is generally based upon the benefit amounts determined under the QJSA rules.

 

Other Benefit Payment Options and Considerations

Single-life annuity

In general, if a participant is unmarried, payments from a DBP are made in the form of a single-life annuity.  A married participant also can choose a single-life annuity if the participant's spouse consents.

 

Lump-sum payouts

A plan may provide that, if the PV of a QJSA or a QPSA is $5,000 or less, the entire PV of the benefit will be immediately distributed to the participant.  However, if the PV of the benefit is more than $5,000, a lump-sum distribution can only be made with the participant's (and spouse's, if applicable) written consent.

 

Payments to same-sex spouses or domestic partners

Under section 3 of the Defense of Marriage Act of 1996, before it was found to be unconstitutional by the Supreme Court's Windsor decision in 2013, a qualified plan could not define the term "spouse" for its QJSA to include a same-sex spouse or domestic partner. Subsequent to the Windsor decision, Revenue Ruling 2013-17 held that for federal tax purposes, the terms "spouse," "husband and wife," "husband," and "wife" include an individual married to a person of the same sex if the individuals are lawfully married under state law, and the term "marriage" includes such a marriage between individuals of the same sex.

 

Under IRS Notice 2014-19, any retirement plan qualification rule that applies because a participant is married must be applied with respect to a participant who is married to an individual of the same sex.   Thus, all prior rules discussed regarding spousal benefits and the requirement of spousal consent is also applicable to same-sex couples.

 

Having a defined benefit plan presents multiple options for receiving retirement benefits.  The Tax Warriors® at Drucker & Scaccetti have assisted others with reviewing their options and are available to help determine the option that best fits your long-term goals.  Call on us. We are always prepared to help with this or any tax-related matter.

Topics: Pension, payments, Tax, beneficiaries, defined contribution plan, benefit, qualified

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