Periodic Payments from Employer-Sponsored Retirement Plans

In General

You may be able to take distributions from your employer-sponsored retirement plan in the form of periodic payments. As the name suggests, periodic payments are a series of distributions that are spread out over time. In most cases, the payments are made to you on a monthly or other regular basis. Unlike discretionary distributions, periodic payments typically lock you into a distribution schedule ahead of time.

Different kinds of periodic payments may be available to you as a retirement plan participant, depending on the particular type of plan and the provisions of the plan. You should consult your plan administrator or your employer's benefits department to gain a clear understanding of the distribution options available to you. You should also speak with a professional advisor regarding tax implications and other issues.

Tip: If you participate in a defined benefit pension plan, your distribution options are typically limited to some form of periodic payment. For more information, see the sections below on qualified joint and survivor annuity and qualified pre-retirement survivor annuity.

Annuities

An annuity is an investment contract issued by a life insurance company or other financial institution. Funds grow tax deferred in the annuity until distributed to you. You generally give up control of your funds in return for a series of fixed monthly payments that continue over your lifetime, over the combined (joint and survivor) lifetime of you and another individual, or over a specified time period (a "term certain").

The amount of each payment depends on the amount you invest in the annuity, the rate of investment return, and the applicable life expectancy. There are many different types of annuities that have different investment options and other features. Plans known as 403(b) plans are often funded with the purchase of annuity contracts for participating employees.

Caution: Annuity guarantees are subject to the claims-paying ability of the insurance company.

Qualified Joint and Survivor Annuity

A defined benefit plan guarantees you a certain monthly benefit payment at retirement. Such plans must provide the option of a qualified joint and survivor annuity (QJSA) to certain married participants who meet IRS requirements. A QJSA provides a monthly annuity payment for as long as either you or your spouse is alive. The payments under a QJSA are generally smaller than with a single-life annuity because they continue until both you and your spouse have died.

(The single-life annuity provides a larger monthly payment because all payments must stop once you, the plan participant, die.) The spousal survivor benefit of a QJSA will typically be 50 percent of the amount you receive during your joint lives. However, depending on the terms of your employer's plan, you may be able to elect a spousal survivor benefit ranging from 50 to 100 percent of the amount you receive during your joint lives. (Generally, the greater the survivor benefit, the smaller the amount you will receive during your lifetime.) In addition, your spouse's survivor benefits cannot be terminated or reduced if he or she remarries after your death.

In addition to defined benefit plans, some defined contribution pension plans (e.g., money purchase pension plans) must offer a QJSA as an option for married participants. Profit-sharing plans and stock bonus plans must offer a QJSA unless (1) the vested benefit is payable in full to the spouse or other beneficiary (if the spouse consents) upon your death, (2) you did not elect a single-life annuity as your payout option, and (3) with respect to the participant, the plan is not a "transferee plan" or an "offset plan." Consult a tax advisor for details.

You may waive the QJSA with your spouse's written consent during the waiver period. Assuming the QJSA is available to you, and your spouse would agree to a waiver, the two of you may have a difficult decision to make. If you opt for the QJSA, you have the security of knowing that your spouse will receive a guaranteed monthly income after you die. Also, choosing a QJSA often entitles both spouses to continued health coverage and other benefits that might otherwise be lost.

On the other hand, waiving the QJSA in favor of a single-life annuity or other payout will often increase the monthly benefit. That additional income might enable you to purchase life insurance to protect your spouse after your death. (This option is often referred to as "maximizing your pension with life insurance"). If a QJSA is offered, you and your spouse should receive an explanation of the QJSA (including your right to a waiver) and discuss your options before making an election.

Tip: For plan years beginning after December 31, 2007, the Pension Protection Act of 2006 provides that if the survivor annuity provided by a plan's QJSA is less than 75 percent, a participant must be allowed to instead elect a 75 percent survivor annuity. If the survivor annuity provided by the plan's QJSA is greater than or equal to 75 percent, the participant must be allowed to instead elect a 50 percent survivor annuity. This qualified optional survivor annuity is actuarially equivalent to a single annuity for the life of the participant. (Generally, a later effective date applies to collectively bargained plans.)

Qualified Pre-Retirement Survivor Annuity

If you are a married participant in a defined benefit plan or a defined contribution plan in which you have vested retirement benefits, and you die before you begin receiving distributions from the plan, your spouse (as the presumed beneficiary) may receive what is known as a qualified pre-retirement survivor annuity (QPSA). For defined benefit plans, the QPSA is generally an immediate annuity payable for your surviving spouse's life equal in value to the QJSA benefit your surviving spouse would have received if you had retired upon reaching the plan's earliest retirement age (or, if later, your date of death). For defined contribution plans, the QPSA is an immediate annuity equal in value to at least 50 percent of your vested account balance as of your date of death.

Retirement plans (profit-sharing plans, stock bonus plans, and 401(k) plans) that are not required to offer a QJSA (see above) are not required to offer a QPSA. In general, though, all other qualified plans must offer a QPSA, as well as a QJSA. You generally may waive the right to a QPSA and instead have your death benefits paid in some other form, or to a beneficiary other than your spouse, but only if the plan permits such an election and your spouse consents to the waiver in a timely filed and witnessed writing. If you waive the QPSA, your spouse will not receive any annuity benefits should you die prior to retirement. If a QPSA is offered, you and your spouse should receive an explanation of the QPSA (including your right to a waiver) and discuss your options before making an election.

Installment Payments

Depending on the distribution options your plan offers, you may be able to receive installment payments from the plan in one of several ways:

• Fixed period of time: You may choose to receive payments over a fixed period, such as 10 or 15 years. The period of time cannot be longer than your life expectancy or the joint and survivor life expectancy of you and your beneficiary. Payments are set in an amount that will deplete the account balance by the end of the specified period. Payments will typically be adjusted upward or downward if actual investment returns are different than anticipated.
• Based on a life expectancy calculation: You may choose to receive payments based on a specified life expectancy calculation, such as over your single life expectancy. The applicable life expectancy figure is determined by referring to IRS tables. This option is similar to the fixed period of time option, but the payout period to be used is not a specified number of years. Instead, it is based on the applicable life expectancy.
• Fixed amount until balance is exhausted: You may choose to receive regular payments in a fixed amount that will be paid periodically until there are no funds left in the account. The payments are made on specified payment due dates. Some assumption as to future investment returns is necessary to estimate the length of the payment period. The actual period may vary depending on investment results, but the amount of each payment never varies.
• As needed: This highly flexible arrangement permits you to withdraw from your account on a variable basis as you need the funds. You may receive a certain amount on regular payment dates for a fixed period, or you may choose to receive any amount at any time. This arrangement is the equivalent of taking discretionary distributions from your retirement plan.
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Taxation of Periodic Payments

In general, retirement plan distributions are subject to ordinary federal (and possibly state) income tax. The one exception is if you have ever made any after-tax contributions to your plan account. Those dollars have been taxed once already, so they will not be taxed again when they are paid out to you. If your plan account contains any after-tax contributions, a portion of each periodic payment made to you will not be subject to income tax. (Special rules apply to Roth 401(k), 403(b), and 457(b) plans.)

For example, here is how the taxation of annuity payments generally works. The portion of each payment that is excluded from federal income tax is a level dollar amount determined by dividing your investment in the contract by a set number of annuity payments based on tables provided by the IRS. The IRS tables set out a certain expected number of monthly payments related to the age of the participant when payments begin.

Example(s): David expects to get $12,000 per year for life in monthly installments of $1,000 beginning one month after he retires. David retires at age 60. David has made after-tax contributions to the plans totaling $24,000. According to the IRS tables, the expected number of annuity payments for an annuitant age 56-60 is 310. The amount of each monthly annuity payment that is excluded from David's taxable income for federal income tax purposes is thus calculated as follows: $24,000 (David's investment in contract) / 310 (expected number of payments) = $77.42 Therefore, when David gets each monthly payment, he won't pay taxes with respect to $77.42 of the payment. If he is still receiving monthly payments after a total of 310 monthly payments have been received, the entire amount of each monthly payment after that will be subject to tax. If David dies before receiving 310 monthly payments, and all payments cease by reason of his death, a deduction for the irrecoverable investment in the contract is allowed on David's last income tax return.

Caution: Many periodic payments are not eligible to be rolled over to an IRA or employer-sponsored retirement plan. Consult a tax professional.

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