Plan Distributions

Distributions from a plan can be paid either as a single lump sum or in installments. There are special rules that apply to both.

Installments. The calculation of the annual distribution is determined by the employee's life expectancy. Although an employee may defer receipt of the distributions, the employee must begin taking distributions by April 1 of the calendar year after the year in which the participant turns age 70 1/2 or, if later, the year the participant retires.

The distributions may be distributed over:

• the life of the employee
• the lives of the employee and a designated beneficiary (e.g., a spouse)
• a period not extending beyond the life expectancy of the employee or the joint life and last survivor expectancy of the employee and the designated beneficiary

In the event the employee dies before any distributions are made, under what is referred to as the five-year rule, the entire interest of the employee must be distributed as of December 31 of the calendar year containing the fifth anniversary of the employee's death. There is one exception to the five-year rule, which says that any portion of an employee's interest that is payable to or for the benefit of a designated beneficiary must be distributed, beginning within one year of the employee's death, over the life of the beneficiary or a period not extending beyond the life expectancy of such beneficiary.

Lump sum. Lump-sum distributions trigger special tax rules. The tax treatment of lump-sum distributions depends on how old the employee is and which years the employee participated in the plan.

The general rule is that if the individual accepts the lump sum and does not roll it over into an eligible IRA, the entire amount is taxable that year at regular income tax rates. If the individual attained age 50 on or before January 1, 1986, the individual can use five-year averaging at present tax rates or 10-year averaging at 1986 rates, whichever is better for the individual. As of the year 2000, five-year averaging is no longer available.

If the lump sum is rolled over into an eligible retirement account, no tax is due until distributions are taken from the account under the usual rules.

There are also special rules involving annuity contracts received as part of lump-sum distributions, employee securities included as part of lump-sum distributions, and lump-sum distributions received from a disqualified plan.

To qualify as a lump-sum distribution, the distribution must have been made for one of the following reasons:

• the employee's death
• the employee has reached age 59 1/2
• the employee has quit or has been fired (for this purpose, a self-employed person is not considered an employee)
• a self-employed has become disabled

Communications. A plan administrator must provide plan participants with the following information about plan distributions:

• the tax implications of a plan distribution
• which distributions are eligible for tax-free rollover treatment
• information about forward averaging

A plan administrator must provide those who are receiving a distribution with the following information:

• a summary plan description
• documents summarizing the latest annual reports
• a statement of the individual's total accrued benefit
• a registration statement