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How Can a Distribution Be Made?
I. Defined Contribution Plan
All DB plans must specify the plan's "normal form of benefit" – the benefit that is used for defining the promised benefit under the plan's benefit formula. Typically, the normal form of benefit is the single life annuity. Some plans define the normal form of benefit as a joint and survivor annuity. All benefit forms other than the "normal form of benefit", i.e., "optional forms of benefit", from a DB plan must be "actuarially equivalent" to the plan's normal form of benefit. The plan must specify the actuarial assumptions used to determine actuarial equivalence, e.g., the present value of a participant's vested accrued benefit for purposes of any lump sum benefit payment. [IRC § 401(a)(25).
A. Annuity Forms
The annuity method of payment is payable for either one lifetime (e.g., for the life of the participant) or two lifetimes (e.g., for the lifetime of the participant and then for the lifetime of the participant's beneficiary following the participant's death). Annuity payments are usually equal payments that are made over the individual's lifetime on a monthly, quarterly or annual basis. Annuities under a DB plan are guaranteed by the plan regardless of the current value of the plan's assets and are actuarially determined by the plan's benefit formula. For cash balance DB plans, the amount of annuity is determined by converting the participant's hypothetical account into an actuarially equivalent annuity using the plan's actuarial assumptions.
1. Qualified Joint and Survivor Annuity (QJSA) – IRC §401(a)(11) requires a plan to provide a QJSA as a benefit form, unless an exception applies. The following plans are required to provide a QJSA: DB plans and the following DC plans – money purchase plans and target benefit plans. A married participant must receive his/her benefit as a QJSA unless the participant elects a different benefit form and his/her spouse consents to such election. An unmarried participant must be offered a life annuity. Treas. Reg. §1.401(a)-20, A-25.
a)QJSA – A QJSA is a joint and survivor annuity that must be no greater than 100% and no less than 50% of the annuity paid during the participant's lifetime. [IRC §417(b)] The QJSA must also be at least as valuable as any other optional form of benefit under the plan. For married participants, the QJSA must be at least as valuable as the most valuable optional form of benefit payable at the same time. Treas. Reg. §1.401(a)-20,Q&A 16. A 50% QJSA would provide the participant's surviving spouse with an annuity equal to 50% of the participant's annuity payment. A 100% QJSA would pay the participant's surviving spouse the same annuity payment that the participant received. The plan must specify the QJSA available.
b) QOSA (Qualified Optional Survivor Annuity) – Pension Protection Act of 2006 amended IRC §417(a)(1)(A)(ii) to require plans to offer a QOSA for plan years beginning after December 31, 2007 (note – a delayed effective date applies to collectively bargained plans). The QOSA is 50% or 75% of the participant's annuity payment depending on the plan's QJSA – i.e., if the plan offers participants a QJSA with a survivor percentage that is less than 75% (e.g., a 50% QJSA) , then the plan must offer a 75% survivor annuity option (75% QOSA, plans often call this option the "75% QJSA"). If the plan offers a QJSA that has a survivor percentage that is 75% or more, then the plan must offer a 50% survivor annuity option (50% QOSA). See IRC §417(g).
c) Qualified Pre-Retirement Spousal Annuity (QPSA) – If a plan is required to offer a QJSA, it must also provide for a QPSA. The QPSA is payable if the participant dies before receiving any plan benefits, unless the surviving spouse waives the benefit. A QPSA under a DB plan must be calculated in the same way the survivor annuity is calculated under a QJSA and takes into account the participant's vested accrued benefit as of the date of his/her death. If the participant attained the plan's earliest retirement age prior to his/her death, the QPSA is calculated as if the participant had retired on the day before his/her death and commenced receipt of the QJSA. If the participant had not yet attained the plan's earliest retirement age, the QPSA is calculated as if the participant separated from service on his/her date of death, survived to the earliest retirement age, commenced the QJSA at the earliest retirement age, and died the next day. IRC §417(c)(1).
d) The earliest retirement age is the earliest date that a participant is allowed to elect a distribution under the plan, IRC §417(f)(3). If a plan permits distribution upon severance from employment, the earliest retirement age is the earliest age at which a participant could terminate employment and receive a distribution, Treas. Reg. §1.401(a)-20, A-17(b).
e) The QPSA must be made available no later than the month in which the participant would have reached the plan's earliest retirement age.
1. Single Life Annuity – annuity payable over the lifetime of the participant. This benefit form is the normal form of benefit for unmarried participants. This benefit form can be waived in favor of an optional form of benefit. The single life annuity must be made available for election to married participants if the plan does not fully subsidize the QJSA (i.e., the participant's benefit is reduced when the single life annuity is converted to a QJSA).
2. Optional Forms of Payment – Note: Optional forms of payment are subject to the anti-cutback rules of IRC §411(d)(6). As such, they generally may not be eliminated or changed with respect to any accrued benefits as of the date of the amendment. However, a plan generally may eliminate actuarially equivalent joint and survivor annuity options other than those with the smallest and largest survivor benefits, Treas. Reg. §1.411(d)(4), Q&A-2.
a) Joint & Survivor Annuity – Annuity benefit is paid to the participant for his lifetime and a survivor benefit is payable to the participant's beneficiary for his lifetime. The survivor benefit generally is equal to at least 50% and not more than 100% of the participant's benefit.
b) Annuity with Term Certain Feature –A plan may offer an annuity form that provides payments over a guaranteed term, even after the participant's death. For example, a plan may provide for a life annuity with a 4 year certain. The annuity is payable for the lifetime for the participant, but if the participant dies before receiving 4 years' worth of benefits, the participant's beneficiary receives the annuity payments for the remainder of the 4 year period.
c) Installment Payments –This payment method consists of periodic payments (e.g., monthly or annually) over a specified period of time (e.g., over a number of years or a life expectancy period). Installment distributions are not common for DB plans. Such distributions are usually a specific uniform dollar amount that is payable over a specified number of years. Payments must be actuarially equivalent to the plan's normal form of benefit. Unlike annuity payments, installment payments that are made over a life expectancy period are not guaranteed for the participant's lifetime. For example, if a participant's life expectancy is 20 years at the time installment payments begin and the participant dies before the 20-year period, the participant's beneficiary will receive benefits payable for the remainder of the 20 life expectancy period. Conversely, if the participant outlives his 20 life expectancy period, installment payments will cease once the 20-year period ends.
d) Lump Sum Benefit –This payment method consists of a single sum payment that is the present value of the participant's vested accrued benefit. The present value of a benefit using the plan's actuarial assumptions must not be less than the present value calculated using the "applicable mortality table" and "applicable interest rate" provided in IRC § 417(e). [Minimum present value, see IRC § 411(a)(11)]
II. Defined Contribution Plan
Because the amount of any distribution from a DC plan is not guaranteed, such amount is directly affected by the plan's valuation method, frequency of valuation dates and the timing of distributions. The normal form of benefit is usually the single sum or lump sum benefit.
A. Profit Sharing Plans
1. QJSA – Profit sharing – this includes 401(k) plans – and stock bonus plans are exempt from the QJSA requirement if: (1) the participant's death benefit is payable in full to the participant's surviving spouse unless the spouse has previously consented to another beneficiary; (2) the plan does not make a life annuity option available for election or if there is such an option, the participant has not elected the life annuity; and (3) the participant's account balance does not include a direct transfer from another plan that was subject to the QJSA rule.
2. To avoid QJSA rule, 401(k) plans generally will not make a life annuity option available. Also, if an employer acquires another company, the employer generally will not merge the target's QJSA plan into the employer's non-QJSA plan or allow transfers from the target's QJSA plan.
B. Methods of Payment
1. Installment Payments – Amount distributed is usually determined by dividing the participant's vested account balance by the payment term. For example, if benefits are payable in 10 installment payments that are payable on an annual basis, the participant's installment payment in each year is 1/10 of the participant's vested account balance.
2. Lump Sum Payment – Distribution is in a single sum of the participant's entire vested account balance.
3. QPSA – If a DC plan is subject to the QJSA rules (e.g., money purchase plan), the plan can satisfy the QPSA requirement by purchasing a nontransferable life annuity contract for the spouse. The amount used to purchase the annuity must be no less than 50% and no more than 100% of the participant's vested account balance as specified by the plan, IRC §417(c)(2).
4. The spouse must be permitted to commence payment of the QPSA within a reasonable period of time after the participant's death, Treas. Reg. §1.401(a)-20, A-22(b).
5. Optional forms of payment are subject to anti-cutback rules of IRC §411(d)(6). Such forms may be eliminated or amended if the plan continues to maintain a single sum payment option that is otherwise identical to the optional form of payment being eliminated or amended, Treas. Reg. §1.411(d)(4)(A)-2(e). There are other exceptions to the anti-cutback rule, see Treas. Reg. §1.411(d)(4), A-2.
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