Paying out EE Contribution portion "first"?

[Guest fcdeacy]

Is it permissible to pay out the employee contribution portion of a pension benefit first?

We have a plan that brought several employers together. Two of the employers had plans where employees contributed after-tax. All of these different plans were "rolled-up" into the current plan. We have continued to account for all of the employee contributions but when an employee leaves we would like to pay that amount first if possible. We have situations where employees terminate and rehire all the time and the administration can get very cumbersome.

Further clarification-

We are looking to pay the employee contributions out first, when distribution is sought by employee according to plan document provisions.

So, employee requests distribution, employee contributions are first ones out the door.

Any guidance on this issue would be greatly appreciated.

Thanks,

Fred

[SoCalActuary]

What type of distribution are you discussing, lump sum or annuity?

Lump sum payment covers the entire balance, and after-tax money can be recovered without rollover.

Annuity payments are subject to recovery of "Basis" over the period of the annuity. See IRC 72 for more details. The simplified rule in effect since 1996 governs here.

[david rigby]

Is this a continuation of earlier discussion?

http://benefitslink.com/boards/index.php?showtopic=28726

[Effen]

Lump sum payment covers the entire balance, and after-tax money can be recovered without rollover.

SoCal, I know I am going way back, but what did you mean by this?

Let say my lump sum from a contributory db plan is $100,000. Of this $20,000 is the sum of my post tax employee contributions (no interest, just the amount I put in).

If I elect to take $20,000 in cash and rollover the other $80,000 into an IRA do I owe any tax on the $20K?

I'm thinking 80% of the 20K is still taxable, but I can't find anything that states this clearly. Is IRS Section 72(e)(8) my best site? I was pretty confident until I read this old post and now you have me wondering if I am correct?

[GMK]

A related thread:

http://benefitslink.com/boards/index.php?s...amp;hl=pre-1987

[SoCalActuary]

Lump sum payment covers the entire balance, and after-tax money can be recovered without rollover.

SoCal, I know I am going way back, but what did you mean by this?

Let say my lump sum from a contributory db plan is $100,000. Of this $20,000 is the sum of my post tax employee contributions (no interest, just the amount I put in).

If I elect to take $20,000 in cash and rollover the other $80,000 into an IRA do I owe any tax on the $20K?

I'm thinking 80% of the 20K is still taxable, but I can't find anything that states this clearly. Is IRS Section 72(e)(8) my best site? I was pretty confident until I read this old post and now you have me wondering if I am correct?

Part of the issue is the subtle distinction on trustee accounting. If the trustee will not accept after-tax funds because they do not intend to account for them separately, then the non-taxable portion cannot be rolled. This is a relatively undocumented issue that directly affects your client's plans.

If the trustee can accept after-tax funds with proper accounting, then you have more of a fight on your hands, because the IRS expects you to pro-rate the accounts. Good luck on that.

[Effen]

Thank you, but now I'm really confused (referring to GMK's link). Where does it say in the Code or Regs that pre-87 employee contributions can be taken without taxation?

Found it:

72(e)(8)(D) INVESTMENT IN THE CONTRACT BEFORE 1987. --In the case of a plan which on May 5, 1986, permitted withdrawal of any employee contributions before separation from service, subparagraph (A) shall apply only to the extent that amounts received before the annuity starting date (when increased by amounts previously received under the contract after December 31, 1986) exceed the investment in the contract as of December 31, 1986.

Pg. 26 of IRS Publication 575 says "If you roll over only part of a distribution that includes both taxable and nontaxable amounts, the amount you roll over is treated as coming first from the taxable part of the distribution"

So doesn't that mean if I rollover $80K of my $100K distribution it will be treated as the taxable portion, and therefore, the $20K remaining will be non-taxable?

... Or is this the contradiction/error referenced in the linked post because the language in Publication 575 contradicts 72(e)(8)(B)?