In Service Distribution

[Lori H]

A doctor(age 60), who is the only active employee in a terminated pension plan, wants to take a portion of his account balance ($17,000). He has been advised that 20% with holding is not required. From reading prior posts, it appears as if he is being given incorrect information. He is not terminated and will not be taking installment or periodic payments. Is he subject to the 20% and ordinary income or just the ordinary income?

[Bird]

It is subject to 20% withholding. The distribution will be taxed at ordinary income rates when he does his taxes at the end of the year.

[JanetM]

Terminated Plan??? Doesn't that mean all the assets have to be distributed? Seems to me he should just roll to an IRA for ease of administration if the plan is terminated.

[Lori H]

OK, here is the Drs. intention, he just received this month a $21,250 in service dist of which $4250 was to go to pay the 20% with holding. His intention is to take annual in service distributions until the PC, of which he is now the only employee, goes out of business. The 2006 401(k) answer book states that "In service withdrawals are taxable as ordinary income when received and generally are treated as installment distributions". It mentions nothing regarding 20% mandatory with holding. I know hardhips are not subject to 20% mandatory with holding, but I am not sure about In Service Withdrawals.

[Lori H]

Terminated Plan??? Doesn't that mean all the assets have to be distributed? Seems to me he should just roll to an IRA for ease of administration if the plan is terminated.

the plan is termed by corporate resolution. They have held off on distributions due to good investments. All but one Dr is classified as Terminated. So, no, all assets are not distributed. Maybe a better term would have been Frozen?

[JanetM]

Frozen would be better. After termination the expectation is to distribute assets.

[Guest b2kates]

look at IRC 3405, it is my recollection that only lump sum distributions are subject to mandatory withholding.

periodic payments are subject to voluntary withholding per w-4P

[Belgarath]

Depends upon the periodic payment. Many periodic payments are "eligible rollover distributions." If so, then mandatory withholding applies. If not an ERD, then as B2kates mentions, recipient can elect out of withholding.

[Lori H]

I read IRC 3405 (thanks for the ref) and b2kates and belgarath you are both correct in your statements, 20% mandatory with holding is only required if the periodic payment is an "eligible rollover distribution". However if an "eligible rollover distribution" is a dist. of all or any portion of the balance to the credit of an employee's account in a qualified plan and an exception to the general rule defining "eligible rollover distributions is "any distribution that is part of a series of substantially equal periodic payments made not less frequently than annually over the life of the employee" or for a period of ten years or more, it would seem that if the Dr. is wanting to take out periodic payments for a couple of years and then at some point take the remaining balance in lump sum, then this would constitute a eligible rollover distribution and BE SUBJECT TO 20% with holding since the intention is not to take them for a period of at least 10 years. Incidentally, the Dr. in question is wanting to give 50% of his income to his church.

[Belgarath]

I agree - the distribution you describe would be subject to the mandatory withholding.

[Lori H]

Can someone recommend a gentle way to convey this to him as both his CPA and financial advisor have told him he does NOT need to withhold 20%. That it is not subject to mandatory withholding since it is a periodic payment and not a lump sum.

[Bird]

"Sorry, but 'periodic' payments not subject to mandatory withholding are defined narrowly and we don't believe these are 'periodic' payments."

Then solve the problem by suggesting he roll over to an IRA and then take distributions from the IRA - or send money directly to the charity from the IRA, as you noted earlier.

[Lori H]

Bird

They are not periodic payments because: 1) they are not being made over the period of the Doctors life, 2) they are not going to be equal or 3) they will not be taken for a period of 10 years??? He has made a pledge to his church and is wishing to satisfy that pledge with these funds.

Thanks a heap!

[Lori H]

I just advised this Doctor that his in service distribution would be subject to mandatory with holding and he replied via email with this: "just so you understand, I fully intend on paying W/H as I go but my

tax rate at the end of 2007 will be nowhere near 20% (i.e. it will only be

about 11.5% for 2006). Does your definition of "mandatory" mean a 20%

minimum? Additionally, my plans are to draw down funds as I need them at

no particular time of month (or indeed I may draw done a large amount at

once to last me 3-4 months). This, from a practical standpoint, will be

very "periodic". There will be nothing "regular" about my timing in drawing

down the funds, i.e. the first of every month, etc. Let me know what you

think."

Thoughts please

[Guest Pensions in Paradise]

The plan administrator is required to withhold 20% if the distribution is not a periodic payment at the moment of distribution. Future intent does not come into play.

Or put it this way..... what distribution option will the participant be checking off on the election form? He's going to be checking off partial lump sum payment. Hence its not a periodic payment.

[Belgarath]

In your return e-mail to the Doctor, why not give him the code references, with the applicable excerpts, so that he can show them to his own tax counsel? Maybe that will save you some of the back and forth. If after reviewing the applicable citations the CPA still hasn't seen the light, then you might suggest nicely to the Doctor that you are a professional as well, and you simply do not agree with the CPA. If he doesn't come around to your position, make sure to put in writing that you absolutely refuse to accept any liability for his decision to ignore the appropriate mandatory withholding. Sometimes you just can't save people from themselves, no matter how hard you try!

I'm betting that the CPA will agree once the appropriate info is stuck under his/her nose.

[Lori H]

Thanks, it appears as if the doctor is just not wanting to give 20% of his income to the IRS when he is planning on being in a lower bracket hence an interest free loan to the government.

[Guest Harry O]

Assume the doctor takes a $100 withdrawal and you withhold $20. He then gives $50 to his church and gets a charitable deduction for this amount. His taxable income is now $50. Your $20 withholding means he has "paid" taxes at a 40% rate when the maximum tax rate is 35% and his actual rate may be even lower. Bummer. But too bad. There is no doubt that these payments are subject to 20% withholding. If he had a smarter financial advisor or CPA they would do what was recommended a few posts ago - make an eligible rollover distribution to an IRA with no withholding and then withdraw the amount from the IRA to pay the church with no withholding.

Good luck. Dealing with professional advisors who are blockheads is no fun.