Mandatory Employee Contributions: Basis Recovery & Nonforfeitability

[Guest nicko]

It is my understanding that mandatory employee contributions (increased by a certain amount of interest) to a defined benefit plan are nonforfeitable ("Accumulated Employee Contributions"). Code Sec. 411(a)(1).

It is also my understanding that the simplified recovery rules (the "Simplified Method") is used to calculate the taxable and tax free portions of annuity payments made from a defined benefit plan.

Question: How do these two separate concepts fit together?

Hypothetical: Employee participates in a DB plan requiring employee contributions. At retirement, the participant has contributed a total of $10,000 to the plan (and will recover $30 of that amount tax-free per month under the Simplified Method). The participant's Accumulated Employee Contributions equal $15,000 (i.e., the $10,000 she contributed + a certain amount of interest). She will recieve a monthly single life annuity of $500. The plan provides that a beneficiary will receive any unrecovered Accumulated Employee Contributions that exist at the participant's death.

Assume the participant dies after receiving 10 monthly payments. At that point she has recovered $300 of her tax basis ($30*10) and $5000 (500*10) of her nonforfeitable Accumulated Employee Contributions. Who gets to recover the still unrecovered tax basis? Is it taken into account on the participant's final tax return, or does it go to the beneficiary who will receieve the unrecovered Accumulated Employee Contributions? Do you think Code Section 72(b)(3)© answers the question?

Thanks

[My 2 cents]

My recollection is that the unrecovered basis goes with the proceeds. That is, the beneficiary in your example would receive a lump sum payment of $10,000 ($15,000 less the $5,000 already paid), of which $9,700 (the original basis of $10,000 less the $300 basis already returned) represents a return of basis. But that is just my recollection.