In Retirement News for Employers (Fall 2011), the Internal Revenue Service (“IRS”) provides guidance on distributions from tax-qualified retirement plans. Here is what the IRS said:
The method by which retirement plan benefits are distributed is determined by options available under the plan and elections made by participants and beneficiaries. Defined contribution plans, such as 401(k)s and profit-sharing plans, generally pay retirement benefits in a lump sum or installments. The normal method of distribution in defined benefit plans, on the other hand, is an annuity paid over the employee’s life or the joint lives of the employee and his or her spouse, unless consent from the employee and, if married, the employee’s spouse is obtained.
When an employee terminates employment prior to normal retirement age, before a distribution can be made (except in the case of cash-outs described in Lump-Sums and Installments below), the employee must be given a written notice explaining the available benefit payment options under the plan, the right to delay payment until the later of the plan’s normal retirement age or age 62, and the consequences of failing to delay payment.
A plan sponsor should know what forms of distribution are available to participants and beneficiaries under the plan, retain participant distribution election forms together with notarized spousal consents, if applicable, and communicate with the plan administrator about who provides the notice and consent forms, and who calculates and pays out benefits.
Lump-Sums and Installments. A plan can make a lump-sum distribution of a participant’s or beneficiary’s entire accrued vested benefit without consent (a cash-out) if the benefit is $5,000 or less. If the benefit is more than $5,000, a lump-sum distribution can only be made with the participant’s (and spouse’s, if applicable) written consent. Installment payments are made at regular intervals, for a definite period (such as 5 or 10 years) or in a specified amount (for example, $2,000 a month) to continue until the account is depleted.
Annuities. Annuity payments are made from a defined benefit plan or under a contract purchased by a defined contribution plan. Payments are made at regular intervals over a period of more than one year, depending on the type of annuity. If the participant is married prior to the first day of the period for which benefits are paid as an annuity, a plan subject to the spousal annuity requirements must pay benefits in the form of a qualified joint and survivor annuity (a “QJSA”). In this case, if the participant dies before the spouse, the plan pays the spouse a life annuity. A participant, with proper spousal consent, may waive the QJSA and chose another payment option. Plans subject to the QJSA rules may also have to offer participants a qualified optional survivor annuity (QOSA) that provides a surviving spouse an annuity equal to either 50% or 75% of the annuity payments to be made during the participant’s life.
For a married, vested participant who dies before the annuity starting date, the plan must pay a qualified pre-retirement survivor annuity (a “QPSA”) to the surviving spouse. A married participant, with spousal consent, may waive either the QJSA or QPSA annuities and choose an alternate form of distribution provided under the terms of the plan. An unmarried participant must receive a single-life annuity unless waived.
Plans Subject to QJSA/QPSA. Most defined contribution plans are not subject to the QJSA and QPSA rules. However, when a married participant dies, these plans must pay the entire remaining vested account balance to the participant’s surviving spouse unless the spouse has consented to another beneficiary. Defined benefit, money purchase pension plan and target benefit plans must offer QJSAs and QPSAs if a participant’s vested accrued benefit is more than $5,000, but may offer other payment options as well. Defined contribution plans must also offer QJSAs and QPSAs for account balances over $5,000 unless: (1) the participant doesn’t choose a life annuity under the plan, (2) the plan pays the entire remaining vested account balance on the married participant’s death to the surviving spouse unless the spouse has consented to another beneficiary and (3) the plan is not a transferee of a plan that was subject to QJSA/QPSA.