3944 / How are distributions from a qualified plan taxed?

Benefits distributed from a plan generally are included in the participant’s income as ordinary income in the year received. Certain exceptions to the general rule apply based on the timing and nature (e.g., lump sum or periodic) of the distribution. These exceptions include:

(1)  the taxation of certain lump sum distributions ( Q 3971);

(2)  distribution of an annuity contract ( Q 612);

(3)  distribution of certain employer securities that are distributed as a lump sum distribution ( Q 3972);

(4)  distributions that are made as qualified Roth distributions;

(5)  distributions that consist in part of nontaxable basis (e.g., a participant loan in default that was treated as a deemed distribution, or the total employee after-tax contributions made to a plan); and

(6)  distributions that constitute eligible rollover distributions and that are rolled over to another plan or IRA.

The ordinary income taxation of plan distributions is discussed as follows:

(1)  the taxation of periodic retirement payments ( Q 613 and Q 3973);

(2)  the taxation of disability payments ( Q 384);

(3)  the taxation of payments to beneficiaries ( Q 3974 to Q 3976);

(4)  the taxation of amounts received preretirement ( Q 3968);

(5)  certain early or premature distributions that are subject to a 10 percent penalty ( Q 3969);

(6)  the treatment of amounts received postretirement ( Q 3970);

(7)  distribution of corrective distributions of excess contributions and excess aggregate contributions ( Q 3808);

(8)  corrective distributions of excess deferrals ( Q 3760).

Participant loans meeting certain IRC requirements are not treated as taxable distributions. Loans to employees that do not meet certain requirements ( Q 3953 to Q 3960) will be taxed as deemed distributions.

Distribution to alternate payee. A spouse or other alternate payee under a qualified domestic relations order (QDRO, see Q 3915) is treated as a distributee for most purposes under rules relating to the taxation of distributions from qualified plans ( Q 3971, Q 623).¹

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Planning Point: A divorcing or separating spouse who is negotiating a qualified domestic relations order and who has not attained age 59½ should weigh the relative advantages and disadvantages of a lump sum distribution that can be rolled over to an IRA in his or her own name and a series of distributions directly from his or her spouse’s plan, if available. Distributions from a spouse’s plan pursuant to a QDRO would be exempt from the 10 percent tax, whereas distributions from his or her own IRA made before age 59½ would not be exempt unless another exception, such as the substantially equal periodic payment exception, applies.

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If any assets of an individually directed account under a qualified plan are used to purchase collectibles, including works of art, gems, antiques, metals, and certain coins, the amount so used will be treated as distributed from the account.²