Retirees can’t keep their 401(k) pretax contributions dammed up forever; eventually they must take taxable distributions. Two new sets of final regulations allow 401(k) plans to provide retirees with more options than just pulling out the cash.
1. Distributions for health benefits. Under the first set of final regs, retirees who designate a portion of their 401(k) benefits to pay for health benefits have taxable distributions in the amounts designated. Once distributions are taxed, health benefits are tax-free.
In addition to taxable distributions retirees directly designate to pay for health benefits, the regs cover two other situations, with the same tax result:
- Retirees can’t avoid current taxation of distributions by having the plan pick up their health premiums from current contributions or forfeitures that haven’t yet been allocated to their 401(k) accounts.
- Retirees also can’t avoid current taxation by having payments from a health insurer made to a trust, rather than made directly to a health care provider or to them as reimbursements.
In either case, the regs set up a two-step process to determine the amount of retirees’ distributions—payments are first allocated to retirees, and then charged against their plan benefits or contributed to the trust, whichever the case may be.
These final regs become effective for taxable years beginning on or after Jan. 1, 2015. However, you may choose to apply them to earlier tax years. (79 F.R. 26838, 5-12-14)
2. Qualified longevity annuity contracts. Under the second set of regs, 401(k) plans may offer qualified longevity annuity contracts (QLACs), sometimes called deeply deferred annuities, which kick in when a retiree reaches age 85. This way, retirees won’t outlive their savings.
The regs alter the 401(k) minimum distribution rules, so that an annuity that begins not later than age 85, and that costs no more than the lesser of 25% of an employee’s account balance or $125,000, can be disregarded when calculating minimum distributions.
Retirees who inadvertently exceed the premium ceiling may correct the excess, without disqualifying the annuity purchase, by returning the excess premium to the non-QLAC portion of their account by the end of the calendar year following the year in which the excess premium was paid. The $125,000 limit will be adjusted for inflation.
To allow retirees to pass assets to their heirs, the regs allow QLACs to provide that, if retirees die before (or even after) the age when the annuity begins, the premiums they paid, but haven’t yet received as annuity payments, will be returned to their accounts.
These regs became effective on July 2, 2014 and apply to QLACs purchased on or after that date. (79 F.R. 37633, 7-2-14)