The IRS offers a frustrating lack of guidance on how to tell whether someone is 'retired.'
The reviews are in for the new edition of Natalie Choate's best-selling book Life and Death Planning for Retirement Benefits (7th ed. 2011): "Your book has been a tremendously valuable resource to our firm." "I have found this book extremely helpful." "We have read and used it in many cases already." "I love the 7th edition!" "It's paid for itself already by answering several questions." "I ordered these for our company last week, and everyone loves it!" "GREAT BOOK!" To find out why your colleagues (and competitors!) are raving about the new edition of Life and Death Planning for Retirement Benefits, visit www.ataxplan.com.
Late Retirement and Minimum Distributions
Certain people who are still working after age 70 1/2 get to postpone the "required beginning date" for required distributions from their retirement plans. What can be frustrating is the lack of IRS guidance about how to tell whether someone is "retired."
Question: "Joe" is leaving his job this year, at age 79. He does not now own and has never owned any stock of the corporation he works for. When must he start taking distributions from the company's retirement plan? If he goes back to work for this company later, can he suspend taking those minimum distributions until he retires again?
Answer: Because Joe has never had any ownership interest in the employer, it's easy to figure out when he must start taking distributions. His "required beginning date" for distributions from his employer's retirement plan(s) is April 1 of the year following the later of the year he reaches/reached age 70 1/2 and the year he "retires." He reached age 70 1/2 several years ago, so the "later of" year is this year, the year he retires. Accordingly, 2011 is his "first distribution year," and he can take that first year's minimum required distribution anytime in 2011, or in 2012 (on or before April 1).
If he owned an interest in the employer (now or in the past), we would have to take more steps to verify that he would not be considered a "5-percent owner." A 5-percent owner, unlike other employees, is not entitled to postpone the start of minimum distributions past age 70 1/2, regardless of whether he is "retired."
Unfortunately, the plan apparently cannot suspend minimum distributions if he goes back to work for the company. The statute and regulations key the start of minimum distributions to the year the employee "retires," and there's no mention of any way to stop minimum distributions once they start. If Joe rolled his company plan benefits into an IRA, then went back to work for a different company, and rolled the IRA into his new employer's plan, that might do the trick--because he would not yet be "retired" under the new company's plan!
Question: "Chris" is receiving deferred compensation from the company he used to work for. He is not and never has been a "5-percent owner" of that company. He is completely retired as far as I can tell, but he would like to postpone taking any minimum required distributions from the company's qualified retirement plan. He thinks he is entitled to such postponement because the nonqualified deferred compensation he is receiving is reported to the IRS on Form W-2. Because Form W-2 is reporting his income to the IRS as "wages" (W-2 is the "Wage and Tax Statement" form), he says the IRS would not regard him as "retired," therefore he is not subject to minimum required distributions yet. Is his argument valid?
Answer: "Chris" is not going to be making this decision all by himself. The plan administrator of the company retirement plan and the person who prepares Chris' federal income tax return both also have a stake in getting the right answer here.
The plan administrator of the qualified plan is responsible for making sure the plan stays "qualified." One element of qualification is complying with the minimum distribution rules. If the plan is required to distribute to Chris because he is (1) over age 70 1/2 and (2) retired, then the plan had better make the distribution or risk disqualifying the entire plan. If the plan administrator has done the necessary research and/or gotten an IRS ruling that Chris is not "retired," then Chris and the plan and Chris' return preparer can all rest easy with Chris' decision to postpone distributions.
However, contrary to Chris' belief, there is no authority supporting the position that a person is not "retired" so long as he is receiving compensation that is reported on Form W-2. It's true that Form W-2 is used to report compensation for current services. But it is also used to report certain types of deferred compensation--and believe it or not, the IRS is aware of that fact! A Form W-2 that reports no compensation other than deferred compensation does not support the position that the individual is still working--in fact it supports the opposite conclusion, namely, that the person is retired.
We have something analogous we can look at--namely, the question of what constitutes "compensation" for services for purposes of supporting a contribution to an IRA. "Compensation" for this purpose "does not include any amount received as deferred compensation." Rev. Proc. 91-18, 1991-1 C.B. 522, recognizes that amounts reported on Form W-2 generally constitute "compensation for services" for purposes of supporting an IRA contribution, and accordingly the IRS will accept the "compensation" amount shown on Form W-2 as a "safe harbor" with respect to supporting an IRA contribution--unless the amount is also shown as deferred compensation.
Box 1 of Form W-2 ("Wages, Tips, and Other Compensation") reports the individual's total compensation for services during the year. Box 11 of the 2010 Form W-2 ("Nonqualified Plans") reports how much of the Box 1 amount is deferred compensation. Have a look at Chris' W-2. See whether the amount reported as total W-2 compensation for the year (Box 1) is also reported in Box 11. If it is, the IRS is unlikely to be fooled into thinking that Chris is not "retired."
If Chris fails to take a minimum required distribution, such failure must be reported on Form 5329 attached to his personal income tax return, with the attendant 50% penalty carried over to line 58 of the Form 1040 ("additional tax on IRAs, other qualified plans, etc."). The preparer of Chris' federal income tax return needs to consider this issue when preparing his return.
Resources: For definition of compensation, see Internal Revenue Code § 219(f)(1), and Treasury Regulations § 1.219-1(c)(1) and § 1.408A-3, A-4.