Special Additional Taxes(p33)

To discourage the use of pension funds for purposes other than normal retirement, the law imposes additional taxes on early distributions of those funds and on failures to withdraw the funds timely. Ordinarily, you will not be subject to these taxes if you roll over all early distributions you receive, as explained earlier, and begin drawing out the funds at a normal retirement age, in prorated amounts over your life expectancy. These special additional taxes are the taxes on:

• Early distributions, and
• Excess accumulation (not receiving minimum distributions).

These taxes are discussed in the following sections.

If you must pay either of these taxes, report them on Form 5329. However, you do not have to file Form 5329 if you owe only the tax on early distributions and your Form 1099-R correctly shows a "1" in box 7. Instead, enter 10% of the taxable part of the distribution on Form 1040, line 58 and enter "No" under the heading "Other Taxes" to the left of line 58. If you file Form 1040NR, enter 10% of the taxable part of the distribution on line 56 and enter "No" under the heading "Other Taxes" to the left of line 56.

Even if you do not owe any of these taxes, you may have to complete Form 5329 and attach it to your Form 1040 or Form 1040NR. This applies if you meet an exception to the tax on early distributions but box 7 of your Form 1099-R does not indicate an exception.

Most distributions (both periodic and nonperiodic) from qualified retirement plans and nonqualified annuity contracts made to you before you reach age 591/2 are subject to an additional tax of 10%. This tax applies to the part of the distribution that you must include in gross income. It does not apply to any part of a distribution that is tax free, such as amounts that represent a return of your cost or that were rolled over to another retirement plan. It also does not apply to corrective distributions of excess deferrals, excess contributions, or excess aggregate contributions (discussed earlier under Taxation of Nonperiodic Payments).

For this purpose, a qualified retirement plan is:

• A qualified employee plan (including a qualified cash or deferred arrangement (CODA) under Internal Revenue Code section 401(k)),
• A qualified employee annuity plan,
• A tax-sheltered annuity plan (403(b) plan), or
• An eligible state or local government section 457 deferred compensation plan (to the extent that any distribution is attributable to amounts the plan received in a direct transfer or rollover from one of the other plans listed here or an IRA).

If an early withdrawal from a deferred annuity is otherwise subject to the 10% additional tax, a 5% rate may apply instead. A 5% rate applies to distributions under a written election providing a specific schedule for the distribution of your interest in the contract if, as of March 1, 1986, you had begun receiving payments under the election. On line 4 of Form 5329, multiply the line 3 amount by 5% instead of 10%. Attach an explanation to your return.

If, within the 5-year period starting with the first day of your tax year in which you rolled over an amount from your 401(k), 403(b), or 457(b) plan to a designated Roth account, you take a distribution from the designated Roth account, you may have to pay the additional 10% tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the in-plan Roth rollover that you had to include in income (recapture amount). A separate 5-year period applies to each in-plan Roth rollover. See Figuring your recapture amount, later, to determine the recapture amount, if any.

The 5-year period used for determining whether the 10% early distribution tax applies to a distribution allocable to an in-plan Roth rollover is separately determined for each in-plan Roth rollover, and is not necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution.

For any early distribution in 2012 from your designated Roth account that is allocable to an in-plan Roth rollover, you allocate the amount from your 2012 Form 1099-R, box 10, to the amounts, if any, you have rolled over into that designated Roth account.

If you have not taken a distribution from your designated Roth account before 2012, then allocate the amount in box 10 of your 2012 Form 1099-R to the amounts you reported on the lines listed below, in the order shown, until you have covered the entire amount in box 10.

If you have taken a distribution from your designated Roth account prior to 2012, then allocate the amount in box 10 of your 2012 Form 1099-R to the amounts you reported on the lines listed below, in the order shown; however, do not start at the beginning. Start instead with the first line that has not been used fully for a previous distribution.

• Your 2010 Form 8606, line 23.
• Your 2010 Form 8606, line 22.
• Your 2011 Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b.*
• Your 2011 Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a.**
• Your 2012 Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b.*
• Your 2012 Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a.**

* Only include the amount attributable to an in-plan Roth rollover.
** Only include any contributions (usually Form 1099-R, box 5) that were taxable to you when made and attributable to an in-plan Roth rollover.

Your recapture amount is the sum of the amounts you allocated to the following lines.

• Your 2010 Form 8606, line 23.
• Your 2011 Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b.
• Your 2012 Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b.

You had an in-plan Roth rollover in 2012 of $50,000. You did not have any in-plan Roth rollovers in 2010 or 2011. Your 2012 Form 1040 includes $30,000 on line 16b, the taxable portion of the in-plan Roth rollover, and $50,000 on line 16a, the in-plan Roth rollover including $20,000 of basis. In December of 2012, at age 57, you took a distribution of $35,000 from your designated Roth account. The 2012 Form 1099-R shows the distribution of $35,000 reported in box 1, the taxable portion of the distribution of $3,500 reported in box 2a, and the amount of $31,500 allocable to the in-plan Roth rollover reported in box 10. Since you had no in-plan Roth rollovers in 2010 or 2011, you would allocate the $31,500 reported in box 10 of Form 1099-R first to the $30,000 taxable in-plan Roth rollover reported on your 2012 Form 1040, line 16b. The remaining $1,500 ($31,500 − $30,000) would be allocated to the $20,000 in basis reported on Form 1040, line 16a. The recapture amount, the amount subject to tax on early distributions allocable to the in-plan Roth rollover, is $30,000 ($31,500 − $1,500). Your amount subject to tax on early distributions reported on Form 5329, line 1, for this distribution is $33,500 ($30,000 allocable to Form 1040, line 16b, and $3,500 from Form 1099-R, box 2a).

Certain early distributions are excepted from the early distribution tax. If the payer knows that an exception applies to your early distribution, distribution code "2," "3," or "4" should be shown in box 7 of your Form 1099-R and you do not have to report the distribution on Form 5329. If an exception applies but distribution code "1" (early distribution, no known exception) is shown in box 7, you must file Form 5329. Enter the taxable amount of the distribution shown in box 2a of your Form 1099-R on line 1 of Form 5329. On line 2, enter the amount that can be excluded and the exception number shown in the Form 5329 instructions.

The tax does not apply to distributions that are:

• Made as part of a series of substantially equal periodic payments (made at least annually) for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary (if from a qualified retirement plan, the payments must begin after separation from service). See Substantially equal periodic payments, later,
• Made because you are totally and permanently disabled, or
• Made on or after the death of the plan participant or contract holder.

The tax does not apply to distributions that are:

• From a qualified retirement plan (other than an IRA) after your separation from service in or after the year you reached age 55 (age 50 for qualified public safety employees) (see Separation from service, later),
• From a qualified retirement plan (other than an IRA) to an alternate payee under a qualified domestic relations order,
• From a qualified retirement plan to the extent you have deductible medical expenses (medical expenses that exceed 7.5% of your adjusted gross income), whether or not you itemize your deductions for the year,
• From an employer plan under a written election that provides a specific schedule for distribution of your entire interest if, as of March 1, 1986, you had separated from service and had begun receiving payments under the election,
• From an employee stock ownership plan for dividends on employer securities held by the plan,
• From a qualified retirement plan due to an IRS levy of the plan, or
• From elective deferral accounts under 401(k) or 403(b) plans, or similar arrangements, that are qualified reservist distributions.

In order to meet the requirements for the first exception in the list above, you must have separated from service in or after the year in which you reach age 55 (or age 50 for qualified public safety employees). You cannot separate from service before that year, wait until you are age 55 (or age 50 for qualified public safety employees), and take a distribution.

George separated from service from his employer at age 49. In the year he reached age 55 he took a distribution from his retirement plan. Because he separated from service before he reached age 55, he did not meet the requirements for the exception for a distribution made from a qualified retirement plan (other than an IRA) after separating from service in or after reaching age 55 (age 50 for qualified public safety employees).

If you are a qualified public safety employee, distributions made from a governmental defined benefit pension plan are not subject to the additional tax on early distributions. You are a qualified public safety employee if you provided police protection, firefighting services, or emergency medical services for a state or municipality, and you separated from service in or after the year you attained age 50.

A qualified reservist distribution is not subject to the additional tax on early distributions. A qualified reservist distribution is a distribution (a) from elective deferrals under a section 401(k) or 403(b) plan, or a similar arrangement, (b) to an individual ordered or called to active duty (because he or she is a member of a reserve component) for a period of more than 179 days or for an indefinite period, and (c) made during the period beginning on the date of the order or call and ending at the close of the active duty period. You must be ordered or called to active duty after September 11, 2001.

The tax does not apply to distributions that are:

• From a deferred annuity contract to the extent allocable to investment in the contract before August 14, 1982,
• From a deferred annuity contract under a qualified personal injury settlement,
• From a deferred annuity contract purchased by your employer upon termination of a qualified employee plan or qualified employee annuity plan and held by your employer until your separation from service, or
• From an immediate annuity contract (a single premium contract providing substantially equal annuity payments that start within 1 year from the date of purchase and are paid at least annually).

Payments are substantially equal periodic payments if they are made in accordance with one of the following methods.

1. Required minimum distribution method. Under this method, the resulting annual payment is redetermined for each year.
2. Fixed amortization method. Under this method, the resulting annual payment is determined once for the first distribution year and remains the same amount for each succeeding year.
3. Fixed annuitization method. Under this method, the resulting annual payment is determined once for the first distribution year and remains the same amount for each succeeding year.

For information on these methods, see Revenue Ruling 2002-62, which is on page 710 of Internal Revenue Bulletin 2002-42 at www.irs.gov/pub/irs-irbs/irb02-42.pdf.

An early distribution recapture tax may apply if, before you reach age 591/2, the distribution method under the equal periodic payment exception changes (for reasons other than your death or disability). The tax applies if the method changes from the method requiring equal payments to a method that would not have qualified for the exception to the tax. The recapture tax applies to the first tax year to which the change applies. The amount of tax is the amount that would have been imposed had the exception not applied, plus interest for the deferral period.

The recapture tax also applies after you reach age 591/2 if your payments under a distribution method that qualifies for the exception are modified within 5 years of the date of the first payment. In that case, the tax applies only to payments distributed before you reach age 591/2.

Report the recapture tax and interest on line 4 of Form 5329. Attach an explanation to the form. Do not write the explanation next to the line or enter any amount for the recapture on lines 1 or 3 of the form.

To make sure that most of your retirement benefits are paid to you during your lifetime, rather than to your beneficiaries after your death, the payments that you receive from qualified retirement plans must begin no later than your required beginning date (defined later). The payments each year cannot be less than the minimum required distribution.

If the actual distributions to you in any year are less than the minimum required distribution (RMD) for that year, you are subject to an additional tax. The tax equals 50% of the part of the required minimum distribution that was not distributed.

For this purpose, a qualified retirement plan includes:

• A qualified employee plan,
• A qualified employee annuity plan,
• An eligible section 457 deferred compensation plan, or
• A tax-sheltered annuity plan (403(b) plan) (for benefits accruing after 1986).

The tax may be waived if you establish that the shortfall in distributions was due to reasonable error and that reasonable steps are being taken to remedy the shortfall. If you believe you qualify for this relief, you must file Form 5329 and attach a letter of explanation. In Part VIII of that form, enter "RC" and the amount you want waived in parentheses on the dotted line next to line 52. Subtract this amount from the total shortfall you figured without regard to the waiver and enter the result on line 52.

You might not receive the minimum distribution because assets are invested in a contract issued by an insurance company in state insurer delinquency proceedings. If your payments are reduced below the minimum because of these proceedings, you should contact your plan administrator. Under certain conditions, you will not have to pay the 50% excise tax.

Unless the rule for 5% owners applies, you generally must begin to receive distributions from your qualified retirement plan by April 1 of the year that follows the later of:

• The calendar year in which you reach age 701/2, or
• The calendar year in which you retire from employment with the employer maintaining the plan.

However, your plan may require you to begin to receive distributions by April 1 of the year that follows the year in which you reach age 701/2, even if you have not retired.

If you reach age 701/2 in 2012, you may be required to receive your first distribution by April 1, 2013. Your required distribution then must be made for 2013 by December 31, 2013.

If you are a 5% owner, you must begin to receive distributions from the plan by April 1 of the year that follows the calendar year in which you reach age 701/2. This rule does not apply if your retirement plan is a government or church plan.

You are a 5% owner if, for the plan year ending in the calendar year in which you reach age 701/2, you own (or are considered to own under section 318 of the Internal Revenue Code) more than 5% of the outstanding stock (or more than 5% of the total voting power of all stock) of the employer, or more than 5% of the capital or profits interest in the employer.

You reach age 701/2 on the date that is 6 calendar months after the date of your 70th birthday. For example, if your 70th birthday was on June 30, 2012, you reached age 701/2 on December 30, 2012. If your 70th birthday was on July 1, 2012, you reached age 701/2 on January 1, 2013.

By the required beginning date, you must either:

• Receive your entire interest in the plan (for a tax-sheltered annuity, your entire benefit accruing after 1986), or
• Begin receiving periodic distributions in annual amounts calculated to distribute your entire interest (for a tax-sheltered annuity, your entire benefit accruing after 1986) over your life or life expectancy or over the joint lives or joint life expectancies of you and a designated beneficiary (or over a shorter period).

After the starting year for periodic distributions, you must receive at least the minimum required distribution for each year by December 31 of that year. (The starting year is the year in which you reach age 701/2 or retire, whichever applies in determining your required beginning date.) If no distribution is made in your starting year, the minimum required distributions for 2 years must be made the following year (one by April 1 and one by December 31).

You retired under a qualified employee plan in 2011. You reached age 701/2 on August 20, 2012. For 2012 (your starting year), you must receive a minimum amount from your retirement plan by April 1, 2013. You must receive the minimum required distribution for 2013 by December 31, 2013.

If the employee was receiving periodic distributions before his or her death, any payments not made as of the time of death must be distributed at least as rapidly as under the distribution method being used at the date of death.

If the employee dies before the required beginning date, the entire account must be distributed under one of the following rules.

• Rule 1. The distribution must be completed by December 31 of the fifth year following the year of the employee's death.
• Rule 2. The distribution must be made in annual amounts over the life or life expectancy of the designated beneficiary.

The terms of the plan may determine which of these two rules apply. If the plan permits the employee or the beneficiary to choose the rule that applies, this choice must be made by the earliest date a distribution would be required under either of the rules. Generally, this date is December 31 of the year following the year of the employee's death.

If the employee or the beneficiary did not choose either rule and the plan does not specify the rule that applies, distribution must be made under Rule 2 if the employee has a designated beneficiary or under Rule 1 if the employee does not have a designated beneficiary.

Distributions under Rule 2 generally must begin by December 31 of the year following the year of the employee's death. However, if the surviving spouse is the beneficiary, distributions need not begin until December 31 of the year the employee would have reached age 701/2, if later.

If the surviving spouse is the designated beneficiary and distributions are to be made under Rule 2, a special rule applies if the spouse dies after the employee but before distributions are required to begin. In this case, distributions may be made to the spouse's beneficiary under either Rule 1 or Rule 2, as though the beneficiary were the employee's beneficiary and the employee died on the spouse's date of death. However, if the surviving spouse remarries after the employee's death and the new spouse is designated as the spouse's beneficiary, this special rule applicable to surviving spouses does not apply to the new spouse.

Special rules may apply if you receive distributions from your retirement plan in the form of an annuity. Your plan administrator should be able to give you information about these rules.

Your plan administrator should be able to give you information about how the amount of your required distribution was figured.

If there is an account balance to be distributed from your plan (not as an annuity), your plan administrator must figure the minimum amount that must be distributed from the plan each year.

The minimum amount that must be distributed for any year may be made in a series of installments (for example, monthly or quarterly) as long as the total payments for the year made by the date required are not less than the minimum amount required for the year.

Your plan can distribute more in any year than the minimum amount required for that year but, if it does, you will not receive credit for the additional amount in determining the minimum amount required for future years. However, any amount distributed in your starting year will be credited toward the amount required to be distributed by April 1 of the following year.

Generally, the required minimum distribution must be figured separately for each account. Each qualified employee retirement plan and qualified annuity plan must be considered individually in satisfying its distribution requirements. However, if you have more than one tax-sheltered annuity account, you can total the required distributions and then satisfy the requirement by taking distributions from any one (or more) of the tax-sheltered annuities.