Desarrollar el Cronograma

This book has already dealt briefly with taxes as regards to various pension plans and annuities. This chapter is based on the materials of the Department of the Treasury Internal Revenue Service (Publication 575 Cat. No.15142B), and gives a detailed explanation of pension plans and annuities tax treatment.

Definitions

A pension is generally a series of payments made to an individual after he/she retires from work. Pension payments are made regularly and are paid for past services with an employer.

An annuity is a series of payments under a contract. The contract can be purchased individually or with the help of the employer. Annuity payments are made regularly for more than one full year.

Types of pensions and annuities

 Fixed period annuities. This type of annuity pays definite amounts at regular intervals for a definite length of time.

 Annuities for a single life. This type of annuity pays definite amounts at regular intervals for life. The payments end at death.

 Joint and survivor annuities. The first annuitant receives a definite amount at regular intervals for life. After the first annuitant’s death, a second annuitant receives a definite amount at regular intervals for life. The amount paid to the second annuitant may or may not differ from the amount paid to the first annuitant.

 Variable annuities. A variable annuity holder receives payments that may vary in amount for a definite length of time or for life. The amounts received through variable annuity depend upon such variables as profits earned by the pension or annuity funds or cost-of-living indexes.

 Disability pensions. An individual is entitled to a disability pension if he/she is under minimum retirement age and receives payments because he/she retired on disability. If, at the time of his/her retirement, an individual was permanently and totally disabled, he/she may be eligible for the credit for the elderly or the disabled.

The General Rule. The General Rule is one of the two methods used to calculate the tax-free part of each annuity payment based on the ratio of the investment in the contract to the total expected return.

The Simplified Method. A simplified method is used to calculate tax-part of annuity payment from a qualified plan.

The General Rule cannot be used for the following qualified plans:

 A qualified employee plan is an employer’s stock bonus, pension, or profit-sharing plan that is for the exclusive benefit of employees or their beneficiaries. This plan must meet Internal Revenue Code

requirements. It qualifies for special tax benefits, including tax deferral for employer contributions and rollover distributions, and capital gain treatment or the 5- or 10-year tax option for lump-sum distributions.

 A qualified employee annuity is a retirement annuity purchased by an employer for an employee under a plan that meets Internal Revenue Code requirements

 A tax-sheltered annuity (TSA) is a special annuity plan or contract purchased for an employee of a public school or tax-exempt

organization. It is often referred to as a 403(b) plan or a tax-sheltered annuity plan. Generally, a TSA plan provides retirement benefits by purchasing annuity contracts for its participants.

The General Rule is used to calculate the tax treatment of various types of pensions and annuities, including non-qualified employee plans.

A non-qualified employee plan is an employer’s plan that does not meet Internal Revenue Code requirements for qualified employee plans. It does not qualify for most of the tax benefits of a qualified plan.

The pension or annuity is subject to federal income tax withholding unless an individual chooses not to have tax withheld. If an individual chooses not to have tax withheld from his/her pension or annuity, or if he/she does not have enough income tax withheld, the individual may have to make estimated tax payments.

Typically, the General Rule to calculate the tax-free part of each annuity payment is used if an individual receives pension or annuity payments from the following plans:

 A non-qualified plan (for example, a private annuity, a purchased commercial annuity, or a non-qualified employee plan)

 A qualified plan if:

 The annuity’s starting date is before November 19, 1996 (and after July 1, 1986) and the person is not qualified to use the Simplified Method

 An individual is 75 or over and the annuity payments are

guaranteed for at least 5 years (regardless of the annuity starting date), or

 An individual retirement account or annuity (IRA).

If the annuity starting date is after November 18, 1996, the General Rule cannot be used for the following qualified plans:

 A qualified employee plan

 A qualified employee annuity

 A tax-sheltered annuity (TSA) plan or contract Rollovers and Simplified Method

If an individual withdraws cash or other assets from a qualified retirement plan in an eligible rollover distribution, tax on the distribution can be deferred by rolling it over to another qualified retirement plan or a traditional IRA. The amount rolled over is not included in the income until it is withdrawn from the recipient plan or IRA without rolling over that distribution.

If the distribution is rolled over to a traditional IRA, one cannot deduct the amount rolled over as an IRA contribution.

Self-employed individuals are generally treated as employees for the rules on the tax treatment of distributions, including the rules for rollovers.

Eligible rollover distribution. An eligible rollover distribution is any distribution of all or any part of the balance to an individual’s credit in a qualified plan,

except:

 The cost of life insurance coverage

 Dividends on employer securities

 A loan treated as a distribution

 A hardship distribution from a 401(k) plan (beginning in 1999)

 Any of a series of substantially equal distributions paid at least once a year over:

 Lifetime or life expectancy

 The joint lives or life expectancies of the insured and the beneficiary

 A period of 10 years or more

 The non-taxable part of a distribution (such as after-tax contributions) other than the net unrealized

Direct Rollover Option

An individual can choose to have any part or all of an eligible rollover distribution paid directly to another qualified retirement plan that accepts rollover

distributions or to a traditional IRA.

In the case of direct rollover distribution, no tax will be withheld from any part of distribution that is directly paid to the trustee of the other plan. However, if any part of the eligible rollover distribution is paid to the plan participant, the payer must generally withhold 20 percent of it for income tax. The full amount is treated as distributed to the plan participant, though he/she actually receives only 80 percent. Any part, including the part withheld, should be included in income, if an individual does not roll over to another qualified retirement plan or to a traditional IRA within 60 days.

Partial rollovers. If an individual receives a lump-sum distribution, it may qualify for special tax treatment. However, of any part of the distribution received is rolled over, the part one keeps does not qualify for special tax treatment.

Rolling over more than the amount received. If the part of the distribution an individual wants to roll over exceeds, due to the tax withholding, the amount an individual actually receives, the funds should come from some other funds (an individual’s savings or borrowed amounts) to be added to the amount he/she actually receives.

Example. John receives an eligible rollover distribution of $10,000 from his employer’s qualified plan on January 31, 2000. $2,000 is withheld (20 percent tax withhold for income tax). Thus the actual amount received is

$8,000. If John wants to rollover the entire $10,000 to postpone including that amount in his income, he will have to get $2,000 from some other source to add to the $8,000 he actually received and complete the rollover by March 31, 2000, the 60^th day following January 31.

More than one plan

An individual may also receive plan benefits from more than one program under a single trust or plan of the employer. In this case an individual may be considered to have received more than one pension or annuity. For example an employer may set up a non-contributory profit-sharing plan for the employees with the provision that each participant is to be paid upon retirement. At the same time an employer also set up a contributory defined benefit pension plan for the employees with a provision for the payment of a lifetime pension to each participant after

retirement.

The amount of distribution from the profit-sharing plan depends on the

contributions made for the participant and the earnings from those contributions.

However, under the pension plan the amount of the pension benefits is determined by the formula. The amount of contributions is the amount necessary to provide that pension.

Since each plan is a separate program and a separate contract, the benefits received from these plans should be accounted for separately, even though the benefits from both may be included in the same check.

Qualified domestic relations order (QDRO).

A qualified domestic relations order (QDRO) is a decree, a judgement or order relating to payment of child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent.

An individual who receives a part of the benefits from a retirement plan under a QDRO reports the payments received is if he/she were a plan participant.

Variable Annuities

The tax rules typically apply both to annuities that provide fixed payments and to annuities that provide payments that vary in amount based on investment results or other factors. They apply to commercial variable annuity contracts, irrespective whether it was bought by an employee retirement plan for its participants or bought directly from the issuer by an individual investor.

Under these contracts, the owner can generally allocate the purchase payments among several types of investment portfolios or mutual funds and the contract value is determined by these investments performance.

The earnings are not taxed until distributed either in a withdrawal or in annuity payments. The taxable part of a distribution is treated as ordinary income.

Withdrawals. If an annuity holder withdraws funds before the annuity starting date, and the annuity is under a qualified retirement plan, a ratable part of the amount withdrawn is tax-free. The tax-free part is based on the ratio of the annuity holder’s cost to his/her account balance under the plan.

If the annuity is under a non-qualified plan, the amount withdrawn is allocated first to earnings. This is a taxable part of the contract, and then to the cost, which is the tax-free part. A different allocation applies to the investment and the earnings in annuity contracts bought before August 14, 1982.

If the funds are withdrawn other than as annuity on or after the annuity starting date, the entire amount withdrawn is generally taxable.

The amount received in a full surrender of the annuity contract is tax-free to the extent of any cost that has not been previously recovered tax-free.

Annuity payments. If an individual receives annuity payments under a variable annuity contract, the cost is recovered tax-free.

Death benefits. In case a single sum distribution from a variable annuity contract is received due to the death of the annuity owner, the distribution is generally taxable only to the extent it is more than the un-recovered cost of the contract.

The same rules apply if an individual chooses to receive an annuity.

In the case of a joint and survivor annuity, if the primary annuitant had received annuity payments before death, the survivor will receive tax-free part of the annuity in the same way as the primary annuitant.

A commercial annuity. According to the Department of the Treasury Internal Revenue Service (Publication 575 Cat. No.15142B) “A commercial annuity means an annuity, endowment, or life insurance contract issued by an insurance company.”

The main withholding rule that applies to an annuity is that there will be no withholding on any part of a distribution that will not be included in gross income.

No withholding. An annuity holder is entitled to choose no withholding option, which means not to have income tax withheld from retirement plan payments unless these payments are eligible rollover distributions. This rule applies to both periodic and non-periodic payments. If an annuitant chooses this option, it will remain in effect until he/she revokes it.

The payer is entitled to ignore the annuitant’s choice not to have tax withheld in the following cases:

 An annuity holder does not provide his/her social security number (in the required manner), or

 The IRS notifies the payer, before the payment is made, that an annuity holder gave an incorrect social security number.

To be entitled to choose to have tax withheld, a U.S. citizen or resident must give the payer a home address in the United States, and have the check delivered to an address in the United States. If the recipient has provided a U.S. address for a nominee, trustee, or agent to whom the benefits are delivered, but has not provided his or her own U.S. home address, the payer must withhold tax.

However, if an annuity holder does not give the payer his/her home address in the United States or its possessions, he/she is still entitled to choose not have tax withheld, provided an annuity holder certifies to the payer that he/she is not:

 a U.S. citizen,

 a U.S. resident alien, or

 someone who left the country to avoid tax.

But if the annuity holder does certify to the payer any the above mentioned, he/she may be subject to the 30 percent flat rate withholding that applies to non-resident aliens. The only case when the rule of 30% rate does not apply is if the annuity holder is exempt or subject to a reduced rate by treaty.

(Department of the Treasury, Internal Revenue Service, Publication 519)

Periodic distributions. If an annuity holder does not choose any withholding, the annuity or periodic payments (other than eligible rollover distributions) will be treated as wages like wages for withholding purposes.

Payments are considered periodic if the amounts are paid at regular intervals (such as weekly, monthly, or yearly) for a period of time greater than one year (such as for 15 years or for life). These payments are also known as an annuity.

An annuity holder must provide the payer a completed withholding certificate (Form W-4P or a similar form provided by the payer).

If an annuity holder does not provide the payer such a certificate, tax will be withheld as if the annuity holder is married and is claiming three withholding allowances.

Tax will be withheld as if the annuity holder were single and were claiming no withholding allowances if:

 an annuity holder does not give the payer his/her social security number, or

 the IRS notifies the payer (before any payment is made) that the annuity holder has an incorrect social security number.

A new withholding certificate must be filed to change the amount of withholding.

Generally an annuity holder can recover the cost of his/her pension or annuity tax-free over the period he/she is to receive the payments. The amount of each

payment that exceeds the cost is taxable.

Typically, the cost if the annuity is the net investment in the contract as of the annuity starting date. The total amount includes all the premiums, contributions,

or other amounts an annuitant paid. If an employer also contributed, the employer’s contributions that were taxable when paid are also included.

This amount does not include contributions for health and accident benefits, including any additional premiums paid for double indemnity or disability benefits; neither does it include deductible voluntary employee contributions.

From this total cost the following amounts must be subtracted:

 Any refunded premiums, rebates, dividends, or un-repaid loans that were not included in the annuitant’s income and that the annuitant received by the later of the annuity starting date or the sate on which he/she received the first payment.

 Any other tax-free amounts the annuitant received under the contract or plan by the later of the dates

 If the Simplified Method is used for annuity payments, the tax-free part of any single-sum payment received in connection with the start of the annuity payments, regardless of when the annuitant received it.

 If the General Rule is applied for the annuity payments, the value of the refund feature in the annuity contract. The annuity contract has a refund feature if the annuity payments are for life (or the lives of the annuity holder and his/her survivor) and payments in the nature of a refund of the annuity’s cost will be made to the beneficiary or estate if all annuitants die before a stated amount or a stated number of

payments are made.

(Department of the Treasury Internal Revenue Service, Publication 939) According to IRS, the annuity starting date is either the first day of the first period for which an annuity holder receives payment under the contract or the date on which the obligation under the contract becomes fixed, whichever comes later.

Fully Taxable Payments

The pension or annuity payments that an annuitant receives are considered to be fully taxable if an annuitant have no cost in the contract due to the following:

 The annuitant did not pay anything or is not considered to have paid anything for his/her pension or annuity

 The annuitant’s employer did not withhold contributions from the annuitant’s salary, or

 The annuitant received back all of his/her contributions tax-free in prior years

Deductible Voluntary Employee contributions

Distributions that an annuity holder receives and which are based on his/her accumulated deductible voluntary employee contributions are generally fully taxable in the year when they are distributed to the annuity holder. Accumulated deductible voluntary employee contributions include net earnings on the

contributions. If these contributions are distributed as part of a lump sum, they do not qualify for the 10-year tax option or capital gain treatment.

Partly Taxable Payments

If an individual contributed to his/her pension or annuity plan, a part of each annuity payment can be excluded from income as a recovery of the cost. The tax-free part of the payment can be calculated when the annuity starts and remains the same each year, even if the amount of the payment changes. However, the rest of each payment is taxable.

The Simplified Method is used to calculate the tax-free part of the amount if the annuity is paid under a qualified plan, a qualified employee plan, a qualified employee annuity, or a tax-sheltered annuity plan or contract.

The General Rule is used if the annuity is paid under a non-qualified plan. It has already been said about applying the two methods as regards to the starting date of the annuity payments.

However, there is also an exclusion limit. The annuity starting date determines the total amount of annuity payments that annuitant can exclude from income over the years.

There is also an exclusion limit to cost. If the annuity starting date is after 1986, the total amount of annuity income that can be excluded over the years as a

There is also an exclusion limit to cost. If the annuity starting date is after 1986, the total amount of annuity income that can be excluded over the years as a