 Hello and welcome to this session in which you would look at taxes on distribution from your qualified pension plan. Congratulations. You work all of your life. Now it's time to use the money that you save in your retirement account to live off your retirement. The question is, what happened to this money? How is it taxed? So this topic is important because it's covered on the CPA exam, it's covered on the enrolled agent exam, it's covered in a tax course and it's good to know as a general knowledge as a citizen. Now if you are a CPA candidate or an enrolled agent candidate, I strongly suggest you check out farhatlectures.com, I don't replace your CPA review course. I can be a useful addition. What I do is I give you alternative explanation, a backup explanation, a different way on looking at things and by doing so I can help you understand your CPA review course better and by doing so you can do better on the exam. So I can add 10 to 15 points to your CPA exam score by helping you understand the material differently. Your risk is one month of subscription. If you like it, you keep it. If not, you cancel. Your gain is potentially passing your exam. If not for anything, take a look at my website to find out how well your CPA, your college is doing on the CPA exam. I do have resources for other colleges and for other courses at your college. So connect with me on LinkedIn if you haven't done so. Like this recording, share it with other. Connect with me on Instagram, Facebook, Reddit and Twitter. So let's talk about taxes on distribution from qualified pension plan. Now we looked at qualified pension plan in the prior session, there are many of them. Some of them are defined benefit plan. It means you receive a payment, a fixed payment, usually a fixed maybe it could be adjusted just for inflation, but usually it's a guaranteed amount. And other payment are defined contribution. The fine contribution is you don't know what you're going to be getting out. The payment is not fixed and it's fluctuate with the value of the plan. Now what usually happens when you have this defined contribution? Here's what most people would do. What most people would do, once they get to retirement, once they are ready to take their money out, they will cash out. They will sell older stocks, bonds, mutual fund and what they do, it's called cash out or sell your investment, cash them out. Then what they do, they buy an annuity. And what's an annuity? Annuity will give you a fixed payment of money for a period of time and the reason they do this because once you retire, you don't want to be dependent upon the stock market performance or the bond market performance. What you do is you sell everything, buy an annuity and know what you have a defined benefit plan. The annuity would say we'll pay you this amount of money per month, either for the rest of your life or for the next 25, 30 years, depending on what the annuity is. So this is what I'm trying to say. Although we could be dealing with a defined contribution plan, but most taxpayer, they will switch the fine contribution into an annuity, which technically a defined benefit plan because it gives you a certain amount of money. Now, distribution from those qualified plan, whether it's a pension, profit sharing, KIA, 401K, or 403B, IRA, SEP or simple, and we talked about all these plans in the prior sessions, they could be 100% taxable. They could be 100% non-taxable or they could be a combination of both. That sounds like the weather channel, 50%, it could rain, 50%, it may not be rain. Well, let's go back to basics. What did we learn? Well, that if the plan was funded with a pre-tax amount, pre-tax, it means you did not pay taxes on it, pre-tax, you didn't pay taxes, then guess what? Everything in that plan is taxable. If it was taxed with a tax dollar, if you already paid the taxes, your dollar was non-deductible contribution, then guess what? It's not going to be taxable again. So that's the general rule to keep in mind. And we talked about this early on. So what we're going to do, we're going to be using the annuity provision for the taxation of these distribution. Why the annuity provision? Because the defined benefit is a fixed payment, and we're going to be saying that your defined contribution is turned into an annuity. To use the simplified method, first determine the amount of untaxed dollar, the amount that's been untaxed, it means it was deductible. You did not pay any taxes on it. Then find the amount that's taxed. Take the amount that's taxed, the amount that you could not deduct. This was this amount, when you contributed, it was non-deductible. Non-deductible, it means you did not get any tax benefit for it. You'll take this amount that you already paid taxes on it, and you divide it by the number of future payment. Well, we're going to see, what's the future payment? We're going to see in a moment. And that's going to be the proportion that's tax-free. That's the amount that's tax-free. Let's take a look at the tables first, and how do we determine the numbers? It's from a table. If the annuity is payable over the life of a single individual, we have this table. For example, if the individual is 55 or under, we assume they're going to live for the next 360 month, which is divided by 12. How much is that? How many years? I believe that's how many years? 360 divided by 12. This is what they assume you're going to live. If you're between 55 and 60, then the number of month is 310. Notice if you are 71 or over, we expect you to live another 160. Now, if the retiree plus the spouse, if they're together on this plan, the number of anticipated payment is determined differently. Now, you have to combine the ages. Simply put, if the retiree dies, the spouse will get the benefit, and you will use a different expected future payment. Now, the best way to illustrate this is to work an example. It's pretty straightforward. Tom is entitled to a monthly payment of $2,000 over his life from his employer-qualified pension plan. He contributed $97,500 with previously taxed dollars. So he already contributed this amount, $97,500, and he already paid his taxes. So this amount was after tax. He did not get any deduction for it. So it's previously taxed prior to his retirement at age 64. So he retired at age 64. So what we do, we're going to take, because he's 64, so we're going to go to the single table. 61 to 65 is 260. Take the amount that has been taxed, divided by 260, and Tom would exclude $375 as non-taxable return of his contribution. So this amount is a return. So basically, he contributed this much taxed. Now, they're giving him back $375 of this amount. And $97,500 minus $375 is the amount that remained that's theoretically non-taxable in the future. Because remember, the return of capital, ROC, return of capital, return of principal, that's your money, and you already paid taxes on it. You're not going to pay taxes on it again. The remaining of the payment, which is $1,625, guess what, that amount is taxable. So simply put, Tom would receive $2,000. $1,625 is taxable as ordinary income, $375 is tax-free. Why is the $375 tax-free? Because we assume this $375 coming from the $97,500 that he already paid taxes on it. Therefore, we don't want Tom to pay taxes twice. Instead of the $2,000 over his life, Tom choose to receive the monthly payment of $1,800 a month over his life and that of his spouse, 62 years old. Now, what you do is we combine the ages 64 plus 62. We'll give us $126. Now, we will be dealing with this table right here. Now, we'll take $97,500 divided by $310. Then the executable amount from the $2,000 is $340 and $52, because he chose a lower payment, because he want if something happened, the remainder goes to his wife. Now, what happened if the payment is not monthly, if the payment is quarterly? Well, we have to make a slight adjustment. Let's assume an individual is 55 years old and under 55, it means monthly we'll get 360. If the payment is quarterly, what we do is we'll take 360 divided by 12, that's 30 years. 30 years had four quarters. Therefore, the denominator rather than 360, the denominator will be 120 for the computations. So we're gonna take for Tom 97,500 divided by 120, and that's gonna determine the proportion, the amount of the 2000, that's not, well, the payment could be different because it's quarterly. The proportion of the payment that stacks free, whether it's 2000 or if it's quarterly multiplied by three, we don't know the payment is, but that's the proportion of the payment that's gonna be tax free. Now, the other thing we want to learn about is the required minimum distribution. Simply put, you can, you start to collect your money theoretically, you can start to collect the money once you reach the age of 59 and a half. Now, a lot of people, what they do at this age, especially these days, they are still working. They keep on working. They don't need the retirement account. They don't need the retirement income because they are working and they don't want to take it out. Actually, it's wise to keep your money. Why? Because the more you keep it, the more it continued to grow as a tax deferred. That's the good news. Do you think the government would allow you to do that? Well, no, not forever because the government want you to take the money out because once you take it out, it's taxable. Like a lot of people, they would love to keep that money grow tax deferred. Like for example, if you work all of your life, you have a good job, you save a lot of money on the side, you have a lot of savings in your bank account, in real estate and stocks, and you have to assume you have five million in your retirement account or a million or whatever that amount is. You prefer to keep this money if you can keep it growing tax-free and pass it to your kids. But what happened? The government says, well, we would allow you to defer it but not for very long. At some point, you have to take a minimum distribution. It's called required minimum distribution. And if you don't take that required minimum distribution, the amount that you don't take, they will take half of it and taxes. So they really penalize you because again, the government wants their money. They gave you a chance all of your life to defer the taxes but you cannot do it forever. So a minimum withdrawal is called the minimum required distribution or RMD. So here's what happened. Generally speaking, the plan administrator for the qualified pension plan or the qualified profit sharing plan will determine the rules. If you have an IRA account, the taxpayer must determine the distribution rule because it's individual. You determine this based on IRS and there is no minimum distribution for Roth IRA. We talked about Roth IRA the way it works. There is no minimum distribution because the amount is tax-free anyhow, okay? So the government doesn't care. So here's what happened. So between 59, we have some leeway. If the plan owner reaches 70 and a half, so the rule has been changed recently so we have to know the old and the new. So simply put, if the plan owner, if the retiree reaches 70 and a half, let's assume we're dealing with year 2020, before January 1st, 2020. So simply put end 12, 31, 2019, which is the same thing as January 1st. So if they reach this 70 and a half, this is where you have to start to take the money out no later than April 1st. Okay, so you have to take the money out no later than April 1st of the following year, which is 2021. So once you reach 70 and a half, as long as you reach 70 and a half before January 1st, 2020, okay? You have to take this money a year later. So if someone reaches 70 and a half on November 10th, 2020, during the COVID year, 2020 was the COVID year, they have to start to make the first required minimum distribution, which is how much, we'll see how much it is, no later than April 1st of 2021. Okay, now the rules have changed because people are living longer and guess what? All the Congress people are old people so they won't even defer this later. If the plan owner reaches age 70 and a half after January 1st, 2020, 2020, so this rule has been changed recently in 2018 or 2019, then the applicable age is 72. What happened is they allow you to defer the minimum required payment until 2020, until 72. So simply put, they deferred the minimum required payment for another year and a half. Simply put, if you have money and your retirement and you don't need it, you could defer the withdrawal for a year and a half. Well, obviously again, as I said, it will favor the Congress people, but that's not the reason, but I want you to think about the logic behind it. It doesn't mean that's the reason, but you're deferring your payment. Also people are living longer and working longer, so they don't need this money as of yet, okay? In this case, the first required minimum distribution must be made no later than April 1st of the year after the plan owner reaches 72, okay? And subsequent required minimum distribution must occur no later than December 31st, but they give you a little bit of time. Now for the CARES Act, again, because of COVID, we have this CARES Act, required minimum distribution were waived for calendar year 2020 for IRA and certain defined contribution. This is only for this particular year, okay? So the taxpayer are permitted to take the distribution, but they are not required to do so. So simply put, you can defer that minimum required distribution and every time we have some sort of a crisis, they make an exception for that. For example, when the stock market crashed in 2007, 2008, this is, you don't have to know this. It's old news, I just wanna tell you this. The government suspended this minimum required distribution because what happened during that year, the stock market crash, and if you have money in that account, that money went down and if you have investments like stocks in your account, those stocks went down. So the government says, we are not gonna require you to cash out. If you want to cash out, that's up to you, your minimum required distribution, but we're not gonna penalize you if you don't do it. Same thing they did for 2020, just some flexibility, okay? So this is the idea of the required minimum distribution. And now what comes with the required minimum distribution is the amount that you, what is it divided by? The minimum distribution period. So the required minimum distribution is based on the account balance at the end of the year divided by something called the minimum distribution period. Okay, so this is how we determine that amount, how much you have to withdraw. So what is the minimum distribution period, MDP? Well, that's easy. It's given to you life expectancy table provided by the IRS and pub 590. So it's easy. So that number will be given to you. So giving the, taking the RMD divided it, so basically RMD divided by MDP, I'm sorry, not RMD, taking your account balance, you're gonna take your account balance, whatever your account balance divided by the MDP. And that's gonna give us RMD, the required minimum distribution that you have to take out. So let's take a look at an example. Joseph is unmarried and has been receiving distribution from his retirement. So now we're assuming he's receiving distribution. And remember, this required minimum distribution will change because your account balance will change from year to year. He must determine his minimum required distribution. Well, he's age 76 at the end of 2020. So again, he's already been taken this money out. At the end of 2019, his plan has a balance of 110,000. That's his plan balance. Now we're gonna be using table three life expectancy and the MDP is 22 years. So he's 22 years, so he's 76 years old. So he is 76 years old right here. So we're using, just wanna make sure we're using table three uniform lifetime, unmarried owners or married owners whose spouses are not more than 10 years younger and married owners whose spouses are not the sole beneficiaries of the IRA. So there must be somebody else as a beneficiary to the IRAs. This is the table that you would use. And this is what we got the 22 years from. Now it's easy, once we have the 22, we'll take 110 divided by 22. So Joseph must receive at least make a minimum distribution from his account of $5,000. Okay, let's assume Joseph was married and were married and the age difference between Joseph and his spouse was 10 years or less. Guess what? We'll use the same table because that's the same table. We use the same table, okay? Now, Joseph is unmarried. Now, Joseph is unmarried. His 70th birthday was March 1st, 2019. Now he did not reach 70 and a half yet. We're gonna assume March 1st is 2019 is his 70th birthday. Now we're gonna count six months down the road. Six months, September 1st, 2019, he's gonna reach 70 and a half. So he reached 70 and a half before the end of 2019. It means he have to start to take his minimum required distribution, April 1st, 2020. Remember, that's based on the old rules. As long as you reached 70 and a half before the start of 2020, you have to take the withdrawal of April 1st, the following year. So at the end of 2018, his retirement account has 300,000 and at the end of 2019, he'll be 70 years old. Of course, he'll be 70 years old. Now we're gonna be using table three and the life expectancy is 27.4. So now we're using, again, we're using table three and 70, 27.4. We're gonna take now, we have the life expectancy. We're gonna take this amount. The 300,000 divided by 27.4, he must receive 10,949 dollars, at least no later than April 1st. This is the minimum required distribution. Otherwise, let's assume he only took half of this amount or let's assume he only took $1,000. Well, guess what? The remainder is 9,949. The government will take half of this money as tax. Okay, because you did not take this money. So it's very important that individual remember and understand their minimum required distribution. Okay, assume Joseph's 70th birthday was November 1st, 2018. So he reaches 70 and a half on May 1st, 2019, six months later and is required to start the distribution April 1st, 2020. At the end of 2018, let's assume his balance was 550,000. Well, he needs to calculate his tax. Year 2019 required distribution. Okay, because 2019, he turned 70 and a half. At the end of 2019, he'll be 71 years old. Well, let's take a look at it. Again, using table three. And we're gonna go with 26.5, which is 71 years old, 26.5. Okay, now let's look at the number 550 divided by 26.5. The minimum required distribution is 20,755 dollars. What happened in case of that? The Bene, that's the Bene. We have to determine who the beneficiary is. Beneficiary is who's gonna get your payment after you die as a taxpayer. Okay, special rules apply. If the spouse is the Bene, if the spouse is beneficiaries, you can be elected to be treated like the owner. If the beneficiary is not the spouse or the spouse elect not to be treated like the owner, then what happened is the Bene generally determined the required minimum distribution for the year of that using her age, his or her age, with the reference to table one. Now we're gonna have to use a different table. If the spouse chose not to use the husband or the wife numbers, or if the Bene is somebody else other than the wife. So what's gonna happen, we'll use table one and for each subsequent year, that factor is reduced by one. We're gonna see table one. And there are special rules for if the beneficiaries was not an individual like some sort of an organization. Okay, let's take a look at an example. David died in 2020 at age 80. His nephew, Tom, so it's not the spouse was the sole Bene beneficiaries and was 67 years old. Well, we're gonna use table one for Tom and for 67, 19.4. What's gonna happen is we're gonna take 19.4 as the appropriate factor in 2020. Now in 2021, we'll minus one in 2022, 2022, it will be 17.4 so on and so forth. So just make sure you know this rule. Again, if you take the money out prematurely from your retirement, there is a 10% penalty but there's always exception. Here are some exception. You reach 59 and a half, obviously. After the death of the employee, the beneficiaries don't pay penalty even if they are less than 59 and a half. If you're permanently disabled, you can take the money without being penalized. If you have to pay for medical expenses, okay? If you have medical expenses that are above the 10% threshold of your adjusted gross income, whether you itemize or not, you can take this. If you have to pay your health insurance premium, okay? And if you are unemployed individual, you can take this money out. Higher education expenses, simply you can take from the Coverdale IRA SAP for higher education expenses. A $10,000 as a first-time home buyer. I use this when I purchase my home. It's basically alone, you have to pay it back and you can only do it once. And there are other reasons, the other factors for this waiver of the 10% penalty. During COVID, the government says you can take up to 100,000 from a qualified retirement plan for coronavirus related purposes. Now, what are those coronavirus related purposes? If you were diagnosed, if the taxpayer spouse or dependent is diagnosed with COVID or the taxpayer experienced certain adverse financial consequences like you lost your job, you're self-employed and your business is closed, then you can take 100,000. And the withdrawal is included in taxable income over three-year periods. What happened if you took $90,000 to use it? You don't have to pay taxes on it in 2020. You can spread it over three years, 30,000, 30,000 and 30,000. This would lessen the tax effect. You still have to pay taxes on that money because it wasn't taxed, but you don't have to pay the 10% penalty. At the end of this recording, please like this recording, share it, visit what, farhatlectures.com. If you are looking to study for your CPA exam or enrolled agent, I can tremendously help you in understanding the material. I'll give you alternative explanation, alternative exercises, alternative multiple choice that's gonna help you do better on your exam. Good luck, study hard and stay safe.