A Primer on Forms of Distribution – Questions from Those Approaching or At Retirement Age

Posted by Chris Ciminera

Retirement Distributions - Belfint Lyons ShumanIn my previous blog, I discussed how my young cousin Mike was eligible for a hardship distribution or a terminating distribution, and that he would not be able to avoid the early distribution penalty because of his age. Similarly, my Aunt Mary asked me at a holiday event how she could go about taking money from her 401(k) account to pay for her daughter’s wedding. Unlike the case with my cousin Mike, the additional 10% penalty on early distributions from a qualified plan does not apply to my aunt, who is over 59½. The forms of distribution that are available to the baby boomers in my family are as follows:

Retirement Distributions and In-Service Distributions – Retirement Age definitions typically range from 59½ to social security retirement age. Profit sharing plans can allow an in-service distribution to participants who attain the age of 59½, even if they have not retired. A minimum number of years of service is sometimes required for an in-service distribution, but in-service distributions of “rollover” accounts are generally available to all employees at any time. Exceptions from the penalty are also granted for distributions that are a part of a series of substantially equal periodic payments made for the life expectancy of the employee or the joint life expectancy of the employee and beneficiaries; distributions used to pay medical expenses in excess of 7.5% of adjusted gross income; and payments to alternate payees pursuant to a qualified domestic relations order (QDRO).

Minimum Distributions – If a participant remains employed past Normal Retirement Age, they may generally defer the receipt of benefits until termination of employment, but not past age 70½ if they own 5% or more of the plan sponsor. For 5% owners, distributions must begin not later than the April 1st following the end of the year in which they reach 70½. Distributions in a minimum amount based on the applicable life expectancy table must be made by December 31st of each year. Benefit payments to beneficiaries if the participant dies in pay status will be discussed in the third installment of this distribution blog trilogy.

Qualified Domestic Relations Order (QDRO) – A legal order subsequent to a divorce or legal separation that splits and changes ownership of a retirement plan to give the divorced spouse their share of the asset or pension plan. QDROs may grant ownership in the participant’s (employee’s) pension plan to an alternate payee, who must be a spouse, former spouse, child or other dependent of the participant. A QDRO may provide for marital or community property division between the participant and the alternate payee, or for the payment of alimony or child support to the alternate payee. QDROs apply only to employee benefit or pension plans subject to ERISA, the Employee Retirement Income Security Act, the American law governing private sector pensions. Comparable types of orders are available to divide military retirement pay and federal civil service retirement plans, and for state, county and municipal retirement plans in most states. QDROs must first be entered by the state domestic relations court and then reviewed by the plan administrator for compliance with ERISA or other applicable law and the terms of the plan. The QDRO may be a separate document or it may be part of the divorce decree as long as it meets the standards for a qualified domestic relations order.  The DOL has a publication about QDROs that you can access here. QDROs are not typical in my large Italian family.  An Italian marriage proposal is an offer that can’t be refused.

Personally, I’m not a huge advocate of taking large lump sums out of 401(k) plan accounts unless it is necessary for retirement expenses, but my aunt wanted my cousin’s wedding to be an event to remember, so a penalty-free distribution was her choice. Normal or early retirement is what we all strive for and is the main reason we set aside money each payroll to contribute to a retirement account. Taking minimum distributions for the entire length of our remaining life expectancy according to the generous mortality tables would be ideal. In our next and last blog in the distribution trilogy, I will discuss one last form of distribution that we all hope happens as late in life as possible: death distributions.