When must tax be withheld from retirement distributions?

The IRS has released a summary of the rules governing under what conditions retirement plan distributions are subject to withholding. The summary is contained in the Summer 2011 edition of the IRS Retirement News for Employers.

Distributions from an employer-sponsored retirement plan may or may not be subject to withholding, depending on the nature of the payment. In some cases, withholding is mandatory and, in others, the recipient can elect to have no withholding taken out.

Eligible rollover distributions – The payor of any designated distribution that is an eligible rollover distribution must generally withhold an amount equal to 20 percent of the distribution. A designated distribution is a distribution or payment from, or under:

  • An employer deferred-compensation plan
  • An IRA or individual retirement annuity
  • A commercial annuity

An eligible rollover distribution generally is a plan distribution from an eligible retirement plan, other than:

  • A periodic distribution
  • A minimum required distribution
  • A hardship distribution

Eligible rollover distributions are not subject to withholding if expected distributions to an individual are less than $200 for the year. Also, 20 percent withholding generally applies only to any previously untaxed amount of an eligible rollover distribution. Most important, no withholding is required if the plan directly rolls over, in a trustee-to-trustee transfer, the eligible rollover distribution amount to another qualified retirement plan or IRA.

Periodic payments – Periodic payments are made at regular intervals for more than one year, such as an annuity. The payor of a periodic payment that is not an eligible rollover distribution must withhold from the payment as if it were a wage payment for the appropriate payroll period.

Generally, the plan administrator must withhold at the rate for a married individual with three withholding exemptions. However, recipients have the right – and must be so informed by the plan administrator – to:

  • Elect no withholding or elect to have a different amount withheld, by filing Form W-4P, Withholding Certificate for Pension or Annuity Payments, with the plan administrator; and
  • Revoke the election at any time.

Nonperiodic payments – A nonperiodic payment is a distribution that usually is not made at regular intervals and is not an eligible rollover distribution. Examples of nonperiodic payments are:

  • Distributions of excess annual additions
  • Distributions of excess contributions and excess aggregate contributions from most plans if made within 2½ months after the end of the plan year
  • Hardship distributions
  • Loans treated as distributions

Nonperiodic payments generally are subject to 10 percent withholding. However, the recipient may elect no withholding or have a different amount withheld by filing a Form W-4P with the plan administrator.

Special situations –Special rules apply to:

  • Distributions made because of recognized disasters
  • Distributions delivered outside the United States or U.S. possessions
  • Certain noncash distributions, including employer securities
  • A participant's accrued benefit offset because of a defaulted loan

For distributions from designated Roth accounts in 401(k), 403(b) or 457(b) plans, there is no withholding for a qualified distribution from a designated Roth account because the distribution is not taxable. If a nonqualified distribution is made from such an account, withholding is required only from any distributed earnings that the recipient must include in gross income.

Read more at www.irs.gov/retirement/article/0,,id=244136,00.html.

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