Removing your contributions from a Defined Benefit Plan
I have a 57 year old client who was let go from Delphi after 30 years of service. Last year the Delphi Pension Plan was turned over to the PBGC. The client was told by the PBGC that he could remove his after tax contributions from the plan prior to starting a pension income. The value of his after tax contributions is $35,000 of which $15,000 is principal and $20,000 is growth. He was told he could rollover the growth portion into his IRA, the principal portion would be sent directly to him. In December the client filled out the paperwork and mailed it to the PBGC. Earlier this week the PBGC contacted him and said they were going to withold 20% from the principal portion prior to sending to him. They were not specific, but suggested to the client that this may in fact be viewed as taxable money. This sent up a big red flag. It is sounding very similar to the treatment of after tax contributions in a 401(k) plan. Can anyone explain the rules regarding removing aftertax contributions from a pension plan? Can the total amount be rolled over to the IRA and if so will a form 8606 be required. What advice should I give the client?
Permalink Submitted by Alan Spross on Fri, 2010-06-25 19:58
I can’t speculate on the accuracy of the options stated by PBGC. However, IF the pre tax amount of the earnings are directly rolled over to an IRA, there should be no withholding on those funds. There should also be no withholding on after tax contributions paid to the employee since taxes have obviously already been paid on those funds. Therefore the mandatory withholding info is incorrect unless the character of the funds is in question. Having the money distributed could well be of benefit if the PBGC dollar pension cap comes into play. If the cap came into play (around 50k per year), then a rollover might save irrevocable loss of some benefits.
The withholding data stated above is also consistent with distribution of 401k funds.
With respect to the after tax contributions, there is no reason that they too could not be rolled over to an IRA by the employee. Current rules for reporting basis in IRA accounts emanating from qualified plan rollovers is that the 8606 reporting the added basis is not to be filed in the year of the rollover, but rather in the year the first distribution is taken from any of the employee’s IRA accounts. I think this rule is misguided, since taxpayers are already notoriously lax in reporting non deductible IRA contributions in the year they are made. Expecting that they will remember to include the basis of QRP rollovers several years after the actual rollover is obviously wishful thinking on the IRS’ part.
That said, since once the employee rolls over the after tax amount, it can only come out of the IRA on a pro rated basis. So if there is any projected need for these funds in the near future, they probably should be left in a taxable account. Another option is doing a Roth conversion, but there is also a debate on isolating basis for Roth conversions that you may have seen. The IRS needs to resolve this, but the employee only has 60 days from receipt to make his decision about the after tax rollover.