5.30 E. Federal Income Taxes on Death Benefits

1. Death of Member In Participating Status

1. Lump Sum Death Benefit

The benefit is subject to federal income tax, except that portion attributable to previously taxed IMRF member contributions. Certain beneficiaries The individual(s) or organization(s) a member chooses to receive his or her IMRF death benefits. may be allowed to choose ”forward averaging” to compute the tax.

Surviving spouses may roll over the taxable amount into a traditional IRA Individual Retirement Account. A tax-deferred retirement account for an individual that permits individuals to set aside up to $2,000 per year, with earnings tax-deferred until withdrawals begin at age 59 1/2 or later (or earlier, with a 10% penalty)., Roth IRA, qualified plan, 457 or 403(b) plan A retirement plan that functions like a defined contribution plan and is similar to a 401(k) plan, but is offered by non-profit organizations, such as universities and some charitable organizations, rather than corporations. If you work for a school district or a public hospital, you may be familiar with an Internal Revenue Code Section 403(b) tax-deferred annuity.. Beneficiaries who are not a member’s spouse may also roll over the taxable amount into an IRA. However, the IRS treats the IRA as an ”inherited IRA” and special distribution rules will apply.

A rollover into a Roth IRA is taxable to the beneficiary in the year the rollover is made.

IMRF is required by federal tax law to withhold 20% of the taxable portion of the lump sum benefit paid. The beneficiary can avoid the 20% withholding by electing to have the taxable portion directly transferred to an account as a qualifying rollover.

The non-taxable portion may be rolled over into an IRA (spouse or non-spouse beneficiary) or a qualified plan (spouse). (View Exhibit 5L, Form BW-60, ”Distribution/Rollover Certification.")

Download and Print Form BW-60

A beneficiary who does not ask for a direct rollover has 60 days after receipt to make a rollover to a traditional IRA, qualified plan, 457 or 403(b) plan, as provided by section 402(c) of the Internal Revenue Code.

To be eligible for a rollover, a non-spouse beneficiary must ask for a direct transfer to an IRA.

If a beneficiary is entitled to use 10-year averaging to limit tax liability, this option should be weighed against the rollover option.

2. Lump Sum Death Benefit Taken In Monthly Installments (Beneficiary Annuity)

The monthly payments are subject to federal income tax, but not that portion attributable to the deceased’s previously taxed IMRF member contributions Members who participate in the Regular Plan contribute 4.50% of salary toward a future IMRF pension: 3.75% for the member and 0.75% for a surviving spouse pension. Members who participate in the SLEP plan contribute 7.50% of salary (on and after June 1, 2006) toward a future SLEP pension: 6.75% for the member and 0.75% for a surviving spouse pension. Before June 1, 2006, SLEP members contributed 6.50 percent of salary; 5.75 percent for the member and 0.75 percent for a surviving spouse pension. Members in the ECO plan contribute 7.50 of salary toward a future ECO pension: 6.75% for the member and 0.75% for a surviving spouse pension..

The amount of the monthly payment not subject to federal taxes varies depending upon the amount of the deceased’s previously taxed IMRF member contributions and the age of the beneficiary.

The taxable amount of each annuity payment is computed using the same basic formula as retirement pensions.

3. Surviving Spouse Pension plus $3,000

The $3,000 death benefit is a taxable distribution. However, the surviving spouse can consider two options: having the $3,000 made payable to the spouse or rolling it over into a traditional (not a Roth) IRA, Roth IRA, qualified plan, 457 or 403(b) plan. If the $3,000 is rolled, IMRF will report a taxable amount of $0.

The surviving spouse pension is subject to federal income tax but not that portion attributable to the deceased’s previously taxed IMRF member contributions.

2. Death of Member in Non-Participating (Inactive) Status

1. Return of IMRF Member Contributions and Interest

Returned previously taxed IMRF member contributions are not subject to federal income tax but 414(h) Under Section 414(h) of the Internal Revenue Code, members make their contributions to IMRF on a tax-deferred basis. The member does not pay either federal or Illinois income tax on the money used to pay the contributions. A member’s contributions will be subject to federal income tax, but not to Illinois income tax, when he or she receives them as a refund or as a pension or when the member’s beneficiary(ies) receives them as a death benefit. This tax treatment is provided under the 414(h) tax deferral plan effective July 1, 1984, for all IMRF employers and adopted earlier by some employers. If a member made contributions before his or her employer adopted a 414(h) plan, those contributions were taxed at the time the member made them. They are not taxable when the member receives them as a refund or pension or when the member’s beneficiary(ies) receives them as a death benefit. tax-deferred member contributions and the interest are taxable.

2. Surviving Spouse Annuity

The income tax treatment is the same as that described in subparagraph 1(c) above.

3. Death of a Person Receiving an IMRF Retirement Pension

1. Surviving Spouse Pension

The surviving spouse pension is subject to the same federal income tax treatment as the IMRF retired member’s pension. The spouse may exclude from income the same dollar amount or percentage of each pension payment that the IMRF member was allowed to exclude until all previously taxed member contributions have been recovered.

When all the previously taxed contributions have been recovered, the entire pension will be subject to federal income tax. IMRF will inform the spouse when the pension becomes taxable.

2. Special Needs (Reversionary) Annuity

The Special Needs (reversionary) annuity (see 5.20 B. 15 b. Reversionary Annuity) income tax treatment is the same as described in 3(a) above.

3. Return of Unused Contributions

If the deceased retired member left no surviving spouse eligible for a surviving spouse pension, IMRF pays to the beneficiary the excess of the member’s contributions with interest (less any benefit prepayment) to date of retirement over the pension payments made to the date of death.

The beneficiary receiving this payment may take a tax deduction equal to the amount of unrecovered previously taxed IMRF member contributions.

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