Individual Sees Unfairness in Treatment of Plan Distributions

Deferred Compensation Plans

The federal tax code allows for deferred compensation plans such as 401k's and 457 plans that encourage individuals to save for retirement. When those who have used these savings plans eventually take a distribution, whether required (RMD) or not, they are taxed at their ordinary income tax rates on the full amount of the distribution.

This is unfair because the distribution consists of both contributions, on which taxes were deferred, and dividends and capital gains on those contributions. Change is needed.

My suggestion is to require the deferred compensation plan to determine and report to the IRS the percentage of the balance, as of December 31 of the previous tax year, that contributions represented. That percentage of any withdrawal during the ensuing tax year should then be taxed at the individual's ordinary income tax rate. The remainder of the withdrawals during that year should be taxed at the individual's capital gains rate.

Alternatively, distributions can be taxed at the individual's ordinary income tax rate until the total of all contributions have been withdrawn. The remainder should then be taxed at the individual's capital gains rate as it is withdrawn.

The life expectancy and distribution period tables should be updated every five years in order to lessen the chance that Required Minimum Distributions would cause depletion of the entire balance during the owner's lifetime.

Additionally, tax-free withdrawals should be allowed for higher education, helping grandparents to contribute to the college education of their grandchildren.

Marilyn Seidenberg
Certified Government Financial Manager — Retired
Director of Finance, Retired
Western Monmouth Utilities Authority