Qualified Pension Distribution Requirements
A subtraction may be allowed on the Michigan return for qualifying distributions from pension plans. Pension plans include private and public employer plans, and individual accounts governed by various sections of the internal revenue code (IRC).
Employer plans and individual plans each have rules for receiving pension distributions. For a pension distribution to qualify for the Michigan subtraction, it must comply with the specific distribution rules under its plan.
Employer plans are created by private companies and by public entities.
The employer plan establishes rules that govern retirement age and the pension formula for their employees.
For both public and private employer plans, an employee must retire under the provisions of the plan, the pension benefits must be paid from a pension trust fund, and the payment must be made to either the employee or the surviving spouse. Payments made to the surviving spouse are only deductible if the employee qualified for the subtraction at the time of death.
Although traditional employer plans are defined contribution and defined benefit plans, many employers use 401(k) or 403(b) plans that incorporate employee match provisions.
- Plan distributions are considered qualified distributions to the extent that they are attributable to the employer’s contributions or employee’s contributions that were mandated by the plan.
- An employee’s contribution required by the plan to elicit an employer match is considered mandated.
- Amounts distributed from the plan that allow the employee to set the amount of compensation to be deferred and does not prescribe retirement age or years of service does not qualify as pension benefits.
Individuals may have pension accounts created under various sections of the IRC that may or may not be part of an employer plan. To qualify for the Michigan pension subtraction, the distributions must meet the requirements set forth in the relevant section of the IRC.
Individual Retirement Account (IRA) IRC 408 Distribution Requirements
- 59½ or older, or
- Disability, or
- Death - distributions after the death of the participant may only be subtracted by a surviving spouse if the distributions qualified as a subtraction for the participant at the time of death; or
- Series of equal periodic payments made for life under IRC 72(t)(2)(A)(iv). Distributions from a Roth IRA are not included in AGI and are not subtractable on the Michigan return.
Senior Citizen Annuity IRC 72 Distribution Requirements
- Received from a retirement annuity policy, and
- For life, and
- To a senior citizen.
For purposes of the retirement annuity subtraction, a senior citizen is defined in MCL 206.514(1) as an “individual . . . who is 65 years of age or older at the close of the tax year. The term also includes the un-remarried surviving spouse of a person who was 65 years of age or older at the time of death.
401(k) and 403(b) Plans
If all the contributions are made by the employee or if the employee makes contributions exceeding the amount mandated by the plan to elicit employer contributions, then any distributions attributable to those employee contributions will not qualify for the pension subtraction.
The Michigan Income Act prohibits a pension subtraction of distributions from a 457 plan.
Keogh or HR 10 Plans for the Self-Employed
Distributions are subject to the same general rules for other retirement plans, usually not made until a participant separates from service, the plan is discontinued, or the participant reaches age 59½.
The following distributions do not qualify for the pension subtraction:
- Deferred compensation plans that allow the employee to set the amount of compensation to be deferred and do not prescribe retirement age or years of service e.g., 401(k), 403(b), and 457 plans if all the contributions are made by the employee or if the employee makes contributions that do not elicit contributions by the employer.
- Commercial Annuity Policies (unless the payments are made for life to a senior citizen).
- Premature separation, withdrawal, or discontinuance of a plan prior to the earliest date the recipient could have retired under the provisions of the plan.
- Payments received as an incentive to retire early unless the distributions are from a pension trust.
- Eligible distributions received by a beneficiary of the decedent except for the surviving spouse.
- Distributions that are sourced to rollovers from plans or contributions that do not qualify (i.e., IRA distributions that are sourced to rollovers from a 457 plan).