We've recently been discussing the ramifications of the fact that the assets of a LOSAP are not participant assets, but municipal assets.
Another ramification is that the benefits paid cannot be rolled over to an IRA. There are other tangential reasons as well, but a main reason why is that the assets are not the participants to control.
Let's consider a defined contribution plan to keep it simple. A firefighter has accumulated a $20,000 balance. This firefighter turns the entitlement age and is eligible to be paid this $20,000 on 1/1/2019. Therefore, on 1/1/2019 the $20,000 is made available to the participant, and so it is taxable (we are just tackling Federal income tax for now). Thus, it is distributed to the participant. Prior to 1/1/2019, the $20,000 was not taxable because it was municipal assets and subject to forfeiture (if the municipality were to become insolvent, or bankrupt).
In a rollover situation, a participant transfers his/her own account balance (one that the participant owns 100%) to another qualified retirement plan. But since the LOSAP account is not owned by the participant, this type of transfer cannot take place - it is not from a participant-owned pre-tax account to another participant-owned pre-tax account.
There are similar situations in the qualified plan world. For example, if you inherit an IRA from someone other than your spouse, you are not allowed to roll it over into your own IRA. In addition, required minimum distributions are not eligible for rollover.
Please consult with your own tax adviser about the taxation of receiving your LOSAP distribution. This article is not legal or tax advice.
Benefits paid from a LOSAP are subject to federal income tax as of the date this blog post is being written.
In general, any form of compensation is taxable in the year in which it is earned, unless the the Internal Revenue Code specifically exempts it. One of those exemptions are contributions into 401(k) - the Code allows an individual to defer taxation of compensation by depositing that compensation into a qualified 401(k) plan. Similarly, an individual can make contributions into an IRA and subtract those contributions (up to a certain limit) from the individual's taxable gross income.
Benefits accrued in a LOSAP are a form of compensation, and the Code does not contain any provision to exempt it from federal tax. NY State law stipulates, in summary, that the LOSAP benefits should not be taxable to the participants until it is paid.
In order to prevent a participating volunteer from paying federal income tax on the LOSAP benefits as they are accrued rather than when they are paid, two stipulations are made on the Trust assets:
1) Trust assets are assets of the municipal sponsor.
2) Trust assets are subject to the creditors of the sponsor in the case of insolvency.
Stipulation #2 in particular means that it is possible that a participating volunteer will not be paid the accrued benefit, because the sponsor could, in theory, become insolvent and the Trust assets would be accessed by the sponsor's creditors. This is enough of a stipulation that the benefit is not taxable until it is made available to be paid to the participant. In New York, once it is made available to be paid, it is paid.
Note: this post is not meant to be an exhaustive explanation of all of the nuance of the federal taxability of LOSAP benefits. Please contact your own IRS tax specialist or contact our office for additional details.
Last time we discussed how LOSAP assets are assets of the sponsoring municipality.
One ramification of this is when a participant goes through a divorce. Most people are aware of a Qualified Domestic Relations Order, or QDRO, where pension assets are divided. Many try and divide LOSAP assets in the same way.
But since the assets are municipal assets, a participant doesn't own them, and therefore cannot assign them to an ex-spouse. Therefore, a LOSAP benefit cannot be assigned in a divorce proceeding through a QDRO or similar procedure.
However, that doesn't mean that the spouse cannot claim the LOSAP as a marital asset and use it to trade off on another asset. For example, if the LOSAP benefit is $10,000, and the couple has a car worth $10,000, then the participant could keep the LOSAP and the ex-spouse keep the car.
Or, the ex-spouse could have the court order the participant to pay the ex-spouse a portion of the LOSAP benefit similar to alimony. However, the participant would be responsible for 100% of the tax liability, so that should be considered when deciding what share of the benefit the ex-spouse should receive.