Muni Pension Mandatory Contribution distribution 1099-R code

[Biz Develop Consultant BJF]

We have a municipal pension plan that requires employees to make mandatory pre-tax contributions to the Plan.  If a participant terminates prior to vesting, the mandatory contributions are paid out in the year of separation.  I was told the "prior person" said the code on the 1099-R should always be 7 (normal) or 2 (exception), but no explanation was given.

In reading the Form 1099-R instructions Code 2 does not seem to apply to this distribution, although intuitively it seems to, i.e. participant was automatically enrolled (mandatory contribution) and is now forced to take the withdrawal.  However the section of the Code, 414(w)(1)(B), seems to only address section 401(k) Plan(s) with automatic enrollment.

Thoughts?

[Luke Bailey]

Code 7 would apply if the participant is 59-1/2 or over, but since in your question the individual is leaving without being vested I am going to assume that in most cases the participant will be younger than 59-1/2. If the person is younger than 59-1/2, then you will use code 1 if the distribution does not qualify for an exception to the 10% early distribution tax of Section 72(t), which will probably be the case most of the time, otherwise use code 2. See the 1099-R instructions on pages 15 and 16.

The "exception" for purposes of code 2 is the exception to the 72(t) 10% excise tax. It is possible that an exception would apply, e.g. the employee, even though not vested, terminated after attainment of age 55 (50 if public safety), but otherwise you would use 1. If the participant rolls the distribution over to an IRA or employer-sponsored plan, they would not, of course, pay the 10% excise tax.

Note that in any of these cases, that is, regardless of whether code 7, 1, or 2 is used, if the distribution is an eligible rollover distribution (which it seems likely it would be, since I assume the refund is done as a lump sum) and the participant elects to roll it directly to an IRA or employer plan, then it appears you need to file a separate 1099-R for the same distribution, with Code G in Box 7. Again, see page 16 of the 1099-R instructions for the use of code G and its incompatibility with any of codes 1, 2, or 7, and see page 14 of the instructions with respect to what to do if two different codes apply, but the codes are not compatible.

As always, there are parts of the 1099-R instructions that I find completely baffling.