401(k) Loan balances in Plan termination

[Guest tgraham]

401(k) Plan is terminating effective 12/31/04. Two employees have outstanding loan balances that they will not be able to repay to the plan prior to the termination date. Question then becomes will these "distributions" be subject to a 10% penalty, in addition to ordinary income tax? One employee is 58 and the other is 63. Thank you.

[pmacduff]

Not for the 63 year-old but yes for the 58 year-old. As far as I know, the only ways to avoid the 10% premature penalty if you are under 59 1/2 when you file your personal return is if you are totally & permanently disabled or if take your distribution payment as an annuity. hope this helps

[Harwood]

Are the employees continuing to be employed? If they are terminated, the age drops to 55 by December 31 to avoid the 10% additional tax.

[QDROphile]

I don't understand "drops to age 55 by December 31." IRC section 72(t)(2)(A)(v) applies if the employee terminates before distribution.

[Harwood]

Is this better wording?:

If someone will be at least age 55 by December 31 in the year that they terminate employment, distributions from employers they worked for after age 54 are clear of the 10% additional tax.

The original post says that the plan is terminating; it doesn't say if the company is shutting the doors or if the age 58 person will be leaving.

[pmacduff]

Hey Harwood - thanks for the info! I had always thought that you only received that benefitof no 10% excise @ age 55 if you annuitized. Here are the instructions for form 5329 and it states your point clearly on page 2, line 2.

i5329.pdf

[Lori Foresz]

Hi,

What is the rule on the attainment of age 59 1/2? If you are 59 when you receive the distribution, but 59 1/2 when you file your tax return (or as of 12/31), is the 10% penalty waived? Can't find any guidance but I always presumed it was age at distribution that determined whether an exception to 72t applied. If anyone can help, that would be great!

[Harwood]

Age 59 1/2 is based upon your age when the distribution occurs.

Age 55 is different. From IRS Notice 87-13:

Q-20: What additional tax on early distributions from qualified retirement plans applies under section 72(t) (as added by TRA'86)?

A-20: Section 72(t) (as added by TRA'86) applies an additional tax equal to 10 percent of the portion of any "early distribution" from a qualified retirement plan (as defined in section 4974© of the Code) that is includible in the taxpayer's gross income. A distribution (including deemed distributions under section 72(p)) is treated as an "early distribution" unless it is described in section 72(t)(2)(A) (taking into account section 72(t)(3) & (4)). A distribution to an employee from a qualified plan will be treated as within section 72(t)(2)(A)(v) if (i) it is made after the employee has separated from service for the employer maintaining the plan and (ii) such separation from service occurred during or after the calendar year in which the employee attained age 55.

[QDROphile]

Note that the termination must be before the distribution AND the participant has to attain age 55 or older in the year of distribution. In the original post, they are all older than 55. So the key unknown facts for the younger employee relate to timing of termination.