Premature distribution exception - separation after age 55

[Belgarath]

So, let's say a person terminates employment with Employer A at age 50. The exception under 72(t)(2)(A)(v), as I read it, does not allow the individual to wait until age 55, then withdraw without penalty - the actual separation must occur during or after the year in which the employee attains 55. (That's not quite what the code says, but the IRS blessed this interpretation in some guidance that I can't put my finger on at the moment.)

However, am I correct in assuming that there is nothing preventing this money being rolled to the plan of new Employer B, then when separating from service with Employer B at age 55, it WOULD then qualify for the exception? Any disagreement?

[Kevin C]

The cite you are looking for is in 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 sections 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.

A distribution that is an “early distribution” will not be subject to the additional tax to the extent provided under section 72(t)(2)(B) (relating to deductible medical expenses under section 213), section 72(t)(2)© (relating to certain distributions from employee stock ownership plans), or section 72(t)(2)(D) (relating to distributions pursuant to qualified domestic relations orders). The determination of whether the additional tax under section 72(t) applies to a distribution to be made without regard to whether the distribution is treated as a mandatory distribution for purposes of section 411(a)(11) or section 417(e).

The payor (or, if applicable, plan administrator) is not liable under section 3405 to withhold any amount on account of the additional income tax imposed under section 72(t). However, the taxpayer may have estimated tax liability with respect to such additional income tax.

I agree that if it is rolled to another plan where he/she is currently employed, it would qualify for the exception if distributed from that plan after termination of employment at age 55.

[Belgarath]

Thanks Kevin.

[MoShawn]

I had a question relating to the age 55 exception come up just this morning.

Participant age 60 terminates employment. Due to a testing failure, he receives $2,000 and a Form 1099-R with tax code 8. Subsequently, it is determined that the correction should only have been $1,500.

Currently he has 1 Form 1099-R with a code 8 for $2,000. Assuming he does not return the money to the plan, we will amend the Form 1099-R to be code 8 for $1,500 and issue another with a code 2 for $500.

Doesn't this represent the same tax position, either way? In both instances, $2,000 is includable in income and nothing is subject to the 10% early withdrawal penalty.

[Jim Chad]

I believe you are correct. Same tax effects either way.

[Kevin C]

MoShawn, I'm not following why you would be looking at the age 55 exception in your situation. It only applies to distributions following termination of employment and you said the participant terminated at age 60. Once he is age 59.5, there is no early withdrawal penalty.

[MoShawn]

Doh! Good case of adjusting the facts to protect the innocent, and in the process changing the situation entirely...

Actually terminated at age 58, thus the interest in the exception.

[BG5150]

Actually terminated at age 58, thus the interest in the exception.

Oh. Now I know exactly who you are talking about!

[MoShawn]

Yeah, yeah, call me paranoid...

[Kevin C]

In that case, I'll agree it works out the same either way on the taxes, as long as the refund was paid after he terminated employment.