1099-R code for cash distribution, age 56

[emmetttrudy]

Code 2 (early distribution exception applies) says "A distribution from a qualified retirement plan after separation from service in or after the year the participant has reached age 55.".

Does a plan termination count as a "separation from service" for these purposes? Someone is age 56 and takes a cash distribution from a plan because the plan terminated. Would this be Code 1 or Code 2?

[My 2 cents]

My guess: Although the payment of an in-service distribution to an active employee age 56 is permissible because it was made when the terminating plan distributed all of its assets (otherwise it would have been prohibited), I wouldn't think that, being still employed, the participant would qualify for the exemption from the excise tax.

[ETA Consulting LLC]

Correct. A plan termination isn't considered a severance from employment for these purposes.

Good Luck!

[emmetttrudy]

Thanks!

[My 2 cents]

Concerning the excise tax to be paid: If the termination was admistered properly, the participant was first given a tax notice indicating how the distribution would be taxed if taken as other than a direct rollover and an opportunity to have the distribution rolled directly over to an IRA or another qualified plan, which the participant presumably declined to do, choosing cash instead. Even in plan termination situations, with the exception of really small distributions, the plan administrator must permit the participant to direct that the proceeds be rolled over directly to an IRA of the participant's choice or another qualified plan, and there should have been a place on the election form for direct rollover requests. If the sponsor maintains a defined contribution plan for which the participant is eligible, a normal action would be for the active participant (with spousal consent if the value is over $5,000) to direct that the proceeds from the defined benefit plan termination be rolled over to an account in the defined contribution plan. It is virtually certain that the person had choices to do something other than be paid in cash (unless the amount was really small). The participant was properly warned that being paid in cash would generally result in ordinary income tax plus a potential penalty tax (and that there would be mandatory 20% withholding, which would appear on the 1099-R). So put a code of 1 on the 1099-R and let the chips fall where they may.