Is rollover money exempt from the 10% penalty?

[ldr]

Good afternoon to all,

Our client's document says that unrelated rollover money can be withdrawn at any time, while for all other sources, the participant must be 59.5.

A participant in the plan with 6 figure unrelated rollover balance wants to withdraw money immediately for the downpayment on a new home.  She is literally a month away from turning 59.5.  I say that she needs to wait until her date of attainment of 59.5 to avoid the 10% penalty on her withdrawal.  

However, a colleague is speculating that because the funds originated in the retirement plan of a previous employer, she no longer works for that employer, and she left that employer after turning age 55, she shouldn't have to pay the 10% penalty. I think that could be true if she had left the money in the old employer's plan, but once she rolled it into her current employer's plan, she's subject to the penalty if she doesn't wait until she is literally 59.5.  I am never dead sure of anything, though, so I am asking...........

What say all of you?

Thank you as always for your input.

 

 

 

[Lou S.]

The exception only applies only to the Plan that you separate service from after attainment of age 55.

If you roll the funds from that plan to an IRA or another qualified plan they pick up the characteristic of the new vehicle.

[ldr]

Thanks, Lou S.  That's what I thought, too, but didn't really have anything to "hang my hat on".

 

[QDROphile]

So you are now going to report your conclusion based on "Lou S says"?  That is a decent answer on these Boards, but pretty lame in the wild world.

[ldr]

QDROphile, I was merely thanking Lou S for his answer and commenting that it matches what I thought. It goes without saying that I would wait for more answers and weigh them against each other, plus eventually trying to do more research if necessary, before making a final judgement.

Don't jump so quickly to conclusions!

[Lou S.]

I have no IRS citation to provide him but on this one I'm certain of the answer.

This may or may not be a good citation if he need back up for the office https://www.irahelp.com/slottreport/age-55-exception-10-early-distribution-penalty

 

 

[ldr]

Thanks, Lou S.  Of course the safest and fastest thing to do is to tell the participant that she must wait until the magic day in March when she turns 59.5.  That's easy.  But the colleague who asked if the participant could somehow be construed to meet an exception deserved to have her idea explored, so that's what we are doing.

[ldr]

We did find out this much.  The participant could roll the money to an IRA now, and then take the withdrawal as a first time home buyer from the IRA, penalty free.  But given the logistics of getting the rollover done and then making the withdrawal, she would practically have reached age 59.5 anyway.....

The other idea being kicked around is to see if some kind of letter of guarantee could be provided to the lender or the seller showing that as of x date in March, she can access the funds for the down payment....

[ESOP Guy]

1 hour ago, QDROphile said:

So you are now going to report your conclusion based on "Lou S says"?  That is a decent answer on these Boards, but pretty lame in the wild world.

I don't think Lou needs a cite in this case.  If someone wants to claim the terminated over 55 exception applies to this plan and not the original plan the burden is 100% on them to prove it.  

The plain reading of the rules gives no reason to think that exception "sticks" to the money.  

[QDROphile]

I was just complimenting Lou S.

[Kristina]

When one completes the 1099R to report the distribution, Code 2, Known exception would apply.  Which means no 10% penalty because she is over age 55 when she is taking the money.

[ldr]

@ Kristina, thanks for your input.  As I understand it, merely being over 55 isn't enough.  She has to be over 55 and meet some other criteria before she can use code 2: (from the IRS instructions)

Use Code 2 only if the participant has not reached age 591/2 and you know the distribution is the following. • A Roth IRA conversion (an IRA converted to a Roth IRA). • A distribution made from a qualified retirement plan or IRA because of an IRS levy under section 6331. • A governmental section 457(b) plan distribution that is not subject to the additional 10% tax. But see Governmental section 457(b) plans, earlier, for information on distributions that may be subject to the 10% additional tax. • A distribution from a qualified retirement plan after separation from service in or after the year the participant has reached age 55. • A distribution from a governmental defined benefit plan to a public safety employee (as defined in section 72(t)(10)(B)) after separation from service, in or after the year the employee has reached age 50. • A distribution that is part of a series of substantially equal periodic payments as described in section 72(q), (t), (u), or (v). • A distribution that is a permissible withdrawal under an eligible automatic contribution arrangement (EACA). • Any other distribution subject to an exception under section 72(q), (t), (u), or (v) that is not required to be reported using Code 1, 3, or 4

See, this lady isn't terminated or separated from service from her current employer. She wants an in-service distribution from her unrelated rollover bucket that originated with a previous employer.   I am saying she has no grounds for using Code 2, and my colleague was trying to "stretch" the rules to fit the situation by saying that because the participant IS separated from the employer who generated the rollover she put into her current employer's plan, and because she WAS over age 55 when she left that employer, then she should be able to use Code 2.  Lou S and I are of the opinion that once she rolled the money into her current employer's plan, she lost the ability to use Code 2.

 

[RatherBeGolfing]

Lou is correct.  Can't use code 2 now since she is still employed.  She needs to wait or take the 10% hit

[ldr]

Thanks, RatherBeGolfing.  We are in agreement.

 

[card]

"The participant could roll the money to an IRA now, and then take the withdrawal as a first time home buyer from the IRA, penalty free."

only up to $10,000.

[ldr]

Thanks, card.  We saw that too, but as far as we know, she wants a lot more than $10,000.  Otherwise that would have been a good avenue to pursue.

[Lou S.]

Can she take a loan from plan to cover down payment? When she turns 59.5 take an in service distribution and pay off the participant loan early? It's not best idea but it could be a decent work around if you are talking about saving potentially thousands in tax penalties.

[ldr]

Lou that's a great idea.  The administrator who initially brought me this issue is out this afternoon but Monday we will find out.