Age 55 rule
When an employee separates from service and is over age 55 they can take a distribution (if plan permits) penalty free. My understanding is that the distribution must be from that employer plan, not a previous employer plan. So, if someone has an older plan and they left it with the employer, that plan is not the eligible plan to take a distribution from.
Permalink Submitted by Alan Spross on Tue, 2008-09-23 20:03
That is correct. Only plans of the employer from which an age 55 or later separation occurs receive the penalty exception.
Taxpayer should first check plan flexibility regarding periodic and flexible distributions for plans eligible for the exception. This can enable taxpayer to avoid doing an IRA transfer and starting a 72t plan, which is a very rigid plan with large potential penalties. A taxpayer who can get the distributions from the age 55 plan, but does not have enough funds in the plan may need to use that plan AND have a 72t plan as well from IRA accounts. The 72t amount should be kept as small as possible if it is necessary, but not so small that there is a risk of busting the 72t plan.
Permalink Submitted by Ronald L. Geer Jr. on Thu, 2016-05-26 23:36
I have a client who is age 50, about 500k in his existing 401(k) and has just left the company to work for another company. He plans to retire from his new company sometime between age 55 and 59 1/2. If he rolls his existing 401(k) to the new 401(k), will those “old’ funds qualify for the age 55 rule, avoiding the 10% withdrawal penalty? I realize the income must be from the same company plan he retired from at age 55, however, I was just confused if the primary source of those funds could come from an old 401k. Thank you for any guidance you can provide. Obviously, I’d love to roll that into an IRA but…client comes first:)
Permalink Submitted by Alan - IRA critic on Fri, 2016-05-27 00:49
There is no tracing of funds in the 401k, so any rollovers into the plan are treated as funds of the current plan for purposes of the age 55 separation exception. If the new employer accepts rollovers from IRA accounts, the old 401k could be rolled to an IRA now, and then rolled from the IRA into the current 401k just before the client retires and the entire balance would then be eligible for the penalty waiver. Of course, the plan from which he retires would also have to offer flexible annual distributions instead of a lump sum because if he had to take out enough (roll over the rest) to fund 5 years of expenses, the higher tax rate due on the large distribution would offset much of the advantage of the penalty waiver.
Permalink Submitted by Ronald L. Geer Jr. on Fri, 2016-05-27 13:33
Great Thank you! Very helpful!
Permalink Submitted by Josh Harmon on Sat, 2016-06-04 22:43
I have a client that will be 55 in January of 2017. He plans on retiring in February or March of 2017. Then, in May of 2017, he will recieve paperwork from his employer to diversify 25% of his eligible shares from the company ESOP. If he has the proceeds sent directly to him, will he avoid the 10% penalty? I’m thinking yes, but wanted to double check.Thanks!
Permalink Submitted by Alan - IRA critic on Sun, 2016-06-05 00:27
Yes, the age 55 exception applies here, even if he did not reach 55 until December, 2017. If client wants to use NUA on the ESOP shares or any other employer stock, he must complete a lump sum distribution by year end 2017. He would then pay the lower LT cap gain rate on the ESOP share appreciation that occurred in the plan.
Permalink Submitted by Josh Harmon on Wed, 2016-06-08 14:24
Just so we’re clear, the age 55 rule and NUA are two separate rules, correct? The company is not public, and doesn’t allow stock to be held outside the ESOP. Also, he is only allowed to take a portion (25% of any non- Pre 1986 shares) at 55. Then after 58 months from separation from service, he may start taking a payout over ten years due to the size of the account. My assumption has always been that NUA is not possible for these reasons. Our plan was to roll a portion of his 25% distribution to his IRA after he leaves next year, and have the company send some of the ESOP proceeds to him directly, thus avoiding the 10% penalty.
Permalink Submitted by Alan - IRA critic on Wed, 2016-06-08 16:18
Yes, these are separate, although the age 55 separation exception can be used to waive the 10% penalty that would otherwise apply to the cost basis of the NUA shares, or to the taxable amount of an ordinary distribution. SInce NUA is not possible with these limited distributions, it is off the table unless the plan is changed in the future to allow a retiree’s shares to be bought back by the plan. That would also be preferable from a diversification standpoint. Meanwhile, your plan is best under the current provisions.
Permalink Submitted by Josh Harmon on Thu, 2016-07-14 17:58
I have another client over the age of 55 that will be able to diversify her ESOP funds next year. She will be able to request the funds in April, but would not recieve a check from the plan until September. My question is this: does she need to be retired before she requests the funds (April) to avoid the 10% penalty, or can she retire a month or so before the funds are recieved in September?
Permalink Submitted by Alan - IRA critic on Thu, 2016-07-14 18:56
The tax code exception reads “made to the employee after separation from service after attaining age 55”. This would seem to indicate that the employee needs to be separated from service on the date of the distribution, even though the request may have been made prior to actual separation. That said, it might be wise to call the plan administrator to make sure that the 1099R will show the code 2 exception code if the request is made prior to separation. However, even if the 1099R is coded 1, the employee could still file a 5329 to override the 1 code and show exception code 01 on the form. It may also help to determine if the 5 month delay is always the case, or is also related to other factors.