55 and separated from service
I have two questions. If a client has been laid off and is rolling over his 401K assets, does he need to have already turned 55 in order to make a withdrawal or can he be turning 55 before the end of the calendar year? In other words, he is currently 54 but will turn 55 in November. He wants to withdraw 10K in March since he has been laid off and needs the money until he gets another job, but wants to roll the remaining 401K balance to a rollover IRA. Does he need to wait until his birthday?
Second question concerns Roths. Does each annual contribution need to be 5 years old and the clients age 59 1/2 for withdrawals to be tax free, or just the account opened and the original investment 5 years old? Does each contribution have it’s own separate 5 year waiting period?
Thank you.
Permalink Submitted by Alan Spross on Wed, 2009-02-25 22:41
The separation from service penalty exception applies in the year the employee turns 55 and can be prior to the actual birthday. Therefore, he can take this distribution now without penalty, however the balance rolled over to an IRA will lose that protection, and he will have to wait until 59.5 for IRA distributions to be penalty free. The alternative to IRA early withdrawal penalties is starting a 72t plan if he will need an annual flow of funds prior to age 59.5.
With respect to the Roth IRA aging, for distributions to be qualified the taxpayer must typically be 59.5 AND 5 calendar years completed including the year of the first Roth contribution of any type. However, non qualified distributions can also be tax free, if they are a return of regular contributions or conversion contributions. Once all the regular and conversion contributions have been withdrawn, the earnings are distributed and they are taxable unless the Roth is qualified by having been held 5 years and age 59.5 reached. The 5 year holding period for earnings to be qualified starts with the first contribution only.
There is also a 5 year conversion holding period to avoid early withdrawal penalties. This is a totally different holding period than the one above, and applies with respect to the early withdrawal penalty on each conversion, not to regular income taxes.