Pension buyout offer, under age 591/2

Submitted by Scott Wiard on Tue, 2012-10-02 14:58

I have a client who is 57 and has been offered a lump-sum buyout of his pension. He has been receiving payments + supplemental income (until age 62, then Social Security). He has not taken payments for 5 years yet. Can he take the lump-sum and rollover without incurring the 10% penalty on what he has already received?



Submitted by Alan Spross on Tue, 2012-10-02 16:45

Does this refer to the Auto Mfg buyouts?
Did he separate in the year he turned 55 or later? If so, then no problem. If earlier, see below.

Since the payments were not structured based on his life expectancy or joint LE with spouse, they would likely not qualify for the 72t (SEPP) exception in the first place. Yet it sounds like his prior distributions have not been coded as early distributions, so it is not clear what exceptions have been used.

Despite this question, if he does a direct rollover, the plan will have to issue one 1099R for payments received year to date, and another 1099R to report the direct rollover amount. If the plan codes the prior payments with a “1” in Box 7, it could red flag the IRS to question the prior payments penalty exception.

Employer must have many people in this situation who should be asking them how the 1099R will be coded for payments year to date and also the plan interpretation regarding retroactive penalty and interest.



Submitted by Scott Wiard on Tue, 2012-10-02 20:39

Clarification ……
Yes, this is in regard to a Ford pension buyout offer.
We believe the payments received thus far have not been subject to a 10% penalty because they were being made as “substantially equal” and “for the lifetime of the recipient”,
who retired at age 53.

Our hypothesis is that since the payments were started and received under these assumptions, the recipient should be able to:
A) take the lump-sum rollover to an IRA and maintain the current withdrawal amount, therefore not “modifying” the payment assumptions; or
B) take the lump-sum rollover to an IRA and recalculate the payments under the 1-time exception allowed under reg 72(t)(4).

Your thoughts?



Submitted by Alan Spross on Tue, 2012-10-02 21:54

If the payments were based on life expectancy and not front loaded such that they would stop when SS began, I agree that the 1099R coding in Box 7 (Code 2) contemplates use of the “substantially equal” exception. Such exception requires continuation for the longer of 5 years or until age 59.5.

Since the lump sum will terminate the payments from the DB plan before 59.5, your question is a good one, but it is not easy to answer. Here is a copy of part of RR 2002-62:

>>>>>>>>>>>>>>
(e) Changes to account balance. Under all three methods, substantially equal periodic payments are calculated with respect to an account balance as of the first valuation date selected in paragraph (d) above. Thus, a modification to the series of payments will occur if, after such date, there is (i) any addition to the account balance other than gains or losses, (ii) any nontaxable transfer of a portion of the account balance to another retirement plan, or (iii) a rollover by the taxpayer of the amount received resulting in such amount not being taxable.

>>>>>>>>>>>>>>

ii) above is the problem. The IRS has not clearly interpreted what is meant by either “a portion” or “another retirement plan”. All we have to go on are some inconsistent letter rulings because the IRS has not published any Regs on these plans. The general concensus has been that “another retirement plan” means another type of retirement plan (such a 401k vrs IRA) rather than a transfer to another IRA. IRS Regs do allow the conversion of a TIRA to a Roth IRA without busting the plan. Therefore, your idea of continuing the payments until 59.5 after the direct rollover is about all that can be done under the client’s control and does show good faith on his part. The IRA custodian will issue a 1099R coded “1” and the client would have to file Form 5329 to claim the SEPP exception Code 02. It would also be helpful if the final DB plan 1099R continued the same exception code as in prior years. The two 1099R forms issued for the year of the transfer will have to exactly total the same as prior year distributions.

Now if the IRS makes an inquiry into this, I think the risks are considerable. For one thing, the client cannot produce any calculations to document the amount of this distribution. A DB plan typically uses final average salary and years of service to determine the pension payout. There is no account balance and interest rate used as required by RR 2002-62. Since the IRS has been inconsistent on many facets of 72t plans all along, there is no way to predict how they would react to this scenario.

This offer must affect thousands of workers in exactly the same situation as the client. The employer should have requested an IRS opinion letter on this issue knowing that many of those who take this offer could be exposed to these retroactive penalties and interest. Perhaps the union should have requested it, but these workers need to get some assurance from the source or from the IRS before assuming that they will not have a problem. One solution would be to postpone the buyout of each individual until their 72t plan reaches it’s modification date. It is difficult to believe that no one thought about this issue before presenting the offer.

I think this summarizes the situation, but as you can see, I do not have an opinion whether there will be a problem with the IRS or not. If I come across anthing from other sources of value on this point, I will post back to this thread.



Submitted by Sue Kasmarick on Sun, 2012-11-04 15:42

My husband is in the same situation. He retired at the age of 51 on March 1, 2007. He is now 57 and has been retired for almost 5.5 years. We are needing to make our decision regarding the Ford Buyout and keep getting differeing opinions as to whether or not we would incur the 10% penalty of we took the buyout. Since I cannot find anything specifically saying that we would not incur the penalty, I am leaning towards the fact that we would incur the penalty if we took the buyout. Have you found anything new regarding this subject in the past few weeks?



Submitted by Alan Spross on Sun, 2012-11-04 18:21

While this information is not conclusive, I do not think that acceptance of the buyout offer will trigger the 10% penalty under Sec 72t for payments already received.

The auto manufacturers requested an IRS letter ruling to allow them to offer this buyout for pensioners already in payout mode. The IRS subsequently issued PLR 2012 28045 confirming that a plan amendment of this type would not violate the RMD Regs under Sec 401(a)(9)-6. The annuity RMD Regs required that a life annuity once started would be RMDs even when started well before the usual required beginning date following age 70.5. Those Regs required that the pension be “non-increasing”, however an exception to the non increase requirement was a plan amendment of the type to be offered by the auto mfg.

While the early withdrawal penalty was never mentioned in the PLR request or the ruling, the conclusion that the prior pension payments did constitute RMDs and that the lump sum buyout would be allowed without violating RMD Regs would be totally inconsistent with triggering an early withdrawal penalty for payments already received. If the RMDs could be terminated at this point, it does not make sense to levy a penalty for not meeting the 5 year or age 59.5 requirement for a SEPP plan.

I do find it surprising that this issue was not specifically addressed in the PLR request, but the IRS responds only narrowly to such requests and do not comment on closely related issues. The pension plans themselves should have addressed this issue, and their failure to warn retirees that they would incur such a penalty for an incomplete SEPP plan certainly suggests that there is no such penalty. The plans are not likely to code 1099R forms for the final year with a Code 1 in Box 7 indicative of an early withdrawal penalty.

As indicated above, this conclusion is purely anecdotal and if a more formal ruling is not forthcoming, I would suggest that a person electing the lump sum before age 59.5 (or after 59.5 with less than 5 years of pension payments) should not report a penalty, and only file Form 5329 if they receive a 1099R coding pension payments as early (Code 1 in Box 7). Should the IRS send an inquiry or proposed penalty, then the person should respond that such a penalty would be inconsistent with PLR 2012 28045 (link below):

http://www.millerchevalier.com/portalresource/PLR201228045



Submitted by Sue Kasmarick on Tue, 2012-11-06 17:30

They actually did address it in their Power Point Demonstration. They said: “If you elect the lump sum: If you separated from service before the year in which you turned 55, additional federal taxes MAY apply to monthly benefits you already received before age 59 1/2. Rolling over your lump sum does not eliminate this additional tax on payments already received. It MAY be possible to avoid this additional tax by continuing substantially equal payments from your IRA or qualified plan following a rollover.”

Seems pretty cut and dried to me, however others are telling us we can take the lump sum without doing a 72(t) and not incur penalties. They just can’t show us that in writing. I think it all comes down to how the 1099R would be coded if we took the lump sum. I am not sure that we will be able know that before we would need to make a decision.



Submitted by Alan Spross on Tue, 2012-11-06 18:01

You probably will not know, and 10% plus interest on payments already received would affect the decision for many.

The companies requested the letter ruling with respect to RMD requirements, and they had every opportunity to either add the SEPP question or to file a separate request for that. Their failure to do so is the cause of this uncertainty. If they wanted to encourage acceptance of the offer, they would have taken steps to pursue a firm IRS opinion on this question. At least they did issue a warning to retirees.

The 1099R coding for the monthly payments that end this year would result in a red flag to the IRS. But regardless of the coding, the IRS could still take the position that a SEPP plan had been modified (aka “busted”) by the lump sum payment. Further, it has generally been thought that the transfer of a SEPP plan (the prior payments) to another type of retirement plan (rollover IRA) constituted a modification of the SEPP. Therefore, continuing the same payments until age 59.5 or 5 years was attained may help to avoid the penalty, but would be no guarantee. The other question to consider is starting a new SEPP plan from the rollover IRA using one of the approved methods. The payment will be different than before, but additional penalties for IRA distributions would be avoided in exchange for additional exposure to the retroactive penalty and interest on the monthly pension payments prior to the buyout.

Other than filing a 5329 for the exception if they get the “1” coding on a 1099R , I don’t know what other action could be taken to reduce the chance of penalty. However, if there is no “1” coding on any 1099R, the sudden end of pension payments and an IRA rollover might well escape IRS scrutiny altogether.



Submitted by George Quinn on Wed, 2013-02-06 18:04

The pension 1099 from full year 2012 was coded “1”, and the Lump Sum rollover was coded “G”.  Is it advised to file 5329 with the exception of SEPP, and discontinue 2013 distributions from the former pension asset?Thanks



Submitted by Alan - IRA critic on Wed, 2013-02-06 19:58

Are you one of the prior posters in this thread, and referring to the rollover of an auto mfg lump sum buyout after receiving monthly payments for part of 2012? What was the coding on the 2011 pension 1099R, and age during the 2012 payments?



Submitted by George Quinn on Wed, 2013-02-06 20:52

 The 2011 pension coding was “2”, retired at 52 and currently 57.  Seems to me Ford is saying that their opinion is the stream was broken in 2012 by accepting the Lump Sum (was paid out in late Dec. 2012), and in 2012 that subjected the 2012 piece (at least) to the 10% penalty. I have the GM special tax notice on their offer, and no where do they mention any implication of breaking the stream.  They simply state, to roll the asset over and then a new SEPP can be used from there if you wish.  I know for a fact this notice was given to the same age group (less than 59.5 accepting the Lump, with previous pension payments).  Although I don’t know how GM coded the 2012 1099.The PLR you mentioned earlier in the thread seems to back up the GM stance, acceptance of the Lump makes you a “new annuitant”. 



Submitted by George Quinn on Wed, 2013-02-06 20:52

 The 2011 pension coding was “2”, retired at 52 and currently 57.  Seems to me Ford is saying that their opinion is the stream was broken in 2012 by accepting the Lump Sum (was paid out in late Dec. 2012), and in 2012 that subjected the 2012 piece (at least) to the 10% penalty. I have the GM special tax notice on their offer, and no where do they mention any implication of breaking the stream.  They simply state, to roll the asset over and then a new SEPP can be used from there if you wish.  I know for a fact this notice was given to the same age group (less than 59.5 accepting the Lump, with previous pension payments).  Although I don’t know how GM coded the 2012 1099.The PLR you mentioned earlier in the thread seems to back up the GM stance, acceptance of the Lump makes you a “new annuitant”. 



Submitted by George Quinn on Wed, 2013-02-06 22:42

Thank you for your response, by the “most aggressive” do you mean your final “option”?



Submitted by Alan - IRA critic on Wed, 2013-02-06 21:27

  • When they switch from Code 2 to Code 1, this is the way a busted SEPP Plan distribution is coded, so that is rather ominous. Further, the apparent omission of plan trustees  in making this clear to plan beneficiaries is surprising. The reporting instructions, at least for an IRA busted SEPP is to pay the cumulative 10% recapture tax on all prior plan distributions on Form 5329, and wait for the IRS to bill late pay interest on the penalty payment. Alternatively, if you were to pay the penalty (not file the 5329) for just 2012, there is no telling whether the IRS would connect the dots and bill the penalty for prior years or simply overlook the prior years. IRS oversight of SEPP plans is inconsistent and unpredictable.
  • Alternate approach:  File the 5329 and claim the SEPP exception 02, taking the position that these were SEPP payments right up till the month they ended. IRS reaction to this unknown.
  • Another approach: File the 5329 as above and also enter Code 12 (Other) on the 5329 and attach explanation that pension was terminated by a plan amendment, not by the taxpayer, and the penalty would be inconsistent with PLR 2012 28045; further, that the distributions already taken were RMDs and therefore not voluntary.
  • No way to tell which will work best or even that the examiners seeing each return will react consistently. But probably no harm in starting out with the most aggressive approach.


Submitted by George Quinn on Wed, 2013-02-06 22:48

Thank you for your response, by the “most aggressive” do you mean your final “option”?



Submitted by Alan - IRA critic on Wed, 2013-02-06 23:19

Yes, I changed “plan provision” to plan AMENDMENT. Again, there is no predicting how the IRS will react to any of these different approaches. If the amount reported under Code 1 was small enough, it might be better to pay the penalty and the IRS may not even connect it to a prior SEPP exception with respect to recapturing the penalty for prior years. But several months of distributions adds up to some real money and my impression was that several months of monthly payments were made before the lump sum was distributed. Not possible to determine whether the 1 coding was per specific IRS advice or they are just transferring the burden of a ruling to the participants.



Submitted by George Quinn on Thu, 2013-02-07 12:52

Do you see any benefit in the angle of PLR’s 9103046 and 9221052 that were mentioned on page 293 of the book “Retirment Savings Time Bomb”?  And if so, can an individual who was taking a monthly SEPP or Pension Payment change that to an annual?  Thanks for you answers.



Submitted by Alan - IRA critic on Thu, 2013-02-07 16:24

Those PLRs provide evidence of  IRS thinking at the time, but Notice 2002-62 basically “refreshed” 72t plan administration and left pre 2002 letter rulings in doubt. 2002-62 indicates that a SEPP is modified (busted) when funds are transferred in a non taxable transfer to “another retirement plan”. The general consensus is that “another retirement plan” means another type of retirement plan, eg DB pension to IRA, but not IRA to IRA or IRA to Roth IRA. Therefore, these PLRs may be of limited value, but they cannot do any harm if you wanted to incorporate them in your case. Finally, within a SEPP plan, the distribution pattern does not matter, only the correct annual amount as shown on the 1099R (or on line 15a reduced by any rollover amounts on 15b). Therefore, there is no problem changing from monthly to annual or quarterly, or even random distribution dates within the year.



Submitted by George Quinn on Sat, 2013-02-09 15:20

Form 5329, exception 2.   These payments were a continuation of my SEPP payments for the entirety of the year including the final payment.Form 5329 enter code 12, attaching a note.  The pension payments were terminated by a plan amendment.   Any penalty would be inconsistent with PLR 2012 28045, which created a new annuity start date for the annuitant.   Further, the distributions already taken were RMD’s and therefore not voluntary.  In addition if it satisfies the IRS code the taxpayer is willing to continue the 2013 SEPP payments consistent with PLR ruling 9221052 to qualify for the exception and a 1099R code of 2:  early distribution exception applies.



Submitted by Alan - IRA critic on Sat, 2013-02-09 18:45

Sounds reasonable.



Submitted by George Quinn on Sun, 2013-02-10 15:27

Your thoughts on simply submitting form 5329 with a code 2 without any explanation?  And following up with the code 12 explanation if there is follow up from the IRS? 



Submitted by George Quinn on Sun, 2013-02-10 16:17

Slightly related question, under a SEPP plan what amount must a taxpayer withdraw in the year they 59 1/2?  Is it $0, or some pro rata amount?  Assuming they have previously taken 5 or more years of withdrawals. 



Submitted by Alan - IRA critic on Sun, 2013-02-10 17:40

  1. Re your last post, once the SEPP participant has taken 60 months of distributions, in the year they reach 59.5, they have 3 options. Before the SEPP modification date, they can take nothing, or the full annual, or a pro rated amount based on the number of months before reaching 59.5.
  2. If the 1099R coded 1 included less than the full annual amount of payments, it would be too late to attempt continuing the distributions unless you made up any missing monthly distributions from the IRA. And if you did take disrtibutions from the IRA to round out the 2012 distributions, you won’t know whether the IRS will accept your 5329 for awhile. The problem for 2013 is that if the IRS does not accept continuing the same distribution from 2012, you would have to start a new plan for 2013 using updated age, interest rates, IRA account balance etc. Therefore, if you want to start a new SEPP if the old one fails, you might hold off taking any distributions from the IRA pending the IRS’ decision on the 5329. If the IRS accepts the 5329 (you might request a decision by December, and if acceptable, then you can take the full annual amount out in December, and if the IRS does not accept it, you could start a new plan if you wanted to. If you start a new plan late in the year, you still have the option to take out the full annual in the first year of a new plan. The new plan would then have to run until you took 5 years worth of payments and would therefore run past 59.5. If you are allowed to continue the original payments, the payments could terminate as noted in 1) above.
  3. Re your earlier posted question, if you opt to file the 5329 with exception code 02 (not 2) for 2012 and later years, you could preserve your other arguments until the IRS levies the penalty. There is another ruling I can look into relative to lump sum payments during a SEPP. For now, does your 2012 1099R coded 1 show an amount less than your 2011 annual 1099R?


Submitted by George Quinn on Sun, 2013-02-10 21:18

In 2012 there were 12 monthly distributions so the total amount distributed was the same amount as the 2011 1099R.A follow up on the first portion of your last post, if an individual took the full 2012 SEPP income distribution that satisfied their 5 years (or more) of payments and was turning 59.5 in 2013 could they terminate the pension either late 2012 or 2013 without taking additional income in 2013?You mentioned there was possibly another ruling on the Lump Sum during a SEPP, any information is appreciated.



Submitted by Alan - IRA critic on Mon, 2013-02-11 00:23

  • What I checked into did not relate to this fact pattern.
  • With respect to your last question, if participant turns 59.5 in 2013 and had taken out 60 months worth of SEPP distributions as of 12/31/2012, there would be no SEPP distributions required in 2013 prior to the plan modification date. The reason this is permitted is because a SEPP is a calendar year plan and no distributions are required before the end of the calendar year. If the plan modification date (59.5) comes first, the plan just ends.


Submitted by George Quinn on Mon, 2013-02-11 14:02

Alan, you typed:Re your earlier posted question, if you opt to file the 5329 with exception code 02 (not 2) for 2012 and later years, you could preserve your other arguments until the IRS levies the penalty. There is another ruling I can look into relative to lump sum payments during a SEPP. For now, does your 2012 1099R coded 1 show an amount less than your 2011 annual 1099R?———————————-Do you think there is any chance a code of 02, without explaination has a chance to work?  Or is it best to be upfront with the intention and list the reasons for execption right off the bat?



Submitted by George Quinn on Wed, 2013-02-13 03:25

Thank you for your posts.  Can you take a look at my previous post and let me know your thoughts?  Apreciated.



Submitted by Alan - IRA critic on Wed, 2013-02-13 04:48

The IRS reaction to whatever approach you take is unpredictable, in fact with respect to 72t plans IRS guidance is vague, and with respect to peripheral issues is mostly through letter rulings. The last official Notice was 2002-62. There have been several cases where the IRS levied a penalty for the current year and overlooked all the prior years of penalty free distributions. In your case, if you keep it simple and file a 5329 with an 02 exception code, it probably has a decent chance of skating through since your 1099R shows the same value as prior years.  Good chance the IRS will not even be looking for the same distribution next year or notice the direct rollover 1099R shows the same account number as the other 1099R. However, you wouldn’t have actual closure of this matter for a long time compared with a thorough submission that forces the IRS to make their decision relatively soon. So it boils down to how important the time frame is to you to get this resolved vrs the actual dollar amount of the potential penalty. If the IRS ultimately levies the retroactive penalty they will likely bill late interest on those penalties as well. Finally, this situation probably effects thousands of retirees, so if you stay in touch with others, you may get some advance notice of how the IRS reacts to their reporting.



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