“separation from service” as defined under Sec. 72(t)(2)(A)(v)

Submitted by MARK SKIBBE on Wed, 2014-07-16 02:01

Facts: Employee retires on September 1 of 2013 at the age of 54.5. Doesn’t turn 55 until 2014. Leaves behind large 401(k) plan for which he will take some distributions in 2015). Would like to to take the distributions from the plan without 10% penalty under the above cited exception.

Additional facts: When employee “retired” from company he immediately began rendering independent contractor services identical (in nature and in pay rate) to what he had been providing as an ’employee’ – compensated on form 1099-MISC for the post-retirement months in 2013 and concluding in 2014 ‘after’ he turned 55. He completed terminated all service to the company in June of 2014.

Is there any wiggle room in the definition of “separated from service” that might provide this guy with a basis to say that the continuation as an independent contractor results in a continuation of “service” through 2014, and therefore, giving him 10% penalty avoidance for all pre-age 59.5 distributions he may take from this plan?



Submitted by Alan - IRA critic on Wed, 2014-07-16 03:14

This is a tough question because there is no tax code or IRS Reg definition for “separation from service”. There have been PLRs and various Revenue Rulings but the underlying facts may not make any of them applicable to this situation. Most of these cases relate NOT to the early distribution penalty, but to whether the employee is eligible for a distribution that requires separation as a qualifying event. In your case employee might look to any correspondence or documentation in 2013 that clarified if the employer considered the change from EE to contractor a separation. The plan definition should also be examined to see if this situation is clarified there. Finally, is the plan willing to provide exception code 2 on the 1099R to be issued indicating the separation exception? If the plan codes Box 7 with code 2, then the IRS is unlikely to question the EE, but if the plan enters code 1 and the EE must file a 5329, the IRS is very likely to question the 5329 since this exception is typically determined by the employer without employee interpretation. You would think that will all the phased retirement situations, particularly hours reductions or contract work, there would be clear guidelines, but unfortuneatly this comes down to individual facts and circumstances and how they relate to the provisions contained in the employer plan.

Submitted by MARK SKIBBE on Wed, 2014-07-16 19:26

Thanks for that answer !!  Maybe there is some life in my idea after all…………. Mark S.

Submitted by Larry Wadz on Sun, 2018-01-28 20:44

If a person, upon reaching the year they turn 55 (this year) separates from his/her current position, then two weeks later signs up as a contract worker for a foreign division of the same company, would this be considered a separation from service? While the work is esentially the same, there would be no benefits, and would be strictly outside the US as needed. The person would essentially be semi-retired, withdrawing from the 401k as needed when there is no work.

Submitted by Alan - IRA critic on Mon, 2018-01-29 04:06

“Separation from service” has never been clearly defined by the IRS as indicated in the above 2014 post. However, the person would safely qualify for the penalty waiver in any of these circumstances:

  1. He is eligible to distribute the full 401k balance if he wanted to, as that would show the plan considers him separated.
  2. The plan codes his distributions with Code 2 (separation at 55) on his 1099R.
  3. He is clearly an independent contractor, with no wages reported on a W 2, and therefore no longer eligible to contribute to the plan.

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