Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

QRPs, 403(b) plans: Early retirement

A distribution made to an employee “after separation from service after attainment of age 55” is exempt from the penalty. This exception is available for qualified ( ¶ 8.3.12 ) and 403(b) ( ¶ 8.3.03 ) plans, but not for IRAs. § 72(t)(2)(A)(v) , (3)(A) . For government plan distributions to firemen, policemen, and emergency medical personnel, the age is 50 not 55. § 72(t)(10) . Although § 72(t) limits the exception to distributions made after a separation from service occurring after the employee’s 55th birthday, Notice 87-13, 1987-1 CB 432, A-20, provides that the separation from service can occur on or after January 1 of the year the employee reaches age 55. See PLR 2002-15032. An employee who separates from the company’s service before the year he reaches age 55 is not entitled to use this exception; he cannot simply wait until age 55 and then take a penalty- free distribution. The exception is available only for distributions “after your separation from service in or after the year you reached age 55.” IRS Publication 575, “Pension and Annuity Income” (2009), p. 31; Humberson , 70 TCM 886 (1995). Distributions from a qualified retirement plan or 403(b) arrangement made to an “alternate payee” under a qualified domestic relations order (QDRO; see § 414(p)(1) ) are exempt from the early distributions penalty. § 72(t)(2)(C) . This allows a divorcing spouse who is under age 59½ to receive penalty-free distributions from the share of her ex-spouse’s QRP or 403(b) plan that is awarded to her in the divorce proceedings (if the QDRO procedures are followed). However, even though, in § 408(d)(6) , Congress provided a means for the tax-free division of IRAs between divorcing spouses, analogous to the QDRO procedures for qualified plans, Congress did NOT extend the penalty exception of § 72(t)(2)(C) to IRAs. Thus, a divorced spouse who receives part of her ex’s IRA under § 408(d)(6) cannot withdraw from the account prior to reaching age 59½ unless she pays the 10 percent penalty or qualifies for some other exception. QRPs, 403(b) plans: QDRO distributions

ESOPs only: Dividends on employer stock

Under § 404(k) , a company can take a tax deduction for dividends paid on stock that is held by an employee stock ownership plan (ESOP), and the ESOP can pass these dividends out to the plan participants, if various requirements are met. Such dividend payments are not subject to the 10 percent penalty. § 72(t)(2)(A)(vi) .

IRAs only: Unemployed’s health insurance

An unemployed individual can take penalty-free distributions from his IRA (but NOT from a qualified plan or 403(b) arrangement) to pay health insurance premiums. See § 72(t)(2)(D) for details.

IRAs only: Expenses of higher education

The 10 percent penalty will not apply to IRA distributions that do not exceed the participant’s “qualified higher education expenses” paid in the taxable year of the distribution. § 72(t)(2)(E) .