401k distribution penalty

[Pacun]

On January 2nd, 2019 client took out 100K from his 401k to travel around the world. He was 59 years old on June 29th, 2019.

Does he have to pay penalty?

What if he were born a couple of days later?

 

[jklcpa]

The first exception to the penalty listed in Sec 72(t)(2)(A(i) says "made on or after the date on which the employee attains age 59½." 

Note that there's no mention of "by year end."

[Pacun]

Sounds good.

I guess I was confused with this one. On December 21st, 2018, I tell my employer that I will not return to work after my two weeks of vacation.  So I give my two weeks notice on the date of my 54th birthday (December 21st, 2018). On Friday, January 4th, 2019 I come in and return and apron and spatula and that's the last day I am the dishwasher for the Mortons Restaurant. The following Monday, I took out $100K from my 401k to travel around the globe.  I don't have to pay penalty, correct?

 

[jklcpa]

Entirely different scenario and still subject to the penalty.  This exception to the penalty relating to separation from service is in the same IRC sec, this one falls under 72(t)(2)(A)(v) that says "made to an employee after separation from service after attainment of age 55".

Did you look at the page I linked to and scroll down to subsection (t)?

[Pacun]

Yes, I saw it.

So,  do you think that in my scenario, the employee will not pay penalty if he waits until December 22nd 2019 to make the distribution? or do you think he will still be liable for the penalty?

 

[Pacun]

I was looking at the code and it is very clear but the IRS comes with this conclusion:

"the employee separates from service during or after the year the employee reaches age 55 (age 50 for public safety employees of a state, or political subdivision of a state, in a governmental defined benefit plan)**"

ALSO, this is from a textbook:

"Age 55: Observe the wording of exception 01 carefully. The recipient must have separated from the service of their employer before receiving the distribution. They need not have actually reached their 55th birthday prior to the separation, as long as they do so by the end of the year"

After reading the code and reading the deviation on the IRS website and the textbook, I wonder if there is another deviation for the year the tax payer becomes 59.5.

I also wonder where those deviations come from since the code seems to be clear.

[jklcpa]

1 hour ago, Pacun said:

I was looking at the code and it is very clear but the IRS comes with this conclusion:

"the employee separates from service during or after the year the employee reaches age 55 (age 50 for public safety employees of a state, or political subdivision of a state, in a governmental defined benefit plan)**"

^^  I apologize about the wrong answer I gave you regarding separation from service and age 55.  The part of your statement shown above is correct, and clarification of this part of the code was provided for in Notice 87-13.   With that in mind, I do believe that this exception would only apply to distributions from the plan of the current employer that the participant is separating from.  In other words, if that person has another plan from an earlier former employer, a distribution from that earlier plan in the year of attaining 55 wouldn't avoid the penalty because it isn't related to separation from that employer specifically. I hope that makes sense.

 

Concerning your second question about whether the above rationale could be similarly applied to distributions to the participant before attaining age 59 1/2, my earlier answer is correct as it stands.  The participant must reach age 59 1/2 before the distribution to avoid the penalty.

 

  

[Pacun]

Thank you for the research.  I was trying to read notice 87-13 and I only found references to it from other websites but not the actual notice. I guess the IRS has bundled them and searching for "notice 87-13" doesn't provide any results.

Thank you again.