Are Distributions of Rollovers to a 403(b) Plan Subject to Penalty, if the Rule of 55 Exception Applies?

Q: We are a private university that sponsors an ERISA 403(b) plan. Our plan permits participants to roll in pre-tax funds from prior employers’ 401(k) plans so they can avoid the 10% penalty on early distributions. If a participant terminates employment on or after the calendar year in which she turns age 55, is that rollover contribution penalty free under the “Rule of 55”? Or is it still subject to the 10% penalty for distributions before age 59½?

Kimberly Boberg, Kelly Geloneck, Emily Gerard and David Levine, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

A: Interesting question! Although the relevant Code Section (72(t)(2)(A)(v) does not specifically address rollovers, it does state that any distribution made to an employee after separation from service after attainment of age 55 is not subject to the 10% premature distribution penalty. Because your plan permits these rollover contributions, those funds become part of the participant’s account balance within your plan. Once the funds are successfully moved into your 403(b) plan, they are governed by the rules and tax exceptions applicable to your specific plan at the time of the participant’s separation.

Thus, it would appear that distributions of rollover contributions would not be subject to the 10% penalty if the Rule of 55 exception applies. Of course, any plan participant should consult with a tax professional for advice on his/her own particular tax situation.

NOTE: This feature is to provide general information only, does not constitute legal advice and cannot be used or substituted for legal or tax advice.

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