(b)lines Ask the Experts – In-Service Distributions for Participants in Phased Retirement Program

“Our university recently instituted a ‘phased retirement’ program for faculty where they can gradually transition into retirement by working a reduced schedule while still retaining university benefits. After two years, the faculty member then formally retires from the university. Such employees remain eligible for retirement plan benefits until they actually retire, but my question relates to in-service distributions.

“Our 403(b) plan currently permits in-service distributions of employer and employee contributions at age 59 ½, and indeed most individuals in the phased retirement program, are older than 59 ½ and thus can take distributions from the retirement plan while still working. In addition, since such individuals are older than age 59 1/2, the distributions are not subject to the 10% premature distribution penalty. However, we have a handful of individuals in the program who have not yet attained age 59 ½ and are in-service, albeit with a reduced work schedule. With the approval of counsel, our plan was amended so that phased retirement is an event upon which they can receive a distribution of employer contributions from the 403(b) plan (I realize that they cannot receive a distribution of elective deferrals while in-service). Are such distributions subject to the 10% penalty tax on early distributions?”


Stacey Bradford, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:


Excellent question, and one that frequently comes up given the rise in popularity in such phased retirement programs. Unfortunately, of the many exceptions to the 10% penalty tax on early distributions, distributions for individuals who are part of a phased retirement or similar program that assists with transition into retirement is NOT such an exception, and such individuals would be subject to the 10% premature distribution penalty for as long as they remain employed by the university, unless a different exception to the penalty applies. This penalty applies regardless of the number of hours worked by the employee.


It is important  to understand, however, that once the employee formally retires or otherwise terminates employment, he/she does not need to be 59 ½ in order to obtain a penalty-free distribution, presuming your plan permits distributions upon termination of employment at any age as most plans do. As pointed out in our Ask the Experts column on the subject, an employee can terminate employment as young as age 54 and be eligible for a distribution that would not be subject to the 10% penalty.



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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