“What happens if a participant who has attained age 55 terminates employment and wants to rollover his 403(b) balance to the 457(b) governmental plan at his new employer? Let’s assume he terminates again before age 59 1/2 and takes a distribution. Does the rollover become subject to the 10% penalty under the 457b rules or does it retain the exemption under IRC 72(t) due to age 55?”
Michael A. Webb, Vice President, Retirement Services, Cammack LaRhette Consulting, answers:
Good question, at it points out the uniqueness of the rules regarding rollovers of plan balances from qualified/403(b) plans to IRAs. Normally, distributions from a governmental plan would not be subject to the 10% penalty tax. However, the rollover into a governmental 457(b) essentially carries over the status that it had in the prior plan with respect to this rule. Thus, for example, since distributions from a 403(b) plan would be subject to the 10% premature distribution penalty, that restriction would be retained even after the funds are rolled over into the 457(b) plan, thus affecting subsequent distribution from the 457(b) plan.
But does such a rollover balance also retain the exceptions to the distribution penalty, such as the distribution following termination of employment on or after the calendar year that a participant turns age 55, as described in our question? Normally as clarified in IRS Notice 87-13, such an exception applies only upon termination of employment from the entity sponsoring the plan. However, the preamble to the final 457(b) regulations require separate accounting of rollovers into 457(b) plans from qualified plans/403(b)s specifically to apply the rules regarding early withdrawal income tax under 72(t) to such assets.
In addition, Revenue Ruling 2004-12 contracts the 72(t) tax treatment of amounts rolled over from IRAs to a qualified plan/403(b), where the 72(t) exceptions for IRA are replaced by those for the qualified/403(b) plans, to governmental 457(b), where the 72(t) exceptions of the prior plan would be retained. Thus, in your example, if a individual who has attained age 55 terminates employment form a 403(b) (or qualified plan) plan sponsor, rolls over a distribution from that plan to a governmental 457(b), later terminates employment with the governmental plan sponsor, and takes another distribution, the 10% penalty tax does NOT apply, since that exception is carried over from the prior plan.
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.