(b)lines Ask the Experts – Early Distribution Penalties for Pre-Tax and Roth Accounts

Experts from Groom Law Group and Cammack Retirement Group answer questions concerning 403(b) plans and regulations.
By PS

“I am 57 years old and I just terminated employment with my employer who sponsors a 403(b) plan. My recordkeeper told me that I can withdraw my pre-tax assets and pay ordinary income taxes and that there would be a waiver of the 10% premature distribution penalty since I terminated employment after the calendar year in which I turned age 55. However, the recordkeeper also said to me that I could not withdraw my Roth account tax-free until age 59 1/2 (I have already owned the Roth account for the required five tax years). Is my recordkeeper correct?”

 

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

 

Indeed, your recordkeeper is correct, and the reason this is the case, though it may not sound logical to you, is that two completely different sections of the Internal Revenue Code govern the premature distribution penalty and income taxation of Roth distributions (specifically, earnings on such amounts); Code Sections 72(t) and 402A, respectively. It is in Code Section 72(t) where the exception to the premature distribution penalties reside, and termination of employment during or following the calendar year in which you turned age 55 is one of those exceptions for both pre-tax amounts and earnings on Roth amounts. However, Code Section 402A and the related regulations provide the rules on income taxation of Roth distributions and make no reference to age 55; instead, 59 1/2 is the age that governs.

 

Specifically, Treas. Reg. § 1.402A-1, Q&A-2 states that a “qualified distribution” that is completely free of federal income tax must satisfy the following conditions:

 

“a qualified distribution is a distribution that is both—
 
(1) Made after the 5-taxable-year period of participation defined in A-4 of this section has been completed; and
 
(2) Made on or after the date the employee attains age 59 1/2, made to a beneficiary or the estate of the employee on or after the employee’s death, or attributable to the employee’s being disabled within the meaning of section 72(m)(7).”

 

Notice that there is no reference at all to any age other than age 59 1/2. Thus, though the distribution would not be subject to the premature distribution penalty, such distribution would not meet the requirements to be a qualified distribution if you have not reached age 59 ½. Therefore, while your Roth contributions have already been taxed and are not taxed on distribution, the earnings which are included in the distribution would be subject to income tax.

 

 

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.

 

Do YOU have a question for the Experts? If so, we would love to hear from you! Simply forward your question to Rebecca.Moore@strategic-i.com with Subject: Ask the Experts, and the Experts will do their best to answer your question in a future Ask the Experts column.

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