Rule helps older 401(k) investors

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Dear Dr. Don,
I will be retiring next year at age 55. I have a
401(k) account through my employer, and I asked about the possibility of a
72(t) distribution after I retire. The plan administrator said that although the IRS allows
72(t) distributions, each plan can elect to allow them or not, and my plan has elected to not allow them. Is this permitted?

Bruce Benefits

Dear Bruce,
The plan does get to decide whether it will offer periodic distributions out of the account or require a lump-sum distribution. The following is from the IRS article, ”
401(k) Resource Guide — Plan Sponsors — General Distribution Rules

There are multiple provisions in IRS Code
72(t)(2) concerning exemptions from the 10 percent additional tax. One is the separation from service by an employee after attainment of age 55.

Depending on the terms of the plan, distributions have two types.

2 distribution types
Nonperiodic, such as lump-sum distributions.
Or periodic, such as annuity or installment payments.

Because you are separating from service at age 55 or older, you will be eligible to take money from your
401(k) without the distributions being subject to the 10 percent additional tax on early distributions prior to age 59?. The distributions are, however, still subject to mandatory 20 percent withholding.

You can get around the withholding issue by doing a direct transfer to an IRA rollover. If you do the rollover, you lose the “separation from service” exemption from the penalty tax.

But by giving up that exemption, you gain the
72(t)(2) exemption from the penalty tax based on the ability to receive substantially equal periodic payments from the IRA rollover account.

Starting in the 2008 tax year, you also have the option to
convert the
401(k) money
directly into a Roth IRA account. There are eligibility and other issues. IRS Publication 590, ”
Individual Retirement Arrangements,” has more including:

Any amount rolled over is subject to the same rules for converting a traditional IRA into a Roth IRA. See Converting From Any Traditional IRA Into a Roth IRA in Chapter 1 of Publication 590. Also, the rollover contribution must meet the rollover requirements that apply to the specific type of retirement plan.

You haven’t indicated that any portion of your account is in company stock, but if this is the case, it complicates the situation. An IRA rollover in this case may eliminate the valuable net unrealized appreciation rule, which can provide significant tax savings in some situations.

If you do have company stock, be sure to consult with your tax adviser before taking any withdrawals from the

Thanks to David Littell, professor of taxation and the Joseph Boettner research chair at The American College in Bryn Mawr, Pa., for his assistance in answering this reader’s question.

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