Penalty on Early Distributions from an IRA, Plan, or Annuity
Periodic Payments that Avoid the 10 Percent Penalty on Early Distributions. – The 10
percent penalty on early distributions under annuities, IRAs, or retirement plans does not apply
to certain substantially equal periodic payments over (i) a retiree's lifetime or life expectancy or
(ii) the joint and surviver lifetimes or life expectancies of the retiree and beneficiary. The IRS
provides three alternative methods for safely computing substantially equal periodic payments.
These methods are available to a retiree if he or she receives periodic payments from a
retirement plan, an IRA, or under a personally purchased annuity. (Notice 2004-15, 2004-9 I.R.B.
526.) See Chapters 2, 5, 10, and 14 of the treatise for discussions of the 10 percent penalty tax
on early distributions.
Avoidance of Early Distribution Penalty on Substantially Unequal Distributions. – The
taxpayer applied his own method for taking “substantially equal” IRA distributions, in an attempt
to avoid the 10 percent penalty on early distributions. Subsequently, the IRS ruled the
distributions were not “substantially equal” and had resulted in excessive distributions.
Nevertheless, the IRS waived the expired 60-day rollover period for the excess distributions and
allowed the taxpayer to roll them back into his IRA without penalty. (Ltr. Rul. 200442033;
similarly, Ltr. Rul. 200419031.) For descriptions of other situations where the IRS has waived
the 60-day rollover requirement, click here. Also, see Chapter 5 of the treatise for discussions of
(a) IRA rollovers and (b) the 10 percent penalty for early IRA withdrawals.
Early Distribution Penalty on Nonpayment of Plan Loan Due to Bankruptcy Proceedings. – A
“qualified” loan from a retirement plan is not taxable when a retiree receives the loan proceeds.
However, if the retiree fails to make an installment payment when due (including any grace
period for payment), the tax law treats the entire outstanding balance of the loan as a taxable
distribution. In a summary opinion, the Tax Court determined that the 10 percent penalty on early
distributions could apply to such a deemed distribution even though the taxpayer was precluded
from repaying the loan due to bankruptcy proceedings. White v. Commissioner, T.C. Summary
Opinion 2005-62.
Relief from Penalty on Early Distributions to a Public Safety Employee from a Governmental
Plan. –Effective August 17, 2006, the Pension Protection Act reduces from 55 to 50 the
retirement age at which the 10 percent early distribution penalty will not apply to distributions
from a “governmental defined benefit plan” to a retired “public safety employee.” For this
purpose, a governmental defined benefit plan generally means a government plan that provides
retirement benefits that do not depend solely on discretionary contributions made to an
employee’s individual account. A public safety employee is one who provides police protection,
firefighting services, or emergency medical services within the jurisdiction of the governmental
unit sponsoring the plan.
See Chapters 2 and 4 of the treatise for a more complete discussion of the penalty on early plan
distributions and its exceptions. (Pension Protection Act of 2006, Pub. L. No. 109-280, § 828(a),
(b); I.R.C. § 72(t)(10).)
Effect of Trustee Error on the Penalty Tax for Premature Distributions. – Generally, the
penalty tax on premature distributions will retroactively apply to payments made under the
exception for substantially equal payments if the payment schedule is modified before the later
of (1) age 59 ½ or (2) five years after the first payment. However, the IRS has ruled that failure to
make a substantially equal payment until the year after it was due did not constitute a
modification when the failure was due to trustee error. (Ltr. Rul. 200835033.) On the other hend,
a modification generally occurs upon the rollover to another IRA of part or all of the funds
providing the substantially equal payments. (Ltr. Rul. 200925044.) Nevertheless, a modification
generally does not occur upon a trustee-to-trustee transfer of the funds to another IRA that
continues the substantially equal payments. (Ltr. Rul. 200929021.) See Chapters 2, 4, 5, and 6
of the treatise for an explanation of the penalty tax on premature distributions.
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Periodic Payments that Avoid the 10 Percent Penalty on Early Distributions. – The 10
percent penalty on early distributions under annuities, IRAs, or retirement plans does not apply
to certain substantially equal periodic payments over (i) a retiree's lifetime or life expectancy or
(ii) the joint and surviver lifetimes or life expectancies of the retiree and beneficiary. The IRS
provides three alternative methods for safely computing substantially equal periodic payments.
These methods are available to a retiree if he or she receives periodic payments from a
retirement plan, an IRA, or under a personally purchased annuity. (Notice 2004-15, 2004-9 I.R.B.
526.) See Chapters 2, 5, 10, and 14 of the treatise for discussions of the 10 percent penalty tax
on early distributions.
Avoidance of Early Distribution Penalty on Substantially Unequal Distributions. – The
taxpayer applied his own method for taking “substantially equal” IRA distributions, in an attempt
to avoid the 10 percent penalty on early distributions. Subsequently, the IRS ruled the
distributions were not “substantially equal” and had resulted in excessive distributions.
Nevertheless, the IRS waived the expired 60-day rollover period for the excess distributions and
allowed the taxpayer to roll them back into his IRA without penalty. (Ltr. Rul. 200442033;
similarly, Ltr. Rul. 200419031.) For descriptions of other situations where the IRS has waived
the 60-day rollover requirement, click here. Also, see Chapter 5 of the treatise for discussions of
(a) IRA rollovers and (b) the 10 percent penalty for early IRA withdrawals.
Early Distribution Penalty on Nonpayment of Plan Loan Due to Bankruptcy Proceedings. – A
“qualified” loan from a retirement plan is not taxable when a retiree receives the loan proceeds.
However, if the retiree fails to make an installment payment when due (including any grace
period for payment), the tax law treats the entire outstanding balance of the loan as a taxable
distribution. In a summary opinion, the Tax Court determined that the 10 percent penalty on early
distributions could apply to such a deemed distribution even though the taxpayer was precluded
from repaying the loan due to bankruptcy proceedings. White v. Commissioner, T.C. Summary
Opinion 2005-62.
Relief from Penalty on Early Distributions to a Public Safety Employee from a Governmental
Plan. –Effective August 17, 2006, the Pension Protection Act reduces from 55 to 50 the
retirement age at which the 10 percent early distribution penalty will not apply to distributions
from a “governmental defined benefit plan” to a retired “public safety employee.” For this
purpose, a governmental defined benefit plan generally means a government plan that provides
retirement benefits that do not depend solely on discretionary contributions made to an
employee’s individual account. A public safety employee is one who provides police protection,
firefighting services, or emergency medical services within the jurisdiction of the governmental
unit sponsoring the plan.
See Chapters 2 and 4 of the treatise for a more complete discussion of the penalty on early plan
distributions and its exceptions. (Pension Protection Act of 2006, Pub. L. No. 109-280, § 828(a),
(b); I.R.C. § 72(t)(10).)
Effect of Trustee Error on the Penalty Tax for Premature Distributions. – Generally, the
penalty tax on premature distributions will retroactively apply to payments made under the
exception for substantially equal payments if the payment schedule is modified before the later
of (1) age 59 ½ or (2) five years after the first payment. However, the IRS has ruled that failure to
make a substantially equal payment until the year after it was due did not constitute a
modification when the failure was due to trustee error. (Ltr. Rul. 200835033.) On the other hend,
a modification generally occurs upon the rollover to another IRA of part or all of the funds
providing the substantially equal payments. (Ltr. Rul. 200925044.) Nevertheless, a modification
generally does not occur upon a trustee-to-trustee transfer of the funds to another IRA that
continues the substantially equal payments. (Ltr. Rul. 200929021.) See Chapters 2, 4, 5, and 6
of the treatise for an explanation of the penalty tax on premature distributions.
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| Copyright © 2005-2009 by Vorris J. Blankenship All Rights Reserved |
The author intends that this website provide accurate and authoritative information on the subject matter
covered. However, the information provided on this website is not a substitute for the advice of an attorney,
accountant, or other professional; and the author is not offering legal, accounting, or other professional
advice. The material presented on this website is not intended for use, and may not be used, to avoid tax
penalties. If you need legal advice or other professional help, you should seek (from an independent
attorney, accountant, or other competent professional) advice based on your own particular circumstances.
covered. However, the information provided on this website is not a substitute for the advice of an attorney,
accountant, or other professional; and the author is not offering legal, accounting, or other professional
advice. The material presented on this website is not intended for use, and may not be used, to avoid tax
penalties. If you need legal advice or other professional help, you should seek (from an independent
attorney, accountant, or other competent professional) advice based on your own particular circumstances.
Key Tax Developments Affecting Retirees
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