Photo credit: jb
Most of the time, when taking a distribution from a 401(k) or other Qualified Retirement Plan (QRP) prior to age 59½, there generally is a 10% penalty that applies. That is, unless one of the exceptions applies.
If you happen to be over age 55 when you leave employment, there is another exception that applies. Any distribution that you take from the QRP, as long as you were at least 55 years of age when you left employment, will not be subjected to the 10% penalty. Only ordinary income tax will apply to the withdrawal.
This provision only applies to QRPs, such as a 401(k) or 403(b), and not to IRAs. So if you’re leaving employment at or after age 55 but before reaching 59½, it can be in your best interest to not rollover your QRP to an IRA, at least until after you reach 59½. Even if you don’t need the money right away, it could be beneficial to have the source of funds available penalty-free.
For retiring police, firefighters and medics, the age for this exception is 50 – so these folks can take distributions from their QRPs after age 50 if they’ve left employment without penalty.
Sterling Raskie, MSFS, CFP®, ChFC®
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And if you’ve come here to learn about queuing waterfowl, I apologize for the confusion. You may want to discuss your question with Lester, my loyal watchduck and self-proclaimed “advisor’s advisor”.
I was advised that one additional requirement is that your individual plan allows for this, it is not mandatory. I checked with the trustees of my plan to make sure that my plan did prior to retiring early.
That is true, to a certain extent. My understanding is that the plan administrator could refuse a partial withdrawal, but cannot refuse a total withdrawal. So there could be a case (and I have seen this) where the administrator will only allow a complete withdrawal of the account, which would limit the effectiveness of the post-55 rule.
In such a case one would need to plan for the amount that they’d like to be treated with no penalty (to take in cash) and then rollover the remainder to an IRA or other QRP. In other words, the penalty exemption does not rely on the plan administrator’s rules, it is an exemption within the Internal Revenue Code.
For this purpose, is SEP IRA considered a QRP?
Sam – no, a SEP-IRA is still an IRA, for the purposes of this particular provision.
jb