Age 55 distributions from 401Ks

[samclem]

I've got a Solo 401K at Fidelity. On this board we have discussed the practicalities of beginning withdrawals at age 55 (rather than waiting for age 59 1/2) under the IRS rule that allows penalty-free distributions from 401Ks "after separation from service if separation from service occurred during or after the calendar year in which the participant reached age 55." I think many of us were of the opinion that this would have to be allowed by the plan document for the particular 401K. According to Fidelity (and Vanguard, who I called next), their plan documents make no reference to any waivers for withdrawals beginning at age 55--they will still be reported to the IRS as "early withdrawals" and subject to the 10% penalty tax if they are made before the recipient reaches age 59 1/2.

Anyway, for folks in a similar situation, I don't think that what the plan document says makes much of a difference. According to the IRS instructions, when I fill out my tax form at the end of the year I'd just need to fill out Form 5329 to tell the IRS (Line 2, reason "02") that the age 55 exception applies and no 10% penalty is due. I'm not sure if Fidelity will automatically withhold the 10% penalty on this "early withdrawal" but if they do it would be credited back to me in my taxes. At worst, I'd lose interest on the withheld money for the duration of the time it was in limbo.

So, that's my plan. It sounds easier than searching around for a custodian that includes the age 55 distribution caveat in their plan document, and more flexible than rolling all the dough to a tIRA and taking 72T withdrawals.

Note for Solo 401K holders: For this to work, you can't "separate from service" before the beginning of the calendar year in which you turn 55. I'm still trying to find info on how I notify the IRS that I've "separated from service" (fired myself?) without actually terminating the Solo 401K plan (termination of the plan would be reported on a Form 5500-EZ, box A(3). But if you terminate the plan and roll everything into a tIRA, you'd lose the ability to take unlimited distributions penalty-free before the year you reach age 59 1/2)

Anyway, for what it is worth . . .

 

[daylatedollarshort]

Here is an older thread on the topic:

http://www.early-retirement.org/forums/f28/solo-401-k-withdrawals-at-55-a-54660.html

 

[pb4uski]

Have you talked with Fidelity about this question?

For 401ks as I recall, there was a provision in a Reagan era tax bill that allowed for penalty-free withdrawals if separating from service after the year you turn 55 but the plan had to make certain amendments in order for that to apply. many plans did but some didn't which is why we have diversity/confusion today where some plans do and others don't.

While I don't know the specific answer for a solo 401k, your 401k administrator shoudl be able to tell you.

If you just go ahead and do it as you seem to be inclined to do, you may get an unpleasant surprise. I wouldn't tread in those waters myself....

 

[samclem]

Have you talked with Fidelity about this question?
. . .
While I don't know the specific answer for a solo 401k, your 401k administrator shoudl be able to tell you.

I talked to a rep at Fidelity, they only said that their plan document does not provide for penalty-free distributions before age 59 1/2. If they send me a check when I'm 55, it will be reported to the IRS as an early distrinution.

Here is an older thread on the topic:

http://www.early-retirement.org/forums/f28/solo-401-k-withdrawals-at-55-a-54660.html

Thanks, that was a good thread, and now I recall that Martha (where have ya been, gal?!) provided some good info from the Fairmark site. A contributor there (Allan) responded to several similar questions on this (including Martha's), and was of the opinion that:
1) There was no guidance from the IRS concerning what constitutes "separation from service" in the context of a self-employed person.
2) Once a self-employed person separates from service, there is no employer, and without an employer there can't be a Solo 401K plan--it has to be terminated. So, (according to his logic, he didn't explicitly say this) it wouldn't even make sense for a Solo 401K plan document to allow for distributions after age 55 due to separation from service, because the plan has to be terminated anyway.
3) There was no clear guidance from the IRS about just how rapidly the plan would need to be terminated, but that the DOL might look askance if it wasn't done promptly.

This cascade (you quit=the employer has quit=without an employer, the plan must be terminated) was something I hadn't considered. And I haven't confirmed that it works this way, but I can see the logic.

Another approach: I could "separate from service" and take an "after age 55" distribution in the year I turn 55, at the end of December. Then I terminate the plan a few weeks later (hey, if there's no clear guidance on how fast this has to happen, surely a couple of weeks after the business goes kaput isn't unreasonable . . .), take another "after age 55" distribution in early January (new tax year), roll the rest into my tIRA. At least I've spread a chunk of the 401K withdrawals over 2 tax years (age 55 and age 56). It would allow me to take about 3 times as much each year (before reaching the top of the 15% bracket) as I could withdraw under the 72T rules. Age 57, 58, 59: Take 72T withdrawals from a tIRA account set up just for this purpose. Age 59 1/2 and later: Burn off the last 2 years of restricted, fixed 72T withdrawals from the affected tIRA, but take as much additional as needed from a separate tIRA (it's fine to segregate them like this--they don't have to all be put together for purposes of computing the 72T amount).

Yea, it's not exactly bulletproof. I sure wish we could write to our tax authorities and get timely, authoritative information on how they interpret the rules.

 

[supernova72]

I had a similar question and finally called our benefit office. I guess mine is not "solo" although the same rules could apply? "Rule of 55" IRS Pub 575 attached. Scroll down to page 34 and it highlights the exceptions. Cheers.

http://www.irs.gov/pub/irs-pdf/p575.pdf

 

[samclem]

I had a similar question and finally called our benefit office. I guess mine is not "solo" although the same rules could apply?

Thanks. Yes, it is the "solo" part that makes this situation different/tricky.

Another approach: I could "separate from service" and take an "after age 55" distribution in the year I turn 55, at the end of December. Then I terminate the plan a few weeks later (hey, if there's no clear guidance on how fast this has to happen, surely a couple of weeks after the business goes kaput isn't unreasonable . . .), take another "after age 55" distribution in early January (new tax year) . . .

Okay, more on this angle. From IRS guidance on terminating a retirement plan:

Steps to terminate a plan

Generally, the steps to terminate a retirement plan include:
. . .

6. Distribute all plan assets as soon as administratively feasible (generally within 12 months) after the plan termination date to participants and beneficiaries;

"12 months" . . .heck, I could distribute them within a single month (15 Dec to 15 Jan) and still spread the proceeds over 2 tax years. It's not as good as being able to cover every year from age 55 to 59, but it's about 1/2 of the way there.

But--if I "terminate the plan" on 15 Dec, then on 15 Jan do I still have a solo 401K for purposes of the "no penalty if separated at age 55" rule?

Other ideas solicited!

 

[daylatedollarshort]

I researched a similar issue an few years back and never found a way to do it with our own company 401K because of the Catch-22 you described.

What we did is my husband had a 401K plan where he worked when he retired from the day job. (We had a couple of businesses with a 401K plan and he had a megacorp job with a 401K plan as well.) We rolled over some old IRAs and another former company 401K plan to his last megacorp job 401K plan before he retired. We rolled enough other retirement accounts to that plan to cover all our expenses, less what was covered by our pensions, until he turned 59.5.

 

[pb4uski]

You might try to find a local CPA tax practitioner that specializes in working with small businesses.

 

[RetireAge50]

Having the plan documents dictate tax laws makes no sense to me. I think it will work as OP
described (but I am not a CPA).

 

[pb4uski]

The tax law says that if the plan has certain provisions then there is not a penalty for certain distributions and if it doesn't have those provisions then penalties apply. I tend more to blame the plan sponsors and plan administrators for not making the requisite updates to their plans. Absurd situation that some plans get treated one way and others a different way.