Recovery of After-Tax Employee Contributions

[Leonidas]

At the end of this month my pension will kick in and I’ll start receiving a monthly annuity-like payment. At about the same time I will have to make a decision on how to deal with the lump sum portion of the pension. My choice is to do a rollover into an IRA and take distributions sometime after age 59 ½ (I just turned 48).

It’s a contributory pension, and in 1994 the contributions switched from “after-tax” to “pre-tax”. I understand that the IRS has devised an allegedly “simple method” for returning the “after-tax” portion of my contributions by making part of my monthly payments “non-taxable”. But until today I thought that was limited to just the monthly payments. Now I’ve learned that part of the lump sum is also “non-taxable”

Since your…pension benefit consists of a monthly annuity and a lump sum the amount of benefits you will receive tax-free can vary greatly depending upon the options you choose at retirement…This is simply a tax-free return to you of the contributions you previously made to the System and on which you have already paid income taxes. This prevents you from having to pay income taxes on this money again when it is received by you.

Sounds simple enough and I understand it. But then I read the examples of how the money would be distributed…

Example #3 - Officer Doe retires and rolls entire [lump sum] balance to IRA**

In this option $57.53 of the monthly annuity will be non-taxable for 360 months. ($57.53 x 360* = $20,701.80, not exact because of rounding) plus $9,289.08 of the entire [lump sum] distribution is non-taxable. ($20,701.80 + $9,289.08 = $29,990.88)

**While the member wanted to rollover the entire [lump sum] balance, $9,289.08 is non-taxable and not eligible for rollover and will be distributed to the member. Only $240,710.92 ($250,000 - $9,289.08) will be rolled to the IRA.

My first reaction was that this rule was screwing me. My numbers are higher than the imaginary Officer Doe’s figures, and I think I’m going to find myself about $13K lighter in the IRA than I anticipated. Not the end of the world, but still not what I was planning on.

My second reaction was to wonder if they’re calling it a “distribution”, and I’m only 48 years old, is the IRS going to hit me with a penalty for early withdrawal from a qualified pension plan?