Premature Distribution FAQs
Rev. 09/12/08, E-mail Alert 2008-12

A 52-year-old individual has been taking substantially equal payments from her retirement account using the amortization method outlined in IRS Revenue Ruling 89-25 to avoid the 10% premature distribution penalty. She subsequently divorces her husband. As part of the divorce settlement, the ex-spouse is awarded 50% of the current balance in the participant's account. As a result, the participant would like to change her distribution method so she could take a lower amount each year. Can the annual distribution amount be adjusted without triggering the 10% penalty tax? Rev. 03/31/05, E-mail Alert 2005-06, Reviewed 09/12/08

Rev. Rul. 2002-62, which superseded Rev. Rul. 89-25, contains a provision permitting an individual to make a one-time election to change from the amortization or annuitization method of payment to the life expectancy method. The use of the life expectancy method would allow the participant in this scenario to calculate each future annual distribution using her prior year-end account balance. After the qualified domestic relations order (QDRO) payment is made, her balance — and her distributions — will be lower. If the election is made, however, it is irreversible. She must continue using the life expectancy method thereafter.

Does the 10% excise tax penalty for premature plan distributions apply when the reason for the distribution is a participant's disability? Rev. 05/26/05, E-mail Alert 2005-10 Reviewed 09/12/08

That depends. A plan may define disability in a number of ways and use those definitions as triggering events for a distribution. However, for a distribution to be exempt from the 10% penalty, the participant's disability must meet the Social Security Administration's (SSA) definition of disability.

The Social Security definition of disability is generally the same as the IRS definition found in IRC Section 72(m)(7): “An individual will be considered to be disabled if he or she is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long, continued and indefinite duration. An individual shall not be considered to be disabled unless he or she furnishes proof of the existence thereof in such form and manner as the Secretary may prescribe.”

Disability may also be defined in a plan as: "An illness or injury of a potentially permanent nature, expected to last for a continuous period of not less than 12 months or can be expected to result in death, certified by a physician selected by or satisfactory to the Employer, which prevents the Participant from engaging in any occupation for wage or profit for which the Employee is reasonably fitted by training, education or experience.” However, the above definition will not exempt the individual from the 10% penalty if the distribution occurs prior to age 59½.

Some plans define disability by adopting the Employer’s Disability Insurance Plan definition. However, exemption from the 10% penalty for a distribution prior to age 59½ will depend on how disability is defined under that plan. Frequently, this definition will not comport with IRC Section 72(m)(7).

A 35-year-old participant would like to take a $10,000 in-service distribution from her qualified retirement plan to purchase her first home. Is the distribution exempt from the 10% penalty on premature distributions? Rev. 08/04/05, E-mail Alert 2005-15, Reviewed 09/12/08

No. Unfortunately, the exception to the penalty for premature distributions (before age 59½) for first time home-buyers applies only to IRAs. Qualified plans, such as 401(k) or profit-sharing plans, do not have an equivalent rule. So, even if a qualified plan participant is eligible to receive either a hardship withdrawal or an in-service distribution to buy a first home, if the participant is under age 59½, the 10% premature distribution penalty applies.

A 56-year-old participant is terminating employment and would like to take a distribution of his entire balance from your 401(k) plan. Does the 10% premature distribution penalty apply to this distribution? Rev. 08/18/05, E-mail Alert 2005-16, Reviewed 09/12/08

No. The 10% penalty for premature distributions does not apply to plan participants who separate from service and take a distribution after reaching age 55. This exception is written into the tax law, so there is no need to include a formal early retirement provision in plan documents. It only applies to qualified plans, such as profit sharing and 401(k) plans, as well as to 403(b) and 457(b) plans; it does not, however, apply to IRAs.

Is the amount paid due to a QDRO to the ex-spouse subject to the 10% penalty when the ex-spouse and the participant are under age 59½? Rev. 09/12/08, E-mail Alert 2008-12

No. Payments to a spouse or ex-spouse due to a QDRO are exempt from the 10% penalty for distributions under age 59½.

Are substantially equal payments made using the RMD calculation method able to use the uniform lifetime table to start the RMD method of substantial distributions prior to age 70, and if so, where is a uniform distribution? Rev. 09/12/08, E-mail Alert 2008-12

Yes. The substantially equal distribution method may be calculated using one of three methods: the RMD method, the annuity method or the amortization method. The RMD method is to be calculated for individuals under age 70 using the uniform lifetime provided in Revenue Ruling 2002-62. Click here for Rev. Rul 2002-62.