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Special for Baby Boomers: Managing Retirement Plan Distributions

Feb 2nd 2015
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Whether you're  planning to get your retirement funds come from employer plans, IRAs or annuities, you need to understand the important tax guidelines associated with each account to ensure you get the most bang for your buck.

If you’re one of the lucky retirees to depart the work force at age 55, you can receive funds from your former employer’s qualified retirement plans without being subject to the normal 10 percent premature withdrawal penalty tax. This is an exception to the general rule for taxable distributions from qualified retirement plans received before age 59 1/2. The key takeaway here is if you can retire early and want to avoid a penalty tax, age 55 is the earliest age for this penalty exception.

Those age 59 1/2 or older can receive funds from all types of tax-favored retirement plans and accounts (for example, IRAs, 401(k) plans and pensions) without being subject to the 10 percent premature withdrawal penalty tax. Unless there is an exception to early withdrawal, the 10 percent penalty tax will be applied to those younger than age 59 1/2. Retirees generally must begin taking annual required minimum distributions (RMDs) from a tax-favored retirement account and pay income taxes on the RMDs beginning at age 70 1/2. Before accessing your retirement funds, it is crucial to know the rules for avoiding penalty tax on early distributions. Unless an exception applies, withdrawal of your retirement funds made before the age of 59 1/2 will result in a 10 percent tax penalty (25 percent for certain SIMPLE IRA distributions).  Certain penalty exceptions apply to qualified plan or IRA distributions, but not both.

Understanding if you are eligible for a penalty exception can get tricky, but some exceptions that are widely used include:

Separation from service after age 55: Qualified retirement plan distributions received after the employee reaches 55 and separates from the employer do not incur a tax penalty. This exception only applies to employees who separate from an employer during or after the year they reach age 55.

Substantially equal periodic payments (SEPPs): This rule is specifically designed for those who want to access retirement funds before age 59 1/2 without being hit with the 10 percent tax penalty. Qualified plan distributions are eligible only if an employee has separated from his or her employer. Retirement payments are based on the life expectancy or the joint life expectancies of the individual and the designated beneficiary. The payments must be made annually, using a method prescribed by the IRS.

Understanding penalties and knowing the proper time to begin your retirement will benefit you financially in the long run. Depending on when you are planning to leave the workforce, having a plan in place will help you feel settled and secure for the future.

About the author:

Anthony J. DeChellis, CPA, CFP® is a Senior Technical Editor-Tax with the Tax & Accounting business of Thomson Reuters.  He has over 30 years of tax experience, specializing in individual and small business taxation, and contributes to Checkpoint, the leading global brand of knowledge solutions for tax and accounting professionals.


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