Starting My Pension Early
L1: Starting My Pension EarlyI had a great job, but was separated last year at age 53. Like a previous post, my employer was racheting down the value of the retirement lump sum every year, so after much consideration, I decided not to take the lump sum at all, just go for the pension (annuity). So after my severance pay runs down, I want to start the monthly pension when I turn 55, and my understanding now is that this will be subject to the 10% tax penalty. What I don’t understand, is how to protect these payments with the 72t, I’m assuming this would qualify as equal payments based on life expectancy, since that’s how the company calculates the pension, but who sets upmy exemption,and how is it normally done? Have I misunderstood anything so far as it relates to a regular company pension instead of an IRA or 401k withdrawal? I also want to be sure the amount withheldmonthly is not going to include the 10% penalty… but I suppose that’s a question for my company retirement plan administrator(?)
It’s very scary to look at this when you read about people who have gone bust. I want to do it right, it seems like it “should” be easy and straightforward when you take a life-time pension arrangement.
2011-06-30 15:39, By: Mikie, IP: [220.127.116.11]
L2: Starting My Pension EarlyHello, Mikie:
I don’t have experience with a company pension plan but I do have some with early retirement pensions. My wife retired from the local school district in 2001 at age 51 after 30 years of service. She receives a monthly pension check from the state. She also receives an annual 1099-R form that shows a “2” in box 7. This signifies “early withdrawal, exception applies”. The IRS has never questioned this and she has never paid any penalty on this money, even before she turned age 59.5. After she became age 59.5, this code was changed to “7” for normal distribution. It is likely that your company will do the same. You should talk to your HR person or department and find out how they mark the pension 1099-R forms, particularly as regards box 7. You can also ask anyone you know who has retired and taken the pension how this was handled for them. If they use a “2” in box 7, then you should not have to worry about a penalty on your pension distributions. I am sure that others with specific company experience will add their thoughts to this question.
2011-06-30 18:06, By: Ed_B, IP: [18.104.22.168]
L3: Starting My Pension EarlyEd, thanks for your reply. I’m reading some publications and forms now from the IRS, in particular the 1099-R. And I was beginning to think it worked more-or-less just how you describe. I wanted to learn as much as possible before calling HR (again), since the answers have varied in the past depending on who answers. I’m sure the really knowledgeable folks are assigned once I trigger the 30-day notice for starting the distribution, but I want to know details well in advance. I guess I would just tell them to use that code, from what I can tell so far, there’s nobody that I really have to provide a SEPP plan to (right?). I thinkwe’re basically on the right track though, I was so frustrated when my tax accountant wasn’t able to tell me these types of details. I will keep reading, and alsoappreciate any more comments / advice.2011-06-30 18:28, By: Mikie, IP: [22.214.171.124]
L4: Starting My Pension Early1. Get a new tax accountant.
2. I thinka SEPP 72-T plan involves an IRA account, not a company pension.
3. Annuities do not necessarily qualify for SEPP 72-T exceptions for the 10% penalty. The SEPP plan has a formula/calculation based upon age, federal interest rate, and account balance. The annuity makes its payments according to its own formula, and the rate that it can invest the money at. which is usually different from the allowable federal interest rate for the SEPP calculation. The payments from the annuity are received by you, unless the annuity was purchased by the IRA. This concept can be confusing, so I suggest that you work with an advisor who can explain this to you.2011-06-30 18:53, By: dlzallestaxes, IP: [126.96.36.199]
L4: Starting My Pension EarlyNo problem with the answers, Mikie. Glad to help if I can.
I know what you mean about HR. Some of them are very knowledgable and some aren’t, so you need to know when you are getting the straight scoop and when you aren’t. That’s not always an easy task.
It is likely that you do not need a SEPP plan at all. Getting the right code on your annual 1099-R for your retirement distributions should pretty much mean that you are fine as is.
You’re right about not having anyone to whom you can provide a SEPP document. Even if you were to have a SEPP, you do not have to file any paperwork with anyone other than your IRA custodian. In most cases, that is just a systematic withdrawal form. When you pay your taxes, you also file a form 5329 to claim the 72t exemption if your 1099-R has a “1” in box 7. I suspect that this will not be an issue for you.
The whole thing about retirement plans and IRS involvement is that there are a lot of rules involved. Most of these exist to protect people from spending too much of their retirement money too soon and thereby becomming destitute in their old age. We do not, of course, become magically money-smart when we reach age 59.5 but the government does what it can to help people understand that their retirement money is not equivalent to winning the lottery. Pensions are generally paid out monthlyand therefore cannot be spent all at once. Unless you can take it as a lump sum distribution, you do not need the kind of protection that the law includes.
In your position, I would ask an HR supervisor how the 1099-R is handled. If they say that they code box 7 as a “2”, then you should be fine. Just collect your pension and enjoy life to the best extent you can.
Remember that even if the 10% early withdrawal penalty does not apply to you,your pensionmoney will be taxed in the year when it is paid out. Make sure that your cash flow is sufficient for your needs AND for the taxes that will be due.
Ed2011-06-30 23:34, By: Ed_B, IP: [188.8.131.52]
L5: Starting My Pension EarlyThanks again, all good info. I will call HR tomorrow, I like the way you word the question, maybe I can get a definitive type of answer from them. I “can” take it as a lump sum, but I’m choosing not to.
As for cash flow and long-term planning, I’ve really been working on it alot. I’ve been off work just over 6 months now and love it so much, I think I would cut back on any expenses just to be able to keep this free lifestyle. So yes, I think I can make it work, if taxes and inflation don’t go nuts, if my 401k doesn’t crash, my house doesn’t burn down, and I don’t get any bad diseases. But hey, don’t get me wrong, I’m very positive about this – I see this as my new fulltime job, to guard what I have, and avoiding a 10% penalty just because of my age is top of the list right now.2011-07-01 02:44, By: Mikie, IP: [184.108.40.206]
L6: Starting My Pension EarlyI only mentioned the lump sum distribution because there are different options for what you can do with that thanwith the annuity. I know what my preference would be for that but was not recommending one vs. the other.
I know that you mean about the freedom that comes with retirement! It IS intoxicating, for sure. When I look at all the toys that people use as reasons to continue working, I just have to shake my head. Thereare nothings in this world that would induce me to give up retirement and resume working. Family, yes… things, no!2011-07-01 03:39, By: Ed_B, IP: [220.127.116.11]
L2: Starting My Pension EarlyStart by looking through your Summary Plan Description. You probably don’t need a SEPP plan.
Is it a defined benefit plan or a defined contribution (money purchase, target benefit, profit sharing) plan?
Is there a definition of early retirement? If yes, what is the age? What is the definition of the early retirement?2011-06-30 18:43, By: Gfw, IP: [18.104.22.168]
L3: Starting My Pension EarlyMikie,
I retired at age 55, and started taking a lifetime pension (defined benefit plan from a private sector job) and it was not subject to the 10% penalty. It may depend on how the retirement plan is written, so the Summary Plan Description (SPD) for the retirement plan may outline how early payments are classified from an IRS standpoint. I got the code “2” in box #7 on my 1099-R’sfor5 years, and now get code 7.
Otherwise, you need to get definitive answer from your employer. KEN2011-06-30 21:09, By: Ken, IP: [22.214.171.124]
L4: Starting My Pension EarlyThanks Ken, very good info for me. I found the list of the codes, and #2 seems to cover alot of circumstances, so I’m hoping they tell me this is what they would normally do for a case like mine.2011-07-01 02:45, By: Mikie, IP: [126.96.36.199]
L3: Starting My Pension EarlyI hope you’re right about not needing the SEPP plan. The retirement plan is a defined benefit plan, and I was not contributing to it. We also have a 401k plan, but it’s a whole separate thing, with company stock and lots of rules; my intention is to keep the 2 entities separate because I want the annuity-style of lifetime income plus the 401k which I can continue to direct the investments – and – I will not go near it until AFTER age 59 1/2.
Oh yes, there is a definition of early retirement age, it is 55. But, I’ve always had trouble seeing how this matters. We can initiate the withdrawal or rollover of the retirement funds at any time after leaving active employment.2011-07-01 02:51, By: Mikie, IP: [188.8.131.52]
L4: Starting My Pension EarlyMikie,
I think the context of age 55 early retirement, if it is listed in your defined benefit pension,means you can start collecting your pension at age 55, and no early tax penalty applies. This would be true if they tell you the 1099-R will be coded with a “2” in box 7. Because of that, there is no need to ask for a lump sum that you would have toroll over to an IRA, in order tostart a SEPP (72t) withdrawal plan to avoid the 10% tax penalty on all withdrawals (payments to you) made prior to age 59 1/2. KEN2011-07-01 03:21, By: Ken, IP: [184.108.40.206]
L5: Starting My Pension EarlyYou should study the “NUA” regulations for your 401-K with the company stock. It is one of the best, and best-kept, secrets in the tax code. If you qualify, and the company stock has appreciated significantly in value , you can pay taxes on the COST when the company purchased the stock for your 401-K account. You should get this NUA cost figure from HR as soon as possible. This cost figure will never change.
If NUA is right for you, DO NOT ROLL OVER the 401-K to a IRA, because it will negate all of the benefits of this great provision. You would take a distribution of the company shares, and put them into a non-retirement regular brokerage account. Then you would pay the 15% long-term capital gains tax on the GAIN whenever you sell any shares, even if you sell some or all of the shares the next day !!!
Further, if you are in the 15% INCOME TAX BRACKET, then long-term capital gains are taxed at -0-% !!! SO there is need for some careful tax planning. Finally, in several situations, I have had clients establish the brokerage account as a “margin account”, and take margin loans if they are in the 25% tax bracket. They were able to live on the tax-free proceeds of the sales of the company shares, plus the margin loans, for several years. An additional benefit of this approach was to reduce the concentration of their investments in the company stock.
By the way, you will be able to roll over the 401-K balance that is not in the company stock. But the entire 401-K account must be distributed in the same calendar year.2011-07-01 04:06, By: dlzallestaxes, IP: [220.127.116.11]