Not Qualified Distribution

Today TaxMama hears from Harry in Pennsylvania, who tells us, “I withdrew money from an IRA which used to be an employer annuity, but became an IRA when I left them. I am over 55 and separated from service. Does exception 2, separation from service, apply to distributions from an IRA? Since I am under age 59 ½ , the 1099R I received for the IRA has a 1 in box 7 – which means early distribution, penalty applies.”

Hi Harry,

I wish I could answer you with more clarity, but I cannot.

Exception 2 refers to distributions from “qualified plans”. First of all, I don’t know if your employer’s annuity was part of a qualified plan. Second, once you took the money out and put it into an IRA, you changed the nature of the funds. IRAs are not qualified plans.

So, I really don’t think your distribution is exempt from the early withdrawal penalty. Some planning before you took the money might have made it accessible with less taxes or penalties. So sorry.

There may be one other thing that will help you avoid some or all of the penalties. That all depends on what you used the money to buy.

If you are now unemployed and used the money to pay for your health insurance, that part of the distribution may avoid the penalties.

Read the list of exceptions on page 3 of the instructions to Form 5329. See if you can fit yourself into any of the others. http://www.irs.gov/pub/irs-pdf/i5329.pdf

In case you’re interested in the rules for qualified plans, or what they are, read Chapter 4 of IRS Publication 560, Pensions and Annuities. http://www.irs.gov/publications/p560/ch04.html

And do me a favor, before you make major financial moves like that, ask your tax pro. Or ask me.

And remember, you’ll find answers to lots of questions, about distributions from retirement plans and other tax information, free. Where? At TaxMama.com

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