New Exception to Early-Distribution Penalty
July 31, 2015 9:10 AM
By Brian Dobbis
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New law extends the exceptions on early-distribution penalties to federal employees and includes all governmental retirement plans.
THE ROAD TO RETIREMENT with BRIAN DOBBIS
On June 29, 2015, President Barack Obama signed a law that expands the universe of retirement plans that will not be subject to the 10% early-distribution penalty. The "Defending Public Safety Employees’ Retirement Act" broadens both the number of workers and the types of plans eligible for the exception.
Generally, early distributions from retirement accounts are subject to both income tax and penalties when the account holder is younger than 59½. However, a number of exceptions apply that allow participants to avoid the penalty when making early withdrawals from employer workplace plans and/or IRAs.
The Pension Protection Act of 2006 made special allowances for “qualified public safety employees,” allowing state and local workers who separated from service after reaching age 50 to take penalty-free early withdrawals from governmental defined-benefit plans. The rationale was that these workers, who included police and firefighters, are able and required to retire earlier than the general public, and, therefore, should have earlier access to their retirement funds.
The act did not, however, extend to federal workers performing the same public safety jobs as state and municipal workers, nor did it apply to withdrawals from IRAs or other employer-sponsored plans. (It should be noted that distributions from governmental 457(b) deferred-compensation plans are not subject to the 10% distribution penalty, regardless of the participant’s age at distribution.)
The new law expands the definition of “qualified public safety employees” to include federal workers, and extends the exception to governmental defined-contribution plans as well.
By expanding the definition of “qualified public safety employees” to include federal workers, the law opened the door to thousands of customs workers, border-protection officers, and air-traffic controllers, as well as law-enforcement officers and firefighters, all of whom now have the potential to make early withdrawals from their retirement plans without incurring penalties. Of course, they still will be expected to pay regular income tax.
Similarly, by allowing qualified penalty-free withdrawals from any governmental plan as defined by Code Section 4149(d), including defined-contribution plans, the government significantly enlarged the pool of potential participants who may be eligible for penalty-free early withdrawals.
The new legislation becomes effective on January 1, 2016, and will apply to distributions made after December 31, 2015. Sponsors of governmental defined-contribution plans are advised to review their administrative procedures to accommodate this expanded exception to the 10% penalty tax on early distributions.
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