Early Retirement Benefit Overlooked

BY JOHN SOTO

“Coping With Retirement” ( JofA, Dec.99, page 67) ignores the most important benefit available to workers who retire before age 59 1/2 with 401(k) plans and IRAs and need additional income to supplement their pensions before Social Security benefits kick in.

The article states most arrangements provide a penalty for distributions made before age 59 1/2 except in the case of disability.

However, there is another exception that can be found in IRS publication 590, Individual Retirement Arrangements. Commonly referred to as the “substantially equal periodic payments” exception, it allows an individual to withdraw money from a 401(k) or IRA without incurring the 10% early withdrawal penalty, but has the following restrictions:

  • The payment must be the same monthly or annual amount.
  • The payment must be based on a projected reasonable return of retirement plan investments as determined by historical performance.
  • The payments must continue for 5 years or until the individual reaches age 59 1/2 , whichever is the longer period. Otherwise, the 10% penalty will apply for any lump-sum and all other distributions except in the case of death or disability.

If the participant elects monthly distributions, the first payment will include a lump sum for the prior months in the first calendar year—for example, a person set up to receive $1,000 a month starting June 1 will also receive a $5,000 payment for the prior 5 months.

If the individual’s retirement account investment continues to perform well during the time he or she is receiving the equal monthly payments—as it might have, for example, during the present bull market—at the end of the 5-year period, the principal investment might have remained intact or have increased.

Most early retirees are unaware of the provisions of publication 590. They continue to work to make ends meet because they think their retirement accounts are untouchable without incurring severe tax penalties.

Now that downsizing by corporations and resulting early retirements are commonplace, awareness of this tax benefit allows individuals to better cope with retirement.

In 1996 I retired early and needed additional income to supplement my pension until I could receive my Social Security benefits. When I discovered publication 590, I immediately took advantage of its early withdrawal provisions and set up my distributions. I’m glad I did.

John Soto, CPA, JD
North Attleboro, Massachusetts

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