Rule of 55 - the mechanics

Forum|Forum|3 years ago
October 18, 2022
2 replies
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Hi everyone,

I've read and researched the Rule of 55 extensively but outside of the actual rules nobody talks about the implementation mechanics, how does it work in real life? I find it suspiciously too easy to just file regular taxes and as long as the rules are met - no penalty is levied (completely understanding that 401k distribution is "income" and subject to Fed and State income tax)? The topic here is strictly about the early distribution penalty.

Is there any specific IRS form which is filed with one's taxes to seek the exemption from a 10% early distribution penalty? If there's no form how does IRS actually determine whether you owe a penalty or not? The 401k plan itself does NOT take out penalty upon distributions, only 20% FedTax and for specific states - mandatory State Tax but that's about it.

Have any of you actually done this and if yes please share your experience and how it worked for you?

PS. Does TurboTax detect when 401k 1099 is used and trigger some kind of interview questionnaire around the penalty piece?

Thank you

Boyan

Not A Product Question

Best answer by TomD8

If you receive an early distribution from a 401K, then Box 7 of your 1099-R should show a Distribution Code of 1 or 2.

This is how the IRS (and TurboTax) know that the distribution was early.

See page 15 of this IRS Publication:

https://www.irs.gov/pub/irs-pdf/i1099r.pdf

Anonymous_

Level 15

@dmertz

TomD8

Answer

Alumni - Champ

If you receive an early distribution from a 401K, then Box 7 of your 1099-R should show a Distribution Code of 1 or 2.

This is how the IRS (and TurboTax) know that the distribution was early.

See page 15 of this IRS Publication:

https://www.irs.gov/pub/irs-pdf/i1099r.pdf

**Answers are correct to the best of my ability but do not constitute tax or legal advice.

BoyanAuthor

Level 5

@TomD8 Thank you so much Tom! That's super clear. Ok so then what? How does the process continue? TubroTax fires an interview process to determine whether penalty is due or not? What are the mechanics of determining the penalty question? Thank you!

VolvoGirl

Level 15

Exceptions for Early Distributions from a Qualified Retirement Plan such as a 401(k) or 403(b) plan. See Pub 575 page 36 Additional Exceptions
https://www.irs.gov/pub/irs-pdf/p575.pdf

..Distributions upon the death or disability of the plan participant.
..You were age 55 or over in the year you retired or left your job. (50 for qualified public safety employees)
..You received the distribution as part of "substantially equal payments" over your lifetime.
..You paid for medical expenses exceeding 7.5% of your adjusted gross income.
..The distributions were required by a divorce decree or separation agreement ("qualified domestic relations court order"),

The questions about exceptions to the penalty do not come after entering the 1099-R. Rather, you will see that area after you have finished all the Deductions and Credits section.