Rule of 55 clarification

[marctt]

The statement reads "separation from service the years during or after age 55".  "During" not "be".  Why doesn't the rule simply state separate from at the age of 55 or older (similar to how 59 1/2 rule states)?

How the exception reads leads me to believe it applies to people who are 54 years at separation as long as later in the same calendar year (on or before December 31st of the year in which they separate) they turn 55 years old.

Lets say I was born in December of 1968. Lets also say in January of 2023 I separate from service at the age of 54 years old.   Does the Rule of 55 apply?  I believe it does, as later in the year, which would be during the same year I will turn 55.    

Would this be a correct application of the rule?

[AnnetteB6]

No, that would not be a correct application of the rule.  

Based on information published by the IRS, the exception to the early distribution penalty associated with separation of service and the age of 55, you must be 55 before the separation occurs.  

Here is a link to the IRS site that outlines the early distribution penalty exceptions:

Topic no. 558, Additional tax on early distributions from retirement plans other than IRAs
 

[marctt]

Thank you for your response.  Thank you for the link.

Follow on question/further clarification: If I separate at the age of 54 but delay taking any withdrawals until after I have attained the age 55 would the Rule of 55 apply?  Basically, does age 55 apply to when the separation occurred and when the withdrawal(s) are taken or only to when the withdrawal(s) occurred?

I am expecting that age 55 applies to both, but as before, I would appreciate an expert opinion.

Thanks.

[ThomasM125]

You have to separate from service during or after the year you turn 55, you can't separate at age 54 and wait a year to start distributions per this excerpt from IRS Publication 757 Pension and Annuity Income Pension and Annuity Income

[dmertz]

The only way that the age-55 exception would apply when you separated from service at age 54 from the employer providing the plan would be if you reached age 55 later that same calendar year.

[marctt]

in reply to dmertz:

That would be the situation:  Separate from service in January of 2025 at the age of 54 years old.  In November of the same year (2025) I will turn 55 years and start taking withdrawals.

Your post/reply is how I understood it to be.  Unfortunately, two Tax Experts state otherwise in earlier replies to my original post.  

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-exceptions-to-tax-o...

The key word is "during".  TurboTax even asks you when you are doing taxes "Separation From Service the Year During or After Age 55".  Not Separation From Service on or After the Age 55.

I don't mind paying my taxes.  I just don't want to pay more than I am supposed to.  I might have to schedule some time with a CPA/Tax Attorney or try to reach out to the IRS.

Thank you for the reply.

[dmertz]

From IRS Notice 87-13:

A distribution to an employee from a qualified plan will be treated as within section 72(t)(2)(A)(v) if (i) it is made after the employee has separated from service for the employer maintaining the plan and (ii) such separation from service occurred during or after the calendar year in which the employee attained age 55.

Section 72(t)(2)(A)(v) is the section that establishes the age-55 exception to the early-distribution penalty.  It's clear from this that it does not matter when during the separation-from-service year the employee reaches age 55.  The employee can have their 55th birthday that year before or after separation from service.

[AnnetteB6]

One thing to remember, there are a number of references available to try to define and determine exactly how to apply the exception for separation of service.  They do not all agree as seen in these answers to your question.  Plus, speaking for myself, I am not qualified to give you legal advice regarding your tax situation.    

The bottom line is that when you use TurboTax, you are responsible for the information you include with your return and the application of exceptions you are using.  In the unlikely event your return is audited, then the auditor may or may not agree with your interpretation of the exception.  They could have the same resources cited here, or they may have other resources as well.  

Just as an example, here is another source interpreting the exception for separation of service:

Watson vs IRS

An excerpt:

Moreover, the following legislative history regarding the age 55 exception supports our conclusion:
In all cases, the exception applies only if the participant has attained age 55 on or before separation from service. Thus, for example, the exception does not apply to a participant who separates from service at age 52, and, pursuant to the early retirement provisions of the plan, begins receiving benefits at or after age 55.

@marctt 

[dmertz]

Watson v. Commissioner is not very relevant since it deals with someone who separated from service before the year they reached age 55 (separation from service occurred at age 53) and therefore did not qualify for the exception regardless of which way 72(t)(2)(A)(v) is enforced.  Watson v. Commissioner is not to be treated as precedent, so the fact that section 72(t)(2)(A)(v) was (unnecessarily for the purpose of the case) interpreted differently than in IRS Notice 87-13 should not replace the statement in Notice 87-13, but could indicate how the Tax Court might rule if the IRS chooses to ignore its own guidance in Notice 87-13.

If the plan follows the rule as stated in Notice 87-13, the plan should be reporting the distribution with code 2 no matter when during the year the employee reached age 55.  The IRS is unlikely to disagree with a code-2 reported by the plan.

[marctt]

dmertz,

Can you provide a link to IRS Notice 87-13? 

My plan states:  ". . . .  during or after the year you reach age 55, the 10% penalty tax does not apply to any distribution you take that year or later".

Hopefully, when I do separate, they will issue my 1099-R with the appropriate distribution code (Code 2: Early distribution, exception applies).  If not, it would be beneficial for me to have access to IRS Notice 87-13 ( I haven't been able to find it).

Thank you again for your participation in this discussion.   Much appreciated.

[DaveF1006]

Here is the link. Look on page 22 of this document for Notice 87-13 Guidance.

[dmertz]

I don't have a direct link, but you can search Notices for 87-13 on http://www.legalbitstream.com/ and find it.