Early distribution penalty

[Art]

Taxpayer received a 1099R for $ 38000 (100%) taxable shown in box 1 and 2a) in 2008 with code 1 in box 7 and an X in box for IRA. The distribution was an immediate 5 yr annuity from a Sec 457B plan that was rollover to an IRA when the employee terminated service in Oct 2007 at age 58 and ½. The employer refused to allow the terminated employee to do the 5 yr annuity directly from within the 457 plan and would not allow the employee to leave the funds in the plan until she reached 59 and ½. The payments began in Jan 2008. Was the 1099R prepared correctly? Does exception 2 for a Sec 457 plan not apply when the funds are rolled over to an IRA under the circumstances described above? At a minimum would not the taxpayer be able to exclude the payments received after age 59 and ½ by filing Form 5329 and using a code 12 exception with the excluded amount reported on line 2 of the 5329? Is there any way to avoid the 10% penalty completely? I would appreciate input on this. Thanks in advance.

[kcjenkins]

Even though it is coded as a premature distribution, as long as it was rolled over, it's not subject to the penalty. If she had not taken any distributions, none of it would have been subject to penalty. And none taken out after 59½ is subject to them. I believe the client might qualify for exception 1 and 2, based on what you said, and 12, for the 457. See page 3 of the instructions, especially the info below exception 12.

[Art]

KC,

Thanks for the reply. The rollover itself is not the triggering event as I understand it. However, the fact that the funds were put in an IRA via the rollover, tainted the money as IRA money which apparently does not qualify for exception 2 treatment. When she started taking distributions in Jan 2008 before she was 59 and 1/2 is what I believe caused the insurance company to code all of the payments received in 2008 with a code 1-"no known exception" even though they should clearly have known that she was over 59 and 1/2 after the Sept payment. I realize that we can rectify the latter payments by filing the 5329 and use the code 12 to remove them from penalty treatment, but they really should have issued 2 1099Rs, one for payments before 59 and 1/2 and a second for the payments made after 59 and 1/2. The real rub in all of this is the employer's plan administrator who refused to allow the annuity payment directly from the 457B plan and worse yet would not allow the money to stay in the plan until the taxpayer turned 59 and 1/2. To add insult to injury the financial adviser who worked for the 457B plan told the taxpayer that none of the payments that she was to receive would be subject to the 10% penalty. Taxpayer is calling the insurance company to see what can be done. We are waiting for their response.

[kcjenkins]

Good luck with that. I've never known of much cooperation when it comes to 1099Rs. Usually the best you can get is 'taxable amount not determined'.