Retirement Distribution Why Penalty Code 1

[ddoshan]

Younger client that worked for a company that went out of business in our town 12 years ago. The company had a pension plan for the employees based on their years of service. My client age 40 now, decided to just take out a lump sum distribution in the amount of 8400 dollars coded 1 on her 1099R. She could have waited until age 55 or so and then been entitled to a small monthly pension amount for the rest of her life, but decided to take the one time distribution now.
The employees did not contribute to this plan. This was not a 401 plan or any kind of pretax plan. Just a typical company sponsored retirement plan. Why would their be a penalty? Thinking I should have done a 5329 abating the penalty. Guess I'll read thru the instructions for 5329 once again to see if there is an exception.

[jimfrombx]

Why would it be coded as anything but a code 1? Individual is not 59.5, or retiring from company at 55, so there is no exception to 10% penalty.
That the company went out of business has nothing to do with withdrawal.

[ddoshan]

It just seems to me that the penalties applied to retirement accounts such as 401's, IRA's, thrift plans, etc. Accounts that are pretax or at least accounts taxpayers set up that grow tax free. I know that if I were to withdraw from my companies 401K plan prior to certain dates or times I would be subject to a penalty. But, to me at least, a typical company sponsored retirement plan that I have not contributed to and based on my years of service seems different.

[DaveO]

When the local telephone company here was bought out by Alltel they offered buyouts to a group of employees that tended to be closer to retirement age. They all had to start taking their pensions. Those who were under 59 1/2 got stuck with the 10% penalty even though they had taken no affirmative action to either terminate their employment or to take their pension early it was a condition of the buyout. Some very unhappy campers for a few years.

[Bees Knees]

It just seems to me that the penalties applied to retirement accounts such as 401's, IRA's, thrift plans, etc. Accounts that are pretax or at least accounts taxpayers set up that grow tax free.

This defined benefit plan is no different. It is also pre-tax because the employee never paid tax on it while his/her benefits were accruing inside the plan. Defined benefit plans are funded by employer contributions pre-tax because the employer gets a deduction for funding the plan on behalf of an employee, and the employee does not get taxed on those benefits until they are distributed.

It does not matter whether the contributions are coming out of the employee's pay, or being contributed directly by the employer...any taxable distribution is subject to the 10% penalty because the employee could have rolled over the funds tax free into and IRA and held on to it until age 59½.

[taxea]

an employer contributed plan is a pre-tax plan. The ex employee had the option of transferring the funds into an IRA that would not have been taxed until distribution at retirement age or after reaching 59.5.

From Pub 17
If distribution code “1” is incorrectly
shown on your Form 1099-R for a distribution
received when you were age
591 2 or older, include that distribution on Form
5329. Enter exception number “12” on line 2.
General exceptions. The tax does not apply
to distributions that are:
Made as part of a series of substantially
equal periodic payments (made at least
annually) for your life (or life expectancy) or
the joint lives (or joint life expectancies) of
you and your designated beneficiary (if
from a qualified retirement plan, the payments
must begin after your separation
from service),
Made because you are totally and permanently
disabled, or
Made on or after the death of the plan participant
or contract holder.
Additional exceptions for qualified retirement
plans. The tax does not apply to distributions
that are:
From a qualified retirement plan (other
than an IRA) after your separation from
service in or after the year you reached
age 55 (age 50 for qualified public safety
employees),
From a qualified retirement plan (other
than an IRA) to an alternate payee under a
qualified domestic relations order,
From a qualified retirement plan to the extent
you have deductible medical expenses
(medical expenses that exceed 7.5%
of your adjusted gross income), whether or
not you itemize your deductions for the
year,
From an employer plan under a written
election that provides a specific schedule
for distribution of your entire interest if, as
of March 1, 1986, you had separated from
service and had begun receiving payments
under the election,
From an employee stock ownership plan
for dividends on employer securities held
by the plan,
From a qualified retirement plan due to an
IRS levy of the plan, or
From elective deferral accounts under
401(k) or 403(b) plans or similar arrangements
that are qualified reservist distributions.