IRA distribution - Reservist

[Bill Tubbs]

Form 5329, "Additional Taxes on Qualified Plans", line 2, exception # 11:
Qualified distributions to reservists while serving on active duty for at least 180 days.

Client had been serving in Iraq (as an activated reservist), then came home for a while. While home, took a loan against his 401(k). He then returned to active service and defaulted on his 401(k) repayment, resulting in a deemed distribution. Does this deemed distribution qualify for exception 11?

Thanks,
Bill

[gkaiseril]

Be very careful, 401(k) plans share many similarities to an traditional IRA, but they are different animals and what works for one does not always apply to the other.

IRA's do not have a loan policy, but some 401(k)s may allow a loan.

But that is not the case for reservist placed on active duty for over 179 days and haved a withdrawl from an IRA or 401(k) . They can also put the money back, re-contribute, the removed funds into an IRA.

Active-Duty Reservists Get Relief on Retirement Plan Payments: Refunds of 10-Percent Tax Available Back to 2001, New Law Says

http://www.irs.gov/newsroom/article/0,,id=163054,00.html

The newly-enacted Pension Protection Act of 2006 eliminates the 10-percent early-distribution tax that normally applies to most retirement distributions received before age 59½. The new law provides this relief to reservists called to active duty for at least 180 days or for an indefinite period.

Eligible reservists activated after Sept. 11, 2001, and before Dec. 31, 2007, qualify for relief from this tax. This tax is often referred to as the 10-percent early-withdrawal penalty. Regular income taxes continue to apply to these payments in most cases.

Early distributions from both Roth and traditional IRAs received by a reservist while on active duty qualify for this relief. Likewise, a reservist’s elective contributions and earnings distributed to him or her by employer sponsored 401(k) plans and 403(b) tax-sheltered annuities also qualify for this relief.

Reservists can choose to re-contribute part or all of these distributions to an IRA. Ordinarily, these special contributions must be made within two years after the reservist's active-duty period ends. However, if the reservist's active duty ended before Aug. 17, 2006 (the date the new law was enacted), he or she will have until Aug. 17, 2008, to make these special contributions. No deduction is available for these contributions.

[Bill Tubbs]

401(k)

Early distributions from both Roth and traditional IRAs received by a reservist while on active duty qualify for this relief. Likewise, a reservist’s elective contributions and earnings distributed to him or her by employer sponsored 401(k) plans and 403(b) tax-sheltered annuities also qualify for this relief.

This paragraph says that distributions from a 401(k) also qualify for this relief -- my question is whether a deemed distribution would qualify.

Bill

[gkaiseril]

Intent of Legislation

The information posted by the IRS does not exclude it. The loan was in lieu of removal of funds and the deemed removal just means a check was not cut. Further the intent of the legislation was to provide relief to the Reservist from such penalties and allow them to re-contribute the funds that were removed from the programs. It sounds like the reservist maybe able to put the funds back into the account.

You might want to look at the latest instructions for form 1040-X instructions This is the only item with specifica information about this situation I have seen.