403(b) Withdrawals and the Penalty Tax

Q: My client left his employer at age 53, and will be 55 this year. He would like to make withdrawals from his 403(b) account without the IRS penalty tax being imposed. Can he do that?

A: No! IRS Notice 89-23 specifies that the 10% premature distribution tax is waived only if severance of employment occurs in the same year as the 55th birthday or later. Your client will now have a 10% penalty tax if he makes withdrawals prior to age 59½, unless he has another event which would waive the penalty tax (such as disability). He could use the substantially equal payments option in which an income stream could be generated without penalty tax. If he chooses that route, the income stream must continue to the later of age 59½ or five years, whichever is longer.