Q. What happens if an employee who is younger than age 59½ triggers a lifetime annuity or rider payout? Would that somehow allow the employee to avoid the 10% penalty tax imposed for a distribution before age 59½?
A. If the employee elects a “substantially equal periodic payment” period and continues those payments for the later of attainment of age 59½ (the actual date they attain 59½) and five years (measured from the first payment), then yes, there would be no penalty. If they alter the payments in any way, the IRS will go back to the inception and recapture the 10% penalty. Remember:
- 1. The election must be very specific;
- 2. Use an interest rate that satisfies IRS requirements; and
- 3. Reporting is based on whether your organization calculates this amount for them and tracks the distributions or not.
There are three methods that can be used for this calculation…IRS requirements are found in IRS Notice 2002-62.