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Exceptions For Sanctions & Taxes For Military Service

Exceptions For Sanctions & Taxes For Military Service

Treatment of distributions to persons placed on active service for at least 179 days (article 72(t) of the code)


Under the current law 

Under current legislation, a taxpayer who receives a distribution from a qualifying pension plan before age 59.5, death, or disability is generally subject to an early withdrawal fee of 10% of income, except where a tax exemption applies. Among other exceptions, the prepayment charge does not apply to distributions made to an employee who is separated from service after the age of 55, nor to distributions that are a portion of a collection of essentially equal recurrent payments made for the life (or life expectancy) of the employee—the employee or the combined life (or life expectancy) of the employee and his/her beneficiary.

Certain amounts held in qualified cash or deferred arrangement (a "401(k) plan") or a tax-sheltered annuity (a 403(b)) may not be distributed until termination from employment, retirement age 59, disability, death, or financial difficulties of the employee.


Explanation of the provision

According to the provision, the 10% early withdrawal fee does not apply to qualified reservists' allocation. A qualified reservist distribution is a distribution: 

(1) from an IRA, 403 (b) annuity, or attributable to elective deferrals under a 401(k) plan or related arrangement. 

(2) made to a person who (by the purpose of being a member of a reserve component per Section 101 of Title 37 of the US Code) has been commissioned or put into active service for more than 179 days or an indefinite period; the period commencing on the date of such call to duty or order and ending at the end of the period of active service. A 401 (k) plan or 403 (b) annuity does not violate the distribution restrictions applicable to those plans when distributing qualified reservists.

A person who receives a distribution of qualified reservists may, at any time during the two years beginning on the day following the end of the period of active service, make one or more contributions to that person's IRA for an amount total not exceeding this distribution. . The monetary restrictions applicable to IRA contributions do not apply to contributions made per the provision. No deduction is recognized for contributions made in accordance with the provisions.

This provision applies to persons commissioned or returned to active service after September 11, 2001, and before December 31, 2007. The two-year period for the redistribution of distributions to qualified reservists does not end until the enactment date of two years.


Pros and Cons

Serving in the reserves may have financial difficulties. For example, couples with children face unexpected childcare costs when an adult family member or both are called upon to work abroad. Like many provisions of the HEART Act, the Qualified Reservist Rules provide additional financial flexibility to Reservists.

If there is a compromise, there are significant restrictions. For example, the service provider employees can no longer make optional contributions to their pension plan after the distribution date. This can hurt potential retirement savings.

Perhaps the biggest downside to qualified reservist distribution is that losing even a year of savings in a 401k or IRA can make all the difference in retirement. This is especially true early on in the retirement savings process, as the money withdrawn cannot be capitalized for several years. For this purpose, even a withdrawal of a few thousand dollars, granted to qualified reservists, can cost $ 10,000 or more for several decades.


Effective date

The provision applies to distributions after September 11, 2001, if the refund or credit of any excess tax payment resulting from the disposition is prevented at any time before the end of the one year beginning on the date of adoption of any law or the rule of law (including res judicata / "a matter decided"), such refund or credit may be made or authorized if a claim is made before the expiration of this period.


Summary

  • Many service providers first accept distributions for this reason, but they can have long-term negative effects on retirement savings.

  • Qualified reservists, when called to duty, can make tax-free withdrawals from certain retirement accounts.

  • Retirement benefits received are still subject to certain state and federal taxes.


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