401(k) and IRA Early Distribution Penalty Exception

Being the youngest EA I know, I'm pretty weak on retirement
account stuff. I'm sure this will be much easier for some
of you:

Friend of mine lost his job last year and received
unemployment. During this time, he paid for health insurance
for himself and his ex-wife as ordered by his divorce
decree. His former employer distributed his 401(k) to him,
and he did not roll it over. He thinks there is an
exception to the early distribution penalty for amounts paid
for health insurance while unemployed. My questions are:

1. Does this exception apply to 401(k) distributions? I
seem to recall that it only applies to IRAs.
2. If not, could he have rolled over the distribution to a
traditional IRA and then taken distributions without
penalty?
3. Does the exception apply to the health insurance paid for
his ex-wife? I am thinking no, but that this would be
deductible as alimony.

On a similar note, I will be going back to school this fall
and cashing out my retirement account. I believe that a
similar exception applies up to the amount of my higher
education expenses, but that this, too, applies only to
IRAs.

1. Can I roll it into a traditional IRA and immediately take
a distribution (up to the amount of the education expenses
I'll have this year) without penalty? I realize that I
would have to pay tax on the distribution.
2. Would there be any benefit to doing a Roth IRA instead (I
don't plan on taking it all out in the same year, and would
rather put off paying tax on part of it)?
3. What counts as higher education expenses? I read that
room and board are included for students who are enrolled at
least half-time; does this include off-campus housing?
4. Does it matter how long the money has been in the account?

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Sassy Baskets, EA wrote:

> Being the youngest EA I know, I'm pretty weak on retirement
> account stuff. I'm sure this will be much easier for some
> of you:
>
> Friend of mine lost his job last year and received
> unemployment. During this time, he paid for health insurance
> for himself and his ex-wife as ordered by his divorce
> decree. His former employer distributed his 401(k) to him,
> and he did not roll it over. He thinks there is an
> exception to the early distribution penalty for amounts paid
> for health insurance while unemployed. My questions are:
>
> 1. Does this exception apply to 401(k) distributions? I
> seem to recall that it only applies to IRAs.

The penalty will not apply to the extent that the person had
deductible medical expenses in excess of 7.5% of AGI. T/P
does not have to itemize.

IRS Pub 575 has all the exceptions to the 10% penalty for
pensions and annuities.

> 2. If not, could he have rolled over the distribution to a
> traditional IRA and then taken distributions without
> penalty?
>
> 3. Does the exception apply to the health insurance paid for
> his ex-wife? I am thinking no, but that this would be
> deductible as alimony.

#3 is correct.

In addition, there is an exception to the penalty if your
friend reached age 55 in 2004.

> On a similar note, I will be going back to school this fall
> and cashing out my retirement account. I believe that a
> similar exception applies up to the amount of my higher
> education expenses, but that this, too, applies only to
> IRAs.

Correct.The exception does not exist for retirement plans.

> 1. Can I roll it into a traditional IRA and immediately take
> a distribution (up to the amount of the education expenses
> I'll have this year) without penalty? I realize that I
> would have to pay tax on the distribution.
Yes.

> 2. Would there be any benefit to doing a Roth IRA instead (I
> don't plan on taking it all out in the same year, and would
> rather put off paying tax on part of it)?

I'm confused. There is no direct rollover from a pension
plan to a Roth. You have to go Pension---->IRA-----Roth.
Going from the pension plan to the IRA avoids taxation.
Removing funds from IRA to pay for QHEE avoids 10% penalty.
Moving IRA funds to Roth IRA is taxable and requires a
separate financial analysis and estate planning analysis to
determine if it right for you.

> 3. What counts as higher education expenses? I read that
> room and board are included for students who are enrolled at
> least half-time; does this include off-campus housing?

Quoting from Pub 590:

Qualified higher education expenses are tuition, fees,
books, supplies, and equipment required for the enrollment
or attendance of a student at an eligible educational
institution. They also include expenses for special needs
services incurred by or for special needs students in
connection with their enrollment or attendance. In addition,
if the individual is at least a half-time student, room and
board are qualified higher education expenses.

> 4. Does it matter how long the money has been in the account?

No.
>

--
Alan
http://taxtopics.net

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Sassy Baskets, EA wrote:

> Being the youngest EA I know, I'm pretty weak on retirement
> account stuff. I'm sure this will be much easier for some
> of you:

Somehow I thought you were older. (grin)
<Please refer to Moderator'a Endnote>

> Friend of mine lost his job last year and received
> unemployment. During this time, he paid for health insurance
> for himself and his ex-wife as ordered by his divorce
> decree. His former employer distributed his 401(k) to him,
> and he did not roll it over. He thinks there is an
> exception to the early distribution penalty for amounts paid
> for health insurance while unemployed. My questions are:
>
> 1. Does this exception apply to 401(k) distributions? I
> seem to recall that it only applies to IRAs.
>
> 2. If not, could he have rolled over the distribution to a
> traditional IRA and then taken distributions without
> penalty?
>
> 3. Does the exception apply to the health insurance paid for
> his ex-wife? I am thinking no, but that this would be
> deductible as alimony.
>
> On a similar note, I will be going back to school this fall
> and cashing out my retirement account. I believe that a
> similar exception applies up to the amount of my higher
> education expenses, but that this, too, applies only to
> IRAs.
>
> 1. Can I roll it into a traditional IRA and immediately take
> a distribution (up to the amount of the education expenses
> I'll have this year) without penalty? I realize that I
> would have to pay tax on the distribution.
>
> 2. Would there be any benefit to doing a Roth IRA instead (I
> don't plan on taking it all out in the same year, and would
> rather put off paying tax on part of it)?
>
> 3. What counts as higher education expenses? I read that
> room and board are included for students who are enrolled at
> least half-time; does this include off-campus housing?
>
> 4. Does it matter how long the money has been in the account?

You need to get a copy of form 5329, AND the instructions
therefor. Then, all will be made clear.

ChEAr$,
Harlan Lunsford, EA n LA
1 Apr 2005

Endnote:
Harlan, you MCP, trying to hit on a young girl by telling
her you thought she was older (rotflmao). Only you would
do this, Harlan. (still LoL).

Susan has gone to bed. I will her this in the morning so
she can start her day with a laugh.

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"Sassy Baskets, EA" <> wrote:

> Being the youngest EA I know

That used to be me.

> Friend of mine lost his job last year and received
> unemployment. During this time, he paid for health insurance
> for himself and his ex-wife as ordered by his divorce
> decree. His former employer distributed his 401(k) to him,
> and he did not roll it over. He thinks there is an
> exception to the early distribution penalty for amounts paid
> for health insurance while unemployed. My questions are:
>
> 1. Does this exception apply to 401(k) distributions? I
> seem to recall that it only applies to IRAs.

I believe it does and he meets the requirements.

> 2. If not, could he have rolled over the distribution to a
> traditional IRA and then taken distributions without
> penalty?
> 3. Does the exception apply to the health insurance paid for
> his ex-wife? I am thinking no, but that this would be
> deductible as alimony.
>
> On a similar note, I will be going back to school this fall
> and cashing out my retirement account. I believe that a
> similar exception applies up to the amount of my higher
> education expenses, but that this, too, applies only to
> IRAs.
>
> 1. Can I roll it into a traditional IRA and immediately take
> a distribution (up to the amount of the education expenses
> I'll have this year) without penalty? I realize that I
> would have to pay tax on the distribution.

That's the one.

> 2. Would there be any benefit to doing a Roth IRA instead (I
> don't plan on taking it all out in the same year, and would
> rather put off paying tax on part of it)?

I can't think of one.

> 3. What counts as higher education expenses? I read that
> room and board are included for students who are enrolled at
> least half-time; does this include off-campus housing?
>
> 4. Does it matter how long the money has been in the account?

No.

--
David M. Woods, EA, ChFC, CLU
Woods Financial Services
Norwood, MA 02062
www.woods-financial.com

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Final Authority wrote:

> Endnote:
> Harlan, you MCP, trying to hit on a young girl by telling
> her you thought she was older (rotflmao). Only you would
> do this, Harlan. (still LoL).
>
> Susan has gone to bed. I will her this in the morning so
> she can start her day with a laugh.

Thanks Dick, I had never even thought of such a pick up
line. Down South heah, it's usually "Why honey child, you
don't look THAT old." And it's "de rigeur" to complement
all ladies by (sometimes with a little ole white lie) and
complementing them on their supposed or assumed youth. But
you're from Nawth Caarlina, so you know this.

So I'm going to risk it and ask, what is a "MCP?
"Modified Content Provider"?

================================================== ==========
Harlan, mi amigo, an MCP is a Male Chauvenist Pig. And you
must ne the only person on the face of this earth who would
claim ignorance on this one.

Harlan, I never tell lies - white or otherwise. Ask my sons
"how old is your mother?" and they will reply "I don't know
but she looks 23" and that is a truthful statement. I have
told my 20 year old son he should start introducing his
mother as his sister. I use to introduce her as my daughter
but she didn't like that so how I introduce her as my trophy
wife.
================================================== ==========

ChEAr$$,
Harlan Lunsford, EA n LA
2 Apr 2005
13 days and counting

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