Waives Penalty for Early Distributions
Provisions in the House- and Senate-passed pension bills
March 2006
Waives the 10 percent penalty for early distributions at age 50 (a change from 55) for distributions from DB plans for public safety workers. The Senate bill includes a provision that is intended to give tax relief to public safety workers who retire after age 50 and receive an early retirement distribution and do not roll it over into a tax advantaged retirement account. Currently, when a distribution occurs prior to termination of employment after age 55, a 10 percent penalty tax applies, in addition to income tax, if the participant chooses to receive the funds directly. To avoid paying the penalty tax, a participant could instead roll over the distribution into an eligible retirement plan such as 401(a) or 457(b) (or even keep the funds in a cash balance account in the case where the DB plan provides for it).
Under the new scenario a public safety participant who retires after age 50 would not incur the additional 10 percent penalty tax but would still pay income tax on the distribution. The House bill also contains tax relief from the 10 percent penalty for early distributions to public safety workers. However, that relief is structured more narrowly. While the House relief applies regardless of the age of the public safety worker at retirement, it only applies to the extent an early retirement distribution is attributable to a Deferred Retirement Option Plan (DROP) benefit (i.e., not all distributions qualify and only a portion of a distribution may be eligible for relief).
Since both the Senate and the House have a similar provision — and the revenue cost is minor — some relief from the 10 percent penalty for early distributions to public safety workers is very likely to be in the final pension package, although the exact contours of that relief remain unclear.