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The IRS 10% Early Distribution Tax

What is the IRS 10% early distribution tax?

A federal 10% early distribution tax applies if an employee retires before 59½ and returns to work for the same employer without a “bona fide termination”.  This federal tax does not apply if the employee retires before 59½ and returns to work for a different employer or if there is a bona fide termination with the same employer.

What is a bona fide termination?

A bona fide termination means the employee retired with no explicit understanding or agreement that the employee will return to work for the same employer after retirement.

Both the employer and employee will be required to certify to MainePERS at the time of retirement whether there is an explicit understanding or agreement that the employee will be reemployed after retirement.

What is meant by the “same employer”?

The “same employer” means the last employer the retiree worked for prior to retiring that provides the MainePERS retirement plan from which the retiree retired.  (Note:  This is a different, narrower definition than is used for return to work restrictions.)

Isn’t there a special exception to this tax for public safety employees who have reached age 50?

The 10% early distribution tax applies when distributions are made before age 59½. There are several exceptions to this tax as outlined in IRS Topic 558: Additional Tax on Early Distributions From Retirement Plans Other Than IRAs.

One of those is the public safety age 50 exception.  A second exception that applies to all of MainePERS retirees (including public safety) regardless of age is the exception when the distribution is “part of a series of substantially equal periodic payments over your life expectancy.”  However, both of these exceptions require a “separation from service,” which is the bona fide termination referenced above.

What if I have reached Normal Retirement Age for my plan?

Whether the tax applies does not depend on normal retirement age.  The tax applies if you are under 59½ and you retire and return to work for the SAME employer without a bona fide termination of employment, regardless of your normal retirement age.

How long is the 10% early distribution tax applied?

The tax will stop once the retiree reaches age 59½ or has a bona fide termination of employment.

What are MainePERS reporting requirements?

MainePERS must report on the retiree’s annual IRS form 1099-R that benefits received are subject to the 10% tax if the retiree has returned to work with the same employer without a bona fide termination. This will be reflected with 1099-R’s issued for tax year 2023. Starting on March 1, 2023, MainePERS will require retiring members below age 59½ (or normal retirement age) and their MainePERS employers to provide certification of the nature of the employee’s termination. New versions of the Employer Preliminary Benefit Certification and instructions for completing the form will be provided prior to March 1.    

Are there any other return to work requirements?

Yes, there are additional return to work requirements.

For more information please visit: www.mainepers.org/retirement/return-to-work/

If I qualify for retirement, can I still retire before age 59½ and return to work with the SAME employer without a bona fide termination and just pay the 10% early distribution tax? 

Yes.

Where can I find out more about the federal 10% early distribution tax?

For more information please visit:

IRS Topic 558: Additional Tax on Early Distributions From Retirement Plans Other Than IRAs – https://www.irs.gov/taxtopics/tc558