The Pension Protection Act of 2006 (the “PPA”) made a number of sweeping changes to the retirement plan landscape which have garnered much attention and analysis. These include two provisions which are of specific interest to public safety employees covered by governmental retirement plans, and the entities sponsoring those plans. The PPA provides for a waiver of the 10% penalty on early distributions from governmental plans to certain public safety employees, and permits retired public safety officers to exclude up to $3,000 from their retirement plan benefits to pay for health or long-term care insurance premiums. These two new rights are described in more detail below.
Waiver of Penalty for Early Distributions
Generally, unless a payment from a qualified retirement plan is distributed on or after the employee attains age 59 1/2, dies, becomes disabled, separates from service after age 55, or fits any other exception provided in Internal Revenue Code (“Code”) section 72(t)(2)(A), the distribution will be subject to a 10% early withdrawal penalty. The PPA amends the rule for distributions made after an employee separates from service after age 55 by lowering the age threshold for penalty-free distributions to age 50 for “qualified public safety employees.” Under this new Code section 72(t)(10)(B), any employee who provides police protection, firefighting services or emergency medical services in any area within the jurisdiction of his or her employing state or political subdivision (a “qualified public safety employee”) who separates from service after age 50 may receive distributions from a governmental defined benefit plan penalty-free. This exception applies to distributions made after August 17, 2006.
If a governmental plan covers only employees who qualify as “qualified public safety employees,” then all of the plan’s participants may qualify for the penalty waiver. However, if a governmental plan covers both “qualified public safety employees” and employees who do not qualify as “qualified public safety employees,” the plan sponsor should review its administrative procedures to ensure that only those individuals who are eligible for the waiver receive their benefits penalty-free.
Tax-Free Distributions for Qualified Health Insurance Premiums
Distributions from a retirement plan will generally be taxable to the plan participant. The PPA, however, permits eligible public safety officers (not just those public safety employees referenced above for the penalty waiver) to exclude up to $3,000 of their plan benefits from income tax per year if the benefits are used to pay for the qualified health insurance premiums of the retiree, or the retiree’s spouse or dependents for that year. The new Code section 402(l) applies to distributions from governmental defined benefit plans, governmental defined contribution plans, governmental Section 403(b) tax-sheltered annuity plans and governmental Section 457(b) eligible deferred compensation plans made to any of the following individuals who serve a public agency in an official capacity:
- an individual involved in crime and juvenile delinquency control or reduction, or enforcement of the criminal laws (including juvenile delinquency), including, but not limited to, police, corrections, probation, parole, and judicial officers;
- professional firefighters;
- officially recognized or designated public employee members of a rescue squad or ambulance crew;
- officially recognized or designated members of a legally organized volunteer fire department; and
- officially recognized or designated chaplains of volunteer fire departments, fire departments and police departments.
To qualify for this exclusion, the employee must have separated from service by reason of disability or attainment of normal retirement age while employed as one of the public safety officers referenced above and must have elected to have the plan deduct a portion of his or her eligible benefits for his or her qualified health insurance premiums after such separation. This election must be made on an annual basis.
Any deductions of retirement plan benefits pursuant to this provision of the PPA must be remitted by the governmental plan directly to the provider of the health insurance plan or qualified long-term care contract. Hence, the exclusion will not apply if premiums are paid by the retiree and the governmental plan reimburses the retiree for those payments. Deductions will be limited to the amount of premiums that the retiree pays for his or her coverage and/or dependents’ coverage, up to $3,000. All eligible retirement plans of an employer will be treated as a single plan for purposes of the exclusion. This means that a retiree can only receive one $3,000 exclusion even though he or she receives benefits from more than one governmental plan, e.g., a defined benefit plan and a Section 403(b) tax-sheltered annuity plan sponsored by the same employer.
We note that if a retiree’s premium amounts are deducted in accordance with this rule and are, therefore, excluded from the retiree’s income, the retiree may not also claim a deduction for the same amount under Code section 213 (deduction for itemized medical expenses) or Code section 162(l) (deduction for health insurance costs paid by self-employed individuals).
Governmental plans are not required to provide for this exclusion. A governmental plan is free to decide whether it wants to permit eligible retirees to make annual elections to reduce their benefits and to remit the eligible amounts to the retiree’s insurance provider. If a governmental plan wishes to do so, it must determine whether it can process elections and remit premiums efficiently and develop appropriate election procedures.
This provision of the PPA is applicable to distributions made in tax years beginning after December 31, 2006.
If you have any questions regarding these two new valuable rights for retired public safety employees, please contact the author of this article.