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Separation From Service Rule 55: Explained for USG Corporation Employees

It is essential for USG Corporation employees who are thinking about early retirement to find out more about the specifics of the Separation from Service exception in order to make the best financial decision. As Tyson Mavar from The Retirement Group, a division of Wealth Enhancement Group, recommends, workers should take these rules into consideration and meet with a qualified advisor to ensure that their finances are well positioned,” suggests Patrick Ray, Financial Advisor.

“Understanding the basics of early retirement options like the Separation from Service exception is crucial for USG Corporation employees. Patrick Ray from The Retirement Group, a division of Wealth Enhancement Group, explains the significance of consulting with a qualified professional in order to ensure that these financial strategies are implemented correctly in order to achieve the best results,” says Michael Corgiat, Retirement Specialist.

In this article, we will discuss:

1. The specifics of the Separation from Service rule, also known as the Rule of 55, which allows employees to take penalty-free withdrawals from their 401(k) plans starting at age 55 under certain conditions.
2. The key differences between the Separation from Service rule and the standard age 59½ rule, including the restrictions and limitations of each.
3. Practical considerations and examples that illustrate how the Separation from Service exception can be used to plan for early retirement or to meet certain financial needs if one loses a job.
The separation of service rule 55 is not fully discussed in the qualified retirement planning. Most people are probably aware of the age 59½ provision that permits a person to receive distributions from a retirement plan or an IRA account without incurring a 10 percent early withdrawal penalty.

The separation of service rule states that if an employee, who is participating in a company retirement plan such as a 401(k) plan, leaves the employer during the year in which they turn age 55 or older, distributions from the retirement plan are not subject to the additional 10 percent tax penalty.

The Separation from Service exception can help workers who have a USG Corporation-sponsored retirement account, such as a 401(k), and want to retire early or need to withdraw funds if they have lost their job towards the end of their career. It can be a lifeline for USG Corporation workers who require cash flow and have no other good alternatives.

Here’s how the Separation from Service exception works and whether you should consider using it.

What is the Separation from Service exception (55 Rule)?

The Separation from Service exception sometimes called “Rule of 55” or “55 Rule” is an IRS provision that allows workers who leave their job for any reason to start taking penalty-free distributions from their current employer’s retirement plan once they’ve reached age 55. It offers USG Corporation employees, who are interested in retiring earlier than the usual age or who need the funds, a way to take distributions from their retirement plans before the age of 59½.

Taking a distribution from a tax-qualified retirement plan, such as a 401(k), before the age of 59½ is generally subject to a 10 percent early withdrawal tax penalty. However, the IRS Separation from Service exception may permit you to receive a distribution after reaching age 55 (and before age 59½) without triggering the early penalty if your USG Corporation sponsored plan permits such distributions.

However, any distribution would still be subject to an income tax withholding rate of 20 percent. If it turns out that 20 percent is more than you owe based on your total taxable income, you’ll get a refund after filing your yearly tax return.

For example: In one Tax Court case, a taxpayer, whom we will call Nancy, left her job when she was 53 years old. Under the terms of her company plan, Nancy was eligible to take a distribution upon separation from service. The plan also allowed distributions to terminated employees, age 55 and above. Nancy declined to take the distribution when she left her job but elected to begin distributions once she turned 55. Undoubtedly, Nancy was under the mistaken impression that once she turned age 55, she was exempt from the 10% early withdrawal penalty.

The IRS disagreed and imposed the penalty since she was not age 55 when she was terminated from service. The Tax Court sided with the IRS and ruled that what matters is the age of the taxpayer when they separated from service, not when they took the distribution. Therefore, the 10% penalty was upheld.

The main difference between the separation of service exception and the age 59½ rule is that the separation of service exception only applies to qualified retirement plans and not IRA accounts.

In another court case, a taxpayer, Robert, left his job at age 55 and rolled over his balance from a qualified plan to his IRA. Robert then began taking distributions from the IRA. At trial, the Court sided with the IRS and held that the subsequent distribution did not fall under the Separation from service exception and was subject to the early withdrawal penalty. Therefore, if you leave a job after turning age 55 and need all, or a portion, of your retirement funds immediately, you should be careful about rolling over funds into an IRA. Once you roll over qualified plan assets into an IRA, the Rule of 55 exception is lost. Any subsequent distributions from the IRA before age 59½ will be subject to the 10% early withdrawal penalty unless another exception applies.

How to use the rule of 55 to retire early

Many companies have retirement plans that enable employees to take advantage of the Separation from Service exception, but USG Corporation may not offer the option.

401(k) and 403(b) plans are not required to provide for Separation from Service exception withdrawals, so you shouldn’t be surprised if your USG Corporation-sponsored plan doesn’t allow for this exception. Many companies see the rule as an incentive for employees to resign in order to get a penalty-free distribution, with the unintended consequence of prematurely depleting their retirement savings.

Here are the conditions that must be met and other things to consider before taking a Separation from Service exception withdrawal.

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Retirement plan offers. If the USG Corporation plan offers a 401(k) or 403(a) or (b), the Separation from Service exception withdrawals are allowed. Some plans prohibit withdrawals prior to age 59½ or even 62.

Age 55 or older. You leave your position (voluntarily or involuntarily) at USG Corporation in or after the year you turn 55 years old.

Money must remain in the plan. You fully understand that your funds must be kept in the USG Corporation plan before withdrawing them and you can only withdraw from the USG Corporation plan. If you roll them over to an IRA, you lose the rule of 55 tax protection.

Potential lost gains. You understand that taking early withdrawals means you will be giving up any gains you might have been able to make on your investments.

Reduce taxes. You can wait until the start of the next calendar year to begin rule of 55 withdrawals when your taxable income should be lower if you are not working.

Public safety worker. If you are a qualified public safety worker (police officer, firefighter, EMT, correctional officer or air traffic controller), you might be able to start five years early. Ensure that you have a qualified plan that allows withdrawals in or after the year you turn 50 years old.

However, as with any financial decision, be sure to check with a trusted advisor or tax professional first to avoid any unforeseen consequences.

Should you use the Separation from Service exception?

Whether or not to take early withdrawals under the Separation from Service exception will depend on your financial situation. You’ll want to know your plan’s rules, how much you’d need to withdraw, and what your annual expenses are likely to be in the early years of your early retirement after leaving USG Corporation. Solving those issues should help you know if taking an early withdrawal is the right decision for you.

Here are some situations where it’s likely that taking early withdrawals would not be the right move.

If it would push you to a higher tax bracket. The amount of your income for the year in which you begin the withdrawal plus the early withdrawal might put you into a higher marginal tax bracket.

If you’re required to take a lump sum. The USG Corporation plan may require a one time lump sum withdrawal and this may force you to take more money than you want and be subject to ordinary income tax liability. These funds will no longer be available as a source of tax advantaged retirement income.

If you’re younger than 55 years old. You might want to leave USG Corporation before you turn 55 and start taking withdrawals at age 55. Note this is NOT allowed and you will be assessed the 10 percent early withdrawal penalty.

Other important considerations

If you’re thinking of taking a Separation from Service exception withdrawal, you’ll also want to consider a few other things:

If you have funds in multiple former employer plans, the rule only applies to the plan of your current/most recent employer. If you have funds in multiple plans that you want to access using the Separation from Service exception, be sure to roll over those funds into your USG Corporation plan (if it accepts rollovers) BEFORE you leave the company.

Funds from IRA plans that you might want to access early can also be rolled into your current plan (while still employed) and accessed that way.

If you so choose, you can continue to make withdrawals from your former employer’s plan even if you get another job before turning age 59½.

Be sure to time your withdrawals carefully to create a strategy that makes sense for your financial situation. Withdrawing from a taxable retirement account during a low-income year could save you in taxes, particularly if you believe your tax rate may be higher in the future.

Bear in mind that the only real advantage of the Separation from Service exception is avoiding the 10 percent penalty. Meanwhile, the tax deferral is sacrificed, which may turn out to be more valuable if other financial resources that are not tax-qualified can cover expenses for the coming years and you are able to save the 401(k)/403(b) distribution until later years.

Other Exceptions

You may be able to access the funds in your retirement plan with USG Corporation without a tax penalty in a few other ways, depending on your circumstances.

There is an exception called the 72(t) option which allows withdrawals from your 401(k) or IRA at any age without any penalty. This option is called SEPP (Substantially Equal Periodic Payments), and these payments are not subject to the 10 percent early withdrawal penalty. Once these distributions begin, they must continue for a period of five years or until you reach age 59½, whichever comes later. 72(t) payments have suddenly become a better deal for IRA owners and company plan participants.

Also known as “substantially equal periodic payments,” 72(t) payments are advantageous because they are exempt from the 10% early distribution penalty that usually applies to withdrawals before age 59½. You can take them from an IRA at any time, but only from a workplace plan after leaving USG Corporation.

There are several downsides to 72(t) payments.

First, they must remain in place for at least 5 years or until age 59½, whichever comes later. This means a 45-year old IRA owner must maintain her payments for almost 15 years.

Second, if the payments are modified before the end of the 5-year/age 59½ duration, you are subject to a 10% penalty (plus interest) on all payments made before 59½. Modification will normally occur if you change the payment schedule (e.g., stop payments), change the balance of the account from which payments are being made (e.g., a rollover to the account), or change the method used to calculate the payment schedule (except for a one-time switch to the RMD method – see below).

There are three(3) acceptable ways to calculate 72(t) payments:

The required minimum distribution (RMD) method. Payments are calculated like lifetime RMDs. Therefore, they fluctuate each year. The RMD method normally produces the smallest payout among the three methods. Once you use the RMD method, you can’t switch out of it.

The fixed amortization method. Payments are calculated like fixed mortgage payments. After using this method for at least one year, you can switch to the RMD method without penalty.

The fixed annuitization method. Payments are calculated by dividing the account balance by an annuity factor. Like the amortization method, they remain fixed, and you can switch to the RMD method after the first year.

However, on January 18, the IRS released Notice 2022-6, which said that 72(t) payment schedules starting in 2022 or later can use an interest rate as high as 5%. (And, if 120% of the Federal mid-term rate rises above 5%, you can use a rate as high as the 120% rate.) This is still the updated rate in 2024. This is great news because the higher the interest rate, the higher the payments will be. This change allows you to squeeze higher payments out of the same IRA balance. (Note that you can’t change interest rates for a series of 72(t) payments already in place.)

Other circumstances that exempt you from the early withdrawal penalty include:

1. Total and permanent disability

2. Distributions made due to qualified disasters

3. Certain distributions to qualified reservists on active duty

4. Medical expenses exceeding 10 percent of adjusted gross income

5. Withdrawals made to satisfy IRS obligations

But the IRS offers other exceptions to the early withdrawal penalty.

Bottom line

If you can wait until you turn 59½, withdrawals after that age are not typically subject to the 10 percent IRS tax penalty. However, if you are in a financially safe position to retire early, the Separation from Service exception may be an appropriate course of action for you.

Sources:

1. Brenner, Sarah. '5 Things You Must Know about the Age-55 Rule.' Ed Slott and Company, LLC , 23 June 2021, irahelp.com.

2. 'Understanding the Age 55 Exception to the 10% Early Withdrawal Penalty.' The Money Know How , themoneyknowhow.com.

3. 'Retiring Early? 5 Key Points about the Rule of 55.' Charles Schwab , 12 March 2024, schwab.com.

4. 'Retirement Plan: Separation from Service Rule & Tax Penalty.' Cherry Bekaert , cbh.com.

5. Liang, Eddie. 'Retirement Planning Between Ages 55 & 59.5: The Rule of 55.' Downshift Financial , 21 September 2021, downshiftfinancial.com.

How does the retirement plan structure at USG Corporation impact both final average earnings participants and cash balance participants, especially regarding their eligibility and benefits accrued over time? In what ways does the differentiation between these two categories influence the retirement outcomes for employees of USG Corporation?

Retirement Plan Structure: USG Corporation's retirement plan differentiates between Final Average Earnings Participants and Cash Balance Participants. Final Average Earnings participants, who joined before January 1, 2011, accrue benefits based on their final average earnings and years of service, which can result in higher benefits for longer-serving employees. Cash Balance participants, who joined after January 1, 2011, have their benefits calculated based on a cash balance account, which grows with contributions and interest credits. These differences affect retirement outcomes, as Final Average Earnings participants may see higher pension payments if they have longer service or higher wages, while Cash Balance participants have more predictable but potentially lower benefits based on their account balance(USG Corporation_Retirem…).

USG Corporation's Retirement Plan allows for different age-specific rules regarding early retirement. How do the "Rule of 90" and "Rule of 82" affect the financial planning of employees considering an early retirement option, and what should they consider regarding their long-term financial security?

Rule of 90 and Rule of 82: The "Rule of 90" allows employees to retire early without a reduction in benefits if their age plus years of service total 90, provided they retire at or after age 62. The "Rule of 82" permits early retirement with reduced benefits for those whose age and years of service total 82. Employees planning early retirement must consider these rules as they directly affect the amount of benefits they receive, making it important to assess how long-term financial security will be impacted, especially if they retire before age 62(USG Corporation_Retirem…).

Could you elaborate on the process through which employees at USG Corporation can change their beneficiaries within the retirement plan? What steps need to be taken, and what are the implications of these changes on the benefits received upon the participant's death?

Changing Beneficiaries: To change beneficiaries, USG Corporation employees must contact Your Benefits Resources™, where they can designate a primary and contingent beneficiary. If married, the spouse must provide notarized consent to name a different primary beneficiary. The process involves completing a form, and any changes affect who receives benefits upon the participant's death. Failing to update the beneficiary could result in benefits being paid to unintended individuals(USG Corporation_Retirem…).

As part of the retirement process at USG Corporation, how are pensionable earnings calculated? What factors are included in this determination, and how might they vary among different employees based on their roles within the organization?

Pensionable Earnings Calculation: Pensionable earnings at USG Corporation include regular pay, shift differentials, and bonuses but exclude items like nonqualified deferred compensation, severance, and stock awards. These earnings are used to calculate benefits based on formulas that take into account an employee’s service years and earnings over the 36 highest consecutive months of the last 15 years of participation(USG Corporation_Retirem…).

How does the automatic enrollment in the USG Corporation Retirement Plan work, and what options do employees have if they initially chose not to participate? What implications might this have for their retirement savings strategy?

Automatic Enrollment and Opting In: Employees at USG Corporation are automatically enrolled in the retirement plan unless they choose to opt out. If employees decide not to participate initially, they can enroll later by contacting Your Benefits Resources™. Failure to participate from the start could result in lower retirement savings due to fewer years of contributions(USG Corporation_Retirem…).

In the context of USG Corporation, what are the potential tax consequences for employees withdrawing their retirement benefits, especially regarding the mandatory withholdings? How might employees effectively manage these tax liabilities when planning for retirement?

Tax Consequences of Withdrawals: Employees withdrawing their retirement benefits from USG Corporation will face mandatory federal income tax withholdings, typically 20% for lump sum distributions, unless the distribution is rolled over into an IRA. Employees must plan for these taxes when withdrawing to avoid unexpected liabilities and ensure they maximize their after-tax retirement income(USG Corporation_Retirem…).

How do employees at USG Corporation access the necessary documents related to their retirement benefits, and what is the process for obtaining copies of these documents if needed? What are the responsibilities of the Plan Administrator in this process?

Accessing Retirement Documents: Employees can access documents related to their retirement benefits through Your Benefits Resources™ online or via phone. If additional copies are needed, employees can request them from the Plan Administrator for a small fee. The Plan Administrator oversees ensuring these documents are provided to participants as required by ERISA(USG Corporation_Retirem…).

What unique provisions exist for USG Corporation employees who experience a break in service? How do these provisions impact their accumulated benefit service and overall benefits upon reemployment?

Break in Service Provisions: USG Corporation allows employees who experience a break in service to retain their accumulated benefits if they are reemployed within one year. If reemployed after one year, their previous service may not count toward future benefits unless they were vested prior to termination. This can affect the total benefits an employee accrues if they leave and later return(USG Corporation_Retirem…).

What options do employees of USG Corporation have for managing their benefits if they return to work after retirement? How does this affect their pension benefits and the overall strategy for maximizing retirement income?

Returning to Work After Retirement: Employees returning to work after retirement at USG Corporation will have their pension payments suspended and recalculated based on additional years of service. This recalculation takes into account prior payments, meaning employees should consider the impact of returning to work on their long-term pension strategy(USG Corporation_Retirem…)(USG Corporation_Retirem…).

How can employees of USG Corporation contact their Benefits Resourcesâ„¢ for more information on their retirement plan options? Are there specific channels preferred for different types of inquiries, and what resources are available to assist them?

Contacting Benefits Resources™: Employees can contact Your Benefits Resources™ via the web or a toll-free number to inquire about retirement plan options. Different inquiries, such as changes to beneficiaries or requesting benefit estimates, can be handled through these channels. Resources such as detailed benefit estimates are available to help employees plan for retirement(USG Corporation_Retirem…).