By Paul Zorn, Director of Governmental Research Gabriel, Roeder, Smith & Company
Gabriel, Roeder, Smith & Company is a leading actuarial and benefits consulting firm that specializes in services to the public sector. It is headquartered in Southfield, Michigan, and has over 600 clients nationwide.
The author is not an attorney and the information provided is not legal or tax advice. While this article summarizes certain tax provisions, it is not intended to provide a complete description. Taxpayers should seek tax advice based on their individual circumstances from an independent tax advisor.
Recent changes to the Internal Revenue Code (IRC) resulting from the 2006 Pension Protection Act provide public safety employees with new tax advantages, including (1) waiver of the 10% early distribution penalty for public safety employees age 50 and older; and (2) tax-free distributions (up to $3,000 annually) for health insurance premiums of retired public safety officers. These provisions are described below:
Waiver of the 10% Early Distribution Penalty for Public Safety Employees Age 50 and Older
Section 828 of the Pension Protection Act waives the 10% penalty for early distributions made to “qualified public safety employees” who separate from service after attaining age 50 (instead of age 55, as was the case prior to the Act). This provision applies to distributions made after the Act’s date of enactment (August 17, 2006). As explained in IRS Notice 2007-7:
- “Qualified public safety employee” means an employee of a State or political subdivision (e.g., city, county, etc.) whose “principle duties include services requiring specialized training” in the area of police protection, firefighting services, or emergency medical services for any area within the jurisdiction of the State or political subdivision.
- To be eligible for the exemption, the qualified public safety employee must have received the distribution from a governmental defined benefit plan after separating from service with the employer maintaining the plan, and the separation from service must have occurred during or after the calendar year in which the qualified public safety employee attained age 50. Consequently, a qualified public safety employee who separates from service on June 30, 2006, and attained age 50 on December 12, 2006, would be eligible for the exception.
- The exception applies only to amounts distributed from a governmental defined benefit plan and does not apply to distributions from a defined contribution plan or an individual retirement plan.
- In reporting such distributions to the IRS, the entity paying the distribution is permitted to use code 2 (early distribution, exception applies) in Box 7 of Form 1099-R. Alternatively, the entity may use code 1 (early distribution, no known exception), if the entity does not know whether the exception applies.
Tax-Free Distributions for Health Insurance Premiums of Retired Public Safety Officers
Section 845 of the Pension Protection Act allows “eligible retired public safety officers” to elect to exclude up to $3,000 annually from gross income for certain distributions made from an “eligible government plan” to pay “qualified health insurance premiums.” Eligible government plans include state and local government defined benefit and defined contribution plans qualified under IRC 401(a), tax-sheltered accounts or annuities under IRC 403(a) and 403(b), and governmental deferred compensation plans under IRC 457(b). Qualified health insurance premiums include premiums for accident and health insurance or long-term care insurance contracts for the eligible retired public safety officer, his or her spouse, and dependents. The exclusion is limited to the aggregate amount of actual annual premiums paid, up to $3,000, and the premiums must be paid directly by the retirement plan to the insurance provider. This provision applies to distributions in taxable years beginning after December 31, 2006. Notice 2007-7 explains:
For the purpose of this provision, the definition of “public safety officer” includes a broad range of individuals serving federal, state, local and other public agencies as officially recognized law enforcement officers (e.g., police, corrections, probation, parole, and judicial officers), firefighters (e.g., paid and volunteer), rescue squad members, and ambulance crews, among others. Note, however, that the exclusion is limited to “eligible retired public safety officers” who separate from service due to “disability or attainment of normal retirement age.” Therefore, individuals retiring before normal retirement age would not be eligible.
- The favorable tax treatment is available only when an eligible retired safety officer elects to have an amount subtracted from his or her distributions from an eligible government plan and such amount is used to pay qualified health insurance premiums. However, an employer sponsoring the qualified retirement plan is not required to offer such an election.
- Although the IRS had originally ruled that the accident or health insurance plan receiving the payments could not be a self-insured plan, it has since agreed to interpret the provision to include self-insured plans. [See IRS Notice 2007-99]
- Benefits attributable to service other than as a public safety officer are eligible for favorable tax treatment under this provision, but only if the individual satisfies the definition of eligible retired public safety officer.
- Upon the death of the eligible retired public safety officer, the tax-exclusion would not extend to amounts subtracted from distributions for other distributees (i.e., the officer’s spouse and dependents).