BILL ANALYSIS �
AB 558
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Date of Hearing: May 16, 2011
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 558 (Portantino) - As Introduced: February 16, 2011
VOTE ONLY
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Taxation: retirement plans: early distribution
penalties.
SUMMARY : Temporarily waives the 2 % penalty otherwise imposed
on early distributions from 401(k) plans, provided that the
distributions are received by individuals who are ineligible for
unemployment benefits. Specifically, this bill :
1)Provides that the 2 % penalty does not apply to an early
distribution from a qualified pension, profit-sharing, or
stock bonus plan, within the meaning of Internal Revenue Code
(IRC) Section 401(k) �a 401(k) plan] if received by an
individual who has either exhausted his/her unemployment
benefits or is ineligible for unemployment benefits.
2)Limits the amount of qualifying distribution to $25,000 per
taxable year.
3)Applies to distributions made in taxable years beginning on or
after January 1, 2011, and before January 1, 2013.
4)Takes effect immediately as a tax levy.
EXISTING LAW :
1)Provides that federal changes to Part I of Subchapter D of
Chapter 1 of IRC Sections 401 through 420, inclusive, relating
to pension, profit-sharing, stock bonus plans, other employee
benefit plans, and IRC Section 457, relating to deferred
compensation plans of state and local governments and
tax-exempt organizations, automatically apply without regard
to taxable years to the same extent as applicable for federal
income tax purposes. All federal changes made to those IRC
sections are automatically adopted by California without
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regard to the specified date.
2)Provides that a distribution from a 401(k) plan, a qualified
annuity plan under IRC Section 403(a), a tax-sheltered annuity
under IRC Section 403(b), an eligible deferred compensation
plan under IRC Section 457, or an individual retirement
arrangement (IRA) under IRC Section 408 is included in income
for the year distributed.
3)Imposes a penalty equal to 2 % of the amount includible in
income on early withdrawals from those plans, unless an
exemption applies, in conformity with the federal tax law.
For simple retirement plans under IRC Section 408(p), the
"early withdrawal" tax is set at 6% of any amount includible
in income, instead of the federal rate of 25%.
FISCAL EFFECT : The Franchise Tax Board (FTB) staff estimates
that this bill will result in an annual General Fund (GF) loss
of $18 million in fiscal year (FY) 2011-12 and $4.7 million in
FY 2012-13.
COMMENTS :
1)Author's Statement . The author states that, "As more
Californians exhaust their unemployment benefits, many turn to
savings and retirement accounts to make ends meet. While in a
difficult financial situation, the State charges these
individuals a 2.5% "early withdrawal penalty" to access their
retirement funds before they have officially retired.
"By affording an exemption to this penalty, we will make life a
little less difficult for individuals who have been unemployed
for almost two years.
"Additionally, the exempted funds are limited to the first
$25,000 withdrawn, which is roughly the maximum annual amount
an individual would receive in unemployment payments, or,
slightly more than $480 per week."
2)Arguments in Support . The proponents of this bill state that,
"California's unemployment rate continues to hover above 12%"
and 330,000 individuals had exhausted their full 99 weeks of
unemployment benefits as of February 7, 2011. The proponents
argue that "AB 558 would help ease the financial pressure by
allowing individuals that are not eligible for unemployment
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insurance benefits, or have exhausted their unemployment
benefits, to take a distribution of up to $25,000 per taxable
year from a qualified retirement plan," which is "roughly
equivalent to the maximum annual benefit available through
unemployment insurance."
3)The "Early Withdrawal" Penalty. Congress has authorized
several kinds of retirement savings plans that qualify for
reduced or deferred income taxes to encourage workers to save
for retirement. A qualified retirement plan, such as a 401(k)
plan, allows a worker to save for retirement by investing a
portion of his/her wages while deferring current income taxes
on the original investment and earnings until withdrawal. All
401(k) contributions are invested on a pre-tax basis and not
taxed until the money is withdrawn. With the enactment of the
Roth provisions, participants in 401(k) plans may elect to
deposit some or all of their wages in a designated brokerage
account, commonly known as a Roth 401(k). Qualified
distributions from a designated Roth account are tax free,
while contributions are made on an after-tax basis (i.e.,
income tax is paid or withheld on the contributions in the
year contributed).
Existing federal tax law imposes a 10% withdrawal penalty on
early distributions made from a qualified retirement or
annuity plan, a 403(b) annuity, or an IRA to a taxpayer under
the age of 59 , unless an exception applies. California
imposes a similar penalty but at the rate of
2 % of the amount includible in income on early withdrawals
from those plans. However, recognizing that some significant
events might require people to withdraw money from their
retirement accounts earlier than expected, Congress has
provided for a waiver of the early withdrawal penalty in some
situations, to which California has conformed. An exception
applies to distributions that are (a) used for the health
insurance premiums of an unemployed individual; (b) used for
medical expenses; (c) made to a beneficiary (or to the estate
of the employee) on or after the date of the employee's death;
(d) made to an employee who separates from service at age 55
or older; (e) made to individuals called to active duty; or
(f) used for first-time home purchases. In the case of a
distribution from a simple retirement account under IRC
Section 408(p), the early withdrawal penalty is 25% of any
amount includible in income under federal law and 6% under
California tax law.
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4)Should the Penalty Be Waived? In the aftermath of the 2008
financial crisis, many Californians are struggling to find
work. As of May 3, 2011, over 409,000 individuals in the
state have exhausted their full 99-week unemployment insurance
benefits. The federal legislation enacted on December 17,
2010, was of no help to them as it had not included any
additional weeks of extended benefits. Many of those
unemployed individuals have to rely on savings, credit cards,
and potentially, various social services programs to pay for
basic necessities. One of the savings vehicles utilized by
many workers is a 401(k) plan or an IRA. However, the few who
had managed to save for retirement are unable to access their
retirement funds without paying the heavy penalty under both
federal and state tax laws. As discussed, any non-qualified
pre-retirement withdrawal from a 401(k) plan is subject to a
penalty of 10% at the federal level and 2 % at the state
level, which is levied in addition to any other applicable
income taxes. An early distribution to unemployed individuals
is not a qualifying hardship distribution, and as such, is
subject to the "early withdrawal" penalty.
This bill seeks to expand the universe of qualifying hardship
distributions to include early distributions to an unemployed
individual who has exhausted his/her unemployment benefits,
thus, providing relief to the individual from the 2 % penalty
on the first $25,000 distributed from a 401(k) plan. In doing
so, however, it would take California out of conformity with
the federal tax law. During his presidential campaign,
President Obama suggested a broad temporary suspension of the
penalty on early withdrawals on distributions from IRAs or
401(k) plans, up to a $10,000 limit, for two years - 2008 and
2009. However, the proposal never became law; but it did
highlight the problem that many families were "being forced to
make painful choices like selling their homes or not sending
their kids to college."<1> (President Obama's Speech in in
Toledo, Ohio where he released his "Rescue Plan for the Middle
Class," a seven-page document that included the proposal). It
---------------------------
<1> In response to the steep decline in stock prices in 2008,
which substantially reduced the value of many retirees'
retirement accounts, Congress passed H.R. 7327, signed by then
President Bush, suspending the required minimum distributions
for the 2009 tax year for taxpayers who were 70 or older. It
did not, however, help people who wanted to take funds out of
their retirement accounts.
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is unclear how many individuals would decide to take advantage
of the exception created by AB 558, given that they will still
be subject to the 10% federal penalty, in addition to the
regular federal and state income taxes.
5)Proposed Amendments . In order to resolve the concerns
identified by the FTB staff and the Committee staff, the
author proposed the following amendments at the Committee
hearing on May 9, 2011. Specifically, the amendments would do
all of the following:
a) Provide a waiver of penalty for early distributions from
all qualified annuity plans and retirement arrangements,
including a qualified annuity plan under IRC Section
403(a), a tax-sheltered annuity under IRC Section 403(b),
an eligible deferred compensation plan under IRC Section
457, and an IRA under IRC Section 408.
b) Clarify that the proposed waiver of the "early
withdrawal" penalty would apply to an individual who has
exhausted his/her unemployment benefits. This bill is not
intended to apply to any individual who is ineligible for
unemployment benefits because, as an example, he/she is
employed full time.
c) Specify that the waiver would apply to the first $25,000
distributed to a qualified individual.
d) Include a technical amendment to strike out "on" after
"operative" on page 4, line 18 and insert "for taxable
years beginning on or after".
6)Related Legislation .
AB 726 (Morrell), introduced in this legislative session, would
waive the 2 % tax penalty for early 401(k) distributions if
the entire amount is paid into a health savings account (HSA)
within 60 days. AB 726 is currently pending in this
Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
California Faculty Association
AB 558
Page F
Opposition
None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098