Millicent left the system before retirement. When she left, Millicent was not eligible for any pension but received a lump sum payment of $7,200, reflecting $6,000 in contributions to the fund, and $1,200 in accrued interest. She immediately placed this amount in an IRA to which she made no further contributions. Millicent has now begun receiving distributions from her IRA.
ISSUE: What are the Massachusetts tax consequences of the pre-retirement distribution Millicent rolled over into her IRA?
DISCUSSION: Under G.L. c. 62, § 2(a)(2)(E), income from a contributory retirement plan to which the employee has contributed is returned to the employee tax free. An employee who leaves the system before retirement may receive a lump sum payment consisting of his or her contributions plus accrued interest without incurring liability for income taxes on any part of the lump sum. See DOR-D 86-25.
When a pre-retirement distribution from a state contributory retirement fund is rolled over into an IRA, no taxable event occurs. When the distributions take place from the IRA, the Department will consider the entire amount of the original lump sum distribution as income from the contributory retirement fund exempt under G.L. c. 62, § 2(a)(2)(E). Thus Millicent may recover her entire contribution to the IRA - $7,200 - before her distributions will be taxed.
NOTE: Because the tax treatment of distributions from an IRA is different at the state and federal levels, a taxpayer should carefully maintain all records regarding the tax exempt nature of any distribution.
DIRECTIVE: Millicent's IRA distributions will be tax-exempt for Massachusetts tax purposes until she has recovered the entire amount of the pre-retirement distribution from the state retirement fund rolled over into her IRA. Once the aggregate of her distributions exceeds $7,200, all amounts Millicent receives from her IRA are fully taxable.
REFERENCE: G.L. c. 62, § 2(a)(2)(E); DOR-D 86-25.
/s/Stephen W. Kidder
Stephen W. Kidder
Commissioner of Revenue
15 June 1989