72t – Make changes or leave as is?
We assisted client in initiating a 72t series of equal periodic payments in January of 2008. Client birth year is 1952. Amortization method was selected using single life expectancy of 28.7 and an interest rate of 4.97% (120% of the December 07 annual mid-term AFR) and an account balance of $1.5MM. The calculated annual payment of $99,209.34 was divided by 12 to reach $8,267.44 and withdrawals of that amount have been scheduled for the beginning of each month starting 01/01/08. These calculations were made in mid-December of 2007 in order to get the SEPP established on 01/01/08, based on the expectation that the account balance would remain above $1.5MM, or that it would be a trivial matter to modify the payment stream in early 2008 to correct for the difference. At the end of December the balance was $1.495MM, which if used as the beginning account balance for the scheduled payment yields an interest rate in excess of 4.97%.
Additional Background:
The account was fully funded on 12/14/07 and had a value on that date of $1,488,217. Most of the remaining days in December, the account balance was below $1.5MM, with the exception of 12/24, when the balance was $1,506,968, and 12/26 when the balance was $1,507,128.
As it stands now, the monthly payments (beginning of the month) of $8,267.44, the year end balance of $1,495,197, and the single life expectancy of 28.7 yields, by my calculation, an annualized monthly interest rate of 5.13%, which is less than 120% of the November 07 mid-term AFR, on a monthly( 5.15%) or annual (5.28%) basis. (Alternatively, using the 12/26 balance, the payment and life expectancy would reduce to an annualized monthly interest rate of 5.06%.) It seems to me, based on this calculation, and based on my limited familiarity with these matters, that the payment stream is within limits and no change to the payments need be (or ought to be) made.
Client now wishes to modify the monthly payment to use the actual 12/31/07 balance ($1,495,197.48 per the custodian’s statement), 120% of the December mid-term annual rate (4.97%), and the same single life expectancy (28.7). The modification would consist of a one-time true-up monthly payment and then a permanent change to an ongoing monthly payment of $8,241.00. At year end 2008 the total of monthly payments would be $98,982.00, and that would be the annual total of monthly payments for the remainder of the SEPP period.
Questions:
1) Will the payment series as it stands pass muster?
2) If not, what is the “best” way to bring the series into compliance?
3) If so, is there any downside at all to “tidying up” the payments as is desired by the client? (e.g. Should we ask for permission via a PLR?)
4) a) If the payments are monthly, must the monthly AFR be used as the upper limit? If so, is there any published authority for that requirement?
b) Should the calculation be adjusted for beginning of the period vs end of the period?
c) Is there an exotic formula that should be used to convert from monthly to annual or are the 12 X monthly or annual / 12 methods ok? (It appears to me that the compounding effects are embedded in the different rates themselves and as a consequence, the rates can be used “straight up” rather than being again adjusted.)
We (the client and the advisor) have no prior experience in these SEPP arrangements. We have extensively searched for local CPA’s or Attorneys who are knowledgeable in these matters and who take these issues seriously to assist us with the SEPP, but have found none. This is indeed the “Bermuda Triangle” of IRA distributions.
Permalink Submitted by Bruce Steiner on Wed, 2008-02-27 23:14
I wrote an article on this for the January 2000 issue of Estate Planning: http://www.kkwc.com/docs/AR20041012155030.pdf
Permalink Submitted by Alan Spross on Thu, 2008-02-28 01:01
1) Yes, it passes as is. There is really alot of flexibility that can be applied to the first year to make changes in the account balance and interest rate used in order to “back in” to what the client wants. There is nothing in the rules that ties anyone to their original intent, but once the modifications to the original assumptions are finalized, they should be well documented in order to prepare for any IRS inquiry many years down the road.
2) N/A
3) No downside at all as long the math is correct and no disallowed assumptions are included in the numbers applied. For example, for a January start up any rate less than the higher of the Nov or Dec rates can be used. You can use a reverse calculator to be sure the rate complies. The account balance is any account balance that can be documented by a statement or daily account print out that represents the FMV of the account on any day prior to the date the payment was ordered, but definitely not older than 6 months, and preferably within 3 months. If the actual sepp IRA account was established by rollover or transfer, the balance must be from that specific account, and no contributions or distributions can be made to the account balance selected after that date of the account balance other than actual SEPP distributions starting with the inception month. No need for a PLR here, as there is plenty of flexibility to calculate a rate and still use a 12/31 balance if that is what the client desires. Be sure the age used is as of his birthday in 2008, not 2007. I did not review all your figures for accuracy.
4) On these issues, I would rely on the following post made by the sponsor of the 72tonthenet website:
“Actually Rev. Rul. 2002-62 doesn”t say that you have to used the monthly rate or the annual rate.
If you are using a formula for calculating a true monthly distribution, then you should indeed use the monthly rate which is simply the annual rate adjusted for a montly payout.
However, the IRS in a variety of PLRs has also said that it is Ok to do an annual calculation and divide the annual payment by 12 which is the way that we present the information on this site.”
Seems to leave full flexibility based on lack of guidance and lack of action by the IRS……………
From your post, you are probably more conversant with SEPPs than 95% of your cohorts already. The largest exposure for a client like this is executory failures after the plan is rolling, so you need to be sure he understands not to do anything without checking with you first. Also, the monthly distributions should be set up for early in the month, so the vital annual total can be corrected in December after the 12th distribution and well before the year end chaos.