72q calc question

Submitted by Toby Hartley on Mon, 2014-02-10 17:19

300K with 100K of gains. Client wants to annuitize for a 10 year period certain and the current age is 54. Its enough gain to make it an issue. If the current carrier will not nor does not admin 72t/q’s, the distributions will be reported as pre 59 1/2. What to do? Obviously the taxable portion will be 1/3 of the total monthly payment plus the little amount of interest they apply to the annuitization. Can this be done without pre 59 1/2 penalty?



Submitted by Jose Morales on Mon, 2014-02-10 17:54

If for some reason the custodian will not code the distribution as “Early Distribution, Exception Applies” you can still complete Form 5329 to properly report the distribution as one for which the 10% premature distribution penalty applies.  The instructions for Form 5329 are here:  http://www.irs.gov/pub/irs-pdf/i5329.pdf

Submitted by Toby Hartley on Mon, 2014-02-10 18:01

Thanks, so then the exception would apply then?  I was concerned that the payments being completely distributed in 10 years would have it producing more than the 72 calc would allow.

Submitted by Alan - IRA critic on Mon, 2014-02-10 19:10

There are two penalty exceptions in 72q. The first is the same as a 72t plan and operates the same way. However, there is also an “immediate annuity” exception that appears to allow something like a 10 year period certain plan that would obviously produce a much higher annual distribution than a 72t plan. This annuity exception does not state that distributions must occur over the life expectancy of the owner. Further, it may allow for pro rating of the gains into each distribution. I would discuss this with the insurer and verify if the 1099R will show pro rated gains and also the distribution exception code 2 on the 1099R. But if they will not client can attach a 5329 to claim it.

Submitted by Toby Hartley on Wed, 2014-02-12 19:08

Alan,I contacted the carrier and they stated that they do admin 72t but do not admin or code the distributions for 72q.  The client is 54, 224K cost basis with current value of the NQ annuity of 306K.  I read the form 5328 as well as some FAQs on 72q and I can’t find sufficient info that states a 10 year period certain SPIA would be exempt.  I find the life exp payouts of course, but not the 10 year.  Can you point me in the right direction to something I can read and show the client it would be exempt and how to note that on the 5398 since its not one of the exemptions listed.  Thanks…..

Submitted by Alan - IRA critic on Wed, 2014-02-12 20:52

See exceptions D and I in the following portion of 72q, and click on the 72u link to see the definition of immediate annuity:

(q)   10-percent penalty for premature distributions from annuity contracts

(1)   Imposition of penalty If any taxpayer receives any amount under an annuity contract, the taxpayer’s tax under this chapter for the taxable year in which such amount is received shall be increased by an amount equal to 10 percent of the portion of such amount which is includible in gross income.

(2)   Subsection not to apply to certain distributions Paragraph 1 shall not apply to any distribution –

(A)   made on or after the date on which the taxpayer attains age 59 1/2 ,

(B)   made on or after the death of the holder (or, where the holder is not an individual, the death of the primary annuitant (as defined in subsection (s)(6)(B))),

(C)   attributable to the taxpayer’s becoming disabled within the meaning of subsection (m)(7),

(D)   which is a part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the taxpayer or the joint lives (or joint life expectancies) of such taxpayer and his designated beneficiary,

(E)   from a plan, contract, account, trust, or annuity described in subsection (e)(5)(D),

(F)   allocable to investment in the contract before August 14, 1982, or3

(G)   under a qualified funding asset (within the meaning of section 130(d), but without regard to whether there is a qualified assignment),

(H)   to which subsection (t) applies (without regard to paragraph (2) thereof),

(I)   under an immediate annuity contract (within the meaning of section 72(u)(4)), or

(J)   which is purchased by an employer upon the termination of a plan described in section 401(a) or 403(a) and which is held by the employer until such time as the employee separates from service.

Submitted by Toby Hartley on Wed, 2014-02-12 21:45

Thank you but I must be missing something. “U” states that it must be for the life expectancy, which a 10 year certain only SPIA is not.  72(u)(4)) states that it must start within a year and be periodic and be periodic.  If you are saying that under that definition a 10 year would work, then wouldn’t a 5 year as well?  Im hung up on I can find where life expectancy is not required.   The SPIA this client is looking to purchase will only pay until age 64 and then its exhausted.  Sorry, just not sure I am on board here.

Submitted by Alan - IRA critic on Wed, 2014-02-12 22:53

  • Where are you seeing anything about life expectancy in 72u(4)? An immediate annuity is an annuity for which annual distributions start within a year for the period of the annuity. The annuity period can be be any length of time greater than one year. It is only the SEPP exception 72q(2)(D) which requires the payments to be based on life expectancy.  The immediate annuity exception is a different exception only available for non qualified annuities. Also see Pub 575, p 34. There is no special exception code for Form 5329 if insuror issues Code 1 on 1099R, Client would have to use Code 12 “other” and indicate “immediate annuity” on Form 5329 if insuror does not provide Code 2.
  • A new problem starting this year – NQ annuity distributions are subject to the net investment income tax for those with incomes that reach that threshold.
  • Even if the current carrier will not issue the exception code for a SEPP because of the complexities, ask them if they will issue code 2 for the immediate annuity exception.

 

Submitted by Toby Hartley on Wed, 2014-02-12 23:19

See that’s my issue.  When I read 575 and 72(u)(4)), I read that as Immediate annuities purchased with cash.  Not a deferred product that has 80K in gains.  Yes, they are buying a SPIA, but those gains are being returned to the client over 10 years and quicker than if a normal 72t.  For example, the 80K(not counting the 200 of CB) will produce 711 per month for the 10 years.  If I run a generic 72 calc with a 54 yr old and 80K it allows for only about 294 a month.   I spoke to a couple carrier officers today and they said they don’t feel comfortable coding it 2 when the payments are not listed as life expectancy.  So, if the client goes ahead with this I want to be able to at least say were they can show these payments of 711 monthly at age 54-60 are exempt from pre-59 1/2 penalties.    I do know that the cash portion of 200 and the interest it pays over the 10 years is exempt because it never received deferral.   Sorry if I am driving you nuts.  Hopefully that explains my issue a bit better.

Submitted by Alan - IRA critic on Thu, 2014-02-13 00:14

  • Is the carrier going to spin off the annuitized portion into another account before starting payments? Annuitized payouts are taxable as periodic payments and generally each payment consists of part gains and part principal rather than gains out first. Therefore, in order to determine the taxable amount of the annuitized payments (and therefore the amount subject to penalty), it needs to be determined how much of the principal and how much of the gains are being annuitized. Perhaps it is pro rated, but even if pro rated, some of those annuity payments will be return of principal. Hopefully the carrier can quote this figure even if they are unwilling to recognize the penalty exception for an immediate annuity.
  • This article discusses both the taxable amount of an immediate annuity and the 10% penalty on that amount. Again, the immediate annuity exception is listed and is totally unrelated to SEPP payments based on life expectancy.  http://www.immediateannuities.com/taxation-of-annuities/

 

Submitted by Toby Hartley on Thu, 2014-02-13 00:23

Here are the figures:  306,000 SPIA with 224,000 in CB will produce a monthly payment for 120 months of 2,722.11 with 68.8% exclusion ratio.  That means $855.44 of each payment is taxable.   So about $750 of the taxable portion is from gains already in the contract and another 100+ of new interest based on the SPIA itsself on the total 306K.  If its was cash, then sure that 100+ a month of taxable would be coded 2.  Im conserned about the other 750 or so.  Am i making sense? 

Submitted by Toby Hartley on Thu, 2014-02-13 00:26

Ok look here.  On the link you just posted above, 1/3 down the page its states:Note: An exchange from a deferred to an immediate annuity does not qualify as an immediate annuity for the purposes of avoiding tax penalty.That is my concern right there.  That is how I understood it.  Let me know if I am missing anything

Submitted by Alan - IRA critic on Thu, 2014-02-13 01:48

Agree. The exchange from the deferred annuity would eliminate the immediate annuity penalty exception that would be available had client purchased a new immediate annuity. This appears to be conform to Pub 575, p 20 “Date of Purchase of Contract”. The rationale here is that since the original deferred annuity was apparently purchased more than one year ago, then the immediate annuity would also be deemed to be purchased at that time, and periodic payments would not begin within the one year time limit. Don’t suppose the carrier has another way of doing this rather than through a tax free exchange. Problem is despite the fact that this is their only business they are not issuing clear explanations with respect to what the client wishes to do. We have had to try to ferret it out here. If client goes back to the SEPP approach, the penalty could be waived but I assume he will not be getting a sufficient distribution at 13-14k per year, with gains out first and no exclusion ratio.

Submitted by Toby Hartley on Thu, 2014-02-13 17:44

Yeah, agreed.  So my concerns were justified.  Tax facts says it this way when defining the “immediate annuity” exemption: Where a deferred annuity contract was exchanged for an immediate annuity contract, the purchase date of the new contract for purposes of the 10 percent penalty tax was considered to be the date upon which the deferred annuity was purchased. Thus, payments from the replacement contract did not fall within the immediate annuity exception to the penalty tax. 

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