72t
I have a client age 54 considering retirement. Will have approximately 3.1 million upon payout from ESPO plan.
Few general questions regarding 72t-
At this point we are weighing out advantages/disadvantages of either putting enough money into his current 401k from ESOP transfer to utilize after age 55 for living expenses until he reaches 59 1/2 or establishing a 72t plan.
If we go route of 72t-—
Are 401k assets and all IRA’s included in calculation for 72t or just one particular IRA account that would be set up for 72t distributions?
If one specific IRA can be used by itself for calculation and that is what we set up- would any emergency need taken from separate IRA cause penalty on the 72t distributions or only the amount taken beyond 72t be penalized as early withdrawal? Further, once he reaches age 55 and no longer working can money be withdrawn from 401k while taking 72t distributions without additional penalty?
Thanks for any guidance!
Permalink Submitted by Alan - IRA critic on Mon, 2024-09-30 12:18
Specific accounts can be used to start a 72t plan, but a 401k should not be used because of the added risk of loss of control of the account. Generally, the amount needed to generate the needed annual income from the 72t plan should be directly rolled to an IRA and the 72t plan set up with that IRA. Another IRA outside of the 72t plan can be used for emergency needs, but distributions from the non 72t IRA will be subject to penalty unless client qualifies for a different penalty waiver (eg disability).
To avoid the complexity and risk of a 72t plan, if separation from service occurs in the year client will reach 55 or later, AND if the 401k plan allows flexible distributions as needed, the client can avoid the 72t, just take penalty free distributions as needed and do the IRA direct rollover upon reaching 59.5. The challenge here is that some plans only allow total distributions after separation, and a distribution large enough to fund expenses all the way to 59.5 would likely spike the marginal tax rate in the total distribution year.
To add further complexity to the situation, if client has appreciated employer shares in the 401k or ESOP, NUA would be an option to consider, and client could sell the distributed shares and pay the lower LTCG rate on the NUA. NUA requires a total distribution of the ESOP and 401k balances. Client might also have a Roth 401k or after tax non Roth balance in the plan.
First thing is to identify the composition of the plan before selecting the best combination of transactions to meet these goals.
I assume that your first sentence referred to an ESOP, rather than an ESPP which is not a qualified plan.