72(t) strategy with aggregated Traditional and Roth
Thanks to all the contributors on this forum! I’ve learned a lot about 72(t) on this website (and other sources.) Trying to bring it all together in an optimal strategy for my situation.
Using hypothetical numbers, but here is my game plan for a 72(t). Are my taxation assumptions correct?
Traditional IRA balance $300,000
Roth IRA balance $700,000
Roth IRA basis $200,000 (all free and clear of 5-year holding periods)
At age 50, I start a 72(t) for $60,000 per year in January ($5,000 per month).
In years 1-4, I withdraw $20,000 per year from Traditional. All is taxable.
In years 1-4, I withdraw $40,000 per year from Roth. All of these count as withdrawal of basis and therefore none is taxable.
In years 5+, I withdraw $55,000 per year from Traditional. All is taxable.
In years 5+, I withdraw $5,000 per year from Roth. All of these count as withdrawal of basis and therefore none is taxable. If, however, the Traditional IRA is exhausted prior to end of 72(t) and I have to switch to larger withdrawals from Roth, and end up withdrawing more than $200,000 cumulatively from Roth, any withdrawals in excess of $200,000 will be taxable.
I also have the option to switch to the RMD method later on – are there any conditions to this or is it available under any circumstances? Am I still able to choose the split of how much comes from the Traditional and Roth, based on the RMD calculated from the aggregated value, or do I have to actually take the RMD that applies to each account?
Permalink Submitted by Alan - IRA critic on Thu, 2024-12-26 11:33
Your taxable amounts are correct, but the assumption that you can include two different types of IRA accounts in your SEPP universe is not clearly supported. As far as I know, the only IRS Reg or Notice that deals with a combined account is Reg 1.408(A)-4, QA 12, and that Reg presents a different structure than yours. It addresses a TIRA SEPP that can be converted to a Roth IRA, and appears to contemplate a total conversion, so that at any point in time the taxpayer’s SEPP contains only one type of IRA, that is first a TIRA only, then after the conversion a Roth IRA only.
Your plan differs by having your SEPP universe consisting of both types of IRAs throughout the plan. While the IRS might consider it reasonable and not bust it, it is quite likely to attract their attention at some point by the way you must report the distributions on Form 8606 (for the Roth) and on lines 4a and 4b of Form 1040, with a 5329 to claim the SEPP penalty exception for the TIRA portion.
Another option that would present less risk from the IRS, but would not exactly produce the same taxable amounts as each year would be to start a SEPP with only your TIRA 300k, which would produce about 18k of taxable distributions every year. The Roth would be outside the plan, and you could withdraw 42k per year of Roth IRA basis tax free for about 5 years. After 5 years you would then start a 2nd plan using your Roth IRA only, and the 8606 would include taxable gains every year for 5 years, but no penalty due to the SEPP exception. So at no time are these two plans combined in any way and they must be maintained as totally separate plans in all respects. The taxable amounts in each year from these two plans would not be much different than your plan to combine the two IRAs into a single plan.
With either plan you could opt for the one time switch to the RMD method, and again to avoid confusion, this should only be done effective 1/1 of any year. If you maintained two independent plans, you could make this change on different years, or on only one of the two plans, since these would be two totally independent SEPP plans. Conversely, with your proposed plan this switch would be for the entire plan, but the reduced RMD could still be taken in any combination from the two IRA types.
In general, SEPP should be kept simple to avoid IRS attention and the risk that your plan could be busted. Both your version and my version might attract attention because neither are simple standard structures, but I think my version carries less risk because the IRS has clearly allowed two separate SEPP plans to exist at the same time and started in different years.