72t help

Submitted by Rick Piedade on Fri, 2020-03-13 22:05

I wanted to first say thank you for everyone that contributes to the forum. I have learned so much and found just about everything I needed thus far.
Today I felt the need to ask a question that I am a bit unclear about.

I am 46 and was planning on starting a 72t account. I have decided to move to Portugal where the cost of living is enough that I can easily afford to live on $3,500/m. That was approximately my target amount.

My question has a few parts. About 4 weeks ago I had $810,000 in a Traditional IRA and $198,000 in a 401k account. The total of the accounts was $1,008,000. With the February 120% midterm rate at 2.1% that gave me an Amortization amount of $38,834 which is well above what my target amount was.

Well, things have changed a bit in the last few weeks and now my accounts are $625,000 for the IRA and $175,000 in the 401k for a total of $800,000.

The 120% midterm rate went from a rate of 2.1% in February to a March rate of 1.83%. With bond rates dropping the way they did this month, I’m assuming the rate will drop even lower in April.

Ok… so here is my question. I would like to be able to capture the 2.1% February rate and wanted to confirm how to do that. I believe that I would have until the end of April to begin the SEPP since I can go back up to 2 months prior.
Is that correct?

And then as far as the amount I’m using in case of an IRS inquiry…
Can I still go with the $1,008,000 which was my combined IRA and 401k amount?
I don’t believe that’s possible, but was looking to verify that I can not. Hoping I can, obviously.

If I can’t combine them to represent that amount, then what are my options?
Can I use the $810,000 that was the peak IRA amount on one account and then just set up the 401k as another IRA that I would set up as a 2nd SEPP?

If I can do that, then would that mean I can still calculate my Amortization rate as $810,000 for the original IRA? And then the 2nd IRA would be the amount that it is when i convert the 401k to an IRA? Let’s say about $175k.
If I can do that, I would be at $31,200 + $6,700 which I’m happy about,

Many thanks and I hope I have explained this well and not too confusing.



Submitted by Alan - IRA critic on Fri, 2020-03-13 22:44

  • Yes, you have until the end of April to take your first 72t distribution and use the Feb rate. After that the rates will plummet. 
  • You cannot combine an IRA and 401k into a single plan. You would normally do a direct rollover of the 401k plan into the current or separate IRA plan to avoid the added risks of having a separate 72t from your 401k. These risks include a corporate merger or buyout, and general lack of control since the employer controls the plan, not the participant. To avoid the complexity of having two independent plans, one from each IRA, you would need to get the direct rollover ordered very soon.  For a single 72t plan the account balance in your calculation would have to be determined after this rollover, meaning there are real risks that your account balance would be even lower than today. Of course, you would also need to have the rollover done in time to get the first distribution out by end of April. So the order would to first get the rollover done, then determine the date of your account balance, and finally take the distribution by the end of April.
  • Plan B if you are worried about further major drops. Start a plan from the current IRA now, still order the 401k rollover into a NEW IRA, then start a second plan using the new IRA account balance, still before end of April. You still get the Feb interest rate and assure against further drops of the big IRA with the downside being having to run two entirely separate plans.
  • More regarding account balance in a bear market – RR 2002-62 states that the account balance for your 72t plan must be reasonable in relation to to the balance on the date of the first distribution, but the IRS has not defined “reasonable”. My guess is that if the calculation balance is more than 15% higher than the current value it could be challenged by the IRS. Therefore, even now you should not try to use a mid Feb peak balance for the calculation since that is too high. We have gone from a market peak on 2/19 to a bear market in only 3 weeks. That is the second fastest in stock market history. 
  • In summary, you have alot of flexibility and trade offs. While you have account balance leeway right now, you also are starting a plan at only 46 that must run 13 years, which is much longer than the average 72t plan, so you must pad the distribution to reflect your needs after many years of inflation.

Submitted by Rick Piedade on Sun, 2020-03-15 16:31

Thank you, Alan, for your insights and help.  I really appreciate it.Do you think this would work for me?  I would like to just confirm this…Before the end of April, I start a plan from my current IRA (the one that went from $810k to 625k) and find a value that is within 15% of where it will be on that date I start it.  And with that, I am using the 2.1% midterm rate calculation.  Roll my 401k into another IRA when I leave my firm mid-April.  And at that point, I can start a 2nd 72t plan with the 2.1% midterm rate calc.  I think this is essentially what I originally thought of doing in my original post, except for the part that you mentioned of the 15% from the peak number that would be an issue.  So I am adjusting it here in this revision to make sure I’m inside the 15% of where my account is when I begin taking distributions. As far as where things will be with the market at the end of February, I have converted some of my accounts into cash and even put on a few hedges to try to keep it somewhat stable from now until then.  Hopefully, at the end of April, I’m still pretty close to the $625k that I currently have, so that I can use a reference amount of around $700k (which inside the 15% of $625k). For the 2nd IRA that I am rolling from the 401k… are there any rules I need to know when having a 2nd 72t account setup?  Can they both be set up as an Amortization Distribution method for example?   I’m also considering after the first year if my original IRA goes up significantly + the midterm rate goes up too, then I can break the 72t plan and restart it for the higher amount distribution and just pay the 10% penalty.  I do understand the risks of running this for 13 years.  I have a bit of a safety net of cash reserves if and when I might need it.  My main goal with the SEPP is to get around $36k/yr as my distribution.  As always, thank you.       

Submitted by Alan - IRA critic on Sun, 2020-03-15 18:32

  • To be clear, there is no formal 15% limitation. That’s just my estimation where an IRS examiner might be concerned about the valuation not being reasonable. And I don’t know if the IRS looks at this differently in the midst of a market crash than they would in stable times. Therefore, in these times you may very well have considerable leeway to use an opening balance more than 15% above the current balance.
  • Am concerned that if you separate in mid April, the direct rollover may not be completed in time for an April distribution from the rollover IRA. Your max interest rate for a May distribution will then be the March rate of 1.83. Your account balance for the second plan will have to be very close to the first distribution, giving you less flexibility there.  Otherwise, you would just manage these plans as entirely separate from each other. You can use a different method if you want to. You will have to be sure not to confuse them in any way when you request distributions. 
  • Yes, you can bust a plan voluntarily at any time for any reason, then start a new one. It is also legal to use a recalculated plan where you determine the annual distribution anew each year, updating your age, interest rate, and account value. But due to the risks of all the calculations, making an error, and drawing more IRS scrutiny, using recalculation is probably not the best decision.

Submitted by Rick Piedade on Mon, 2020-03-16 18:22

  • Thanks for clarifying the 15% limitation.  From your experience, if the IRS was concerned and questioned it, do they do it after year 1?  I would be worried that 3 or 4 years later is when they think it’s a problem and hit me with a 10% fee on all that additional time I’ve been taking out the wrong amount. Obviously increasing the amount on the 10% fee.  I was just curious what typically happens when the IRS does need to examine.

(I think this is my last question!) 

  • Good advice on the roll over timing. Thank you. I will be sure to check and see what the typical rollover time is and be sure to have that sorted out properly before April ends. I will also be sure to use the amount when the rollover completes and have it on record as you suggested.

 

  • I will weigh your final point if and when I need to go the route of recalculation.

 Many thanks again!

Submitted by Alan - IRA critic on Mon, 2020-03-16 22:39

The IRS could inquire into the plan’s initial calculation based on some execution error late in the plan, like taking a distribution different from the prior distributions. I doubt that the IRS spends much time checking initial calculations unless they have some other reason to look at the plan. But I would keep your documentation up to 3 years after your last distribution.

Submitted by Rick Piedade on Tue, 2020-03-17 14:21

Got it. Thank you so much for your time.

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