72t Mistake
I have a client that retired from the Federal Government at age 50. He decided to do a 72(t) starting in 2007. He turned 51 in December 2007. He correctly used his account balance as of 12/31/06.
However, he used age 50 for his calculation. His annual amount was calculated at $17,212 ($1,434.33 per month). He took a distribution of $12,906. It appears that he started taking distributions in April. My questions are
1. Can you prorate the first years distribution?
2. What is the best way to correct this problem? The distribution should have been $17,393 per year ($13,045 for 2007/)
3. The distribution code on the 1099 is “1” for early distribution. I think the most appropriate code should be “2” exception applies. I do not see a code specifically for 72(t)s. Can you get the company/Govt to code these properly on 72(t)s or do you have to fill out form 5329 each year?
Thanks,
Ed Lustberg
Permalink Submitted by Alan Spross on Tue, 2008-02-05 04:09
Ed,
1) The first year can either be taken in full or pro rated by the month. If his first distribution was in April, then he could take 75% of the annual amount instead of the full annual. But he cannot take some figure between 75% and 100%, so this will not work.
2) All attempts to “back into” the correct amount should be explored that do not violate 72t approved calculation options. One option would be to determine if the maximum interest rate was used for the highest of the Feb or March rates. If not, see if there is room to raise the rate enough to equal the annual distribution amount. If joint instead of single mortality was used, he could switch to single which would increase the distribution, and then tweak the interest rate downward until the needed amount is reached. Before doing any of this, very the month of the first distribution.
Perhaps easier than any of the above would be to locate any account balance not too much earlier than the one used this is more than 1.5% higher. Then the interest rate used could be tweaked downward.
The point of all this is being able to meet the requirements. It does not matter if this is done by changing the intent of some of the assumptions. This flexibility is of course only good for the first year, before the first year amount is set in concrete. I think the prospects are good for re working the calculation to match the amount distributed using his correct age.
3) The majority of IRA custodians are now refusing to underwrite the plans to the point where they provide the “2” exception coding. As a result, most taxpayers will have to attach a 5329 every year to claim the exception. So many taxpayers are having to do this now, it should not materially increase the chances of audit. No point in trying to convince the custodian to re-issue the 1099R.
Permalink Submitted by Edward Lustberg on Tue, 2008-02-05 04:40
Alan,
Based on the distribution that was actually taken, I computed an annual amount of $17,208. I played with the interest rates. The closest I could come to that amount was using a rate of 4.91%.
That would make the Distribution amount $17,203, within $5 dollars. I think the only was I could be exact is to use more then 2 decimals, e.g. 4.912. Is there any other options?
Thanks,
ED
Permalink Submitted by Alan Spross on Tue, 2008-02-05 05:12
There is no limit to decimal places. so you can go out as much as needed to get the exact amount. That should solve the problem. I am just surprised that the rate used is so much less than the 120% of mid term rate, which was over 5.5% for that period. Looks like a rate well below the max rate was used, but this should get you to where you need to be to justify the actual amount taken in 2007. Of course, the calcs should be thoroughly documented because this flexibility essentially disappears after the end of the second calendar year.
Permalink Submitted by Edward Lustberg on Tue, 2008-02-05 18:59
Alan,
The problem with the calculation is that 72t.net and other calculators will only take 2 decimal places. The calculation uses the amortization method. Do you know of a calculator that will allow more decimal places?
Also, It sounds like you have done the 5329 form. Code “2” is for substantially equal lifetime payments. That seems to be more for a lifetime annuity. Code “12” othe seems to be the only one that fits. Is that the code you have used?
Thanks
Ed Lustberg
Permalink Submitted by Al Fry on Tue, 2008-02-05 20:13
Code “2” is correct, for both 1099-R and 5329. There should not be a problem for not being able to establish the exact rate used, since it is lower than the Feb & Mar 07 rates. Most everyone uses the annual rate, then divides the amount by 12 for monthly, whreas the Rev. Rul. 2002-62 author has said the monthly rate should be used, along with a monthly calculator. It seems like they’re looking for abuses, which in this case would not apply.
Permalink Submitted by Alan Spross on Wed, 2008-02-06 01:48
Ed,
The 1099R Box 7 codes are totally separate from the 5329 exception codes. It just so happens that when the 1099 R is coded early (1) and the 5329 is attached to override the 1099R, the 5329 exception listing of 12 items assigns a number of “02” as the SEPP exception.
Code #12 is the dump code or to signify that more than one exception applies which must be itemized on an explanatory statement.