72-t using Required Minimum Distribution
We have an individual who would like to move her IRA from her current advisor to us for management. She began taking 72-T distributions in 2008 and we want to be sure we continue it properly when we move the account so she does not have any penalties. We have received a copy of the 72-T election form from her former advisor. It looks like they chose the Required Minimum Distribution option. I have never used the RMD option. It looks like they were stating that the distribution would be recalculated each year using the life expectancy tables but I thought that the distributions had to remain the same for all 5 years. Does the RMD option simply mean using the life expectancy tables to determine what the annual payment will be for all 5 years (not recalculating)? Your input would be appreciated. (Sadly she never should have started the 72T to begin with – not needed and now stuck with it.)
Permalink Submitted by Alan Spross on Wed, 2009-08-19 03:29
The RMD method contemplates a complete new calculation every calendar year and this will cause the annual distribution to bounce around somewhat, particularly if the IRA holds volatile investments. Each calendar year, the age is increased by 1, the prior year ending account balance is used, and interest rates are immaterial. The RMD method typically yields about 40% less than one of the two fixed dollar methods in the first year, and then varies from there. The same life expectancy table must be used each year with the updated age, and if the joint life table is used, the actual beneficiary on the IRA dictates the age of the other person. Since the table has already been selected here, you must determine which one it is. There may still be flexibility in 2009 to fix any errors so far in the 2009 distribution assumptions unless too much has already been taken up front for the year. If within 60 days of a SEPP busting distribution, the excess amount can be rolled back to save the plan, so I recommend that the IRA be moved to you by direct trustee transfer rather than by rollover. That will preserve the one rollover allowed per year as a safety valve.
Be sure the client is actually using the RMD method, because it is also possible to use one of the other methods will annual recalculation under that method. If that happens to apply, client can still make the one time change to the RMD method and it would reduce the payout in most cases. Obviously, the main risk of the RMD method is the increased number of calculations that must be done, each with the potential for error.
Permalink Submitted by Lynn M Diveley on Wed, 2009-08-19 19:44
Thank you for your response. The former investment advisor states “we may use the previous calendar year end market value or any other date to calculate market value. Once the date is selected we may not change it.” The chose 1/10/08. does that mean that to recalculate the balance we would have to get the 1/10/09 balance rather than 12/31/08? By the way, the other investment advisor has continued to pay the same amount this year as was paid in 2008….If we use the single life table we come up with the same distribution number they did in 2008 – so we are assuming that is the table they used. Any other words of wisdom!!!
Permalink Submitted by Alan Spross on Wed, 2009-08-19 20:36
It IS permissible to use a date such as January 10th, although it is not a good idea vrs using a calendar YE date because IRA custodians MUST provide year end values for Form 5498 IRA reporting. Certain investments may not be easy to value on an interim date such as this, but if they used 1/10, then the client must stick with that date for the term of his SEPP. A copy of each year’s 1/10 IRA statement (on line daily copy of account balance should suffice) should be preserved to document the annual calculation in the event of IRS inquiry. At this point, someone does have to produce a 1/10/09 figure as needed to calculate the 2009 distribution.
For the 2009 RMD method distribution to exactly equal the 2008 distribution, the account balance would have to fall exactly in proportion to the lower table divisor produced by the added age of 1 year. It would be a real fluke to have that happen, but it is of course mathematically possible. The 72t distributions removed from the account will reduce the account value if asset prices remained identical. In addition, for 2008 the client had the option to distribute either the full annual amount or a pro rated amount based on the month of the first distribution. Eg, if first distribution was in April, either 100% or 75% of the annual amount could have been distributed.
These days IRA custodians are largely backing away from “underwriting” the accuracy of SEPP plan calculations and are coding the 1099R as an early distribution (Code1). In these cases, the taxpayer must file a Form 5329 and enter exception “02” on the Form claiming the substantially equal payments penalty exception.
Finally, the IRS has issued letter rulings twice since 2007 busting SEPP plans for partial transfers. While these rulings have not been clearly explained, it is better to transfer the entire IRA if you need to and avoid partial transfers. REF: PLR 2007 20023; PLR 2009 25044.
Permalink Submitted by Lynn M Diveley on Thu, 2009-08-20 12:00
Thanks much Alan. Very helpful. Looking at what the former advisor told her to do, and the use of the 1/10 date once again illustrates how little some advisors know and how much trouble they can get folks into. (Not that we know it all obviously but at least we know when to ask for help!) Just looking at the 12/31 balance (not the 1/10) the distribution they are making this year isn’t even close to the RMD method they chose. We will be transferring the entire IRA, adjust the distributions (at this point it appears they would have overdistributed by about $4,000) and will run it by her accountant as a final safeguard. Your help was definitely appreciated.