72(t) and IRA split annuities
A new client of mine has taken early retirement and is now 57 years of age. He needed to withdraw $36,000/year but, did not want to pay the early 10% penalty therefore, he elected to place his retirement in a 72(t). His funds are at risk and he has lost a large percentage of his retirement therefore, he is interested in positioning his retirement portfolio in an annuity with minimum guarantees and a lifetime payout.
His interest is in keeping his IRA/72(t) distributions intact for two years; and, in the meantime, split the IRA into two IRAs, one with the 72(t) ($68,000) and the other as a simple IRA with the remainder of funds (about $400K to 500K). Can this be done? If so, how would I go about doing this for him?
I learned about this possibility in Ed’s book, The Retirement Savings Time Bomb, but I am not aware if there may be any new laws that might negate that possiblity. I do hope you can assist me in working with this client.
Thank you,
Nancy Schilreff
(928) 443-9696
[email protected]
Permalink Submitted by Alan Spross on Wed, 2009-09-09 22:36
The first project here would be getting ahold of the documentation for the 72t plan, and making sure that the plan is valid based on the calculations done at the inception of the plan. This would also indicate his modification date, which is the longer of 5 years from his first distribution OR reaching age 59.5.
Note that the IRS has busted two 72t plans in the last two years, just for doing a partial transfer to a new IRA account. There is no way to guarantee that these rulings are aberrations, although I think they probably are. Two out of thousands is pretty good odds, but he should be made aware that there is some risk in doing the partial transfer. Alternately, the entire IRA could be shifted if the annuity allowed at least 36,000 to be distributed without surrender charges. It does not matter which account distributes the 36,000 or the frequency of payments as long as the total payout for the calendar year is 36,000.
If he does not need the full 36,000, he can also do a one time switch to the RMD method next January, but that may reduce his payments too much, so should be considered carefully.
Permalink Submitted by Nancy Schilreff on Thu, 2009-09-10 01:23
Hi Alan,
Thank you so very much for your speedy response to my querry. You mentioned an alternative that sounds very interesting. He has greater than $450,000 (he is faxing his statements to me in the morning) – and, the annuity will allow him to take up to a 10% withdrawl each year – so, you see, this is conceivably a great alternative for him. These are my questions: Would his IRAs be transferred in the same manner we would transfer any other simple IRA? My question is this: How should the 72(t) be addressed/documented in the paperwork? By moving his positions from the market to a fixed annuity, will his 72(t) automatically stay intact? I do want to ensure that he avoids the 10 percent penalty. He has been in retirement for about 3 years so, he is likely to have at least another 2.5 years remaining to keep the 72(t) intact.
Thank you greatly for your assistance, Alan. And, lastly, if this alternative is offered to him , would it deflect any risk with the IRS?
Thanks once again.
Nancy Schilreff
Permalink Submitted by Alan Spross on Thu, 2009-09-10 01:49
The transfer would be done like any other IRA transfer, and it should be done directly to save the allowed one rollover to correct any errors in the 72t administration. For example, if more than 36,000 is distributed, the taxpayer can roll back the excess within 60 days to correct the error and save the 72t plan.
The insurance company should be told about the plan and hopefully will understand and support it. It certainly appears that the 45,000 max withdrawal without surrender will do the job since all the client needs is 36,000 for each remaining calendar year. It would also be helpful if they would agree to accept a roll back of a distribution within 60 days if needed to preserve the 72t plan.
There is no filing or added tax reporting with respect to the 72t plan. If the transfer is done mid year, the total distributions from the prior and current IRA custodians must equal the exact amount required of the 72t plan. The IRS will be looking to see that this correct gross amount shows on line 15a of Form 1040. The 1099R forms must also be coded to show the penalty exception (Code 2) or the client simply adds Form 5329 to the tax return to correct the coding to “02” on Form 5329. Most taxpayers must do that today because most custodians no longer provide the exception coding on the 1099R.
There is always some risk that the IRS will inquire about the plan for any number of reasons. But if the client has their documentation in order and provides the calculations to the IRS and they are correct, that will be the end of it. This is why I suggested that the initial calculations be checked now to be sure that the current plan is in fact valid. The 36,000 makes we wonder because it is such a round number and generally you can only get a round number by doing a reverse calculation before the plan starts and create and IRA containing the exact balance that produces a 36,000 annual distribution. You cannot simply select a round figure and take out that amount every year.