SPIA to fund IRA taking SEPPs under 72(t)
An advisor friend of mine wants to fund an IRA for a retiree using a single premium annuity for 5 years. The client will be 53 years old. Therefore the client will receive a stream of income for 5 years and after that, nothing from the IRA since it will have no assets at that time. Since he would stop taking distributions from the IRA prior to age 59 1/2, seems that he would owe 10% penalty. Advisor wants to use the “bucket” retirement planning method where client begins taking distributions from another bucket (funded by a variable annuity) for the same amount as the distributions coming from the SPIA. This will be in another IRA, however.
My suggestions were:
See if you could leave a nominal amount in the SPIA somehow and drop to the minimum distribution method for the remainder of his 71(t) period. Result – no penalty. Start distributions from anothe IRA to continue clients living expenses.
Or – See if BD would allow consolidating VA and SPIA in one IRA account – (doubtful)
Anybody have any other suggestions?
Permalink Submitted by mk foss on Tue, 2009-12-29 19:05
One of the exceptions to the 10% penalty while taking SEPPayments is running out of money. That came in in 2002 when so many high payment streams were in trouble. This one makes me nervous because it’s a deliberate running out of money.
Permalink Submitted by Alan Spross on Tue, 2009-12-29 19:42
An SPIA owned by the IRA could pay into the IRA account which in turn issues distributions under a 72t plan. However, that does not appear to be the plan here. Actual distributions from an IRA holding a SPIA with a 5 year payout will not even qualify for a 72t plan because 5 years is not even close to the life expectancy of a pre age 59.5 person. With current interest rates, a distribution over 6% of the original balance is not possible under 72t rules, so I agree that these distributions would be subject to tax and penalty.
I think the first thing to do is determine whether the total balance of both IRA accounts will yield a large enough 72t distribution to fund the estimated living expenses for at least 6.5 years (age 59.5). If not enough, then a possible compromise is to set up one IRA under a valid 72t plan (VA is possible if it allows distributions without surrender charges). While this would escape the early withdrawal penalty and could be changed to the MD method later on to preserve assets), the other account would have to distribute more than possible under 72t rules and therefore would be subject to penalty. But at least a portion of the total distributions would escape the penalty.
The main concern is that if a 72t plan is started that will not cover expenses because the total balance was too low, then sooner or later the client will bust the plan by taking out more than the rules allow, triggering retroactive penalty plus interest. I do not see how an SPIA could be used in this situation unless it was paid into a custodial IRA account which would then use those funds to fund a valid 72t payout along with other investments such as the VA IRA account. This might be the combined approach you had in mind.
Another possibility is having two separate IRA accounts as part of the “SEPP universe” IF the total will generate enough to fund the expenses over the 6.5 years. In that case, the IRAs could be partitioned so that an SPIA IRA payout equalled the exact 72t payment. The other IRA could be used for a VA or other investments but could not be touched without busting the plan. If the SPIA ended at 5 years, then the other account could be tapped for an amount equalling the former SPIA amount for the remaining 1.5 years. Again, this requires an adequate total balance to cover the expenses under 72t guidelines.