72t first year distribution
I am trying to establish a 72t distribution from my 401k, using the annuitization method, and desire monthly distributions of $2,000 per month to total the annual annuity calculation amount of $24,000. The question is how do I establish the first year distribution amount. In other words, if I begin the distributiion in August, 2010, can I begin the 72t distribution with monthly distributions of $2,000 per month for August, September, October, November, and December, 2010 (5months), or do I have to take the entire annuity amount of $24,000 in 2010? The mutual fund that my funds are with says that I have to take the entire $24,000 in the first year, as the IRS ruling is based on calendar year. I disagree for several reasons and need some expert guidance. Thanks
Permalink Submitted by Gordon Weis on Fri, 2010-08-06 10:27
If you start in August, you have the option of taking 5 months or the full years distribution amount – either is acceptable to the IRS.
Question, the $24,000 annual distribution amount… what assumptions (age, interest rate, initial balance, etc) did you use to calculate? Unless you worked backwards to it, very seldom does the distribution come out to such an even amount.
Just to make sure, you may want to check out our calculator at 72t.net [url]http://72t.net/72t/Calculator/Distributions%5B/url%5D and for a few helpful tips, also check out our planning pointers page [url]http://72t.net/72t/Planning/Pointers%5B/url%5D
Permalink Submitted by jim markwell on Fri, 2010-08-06 12:50
Thanks, gfw. I did use the calculator and the life expectancy tables, mid term rate for July, etc. The actual amount was not even money, as I only stated the $24,000 amount for simplification of the question.
Another question…. Can I use either the June or July Mid-term rate, or does it have to be the lesser of the two (for an August annuitization calculation/distribution)? My fund says you have to use the “lesser” of the latest two months.
Thanks again.
Permalink Submitted by Gordon Weis on Fri, 2010-08-06 14:19
I really don’t think that the people that you are talking to know what they are talking about. It is the higher (or any rate less than) of the 2 rates. From Rev.Rul. 200-62…
Section 2.02(c) Interest rates. [b]The interest rate that may be used is any interest rate that is not more than 120 percent of the federal mid-term rate (determined in accordance with 1274(d) for either of the two months immediately preceding the month in which the distribution begins). [/b]
Permalink Submitted by jim markwell on Sat, 2010-08-07 04:07
Thansk again, gfw. The problem is with AM Funds…..they won’t budge and insist that I take the annual amount now for 2010, rather than a prorata 5 months. This loads me up on income re: tax for 2010, and I shouldn’t have to pay more tax simply because of their ignorance of the IRS rules. Would it do any good to file an SEC complaint to get them to reverse their incorrect understandings? I’d move to another fund but with the midterm rates falling, I need to use June; i.e. an August begin date for my 72t, and don’t have time to move to another fund and establish a 72t by the end of August.
I am now 55, and by having to take the entire annual amount now (August), it makes my 5 year 72t distributuion fall over 5 calendar years, versus 6, further increasing my tax liability. It would also violate the 5 years or until 59 1/2 rule, because I’d have to take a 6th distribution to prevent a violation of the 5 year rule. HELP!!!
Any suggestions?
Permalink Submitted by Gordon Weis on Sat, 2010-08-07 10:05
Just make sure that your initial calculations are right and keep good documentation. You really don’t need the mutual fund’s blessing to set up a SEPP. An IRA is between you and the IRS. The mutual funds only inolvement is that they will be sending you a 1099 for the distribution. If they don’t use a code of ‘2’ on the 1099, merely file an IRS form 5329 to claim the exemption to the 10% penalty.
Permalink Submitted by Alan Spross on Sat, 2010-08-07 19:32
gfw is of course correct. He manages the long standing 72t dedicated website dealing with SEPP plans and has seen this question countless times.
His recommendation is the most hassle free way to proceed. However, if you want to have a little fun with AM Funds reps and provide them with some education on this subject, you might refer them to IRS Letter Rulings 2001 05066 and 2001 06039, both of which established IRS approval to take pro rated monthly distributions in the first calendar year of a SEPP plan. Nonetheless, since this is not formally part of the IR Code, different IRA custodians come up with their own guidelines and they are far from consistent. In this situation, you could also find custodians that will tell you that you MUST pro rate the first year distribution and cannot take a full annual amount. In fact, you have your choice and the IRS has not questioned either choice for many years.
You will probably not get a properly coded 1099R from them even if you opted for the full annual amount. But there is a marginal benefit for having your IRA custodian recognize your 72t plan even without the exception code. They might catch some error on your part that actually WOULD have busted your plan. Therefore, there might be some benefit in trying to convince them the error of their ways on the first stub year distribution choice.
Forcing taxpayers to substantially increase income unnecessarily not only can inflate the tax bill, but can sacrifice many years of tax deferral on the excess amount distributed. Since you are already 55, you must take out a minimum of 60 months worth before your modification date in August, 2015. Accordingly, if you opt to take out 5 months worth (10,000) this year, you must take out 7 months worth as a minimum prior to your modification date in 2015. But you will also have the option of taking out 12 months worth in 2015 prior to the modification date if you wish. If you opted to take out the full annual amount this year, you would have the option of taking out nothing in 2015 since you would still have the 60 months of distributions.
You do not have to make your final decision until December, 2010. If you take out the 2,000 each month thru November, in December you can just take another 2,000 or you can add the other 7 months to it to bring the 2010 total up to 24,000. That will give you another few months to consider which choice is best, although you appear to have already done that.
Permalink Submitted by Bruce Steiner on Sun, 2010-08-08 13:04
I wrote an article on the exceptions to the Section 72(t) penalty on early distributions, which appeared in the January 2000 issue of Estate Planning: http://www.kkwc.com/docs/AR20041012155030.pdf. It was published before the IRS issued Rev. Rul. 2002-62, so it’s not current, but it may nevertheless be useful.