72t withdrawals being converted to Roth
Situation:
Clients are 58, just retired with no income and very little non qualified money to live on.
Clients have approximately 1 million in traditional IRA monies and about $50,000 in Roth monies.
Clients need to take premature withdrawals under rule 72t for the next 5 years to generate needed income.
Clients have a current income need of $32,000 and have been advised by someone else to simply take that amount under rule 72t.
Missed opportunity/question;
Can these clients withdraw $55,000 under rule 72t, use $32,000 for current income needs and income taxes and deposit the $23,000 balance into a Roth account? If so, can that money stay in the Roth account (I thought I read somewhere that they would have to pull 72t withdrawals from that Roth which would basically defeat the purpose).
Permalink Submitted by Alan Spross on Thu, 2011-02-17 18:30
No, they cannot take a 72t distribution and roll over any portion of it, and a Roth conversion is considered a rollover.
However, all or part of the IRA account(s) they used to determine the initial balance for the plan can be converted to a Roth IRA with the Roth IRA then becoming part of the 72t plan. They would then have more than one type of IRA account from which to take their 72t distributions depending on their tax goals. The Roth conversion does NOT have to be held 5 years in this case to avoid penalty because the 72t plan itself waives the penalty. If they are interested they also must budget to pay the taxes on the Roth conversion, and since they do not have NQ money, the taxes would have to come out of 72t distributions. Therefore, it appears that their choices are:
1) Take a loan or use any other possible source of funds until the first one of them reaches 59.5. It would avoid being stuck with all the formal 72t requirements for 5 years when they only need the funds for a year or so. If clients still have a 401k with the firms they separated from at age 55 or later, they could take distributions directly from that plan without penalty using the age 55 separation exception. That would also avoid setting up a 72t. Also, check to see if they took Roth distributions from the 50k Roth, how much would be tax free. Probably most of it but there would be a penalty for conversion distributions if the conversion was after 2006. While doing this would eat up their Roth, after they reached 59.5 they could quickly replenish it with conversions from the TIRA. All they need to do is leave $1 in the Roth to be totally sure they will not have to start their 5 year holding period over.
2) If they still want the 72t plan, note that these plans are individual, so if they needed to use the IRAs of both spouses, they would need to set up a plan for each spouse.
3) If they want to fund Roth conversions within their 72t plans they obviously need a larger balance and larger 72t distribution to fund the tax payments for the conversion.
4) They need to factor inflation in determining their cash needs. In 5 years 32k may not be enough. The current interest rates for 72t plans would probably generate somewhat more than 32k annually if they used the full 1mm TIRA balance, but without using the calculator I don’t know that it would generate 55k. It they proceed with a 72t, I would recommend they partition 50k off into another TIRA account and keep that one out of the plan for emergency needs. After 59.5 distributions they take from the partitioned IRA would be penalty free.
But in the long run, they will feel better if they can avoid the 72t altogether, being so close to 59.5.
Permalink Submitted by Simon Rogers on Fri, 2011-02-18 02:26
Thank you alan-oniras! I suspected that would be the answer.
Unfortunately, this client came to us a little late. A few months ago they each had $100,000 in a 401K but their current advisor had them roll it into their IRA, preventing penalty free distributions from these accounts and backing them into a 72t scenario.
We are meeting with them tomorrow and will discuss the option of withdrawing basis out of their Roth accounts to hold them over for the next 18 months and avoid the 72t altogether.
Thank you so much for your advice!