How can I minimize 10% penalty and calculate 72t early w/d?
Hello,
As a 55 y/o single female – for 2011 – Federal income tax owed was just $150. I must now distribute $60,000 from my IRA to pay off debt. Also, I would like to calculate the minimum 72t substantially equal periodic payments I can take, beginning now, to avoid the 10% early withdrawal penalty. My oldest IRA beneficiary is age 37.
Can someone please help me to determine whether I must withhold and submit federal tax on the $60,000 lump sum, and 72t distribution in 2012, or, can I defer paying the Federal tax due for 2012 until 2013 when I submit my 2012 return? Also, how to calculate the minimum 72t distribution election ?
With thanks in advance for your kind assistance.
Permalink Submitted by Alan Spross on Mon, 2012-02-13 17:51
Yes, we can get into the details of 72t plan after you post back. However, a 72t plan is designed to address rather stable expense needs over a period of 5 years in your case, and your 60,000 in debt reduction appears to be a one time need. If you reduced the debt over the 5 year period, the interest rates may cost you more than the 10% penalty of 6,000. You may need both, ie a penalized distribution of 60,000 with a 72t plan to address your other living costs for 5 years. Please clarify.
Also, note that if you separated from a job with a pension plan IN the year you reached 55 or later, you can take distributions from that particular plan penalty free. Do you meet those requirements? If so, then you may not need a 72t plan. Otherwise, I assume you plan to use an IRA account to fund the plan if needed.
Taxes on IRA distributions can be paid through withholding at the rate you specify, or you can pay quarterly estimated taxes. With a 72t plan, it is usually better to pay by quarterly estimates since it gives you control of the money and avoids the risk of errors caused by the custodian. If you wait until April, 2013 to pay all the taxes, you will incur an underpayment penalty from the IRS.
Permalink Submitted by Justin de Luca on Mon, 2012-02-13 18:05
Thanks for your reply.
There’s actually 2 parts to my problem.
1. I need to dist. $60,000 now to pay off debt. Must I withhold taxes & penalties in 2012 since only owed $150 in federal tax for 2011, or just w/d it and pay when I file my 2012 retrun next year?
2. Separate need is the 72t minimum amount to qualify for the substantially equal payments schedule. I know I must have either withholding or estimates paid on this. Also, can I use 0.00% as the reasonable interest rate?
Thank you very much !
Permalink Submitted by Alan Spross on Mon, 2012-02-13 18:30
1) You do not have to pay taxes in excess of $150 in 2012 because paying an amount equal to your 2011 tax liability meets a “safe harbor” to avoid underpayment penalties. Of course, you would still owe the taxes by April, 2013 and your 2013 safe harbor would be much higher due to your 2012 taxable income. That could present a planning challenge with respect to how much you need in 72t distributions. You would still have to pay the 10% penalty on the 60,000 withdrawal and you would have to take that distribution BEFORE starting your 72t plan and the intial IRA balance for your plan calculations would of course be 60,000 less because of that distribution. Of course, if you think you could squeeze a small amount, ie 5,000 out of the 72t payments, you could take a penalized distribution of 55,000 and then pay off the other 5,000 from your 72t payments.
2) With respect to the 72t plan, with interest rates at record lows it means that you need a higher balance in the IRA to generate a certain 72t distribution amount. The last thing you would want to do is to use an even lower interest rate which would lower your distribution even more. For example, even if you have an IRA to 10 million, what you would do is calculate the amount you need to live on per year for the 5 years and pad it slightly for inflation. Then use reverse 72t calculator to determine what IRA balance is needed to supply the amount you need to live on. If that amount was 1 million, you would transfer the other 9 million to a different IRA and then use only the 1 million IRA for your 72t plan. The other account would be used for emergency needs subject to penalty or even to start a second plan later on if needed. That way you do not drain more out of your IRA than you actually need. But use the highest possible rate for the 72t calculation. Also, you would use your individual age only for the calculation as that also generates a higher amount than using joint calculations with a beneficiary.
Here are the “planning pointers” from a site dedicated exclusively to 72t plans. It includes calculators and everything else needed including it’s own discussion forum for 72t plans. For greater detail, you may wish to post in that forum:
http://www.72t.net/72t/Planning/Pointers
Permalink Submitted by Justin de Luca on Mon, 2012-02-13 18:55
Thanks again.
In my case I’m looking for the lowest 72t to distribute, whereas most of the time, people look to take the highest they can. Accordingly, should I use a high or a low interest rate?
Also, I have 2 IRA accounts -(1) mutual fund, and (1) Variable Annuity. Were you saying that I can use one account and make the 72t calculations from that for the maximum or minimum.
Regards.
Permalink Submitted by Alan Spross on Mon, 2012-02-13 20:14
When you have two IRA accounts you can combine as follows:
1) Calculate the 72t distribution using the balance of both accounts, and take distributions from either or both (eg use both for total balance but only take your distributions from the mutual fund IRA)
2) Use the balance of only ONE of those IRAs and keep the other totally outside the 72t plan.
With this structure, if you wanted to change the balance in the mutual fund IRA to generate the exact 72t distribution you want, you would have to transfer funds either in or out of that IRA to/from the other IRA.
Note that with these low interest rates, you need a balance roughly 23 times the annual distribution amount you require for the plan. Therefore, if you want to take out 30,000 per year, you need an account balance of roughly 690,000 to generate that at your age and current interest rate. The first challenge is whether you have enough or not, and if you have extra to determine how much to transfer to the IRA that will not be part of the plan.
Note that the 72t calculation produces an exact amount you must withdraw each year. There is no max or minimum, but you can set up the IRA balances before you start so that the exact amount you must withdraw meets your needs without being more than you need. Note that no matter which month you start your plan, for the first calendar year you can take out either the full annual amount or the pro rated amount by the month (eg first distribution in April, choice of the full annual or 75% of the annual).