Rollover IRA converted to an Annuity
The Situation is as follows:
Taxpayer is age 56
T/P has 3 IRA’s: 1) Rollover IRA (originally from an employer’s 401(k) type plan)
2) Traditional IRA
3) Roth IRA
T/P needs additional income and would like to take only the Rollover IRA balance and convert it to Single Premium Immediate Annuity.
Can this be done to prevent immediate taxation on the entire amount used to buy the annuity and avoid the 10% early distribution penalty under the 72(t) exception?
If so, please advise on what the proper procedures are to accomplish this.
Thank you
Permalink Submitted by Alan Spross on Fri, 2012-06-01 18:36
Since there is no separate annuity exception for IRA accounts as there is for NQ annuities, the distributions would have to be calculated using one of the 3 approved methods per RR 2002-62 that qualify distributions for the substantially equal periodic payments exception (ie 72t plan aka SEPP).
A 72t plan at age 56 requires that the exact annual distribution be taken for a minimum of 60 months. Taxpayer could execute a 72t plan without forfeiting the principal to an insurance company for life. After 5 years taxpayer would have the remaining principal and payments could cease until RMD time.
However, if the taxpayer actually wants to irrevocably annuitize the IRA account for life or joint life with a beneficiary for investment reasons, the insurance company will have to make sure that the annual payment falls under the allowed flexibility in calculating a 72t plan AND the insurance company should agree up front to code the 1099R with Code 2 (penalty exception) for all pre age 59.5 distributions. As the payments continue the IRA annuity will meet the RMD requirements for this IRA account only and cannot be aggregated with any other TIRA accounts for RMD purposes.
The transfer to an IRA annuity itself is a non reportable transfer with no tax impact.
Another approach to consider if the taxpayer is still working is to take out a 401k loan or transfer the rollover IRA into the current employer plan to increase the amount of a loan he would qualify for. There is no tax due for this unless he were to default on the loan repayment provisions.
Obviously, the best course of action will depend on how long he will need the additional income.