Using 72t payments to avoid 10% penalty on Roth Conversion

Submitted by Brent McCormick on Thu, 2015-05-21 19:27

In David McKnight’s book “Power of Zero” he mentions a strategy of someone under age 59-1/2 doing a Roth conversion. They don’t have the money outside the IRA to pay the income taxes. They want to avoid the 10% early withdrawal excise tax on the amount used to pay taxes. He submits that you set up a 72t (SOSEPP) plan, take the payment, hold back your estimated tax cost and place the balance of the 72t payment into a Roth IRA within 60 days. IRC Section 402(c)(4) appears to say that SOSEPP are not eligible for rollover. However this section seems to apply to company retirement plans. Am I reading too much into this, or does this strategy collapse because 72t payments are not eligible to be rolled over. It would also appear that direct transfer of a 72t payment would be unworkable as well. Thank you.



Submitted by Alan - IRA critic on Thu, 2015-05-21 22:54

IRS Reg 1.408(A)-4 Q 12 copied below may have been misinterpreted:

Q-12. Can an individual convert a traditional IRA to a Roth IRA if he or she is receiving substantially equal periodic payments within the meaning of section 72(t)(2)(A)(iv) from that traditional IRA?A-12. Yes. Not only is the conversion amount itself not subject to the early distribution tax under section 72(t), but the conversion amount is also not treated as a distribution for purposes of determining whether a modification within the meaning of section 72(t)(4)(A) has occurred. Distributions from the Roth IRA that are part of the original series of substantially equal periodic payments will be nonqualified distributions from the Roth IRA until they meet the requirements for being a qualified distribution, described in § 1.408A-6 A-1(b). The additional 10-percent tax under section 72(t) will not apply to the extent that these nonqualified distributions are part of a series of substantially equal periodic payments. 

Note that the conversion is done with additional amounts of the IRA balance, it is not done with the 72t distribution amount because as you indicated a 72t distribution is not eligible for rollover. Taxes would therefore be due on both the 72t distribution as well as any additional amount converted to the Roth. The tax he held back would not be subject to penalty, but would not be enough to pay both the taxes on the 72t amount plus the tax on the additional conversion. 

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