72t Distribution Details

Submitted by Michael Copley on Sat, 2015-09-19 19:27

Hi. I have a couple questions before feeling comfortable using the 72t rule to take early distribution from my IRA–without 10% penalty. I’ve read all the applicable tax code and various websites on the rule, but am left with some nagging details I was hoping you could help me with.

1. Assuming I take my first annual distribution on 15 Oct of this year, are there any annual proration rules I must follow (e.g., only take 3/12th of the annual payment) or can I take the full annual annuity amount as determined by the IRS calculation method? (FYI, I plan on taking annual payments vs. monthly or some other mode)

2. Should I take my annual distribution on the same exact day & month each year or does it matter so long as the exact annuity amount (dollar and cents) is taking each year (between 1 Jan and 31 Dec)?

3. When determining the account value to use in the annuity calculation (i’m using the amortization method), can I use the account value as of 15 Oct when I call and request the distribution from my IRA custodian and using a “print screen” shot of my online account balance to document/record to the IRS the balance I used in my annuity calculation? Or should I use the latest “official” account statement (a/o 30 Sep 15 in this case) from my custodian to use in my annuity calculation? If neither, what balance should I use that meets the IRS 72t rule to calculate my annuity payment?

4. How do I ‘inform’ the IRS that I’m using the 72t exemption rule? IAW, how do I communicate with the IRS/what form or documentation do I file with my tax return that shows them how I determined the distribution amount (i.e., the fed mid-term rate used, the present value used, and the annuity method used)? I realize I will report the IRA distribution as income on my 1040, but I’m not sure how the IRS will know that the amount declared meets the 72t exemption rule, particularly if my custodian doesn’t code the 1099B accurately.

5. On that point, how should I inform my IRA custodian of my 72t exemption to insure they code my 1099B correctly as an “early distribution with exemption” vs “an early distribution without exemption” and prevent them from withholding 10% penalty tax or raise a flag to the IRS?

I know this is a lot to ask, but I need to clarity on these tactical details to feel confident requesting using the 72t rule and requesting my first distribution from my IRA custodian.

Thank you so much for the help.

Mike C in Ohio



Submitted by Alan - IRA critic on Sat, 2015-09-19 23:12

  • 1. Assuming I take my first annual distribution on 15 Oct of this year, are there any annual proration rules I must follow (e.g., only take 3/12th of the annual payment) or can I take the full annual annuity amount as determined by the IRS calculation method? (FYI, I plan on taking annual payments vs. monthly or some other mode)
  • YOUR OPTIONS FOR 2015 ARE EITHER 3/12 OF THE ANNUAL CALCULATION OR 100% OF IT. HOW YOU SPREAD THIS OUT IS IMMATERIAL AS ONLY YOUR TOTAL DISTRIBUTION REPORTED ON FORM 1099R IS WHAT THE IRS CONSIDERS.
  • 2. Should I take my annual distribution on the same exact day & month each year or does it matter so long as the exact annuity amount (dollar and cents) is taking each year (between 1 Jan and 31 Dec)?
  • PER ABOVE, THE FORMAT FOR DISTRIBUTIONS DOES NOT MATTER ONLY THE TOTAL. FOR EXAMPLE, IF YOU TAKE OUT 25% OF THE ANNUAL IN OCTOBER, YOU CAN WAIT UNTIL DECEMBER TO DECIDE IF YOU WANT THE OTHER 75% OR NOT. THE DATES OF DISTRIBUTIONS DOES NOT MATTER EITHER, AND THE FREQUENCY DOES NOT MATTER EITHER, JUST THE ANNUAL TOTAL.
  • 3. When determining the account value to use in the annuity calculation (i’m using the amortization method), can I use the account value as of 15 Oct when I call and request the distribution from my IRA custodian and using a “print screen” shot of my online account balance to document/record to the IRS the balance I used in my annuity calculation? Or should I use the latest “official” account statement (a/o 30 Sep 15 in this case) from my custodian to use in my annuity calculation? If neither, what balance should I use that meets the IRS 72t rule to calculate my annuity payment?
  • YES, YOU CAN DO THAT. A MONTH END STATEMENT FOR SEPT WOULD ALSO BE GOOD BECAUSE IT COULD SURELY BE REPRODUCED LATER ON IF YOU LOST THE SCREEN PRINT. IF YOU WANTED TO USE A HIGHER BALANCE YOU COULD GO BACK TO THE JULY STATEMENT AS WELL AS LONG AS THE JULY STATEMENT IS NOT MORE THAN 10% HIGHER THAN YOUR 10/15 BALANCE. USING A HIGHER BALANCE WILL OBVIOUSLY INCREASE YOUR CALCULATION. NOTE THAT THERE CANNOT BE ANY CONTRIBUTIONS OR DISTRIBUTIONS FROM THE ACCOUNT BETWEEN THE DATE OF YOUR BALANCE USED IN THE CALCULATION AND THE START OF YOUR PLAN.
  • 4. How do I ‘inform’ the IRS that I’m using the 72t exemption rule? IAW, how do I communicate with the IRS/what form or documentation do I file with my tax return that shows them how I determined the distribution amount (i.e., the fed mid-term rate used, the present value used, and the annuity method used)? I realize I will report the IRA distribution as income on my 1040, but I’m not sure how the IRS will know that the amount declared meets the 72t exemption rule, particularly if my custodian doesn’t code the 1099B accurately.
  • VERY FEW CUSTODIANS PROVIDE THE BOX 7 DISTRIBUTION CODE NEEDED FOR THE PENALTY WAIVER SO THE TAXPAYER WILL NEED TO FILE FORM 5329 TO CLAIM THE 72T EXCEPTION CODE 02. THAT IS ALL THAT GOES ON YOUR TAX RETURN BUT YOU NEED TO DOCUMENT YOUR CALCULATION AND ALL THE ASSUMPTIONS USED FOR THAT CALCULATION AND KEEP IT IN YOUR RECORDS IN CASE THE IRS INQUIRES ABOUT YOUR PLAN. KEEP YOUR ACCOUNT SCREEN PRINT THAT SHOWS A DATE WITH THE CALCULATION.
  • 5. On that point, how should I inform my IRA custodian of my 72t exemption to insure they code my 1099B correctly as an “early distribution with exemption” vs “an early distribution without exemption” and prevent them from withholding 10% penalty tax or raise a flag to the IRS?
  • THE CUSTODIAN WILL WITHHOLD 10% UNLESS YOU CLEARLY DECLINE WITHHOLDING. WHILE YOU CAN UTILIZE WITHHOLDING AT ANY RATE YOU WANT, THERE IS LESS RISK IF YOU DECLINE WITHHOLDING AND PAY QUARTERLY ESTIMATES. THAT WAY YOU HAVE CONTROL OF YOUR MONEY AND YOUR DISTRIBUTIONS ARE LESS LIKELY TO BE MESSED UP BY THE CUSTODIAN. DO INFORM THE CUSTODIAN THAT YOU ARE STARTING A 72T PLAN FROM THE IRA ACCOUNT, SOME MAY BE INTERESTED IN LOOKING IT OVER AND POSSIBLY CODING THE EXCEPTION ON THE 1099R, BUT AT THE END OF THE DAY YOUR PLAN IS BETWEEN YOU AND THE IRS, NOT THE CUSTODIAN. 

Submitted by Michael Copley on Sun, 2015-09-20 14:28

I really appreciate the clarity on my earlier 72t detail questions–very helpful–thank you. Since those questions, i’ve been exploring immediate annuity calculators and with my current insurance company.  I have a few more questions please.Can i use a life-time immediate income annuity product to meet the the IRS 72t rules?  Reason I ask is because when i enter the same lump-sum amount into the single-life annuity calculator (with death benefit), the annual amount (paid monthly) is roughly $200 more per year than using the annuity or amortization IRS-prescribed calculation under 72t at a 2.18% interest rate.  Since life-expectancy should be equal and 2.18% is the highest rate allowed by IRS code for the present month, it would suggest to me the higher insurance annuity amount would NOT meet the 72t distribution rules.  Am i correct on this?I guess, alternatively, I could taper back the annuity premium to the point the monthly payment doesn’t exceed a 2.18%-generated payment.  Since this is a maximum rate, i would assume an annunal amount that is slightly LOWER would make the insurance annuity viable.  And, my insurance company informs me they are familar with the 72t rule and will code the 1099 correctly.  Does this make sense?I appreciate your help on these matters; more specifically, how one specifially can use an insurance annuity (single-life immediate payout) that complies with the 72t code/rules.

Submitted by Michael Copley on Sun, 2015-09-20 20:11

Alan, you advised that I could go as far back to my Jul Statement for an Oct 15th initial annual distribution, so long as the difference in account value from 31 Jul doesn’t exceed 10% (and no contributions or distributions between the time period were made) from the 15 Oct value (or value when i drop off the request to my local office presumaby).  That actually does work in my favor. Could you point me to the IRS code or revenue ruling that explains this 10% threshold for determining account balance you mention please and the rule that tells me going back three months to establish my account balance is allowed?  Seems like the only rule on determining account balance is that the value must be reasonably determined.  So i’m trying to understand how going back to Jul is as reasonable as going back to the latest statement available (31 Aug in this case).  If IRS were to audit me and ask why I used Jul statement vs Aug or Sep statement, i need to have a good answer for that…citing the rule that allows me to choose the higher historical value.  Right now, as you correctly suggested, my Jul EOM account value is higher by 8% than the current balance today (I have numerous equities in the account).  I could actually take my first distribution start next week (instead of 15 Oct) by dropping off the distribution form with my local brokerage office.  If i do, i will screen shot the value as of tomorrow for my records so that I can show it’s value is less than 10% lower than my 31 Jul statement value.Thanks very much for the clarification on this finer detail.Mike from Ohio

Submitted by Alan - IRA critic on Sun, 2015-09-20 22:59

  • With respect to the account balance, the IRS has published only very general guidelines on most facets of 72t plans. The main document is RR 2002-62 http://www.irs.gov/pub/irs-drop/rr-02-62.pdf and the top of p 5 includes an example where the account balance used that was over 6 months old was deemed reasonable. That is all we have. The 10% is simply my judgement as a safe variation from the current value that the IRS would consider reasonable. And I would not go back more than 6 months in any case. A dedicated website to 72t plans that has it’s own forum (72tonthenet) has never had a post reporting that the IRS busted a plan for account balance considerations, so the time and variance thresholds that I suggest are conservative considering this fact. I have been monitoring and posting on that site for years. The 7/31 balance should be very safe for you to use.
  • On the proposed annuity IRA, how is the brokerage invovled? Typically, you would have to do a transfer of the IRA balance you wish to use (apparently the entire account in this case) to an insurance company to invest in an IRA annuity account. If you now transfer this IRA to a new insurance company custodian you create a possible IRS issue because the account balance statement will be on a different IRA account than the 1099R form will report for your 72t distributions. This should NOT bust your plan but it is less clear that it will not create more IRS scrutiny and questions. If you want to use an insurance IRA product, you should do the transfer and then use your opening account balance on that account to document your plan. Of course that account balance will be less than your July statement.
  • Using an annuity IRA presents extra pitfalls for a 72t plan, particularly if the IRA is annuitized. You would generally not annuitize the IRA annuity, you would just take annual distributions from it that match your 72t calculation. The account balance would not include any death benefit. After your 72t plan terminated, you could then annuitize it if you wanted to. If the insurance company will provide the 2 code on the 1099R, that is helpful in heading off any IRS scrutiny of the plan, but not a guarantee that the IRS would accept the plan if the payments changed from year to year or some other violation of generally accepted 72t plan rules occurred.

Submitted by Michael Copley on Mon, 2015-09-21 14:55

Alan, didn’t meen to confuse you.  I’ve been doing ‘what-if’ calculations over the weekend.  Right now, my IRA is with Schwab in a brokerage account.  Schwab and my Insurance company, USAA, both have annuity calculators.  I will either do a 72t plan from the brokerage account or transfer the money first to an new IRA annuity account…then annuitize.  As my earlier note explained, when i use the annuity calculator, it yields a higher amount of annual income over my life time than what the 72t calculator yields at 2.18%.  Both calculations assume life expectency.  Insurance annuities include mortality credits though, which is why i believe it yields a higher income stream than the 72t plan. That’s why i’m thinking about transfering to an annuity account.What I’m trying to figure out is does the IRS consider a single-life immediate annuity that is annuitized as meeting the 72t substantially equal periodic payment criteria even though the annual amount is a couple hundred dollars more than the 2.18% max rate (current) allowed using the IRS annuity or amortization method. You have any additional thoughts on this before I punt?

Submitted by Alan - IRA critic on Mon, 2015-09-21 17:55

OK – the IRS only authorizes 3 calculation methods for 72t plans. There is no penalty exception for life annuities for IRA accounts, although there is for non qualified annuities. Any calculator that does not state that it is constructed for 72t plans will not produce an annual distribution amount that complies with the requirements. An insurance company should not be using code 2 on the 1099R in this situation, but they might be confused because almost all of their annuitized contracts are non qualified annuities or pension plans that get code 2 due to separation at age 55 or later. Some people use an IRA annuity in their 72t plan, but they are not annuitized and the annual distribution is determined by one of the 2 fixed dollar methods, or rarely using the RMD method.

Add new comment

Log in or register to post comments