IRA money used to purchase Immediate Annuity before 59.5 Penalty?

Submitted by Stanley Ng on Tue, 2015-12-01 21:15

IRA money used to purchase Immediate Annuity before 59.5
Would there be a 10% penalty for the payments received before 59.5

I see the Annuity in Pub 590 (page 56):

Annuity. You can receive distributions from your traditional
IRA that are part of a series of substantially equal
payments over your life (or your life expectancy), or over
the lives (or the joint life expectancies) of you and your
beneficiary, without having to pay the 10% additional tax,
even if you receive such distributions before you are age
59 1/2. You must use an IRS-approved distribution method
and you must take at least one distribution annually for
this exception to apply. The “required minimum distribution
method,” when used for this purpose, results in the
exact amount required to be distributed, not the minimum
amount.

The other 2 methods are the fixed amortization and fixed annuitization method. Both require using no more than 120% of fed midterm rate. So I am guessing that these 2 methods don’t match up with an immediate annuity.

Looking at the immediateannuity.com website. It says an IRA immediate annuity before 59.5 would not be subject to the 10% tax penalty

https://www.immediateannuities.com/roll-over-ira-or-401k/

Please help clarify what is correct?

Thanks



Submitted by Alan - IRA critic on Tue, 2015-12-01 23:37

You ask a very good question, which causes alot of confusion. The immediate annuity article is incorrect regarding the penalty exception. As you indicated, since this is IRA money and not a non qualified immediate annuity, receiving penalty free distributions prior to 59.5 must meet a penalty exception per IRS Pub 590-B. Assuming another exception such as higher education expenses, disability, etc do not apply, then to apply the “Annuity” penalty exception, the distribution must be calculated exactly with one of the 3 specified methods that are outlined in RR 2002-62. Since the insurance company immediate annuity calculation would only match up to one of those calculation methods as a mathematical fluke, using the payout calculated by the insurance company would not match up to one of those 3 methods, and accordingly the penalty would be due on distributions received prior to 59.5. Worse yet, an immediate life annuity with an IRA is deemed to be an IRA RMD even when started long before 70.5. The required beginning date for RMDs from that IRA are moved up to the date of the first payout. SInce these distributions are considered RMDs, they cannot be rolled over. It is odd that a 10% penalty would be due on an RMD, but that penalty would be due since the IRA is being distributed prior to 59.5 with a calculation that does not exactly match one of the 3 methods. Conversely, a non qualified annuity that is annuitized receives a pure immediate annuity penalty exception under Sec 72q. This exception is not available for IRA money and that is where the article goes awry.



Submitted by Stanley Ng on Wed, 2015-12-02 12:40

Alan, Thanks for that explanation.  That is mistake that would have been a disaster.  Now what if the money is in a cash plan pension (as opposed to a regular pension plan that pays based on years of service and salary) that offers an immediate annuity.  If taken before 59.5, what rules govern this scenario as to a 10% penalty tax.Also now that I writing this, is a regular pension plan as described above in parenthesis,  if paid out before 59.5  not subject to the 10% early distribution penalty tax?  



Submitted by Stanley Ng on Wed, 2015-12-02 13:46

Even Taxact.com says an annuity is considered an early distribution exception to the 10% tax for a qualified plan (pension question above) or IRA(original question).   Maybe the immediate annuity does qualify as one of the 3 methods??   https://www.taxact.com/tax-information/tax-topics/7-things-to-know-before-you-take-early-withdrawals-from-your-retirement-plan.asp

  • Distributions as part of series of payments over life expectancy, such as an annuity

The question is what do they consider an annuity



Submitted by Alan - IRA critic on Wed, 2015-12-02 18:43

  • A cash balance plan is still a qualified plan, and the immediate annuity penalty exception only applies to non qualified annuities. However, if the cash balance plan or any employer qualified plan purchases an annuity for retirees, the penalty would apply. Usually, the separation from service at 55 penalty exception will result in a penalty waiver at 55 rather than 59.5 so most early retirees get a 1099R with code 2 which waives the penalty on all distributions at 55 except when the retirement took place prior to 55.
  • I consider the article misleading with respect to the statement regarding an annuity from an IRA or qualified plan getting an unconditional penalty exception. Sec 72t which assesses the penalty on qualified plans contains no such exception other than equal payments calculated using one of the approved methods. Conversely, section 72q applies to non qualified annuities and does include an exception for immediate annuities which are not conditioned by those 3 methods.
  • That said, if the insurance company paying out annuity payments codes the 1099R with the penalty exception, the IRS is unlikely to question it. Some taxpayers may also be filing a 5329 and claiming a penalty exception using the substantially equal payments code and the IRS may not be asking to see the calculations to determine if it matches one of the 3 approved methods.


Submitted by Stanley Ng on Wed, 2015-12-02 19:52

Now its getting interesting, I agree that the IRS only has only the  3 methods that the before 59.5 distribution must match for substantially equal payments exception, but the many articles i see all assume that an annuity would satisfy the SEPP exception.   I guess the coding is the key if the IRS does not verify.Now what about a state pension that the person is vested and received a monthly check at age 45.  I have called the state retirement board, and they don’t think a early distribution would apply.    I think a lot of state employees can be fully vested after 20 years of service with no age requirement to be entitled to a monthly pension when they separate from service.  I see that you said its a qualified plan, but is there a subcatagory where some different rules would apply to the early distribution?



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