SEPP Scenarios Requesting Assistance

Submitted by Carolina Williams on Wed, 2019-09-04 01:21

Background info for SEPP Questions:

DOB is Feb 20 1964 so turned 55 1/2 on Aug 20 2019 and plan to take first year full amount distribution on Sept 17 2019.

Plan to separate 401K IRAs from several different employers so that 700K is in the SEPP pool and 70K is outside of the SEPP based on Dec 31 2018 values in accounts.

Plan on using the RMD Method with the Uniform Life Table and will use the EXACT amounts in my accounts on Dec 31 of the previous year for calculations.

Have emergency funds (ROTH IRA contributions, stocks) available to tap without penalty and avoid busting the 72t before the 5 years are up on Sep 17 2024 as I realize using the RMD method results in lower annual payouts.

(1) Can I separate my 401K IRAs and leave the 70K outside of the SEPP pool so that I can dip into it without restrictions once I turn 59 1/2 on Aug 20 2023?

(2) The first year calculation using the Uniform Table for age 55 appears to be $700,000 / 41.6 (age 55 number) so my SEPP distribution for this year 2019 is 16,826.92, correct?

(3) If my math is right in #2 above, then I would divide the amount in my accounts as of Dec 31 the previous year for 5 years until I reach 59.5 so 2019, 2020, 2021, 2022, and 2023. The Uniform Life Table shows 41.6, 40.7, 39.7, 38.7, and 37.8 for ages 55 – 59. Is this all accurate?

(4) Am I able to take the payments at any time during the year? For example, I plan to take first payment in about 2 weeks on Sep 17, 2019. Can I take my 2020 payment for year 2 at anytime during the year say in Jan 2020 or May 2020 or do I have to wait until a full year goes by so forced to take the full payment after Sep 17 2020? Does same timing of payment rule apply for all following years including the final year in 2023 when I turn 59 1/2?

(5) After I take the 5th and final payment sometime in 2023, then I cannot take any more 72t distributions from the SEPP until AFTER Sep 17 2024 so that I complete the full 5 year anniversary cycle, correct? If so, after Sep 17, 2024 I can take out any money I want from my SEPP 401K IRA accounts with no 10% early withdrawal penalty as the SEPP 5 year / 59.5 age rules will be satisfied, correct?

(6) I plan on withdrawing all payments from one 401K IRA with about $150K in it right now. If it somehow goes to $0 before the 5 years of SEPP distributions are up, can I take money out of another IRA that is part of the SEPP pool?

(7) Will the IRS be concerned that I will need to recalculate distribution amount every year due to RMD method via Uniform Life Table and make it more likely for me to be audited? Is there a way to indicate method used on IRS tax form?

(8) Will the holder (aka Vanguard, Fidelity, etc.) of my 401K IRA be able to indicate on the tax documentation they send me that my distributions are from using SEPP and do not incur the 10% penalty? If not, is it form 5392 that I have to file if broker will not mark payment as SEPP? What percentage of taxes (20%?) are withheld from SEPP payments?

(9) Finally, are there any “gotchas” that people seem to overlook when setting up their SEPP that causes them to be hit by the 10% early withdrawal penalty and interest charges by the IRS?

I apologize for the lengthy set of questions but I want to avoid making any costly errors. THANKS again for all of your assistance…much appreciated!!



Submitted by Alan - IRA critic on Wed, 2019-09-04 04:32

  • Please confirm – I think you have rolled over all the 401k balances to some number of IRA accounts. When was this done, and how many IRA accounts do you have now?  Note that you cannot use a balance from an account if there have been any transactions to or from that account after the date of the balance you wish to use. Generally, you also should not use a balance over 6 months back.
  • It is not recommended to use the RMD method because you will have to make 5 calculations, so 5 times the risk of error. In addition, the RMD method will produce a much smaller distribution per dollar of account balance than a fixed dollar method, and you eliminate the option of making the one time switch to the RMD method in a later year if you do not need as large a distribution. For the fixed amortization method for example, you would determine how much you need in distributions, the partition your IRAs by direct transfer to produce a starting balance that yields exactly what you need. This enables you to leave a larger amount outside the plan for emergency needs, assuming you have a sufficient total balance. The IRS rarely sees an RMD method and do not expect your distribution to change every year, so RMD will attract more attention.
  • Simplicity is best as you do not want to have to explain any complex arrangement to the IRS and hope they understand it. You should have just one IRA account to fund your 72t plan, with the rest in one or more accounts outside the plan.
  • For a 5 year plan such as you plan, you should take a full annual distribution before year end. In each of the next 4 years you can take this distribution in any combination of distributions and timing that you want. For the 6th calendar year (2024) you should not take any distribution before the plan ends 5 years from the date of your first distribution this year.
  • I can address your other questions after you clarify the issues raised above, but neither Fido or VG will show the 72t exception code on Form 1099R, so you will have to file a 5329 each year to claim the penalty exception. Due to various complex issues, they do not wish to underwrite the accuracy of your plan.

Submitted by Carolina Williams on Wed, 2019-09-04 13:51

Alan, you have convinced me to use the Fixed Amortization Method as I can use a lower 401K balance to generate the same annual distribution that I need for living expenses.

  • I will add the values of two of my 401Ks from Fidelity to determine the starting account balance BUT I would like to leave the money in the 2 separate 401Ks.  
  • Do I really need to transfer the funds out of both accounts into one IRA account to fund the 72t plan?  If so, can Fidelity handle that easily?  If I do transfer the money into one IRA account, then I would use that starting balance when figuring out the fixed amortization amount – is this accurate?

 

  • Let’s assume NO TRANSFER into one IRA account so 401k Account 1 has a value of $300K and 401k Account 2 has a value of $185K as of the June 30, 2019 account statement from Fidelity.  Note:  I will use the EXACT figures when performing the one time fixed amortization calculation.
  1. Important:  If I plan to take a distribution early next week (say Sept 10), can I used the June 30, 2019 balances or must I use the account balances on Sept 10 for the one-time fixed amortization method?  Can I use any balance between Dec 31, 2018 and Sept 10, 2019?
  2. I am married but I believe I can use either the Uniform Lifetime or Single Life Expectancy Table, correct?
  3. I plan on taking the money out of just one of the 401K accounts (probably the one with $185K) 
  4. The 120% of Applicable Federal Midterm Rates that I can use per IRS guidelines is either the July (2.5%) or August (2.24%) as these are the 2 months preceding the Sept 2019 distribution regardless of which date I used to calculate the account balance, correct?
  5. I used the 72t Calculator on BankRate for Fixed Amortization Method with the following figures:  485K balance, 2.5% interest rate, my age is 55, and beneficiary (wife) age is 51.  Single Life Expectancy value comes to $23,384 and Uniform Life is slightly lower at $23,283.  Does this all sound correct and is there a really good 72t calculator online that you can direct me to for doing this calculation?
  6. In the following years of 2020 – 2023, if I use the Single Life value, then I can take out $23,384 any time I want during the calendar year (does not have to be on Sept 10), correct?
  7.  The fixed Amortization Method will allow me to keep all of my other 401k’s outside of the SEPP so I will have about 300K for any emergency purposes and would incur the 10% penalty only on the amount I pulled from these outside accounts prior to turning 59 1/2 on August 20, 2019, correct?

Alan, thanks again for all of your help!

Submitted by Carolina Williams on Wed, 2019-09-04 14:21

Alan, I have NOT rolled over my 401K accounts.  I have 4 accounts from different employers with Fidelity and 1 account with Vanguard.  Based on your analysis and suggestion about using fixed amortization method, I now want to use only two 401K accounts from Fidelity totalling about 485K to fund my SEPP but it sounds like you are suggesting combining these two 401K accounts into one IRA account to fund the 72t plan.  Please see next comment below for questions about fixed amoritization method and how to proceed. 

Submitted by Alan - IRA critic on Wed, 2019-09-04 16:08

  • While it is legal to set up a 72t plan using a 401k account, it is risky because you do not have complete control of that account, the employer does.  Therefore, it is advisable to do a direct rollover of as many 401k plans as you need to generate the 72t distribution amount needed. The other 401k plans can stay in place. You should roll the 401k plans into a single rollover IRA and use the account balance of that IRA after ALL rollovers are completed. You can use a balance up to the day before your first distribution, but there is probably not enough time to get the rollovers are all by 9/17.
  • If you want to accept the possible risks in running your plan directly from a 401k, then you need to be sure there are no issues with these plans, such as any pending corrective actions due to any recent contributions you made (for example if you were an HCE).  You also need to be sure that these plans support partial annual distributions. Since 401k plans cannot be aggregated for any other purposes, if you still want to do this, it would be safer to run separate 72t plans from EACH 401k. These two plans would be totally independent of each other, meaning you could use a different account balance date for each, different interest rates, etc.  If one plan is busted for whatever reason, it will not affect the other. Of course, you will get a 1099R for each. If either plan includes a Roth 401k balance, please advise.
  • Since interest rates are falling, you would probably want to use the July rate, but if your first distribution is not done in Sept, you will have to use the lower August rate. You should use the highest rate published for either of the two months prior to the month of your first distribution. You can use a lower rate, but that will generate a lower distribution. Use the single life table as that will produce the highest distribution, and you can use this despite being married. Do not enter beneficiary info. Once you are done with the calculation, you won’t have to do any more calculations, just distribute the same dollar amount each year for 2019-2023.
  • If you have a need for additional funds, you can roll another 401k account over to a new IRA or take a distribution from a 401k not included in your plan. You can then take a distribution from that new IRA that will not affect the 72t plan, but you will owe the penalty on the additional distribution, if prior to 59.5.
  • Since the highly regarded “72tonthenet ” site was discontinued in May due to retirement of the site owner, bankrate is about as good as any, but I would double check that calculation  with another calculator. Fidelity Investments has one you can use as a guest. 
  • Your observations are mostly correct, except that I am still concerned about the account set up. If 23,384 is an acceptable annual distribution for your spending needs, then you need to do a direct rollover of both the 300k and 185k 401k plans into a rollover IRA, which will fund your plan OR instead run a plan from each 401k directly.

Submitted by Carolina Williams on Wed, 2019-09-04 18:20

Alan, you have convinced me that it is safest to take the Fidelity 401K plans and put them into a Rollover IRA with Fidelity.  One of my four 401Ks worth about 185K has company stock so I decided not to use it in the rollover and instead use the three other 401Ks that will still get me roughly the 485K that I need to fund the 72t plan.  NONE of the 401ks is a Roth IRA.  Here are my next steps:

  • Call Fidelity this week and have them setup a rollover IRA in preparation for moving the 401k funds.
  • After the rollover IRA is established, call Fidelity again and have them move the entire balances from the three 401ks that I will use to fund this 72t plan.
  • After ALL rollovers are completed, I can then watch the closing value of the account each day and when it gets close to the 485K, use the exact balance to calculate the annual amount to be distributed using the fixed amortization method calculators on several sites to confirm correct value.
  • Take first distribution before the end of Sept (if possible) so that I can use the 2.5% interest rate from July.

Alan, how long do you think it will take for Fidelity to establish the rollover IRA and move the funds completely from the three 401Ks?  Any chance they can do it by the end of Sept so that I can get distribution by Sep 30 and get to use the much higher July interest rate?  Since the rollover IRA and the 401ks are all with Fidelity, I am hopeful it can be completed in a couple of weeks.  Thoughts?

Submitted by Alan - IRA critic on Wed, 2019-09-04 20:09

Unless there is some complication in the rollover process, you should be able to complete the direct rollovers to a single IRA account and take your first 72t distribution by the end of Sept. Once all the accounts have been consolidated in the rollover IRA, you should make a copy of your on line account showing the balance and keep that copy along with the calculations for your plan. This should be a simple plan setup that should not be confusing to the IRS as there will be only one 1099R issued for the same amount each year. 

Submitted by Carolina Williams on Thu, 2019-09-05 16:07

Alan – I setup the rollover IRA account with Fidelity and the money from my 401ks will be moved after close of trading today.  Thanks for all of your assistance…much appreciated!!

Submitted by Carolina Williams on Mon, 2019-09-09 18:46

Alan, please confirm my 72t calculation is correct.  

  • My DOB is Feb 20 1964.  Spouse DOB is July 27 1968.  
  • Will take first distribution this month (Sept 2019).  
  • IRA Balance as of Sunday (Sep 8) is $486,368.57.  
  • Use Single Life Expectancy.  
  • 120% Federal Midterm Interest rate will be 2.5% from July 2019.  
  • Fixed Amortization Method will be exactly $23,449.61

Does this sound correcct?  I plan to take this year (2019) as one-time payment of $23,449.61.  

  •  Also, I assume if I want to go to monthly payment stream in 2020, then it would be $1.954.13416 which rounds DOWN to $1,954.13.  
  • I believe the IRS wants an EXACT amount to the penny so I cannot round the original $23,449.61 to $23,450 for the annual amount or when doing the monthly payout calculation – correct?

 

Submitted by Alan - IRA critic on Mon, 2019-09-09 23:39

Your figures are correct, but the Fidelity calculator rounded the annual to 23,450 even. You can use your rounded monthly figures, and on your 1040 line 4 you will show 23,450 for both 2019 and later years when you take the rounded monthly amounts. I have not heard of the IRS requiring pin point rounding or busting any plans for minor differences in rounding. However, in 2020 when you set up monthly installments, try to get the payout date between the 5th and 20th of each month. Avoid the first few days or the last few days of the month to avoid issues with the Dec distribution being missed or the Jan. distribution being made too early. 

Submitted by Carolina Williams on Tue, 2019-09-10 00:56

I am tempted to just get the payments on a one-time annual basis for 2020 – 2023 and eliminate the chances of an error in distributing the monthly payments (missed Dec / early Jan) by Fidelity.  

  • Are there any disadvantages to getting the payment in one lump sum of $23450 each year at anytime I want from the rollover IRA besides the fact of having to manage the money to last the whole year and divide it up myself to cover monthly expenses?  
  • Given that I will take the first annual distribution later this week around Sep 12, my annual payment in 2023 (year 5) of the 72t plan must be taken by Aug 2023 and after that I cannot take any more payments from this rollover IRA until Oct 2024 to ensure I don’t bust the 72t plan.  However, I can take money from my other retirement accounts like 401ks after I turn 59.5 after Aug 20, 2023.   Is this all accurate?  
  • Finally, does it make sense to wait until at least Jan 2025 to tap the rollover IRA to ensure no issues with IRS regarding SEPP from my 72t plan?

Submitted by Alan - IRA critic on Tue, 2019-09-10 01:25

  • No other disadvantages. The fewer distributions, the less chance of an error in execution. Of course, you could take 2 distributions 6 months apart (eg March and Sept), which would be a reasonable compromise in transactions and perhaps money management.
  • You do not have to take the 2023 distribution by August. You have until December. But best not to take any 72t distribution in 2024 before the plan terminates. You will have taken the required 5 years worth by the end of 2023. Correct, no restrictions on distributions from any other retirement accounts outside the plan.
  • Yes, as long as you have other sources of funds, it makes tax reporting and your 72t plan simpler by avoiding a 1099R on the 72t IRA for 2024. Less chance of any type of IRS inquiry. 

Submitted by Carolina Williams on Wed, 2019-12-04 19:47

2019 Rollover IRA and 1099R Form Info for Distribution  Alan – please start at CONFIRMATION 72T CALCULATION entry for detailed info for this question.  I rolled over three 401Ks to a Rollover IRA (all accounts with Fidelity) which was completed on Sept 5 2019.  All money total of $486,368.57 was moved internally by Fidelity and never touched my hands.  I then took  72T distribution on Sep 11 2019 of $23450.

  1. Will the 1099R form show just the distribution of $23450 and the taxes I had withheld for Federal (10%) and State (5%) or will it also show the entire amount that was rolled over of $486,369?
  2. On the 5329 tax form, will I only show the $23450 that was distibuted early on Line 1, then enter exception number 02 (SEPP) for Line 2?  Will I ever have to show the entire amount that was rolled over so that IRS has it for their records as they track my 72t plan?
  3. I took my first distribution on Sep 11 2019 when I was almost 55 and 7 months (so past 55.5 years old).  Your earlier responses above indicated I can take my future distributions of $23450 ANYTIME I want in 2020, 2021, 2022, and especially 2023.  My current plan is to take annual distributions each year in Sept.
  4. On Aug 20, 2023 I will turn 59.5 years old.  If I take the distribution early in 2023 will that mess up the 5 years of distibutions or turning 59.5 requirement?  Should I wait until after I turn 59.5 so let’s say Sept 2023 to take that final distribution to hit the 5 years of distributions AND the 59.5 requirement?
  5. Finally, it sounds like it would be best to take NO distributions from the Rollover IRA in 2024 (the year I turn 60 in Feb) so that the IRS will realize that I have completed my 72t plan because I turned 59.5 and took distributions for 5 years by the end of 2023.  
  6. With respect to items (4) and (5), I think I am getting confused by which PART of the requirement is relevant for me:  5 Years vs. 59.5 Age.  Can you please shed some light on this situation?

Alan, thanks again for all of your help…much appreciated!   

Submitted by Alan - IRA critic on Thu, 2019-12-05 01:26

  1. You will get a 1099R from each 401k plan reporting a G coded direct rollover of the plan balance. You must report this on line 4c and 4d of your 1040, but none if this is taxable. This is the ONLY place you will have to show the 486k figure.
  2. You will also get a 1099R from your IRA custodian reporting your IRA (72t) distribution of 23,450. This 1099R will probably be coded 1 (early), so you will have to claim the 72t exception by filing Form 5329 and entering exception code 02. This 1099R only shows the amount you distributed from the IRA. 
  3.  This is fine.
  4.  Since your first distribution was after age 54.5, your plan terminates 5 years from the date you received your first distribution. You can still take your 2023 distribution anytime you wish, but if you take it after you reach 59.5, the 1099R may be coded 7 (normal). If it is coded 7, you do not have to file the 5329, but if they code it 1, file the 5329 as you have done in the prior years. If you can wait that long, it is better to take your 2023 distribution AFTER you reach 59.5. The reason is that if you ever bust your plan (or the plan was not valid from the start according to the IRS) the post 59.5 distribution will not be subject to retroactive penalty since it would not have been penalized if you did not have a plan. In other words, this would limit the damage of a busted plan.
  5.  Yes, this is correct. For a 5 year plan that ends after 59.5, it is safer to stop your distributions with the 5th calendar year (2023), which means no distribution in 2024 until after 9/11/2024.
  6.  The key is that you have a 5 year plan, because that is when it ends. 59.5 does not affect your plan except if you bust it as I indicated above. The usual error people make is that they think the plan has ended after the 5th distribution and then they take a random additional distribution before the 5 years is complete, and that random distribution busts the plan. The plan does not end until 5 years from the date of the first distribution.   NOTE: If you happened to need funds in 2024 prior to 9/11, and you took the same distribution you have been (a 6th calendar year distribution), the IRS would probably not bust your plan, but there is a small risk that they might, so it is best to not take a 2024 distribution until after 9/11.

Submitted by Carolina Williams on Thu, 2019-12-05 03:29

I just checked the IRS website for 1040 and 5329 forms for tax year 2019 and the associated instructions.  Let me make sure that I am understanding this correctly based on your response above:

  • On 1040 form – Line 4a gets $23450 to show the distribution from the rollover IRA.  Line 4b also gets $23450 as all of this amount is taxable.

 

  • On 1040 form – Line 4c gets $486369 to show the TOTAL amount rolled over from the three 401ks.  Line 4d gets $0 as none of the money rolled over by Fidelity from the 401ks to the new rollover IRA is taxable.  Also, the instructions indicate to write “ROLLOVER” next to line 4d.

 

  • On 5329 form, Part I – Line 1 gets $23450 to show the early distribution included in income.  Line 2 gets the same $23450 as all of the amount shown in Line 1 is NOT subject to additional taxes.  Line 2 Exception code gets filled out with a 02 to show the SEPP / 72t exception.  Line 3 gets a $0 when you subtract line 2 from line 1.  Line 4 also gets a $0 as there is no additonal 10% tax due.

Alan, does this all seem accurate?  I apologize if this info seems basic but I want to ensure that I fill out the tax forms correctly for 2019 as it will set me up for success in the following years.  Of course, there will be no rollover of 401ks in future years so in 2020 – 2023, Lines 4c and 4d will be left blank.  Thank you!  

Submitted by Alan - IRA critic on Thu, 2019-12-05 03:40

Yes, you are entirely correct. If you file with a tax program, the forms generated should follow the above, but it is good to know what they should look like if you plan to use a tax program – or even if you use a fee preparer because they do not always get this right.

Submitted by Alan - IRA critic on Wed, 2020-01-01 21:08

There has been no indication that the IRS is concerned with rounding conventions. Remember, the “S” in SEPP stands for “substantially”. If set up monthly or other automatic distributions to be equal, you will have to round them to the nearest penny, so you will always be a few cents over or under your indicated annual amount. As for the initial balance, enter the exact balance that you can document with a statement copy or screen print, but if the calculator you use rounds to the nearest dollar, don’t worry about the cents. You will find that some calculators make different assumptions about how often during the year you plan to take distributions. If you run into one of those, just elect annual payment. You are free to take your distribution in whatever pattern you wish.  The only thing that matters is what the 1099R adds up to for all distributions during the year. 

Submitted by Bruce Capasso on Thu, 2020-01-02 17:54

Thank you Alan. Bruce.

Submitted by Bruce Capasso on Thu, 2020-01-02 17:46

Hello, I was wondering if you could answer a few question regarding calculation on the IRA balance and the distribution being to the penny. I am 54 with a 12/25/1965 birthday. Lets say the day I select for the SEPP 72t balance is 1/15/2020 and the IRA balance is $401,225.27. Using the single amortized method, do I round that to $401,225 for the calculated balance? Also, many online SEPP 72t calculators round the balance and distribution however I’ve read it has to be to the exact penny. Is there and accurate to the penny calculator you can recommend? Thank You, Bruce Capasso.

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