How to avoid the 10% penalty pre 59 1/2

Submitted by Waldemar Sender on Fri, 2019-09-13 16:38

Hi – I wanted to check with you whether annuitizing the IRA annuity for the period certain which would be equivalent to the life expectancy, would avoid the 10% penalty? I know the other options are SEPP or straight life expectancy. The owner of the contract, in case of early death, wishes to have any residue money to be paid to the beneficiary for the remainder of period certain. Thank you.



Submitted by Alan - IRA critic on Fri, 2019-09-13 18:50

No, there is no annuitization penalty waiver for IRA distributions. For continuing penalty waivers a SEPP must be set up using one of the 3 approved calculation methods. Of course, there are other penalty waivers such as high medical costs, higher education costs, disability, etc but many of these costs are not consistent from year to year. Another consideration when annutizing an IRA before 70.5 over life expectancy or joint life expectancy is that the first distribution date becomes the RMD required beginning date. As such all these payments are RMDs and not eligible for rollover. 

Submitted by Waldemar Sender on Fri, 2019-09-13 19:06

Please find the clarification, my original question referes to the IRA is set up in annuity contract, the ways to avoid the 10%  penalty pre 59 1/2 are: SEPP and annuitization for a life expectancy (disregard the medical, education costs, disability.)  The question came up – if the contract is set up just as a stright life annuitization, upon passing the payments end.  I assume if the straight life annuitization is set up with a period certain or with cash refund, that would also avoid 10% penalty?

Submitted by Alan - IRA critic on Fri, 2019-09-13 19:28

  • Simply annuitizing an IRA does not qualify for a penalty waiver. It might for a NQ annuity per Sec 72(q)(2)(I) but the IRA penalty waivers are in 72(t) and there is no annuity penalty waiver there.  One of the 3 SEPP calculation methods per Notice 2002-62 would have to be used to waive the penalty. Of course, once the IRA owner passes, both the plan ends and the need for a plan ends since beneficiaries never pay an early distribution penalty.
  • The same issue comes up with traditional DB pension plans, which pay out as a function of years of service and average salary. While the age 55 separation exception is more favorable than reaching 59.5, if someone retires prior to 55 (except public safety officials) and starts pension payments they will be subject to penalty since these plans also fall under Sec 72t, not 72q..

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