72t plan with TIRA

Submitted by Doug Stecklein on Sat, 2020-12-12 20:38

Looking for guidance on starting my 72t plan.

I am 42 years old and my birthday isn’t until July 14th. I am assuming I will use 42 as my age in the first year of the plan to calculate my life expectancy??
I plan to take my first year’s withdrawal in the 1st or 2nd week of 2021.
I will use the beginning account balance on Dec. 31st 2020 and Dec. 31st of each year thereafter.
I have already rolled some of the funds over to another TIRA.
The 72t TIRA will not be touched after the 72t plan starts.
TD Ameritrade says they will characterize the withdrawal as an exception to the early withdrawal penalty so i believe I will just need to get the 1099 for the withdrawal from the IRS and report it on my tax return. No other reporting to the IRS needed to be done on my part?

I will use the CalcXML & Bankrate 72t calculators to calculate my yearly withdrawals. I will also triple check using the IRS life expectancy tables.
I will be using the single life RMD method to calculate my variable yearly withdrawal.
I realize starting a 72t plan at the age of 42 is a risky proposition so I want to make sure I have thought of everything.
Please let me know if there is anything I have missed.
Thank you!



Submitted by Alan - IRA critic on Sat, 2020-12-12 22:03

  • If your first 72t distribution will be taken in 2021, your age used should be the age you will reach in 2021. Sounds like the correct age is 43.
  • Use of the RMD method is not recommended for the following reasons. 1- It produces a lower amount per dollar of account balance.  2- It requires a new calculation every year, which in your case means  17 independent calculations and 17 times the chance of a calculation error  3- It may attract IRS attention because the IRS is most used to fixed dollar method 72t plans where the distribution amount remains the same each year. 4- It eliminates the one time switch option to the RMD method from another method if you wish reduce your payout in the future.  You will also have to deal with new IRS tables starting in 2020, which will slightly reduce RMD method calculations. Estimated reduction about 6%. So even though today’s record low interest rates for the fixed dollar methods reduces the calculation gap between them and the RMD method, I would avoid the RMD method.
  • If TDA will code the distributions as code 2, that will save you having to claim the penalty exception using Form 5329. Very few custodians will do that anymore. They are being purchased by Schwab, so this might change. There are no other 72t plan tax reporting requirements unique to these plans. If your IRA includes any basis, you would complete Form 8606 as usual to calculation the taxable portion of the 72t distribution.
  • If you still want to go with RMD, the single life table will provide the largest calculation using RMD.
  • Of course, you already know that a 17 year plan has a high risk of falling short of your needs due to inflation or a financial shock. That tends to lead to a busted plan, but due to the retroactive penalty and interest for busting a plan, better to happen early in the plan rather than later.  Therefore, if you think early on that your plan will not produce enough income, better to voluntarily bust it and start new plan that looks more likely to last to  59.5.

 

Submitted by Doug Stecklein on Sun, 2020-12-13 17:11

Thank you Allen for the thorough response.  After hearing your advice and reading through some of William J. Stecker’s, A Practical Guide to 72t’s, https://retireearlyhomepage.com/rpt003e4.pdf I am once again unsure about whether I am willing to take on the high risk associated with a 17 year long 72t plan.I created a table(like on page 40 of the document) that calculates penalties & interest for each year of the plan if it were busted.Assuming my withdrawal predictions are correct I would owe $100,000 in penalties & interest if the plan was busted in year 10, & $300,000 in year 17.I could do everything perfectly for 16 years and then one simple mistake in year 17 could cost me $300,000!!!That just seems absurd to me.  The punishment should match the crime, and this absolutely does not.  By creating a rule that assesses Penalties and interest on every year of the plan for one mistake, the IRS has turned SEPP’s through 72t into a giant tax trap.Had I known about the intricacies of this rule I would not have put 100% of my life savings in retirement accounts throughout my career.  

Submitted by David Mertz on Sun, 2020-12-13 19:30

You might consider converting some amount to a Roth IRA each year.  Once at least 5 years have passed from the beginning of the year in which you make each particular distribution that was converted to Roth, that particular amount could be taken out of the Roth IRA tax and penalty free.  Taking this approach instead of a 72(t) plan would either mean delaying taking distributions and having access to the cash from the Roth IRA until at least 2025 or taking additional distributions as early distributions between now and then, subject to the 10% early-distribution penalty (or perhaps doing a 72(t) plan on a smaller amount).  However, doing Roth conversions would mean paying the taxes now but not having penalty-free access to that cash until at least 2025, so the money for the taxes would have to come from elsewhere.  (The Roth-conversion approach would have been even more viable had it been started in 2016 since the amount converted in 2016 would have been distributable penalty-free at the beginning of 2021, only a few weeks from now.)

Submitted by Doug Stecklein on Mon, 2020-12-14 00:50

Thank you for the alternative options DMx.I have looked into the Roth conversion ladder, and waiting 5 years and paying the taxes 5 years in advance are both deal breakers for me. I am not worried as much about busting the 72t plan due to forgetting to take a distribution or calculating the wrong distribution amount.My wife & I have run a business for 20 years so I would say we are responsible enough to manage those things.I am more worried about the unknowns.Can you tell me if everything in my plan looks correct, or if there is something I may be forgetting? TIRA balance = $1,500,000.My 1st withdrawal will be in the first couple weeks of 2021.My beginning balance will be determined on 12/31/20.My current age is 42, but I will be turning 43 next July. I have been told to use the age that I will be turning in that year to calculate my life expectancy.Using the single life RMD method, a theoretical TIRA balance of $1,500,000 on Dec. 31st 2020, and an age of 43 my distribution amount should be $36,855.I will recalculate my withdrawals each year using the new account balance on Dec. 31st of the previous year and the age I will turn in that year.TD Ameritrade has informed me that they will characterize the distribution as an exception to the early withdrawal penalty so the only reporting I should need to do is the additional income I’ll need to report from the 1099 TD Ameritrade will send me each year.I know that I have to take the RMD every year until age 59 1/2.I know that I cannot touch the account other than that.   

Submitted by Alan - IRA critic on Mon, 2020-12-14 01:48

  • Your numbers check out for your initial 2021 distribution.
  • If your wife has her own IRA, she could also start a separate 72t plan, which would spread the risk if one plan was busted.
  • Switching gears, do you still operate the business? If so, in most cases your revenue would be down due to Covid conditions, and that would entitle you to take a CRD distribution (deadline is 12/30/2020). A CRD is penalty free, but is limited to 100k for each spouse’s IRA accounts. You can report the distribution income ratably for 2020-2022, and even repay any amount you wish for 3 years, but in your situation repayment is not a significant benefit. But a CRD of 100k would provide you with 33,333 of income for each of the 3 years, and buy you some more time before you needed to initiate a 72t plan. Given the cash flow, you could delay the 72t decision until early 2024, and that knocks your risky 17 years 72t plan down to 14 years and also reduces the cost of busting the plan at certain times.

Submitted by David Mertz on Mon, 2020-12-14 01:52

In your earlier post, I think that your calculation of the recapture penalty for busting the plan in year 10 or year 17 is substantially off, much higher than actual.  The recapture penalty would be 10% of the amount taken to the point where the plan was busted, plus interest.  Busting in year 10 that would only about $37k penalty plus perhaps around $7k in interest.  (My calculations assume essentially no investment gains over the period.  Still, it would take pretty substantial investment gains with annual recalculation to have distributed $1M over 10 years that would result in $100k of penalty.)

Submitted by Doug Stecklein on Mon, 2020-12-14 05:46

  • Glad to hear that my numbers check out.  I may consult a CPA as well just for extra piece of mind.
  • I have already taken advantage of the CRD(since my wife had to close her other business in late February) as well as withdrew all of my wife & I’s Roth IRA contributions.  All of this money is now being invested in a normal brokerage account.  
  • My goal is to retire in 2-3 years(I have a dangerous job), so I would like to start the 72t immediately To build my regular brokerage account balance.
  • I recently completed a cash out refinance on my home to invest with and boost my returns.
  • I also rolled over some of my TIRA funds which I could use in case of an emergency.
  • I have had very good investment returns over the last 10 years so my penalty & interest calculations were based on my account balance appreciating considerably during the 72t plan.

Submitted by Alan - IRA critic on Mon, 2020-12-14 14:33

When I said your numbers check out, I only checked the 72t calculation. DMx posted above a correction to your cost to bust the plan penalty. Your figures for that were too high, but that cost is subject to what your RMD distributions turn out to be each year. You could have large investment gains or losses that would either increase your distribution or reduce it respectively. Therefore another characteristic of RMD calculations is instability of your distribution amount, particularly if your invest in stocks or stock funds.

Submitted by Doug Stecklein on Mon, 2020-12-14 14:54

  • Also, after reading through much of William J. Stecker’s, A Practical Guide to 72t’s, over the last few days, It sounds like the amortization method can be recalculated annually.  The discussion on the topic starts on page 77.
  • This is contrary to everything else I have read so I wanted to see what you thought about it.
  • Since I am looking for the largest payout and I anticipate my account balance growing substantially, this seems like the best choice in methods.

Submitted by Alan - IRA critic on Mon, 2020-12-14 15:37

  • Yes, the IRS has approved “recalculated” amortization plans, but the IRS sees very few of them and that may trigger more attention from the IRS than you want. Stecker’s report indicates the timing requirements such as selecting your account balance and interest rate at the same time for each annual recalculation and from year to year. Since current rates are rock bottom, there is potential for rates to increase considerably once they rise, and that will increase your calculations. Account balance changes and annual age increase are the same as if you used the RMD method, therefore the interest rate becomes the main source of increased distribution potential.
  • Stecker’s report is still largely accurate, but it is around 16 years dated now, so there are some portions that have changed since this was published. It is best to recheck your calculation using different calculators. You might check into the replacement website for the original 72onthenet site that the owner shut down about 18 months ago.  I have not used the new site, operated by different people.

Submitted by Doug Stecklein on Mon, 2020-12-14 23:21

  • Good news!  I was able to get a hold of William J. Stecker and he is going to help me set up the plan!!
  • Thank you both for all of the advice.  It is a huge relief to finally find a Professional that can help me get this done.

 

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