72(t) and Solo 401(k) – Same Year
Client Background:
- Age: 50 years old
- IRA Balance: $1.2 million
- Goal: Retire using IRA funds without incurring the 10% early withdrawal penalty
- Additional Income: Runs a handyman business with income varying between $25,000 and $100,000 annually
Question:
If the client initiates a 72(t) payment plan, I estimate the annual distribution to be around $35,000 (using the RMD method). Given that his handyman business income fluctuates, could he use the 72(t) distributions to contribute to a Solo 401(k) plan and potentially deduct those contributions? Specifically, in years where his business income exceeds his living expenses, can the client “recontribute” the 72(t) distributions to offset the tax impact?
Thanks for your insights.
Permalink Submitted by Alan - IRA critic on Thu, 2024-08-15 17:36
He can use the 72t distributions to subsidize solo K contributions. Note that this is not a disallowed rollover and the 72t distributions will still be taxable, but those taxes can be reduced by the solo K contributions.
It is also advisable not to use the RMD method for the 72t. The distribution is lower per dollar of IRA balance, a new calculation is required each year (more risk of error), the one time switch to the RMD method to lower the distributions is voided because RMD is already used. 72t distributions with the RMD method bounce around every year based on investment results and age, usually that is not as reliable as one of the fixed dollar methods.
That said, starting a plan at 50 bears risks because it is impossible to predict spending needs and inflation over that long a period, so a cushion needs to be built into the calculation. Since using the amortization method would produce a larger distribution, the IRA could be partitioned by direct transfer leaving an IRA of sufficient amount to produce the needed income and an additional IRA outside the plan for use in emergencies to avoid having to bust the plan. A busted plan after 8 or 9 years would create a huge penalty and late interest due for paying the penalty late.