72t Distribution Calculation

Submitted by Matthew Ottusch on Thu, 2023-05-25 15:14

I have a client (53 y/o) looking to start taking 72t IRA distributions. The client would like to take $48k annually, net. I completed a calculation and the maximum allowable, via the annuitization method is $48,250. This covers what the client would like to take net, but leaves no room to withhold taxes.

Question is, what are the ramifications of taking over this amount (in order to withhold taxes)? Or, is the client better of taking 0 withholding and paying any associated tax liability via other available sources. This $48k will likely be the client’s only taxable income in 2023.

Thank you



Submitted by Alan - IRA critic on Thu, 2023-05-25 15:53

  • You need to gross up the net amount desired to account for tax withholding because all 72t calculations are done with gross amounts. The gross distribution before withholding is reported on the 1099R and is the amount the IRS will expect to comply with one of the approved calculation methods. Given that the client will have a tax liability as part of their annual living expenses, the expected taxes plus inflation on other expenses for the next 6 years should be considered in determining the annual 72t distributions needed. If the client’s IRA balance is not sufficient to generate the needed distribution the plan is at risk of being busted at some point.
  • Nothing wrong with using withholding, but to avoid confusion the calculation and the client’s distributions management must consider the gross distribution. Taking out more than the calculated amount for withholding or any other reason will bust the plan. Roughly, if the IRA balance is much less than 1mm, the calculation will fall short of 48k.
  • The amortization method will generate a slightly higher annual calculation, but not much. If the client’s IRA balance is much larger than 1mm and the entire balance is not needed, the IRA should be partitioned by direct transfer before the plan begins into one IRA holding the amount needed to generate the gross distribution needed, with the other IRA left outside the plan calculation to be used for emergency needs in the future (insurance against busting the plan), or even to start a second plan down the road if needed.

Submitted by Matthew Ottusch on Thu, 2023-05-25 18:07

The amortization method actually resulted in a lower annual calculation. Given the current balance, the calculation via the annuitization method comes out to $48,250. Given the client wants $48,000/yr net, would it be reasonable to set this amount as the gross amount, not withhold taxes, and pay any tax liability from non-qualified assets?

Submitted by David Mertz on Thu, 2023-05-25 18:59

  • “would it be reasonable to set this amount as the gross amount, not withhold taxes, and pay any tax liability from non-qualified assets?”  There would be no difference except that with estimated tax payments instead of tax withholding any potential tax underpayment penalty could be higher.  Ignoring any possible underpayment penalty, the client ends up with the same amount in the end because the client pays the same amount in income tax whether done through withholding, estimated tax payments or balance due.
  • If the maximum permissible annual amount is insufficient to support the client’s needs after taking taxes into account (no matter how the taxes are paid), a 72(t) plan alone is not the solution, it’s a budgeting problem.  An increase in income from other sources, cashing in on equity or a decrease in needs (a decrease in expenses) is necessary.

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