By Randy Neumann
In these days of layoffs, downsizing, corporate packages and unemployment at historic highs, there are a lot of wounds and little salve. Well, 72(t) might be the balm.
Many people are finding themselves left with little else than the money in their retirement plans. They are reluctant to withdraw money from these plans because, with today’s markets, they have appreciable losses. Further, section 72(t) of the Internal Revenue Code provides that if you withdraw money from a qualified plan and you are under the age 59 1/2, you are subject to a 10% penalty in addition to having to pay tax on any withdrawal. You could be looking at a 40% haircut on the money you withdraw from your retirement plan.
You may be thinking, “This sounds more like a bomb than balm.” That is because within the same section of the Internal Revenue Code, Uncle Sam taketh away and then he giveth. Here it is, right from the horse’s mouth. “Section 72(t)(1) provides that an additional tax of 10% will be imposed on the amount includible in income with respect to a distribution from a qualified retirement plan as defined in section 4974(c). Various exceptions to this tax are set forth in section 72(t)(2).”
“Section 72(t)(2)(A)(iv) provides, in part, that if distributions are part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee, or the joint lives (or joint life expectancy) of the employee and beneficiary, the tax described in section 72(t)(1) will not be applicable.”
This means that there are ways to take money out of qualified plans prior to age 59 1/2 without paying the 10% penalty. The key is you have to know how to do it.
Under Section 72(t) of the tax code, you can make penalty-free withdrawals from your IRAs as long as you take “substantially equal periodic payments” (SEPP) at least annually, and for at least five years or until you turn 59 1/2 —whichever is longer. Notice the acronym IRA in this paragraph. This assumes that you have rolled over your pension, profit sharing, 401(k), 403(b) or 457 plan into an Individual Retirement Account (IRA). So, step one is to roll these other qualified plans into IRAs.
The next step is to decide which of the three methods available to calculate the SEPP is best for you. They are required minimum distribution (RMD), fixed amortization or fixed annuitization. The RMD method applies the same math that is used when IRA owners turn 70 1/2. Each year, the owner uses a divisor based on his (and perhaps his beneficiary’s) age to determine how much should be withdrawn. This method will cause the required amount to vary from year to year.
The fixed amortization method calculates the amount based on the single or joint life expectancy tables in IRS Publication 590, along with the applicable federal rate. Once the initial calculation is made, the amount will remain the same each year.
The fixed annuitization method, when distributed over the IRA owner’s life expectancy, is based on the present value of the IRA. It is also a fixed payment, determined in part by the applicable federal interest rate. IRA owners choosing the fixed amortization or RMD methods must also decide which one of three life expectancy tables (located in IRS Publication 590) they will use to further determine the withdrawal amount.
This is pretty heavy lifting, so don’t make these calculations yourself. Let’s say that your advisor comes up with a number that is too “high” for you. Assume that you have a $700,000 IRA, and each of the three calculations generates more money than you need annually. Not to worry, you can get the “right” number by splitting the $700,000 between 2 IRAs. For example, you make the IRA from which the withdrawal will be taken $500,000 and the other IRA $200,000.
Since we don’t know what the future holds, let’s keep our options open. As mentioned above, you must continue distributions for at least 5 years or until you reach age 59 1/2. Let’s say that some unforeseen need arises and you need to withdraw additional money. If you take one nickel more than the projected annual amount from the withdrawal IRA, all this work has been for naught. You will have to pay a 10% penalty on all prior payments. This is another reason to split the IRAs. If you need extra money, take it out of the other IRA, the one that does not have annual withdrawals and pay the 10 percent penalty only on any additional money withdrawn from it.
This is not an “off the rack” suit. This is a custom made suit that requires an expert tailor.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann, CFP® is a registered representative with and securities and insurance offered through LPL Financial. Member FINRA/ SIPC. He can be reached at 600 East Crescent Avenue, Suite 104, Upper Saddle River, NJ 07458, 201-291-9000.