Setting up IRA 72(t) distribution - no 10% penality

[dex]

I'm playing with the idea of setting up an IRA 72(t) distribution - no 10% early withdrawal penality because I think taxes will increase in the future and I'm in the lowest income tax level now. I only paid $200 in state taxes last year.

My understanding is that the company that does the IRA distribution must issue a 1099R form.
If you have done this:
1. How do you set it up with the company so they know it is a 72(T) distribution and not subject to the 10% penalty. I think they also have to check off a box about it.
2. How did you report the income and note that it is not subject to the 10% penalty on your tax return? I looked on the 1040 form but it was not clear to me.
3. Is there an IRS form to do the calculations to determine the amount to return?
I found on line calculators but not an IRS form
I know about IRS publication 970
72t Calculator | 401k Planning

Thanks

 

[easysurfer]

When I FIRE'd, I took both the lump sum from my 401K and pension and put that into an existing IRA. From the pot of money I put part of it into an immediate annuity (SPIA). Since this was a SPIA immediate annuity, that automatically met my 72t requirements.

Yes, when tax time comes the company that managed your 401K (in my case it was Fidelity) will send you a 1099-R.

Also, during the course of the year, the insurance company that pays out on the annuity sends me a 1099-R.

I did my taxes via Turbotax so it did the filling of forms me. I do see in the fed tax form for the year I retired, lines 15a and 16a were populated.

I know this might not be the method you are looking at (I went the A, as in annuity route). But that made the requirement and calcuations transparent for me.

 

[bizlady]

You'll have a code on your 1099R, and that will identify it as a 72(t). This assumes you communicate your desire to the holder of the funds.

There are several payment forms your may be eligible for, and you may want to call the holder of your funds and get your options and payout amounts. You do not "set it up", but do identify it as that type of withdrawl. There is also a set amount of time you must take these withdrawls.

 

[dex]

You'll have a code on your 1099R, and that will identify it as a 72(t). This assumes you communicate your desire to the holder of the funds.

There are several payment forms your may be eligible for, and you may want to call the holder of your funds and get your options and payout amounts. You do not "set it up", but do identify it as that type of withdrawl. There is also a set amount of time you must take these withdrawls.

So, you mean I call up Vanguard, for example, and say I want to do a 72 (t) and they help me compute the amount and all? That would be nice and easy.

I read the pay out time is the longer of 5 years or until I reach 59.5.

 

[Leonidas]

A good source on the net is here: 72t.Net | SEPP Plans | IRC Section 72(t) | 72t Distribution | IRC Section 72(q) | yyyZ.Com

 

[jimnjana]

So, you mean I call up Vanguard, for example, and say I want to do a 72 (t) and they help me compute the amount and all? That would be nice and easy.

I read the pay out time is the longer of 5 years or until I reach 59.5.

The only drawback is that you have got to calculate your payouts using your life expectancy, so you can't maximize the income stream.

 

[zinger1457]

The only drawback is that you have got to calculate your payouts using your life expectancy, so you can't maximize the income stream.

When setting up a 72t you have 3 withdrawal options (amortization, annuitization, minimum distribution), only the minimum distribution method is based on life expectancy and it also provides the lowest return of the three. You will maximize your payouts by using the amortization or annuitization methods.

I haven't set up a 72t yet but have been looking at it, the best resource I have found is the previously mentioned 72t.net. Ideally you would want the company where the 72t is set up to classify the account as being an early distribution and exempt from the early withdrawal penalty by ensuring box 7 on the 1099R form is coded with a 2. It is my impression that very few companies (Vanguard, etc.) will classify the account as being exempt. They don't want to take responsibility that the amount being withdrawn was calculated correctly. If that is the case you will have to fill out IRS form 5329 to claim the exemption. There is a lot of planning required to ensure a 72t is set up correctly and that it is not busted before you reach 59.5, could get some stiff IRS penalties otherwise.

 

[zinger1457]

Correction to my response above, all three 72t distribution methods are based on life expectancy.

You can start out with the amortization or annuitization withdrawals method and do a one time switch to the minimum distribution methods but not vice versa.

 

[queeneev]

My husband is doing a 72(t). All he did was submit a form to his broker (Schwab), which he did online, and it had a place on the form where he checked the box saying he was exempt from tax and penalty because of 72(t).

Schwab sends the 1099R each year, with the proper codes on it. I imagine they (Schwab) would have helped him compute his amount if he asked for that, but he computed it himself and told them the amount.

Here is a section from the form:
2. Reason for Distribution Choose only one from Sections A–C below. For a “Withdrawal of Excess Contribution,” skip to Section 3, or for a
“Transfer Pursuant to Divorce,” skip to Section 4.

A. From a Traditional IRA, Rollover IRA, Inherited Traditional IRA, SEP-IRA, SARSEP-IRA or SIMPLE IRA Only:
Normal Distribution (Code 7)
Use for any of the following when the taxpayer is age 59½ or older: Normal Distribution, a distribution that will be rolled over to another IRA or an
employer plan* within 60 days, an IRA revocation, or a Roth IRA conversion or reconversion.
Early Distribution, no known exception (Code 1)
Use for a distribution when the taxpayer has not reached age 59½ and no known exception under Section 72(t) applies (see Section 9), including
a distribution that will be rolled over to another IRA or an employer plan within 60 days when the taxpayer is younger than age 59½, or for an IRA
revocation when the taxpayer is younger than age 59½.
Early Distribution, exception applies (Code 2)
Use for a distribution when the taxpayer has not reached age 59½ but an exception under Section 72(t) applies (see Section 9), or for a Roth IRA
conversion or reconversion when the taxpayer is younger than age 59½.
Disability Distribution (Code 3)
Use for a distribution due to permanent disability within the meaning of IRS Section 72(m)(7). Consult your tax advisor.
Death Distribution from an Inherited Traditional IRA (Code 4)
(remainder not pasted)

 

[frayne]

I am in the fourth year of a 72T with Fidelity. My 1099Rs are coded as a regular distribution with no exception and I have to complete a 5329 form in order to avoid the 10% penalty. I believe it is line two on the 5329 and 2 is the SEPP exception code.

The IRS sent me a letter after my second year telling me that I didn't qualify for the 72T and I would have to pay penalties. I got the necessary paperwork, payment schedules, etc. from FIDO and sent a packet to the IRS. They replied I did qualify and all was OK.

 

[kramer]

I would examine your assumptions carefully in order to determine whether this is really a good idea.

Dex, if you have a decent sized taxable account, then I assume that you know that qualified dividends and long term cap gains are tax free up to the top of the 15% bracket in 2010. Last year I intentionally maxed out my cap gains to the top of the bracket and paid zero federal income tax. And I am doing it again this year.

This will end after the current tax year.

 

[dex]

The IRS sent me a letter after my second year telling me that I didn't qualify for the 72T and I would have to pay penalties. I got the necessary paperwork, payment schedules, etc. from FIDO and sent a packet to the IRA. They replied I did qualify and all was OK.

That is what I fear.

 

[dex]

I would examine your assumptions carefully in order to determine whether this is really a good idea.

Dex, if you have a decent sized taxable account, then I assume that you know that qualified dividends and long term cap gains are tax free up to the top of the 15% bracket in 2010. Last year I intentionally maxed out my cap gains to the top of the bracket and paid zero federal income tax. And I am doing it again this year.

This will end after the current tax year.

I'm thinking that with the standard deduction, personal deduction, real estate credit, loss carry forward I have some room t say withing the 15% tax bracket.

 

[dex]

From Vanguard


Thank you for taking the time to contact us.

A traditional IRA withdrawal is generally taxed as ordinary income in the
year it is taken. If you are under age 59 1/2, you may also be assessed a
10% federal penalty, unless an exception applies. Federal and state income
taxes may apply as well.

If an exception for a premature distribution applies, you are responsible
for filing IRS Form 5329 with your tax return to avoid paying a federal
penalty tax. Vanguard cannot withhold the penalty for you.

 

[frayne]

As a side note I had a CPA firm do the 72T calculations as well as Fidelity and they came out with about the same answers on what distribution I could take. As far as the letter from and dealing with the IRS it really wasn't any big deal and I wasn't worried as I had researched the crap out of 72Ts prior to setting it up and taking it. If you have any other questions or would like to call and chat about anything I would be glad to share my experience with you. Just drop me a PM and I'll send you my number.

 

[Sue J]

I'm thinking that with the standard deduction, personal deduction, real estate credit, loss carry forward I have some room t say withing the 15% tax bracket.

Do you mean the real estate tax credit for taxpayers who do not itemize? It was an addition to the Standard Deduction and unless it gets extended it was only good for 2008 and 2009.

 

[winger]

We have 72T withdrawals with Vanguard. I've received deficiency letters twice, both saying I needed to pay the 10% penalty plus penalties.

On the most recent, found out IRS had not recieved the 5329 form with our return. It was with our PDF copy of the return, no explanation why the IRS didn't have it or ignored it.
I'll leave it to others to parry with the IRS. It's not a fair fight, even when you have right on your side.

 

[dex]

Do you mean the real estate tax credit for taxpayers who do not itemize? It was an addition to the Standard Deduction and unless it gets extended it was only good for 2008 and 2009.

Thanks - I'll have to amend my tax projections.

 

[dex]

We have 72T withdrawals with Vanguard. I've received deficiency letters twice, both saying I needed to pay the 10% penalty plus penalties.

On the most recent, found out IRS had not recieved the 5329 form with our return. It was with our PDF copy of the return, no explanation why the IRS didn't have it or ignored it.
I'll leave it to others to parry with the IRS. It's not a fair fight, even when you have right on your side.

I have an IRA with Vanguard and E*Trade. I'll ask E*Trade about their policy. My understanding is that I can do a 72 (T) or one or both accounts..

 

[mikex]

I have an IRA with Vanguard and E*Trade. I'll ask E*Trade about their policy. My understanding is that I can do a 72 (T) or one or both accounts..

Haven't been on the forum for a while, but I started my 72t this year after researching it thoroughly for several years on the 72t.Net | SEPP Plans | IRC Section 72(t) | 72t Distribution | IRC Section 72(q) | yyyZ.Com website, and quitting my job last Oct.

As long as it is an IRA you can use it for a 72t, the custodian has no say in what or how you use the money - that's between you and the IRS. Most these days wash their hands of responsibility for the plan, so you won't get the code 2 on the 1099r. No biggee, just as others have said you can file a 5329 and claim the exemption to the 10% penalty. The calculations are the calculations - math is math - no matter who does them they stand on their own as valid if they are correct. I just withdraw my exact SEPP annual amount from Fidelity myself and have regular taxes taken out, that's that.

I've read where people get letters asking for the 5329 form, as if it was never filed with the other tax forms. I've read about this several times. One guy at the 72t.net forum asked the last guy who got a letter from IRS which asked for the 5329, whether he filed electronically, and he said yes. It was then speculated that some electronic filing systems were not sending in the 5329 form properly. Don't know if this is true or not but it might be worth it to file "real" pieces of paper.

Another speculation he made was that the code for the 5329 form, for an SEPP exemption, is not "2" but "02". He said it was a small point but may make some difference to the IRS computers.

 

[chinaco]

Dex,

Am I missing something?? Why not roll it to a Roth IRA in steps? Pay income tax today and shield future earnings/gains?

 

[bks]

Here is another overview of 72t.

 

[jazz4cash]

Another vote for www.72t.net

 

[CyclingInvestor]

I have been using 72t distributions since 2006 thru Schwab, using the annual recalc/minimum distribution method (currently resulting in about a 3% distribution of last Dec 31 balance). No problems with Schwab or the IRS. I log on to Schwab, download the very simple form, fill it out, mail it in, and a couple days later the $$ moves from my IRA to my regular stock account. I use a simple spreadsheet to calculate the amount to withdraw every year.