72t option & Contribution Withdrawal from Roth IRAs before 60 Questions

[Aeowyn]

I'm considering "retiring" from my current job in the near future. I've started looking at the 72t option of taking money out of your IRAs before 60 to avoid the 10% penalty. As I understand it, once I choose this option there is a set amount I can take out each year based on the prior end of year value and the life expectancy tables (and alternative method of using a conservative growth rate).

I'm 45 years old now and will have a military reserve pension kick in when I'm 60. I have both Traditional and Roth IRAs.

My question is this: Can I use the 72t option on the total of all my IRAs and then pick which ones I want to take the money out of? Since I have a taxable pension kicking in when I turn 60, if we have low income years prior to that I'd like to maximize the amount from the Traditional accounts. On the other had if we have a really good year (husband self employed and we'll be starting a small farm), then I might want to take the money out of the Roth.

That brings up another question. If I choose the 72t option but then have earned income, am I still allowed to put an annual contribution into my IRA?

I'm more concerned about low income years and getting the tax-deferred money out (My goal is to maximize the 15% tax bracket on our taxes each year based on the current tax system). So if I have to take the money out evenly between the IRAs, I suppose one way around this would be to "convert" funds from Traditional to Roth at the end of the year when I know how I'm going to stand tax wise.

We have ~2/3 of our IRAs in Roth accounts. As I understand it, we can take out our Roth Contributions and Conversions (as long as it's been 5 years) before 60 without tax or penalty. If this is true, then it seems that I might want to just forget about the 72t option. If I want to get money out of a Traditional IRA, I'll just take that amount out of a Roth IRA and then convert the same amount from the Traditional account to the Roth account. This way I'm not tied to a certain amount each year. I'd also be able to better control what I use from tax-deferred, tax-free, and unsheltered accounts.

Please let me know if my understandings are correct. I'd like to have our Roth contributions grow as long as possible, but if I know we have the option to take out our contributions before 60, then I'll feel more comfortable about drawing down on our non-sheltered savings.

 

[REWahoo]

I understand this site is an excellent resource concerning everything related to 72t: 72t.Net | SEPP Plans | IRC Section 72(t) | 72t Distribution I'd ask your questions there.

 

[Nords]

As I understand it, we can take out our Roth Contributions and Conversions (as long as it's been 5 years) before 60 without tax or penalty. If this is true, then it seems that I might want to just forget about the 72t option.

Yep.

You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s)

The discussion starts on page 64 of IRS Pub 590:
http://www.irs.gov/pub/irs-pdf/p590.pdf

 

[CyclingInvestor]

Each IRA acct is separate for 72t withdrawal purposes. 72t rules do not apply to Roth IRAs.

No deposits to an IRA once 72t withdrawals are started - that would 'break' the 72t. However, deposits may be made to a different IRA.

 

[teejayevans]

No deposits to an IRA once 72t withdrawals are started - that would 'break' the 72t. However, deposits may be made to a different IRA.

I didn't know about the deposits caveat, what about Roth conversions, do they break the 72t?
TJ

 

[CyclingInvestor]

I didn't know about the deposits caveat, what about Roth conversions, do they break the 72t?
TJ

Once you start a 72t withdrawal plan from an IRA, you must withdraw the exact amount by formula each year, and that is it for at least 5 years and until you turn 59.5. No deposits, extra withdrawals, conversions, anything (except a QDRO - for divorces) or you owe penalties and interest from your first withdrawal.

 

[Aeowyn]

Thanks for the great info. I'm just going to forget I ever heard of the 72t option.

The Roth's had me at tax-free growth. But the ability to take out contributions penalty free any time and conversions after 5 years makes them even better.

Earlier retirement prospects are looking better all the time.

 

[zinger1457]

Once you start a 72t withdrawal plan from an IRA, you must withdraw the exact amount by formula each year, and that is it for at least 5 years and until you turn 59.5. No deposits, extra withdrawals, conversions, anything (except a QDRO - for divorces) or you owe penalties and interest from your first withdrawal.

There are three withdrawal options with a 72t (amortization, annuitization, and minimum distribution). The amortization and annuitization methods will give you the greatest withdrawal amount. If either of these two methods are selected the 72t rules do allow a one time switch to the minimum distribution method.

 

[teejayevans]

There are three withdrawal options with a 72t (amortization, annuitization, and minimum distribution). The amortization and annuitization methods will give you the greatest withdrawal amount. If either of these two methods are selected the 72t rules do allow a one time switch to the minimum distribution method.

To make it more complicated...I thought you have the option of just withdrawing the same amount every year, or recalculating each year?
TJ

 

[zinger1457]

To make it more complicated...I thought you have the option of just withdrawing the same amount every year, or recalculating each year?
TJ

Yes, I believe you have the option of recalculating once a year on the anniversary date based on the new federal mid term interest rate and account balance. My understanding is that if you select to recalculate you have to do it every year. It could result in your payments going up or down depending on the new interest rate and account balance. The 72t rules can be complicated and are unforgiving if you screw up the calculation, probably a good reason to minimize any changes.

 

[Trawler]

Another caution on 72T is once started you must take the distribution for at least 5 years. I would have hated to take a distribution when market was down signifantlly if had other assets I could live off of.

 

[CyclingInvestor]

Another caution on 72T is once started you must take the distribution for at least 5 years. I would have hated to take a distribution when market was down signifantlly if had other assets I could live off of.

Actually, it is not too bad. In your early 50's the minimum distribution method requires withdrawals around 3%. My portfolio of stocks (such as ABT, ADP, JNJ, KO, PG, SYY, etc) generates dividends of a bit more than that, so I am actually still buying, not selling.

 

[swampwiz]

I recently had a long conversation with an IRS representative about this. There were a few questions that the representative did not answer, and I am working with my Congressman to force the IRS to give an answer (and as I expect it to be no less than 8 years until I would use the 72t, I have plenty of time for my Congressman to get me these answers )

Anyway, the way it works out is that you basically draw up a contract (for your own records, and I suppose to give to an IRS auditor, if the time were ever to come) and you list all the IRA accounts - either Roth or traditional - that you want to be part of a specific 72t set; this set of accounts will basically be treated as single account by the IRS. Obviously it would make sense to merge any accounts in such a set into a single account (or single account each of Roth and traditional) first, but it is not necessary.

Then for whatever date you start the plan, you can look back to Dec 31 of the year before, or any day thereafter for the initial balance of the 72t account. For formulae that use an updated value for subsequent years, the value on Dec 31 for the previous year must be used. Then based on that balance and the formula being used, you must take a total distribution for the year. (NOTE: it is unclear exactly how this distribution must be done - as a single distribution at the same time every year, as equal monthly distributions, or if the actual layout of the distributions matter at all - this is one of the questions I have yet to get answered!) There are also some special rules for the first and last year, but the easy way to do this is to simply start the 72t at the beginning of some year, and follow through the year that is either the 5th year of the year that you turn 59-1/2 (whichever is later) before stopping, and then just to be safe, when it is time to stop, call up the IRS and describe what you had done in terms of distributions, and ask that if you were to change the distribution amount for the next year, would it be considered to be a breaking of the 72t plan. Once the plan is finished, you can take any distribution or nothing, as you would be covered under the regular 59-1/2 distribution rules.

As for the possible formulae, there seem to be 2 that are useful (there is another one, but it doesn't seem useful, as one off the others could suffice.) The basic formula is the minimum distribution formula, and it is the same that is used for the required minimum distribution for folks over age 70-1/2 or for beneficiaries that are not allowed to roll over an inherited IRA. This formula is based on the value of the 72t account on Dec 31 (i.e., it is updated every year) and your age (which has a corresponding factor which is the portion of the balance that must be taken out for that year - this is presented in a table that the IRS publishes every year - and seems to almost be the reciprocal of {85 - age}.) The other formula is a fixed amortization that uses the initial balance and an assumed interest rate (which must be no more than 120% of some treasury benchmark, and is published by that 72t website), and the amount withdrawn must be the same every year. At any time, the choice can be made to change from the fixed amortization to the minimum distribution (but not vice-versa!) It is unclear whether the change can be made mid-year (but certainly can be made across different years.)

Once this is set up, everything else dealing with IRA's is totally separate. If you have an IRA that is not designated as part of the applicable 72t set, you can take distributions or make contributions just as if you didn't have a 72t program. You cannot however merge anything outside of the 72t set into the 72t set.

As for having both traditional and Roth accounts in a 72t set, it is unclear whether a choice can be made as to which to take distributions from, or if equal proportions must be distributed. But since a Roth distribution that is not a contribution or conversion would be considered taxable before age 59-1/2, it would make much, MUCH more sense to only use a traditional IRA for a 72t. It would be far better to do a Roth conversion 5 years prior to an anticipated 72t and simply take totally tax free distributions out - and as these distributions could be done as needed, they can be the variable part while the 72t is some fixed part of a total distribution plan. Of course, the problem with doing a conversion is the one must pay taxes on it, which would be a problem for folks in a high tax bracket. As for myself, as I am now earning my income abroad (which ends up being no net income after expenses), totally outside the realm of the IRS, I am using all my 0% bracket income availability ($12,550 in 2011 for a single person with $3K capital gains loss) to convert my traditional to Roth tax free, so that I will have a bunch of tax-free money on tap to distribute as I see fit.

 

[swampwiz]

Actually, it is not too bad. In your early 50's the minimum distribution method requires withdrawals around 3%. My portfolio of stocks (such as ABT, ADP, JNJ, KO, PG, SYY, etc) generates dividends of a bit more than that, so I am actually still buying, not selling.

The minimum distribution factor seems to almost be the reciprocal of { 85 - age }.

 

[swampwiz]

Another caution on 72T is once started you must take the distribution for at least 5 years. I would have hated to take a distribution when market was down signifantlly if had other assets I could live off of.

Yes, definitely the WORST thing that could happen is that you get in some type of bind and you absolutely need to take more money out - you really get hosed. The way around this is to have a nice pile of Roth contributions (or 5 year seasoned conversions) that you can distribute as you see fit, independent of the 72t.