Decision to start SEPP or 72(t) plan

[SnowballCamper]

We're about to make a big commitment, and start SEPP withdrawals from my TSP, beginning in 2022. The main reason is to level our income stream over the retirement years, and second to access the funds for hobbies and interests while we're more mobile than we'll likely be in the future. A while ago I posted here https://www.early-retirement.org/forums/f28/thrift-savings-plan-withdrawals-99511.html, and have since read a lot about rollovers, and just recently found this wonderful paper about setting up a SEPP https://72tnet.com/wp-content/uploa...-To-SEPPS-and-IRC-72t-Bill-Stecker-4th-ed.pdf.

Here are the basic stats:

Ages 47 & 50
Military pension income ~86k
Roth IRA combined ~300k
TSPs: ~350k+~550k
ESA and 529: ~80k
Cash: ~40k
I closed our brokerage when retiring a few years ago and paying off the house. I'll be opening a new one for the SEPP payments to go in (while we decide what to spend them on).

Current expenses easily met by pension income, and no debt.

For our situation, modeling Roth conversions with I-orp yielded very little advantage (at most $1,000 per year advantage). Keep in mind that I-orp computes the maximum average annual income after taxes. So if the goal was to maximize total $$ for the lifetime, then I, and most people, should do the Roth conversion before RMDs. But as my tag line says.... When does it stop making sense to spend less now, in order to have more later? And for us the answer is, next year.

I'm going ahead with the option to include my Roth balance in the SEPP plan. This will allow for a larger annual withdrawal amount. But my withdrawals will only come from the TSP.

For simplicity, I'm not doing the annual recalculation method.

How does the SEPP level our income? It only partially offsets the increases when SS starts and at RMD time. Once I turn 60, we'll have the option to stop/change the withdrawals.

Why wait till next year? It appears the mortality tables for the withdrawal calculation are set to change early next year. I plan to do quarterly payments, and will rebalance within the TSP at about the same time as the payments.

Why aren't you both doing a SEPP? Good question...DW isn't interested, has cheaper hobbies, :shrug:

At this point I don't have a question. I spent a lot of searching online to find some info specific to a SEPP with the TSP and just recently found William Stecker's book (linked above). While it is a bit old, the main reference he uses is still current on the IRS website. His book doesn't mention the TSP at all, but since the TSP relaxed their withdrawal rules a year or so ago, it's easy to follow his guidance & recommendations.

I'll answer any questions, and post progress updates through the process next year.

 

[SecondCor521]

I'm going ahead with the option to include my Roth balance in the SEPP plan. This will allow for a larger annual withdrawal amount. But my withdrawals will only come from the TSP.

[...]

I'll answer any questions, and post progress updates through the process next year.

[Edited out non-applicable parts.]

I don't think you can do what you're describing in the first paragraph. As far as I understand, an SEPP comes from a single account, and the calculations are based on the balance of that single account.

I'd recommend double checking whether you can do what you're describing with some current, authoritative sources, such as the IRS or your qualified tax professional.

(As a secondary comment, while technically you could do a SEPP from a Roth IRA, most people wouldn't want to because the SEPP distributions become taxable income, whereas Roth withdrawals after age 59.5 are generally completely tax free.)

...

I understand the motivation to level out taxes. I'm doing things tax-wise with a similar motivation in mind. I also understand the motivation to spend while young and healthy.

But if I were in the OP's shoes, I'd probably spend (above and beyond the pension) from Roth IRAs from now to age 55, then from the TSPs from age 55 to 59.5. If that doesn't levelize things enough, I'd consider offering to the spouse to do the SEPP mechanics and withdrawals and stuff for them. But whether that flies or is a lead balloon offer depends on the marital dynamics.

 

[SnowballCamper]

[Edited out non-applicable parts.]

But if I were in the OP's shoes, I'd probably spend (above and beyond the pension) from Roth IRAs from now to age 55, then from the TSPs from age 55 to 59.5. If that doesn't levelize things enough, I'd consider offering to the spouse to do the SEPP mechanics and withdrawals and stuff for them. But whether that flies or is a lead balloon offer depends on the marital dynamics.

How do you spend from Roth IRA from age 47 until 55 without triggering the 10% penalty (anything beyond a return of contributions)?

Also, as the Roth account has already been taxed, this doesn't help to level current low taxable income with high taxable income during RMDs...

I recognize this isn't the lowest risk withdrawal option, but other sources endorse IRA aggregation for SEPP plans, such as https://www.thinkadvisor.com/2015/03/01/how-to-aggregate-iras/

 

[zinger1457]

I'm also confused on how you plan on combining the ROTH and TSP in your 72t plan. I know taking withdrawals from the TSP based on life expectancy meets the 72t requirements. I don't believe you can use the balance from two separate accounts for your 72t and only take withdrawals from one, you would need to set up a 72t for each account.

 

[SnowballCamper]

Page 96 in the linked book starts the discussion and finishes with:

In sum total, we travel through at least five different code sections (IRC §§ 72, 4974(c), 408(a), 408A & 7701(a)(37)) all to learn that QRPs, IRPs, IRAs and Roth IRAs are all the same thing. Said another way, for purposes of applying IRC §72(t), a traditional IRA and a Roth IRA are treated in the same manner unless a specific exception can be found in IRC §408A.
Lastly, taxpayers have always had the option of treating their IRAs discretely or logically combining them for purposes of computing distributions under IRC §72(t). Therefore, albeit at first appearance illogical, we came to the conclusion that one may combine a traditional IRA with a Roth IRA for purposes of computing substantially equal periodic payments as defined in IRC §72(t)(2)(A)(iv).

 

[gauss]

How do you spend from Roth IRA from age 47 until 55 without triggering the 10% penalty (anything beyond a return of contributions)?

One way to do this is available if you have a Roth 401k available at work that you can take distributions from or rollovers to a Roth IRA.

I can "convert" lets say $100,000 from my traditional 401k to my Roth 401k and pay the income taxes.

If I then roll over the a portion of the Roth 401k to a Roth IRA, then the employer will calculate a "basis in the contract" in box 5 on the 1099-R that shows the distribution/rollover from the Roth 401k to the Roth IRA. This box 5 amount will be available soon, tax and penalty fre, once the funds arrive in the Roth IRA -- regardless of your age.

The magic happens when this money lands in the Roth IRA. The box 5 amount is not considered a conversion, but rather gets booked to the Roth IRA "contribution basis" ie line 22 8606. See the instructions for IRS form 8606 for a reference -- and read the full instructions. They describe how to calculate line 22 in several different places. Maybe just search for "investment in the contract".

As I think it is well known, distributions from Roth IRAs before age 59 1/2 first come from the contribution basis and are tax and penalty free.

This strategy has been a huge windfall for me in freeing up cash-flow between retiring at age 47 and age 59 1/2.

The beauty of this method is there are no five year fixed waiting periods between doing the "conversion" portion and paying the taxes -- and the ability to withdrawal tax/penalty free from the Roth IRA.

To fully flush this out, you should read the instructions for form 1099-R box 5 to establish how the employer determines the "investment in the contract" of the Roth 401k. I suspect that it is pro-rata between Roth 401k contributions and growth. It is possible that there may be a rule that the Roth 401k has to be established for 5 years before this would work. I would need to research this because I was past the 5 year point for first contributing to the Roth 401k, so any possible/potential limitation did not effect me.

-gauss

 

[SecondCor521]

[1] How do you spend from Roth IRA from age 47 until 55 without triggering the 10% penalty (anything beyond a return of contributions)?

[2] Also, as the Roth account has already been taxed, this doesn't help to level current low taxable income with high taxable income during RMDs...

[3] I recognize this isn't the lowest risk withdrawal option, but other sources endorse IRA aggregation for SEPP plans, such as https://www.thinkadvisor.com/2015/03/01/how-to-aggregate-iras/

[Numbers added for reference.]

1. You're right, you'd only be able to spend the contributions. I'm doing a Roth conversion ladder - you could too I think, either directly from your TSP or after rolling your TSP into a traditional IRA - so I can spend the contributions then the conversions. A Roth conversion ladder would be more flexible than a SEPP, and allow penalty-free access to TSP money before 55, but works best if you have 5 years of expenses already available (I'm using a combination of taxable and Roth contributions). My Roth conversion ladder approach giving me access to Roth conversion amounts was what I was thinking of when I wrote what I did.

2. Right, understood, which is why I wrote "if that doesn't levelize things enough" - the TSP withdrawals from 55 to 59.5 would be some levelizing, but not as much as the SEPP (or Roth conversion ladder) would.

3. Hmm. I have a few concerns:

a. I don't know who this Mr. Towers fellow is, and I don't know who thinkadvisor.com is. I'm not sure if their advice is trustworthy or not.

b. For his central premise, he refers to a PLR. The IRS explicitly states that PLRs can only be relied upon by the taxpayer who submitted it. It can be dangerous to rely on a PLR that isn't yours. It can be even more dangerous to rely on someone else's interpretation of a PLR. I wasn't able to find a copy of that PLR on the web, but it should in theory be findable in the IRS electronic reading room.

c. The above being said, I've seen references to the PLR mentioned, and they do seem to come to the conclusion that you can aggregate IRAs to determine a balance to do SEPPs. This includes a citation from 72t.net, which is a widely known source for SEPPs and one I would probably trust.

d. You're talking about taking an SEPP from a combination of an IRA and a TSP, but the PLR and related references only talk about a combination of IRAs. I'm not sure if that distinction matters, but it could. ETA: This also applies to your comments in post #5 on this thread.

 

[SecondCor521]

One other thing - if you do the account aggregation thing, I think that would mean that you would not be able to touch the related Roth IRA account for the duration of the SEPP. That would mean no contributions and no withdrawals for that 10 year period.

The reasoning here is that typically the account that the SEPP is made from is typically off limits for anything else; otherwise it is considered breaking the SEPP. If you're aggregating accounts, I would think that even if you were only making the distribution from one of the two accounts, the other account would likewise be off limits.

 

[SnowballCamper]

Yes, I'm tracking that the only permitted transactions in or out of an account in the SEPP plan are the SEPP withdrawals, until the end of the plan (the latter of five years or after 59.5y/o), rebalancing within the account is allowed.

 

[zinger1457]

Therefore, albeit at first appearance illogical, we came to the conclusion that one may combine a traditional IRA with a Roth IRA for purposes of computing substantially equal periodic payments as defined in IRC §72(t)(2)(A)(iv).

Thanks for the clarification, everything I had read previously stated to do it from one account, thought that was the rule but sounds like it just makes the management of a 72t easier.

 

[chassis]

@SnowballCamper

Thanks for posting.

1. Who is doing your SEPP calculation?

2. What date are you using to value the accounts for the purpose of the SEPP calculation?

3. How are you documenting the above in case the IRS become interested in learning more?

 

[SnowballCamper]

[1] I'll be doing my SEPP calculation using the PMT function in excel as described in the link in my original post, and then check the final number with the various online calculators for consistency.
[2] Probably the end of the calendar year statements' ending balance.
[3]. Following the suggestions on page 85 of the same reference.

 

[chassis]

[1] I'll be doing my SEPP calculation using the PMT function in excel as described in the link in my original post, and then check the final number with the various online calculators for consistency.
[2] Probably the end of the calendar year statements' ending balance.
[3]. Following the suggestions on page 85 of the same reference.

Excellent, page 85 is a big help. I'm likely to follow in your footsteps with a 72(t) SEPP.

 

[NgineER]

One way to do this is available if you have a Roth 401k available at work that you can take distributions from or rollovers to a Roth IRA.

I can "convert" lets say $100,000 from my traditional 401k to my Roth 401k and pay the income taxes.

If I then roll over the a portion of the Roth 401k to a Roth IRA, then the employer will calculate a "basis in the contract" in box 5 on the 1099-R that shows the distribution/rollover from the Roth 401k to the Roth IRA. This box 5 amount will be available soon, tax and penalty fre, once the funds arrive in the Roth IRA -- regardless of your age.

The magic happens when this money lands in the Roth IRA. The box 5 amount is not considered a conversion, but rather gets booked to the Roth IRA "contribution basis" ie line 22 8606. See the instructions for IRS form 8606 for a reference -- and read the full instructions. They describe how to calculate line 22 in several different places. Maybe just search for "investment in the contract".

As I think it is well known, distributions from Roth IRAs before age 59 1/2 first come from the contribution basis and are tax and penalty free.

This strategy has been a huge windfall for me in freeing up cash-flow between retiring at age 47 and age 59 1/2.

The beauty of this method is there are no five year fixed waiting periods between doing the "conversion" portion and paying the taxes -- and the ability to withdrawal tax/penalty free from the Roth IRA.

To fully flush this out, you should read the instructions for form 1099-R box 5 to establish how the employer determines the "investment in the contract" of the Roth 401k. I suspect that it is pro-rata between Roth 401k contributions and growth. It is possible that there may be a rule that the Roth 401k has to be established for 5 years before this would work. I would need to research this because I was past the 5 year point for first contributing to the Roth 401k, so any possible/potential limitation did not effect me.

-gauss

Thanks Gauss-this is huge for me. I do have $300k in Roth contributions, but this would simplify the Roth rollover ladder substantially!
How long have you been doing this and what do I need to look for and read through?
I will immediately roll some of.my trad 401k over to the Roth 401k and then send it to my Roth IRA. I guess my problem would be separating it from my standard after tax rollovers. But that might become a moot point next year anyway.

 

[SnowballCamper]

I ended up not including the Roth balance when calculating the SEPP payment. If the tax rates revert back (as is current law) in 2025, there is less advantage for me. I guess I'm late to the ball game on this...

Anyway, finally got the EFT from the TSP, and they didn't withhold any taxes, even though the request said to withhold. Oh well...might have to make a tax payment...drat.