Correct execution of a 72t plan?

[Cybertruck]

I am starting a 17 year long 72t plan and am really concerned that I will do something wrong to bust the plan.
I did some math and if I bust the plan in year 17 I could owe the IRS $300,000 in penalties & interest.
I’m hoping someone with knowledge on 72t’s can confirm that I am doing everything correctly.

TIRA balance = $1,500,000
My 1st withdrawal will be in the first couple weeks of 2021.
My beginning balance will be determined on 12/31/20.

My current age is 42, but I will be turning 43 next July. I have been told to use the age that I will be turning in that year to calculate my life expectancy.

Using the single life RMD method, a theoretical TIRA balance of $1,500,000 on Dec. 31st 2020, and an age of 43 my distribution amount should be $36,855.

I will recalculate my withdrawals each year using the new account balance on Dec. 31st of the previous year and the age I will turn in that year.

TD Ameritrade has informed me that they will characterize the distribution as an exception to the early withdrawal penalty so the only reporting I should need to do is the additional income I’ll need to report from the 1099 TD Ameritrade will send me each year.

I know that I have to take the RMD every year until age 59 1/2.
I know that I cannot touch the account other than that.

Is there anything I am missing?

 

[stargazer08]

I have done a 72T for 10 years. I went to a CPA because I didn't trust myself to not make a mistake.
I didn't know you could make changes to the amount you withdraw. I can't on mine....well, I believe I could make one change without a penalty but haven't needed to do that.
I have to take these withdrawals for a minimum of 5 years or until I turn 59.5 whichever is the longest period of time.

 

[Cybertruck]

10 years! That’s great. It’s good to know that it’s possible.
The RMD method bases your withdrawals off of your balance and age which change every year, so the distributions will be different every year.
If your account balance has grown considerably since you started your 72t plan and you want higher withdrawals you can do a one time switch from your current method to the RMD method.
I have a CPA but I think I know more about how to execute a 72t plan than he does. Maybe I need to look for another CPA more knowledgeable in these things.

 

[gauss]

Is there anything I am missing?

I looked at using a 72t plan ~ 10 years ago before I ER'd.

What I was missing, but later realized, is that I could accomplish my goals via Roth conversions in a much simpler and lower risk strategy than the 72t.

An added benefit is that I am Roth converting over many years, which can have advantages discussed in other threads.

-gauss

 

[SecondCor521]

Yes, OP, you generally have it correct.

The RMD method is the easiest to calculate, and your understanding of it is correct.

Your understanding is also correct that you can't add to or take out anything from that tIRA except the SEPP amount.

The amount you take out must equal the SEPP amount to the penny. (Although interestingly an example I found on the IRS website rounds to the nearest dollar.) This should be easy to do.

You can take the amounts out in varying installments if you wish during the year. So if your SEPP amount is $60K, then you can take out $30K in January, $20K in July, and $10K in November.

...

The main thing that I would look into if I were in your shoes is this: The IRS is in the process of issuing new RMD tables with updated divisors. These divisors are larger to reflect the longer life expectancies.

I believe what this would mean for you is that you would use the current RMD table for your 2021 withdrawal and the new RMD table for your 2022 and subsequent withdrawals. However, I would want to confirm this with the IRS to make 1000% sure.

Another thing from a planning perspective is that you should understand with these new RMD divisors that your withdrawal in 2022 will be smaller than it would be under the current tables. Make sure your plan accounts for this, either by the 2022 and subsequent year relatively lower amounts being approximately right, or by having other accounts to meet your spending requirements.

...

@stargazer08, if you're on one of the other two methods, you can make a one-time and one-way switch from either of those two methods to the RMD method. And using the RMD method, the amount varies each year with the person's age and end-of-previous-year account balance, but the method remains the same throughout the SEPP: take the ending balance and divide it by the divisor from the table. You are correct that with the other two methods, once an amount is determined you must take out that same amount every year (although I think there are now exceptions to the penalty if the account runs dry before the SEPP period is up).

 

[SecondCor521]

I'd echo gauss' comment as well. 17 years is a long time. You never know what can happen in your financial life that might indicate an adjustment.

I was going to do a series of 72(t) programs before I found out about Roth conversion ladders. Based on the flexibility alone, I decided to go with the conversion ladder over the 72(t).

The main drawback to the Roth ladder method is that it works best if you have about 5 years of expenses available in taxable or Roth contributions or side gig income. You need that money to live on while the Roth conversions "season" and become usable. You may or may not have that available to you at this point.

What I did is work an extra year or two and stash some of my savings in taxable to build up my 5 years of expenses. Then I FIREd in 2016 and started doing conversions that year. I ended up discovering some miscellaneous income that covers a lot of my expenses. So now I have about 5 years expenses in taxable and 5 years expenses in available Roth money (between contributions and conversions). Since my miscellaneous income covers about 2/3 of my spending, this means I actually have about 30 years worth available to me, which should be enough since I'm 51 1/2 now and only have 8 years to go to get to 59 1/2.

I think this MadFientist article about Roth ladders lays things out pretty clearly:

https://www.madfientist.com/how-to-access-retirement-funds-early/

Scroll down to the "sexy graphic"

 

[OddGuy]

I have an IRA with Fidelity set up for 72t.

It involved me calling them, talking to a rep who somewhat condescendingly advised me this is a serious commitment (thanks!) and who told me I basically had no real control over the intervening years, other than filling out the initial 8 page request and choosing one of the three methods of figuring the annual amount.

Every year as May 1 rolls around (the date I chose), Fidelity sells off some assets to convert to cash, and then deposits the precise amount into my cash account on the morning of May 1.

I make a point of reminding my accountant each year that the distribution should be considered under the 72t rules.

 

[SecondCor521]

^ The IRA custodian should mark a "2" in box 7 if they know it's an SEPP. If they don't, you can file Form 5329 and mark a "02" on Line 2 to correct/clarify the situation.

 

[Jerry1]

I have a CPA but I think I know more about how to execute a 72t plan than he does. Maybe I need to look for another CPA more knowledgeable in these things.

I don't think I'd look for another CPA. I'd challenge the one you have to document his thinking for you to review. I'd make sure you discuss all your concerns with him/her and only if the responses do not meet your expectations of a thorough, thoughtful response, then consider another CPA. If he/she is out of their comfort zone, they should refer you to someone else.

 

[Cybertruck]

Yes, OP, you generally have it correct.

The RMD method is the easiest to calculate, and your understanding of it is correct.

Your understanding is also correct that you can't add to or take out anything from that tIRA except the SEPP amount.

The amount you take out must equal the SEPP amount to the penny. (Although interestingly an example I found on the IRS website rounds to the nearest dollar.) This should be easy to do.

You can take the amounts out in varying installments if you wish during the year. So if your SEPP amount is $60K, then you can take out $30K in January, $20K in July, and $10K in November.

...

The main thing that I would look into if I were in your shoes is this: The IRS is in the process of issuing new RMD tables with updated divisors. These divisors are larger to reflect the longer life expectancies.

I believe what this would mean for you is that you would use the current RMD table for your 2021 withdrawal and the new RMD table for your 2022 and subsequent withdrawals. However, I would want to confirm this with the IRS to make 1000% sure.

Another thing from a planning perspective is that you should understand with these new RMD divisors that your withdrawal in 2022 will be smaller than it would be under the current tables. Make sure your plan accounts for this, either by the 2022 and subsequent year relatively lower amounts being approximately right, or by having other accounts to meet your spending requirements.

...

@stargazer08, if you're on one of the other two methods, you can make a one-time and one-way switch from either of those two methods to the RMD method. And using the RMD method, the amount varies each year with the person's age and end-of-previous-year account balance, but the method remains the same throughout the SEPP: take the ending balance and divide it by the divisor from the table. You are correct that with the other two methods, once an amount is determined you must take out that same amount every year (although I think there are now exceptions to the penalty if the account runs dry before the SEPP period is up).

Thank you for the RMD table info. I happened to run across that while doing some research, and yes, it sounds like the new tables will go into effect in 2022. It’s good to get confirmation on that.

 

[SecondCor521]

What I was trying to say is that I think you should confirm that you should switch from the old tables to the new tables when they're in effect. That's plausibly the correct course of action.

But it's not entirely implausible that the IRS rules would have you continue with the old tables. With $300K on the line I'd double check that this is not the case.

 

[Cybertruck]

Good point.

 

[Sunset]

OP - Did you split off some of your IRA money before doing the 72t, so that you would have a separate, non-restricted, dire emergency pile of funds (subject to 10% penalty)?

 

[CyclingInvestor]

OP - Did you split off some of your IRA money before doing the 72t, so that you would have a separate, non-restricted, dire emergency pile of funds (subject to 10% penalty)?

You should definitely do this. I split 10% of my IRA into a new IRA as an emergency reserve before starting a 13 year 72t from 2006-2018. Schwab had no trouble with it. I made a simple spreadsheet to compute each years withdrawal.

 

[PoorOldCountryBoy]

You should definitely do this. I split 10% of my IRA into a new IRA as an emergency reserve before starting a 13 year 72t from 2006-2018. Schwab had no trouble with it. I made a simple spreadsheet to compute each years withdrawal.

OP, +100 on this. I've be doing an 8 year 72t and DW reaches her 59.5 window in 2021. Using the life expectancy tables just means keeping a spreadsheet active with your end of year totals. Easy peasy.



The importance of other sources of emergency funds cannot be overstated. It was easy for us because we have at least 6 iras/rollovers/403bs etc that we have opened over the years and we could just use one each, supplemented with a taxable account savings for the last 5 years.



But if you have just one IRA, do a split with enough money so that you could withdraw from the new IRA, pay a penalty but leave the 72t program constant. At your young age I'd do this even if you had a large taxable account.



Also consider the wisdom of doing a 72t with a fraction of what you could do, then doing more later. Ex: 50% in one 72t now, with another 30% in a second 72t when you reach 50 and 20% in the emergency IRA fund. What you gain with this is flexibility, because as my Depression era/WW2 relatives would say "you never know".... and they had the emotional and physical battle scars to prove it!

 

[Cybertruck]

OP - Did you split off some of your IRA money before doing the 72t, so that you would have a separate, non-restricted, dire emergency pile of funds (subject to 10% penalty)?

Yes, I did rollover some of the funds in the IRA for emergencies before starting the 72t plan. Thank you!

 

[zinger1457]

When I first looked at your calculation the number seemed low ($36K from $1.5M) but looking at the 120% midterm interest rates it definitely explains why, it's near the lowest it's ever been at .58%. The same 72t calculation 12 months ago would have resulted in $54K. Seems like a low return for $1.5M but if you're good with the amount it definitely reduces your chances of running dry which would be unlikely at even much higher rates.

 

[Cybertruck]

My balance has been growing very quickly over the years so the RMD method made the most sense since the distribution amount is recalculated every year with the new account balance.
I’ve been reading through William J. Stecker's, A Practical Guide to 72t's, https://retireearlyhomepage.com/rpt003e4.pdf
and it sounds like with the amortization method your distributions can also be recalculated every year.
This is contrary to everything else I have read, but he is an expert on the subject so I would take his word over Google’s.
If this were truly the case, the amortization method recalculated every year would produce the highest distributions over time considering interest rates will eventually come back up.

 

[zinger1457]

I’ve been reading through William J. Stecker's, A Practical Guide to 72t's, https://retireearlyhomepage.com/rpt003e4.pdf
and it sounds like with the amortization method your distributions can also be recalculated every year.
This is contrary to everything else I have read, but he is an expert on the subject so I would take his word over Google’s.
If this were truly the case, the amortization method recalculated every year would produce the highest distributions over time considering interest rates will eventually come back up.

Do you trust him over the IRS?

Fixed amortization method

The fixed amortization method consists of an account balance amortized over a specified number of years equal to life expectancy (single life uniform life or joint life and last survivor) and an interest rate of not more than 120% of the federal mid-term rate. Once an annual distribution amount is calculated under this method, the same dollar amount must be distributed in subsequent years.

 

[Cybertruck]

There are private letter rulings that open up revenue ruling 2002-62 to other methods of calculating distribution amounts.
Alan, from Ed Slott & Company also confirmed that it is possible:
“Yes, the IRS has approved "recalculated" amortization plans, but the IRS sees very few of them and that may trigger more attention from the IRS than you want. Stecker's report indicates the timing requirements such as selecting your account balance and interest rate at the same time for each annual recalculation and from year to year. Since current rates are rock bottom, there is potential for rates to increase considerably once they rise, and that will increase your calculations. Account balance changes and annual age increase are the same as if you used the RMD method, therefore the interest rate becomes the main source of increased distribution potential.
Stecker's report is still largely accurate, but it is around 16 years dated now, so there are some portions that have changed since this was published. It is best to recheck your calculation using different calculators. You might check into the replacement website for the original 72onthenet site that the owner shut down about 18 months ago. I have not used the new site, operated by different people.”

Also, from A Practical Guide to 72t:
So how do we reconcile all of the “fixed” language found in Revenue Ruling 2002-62 versus the approved PLR language above? Fortunately, we don’t have to. In the Fall of 2002, the Service issued FAQs Regarding Revenue Ruling 2002-62. This document containing seventeen different questions and Service answers to help taxpayers interpret the provisions of Revenue Ruling 2002-62. Of particular note is Q&A 17:
“(17) Are the [computational] methods contained in Rev. Rule 2002-62 the only acceptable methods of meeting section 72(t)(2)(A)(iv) of the Code?
147
This language is a direct transcription of a private letter ruling issued in June, 2004. Also see PLRs 2004-32023 and 2004-32024.
79

No. Another method may be used in a private letter ruling request, but, of course, it would be subject to individual analysis.”
This effectively became an open invitation to taxpayers for the submission of new methods not currently found in Revenue Ruling 2002-62. Although the operative language in the recently approved private letter ruling does not explicitly say so, this PLR effectively create a new method #4, outside the boundaries of the Ruling, making annual recalculation with the amortization148 concept an approved method149

 

[chassis]

I am starting a 17 year long 72t plan and am really concerned that I will do something wrong to bust the plan.
I did some math and if I bust the plan in year 17 I could owe the IRS $300,000 in penalties & interest.
I’m hoping someone with knowledge on 72t’s can confirm that I am doing everything correctly.

TIRA balance = $1,500,000
My 1st withdrawal will be in the first couple weeks of 2021.
My beginning balance will be determined on 12/31/20.

My current age is 42, but I will be turning 43 next July. I have been told to use the age that I will be turning in that year to calculate my life expectancy.

Using the single life RMD method, a theoretical TIRA balance of $1,500,000 on Dec. 31st 2020, and an age of 43 my distribution amount should be $36,855.

I will recalculate my withdrawals each year using the new account balance on Dec. 31st of the previous year and the age I will turn in that year.

TD Ameritrade has informed me that they will characterize the distribution as an exception to the early withdrawal penalty so the only reporting I should need to do is the additional income I’ll need to report from the 1099 TD Ameritrade will send me each year.

I know that I have to take the RMD every year until age 59 1/2.
I know that I cannot touch the account other than that.

Is there anything I am missing?

I’m considering a 72t.

What specifically is your concern? Hypothetically, what would you do to “bust” the plan?

 

[Cybertruck]

Here is one example:

I will be taking my distributions on Jan. 7th of each year. Next year i will be 42 years old on Jan. 7th so you would think I would use that age to determine my distributions.
But instead you use the age you will be turning in that year. This one miscalculation can bust the entire plan.

As much money as I will have on the line in possible penalties and interest with a busted 17 year long 72t plan I want to make sure I know all of these tiny little details.

 

[SecondCor521]

When I first looked at your calculation the number seemed low ($36K from $1.5M) but looking at the 120% midterm interest rates it definitely explains why, it's near the lowest it's ever been at .58%. The same 72t calculation 12 months ago would have resulted in $54K. Seems like a low return for $1.5M but if you're good with the amount it definitely reduces your chances of running dry which would be unlikely at even much higher rates.

OP is using the RMD method and is 42 years old. That means that (a) the midterm AFR doesn't matter, and (b) the withdrawal amount will start pretty low depending on which table one uses (I thought there was only one but it looks like there are at least two).

 

[blue.zapfel]

72t PLR question

How do you interpret this? Would I need to get my own private letter ruling? I wouldn't even know where to begin and I think it's expensive.

I hope not... I guess I'm not understanding the how the PLR effectively created a new method #4, outside the boundaries of the Ruling.

I'm planning to start a 72t this year, for the next 10 years and was going to use the fixed Amortization method, but the mid-term rates are far to low for me. If the ruling is true, then I could recalculate when the mid-term rates are higher, also, would I then also calculate on the newer account value, I wonder.

I've been planning this 72t for over a year and I continue to be very worried I'll screw up and owe penalty on 9 years of withdrawals.

Thanks for this most informative post, I likely would have never know about this PLR.

TIA

No. Another method may be used in a private letter ruling request, but, of course, it would be subject to individual analysis.”
This effectively became an open invitation to taxpayers for the submission of new methods not currently found in Revenue Ruling 2002-62. Although the operative language in the recently approved private letter ruling does not explicitly say so, this PLR effectively create a new method #4, outside the boundaries of the Ruling, making annual recalculation with the amortization148 concept an approved method149

 

[plex]

I've taken a good look at using 72t because I'm close to when I would consider using one. I think it is a decent, though slightly more time-consuming option for you since the withdrawal amount is reasonable, even if inflation kicks up, despite the extremely low mid-term interest rate that the 72t starting amount is based upon.

For a majority of people though, the current extremely low mid-term rates are a huge problem, resulting in the maximum possible amount coming from a 72t being a lot lower than they need for income, because the only option that doesn't rely on the mid-term rates, RMD, is almost always an even smaller amount for awhile even under low interest rate scenarios. This means they need to sometimes/often do roth conversions anyway, making the 72t mostly pointless for them. Also, once you start the 72t, you cannot stop it, so if for some reason you have to go back to work, you are going to have a lot of extra income you do not want.

Personally I will be doing a roth conversion ladder during the years my taxable accounts are not producing enough taxable gains, and forgoing the extra complications of a 72t.