RMD Problems – Suggestions Needed
I have a client who is 53. She was laid off her job. She is going back to college to get her degree. She needs about $46,000.00 ($36,000 living expenses + $10,000 school cost) per year for the next 3 years out of her IRA. The problem is she has about $380,000.00 in her IRA and the maximum RMD works out to be about $21,000.00. Any suggestions on how she can get more money out without penalties? I though about taking IRA money out for education. Would taking money out to pay for tuition impact RMD? Also, can distributions be used for tuition and fees or more such as living expenses.
Thanks for any suggestions.
Permalink Submitted by Alan Spross on Wed, 2008-11-26 20:49
I think that you are referring to the max amount generated by a 72t plan using the amortization method, which is not an RMD.
The problem here is that the entire IRA must be set up for a 72t plan and it will produce only half the amount needed. That would cause her to bust the plan and then owe the retroactive penalty. A solution to this would be to partition the IRA into two IRAs, one for 280,000 and one for 100,000. The 280,000 IRA would be used for a 72t plan and would produce almost 17,000 penalty free. The other IRA would be used for the other distributions, of which 10,000 anually would be penalty free under the higher education exception, and 19,000 would be subject to the penalty. The 19,000 could only be reduced by cutting living expenses or even moving on campus so that room and board could qualify for the penalty exception. See Pub 590, p 54.
The 72t plan would have to be maintained until age 59.5, however after she gets a job, the one time switch to the RMD method would knock down the 72t distribution by 40-50%.
There is also the possibility of part time work and or education assistance that could change the numbers. If her plans are solid enough and she chose to start the 72t in December, she could take the entire 2008 annual amount of 17,000 out without penalty. The downside here is that it would be added to 2008 income in a year where her other income could raise her tax rate.
Permalink Submitted by mk foss on Wed, 2008-11-26 22:41
I’m confused by the reference to $10,000 in Alan’s answer. There is no dollar limit for penalty-free withdrawals from IRAs for higher education. The funds must be spent for currently incurred education expenses (not to pay college loans) and the expenses must qualify as tuition, books, required equipment etc.
Court cases have pointed out what people do wrong – withdrawing funds the year before the education expense is incurred, taking money from a 401(k) plan instead of an IRA, expending funds for “equipment” IRS thinks is not required.
Permalink Submitted by Alan Spross on Wed, 2008-11-26 23:23
Hi, Mary Kay.
The $10,000 was the indicated school cost in the original post. I referred kurt to Pub 590 in order to determine whether that 10,000 matched up to the types of costs that qualify for the higher education exception. Could be more or less; if room and board became qualified by living on campus it would be higher. The idea was to have the expenses that qualified for the exception plus funds that client would need in excess of the 72t come from a separate IRA.
Since a 72t for the entire 380,000 IRA would only produce half the needed cash flow, it would be vulnerable to busting the plan early on. But limiting the 72t to 280,000 would allow enough to go to the other IRA such that the 72t could remain intact.
If the qualified education expense turned out to be more than 10,000 under the definition, all the better because more of the distributions from the non 72t IRA would get their own penalty exception.
I could not think of a way to avoid the penalty on more of the expenses. Perhaps unemployment could be tapped initially for 12 weeks for the medical insurance exception for after tax Cobra premiums. Possibilities exist for more exceptions to the penalty but they all have some challenging timing issues to qualify.
Permalink Submitted by Bill Edwards on Wed, 2008-12-03 15:32
Does it matter for the timing of the RMD distributions if she is taking them annually. Could she take one now before the year end and turn around and take another one early next year or will she need to wait 12 months.
Permalink Submitted by Alan Spross on Wed, 2008-12-03 21:29
Short answer to your question is “Yes”.
These are calendar year payment plans. Within a given calendar year, the taxpayer can distribute the payments any way they wish, eg monthly, quarterly, one lump sum in January or one lump sum in December. The critical requirement is that the exact annual distribution is withdrawn within the full calendar year.
The first and last years are referred to as “stub years”, since a plan can begin and end mid year. In the first year, taxpayer has a choice of taking a pro rated distribution per month or taking out the full annual payment. An example of pro rated distribution would be a plan in which the first payment is made in Sept can take 25% of the annual payment or the full annual payment.
Similar rules apply in the final stub year, which is the portion of the calendar year prior to the plan modification (termination) date.
You asked about taking the full the 2008 amount in December and the 2009 amount in January. This is OK, however I have my reservations about some people’s ability to properly budget a full year payment up front. If they do not have really good discipline, they could run dry by fall and then have to bust the plan.
Note that these are NOT RMD distributions, they are substantially equal periodic payments. While one of the payment methods is the RMD method, your original numbers indicate that the actual calculation method used here was either the fixed amortization method or the fixed annuitization method, which result in higher payouts.