Validating a 72(t) SEPP plan

Submitted by Bob Friedman on Fri, 2020-01-03 00:03

Hello, I have phoned tax people and there is very little guidance on 72(t) SEPP plans. I spent time to calculate the SEPP plan to avoid the 10% tax penalty for distributions under 55 (403b and 457), and I used a few calculators online, but my question is whether this would be sufficient to document the SEPP plan in case of any future issue. I considered asking a CPA to verify the calculation, but the main purpose in this would be to further document the plan in case the IRS asks. Would the IRS consider the calculator and documentation sufficient or that instead a CPA should certify the SEPP plan? Thank you for any advice on this.



Submitted by Alan - IRA critic on Fri, 2020-01-03 01:17

  • 457 distributions are penalty free, so you do not need to include them in any SEPP plan. As for a 403b or 401 plan, starting a SEPP directly from these plans is a little risky because you do not have the control over these plans like you do for an IRA. If a plan were to adopt some rules changes or change administrators, there could be issues. One way to avoid a SEPP plan is using the age 55 separation exception if you did not separate sooner, but even if you qualify, a plan might not provide for flexible distributions as you need funds.
  • You need to understand the basic rules for 72t SEPP Plans, many of which are contained in RR 2002-62. But other than that the IRS has issued various private letter rulings over the last 2 decades to clarify some finer points. You should use at least two calculators to check for the same result, but for the result to be correct you cannot make the same error when entering data into the two calculators. As for the opening account balance, it should not be more than 6 months old and should be reasonably representative of the plan balance on the date of the first distribution. The IRS has not defined what a reasonable difference is, but I would avoid a balance more than 15% difference (usually 15% higher) than the current balance. Then collect all your documentation including the interest rate used and whether joint or single (use single) life expectancy applies. Keep the documentation for about 5 years after the plan has ended.  Of course, be careful to execute your plan correctly, since many plans that are correctly calculated get busted due to making distribution errors. Keep your plan as simple as possible by avoiding multiple account SEPPs and recalculated plans if you can. Fortunately, the IRS has not been busting plans for minor issues such as rounding rules. A very comprehensive explanation of SEPP Plans is contained in the following link, and even though it is dated, remains 99% on point.
  • https://retireearlyhomepage.com/rpt003e4.pdf


Submitted by Bob Friedman on Fri, 2020-01-03 12:11

Thank you for the very helpful information on navigating the SEPP. The 403/1 plans are with TIAA. Is there a way I can mitigate the low risk of rule or administrator changes to the plan? My thought is I could document with TIAA the particulars of my SEPP plan and document the necessity to continue the yearly fixed distributions until age 59.5. I could also ask if they have had any account holders with a SEPP issue.Another question, less important than the above, is whether the TIAA annuity option is significantly better than periodic distributions, if waiting until age 55, so as to remove any potential difficulty of requesting flexible withdrawals from them over the long term. I favor the annuity option in that case anyways, but I had thought that the SEPP withdrawals provide some flexibility if interest rates change a lot.



Submitted by Alan - IRA critic on Fri, 2020-01-03 14:13

  • You can contact TIIA and ask them to what extent they provide support for a 72t plan. Both employer plans and IRA custodian vary considerably on this, and I don’t know what TIIA offers. The more time that has passed since you contributed to the plan, the better. Two years should be pretty safe to avoid any corrective distributions the plan may need to take with respect to your account.  However, compliance is basically between you and the IRS. Most plans also no longer code the 1099R with the exception code 2 for a 72t plan. They issue code 1 (early) and then you need to file Form 5329 to override the penalty with exception code 02 (72t plan). Having to file a 5329 is not a red flag for the IRS, so don’t worry about that.
  • If you separate from service anytime in the year you reach 55 you qualify for the penalty exception and the 1099R code should be 2 automatically. This avoids a 72t plan and is preferable as long as the plan allows you to take flexible partial distributions. Even if the plan only allows one distribution a year, you can probably live with that, but if the plan only allows a lump sum distribution, even though it would be penalty free, it would spike your marginal rate too much in a single year.
  • While the IRS has approved “recalculated plans”, they are rarely used because of the complexity and annual execution risks since a new calculation is needed every year, and your annual distribution would vary. These invite IRS scrutiny because the distribution changes and the IRS is not used to seeing that. For the usual fixed amount plans, the initial calculation and interest rate for either of the two months preceding the month of the first distribution is fixed and interest rate changes after that do not affect the plan. The 1099R must show the same amount each year, unless you choose to do a one time switch to the RMD plan to reduce your payout. 
  • If you annuitize the payout due to age 55 separation it would be penalty free. But if you separate from service prior to the 55 year, it would not qualify and the distributions would be subject to penalty because they would be calculated on your average salary and years of service in most cases, and not according to one of the 3 approved IRS methods outlined in RR 2002-62.

 



Submitted by Bob Friedman on Sat, 2020-01-04 04:19

  • Thank you for the very informative and concise help! I will verify with the retirement plans that they allow for partial distributions and then keep good records of the SEPP plan with fixed periodic distributions.
  • I have a question. The above discusses the issue of the tax implication in the case of a lump sum distribution from a (qualified) retirement plan. Is this tax burden delayed by instead requesting a rollover of the lump sum into a new IRA account or would the account then become inaccessible until age 59.5.?
  • Also, is it possible to include both a 401 and a 403 account (qualified plans with TIAA) under a single SEPP plan and then distribute the SEPP distribution from just one of the two accounts?


Submitted by Alan - IRA critic on Sat, 2020-01-04 17:34

  • There is no tax due on a direct rollover to an IRA (other than a Roth IRA). A 72t plan could then be intiatied from the IRA over which you would have more control. You can take any distributions you wish from an IRA at anytime, but usually subject to penalty prior to 59.5. A 72t plan would eliminate that penalty. To be clear, if you qualify for the age 55 separation exception, that is only available for direct distributions from the plan. This exception does not apply to an IRA that received a rollover from an employer plan after separation at 55.
  •  Since 401 and 403b plans are treated as separate plans under the tax code, you could not establish a 72t plan covering both. You would need separate 72t plans which adds undesired complexity.
  • Even though 403b plans are required to provide a direct rollover after separation as 401k plans do, it is possible that your plan may require a delay. You should ask the plan administrator to verify that you are eligible for a direct rollover immediately after separation regardless of age, and this question fits well with whether flexible direct distributions after age 55 separation (to avoid a 72t plan) will be available. If not entirely flexible, what options are available?


Submitted by Bob Friedman on Fri, 2020-01-10 17:32

  • I contacted the plan administrator and confirmed that I am eligible for a direct rollover of the 403b plan on separation regardless of age. I also confirmed that the 401 plan could accept that rollover and there is no time delay for either process on separation. It is also possible to request distributions from the 401 plan each year and they would issue a 1099 per plan. I assume it is best to consolidate the plans for early retirement so that there is a single 1099 form instead of two forms each year.
  • However, there is one concern. I verified with the administrator that my employer has the right to alter the plans. Is it possible the employer would alter the plan in a way that prevents future distributions once the SEPP plan starts?


Submitted by Alan - IRA critic on Fri, 2020-01-10 18:26

  • It is always possible that a qualified plan could restrict certain distribution options, but the trend is toward broader distributions and the chance that a plan that already offers broad options would restrict them is quite slim. 
  • If you need a SEPP because you separate before the year you reach 55, then you should roll the plan balance to an IRA and use the IRA for the SEPP. However, if you separate at 55 and the plan offers flexible distributions you will not need a SEPP at all with all of it’s restrictions. Again, if you separate at 55 and start flexible penalty free distributions and the plan is changed (highly unlikely) to restrict those distributions in favor of a lump sum, you could then do a direct rollover and start a SEPP from your IRA.


Submitted by Bob Friedman on Sat, 2020-01-11 00:23

  • Thank you for the great help. I confirmed that the 401 plan is not fully liquid upon leaving service (even at 55), so an IRA plan would only be available to the 403b funds. And so a conversion of the 403b to an IRA would prevent the consolidating of the 403 to the 401 for the purpose of a single 1099 distribution form. [There is actually a way to make the 401 plan liquid, but there is a substantial fee to do this and it would require distribution of a lump sum before any rollover to an IRA.]
  • As an alternative method, I confirmed by talking to a couple of plan representatives that I can annuitize the funds without the 10% tax penalty. However, in the past I’ve had conflicting information on whether this is possible, but does this seem reasonable to consider if they provided some assurance?


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