Distribution Year 72T - calendar or fiscal | Ed Slott and Company, LLC

Distribution Year 72T - calendar or fiscal

Hello,

I have a client who plans on starting a 72t this October 2020. She is 52 years old and plans to withdraw $3000 per month ($36,000 annually). If she starts monthly in October, it looks like she needs to take a lump sump of $27,000 for the previous 9 months of this year.

One thing we're thinking about is for her to take the $9,000 in one of her IRA accounts (smaller IRA) and pay the 10% penalty for 2020. Then begin the 72t in Jan 2021 on the new 72t IRA (bigger balance). It's seems simpler than worrying about which year it starts and the extra $27,000 withdrawal she doesn't need this year. Thoughts?

  • In the first stub year of a 72t plan, either the full annual distribution or a pro rated amount by the month is permitted. The full annual is not a requirement.
  • I assume that the 3000 figure was just rounded for the sake of illustration. The actual distribution must reflect the correct calculation, pro rated or annual.
  • If the plan does not start until 2021, she can take whatever amount she wishes from either IRA this year, although she will owe the penalty. 

Hey Alan,Thanks for responding. You are correct, the $3000 was for illustration purposes only. To further clarification, the client can begin Oct 1st $3000/month for 2020 and withdraw $3000 for the next several years. When she turns 59.5 and in her case July 27 of 2027, is her last SEPP amount on July 1, 2027 (59.5 this month) or Sep 1st 2027? Thank you again. Your knowledge is very much appreciated.

  • She will have 3 options in 2027. Distribute full annual by 7/26, distribute a pro rated amount by the month ending in June (50% of annual), or distribute nothing in 2027. For the first two options, it does not matter when or in what pattern the distributions are taken as long as the correct total has been distributed by 7/26.
  • If automatic monthly payments are being used, it not a good idea to schedule them on the first or last 5 days of the month for a 72t plan. This can result in distribution errors due to the New Years Holiday or year end weekends that can result in 13 distributions (or 11 distributions) in a calendar year rather than the expected 12. 
  • With respect to an earlier question, 72t plans are calendar year plans, not fiscal year plans.

Thanks for monthly payment tip. Will schedule On a different day. Curious why the Option of Zero distribution on the final stub Year. Is it because the plan is already over the 5 year minimum and 59.5?

Yes, the absolute minimum is 5 years of distributions. A distribution is not required until the end of the year, so if a plan modification date (plan ends) occurs anytime within a year, there is no distribution required for that year. On the other hand, if a distribution is taken before the modification date it must be either a pro rated by the month or full annual distribution. It cannot be some other amount. 

So if for example the client turned 59.5 on a different month say, Sept 18th, her last year, she can do a pro-rata monthly of 8 months worth or full by Sept 17th Or zero. It's much clearer with your help and examples. thank you again!

Yes, that is correct.  While 8/12 of the annual is technically correct, the IRS has not been busting any plans if the taxpayer used 9/12 in this situation, counting that 9th month. 

thank you so much for your prompt reply. This forum is excellent!

Hi Alan, I did a reverse calculation and if she takes $3000 monthly with the Aug mid-term rate of 0.49% (which may change in Sept), she needs a SEPP account balance of $1,073,026. If her first distribution is for example, Oct 10th and that balance was transferred late Sept or early Oct to the SEPP account, there's a good chance the account will grow before her first distribution. Is the IRS looking at a minimum balance for the SEPP to start the distribution? That is as long as there is the minimum balance the SEPP account to initiate the 72t.

The account balance must be reasonable in relation to the balance on the date of the first distribution (usually that means losses should not be more than 15% (my guess here, the IRS has not published anything) from the initial transferred balance to the actual balance at the date of the first distribution. Also, there cannot be any contributions, transfers, or distributions made between the date of the initial balance and the first 72t distribution if the initial balance is to be used in the calculation.  Therefore, if you transfer 1,073,026 to a new IRA in Sept, and no distribution or contributions are made before the first 72t distribution, changes in the account value up to 150,000 before the first distribution can be safely ignored. While that sounds like a large drop, we already saw this happen in early March, so it is definitely possible. 

Ooops forgot about "large drop" possibilities. We will need to tranfer from 2 IRAs to create the initial balance. I also used the amortization method forgot to mention that. Loaded question Alan, what would you recommend is the simplest and cleanest way of doing it?Use the balance at the end of Sept custodian statement date for the Oct 10th distribution? 

The Sept month end statement would be ideal, but you cannot use it unless the transfers have been completed before that date and included in that statement. An easily available statement is preferable to a screen print of the account balance on some other date, but this is not a requirement. Again, since there are two transfers being made, the balance used must be after both of them are completed.  The annual distribution will then not be affected by value changes after transfer or at any other time since the one time fixed amortization calculation is good for the life of the plan, excepting the option of the one time switch to the RMD method in some later year if a reduced distribution is beneficial.  Due to record low interest rates, the difference between these two methods is not nearly as large as it used to be.

So it sounds like its cleaner to start a 0 balance SEPP IRA account, transfer the amounts needed by end of Sept date.   I can then use the transferred balance amounts and any valuation changes in the account balance by end of Sept or moving forward will not affect the annual withdrawal amount because she's using an amortization method. No additional contributions or distributions before first 72t distribution. Grateful for your assistance Alan!

Yes, that is correct. 

Hi Alan,What is the accepted variance for the annual distribution amount? Say we calculate $35,999.98.. off 2 cents. Is it ok to distribute $36,000? Thank you!

The IRS has not been busting 72t plans for such minute discrepancies in recent years, but technically the distribution should be exact to the penny. The 1099R will report to the penny.

 

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