SEPP, SPIA, Rollovers, and 72(t): Today’s Q&A Mailbag
By Jeremy Rodriguez, JD
Follow Us on Twitter: @theslottreport
No one seems to know the answer to this. Figured I would try you. Client has a 600k IRA. Doing a SEPP of 24k/yr. Has to give 400k to her ex-husband from her IRA. How to adjust SEPP? She is 57 and he is 65.
Do we pro-rate the SEPP so she takes 8k/yr now and he takes 16k until the original term of SEPP would be finished? Seems unreasonable for her to still take 24k/yr of a 200k/balance.
Do we continue the full SEPP on the FULL balance and then give him his share of the IRA after the terms of the 72t have been met? (her reaching 59½ in this case?)
This is a tricky question because the only guidance from the IRS has been private letter rulings. If the transfer is part of the divorce decree or separation instrument, then the transfer itself would not affect the substantially equal period payments (SEPP) and trigger tax consequences. The real question concerns the SEPPs. Can they be modified or does the ex-spouse need to begin receiving payments?
Three private letter rulings provide some guidance, and all three involve an ex-spouse being granted in a divorce a portion of an IRA that was distributing SEPPs to the accountholder. In the first letter ruling, the account holder reduced his payments, but the ex-spouse also began receiving payments. In the end, the total amount of payments to both after the divorce was similar to the total received before the divorce. The IRS held that this did not violate 72(t).
In the second letter ruling, the ex-spouse did not want to receive any payments and the IRS held in her favor. The IRS stated that since the transfer was pursuant to a divorce, the ex-spouse did not need to comply with 72(t) to prevent tax consequences on the original SEPP payments.
Finally, in the third letter ruling, the account holder elected to reduce his SEPPs in the same proportion as the amount transferred in the divorce. He was receiving $300,000 annual payments, was required to transfer 1/3 of the IRA to the ex-spouse, and wanted to reduce the annual payments to $200,000 beginning in the year after the divorce. The IRS held that the reduction in the annual distribution did not violate Section 72(t).
Based on the letter rulings, your client could reduce her SEPPs in the same proportion as the amount transferred and the receiving spouse is not required to continue the SEPP distributions. However, there is some uncertainty here since letter rulings only apply to the individual who requested them. Given that uncertainty and her age, it may be better to continue the original distribution schedule and then transfer the necessary IRA balance to the ex-spouse once the terms of the 72(t) have been met.
Actually, I have a situation that hopefully you might help clarify for me. I have a client that rolled her 401 into an SPIA (single premium immediate annuity) IRA. The age at rollover was 55. Her first distribution was age 56 and she's taking equal payments for the next ten years until age 66 when the SPIA is empty. Does she qualify, under the 72T exemption, of being exempt from paying the 10% early withdrawl penalty for the first four years until she reaches age 59½ in 2020; her birthday is 12/18/1960.
Hope you can help clarify for me.
To qualify for the 72(t) exemption, the distributions must be part of a substantially equal periodic payments (SEPP) made for the life (or life expectancy) of the individual or the joint lives (or joint life expectancy) of the individual and beneficiary. Thus, whether your client qualifies for the exemption is going to depend on the type of SPIA IRA she has. If she has a life only or life with period-certain guarantee settlement option, that would qualify for the SEPP exception. This is because a SPIA IRA with those payment options would be payable over the lifetime, or life expectancy, of your client according to one of the permitted calculation methods. On the other hand, if she purchased a SPIA IRA with a period-certain-only settlement option, this would not qualify for the 72(t) exemption. This type of SPIA IRA is not payable over the lifetime or life expectancy of the IRA owner and does not use any of the permitted calculation methods. However, the client might qualify for other exceptions to the penalty such as higher education expenses or payment of certain medical expenses. You can find information on IRA exceptions to the penalty in IRS Publication 590-B.