Incredibly, Donald Trump has signed up to make that choice, starting January 20th.
How can that be? It relates to SECURE 2.0. SECURE 2.0 made dozens of additions to the already complicated retirement account rules. Many like its delaying retirement account required minimum distributions (“RMDs”) for many Americans from age 72 to age 73 (and eventually to age 75).
But there is a big time issue few have commented on.
It has to do with the Omnibus Bill’s purported passage in December 2022. If the Omnibus, which contained SECURE 2.0, was not passed in a Constitutionally qualified manner, any Administration enforcing it would be acting counter to the Constitution and contrary to the rule of law.
The Constitutional Problem with SECURE 2.0
A federal judge, in a very well written and reasoned opinion, determined that the 2022 Omnibus Bill, was passed by the House of Representatives at a time the House did not have a required quorum to enact legislation. In Texas v. Garland (accessible here and here), Judge James W. Hendrix ruled for the State of Texas that the House of Representatives impermissibly used proxies to establish a quorum. The House did not have a majority of members physically present, and thus did not have a sufficient quorum to enact legislation at the time of Omnibus’s purported passage.
The quorum rule isn’t contained in the back of a House of Representatives parliamentary procedure manual. Rather, it is contained in the Quorum Clause of the United States Constitution, making it the highest level of legal authority.
This ruling has broad implications for SECURE 2.0. If the Omnibus was not enacted in a Constitutionally qualified manner, SECURE 2.0 is not the law of the land. Any Administration enforcing it would be enforcing a law that is simply not the law of the land.
I encourage the reader to read the Texas v. Garland opinion. I find it convincing, but you get to be the judge and jury in your own mind.
Assuming the new Administration agrees with Judge Hendrix’s reasoning, they should announce they will not enforce SECURE 2.0 in order to avoid acting contrary to the law.
Proposed Action
I recommend that shortly after President Trump’s inauguration the IRS and Treasury issue a Notice announcing the following:
In order to uphold the Constitution and the rule of law, the IRS and Treasury will not enforce SECURE 2.0.
Considering the equities involved, the uniqueness of taxpayers having acted under an announced law that was not, in fact, the law, and the limited enforcement resources available, the IRS will not challenge any acts made, plan/account qualification, and tax return positions taken based on SECURE 2.0 prior to the issuance of the Notice. Plans and financial institutions will be allowed a reasonable amount of time to adequately account for the Notice.
In order to eliminate harm from detrimental reliance on SECURE 2.0, appropriate equitable remedies will be applied to prior acts taken under SECURE 2.0 with relevance going forward. For example, any Roth SEP IRAs and Roth SIMPLE IRAs properly created and funded under SECURE 2.0 will be deemed to be Roth IRAs with respect to which valid contributions were previously made.
The IRS and Treasury will exercise their authority under Sections 402(c)(3)(B) and 408(d)(3)(I) and waive the 60-day requirement with respect to rollovers for any SECURE 2.0 qualified distributions followed by three year repayments so long as the distribution occurred prior to the issuance of the Notice and repayment is made back to the retirement account no later than December 31, 2025.
The IRS will not require RMDs and not enforce the failure to withdraw penalty for those who turned age 73 in 2023 and for those who turned age 73 in 2024.
The IRS will require RMDs and enforce the failure to withdraw penalty for those who turn age 73 starting in 2025.
Relevant 2025 limits will be applied not factoring in provisions from SECURE 2.0. Thus, guidance such as Notice 2024-80 is modified accordingly. For example, the 2025 qualified charitable distribution limit is $100,000 and for those age 60-63 the catch-up contribution limit is $7,500.
I recommend the new Administration issue that notice shortly after Inauguration Day to uphold the Constitution regardless of whether the new Congress chooses to take additional action with respect to SECURE 2.0.
The question then becomes what to do in Congress, if anything, with respect to SECURE 2.0. Since it is likely Congress will enact significant tax legislation, there will be one or more opportunities to address the issue.
I propose that as part of the 2025 tax changes Congress passes, Congress include a provision repealing SECURE 2.0 for the avoidance of doubt. That will end any possible litigation around SECURE 2.0, since the IRS will have waived any challenges resulting from acts occurring prior to the Trump Administration, and Congress will have repealed it (in case it is the law, counter to my opinion) going forward.
SECURE 2.0 had more to do with 401(k) plan administrators and lawyers securing full employment than securing retirement for working Americans. SECURE 2.0 being pushed to the side would be no tragedy. Perhaps Congress should salvage a few good provisions, but most of it should be left on the scrap heap while Congress focuses on more important tax reforms and extending Tax Cuts and Jobs Act individual tax cuts.
I am more ambivalent about the delays in RMDs. Congress could simply enact SECURE 2.0’s RMD delays as part of its 2025 tax reforms. That said, I believe that tax cuts such as eliminating the taxes on tips and overtime are much better tax policy and should be prioritized.
Further, the tax benefit of eliminating the tax on Social Security potentially dwarfs the tax benefit of a one or three year delay in RMDs. There’s a very valid argument that eliminating taxes on Social Security and having RMDs start at age 72 is appropriate and will leave many seniors in a vastly improved tax position when compared to where they stood prior to 2025.
Conclusion
I would pick the Constitution over delayed RMDs any day of the week. The Constitution is far more important than any retirement account tax rule. While it is not good to say dozens of rules that Americans have planned around are invalid, it is far worse to disregard the Constitution.
My hope is that the new Administration’s tax policy staff, including the new Assistant Secretary for Tax Policy, work to uphold the Constitution.
The new Administration, consistent with Judge Hendrix’s ruling, should acknowledge the Constitutional problem with SECURE 2.0 and addresses it head on. Doing so will demonstrate President Trump’s commitment to honor the Constitution and the rule of law.
This post is for educational purposes only. It does not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, and tax matters. Please also refer to the Disclaimer & Warning section found here.
Note that a version of this proposal has been posted to the crowd sourced policy website PoliciesforPeople.com. The views reflected in this post are only those of the author, Sean Mullaney, and are not the views of anyone else.
The 100%/110% safe harbor protects the late-in year lottery winner (among others). As long as he or she has withholding or estimated tax payments that meet 100% or 110% (as applicable) safe harbor, he or she can have millions or billions of dollars in income, meet the safe harbor requirements, avoid the underpayment penalty and pay most of the 2024 tax by April 15, 2025.
Estimated tax payments are great, but they require early in the year action not possible in the fourth quarter. To meet the safe harbor, generally one quarter of the total amount due under the safe harbor must be paid by April 15th, June 15th, September 15th, and the following January 15th. That’s great, but for those who didn’t make the first three payments going into the fourth quarter, estimated tax payments may not be all that helpful at this point.
Most states with an income tax have rules that mirror the federal income tax withholding rules, but some states have differences.
The Retiree’s Secret Weapon for Estimated Tax Payments
Retirees have a secret weapon for making income tax payments, particularly late in the year. IRAs!
People miss paying taxes during the year. It happens for a variety of reasons. If I were a retiree and I found myself underpaid for either (or both) federal and state income taxes purposes in the fourth quarter, the first place I would look to make an estimated tax payment would be a traditional IRA.
Why?
Because income tax withheld from a traditional IRA is deemed paid equally to the IRS throughout the year regardless of when the withholding occurs.
IRA owners can initiate a distribution from their traditional IRA and direct that most of it be directed to the IRS and/or the state taxing authority. That withholding is treated as if it is paid equally throughout the year regardless of whether it occurs on January 5th or December 21st.
That’s pretty good! A late in the year IRA distribution withheld to the IRS can meet either (or both) the 90% safe harbor and/or the 100%/110% safe harbor.
The downside is that it creates taxable income. In many cases, it turns out retirees are rather lightly taxed. As long as the retiree had a relatively low income tax burden either last year or this year, the taxable withdrawal won’t be a large number, because the applicable required safe harbor withholding will be modest. Thus, the tax hit on the mostly withheld distribution should be rather modest.
Another advantage of using a traditional IRA to pay income taxes is RMD mitigation. While I believe the concerns around RMDs are wildly overstated, RMD mitigation is a perfectly valid financial planning objective and a good outcome.
Using an IRA to Pay Income Taxes Under Age 59 ½
You may now be thinking “Sean, that’s a great idea for those over age 59 ½. But what if I’m under age 59 ½? Won’t I be subject to the 10% early withdrawal penalty on the amount I fork over to the IRS?”
That’s an excellent thought! Fortunately, the answer to your questions is “maybe.”
The IRS maintains a list of exceptions to the 10% early withdrawal penalty. Many will not be applicable to most retirees. But there are some options–let’s explore two of them: Inherited IRAs and 72(t) payment plans.
Inherited IRAs
Beneficiaries of inherited IRAs never pay the 10% early withdrawal penalty with respect to distributions from their “inherited IRAs.” Thus, the inherited IRA is a great place to look to pay taxes from late in the year.
The only downside is the distribution to the IRS or the state taxing authority is itself taxable to the beneficiary. However, the money in the inherited IRA has to come out eventually (usually under the 10 year rule at a minimum), so why not whittle the traditional IRA down by using it to pay income taxes and avoid an underpayment penalty?
72(t) Payment Plan to Pay Income Taxes
Could someone start a 72(t) payment plan to pay required income taxes? Absolutely, in my opinion. It might even be a good idea!
72(t) Payment to Pay Income Taxes Example
Homer and Marge both turned age 56 in the year 2024. They retired early in 2023 and thus had some W-2 income and some investment income in 2023. They had approximately $120K of adjusted gross income in 2023 and thus paid approximately $8,800 of federal income taxes in 2023 (see Form 1040 line 24 less most tax credits — see the comment below) and $2,000 of California income taxes in 2023.
In 2024 they have ordinary income below the standard deduction and taxable income below the top of the 12% federal income tax bracket. Thus, they owe no federal income tax and a very small amount of California income tax for 2024. They’ve made no estimated tax payments.
In August 2024 they decided to sell their Bay Area home worth $2M to move to a more rural part of California. The sale closed in October 2024 and they had a $500,000 basis in the home. Qualifying for the $500K exclusion, this triggers a $1M taxable long term capital gain to Homer and Marge in 2024. D’oh!
Very, very roughly, the capital gain creates approximately $175K of federal income tax, $30K of federal net investment income tax, and $100K of California income tax. Note also that the proceeds from the home sale are likely to cause some taxable income in December 2024, but let’s just use the above three tax numbers for illustrative purposes only.
One of their other assets is a $2M traditional IRA. They have no inherited retirement accounts but they do have some taxable brokerage accounts. To my mind, there are four main ways Homer and Marge can avoid an underpayment penalty.
Option 1: Q4 Estimated Tax Payments
Homer and Marge could make substantial fourth quarter estimated tax payments out of their taxable brokerage accounts by January 15, 2025. They would owe 90% their entire 2024 tax liability at that time and would need to use annualization on the Form 2210 to avoid an underpayment penalty.
Compared to the other three methods described below, this costs them 3 months of interest on about $275K. In today’s interest rate environment, that is about $2,700 of interest in an online FDIC insured savings account.
Option 2: IRA Regular Distribution
Homer and Marge could, no later than December 31st, trigger a distribution from one of their traditional IRAs, say for $11,100. They could direct the institution to send $8,880 (80%) to the IRS, $2,109 (19%) to the California Franchise Tax Board, and $111 (1%) to themselves (the intuition will likely require they take at least 1% of the distribution). This creates $11,100 more taxable income (taxed at a low federal rate due to income stacking).
The advantage is this qualifies for the safe harbor, meaning Homer and Marge don’t have to pay most of their 2024 income tax until April 15, 2024. The downside to this is it triggers a 10% early withdrawal penalty ($1,110) payable to the IRS and a 2.5% early withdrawal penalty ($278) payable to California.
Option 3: IRA Regular Distribution and Rollover
This option is the IRA Regular Distribution option plus refunding the $11,100 traditional IRA distribution to the traditional IRA from their taxable accounts within 60 days. This has all the same advantages as the IRA Regular Distribution option plus it reduces 2024 taxable income by $11,100 and avoids the early withdrawal penalties.
Gold, right? My view: I tend to disfavor this tactic. Why? Americans are limited to one 60 day rollover from an IRA to an IRA every 12 months. My personal opinion is that pre-age 59 ½ retirees are usually better served to keep that option on the table. You never know when a significant sum will pop out of a traditional IRA. It will be good to have the option to put that money back into the traditional IRA. If Homer and Marge do the $11,100 IRA Regular Distribution and Rollover, they are locked out from the ability to do a 60 day IRA to IRA rollover for the next 12 months.
Option 4: 72(t) Payment Plan
This option is simply the IRA Regular Distribution option as part of a 72(t) payment plan. The advantage of adding the 72(t) payment plan is avoiding the 10% early withdrawal penalty (federal) and the 2.5% early withdrawal penalty (California).
Here’s how it works. Before making the $11,100 IRA withdrawal, Homer and Marge do a 72(t) distribution calculation and have their financial institution set up a $172,116.10 72(t) IRA. Here is the 72(t) fixed amortization calculation:
Item
Amount
Source
Interest Rate
5.00%
Notice 2022-6
Single Life Expectancy Years at Age 56
30.6
IRS Single Life Table
Account Balance
$172,116.10
Annual Payment
$11,100.00
Homer and Marge then take the distribution from the 72(t) IRA prior to the end of 2024, directing 80% to the IRS and 19% to the Franchise Tax Board.
You say, but wait a minute, now they have $11,100 they have to take annually for each of the following four years. I say, well, okay, they have $2M in tax deferred accounts, why not take some of that without a penalty (perhaps as a form of the “Hidden Roth IRA”) and whittle down future RMDs a bit?
That said, Homer and Marge can drastically reduce the annual 72(t) payment if they want with a one-time change to the RMD method. Assuming the 72(t) balance on December 31, 2024 is $164,000, here’s what the 2025 taxable RMD from the 72(t) could look like:
Item
Amount
Source
Account Balance
$164,000
Single Life Expectancy Years at Age 57
41.6
Notice 2022-6 Uniform Life Table
2025 Payment
$3,942.31
One would hardly expect that $4,000 of taxable income would derail Homer and Marge’s tax planning in retirement. Further, they can direct most of that $4,000 to the IRS and Franchise Tax Board to help take care of 2025 tax liabilities, if any.
Conclusion
For those under age 59 ½, a 72(t) payment plan might be the answer to an underpayment of estimated taxes problem. It is a bit of an “out of the box” solution, but it has several advantages. It allows some taxpayers to delay paying significant amounts of tax until April 15th of the following year by qualifying the taxpayer for the 100% of prior year tax safe harbor. Second, it avoids the 10% early withdrawal penalty. Third, it avoids the once-every-twelve-months 60 day rollover rule. Lastly, a 72(t) payment plan is rather flexible and the required taxable distribution in future years can be significantly reduced by a one-time switch to the RMD method.
The above said, the first IRA I would look to if I was under age 59 ½ and looking to pay estimated taxes is an inherited IRA. Those are never subject to the early withdrawal penalty and can always be accessed in a flexible manner.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters.Please also refer to the Disclaimer & Warning section found here.
One area that is insanely and needlessly complicated is the inherited retirement account rules. What happens when someone inherits a traditional IRA, Roth IRA, and/or qualified workplace retirement account? It depends on far too many factors and there are far too many potential outcomes! As just one example, financial planner Jeffrey Levine came up with a flow chart of possible outcomes when a successor beneficiary inherits a retirement account.
That Mr. Levine could come up with such a flow chart is an absolute disgrace (to the government, not to Mr. Levine).
Complexity in our tax and retirement account laws shifts power away from ordinary Americans towards lawyers, accountants, advisors (such as me), and the IRS. Let’s shift some power back to ordinary Americans!
It’s time to radically simplify and reform the inherited retirement account rules.
Current Inherited Retirement Account Rules
Upon the death of the owner of an IRA or qualified plan, the following are potential outcomes in terms of potential inherited retirement account distribution rules:
I propose that the current voluminous, complicated inherited retirement account rules be scrapped. They should be replaced by the following simple rules, all effective January 1, 2025 unless otherwise noted.
At the decedent spouse’s death, any retirement account left to a spouse becomes the surviving spouse’s retirement account in the surviving spouse’s own name automatically and immediately upon death.
All other beneficiaries inherit an inherited retirement account which must be emptied within 10 full years following the owner’s death with no RMDs in years 1 through 9.
The death of a spouse entitles the surviving spouse to a permanent exception to the Section 72(t) 10 percent early withdrawal penalty with respect to distributions from any retirement account.
This applies even if the widow/widower remarries.
For fairness and simplicity, this applies even if the spouse died prior to 2025.
Any inherited retirement account a widow or widower treats as an inherited retirement account instead of a spousal rollover account as of the end of 2024 automatically becomes the surviving spouse’s own retirement account in their own name as of January 1, 2025.
The death of the beneficiary of an inherited retirement account does not change the clock. Successor beneficiaries must empty the inherited retirement account by the end of the 10th full calendar year following the original owner’s death.
Existing inherited retirement accounts (as of the end of 2024) are no longer subject to both the 10 year rule and RMDs. For 2025 and beyond, such accounts are subject to only the 10 year rule.
For fairness and simplicity, any retirement account inherited prior to 2025 subject to a 5 year rule will switch to the 10 year rule (measured as of the owner’s date of death).
Reset Day for Inherited Retirement Accounts Subject to an RMD in 2025: If the original owner died in 2024 or earlier and the inherited retirement account is subject to only an RMD in the year 2025 (under any of the old rules), the inherited account will become subject to the 10 year rule, and no longer be subject to RMDs (both as of 2026), as if the original owner died on December 31, 2025.
The 2025 New Year’s Eve Reset Day applies to both beneficiaries and successor beneficiaries, including those who become successor beneficiaries during 2025.
Simplification
After my proposed reform, there will be two and only two potential treatments for an inherited retirement account: spousal rollovers for spouses and the 10 year rule for everyone else. Note: It takes 8 rules to get to a 2 rule system because in order to get to a 2 rule system there needs to be rules to account for the transition from a very complex system to an understandable system.
Replacing the existing rules with the above 2 rule system would significantly reduce the amount of federal regulations and reduce complexity. Congress stumbled into a great inherited retirement account rule in the SECURE Act: the 10 year rule. It’s time to make that the rule for all inherited retirement accounts except spousal rollovers.
Rules 4, 7, and 8 are simplification and consistency measures. They logically transition the inherited retirement accounts rules to a single, uniform system with only two outcomes: a spousal rollover or the 10 year rule.
Rapid Transition
I propose a rapid, though not overnight, transition to a uniform system. Assuming a bill is passed in early to mid-2025, 2025 can be a transition year and then by New Year’s Day 2026 all inherited retirement accounts would be on the new system, meaning all inherited retirement accounts, regardless of when inherited, would be subject to only one of two rules as of New Year’s Day 2026.
Protecting Young Widows and Widowers
Rule 3 is needed to avoid reform harming pre-age 59 ½ widows and widowers. Under today’s rules, surviving spouses can elect to treat a spouse’s retirement account as an “inherited” account instead of doing a spousal rollover. That inherited treatment avoids the 10 percent early withdrawal penalty on pre-age 59 ½ distributions.
If pre-age 59 ½ widows/widowers must do a spousal rollover (as I propose), they would be subject to the 10 percent early withdrawal penalty if they took taxable distributions prior to their 59 1/2th birthday. To avoid that outcome, why not make becoming a widow/widower an automatic, permanent exception to the 10 percent early withdrawal penalty?
Transition Entirely to a New Uniform System
Reform should clean the slate of complexity. Without rules 4, 7, and 8, there would be separate systems of rules for retirement accounts inherited prior to 2025 and those inherited in 2025 or later. There’s no need for two separate systems of rules. These three rules make the rules simple for all inherited retirement accounts going forward.
A Small Net Tax Increase
Rule 8 is a modest tax increase, mostly falling on the wealthiest Americans. Considering the hope that 2025 will bring some popular tax cuts, such as eliminating taxes on tips and Social Security, it is good to have at least some logical tax increases in 2025 that would not significantly impact ordinary Americans. Note also that rules 2 and 5 are also likely to be small tax increases while rules 3 and 7 are likely to be small tax cuts.
Regardless of the likely very modest net tax effect, the simplicity brought by this new system would greatly benefit the administration of the tax rules and ordinary Americans.
Rule 8 Transition Examples
Rule 8, eliminating inherited retirement account RMDs and switching to a 10 year rule as of 2026, is key to transitioning old inherited retirement accounts to the new, uniform system for taxing inherited retirement accounts. Here are three examples of how it would work.
Example 1: In 2017 Jock died and left his $1M traditional IRA to his son JR. JR, 23 years younger than Jock, turned 40 in 2017. JR started taking traditional IRA RMDs based on the IRS Single Life Table in 2018. In 2022 he redetermined the RMD factor such that by 2025 the factor was 37.8 (start with 44.8 for 2018 theoretically, subtract one annually to get down to 37.8 for 2025). For 2025, JR must take his RMD under the old rules (which still apply) by dividing the inherited traditional IRA 12/31/2024 balance by 37.8 and taking that amount by December 31, 2025. In 2026 JR becomes subject to the 10 year rule by Jock’s deemed death on December 31, 2025. Thus, JR has until the end of 2035 to empty the inherited traditional IRA. He has no RMDs other than in 2035 (the entire remaining balance).
Example 2: In 2022 Huey died and left his $1M traditional IRA to his brother Earl. Earl, two years younger than Huey, turned 66 in 2022. Earl, an “eligible designated beneficiary” under the SECURE Act, started taking inherited traditional IRA RMDs based on the IRS Single Life Table in 2023. For 2025, Earl must take his RMD under the old rules (which still apply) by dividing the inherited traditional IRA 12/31/2024 balance by 19.2 and taking that amount by December 31, 2025. In 2026 Earl becomes subject to the 10 year rule by Huey’s deemed death on December 31, 2025. Thus, Earl has until the end of 2035 to empty the inherited traditional IRA. He has no RMDs other than in 2035 (the entire remaining balance).
Example 3: In 2017 Al died and left his $1M traditional IRA to his son Barry. Barry has taken RMDs annually. During 2025 Barry dies and Carl becomes the successor beneficiary. In 2026 Carl becomes subject to the 10 year rule (as Al is deemed to have died December 31, 2025) and Carl has until the end of 2035 to empty the inherited traditional IRA. He has no RMDs other than in 2035 (the entire remaining balance).
Conclusion
The inherited retirement account rules are mindlessly and needlessly complicated. The complexity creates confusion shortly after the death of a loved one. Enough is enough!
It’s time for greatly simplified inherited retirement account rules. That simplifying these rules might help fund popular tax cuts such as eliminating taxes on tips and Social Security is the cherry on top of a great tax reform proposal.
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, and tax matters. Please also refer to the Disclaimer & Warning section found here.
Note that a version of this proposal will be posted to the crowd sourced policy website PoliciesforPeople.com. The views reflected in this post are only those of the author, Sean Mullaney, and are not the views of anyone else.
I’ve talked about what I refer to as a “72(t) IRA” both here on the blog and on my YouTube channel.
What I haven’t talked much about, until now, is a 72(t) payment plan coming out of a 401(k). Is it possible? Does it make sense?
Inspired by a comment on a recent video, I’m breaking down taking 72(t) payments from a 401(k) in this post. As you will see, when compared with the 72(t) IRA, the 72(t) 401(k) has significant disadvantages.
401(k) Plan Rules
Can you do a 72(t) out of your 401(k)? The answer is “maybe.” Qualified plans, including 401(k)s, have all sorts of unique rules. They vary plan to plan.
There’s no guarantee that you can access partial withdrawals from a 401(k) in accordance with a 72(t) payment plan after a separation from service.
By contrast, IRAs allow for easily accessible partial withdrawals regardless of age.
Must Separate From Service
There’s a tax rule to consider: one can only do a 72(t) payment plan from a 401(k) or other qualified plan after a separation from service from the employer.
From a planning perspective, this is not much of an issue. Few would want to do a 72(t) payment plan while still working, as taxable withdrawals from a 401(k) are not ideal if one still has significant W-2 income hitting their tax return.
72(t) Account Size
According to Notice 2022-6, the 72(t) account balance for the fixed amortization calculation must be determined in a reasonable manner. See Section 3.02(d). The Notice goes on to state that using a balance of the account from December 31st of the prior year through the date of the first 72(t) distribution is reasonable. One should document, usually with an account statement, the balance they are using to have in case the IRS ever examines the 72(t) payment.
Account size is one area where a 72(t) IRA is generally preferable to a 72(t) 401(k). As Natalie Choate observes in her classic Life and Death Planning for Retirement Benefits (8th Ed. 2019), an IRA can be sliced and diced into two or more IRAs, allowing one to take a 72(t) payment from a smaller IRA and remain flexible, in part through having a non-72(t) IRA as well. This flexibility is generally not possible with a 401(k) or other qualified plan. See Choate, page 595. That means without a transfer to an IRA first, the 401(k) account holder is generally stuck with an account size for the fixed amortization calculation, other than the bit of wiggle room given by Notice 2022-6 Section 3.02(d). Further, the entire account is subject to the locked 72(t) cage.
72(t) Locked Cage
A 72(t) 401(k) is entirely subject to the many restrictions on 72(t) retirement accounts. When one uses a 72(t) IRA, they often can have a 72(t) IRA and a non-72(t) IRA. This means less of their retirement account portfolio is subject to the 72(t) rules “locking the cage.” For example, the non-72(t) IRA can be used to accept other IRA roll-ins.
72(t) 401(k) Example
An example can illustrate the problems involved in using a 72(t) 401(k) instead of a 72(t) IRA.
Bob wants to retire early in 2024 at age 53. He has some rental real estate that will generate $40,000 of positive cash flow annually and needs $50,000 more annually from his retirement account to support his lifestyle. He has a $2,000,000 401(k) at his current employer. He sets up a 72(t) 401(k) instead of rolling out to a traditional IRA and establishing a non-72(t) IRA and a 72(t) IRA.
Solving for interest rate, we get an interest rate of -1.015124%.
Notice that in order to generate a $50K annual payment out of a $2M 401(k), Bob must use a negative interest rate. Bob can’t simply ask his 401(k) administrator to establish two separate 401(k) accounts for him and then use a positive interest rate for the 72(t) payment plan.
72(t) Negative Interest Rate
This raises an issue: can a taxpayer use a negative interest rate for a 72(t) payment plan under the fixed amortization method?I believe the answer is Yes. Notice 2022-6 Section 3.02(c) allows an interest rate “that is not more than the greater of (i) 5% or (ii) 120% of the federal mid-term rate (determined in accordance with section 1274(d) for either of the two months immediately preceding the month in which the distribution begins)” (emphasis added).
In my opinion, that wording in no way precludes using a negative interest rate for a 72(t) payment plan. Further, I see no compelling reason for the IRS to be concerned about using a negative interest rate. That said, there is at least some uncertainty around the issue.
The issue is entirely avoided if Bob rolled out to a traditional IRA and then split that traditional IRA into two IRAs. He could have a 72(t) IRA of about $804K generating an annual $50K payment (using a 5% interest rate) and a non-72(t) IRA of about $1.196M. From a planning perspective, it’s certainly my preference to avoid the issue by using the 72(t) IRA.
72(t) Structuring Alternative
As a structuring alternative that might be available to Bob (depending on the plan’s rules), Bob could roll the $804K out to a traditional IRA and use that as a 72(t) IRA. He could keep the balance inside his 401(k) and effectively use his 401(k) as what I refer to as the “non-72(t) IRA.” This sort of structuring was discussed on the Forget About Money podcast (timestamped here).
Unfortunately, using a 72(t) 401(k) boxed Bob into a bad corner. Say Bob is age 57 and the 72(t) 401(k) is still worth exactly $2M. He could use the age 57 factor from the Notice 2022-6 Uniform Life Table (41.6) and reduce his annual payment to $48,077. Not much of a reduction from his $50,000 required annual payment.
Had he used a 72(t) IRA/non-72(t) IRA structure instead, and the 72(t) IRA was worth $804K, he could reduce his $50,000 annual payment all the way down to $19,327.
For those looking for protection against significant tax in the event of an inheritance or other income producing event, the 72(t) IRA is preferable to the 72(t) 401(k).
What if Bob has a 72(t) 401(k)? I believe that establishing a second 72(t) payment from his 72(t) 401(k) would blow up his existing 72(t) payment plan. The second 72(t) payment would be an impermissible modification of the original 72(t) payment plan, triggering the 10 percent early withdrawal penalty and interest charges with respect to all prior distributions.
I am uncomfortable with any modification to a 72(t) retirement account unless it is specifically allowed by IRS guidance such as Notice 2022-6, and I see no evidence that a second 72(t) payment plan out of the same retirement account is permissible. Natalie Choate is also of the opinion that taking a second 72(t) payment from an existing 72(t) account is an impermissible modification of the first 72(t) payment plan. See Choate, page 594. See also IRS Q&A 9 (nonbinding), allowing a new 72(t) payment plan from the retirement account only after the taxpayer has blown up their original 72(t) payment plan.
That said, there is a single 2009 Tax Court case, Benz v. Commissioner, that gives the slightest glimmer of hope. In that case an additional distribution from a 72(t) IRA excepted from the 10% early withdrawal penalty as being for higher education expenses did not blow up an existing 72(t) payment plan, because the additional distribution itself qualified for a 10 percent early withdrawal penalty exception under Section 72(t)(2)(E).
It’s likely a stretch to apply Benz to a second 72(t) payment plan from the same retirement account. That said, I don’t believe it is an impossible outcome. But note that Benz is a single 15 year old court case binding neither on any federal district court nor on any federal appellate court. Further, the IRS never acquiesced to the decision in Benz, meaning they may still disagree with it. Even if the IRS now agrees with Benz they (and more importantly, a court) may not believe the logic of Benz goes so far as to allow a second 72(t) payment plan from the same retirement account.
Asset Protection
Depending on the circumstances and on the state, it can be true that IRAs offer materially less creditor protection than 401(k)s and other qualified plans. That could be a reason to use a 72(t) 401(k) instead of a 72(t) IRA.
I believe that, as a practical matter, sufficient personal liability umbrella insurance, which tends to be affordable, can adequately fill-in gaps between IRA and 401(k) creditor protection. Of course, everyone needs to do their own analysis, possibly in consultation with their lawyers and/or insurance professionals, as to the adequacy of their creditor protection arrangements.
72(t) Payment Plan Resources
72(t) payment plans are complex. Here are some resources from me and other content creators for your consideration:
The 72(t) 401(k) is a possibility if one’s 401(k) plan allows it. I usually strongly disfavor doing a 72(t) payment plan out of a 401(k) considering how rigid it is compared to the 72(t) IRA alternative. Further, as discussed above, 72(t) 401(k)s can create situations where the tax law has not, to my knowledge, definitely stated the governing rules. For these reasons, I generally favor using 72(t) IRAs in conjunction with non-72(t) IRAs instead of the more inflexible 72(t) 401(k).
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters.Please also refer to the Disclaimer & Warning section found here.
Recently, the IRS and Treasury issued Notice 2024-55. This notice provided initial rules for SECURE 2.0 emergency personal expense distributions (“EPEDs”), domestic abuse victim distributions, and repayments into retirement accounts. The Notice also asked for comments on the above and on Section 72(t) in general.
I wrote a comment letter (which you can read here) to the IRS and Treasury obliging that request. The letter addresses EPEDs, repayments into retirement accounts, and the impact of Texas v. Garland on SECURE 2.0. Further, the comment letter requests clarification that Solo 401(k)s of retired solopreneurs qualify for the Rule of 55 exception to the Section 72(t) ten percent early withdrawal penalty.
This post (and the linked-to comment letter) is for entertainment and educational purposes only. They do not constitute accounting, financial, investment, legal, or tax advice for you or any other individual. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.
If that is the case, the Solo 401(k) should be rolled over to an IRA and there’s no ability to use the Rule of 55.
Until now, I’m not aware that anyone has done a deep dive to validate or disprove that concern. So I decided to do it myself. My research took me as close to the year 1962 as one can get without a flux capacitor, a DeLorean, and 1.21 gigawatts of electricity.
I’ve now changed my view on the Solo 401(k) Rule of 55 issue. The analysis is too complicated to write adequately in a blog post. Thus, I’m self-publishing an article, Solo 401(k)s and the Rule of 55: Does the Answer Lie in 1962? (accessible here), on the topic.
Of course, the article is not legal or tax advice for you, any other individual, and any plan.
For those of you who read my book, Solo 401(k): The Solopreneur’s Retirement Account (thank you!), please know the article is written differently. The book is a “101” and “201” level discussion of tax planning for the self-employed with some beginning and intermediate tax rule analysis. The article is much more akin to a “501” level discussion of a complex and somewhat uncertain tax issue emerging from ambiguities in the Internal Revenue Code
Enjoy the article and let me know what you think in the comments below.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
This post and the linked-to article are for entertainment and educational purposes only. They do not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.
One thing I like about the Financial Independence community is that members are not beholden to Conventional Wisdom.
Many in the Establishment believe retirement is for 65 year olds (and some basically think it’s not for anyone).
My response: Oh, heck no!
Sure, some people have jobs they very much enjoy. If that’s the case, then perhaps retirement isn’t your thing in your 50s. But many in the FI movement have accumulated assets such that they no longer have a financial need to work. Perhaps their job is not all that enjoyable – it happens. Or perhaps their job won’t exist in a year or two – that happens too.
The tax rules require some planning if one retires prior to turning age 59 ½. Age 59 ½ is the age at which the pesky 10 percent early withdrawal penalty no longer applies to tax-advantaged retirement account distributions.
Thus, there’s a need to consider what to live off of once one is age 59 ½. Below I list the possibilities in a general order of preference and availability. Several of these options (perhaps many of them) will simply not apply to many 50-something retirees. Further, some retirees may use a combination of the below discussed options.
Listen to Sean discuss accessing money in retirement prior to age 59 ½ on a recent ChooseFI episode! Part Two on the ChooseFI podcast is coming soon.
Taxable Accounts
The best retirement account to access if you retire before age 59 ½ isn’t even a “retirement” account: it’s a taxable account. I’m so fond of using taxable accounts first in retirement I wrote a post about the concept in 2022.
The idea is to use some combination of cash in taxable accounts (not at all taxable – it’s just going to the ATM!) and sales of brokerage assets (subject to low long term capital gains federal income tax rates) to fund your pre-59 ½ retirement. This keeps taxable income low and sets up potential additional tax planning.
Pros: Because of tax basis, living off $100,000 of taxable brokerage accounts doesn’t cause $100,000 of taxable income. Further, long term capital gains receive very favorable federal income tax treatment. Some may even qualify for the 0% long term capital gains tax rate!
But that’s not all. There are significant creditor protection benefits to living off taxable assets first. As we spend down taxable assets, we are reducing those assets that are most vulnerable to potential creditors. By not spending down tax-advantaged retirement accounts, we are generally letting them grow, thus growing the part of our balance sheet that tends to enjoy significant creditor protection. Note that personal liability umbrella insurance is usually a good thing to consider in the creditor protection context regardless of tax strategy.
Spending taxable assets first tends to limit taxable income, which can open the door to (1) a significant Premium Tax Credit in retirement (if covered by an Affordable Care Act medical insurance plan) and (2) very tax advantageous Roth conversions in early retirement.
There’s also a big benefit for those years after we turn 59 ½. By spending down taxable assets, we reduce future “uncontrolled income.” Taxable accounts are great. But they kick off interest, dividends, and capital gains income, even if we don’t spend them. By reducing taxable account balances, we reduce the future income that would otherwise show up on our tax return in an uncontrolled fashion.
Cons: To my mind, there are few cons to this strategy in retirement.
The one con in the accumulation phase is that when we choose to invest in taxable accounts instead ofin traditional deductible retirement accounts we forego a significant tax arbitrage opportunity. That said, these are not mutually exclusive. Members of the FI community can max out deductible retirement account contributions and also build up taxable accounts.
Ideal For: Someone who is able to save beyond tax-advantaged retirement accounts during their working years. This is the “ideal” for financial independence in my opinion, though it may be challenging for some.
Inherited Retirement Accounts
Withdrawals from inherited retirement accounts (other than those the spouse treats as their own) are never subject to the 10% early withdrawal penalty. Often they are subject to a 10-year drawdown rule, so usually they should be accessed prior to using many other draw down techniques.
Pros: If it’s a traditional retirement account inherited from a parent or anyone else more than 10 years older than you are, you generally have to take the money out within 10 years. Why not just live on that money? Simply living on that money, instead of letting the traditional inherited retirement grow for ten years, avoids a “Year 10 Time Bomb.” The time bomb possibility is that the inherited traditional retirement account grows to a huge balance that needs to come out in the tenth full year following death. Such a large distribution could subject the recipient subject to an abnormally high marginal federal income tax rate.
Cons: Not very many other than if the account is a Roth IRA, using the money for living expenses instead of letting it grow for 10 years sacrifices several years of tax free growth.
Ideal For: Someone who has inherited a retirement account prior to turning age 59 ½.
This is a great way to avoid the early withdrawal penalty. But remember, the money must stay in the workplace retirement account (and not be rolled over to a traditional IRA) to get the benefit.
Pros: Funds retirement prior to age 59 ½ without having to incur the 10 percent early withdrawal penalty.
Whittles down traditional retirement accounts in a manner that can help reduce future required minimum distributions (“RMDs”).
Cons: You’re handcuffed to the particular employer’s 401(k) (investments, fees, etc.) prior to age 59 ½. Review the plan’s Summary Plan Description prior to relying on this path to ensure flexible, periodic distributions are easily done after separation from service and prior to turning age 59 ½.
Limited availability as one must separate from service no sooner than the year they turn age 55.
Creates taxable income (assuming a traditional account is used), which is less than optimal from a Premium Tax Credit and Roth conversion perspective.
Ideal For: Those with (1) large balances in their current employer 401(k) (or other plan), (2) a quality current 401(k) or other plan in terms of investment selection and fees, (3) a plan with easily implemented Rule of 55 distributions, and (4) plans to retire in their mid-to-late 50s.
Governmental 457(b) Plans
Withdrawals from governmental 457(b) plans are generally not subject to the 10% early withdrawal penalty. This is the Rule of 55 exception but they deleted the “55” 😉
Like the Rule of 55, this is only available so long as the governmental 457(b) is not rolled to a traditional IRA.
Pros: Funds retirement prior to age 59 ½ without having to incur the 10 percent early withdrawal penalty. If you have a governmental 457(b), it’s better than the Rule of 55 because you don’t have to worry about your separation from service date.
Whittles down traditional retirement accounts in a manner that can help reduce future RMDs.
Cons: You’re handcuffed to the particular employer’s 457 (investments, fees, etc.) prior to age 59 ½. Review the plan’s Summary Plan Description prior to relying on this path to ensure flexible, periodic distributions are easily done after separation from service and prior to turning age 59 ½.
Creates taxable income (assuming a traditional account is used), which is less than optimal from a Premium Tax Credit and Roth conversion perspective.
Ideal For: Those (1) with large balances in their current employer governmental 457(b) and (2) a quality current governmental 457(b) in terms of investment selection and fees.
Roth Basis
Old annual contributions and conversions that are at least 5 years old can be withdrawn from Roth IRAs tax and penalty free at any time for any reason. This can be part of the so-called Roth Conversion Ladder strategy, though it does not have to be, since many will have Roth Basis going into retirement.
Pros: Roth Basis creates a tax free pool of money to access prior to turning age 59 ½.
Cons: We like to let Roth accounts bake for years, if not decades, of tax free growth. Using Roth Basis in one’s 50s significantly reduces that opportunity.
Some may need taxable income in early retirement to qualify for Premium Tax Credits. Relying solely on Roth Basis can be much less than optimal if Premium Tax Credits are a significant part of one’s early retirement plan.
Roth 401(k) contributions, for many workers, are disadvantageous in my opinion. Many Americans will forego a significant tax rate arbitrage opportunity if they prioritize Roth 401(k) contributions over traditional 401(k) contributions.
Ideal For: Those with significant previous contributions and conversions to Roth accounts.
72(t) Payments
I did a lengthy post on this concept. The idea is to create an annual taxable distribution from a traditional IRA and avoid the 10 percent early withdrawal penalty.
Pros: Avoids the early withdrawal prior to turning age 59 ½.
Whittles down traditional retirement accounts in a manner that can help reduce future RMDs.
Inside a traditional IRA, the investor controls the selection of financial institutions and investments and has great control on investment expenses.
Cons: This opportunity may require professional assistance to a degree that many of the other concepts discussed do not.
There is a risk that if not done properly, previous years’ distributions may become subject to the 10 percent early withdrawal penalty and related interest charges.
Creates taxable income, which is less than optimal from a Premium Tax Credit and Roth conversion perspective.
Ideal For: Those with most of their financial wealth in traditional deferred retirement accounts prior to age 59 ½ and without easy access to other alternatives (such as the Rule of 55 and/or governmental 457(b) plans.
HSA PUQME
Withdrawals of Previously Unreimbursed Qualified Medical Expenses (“PUQME”) from a health savings account are tax and penalty free at any time for any reason. Thanks to ChooseFI listener and correspondent Kristin Smith for suggesting the idea to use PUQME to help fund retirement in one’s 50s.
Pros: Withdrawals of PUQME creates a tax free pool of money to access prior to turning age 59 ½.
Reduces HSA balances in a way that can help to avoid the hidden HSA death tax in the future.
Cons: This is generally a limited opportunity. The amount of PUQME that can be used prior to age 59 ½ is limited to the smaller of one’s (1) PUQME and (2) HSA size. Because HSAs have relatively modest contribution limits, in many cases HSA PUQME withdrawals would need to be combined with one or more of the other planning concepts to fund retirement prior to age 59 ½.
We like to let HSAs bake for years, if not decades, of tax free growth. Using HSA PUQME in one’s 50s significantly reduces that opportunity.
Some may need taxable income in early retirement to qualify for Premium Tax Credits. Relying on PUQME can be less than optimal if Premium Tax Credits are a significant part of one’s early retirement plan.
Ideal For: Those with significant HSAs and significant PUQME.
Net Unrealized Appreciation
Applies only to those with significantly appreciated employer stock in a 401(k), ESOP, or other workplace retirement plan. I’ve written about this opportunity before. That employer stock with the large capital gains can serve as a “Capital Gains IRA” in retirement. Retirees can possibly live off sales of employer stock subject to the 0% long term capital gains rate.
This opportunity usually requires professional assistance, in my opinion.
The move of the employer stock out of the retirement plan into a taxable brokerage account (which sets up what I colloquially refer to as the “Capital Gains IRA” may need to be paired with the Rule of 55 (or another penalty exception) to avoid the 10 percent early withdrawal penalty on the “basis” of the employer stock.
Pros: Moves income from “ordinary” income to “long term capital gains” income, which can be very advantageous, particularly if one can keep their income entirely or mostly in the 0% long term capital gains marginal bracket.
Cons: Remember Enron? NUA is essentially Enron if it goes fabulously well instead of failing spectacularly.
Employer stock is problematic during the accumulation phase since your finances are heavily dependent on your employer without a single share of employer stock. People make their finances more risky by having both their income statement and their balance sheet highly dependent on a single corporation.
It keeps the retiree heavily invested in the stock of their former employer, which is much less than optimal from an investment diversification perspective.
Another con is that this usually requires professional assistance (and fees) to a much greater degree than several of the other withdrawal options discussed on this post.
Ideal For: Those with large balances of significantly appreciated employer stock in a workplace 401(k), ESOP, or other retirement plan.
Pay the Penalty
The federal early withdrawal penalty is 10 percent. For those in California, add a 2.5 percent state penalty. For some, perhaps the best idea is to simply bite-the-bullet and pay the early withdrawal penalty. That said, anyone accessing a tax-advantaged retirement account in a way not covered above should always consult the IRS list to see if perhaps they qualify for one of the myriad penalty exceptions.
Pros: Why let a 10 percent penalty prevent you from retiring at age 58 if you have sufficient assets to do so and you might be looking at a year or two of the penalty, tops?
Whittles down traditional retirement accounts in a manner that can help reduce future RMDs.
Cons: Who wants to pay ordinary income tax and the early withdrawal penalty? Even for those close to the 59 ½ finish line, a 72(t) payment plan for five years might be a better option and would avoid the penalty if properly done.
Ideal For: Those very close to age 59 ½ who don’t have a more readily available drawdown tactic to use. That said, even these retirees should consider a 72(t) payment plan, in my opinion.
Combining Methods to Access Funds Prior to Age 59 1/2
For some, perhaps many, no single one of the above methods will be the optimal path. It may be that the optimal path will involve combining two or more of the above methods.
Here’s an example: Rob retires at age 56. He uses the Rule of 55 to fund most of his living expenses prior to turning age 59 ½. Late in the year, he finds that a distribution from his traditional 401(k) would push him up into the 22% federal income tax bracket for the year. Thus, for this last distribution he instead elects to take a recovery of Roth Basis from his Roth IRA. This allows him to stay in the 12% marginal federal income tax bracket for the year.
Conclusion
Don’t let anyone tell you you can’t retire in your 50s. If you have reached financial independence, why not? Of course, you will need to be very intentional about drawing down your assets and funding your living expenses. This is particularly important prior to your 59 1/2th birthday.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.
Some retiring in their 50s will need to use a 72(t) payment plan. This often involves establishing a “72(t) IRA” and a “non-72(t) IRA.”
People wonder “how do you allocate your portfolio when you have a 72(t) payment plan?”
Below we tackle 72(t) IRAs from a tax basketing perspective. Most investors in the financial independence community want some allocation to bonds and some to equities.* Thus, questions emerge for those employing a 72(t) payment plan: what should be in my 72(t) IRA? What should be in my non-72(t) IRA?
* This post simply takes that as an assumption and is not investment advice for you or anyone else.
Watch me discuss portfolio allocation for 72(t) payments plans on YouTube.
72(t) Example
Monty, age 53, has a $2M traditional 401(k), $10,000 in a savings account, and a paid off house. He wants to retire and take his first annual $80,000 72(t) payment in February 2023. Monty also wants to have a 75/25 equity/bond allocation.
First, Monty would need to transfer his 401(k) to a traditional IRA (preferably through a direct trustee-to-trustee transfer).
Once the 401(k) is in the traditional IRA, Monty needs to split his traditional IRA into two traditional IRAs, one being the 72(t) IRA (out of which he takes the annual 72(t) payment) and one being the non-72(t) IRA.
To determine the size of the 72(t) IRA, Monty uses the commonly used fixed amortization method and decides to pick the following numbers:
With those three numbers, Monty can do a calculation (see IRS Q&A 7 and my YouTube video on the calculation) and determine that the 72(t) IRA should be $1,170,848.59. Thus, the non-72(t) IRA should be $829,151.41.
72(t) Portfolio Allocation
How does Monty allocate the 72(t) IRA and the non-72(t) IRA such that (1) his overall financial asset portfolio ties out to the desired 75/25 allocation and (2) he is as tax optimized as possible.
I believe that Monty should aim to keep his 72(t) IRA as small as possible. Why? Because it is possible that Monty will not need his 72(t) payment at some point prior to turning age 59 ½.
Perhaps Monty inherits $300,000 when he is age 57. At that point, he can use that money to fund his lifestyle until age 59 ½. Why does he want to keep paying taxes on the $80,000 annual 72(t) payment?
Since Monty has decided to invest in equities and bonds, I believe that Monty should house his bonds inside his 72(t) IRA. While there are absolutely no guarantees when it comes to investment returns, equities tend to grow more than bonds. Since bonds tend to be lower growth, they are a great candidate for the 72(t) IRA.
It would stink if Monty wanted to reduce his annual 72(t) payment only to find that a 72(t) IRA composed entirely of equities had skyrocketed in value, increasing the amount of his revised annual payment under the RMD method.
Thus, I believe that Monty should put his entire bond allocation, $500,000, inside his 72(t) IRA. That makes the rest of the tax basketing easy: have the entire non 72(t) IRA be invested in equities, and have the remainder of his 72(t) IRA, $670,849, be invested in equities.
72(t), Sequence of Returns Risk, and Safe Withdrawal Rate
One must remember that 72(t) is entirely a tax concept. At least in theory, it has nothing to do with sequence of returns risk and safe withdrawal rate.
Some might look at the 72(t) IRA, $1,170,848.59, and say “Wait a minute: an $80K withdrawal is way more than 4% or 5% of that 72(t) IRA! Isn’t this a dangerous withdrawal rate? Doesn’t this amplify the sequence of returns risk?”
Remember, Monty’s withdrawal rate is $80,000 divided by the entire $2M portfolio (4%), not $80,000 divided by the $1,170,848.59 72(t) IRA. Further, Monty’s sequence of returns risk on this withdrawal rate exists regardless of the 72(t) plan. The greater the overall withdrawal rate, the greater the sequence of returns risk.
Lastly, the 5.79% interest rate Monty chooses has nothing to do with the withdrawal rate. It has everything to do with keeping the size of the 72(t) IRA as small as possible. The chosen interest rate doesn’t change the amount of the annual withdrawal ($80,000) but rather changes the size of the 72(t) IRA.
Conclusion
Tax basketing should be considered when crafting a 72(t) payment plan. I generally believe that investments that are less likely to have substantial gains sit better inside an investor’s 72(t) IRA rather than their non-72(t) IRA.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters.Please also refer to the Disclaimer & Warning section found here.
Want to retire before age 59 ½? Have most of your wealth in traditional tax-deferred retirement accounts? Worried about the 10 percent early withdrawal penalty?
This post is for you!
Picture it: You’re age 53, have $50,000 in a savings account, a paid-off home, and $2.5M in a 401(k). Including income taxes, you spend about $80,000 a year. You want to retire, but you’re worried about paying the early withdrawal penalty, which would be about $8,000 a year (not factoring in the penalty on the penalty!).
72(t) payments can make retirement possible prior to age 59 ½ when one has most of their assets in traditional deferred retirement accounts. Done properly, these payments avoid the 10 percent early withdrawal penalty.
Below I explore some of the rules of 72(t) payments (sometimes referred to as a “72(t) SEPP” or “SEPP”) and lay out what I hope will be an informative case study.
** As always, none of this is personalized advice for you, but rather educational information for your consideration. Consult with your own advisors regarding your own situation.
72(t) Substantially Equal Periodic Payments
Methods
The IRS and Treasury provide three methods for computing a 72(t) payment. As a practical matter, the third one I discuss, the fixed amortization method, tends to be the most commonly used and most user friendly in my opinion.
The required minimum distribution method allows taxpayers to take a 72(t) payment just like an RMD. Take the prior year end-of-year balance and divide it by the factor off the IRS table. The biggest problems with this method are it tends to produce a smaller payment the younger you are and the payment changes every year and can decrease if the IRA portfolio declines in value. The fixed annuitization method usually requires actuarial assistance, making it more complicated and less desirable. See Choate, referenced below, at page 587.
We will focus the rest of the post on the fixed amortization method of computing 72(t) payments (other than a brief foray into the RMD method to account for changing circumstances)).
Computing Fixed Amortization 72(t) Payments
To compute a 72(t) payment and the size of the 72(t) IRA using the fixed amortization method, we will need to run through some math. Four numbers are required: the interest rate, the life expectancy, the annual payment, and the size of the 72(t) IRA.
Usually the IRS gives us the interest rate and the life expectancy and we need to solve for the 72(t) IRA size.
As a general rule, taxpayers will usually want to use the greatest interest rate permitted to as to decrease the size of the 72(t) IRA. Decreasing the size of the 72(t) IRA will usually be advantageous, for the reasons discussed below.
Life Expectancy: The life expectancy comes to us from an IRS table. While we have three possible choices to use, generally speaking taxpayers will want to use the Single Life Table found at Treas. Reg. Section 1.401(a)(9)-9(b). See Choate, referenced below, at page 587. The taxpayer takes their age on their birthday of the year of the first 72(t) payment and uses the factor from the Single Life Table as the life expectancy.
Payment: Finally, we, not the IRS, get to determine a number! The payment is simply the annual payment we want to receive as a 72(t) payment every year. While this amount is rather inflexible, as discussed below it will be possible to establish additional 72(t) IRAs and payments to increase the amount received if desired.
Size of the 72(t) IRA: This is what we’re solving for to establish a “right-sized” IRA to produce the desired 72(t) payment. In Google Sheets, we do a present value calculation to solve for the size of the 72(t) IRA that generates the desired payment amount. The formula is rather simple: =-PV(Interest Rate Cell, Life Expectancy Cell, Annual Payment Cell). I put a negative sign in front of the PV to have the size of the 72(t) IRA appear as a positive number. It’s important that the formula be entered in that order and that the formatting be correct in each cell.
Note on 72(t) Payments with non-IRA Accounts: Setting up a 72(t) from a non-IRA is possible but not frequent in practice. It is not possible to divide up a 401(k) account in a manner conducive to establishing a “right-sized” 72(t) payment account. See Choate, referenced below, at page 595.
Annual Equal 72(t) Fixed Amortization Payments
The computed payments must be made annually and equally. This means that no more and no less than the computed payment comes out every year. I believe that taking an annual flat payment on or around the first payment anniversary date is a best practice. However, this best practice is not required. See also Choate, referenced below, at page 600. For example, monthly payments of the computed amount are allowable. See Choate, referenced below, at page 600.
Annual payments must be made for the longer of five years or until the taxpayer reaches age 59 ½.
72(t) Payments Case Study
Let’s return to the example discussed above: it is early November 2023 and you (let’s call you Pat) are 53 years old (your birthday was June 8th) and you want to retire, spending $80K a year from your $2.5M 401(k). Let’s solve for the size of the 72(t) IRA:
The size of the 72(t) IRA is $1,236,012.95. See IRS FAQ Q&A 7.
Pat would first transfer (preferably through a direct trustee-to-trustee transfer) the 401(k) to a traditional IRA worth $2.5M. Once in the traditional IRA, Pat would call their financial institution and ask them to divide the traditional IRA into two IRAs: one with exactly $1,236,012.95 (the “72(t) IRA”) and one with the reminder of the traditional IRA (the “non-72(t) IRA”). I recommend initially investing the 72(t) IRA in a money market fund so that it can be clearly established that the beginning account balance was exactly the $1,236,012.95 computed to yield the correct payment. Pat takes the first payment of $80,000 on November 29th from the 72(t) IRA in this hypothetical scenario.
Let’s keep going. Assume that in 2027, when Pat turns age 57 and interest rates are well below 5%, Pat wants to increase their November withdrawal from $80K to $90K. As discussed below, Pat can’t simply increase the withdrawal from the 72(t) IRA. But since Pat kept a non-72(t) IRA, Pat can slice that one up to create a second 72(t) IRA. That second 72(t) IRA can give Pat the extra $10,000 Pat wants to spend.
Here’s what that looks like.
Interest Rate: 5.00%
Life Expectancy: 30.6
Payment: $10,000
The size of the second 72(t) IRA is $155,059.55.
Pat would call their financial institution and ask them to divide the non-72(t) IRA into two IRAs: one with exactly $155,059.55 (the “Second 72(t) IRA”) and one with the remainder of the traditional IRA (the surviving non-72(t) IRA). Pat takes the additional payment of $10,000 also on November 29th from the Second 72(t) in this hypothetical scenario.
Here is what Pat’s withdrawals would look like:
Year
Birthday Age
Required First 72(t) November 29 Withdrawal
Required Second 72(t) November 29 Withdrawal
Total Annual Withdrawal
2023
53
$80,000
$0
$80,000
2024
54
$80,000
$0
$80,000
2025
55
$80,000
$0
$80,000
2026
56
$80,000
$0
$80,000
2027
57
$80,000
$10,000
$90,000
2028
58
$80,000
$10,000
$90,000
2029
59
$80,000
$10,000
$90,000
2030
60
$0
$10,000
$10,000
2031
61
$0
$10,000
$10,000
Remember that the First 72(t) IRA and the Second 72(t) are locked up for a period of time. See Locking the Cage below. The First 72(t) IRA is locked up until and through December 7, 2029, the day before Pat’s 59 ½ birthday. The Second 72(t) IRA is locked up until and through November 28, 2032, the day before the fifth anniversary of the first $10,000 payment from the Second 72(t) IRA. See IRS FAQ 13 on this point. Generally speaking, no amount other than the annual payment should go into, or out of, a 72(t) IRA until the end of the lock-up period.
Maintain Flexibility
I strongly recommend maintaining as much flexibility as possible. One way to do that is to have the 72(t) IRA be as small as possible, leaving as much as possible in a non-72(t) IRA or IRAs. Why?
First, the non-72(t) can be, in a flexible manner, sliced and diced to create a second 72(t) IRA if wanted or needed. Second, it is not abundantly clear what happens when a 72(t) IRA is used for partial Roth conversions. See Choate, referenced below, at page 384. As Ms. Choate discusses, the only clarity we have is that if the entire 72(t) IRA is Roth converted, the taxpayer must continue to take withdrawals from the Roth IRA for the remainder of the 72(t) term. Doing so limits the benefit of doing Roth conversions in the first place, since we usually want Roth converted amounts to stay in a Roth IRA to facilitate many years of tax-free growth.
Imagine if Pat did not divide the $2.5M traditional IRA into two IRAs. Pat could have simply used a smaller interest rate on the entire $2.5M traditional IRA to get the $80,000 annual payment out. However, then Pat would not have had the flexibility to create a second 72(t) payment stream. This is an important reason that it is usually best to use the highest possible interest rate to lower the 72(t) IRA size and maintain the most flexibility.
72(t) Payment Plan Disqualification
A “modification” to the 72(t) payment plan blows up the plan with unfavorable consequences. In the year of the modification the taxpayer owes the 10 percent early withdrawal penalty plus interest on the penalty on all the previously taken 72(t) payments. See Choate, referenced below, at page 596.
A blow up after age 59 ½, for those on the five year rule, is bad but tends to be less deleterious than a blow up occurring with respect to a SEPP ending at age 59 1/2. The early withdrawal penalty and related interest are not assessed on 72(t) payments taken after one’s 59 ½ birthday. See Choate, referenced below, at page 596.
There are a few modifications to a 72(t) payment plan that do not blow it up (i.e., they are permissible and don’t trigger the penalty and interest). See Choate, referenced below, at pages 597-601. Those looking to change the payment amount are often well advised to set up a second 72(t) payment plan (as Pat did) rather than seeking a modification to the existing 72(t) payment plan.
72(t) Payment Reduction
Imagine that instead of wanting an additional 72(t) payment amount, Pat wanted to reduce the 72(t) payment. This is not uncommon. Perhaps Pat has a significant inheritance in 2027 and thus no longer needs to take an $80,000 annual payment and pay tax on it.
Unfortunately, Pat is not allowed to simply discontinue or reduce the 72(t) payment without triggering the early withdrawal penalty (and interest charges) on the previously taken 72(t) payments.
But, the rules allow a one-time switch to the RMD method. Making the switch is likely to significantly reduce the annual 72(t) payment. For example, if Pat wants a smaller payment starting in 2027, Pat could take the 72(t) IRA balance on December 31, 2026 (imagine it is exactly $1M) and divide it by the age 57 factor off the Single Life Table (29.8) and get a 2027 72(t) payment of $33,557.05. Alternatively, Pat could use the age 57 factor off the Notice 2022-6 Uniform Life Table (41.6) and get a 2027 72(t) payment of $24,038.46.
If Pat makes this one-time switch, Pat will annually compute the 72(t) payment for the remainder of the 72(t) term using the table used in 2027 (see Notice 2022-6 page 6) and the prior-year end-of-year 72(t) IRA balance.
The one-time switch to the RMD method is helpful if the taxpayer wants to significantly reduce their 72(t) annual payment, perhaps because of an inheritance, marriage, YouTube channel blowing up, or returning to work. The availability of this method to reduce required 72(t) payments (if desired) is another reason to keep 72(t) IRAs as small as possible.
72(t) Locking The Cage
The 72(t) IRA should be thought of as a locked cage. No one goes in, and only the 72(t) payment comes out annually. The rigidity with which the IRS treats the 72(t) IRA gives early retirees incentive to use as high an interest rate as possible to get the highest annual payment out of the smallest 72(t) IRA possible.
Just how rigid is the IRS? In one case, the IRS disqualified a 72(t) SEPP because a taxpayer transferred a workplace retirement plan into the 72(t) IRA during the 72(t) payment period. See page 4 of this newsletter (page 4 is behind a paywall). Imagine paying penalties and interest on old 72(t) payments for what is seemingly an unrelated rollover!
Remember, the “series of substantially equal periodic payments” requires not just an annual payment. It requires that the 72(t) IRA be locked up. Assuming one is using the fixed amortization method for their 72(t) payments, not a dollar more than the 72(t) SEPP should come out each year. It appears the IRS expects the amount to be equal each tax year, see page 5 of this PLR.
Further, the 72(t) lockup does not end with the taking of the last payment. Rather, as described in IRS FAQ 13, it ends at the end of the lock up period. So if Sean, age 57 in 2023, takes his first 72(t) SEPP of $10,000 from IRA 1 on July 15, 2023, his taking of payment number 5 ($10,000) on July 15, 2027 does not end the lock up. Sean can’t take any additional money out of IRA 1 until July 1, 2028 (the fifth anniversary of his first $10,000 72(t) payment).
Practice Point: Never add money to a 72(t) IRA during the lockup period. This includes never making an annual contribution to a 72(t) IRA and never rolling an IRA, 401(k), or other qualified plan into a 72(t) IRA.
IRS FAQ 13 is instructive in terms of when the lock up ends. The IRS is clear that the lock up ends on the date of the 59 ½ birthday, not on January 1st of that year. Say Rob, born January 14, 1971, takes his first SEPP of $40,000 on August 16, 2023. His 72(t) IRA is free on his 59 ½ birthday, which is July 14, 2030. Presumably, Rob takes his last $40,000 SEPP on or around August 16, 2029. Nevertheless, he can’t add to or withdraw from his 72(t) IRA prior to July 14, 2030 without blowing up his 72(t) payment plan and incurring significant penalties and interest.
As discussed above, the one-time switch to the RMD method is a permissible modification to the 72(t) payment terms that does not trigger the early withdrawal penalty and related interest on previously taken 72(t) payments.
A Note on the 72(t) Risk Profile
The earlier in life the 72(t) payment plan starts, the greater the risk profile on the 72(t) payment plan. The opposite is also true: the later in life a 72(t) payment plan starts, the lower the risk profile.
Why?
Because the sooner the 72(t) payment plan starts, the more years (and more interest) that can be blown up by a future modification requiring the payment of the 10 percent early withdrawal penalty and interest.
Consider Pat’s example. If Pat blows up the First 72(t) payment plan in early 2028, Pat owes the 10% early withdrawal penalty and interest on five previously taken 72(t) payments from the First 72(t) IRA (2023 through 2027). If Pat blows up the Second 72(t) payment plan in 2032, Pat only owes the early withdrawal penalty and interest on the three 72(t) payments received before Pat turned age 59 ½.
72(t) Payment Tax Return Reporting
Taxpayers should keep the computations they and/or their advisors have done to document the 72(t) payment plan. Distributions should be reported as taxable income and on Form 5329. Code 02 should be entered on Line 2 of Form 5329.
72(t) Is An Exception to More Than One Rule
72(t) payment plans are an exception to the 10 percent early withdrawal penalty. They are also an exception to the general rule that the IRS views all of your IRAs as a single IRA. The 72(t) IRA is the 72(t) IRA. If you have a separate IRA and take ten dollars out of it prior to age 59 ½, you trigger ordinary income tax and a $1 penalty. If you take an additional ten dollars out of the 72(t) IRA prior to the end of the 72(t) lock up, you blow up the 72(t) payment plan and owe the 10 percent early withdrawal penalty and interest on all the pre-59 ½ 72(t) payments.
Other Penalty Free Sources of Early Retirement Funding
Let’s remember that 72(t) payments are a tool. In many cases they are not a “go-to” strategy. I’ve written this post not because 72(t) payments are a go-to strategy but rather because I know there are many in their 50s thinking about retirement but daunted by the prospect of accessing traditional retirement accounts prior to age 59 ½.
Generally speaking, I encourage using resources other than 72(t) payments if you are able to. They include:
Taxable Accounts: I’m so fond of using taxable accounts first in retirement I wrote a post about the concept in 2022.
Inherited Retirement Accounts: Withdrawals from inherited retirement accounts (other than those the spouse treats as their own) are never subject to the 10% early withdrawal penalty. Often they are subject to a 10-year draw down rule, so usually they should be accessed prior to implementing a 72(t) payment plan from one’s own accounts.
Rule of 55 Distributions: Only available from a qualified retirement plan such as a 401(k) from an employer the employee separates from service no sooner than the beginning of the year they turn age 55. This is a great workaround from the early withdrawal penalty, and much more flexible than a 72(t) payment plan. But remember, the money must stay in the workplace retirement account (and not be rolled over to a traditional IRA) to get the benefit.
Governmental 457(b) Plans: Withdrawals from governmental 457(b) plans are generally not subject to the 10% early withdrawal penalty.
I previously discussed using a 72(t) payment plan to bail out Roth IRA earnings penalty-free prior to age 59 ½. This is a tactic that I would not recommend unless absolutely necessary (which I believe is a very rare situation).
72(t) Landscape Change
It should be noted that the issuance of Notice 2022-6 in early 2022 changed the landscape when it comes to 72(t) payments. Before the 5 percent safe harbor, it was possible that taxpayers could be subject to sub-0.5 percent interest rates, meaning that it would take almost $1M in a retirement account to generate just $30,000 in an annual payment in one’s mid-50s. Now with the availability of the 5 percent interest rate much more modest account balances can be used to generate significant 72(t) payments in one’s mid-50s.
What if Pat’s 401(k) contained significant amounts of employer stock? What if that employer stock had significantly appreciated in value since the time Pat and/or Pat’s employer contributed that stock? If so, a 72(t) payment plan may not be ideal. Rather, Pat may want to work with Pat’s advisor(s) to look into a separate and distinct tax planning opportunity, net unrealized appreciation (“NUA”).
I collaborated with Andrea MacDonald to discuss the tax return reporting requirements for NUA here.
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters.Please also refer to the Disclaimer & Warning section found here.
The IRS and Treasury have recently issued two updates to the rules for payments which avoid the 10 percent early withdrawal penalty from retirement accounts. These payments are referred to as a series of substantially equal periodic payments, SEPP, or 72(t) payments. This post discusses the updated rules.
72(t) Payments
Tax advantaged retirement accounts are fantastic. Who doesn’t love 401(k)s, IRAs, Roth IRAs, and the like?
However, investing through a tax advantaged account can have drawbacks. One big drawback is that taxable amounts withdrawn from a tax advantaged retirement account prior to the account owner turning age 59 ½ are generally subject to a 10 percent early withdrawal penalty. My home state of California adds a 2.5 percent early withdrawal penalty.
There are some exceptions to this penalty. One of them is taking 72(t) payments. The idea is that if the taxpayer takes a “series of substantially equal periodic payments” they can avoid the penalty.
72(t) payments must be taken annually. Further, they must last for the longer of (a) 5 years or (b) the time until the taxpayer turns age 59 ½. This creates years of locked-in taxable income.
There are three methods that can be used to compute the amount of the annual 72(t) payments. These methods compute an annual distribution amount generally keyed off three numbers: the balance in the relevant retirement account, the interest rate, and the table factor provided by the IRS. The factor is greater the younger the account owner is. The greater the factor, the less the account owner can withdraw from a retirement account in a 72(t) payment.
New 72(t) Payment Interest Rates
In January 2022, the IRS and Treasury issued Notice 2022-6. Hat tip to Ed Zollars for the alert. This notice provides some new 72(t) rules. The biggest, and most welcome, change is a new rule for determining the interest rate.
Previously, the rule had been that 72(t) payments were keyed off 120 percent of the mid-term applicable federal rate (“AFR”). The IRS publishes this rate every month. In recent years, that has been somewhat problematic, as interest rates have been historically low. For example, in September 2020, the mid-term AFR was just 0.42 percent. This made relying on a 72(t) payment somewhat perilous. How much juice can be squeezed from a large retirement account if the interest rate is just 0.42 percent?
Here is what a $1M traditional IRA could produce, under the fixed amortization method, in terms of an annual payment for a 53 year old starting a 72(t) payment if the interest rate is just 0.42 percent:
120% of Sept 2020 MidTerm AFR
0.42%
Single Life Expectancy Years at Age 53
33.4
Account Balance
$1,000,000.00
Annual Payment
$32,151.93
Notice 2022-6 makes a very significant change. It now allows taxpayers to pick the greater of (i) up to 5 percent or (ii) up to 120 percent of mid-term AFR. That one change makes a 72(t) payment a much more attractive option, since periods of low interest rates do not as adversely affect the calculation.
Here is what a $1M traditional IRA could produce, under the fixed amortization method, in terms of an annual payment for a 53 year old starting a 72(t) payment if the interest rate is 5 percent:
5% Interest Rate
5.00%
Single Life Expectancy Years at Age 53
33.4
Account Balance
$1,000,000.00
Annual Payment
$62,189.80
The new rule provides a 5 percent interest rate floor for those using the fixed amortization method and the fixed annuitization method to compute a 72(t) payment. Using a 5 percent interest rate under the fixed amortization method is generally going to produce a greater payment amount than using the required minimum distribution method for 72(t) payments.
The interest rate change provides taxpayers with much more flexibility with 72(t) payments, and a greater ability to extract more money penalty free prior to age 59 ½. Taxpayers already have the ability to “right-size” the traditional IRA out of which to take a 72(t) payment to help the numbers work out. In recent years, what has been much less flexible has been the interest rate. Under these new rules, taxpayers always have the ability to select anywhere from just above 0% to 5% regardless of what 120 percent of mid-term AFR is.
Watch me discuss the update to 72(t) payment interest rates.
New Tables
A second new development is that the IRS and Treasury have issued new life expectancy tables for required minimum distributions (“RMDs”) and 72(t) payments. Most of the new tables are found at Treasury Regulation Section 1.401(a)(9)-9, though one new table is found at the end of Notice 2022-6.
These tables reflect increasing life expectancies. As a result, they reduce the amount of RMDs, as the factors used to compute RMDs are greater as life expectancy increases.
From a 72(t) payment perspective, this development is a minor taxpayer unfavorable development. Long life expectancies in the tables means the tables slightly reduce the amount of juice that can be squeezed out of any particular retirement account.
This said, the downside to 72(t) payments coming from increasing life expectancy on the tables is more than overcome by the ability to always use an interest rate of up to 5 percent. These two developments in total are a great net win for taxpayers looking to use 72(t) payments during retirement.
Use of 72(t) Payments
Traditionally, I have viewed 72(t) payments as a life raft rather than as a desirable planning tool for those retiring prior to their 59 ½th birthday. Particularly for those in the FI community, my view has been that it is better to spend down taxable assets and even dip into Roth basis rather than employ a 72(t) payment plan.
These developments shift my view a bit. Yes, I still view 72(t) payments as a life raft. Now it is an upgraded life raft with a small flatscreen TV and mini-fridge. 😉
As a practical matter, some will get to retirement prior to age 59 ½ with little in taxable and Roth accounts, and the vast majority of their financial wealth in traditional retirement accounts. Notice 2022-6 just made their situation much better and much more flexible. Getting to retirement at a time of very low interest rates does not necessarily hamstring their retirement plans given that they will always have at least a 5 percent interest rate to use in calculating their 72(t) payments.
72(t) Payments and Roth IRAs
As Roth accounts grow in value, there will be at least some thought of marrying Roth IRAs with 72(t) payments.
At least initially, Roth IRAs have no need for 72(t) payments. Those retired prior to age 59 ½ can withdraw previous Roth contributions and Roth conversions aged at least 5 years at any time tax and penalty free for any reason. So off the bat, no particular issue, as nonqualified distributions will start-off as being tax and penalty free.
Only after all Roth contributions have been withdrawn are Roth conversions withdrawn, and they are withdrawn first-in, first-out. Only after all Roth conversions are withdrawn does a taxpayer withdraw Roth earnings.
For most, the odds of withdrawing (i) Roth conversions that are less than five years old, and then (ii) Roth earnings prior to age 59 ½ are slim. But, there could some who love Roths so much they largely or entirely eschew traditional retirement account contributions. One could imagine an early retiree with only Roth IRAs.
Being “Roth only” prior to age 59 ½ could present problems if contributions and conversions at least 5 years old have been fully depleted. Taxpayers left with withdrawing conversions less than 5 years old or earnings in a nonqualified distribution might opt to establish a 72(t) payment plan for their Roth IRA. Such a 72(t) payment plan could avoid the 10 percent penalty on the withdrawn amounts attributable insufficiently aged conversions or Roth earnings. Note, however, that Roth earnings withdrawn in a nonqualified distribution are subject to ordinary income tax, regardless of whether they are part of a 72(t) payment plan.
See Treasury Regulation Section 1.408A-6 Q&A 5 providing that Roth IRA distributions can be subject to both the 72(t) early withdrawal penalty and the exceptions to the 72(t) penalty. The exceptions include a 72(t) payment plan.
Additional Resource
Ed Zollars has an excellent post on the updated IRS rules for 72(t) payments here.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters.Please also refer to the Disclaimer & Warning section found here.
