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Can substantially equal payments be larger?


Guest Jeff Salisbury
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Guest Jeff Salisbury

Greetings,

I have a client who wants to retire at age 55. He has pension benefits kicking in at age 60, and social security will kick in at age 66. Between age 55 and 60 he will need to dip substantially into his IRA capital. Can he take penalty-free distributions that are much greater than the three IRS approved methods (minimum distribution, amortization, or annuity)? In other words, as long as the payments are substantially equal, and last for 5 years and until he is 59 1/2, can the payments be much larger than specified by the three IRS approved methods?

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He cannot basically empty his IRA in the next 5 years. The 3 methods are approved methods, but not necessarily the only ones. But the method is suppose to allow the account to last a lifetime. If you want to use a different method I would suggest spending the money on a private letter ruling.

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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Guest Jeff Salisbury

BPickerCPA,

Thanks for the quick response...

What you say makes sense. However, I had hoped that the substantially equal payments were like the minimum distribution requirements (MDR) where you are always free to take out more if you want...

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[[What you say makes sense. However, I had hoped that the substantially equal payments were like the minimum distribution requirements (MDR) where you are always free to take out more if you want...]]

No way. You're locked in to the schedule. No more, no less.

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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Would a potential solution to this problem be a Roth conversion? Depending upon income levels, this person might have a very attractive window after leaving the work force and before various pension/SSN kicks in to convert IRA assets to Roths.... perhaps a phased conversion. That does not solve the early age issue, but might have some other benefits.

A second option might lie in home equity. The new rules allow a couple to sell their house and keep the $$ if they are down sizing, which is not an uncommon option for empty nesters. The limit I believe is a 500K gain.

Another option is to structure a reverse mortgage, so that you are receiving an income stream from the bank.... then you could revert back to a standard mortgage after the five year period. This might be viable if the couple has any penalties on withdrawals, or wants to keep the assets invested.

[This message has been edited by John G (edited 12-06-1999).]

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The IRS has approved numerous variations on the three methods set forth in Notice 89-25. Also, these three methods are not exclusive.

See my article on this subject, which will appear in the January 2000 issue of Estate Planning. The lawyer who handles your estate planning should subscribe to this magazine.

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Bruce Steiner, attorney

(212) 986-6000 (NY office)

(201) 862-1080 (NJ office)

also admitted in FL

Bruce Steiner, attorney

(212) 986-6000

also admitted in NJ and FL

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Guest Jeff Salisbury

jlf,

Can you provide some references supporting the concept of liquidating an IRA in 5 years prior to age 59 1/2 without incurring a penalty?

Regards,

Jeff

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[[i disagree with the CPA: The account balance may be liquidated over a period of time not shorter than five years. ]]

You're entitled to disagree. You just happen to be incorrect.

From sec 72(t): (exceptions to the 10% penalty)

"(iv) part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary,"

[This message has been edited by Dave Baker (edited 12-10-1999).]

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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to the CPA: The rule you refer to means that it may not be distributed over a period of time that is greater than life expectancy. The $$ may be distributed over any fixed period and to avoid the 10% penalty the money must be withdrawn over at least 5 years if distribution starts before age 59.5.

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[[to the CPA: The rule you refer to means that it may not be distributed over a period of time that is greater than life expectancy. The $$ may be distributed over any fixed period and to avoid the 10% penalty the money must be withdrawn over at least 5 years if distribution starts before age 59.5.]]

Sorry but you are not reading the statute correctly. If you look at the minimum distribution rules of 401(a)(9) and the related rules for IRAs, you will see that the minimum distribution rules state that starting at age 70½ you need to take distributions over a period NOT EXCEEDING the life expectancy or joint life expectancy.

However look at sec 72(t). It says "made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary".

It does not say NOT EXCEEDING, it says FOR THE LIFE. If you're advising clients differently, your clients may find themselves with unanticipated penalties.

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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CPA; Checkout Publ. 590. It uses the term "period certain". One's life expectancy or joint life expectancy with another is a "period certain". The term of the payout may be over a "period certain" not exceeding the period of time equal to the single or joint life expectancy that apply to a particular case. For example, if the life expectancy of a 60 year old is 21.67 years he or she may elect 15 years for the "period certain". He or she is NOT compelled to use the period certain equal to the life expectancy of a 60 year old which is 21.67 years.

Are you saying that one may use a period of time shorter than his or her life expectancy ONLY upon reaching age 70.5, when minimum required distributions must begin?

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[This message has been edited by jlf (edited 12-09-1999).]

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I find no reference to "period certain" in Publication 590 (the 1999 version).

To avoid the 10% penalty tax on the basis of Section 72(t)(2)(A)(iv), distributions must be made over the life expectancy of the participant or the joint life expectancy of the participant and his or her beneficiary as correctly stated by BPicker. The payments may be modified after the later of 5 years of payments or attainment of age 59 1/2 without retroactive application of the 10% penalty tax. See Section 72(t)(4). In other words, it is not possible to receive payments larger than would be required based on a single or joint life expectancy for the first five years, as is desired in the initial post.

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From publication 590:

"Annuity. You can receive distributions from your traditional IRA that are part of a series of substantially equal payments over your life (or your life expectancy), or over the lives (or joint life expectancies) of you and your beneficiary, without having to pay the 10% additional tax, even if you receive such distributions before you are age 59. You must use an IRS-approved distribution method and you must take at least one distribution annually for this exception to apply. See Figuring the Minimum Distribution, later, for one IRS-approved distribution method, generally referred to as the "life expectancy method." Unlike for minimum distribution purposes, this method, when used for this purpose, results in the exact amount required, not the minimum amount."

As you can see, it also uses life expectancy or joint life expectancy. It does NOT give you the choice to pick a term certain. At age 70½ you can pick any term you want as long as it is LESS than the life expectancy or joint life expectancy. However for pre 59½ substantially equal payments, it MUST be life expectancy or joint life expectancy.

Your example of a 60 year makes no sense since the provision would not apply to a 60 year old.

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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I stand corrected with reference to avoiding the 10% penalty for distributions prior to age 59.5. In these cases the "term certain" must be equal to one's life expectancy. No other "term certain" is permitted.

to the CPA: Are you saying that from 59.5 to age 70.5 one MUST use life expectancy tables and only AFTER reaching 70.5 does he have the option of using a period of time that is less than his life expectancy? (Do you agree with my age 60 example?)

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[This message has been edited by jlf (edited 12-09-1999).]

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[[to the CPA: Are you saying that from 59.5 to age 70.5 one MUST use life expectancy tables and only AFTER reaching 70.5 does he have the option of using a period of time that is less than his life expectancy? (Do you agree with my age 60 example?)]]

From 59½ to 70½ you can do whatever the heck you want. If at the time you reach 59½ you are taking substantially equal periodic payments, those payments must continue for 5 years without modification. Once the five years are up, or if you're not taking SEPP as soon as you hit 59½, you have the option of taking none or all or anything in between. It's not until you hit 70½ that you MUST start taking. So your age 60 example is meaningless.

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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To the CPA: Please permit me to summarize.

In order to avoid the 10% penalty on withdrawals prior to age 59.5 one Must use life expectancy factors. The periodic payments must last for at least five years or until reaching age 59.5 which ever is later. For example, if withdrawals begin at age 59 they MUST continue to age 64. If they don't, the 10% penalty tax is applied.

From age 59.5 to age 70.5 the IRA owner may make withdrawals in what ever manner he or she chooses. This assumes the five year rule is not in place as described above.

Upon reaching age 70.5 the balance,if any, must be distributed over a TERM CERTAIN that does not exceed one's life expectancy. For example, one's life expectancy at age 70.5 is 13 years. Unlike the life expectancy rule for distributions prior to age 59.5 our 70.5 year old is NOT required to use his life expectancy of 13 years as his "term certain." He may use, for example, 10 years as his "term certain."

[This message has been edited by jlf (edited 12-10-1999).]

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Guest Steve Hample

You guys are having a wonderful debate. Thanks for allowing others to learn from your exchange of ideas.

I would almost agree with the jlf summary, but suggest the exact meaning of the term period certain in this context should be clarified; I don't think it means the same amount per year for a fixed number of years. The suggested result of using 10 years is fine. But the CPA made a good point that your client can do whatever the heck he wants at that point, in terms of taking larger, faster distributions. Note that there is an irrevocable election at the age 70 1/2 decision point. As I recall, your client could elect to annually recalculate his/her minimum required distribution and could take different amounts in different years, thus taking it out faster while avoiding the RMD penalty by making sufficient distributions.

Steve Hample, CFP

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To Steve; To clarify, "term certain" means in my example, that upon reaching the age of 80.5 the account is depleted. It can be a fixed amount for each of the 10 years if one, for example, buys a 10 year CD with a guaranteed interest rate.

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yes

[This message has been edited by jlf (edited 12-11-1999).]

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I will agree with jlf's summary, but let me phrase it differently.

If you are avoiding the pre 59½ penalty with SEPP, the life expectancy sets THE distributions; no more, no less.

After 70½ the life expectancy sets the MINIMUM that must be withdrawn. If you want more, you're welcome to it.

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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Guest Ray Rogers

Two points:

(1) Seems pretty clear that, with a few incident based exceptions, distributions from a conventional IRA prior to age 59 1/2 must be part of a series of substantially equal, life expectancy based, periodic payments. And, if they are to escape the 10% penalty, they must also continue for at least five years or until at least age 59 1/2 (if longer).

(2) An advantage of keeping funds in an employer's qualified plan -- as opposed to a rollover to an IRA -- that is often overlooked is that (subject to the minimum distribution rules that kick in at age 70 1/2) the plan may permit the retiree to withdraw any amount at any time without penalty as long as separation from service occurs at or after age 55.

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The last post is correct as to what is permissible, however, most qualified plans do not provide for a participant to take any amount at any time. The majority provide for a single election of form of payment available under the plan. Of course, some plans do permit election changes or other multiple choices, but this is not the case in the majority of plans.

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Guest Ray Rogers

Since retirement plans are presumed to be for the benefit of retirees, seems like pretty dumb plan design for most plans not to permet distributions on the most favorable basis allowed by the IRS! (I agree that that's the case in the majority of plans.)

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To the CPA: RE: Ray Rogers post.

MY Statement: The 10% penalty is waived when SEPP start at age 45 and continue to age 50 when they are stopped. (They do NOT have to continue to age 59.5 in order to be relieved of the 10% penalty)

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yes

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