Section 72(t) Blues

[Guest Hickory6]

Hello, everyone...

Here's a subscriber to Mutual Funds Magazine who wrote in with a dicey question:

"Other than the three methods approved by the IRS for retirees under age 59 1/2, if you need much more than the amounts those three methods produced, can you withdraw the amount you need as long as you recieve that amount over the longer of five years or the attainment of age 59 1/2? For example, the 3 methods in my case only produce an annual amount of $8,000, $12,000, and $17,000.

I need $42,000 annually and would take that amount for five years or until reaching age 59 1/2, whichever is longer.

The amount is not based on life expectancies or assumed rates of interest, but simply on my living needs."

Name withheld.

What would you say to such a person if she came through your doors?

Unfortunately, I do not know if she is expecting money from other sources, such as a pension or inheritance, on which to get by once she turns 59 1/2, nore do I know if she has a health concern which might reduce her life expectancy. She hasn't responded to return e-mails, so I'm looking at answering the question under both scenarios: either she MUST rely on this money lasting throughout her (normal) lifespan, or she can safely take it out in 5 years and rely on other sources. Which takes us to the question: what does the law allow?

I'd like to do a first-class job answering her question--she's under a lot of stress, and this probably means a lot to her.

Jason Van Steenwyk

Reporter,

Mutual Funds Magazine

954-229-6907

[Guest gfweis]

You can take any amount that you want, provided that you are willing to pay the 10% penalty! If 5-years is the expected time period, why not take what the 72t plan allows and take a short term loan to make up the difference. Just a few thoughts - more information required for a real answer.

Check out our web site at http://72t.net

[Guest Hickory6]

Thank you very much for your response. Great website, too, BTW!

Thanks!

Jason

[Guest Hickory6]

Anyone see any problems with this response to this woman's letter, before we print a million copies of it?

Under section 72(t) of the Internal Revenue Code, early retirees are limited to three options: 1.) Take ‘substantially equal periodic payments’ based on your life expectancy, 2.) Amortize the entire balance based on your life expectancy compounded by a reasonable interest rate, or 3.) the annuitization method, in which you divide your account balance by an annuity factor using both a reasonable mortality table and an assumed rate of interest. Beyond that, you can still withdraw as much as you need, but you’ll have to pay the 10% penalty on any amount you withdraw over $17,000, counsels Susan Strasbaugh, a CFP in Monument, Colorado. The course of action to take depends on your situation. If you expect to have another source of income five years from now—say, a pension or an inheritance—you may be able to avoid the 10% penalty by withdrawing the amount allowed, and then taking out a short-term loan to make up the difference.

If you do not expect another source of income, though, “you’re going to run out of money pretty quickly,” she warns, suggesting you’ll probably need to continue working, move to an area with a lower cost of living, reign in your lifestyle expectations, move into a smaller house, or all of the above.

For more information on Section 72(t), visit www.72t.net.

Jason Van Steenwyk

Reporter

[MGB]

I don't understand why she would have $17,000 exempted. The entire amount should be subject to the 10% if she takes more than $17,000.

[Guest gfweis]

If only one IRA is being used, then any payment taken outside the SEPP plan would bust the entire plan - back penalties and interest would be due.

She could however, divide the IRA into two accounts - use one account for the SEPP plan and the other for unknown withdrawals. Needless to say, by dividing the account, the SEPP payment would even be less.

[Bruce Steiner]

It's also not quite correct to say that she's "limited" to the 3 methods cited. While the IRS listed these 3 methods in its notice, they are not exclusive. There have been a number of PLRs that have approved variations of these methods, and some rulings have approved hybrid methods. I discuss this in more detail in my article on this subject in the October 1997 issue of Estate Planning.

[Guest Hickory6]

Ok, thanks, Mr. Steiner.

Would any of the hybrid methods approved allow her to do what she wants to do--i.e., do withdrawals at three times the rate generated by the most generous of the three methods used by the IRS as an example? Or is that range still going to be between 8,000 on the low end and 17,000 on the high end?

I'm assuming none of these possible alternatives is going to be a solution to her cash flow problem over the next 5 years. Is that correct?

Jason

[Guest gfweis]

While I have seen several variations to the 3 methods outlined in 89-25, most of the differences occur after the first payment is calculated.

I haven't seen any variations to the basic methods used to determine the initial payment amount.

[Guest gfweis]

BTW - if you do plug our site (72t.net), thanks. Last month we had a plug in the WSJ!

Have a great evening!

[Guest Hickory6]

Mr. Weis,

Yes, I do mention your site in the manuscript I turned in. Don't know that it will make the final version, though, as space concerns can be unforgiving, but I think yours is a useful site for our readers, and I was certainly happy to mention it.

Thanks very much for your insights!

--Jason Van Steenwyk

Reporter,

Mutual Funds Magazine

954-229-6907