10% penalty for interrupting 72t payments

[Guest bmurphy]

I recently took over an account for a client who was set up on a 72t payment schedule in March 2001. He called today & is in a financial bind, needs to take out a 30k lump sum. My understanding is that there will be a 10% early withdrawal penalty on all prior payments (totalling $85,000) plus interest on the penalties. He is not 59 1/2 so the 30k payment will also be subject to the penalty. Looking for info on how interest is calcualted & paid on the prior years penalties. Too bad the former rep didn't carve out a separate IRA for emergency withdrawals.....

[Appleby]

Yeah. Too bad!

I couldn’t locate any reference to how the interest would be calculated. I assume the IRS would assess the interest and then send a notification to the taxpayer, informing him/her of the amount of interest due.

[Mary Kay Foss]

I also looked in vain for the answer to this question but came up with a workable solution on my own.

If the taxpayer completes Form 5329 for 2001, 2002 and 2003 and sends the forms and the 10% penalties to the IRS, interest will be assessed from the original due date of the Form 5329 (4/15 of 2002, 2003 and 2004) until the date IRS receives the check. The taxpayer could calculate the interest on his or her own (there are programs that do this for you) and include the interest in the tax payment. This may save some interest while the Forms are "in the mail."

I was researching this because I had a client who wanted to stop the payments midyear and not wait until they filed the tax return to assess the current year's 10% penalty plus interest. I'm not sure how you'd do that one. Maybe use the Form 5329 for 2003 and cross out the year to add 2004.

Also check to see what your state filing requirements are. In CA there is a 2.5% penalty whenever the IRS 10% penalty applies. I believe WI assesses 3%.

Good luck!

[John G]

I wonder if this client has exhausted all the other avenues for coming up with 30k. The taxes and penalties should be a big incentive to avoid taking out a lump sum.

Suggestions:

Home equity loan

Refinance home mortgage and take out cash

Signature line of credit (banks are trying very hard to loan money)

Sell some asset

Margin borrowing on stock portfolio (not likely given this scenario)

Try for an intra-family loan

Work with creditors to arrange an extended payoff - for example with a hospital, contractor, or

Talk with your employer - possible advance on a commission or bonus

Borrow against a life insurance policy

Even credit card debt might look better than triggering all the taxes and penalties.

It looks like he might just need a short term bridge loan if the next payment in coming in early 2005. Bridge loans are short term loans that are paid off quickly based upon a subsequent sale, deal or receipt of funds.