When a person decides to cash out an IRA before their retirement date, such a decision would result in a 10% early distribution penalty plus an income tax on the remaining amount. An IRA’s owner hard-earned money could be definitely reduced by taxes and penalties in no time. Instead of rolling over an IRA to prevent a penalty, a taxpayer can take advantage of the IRA 72t distribution methods allowed by the Internal Revenue Code that allows people of any age to take the same amount of consecutive payments without assessing a 10% penalty.
People who want to withdraw on their IRA by means of 72t distribution payments must generally continue for at least a complete five years of the date of the first payment, or, if later, age 59½,. In addition, they cannot make changes in the increments or the schedule of their payment distribution, with the exception of a one-time payment calculation using the RMD method. An IRA owner can use three formulas to select 72t IRA payment distributions which gives taxpayers a measurable amount of flexibility: the fixed amortization method, the fixed annuitization method, and the minimum distribution method.
The Fixed Amortization Method
The fixed amortization method is suggested as the best option for Section 72t IRA distributions gives the tax owner the flexibility to take IRA distributions from his or her other IRAs without assessing the 10% penalty after the age of 59 1/2. Furthermore, they can receive more money over the next five years by separating another IRA from their total IRA balances and placing it on a 72t distribution program.
Fixed Annuitization Method
The fixed annuitization method is one of the most complex methods, and uses an annuity factor to calculate your Substantially Equal Periodic Payment or SEPP. The calculation used for this method is based on the non-sex mortality table found in the IRS Revenue Ruling 2002-62. The fixed annuitization method includes a taxpayer’s account balance divided by an annuity factor equal to the value of an annuity of $1 monthly beginning at the taxpayer’s age at the time of the first distribution year and continuing for the life of the taxpayer.
The Minimum Distribution Method
The minimum distribution method is determined by dividing the prior end of the year fair market value of the retirement account by the applicable distribution period or life expectancy. Certain qualified plans will allow specific individuals to put off beginning their required minimum distributions until they retire which can apply even if they are older than age 70 1/2. Qualified plan participants should discuss this option with their employers to determine whether they are eligible for this deferral.
What is the RMD Method?
The Required Minimum Distribution or RMD method calculates an IRA owner’s retirement account balance divided by their life expectancy factor that is provided by the IRS grid, and is reset each year. A life expectancy factor can be determined by: a single life expectancy without a beneficiary, a Uniform Lifetime table or joint life expectancy, both of which includes a beneficiary.
The length of time spent paying on benefits, however, reduces the monetary amount of payments an IRA owner should expect to receive. When calculating your account balance it is suggested to use the balance from your previous tax year to determine the amount you will receive in the first year utilizing the RMD method. Notate the anniversary date of when you can use the RMD method again. It is very important for the IRA owner to calculate the amount they wish to receive carefully, because only this amount is allowed to be distributed.
While the RMD method may be advantageous to provide the IRA owner with a bigger lump sum, distribution payments under this method can fluctuate along with their IRA investments. An IRA owner also should take into consideration that the life expectancy table distributes upfront payments of smaller value and then larger payments as they near retirement age. Since there are pros and cons to using the RMD method, it is best to seek the advice of someone who is experienced in choosing distribution payment methods, before you do anything.
Withdrawing Payments From Multiple IRA Accounts Using the 72t Distribution Program
The advantage of having more than one IRA account is that an IRA owner has the flexibility to withdraw the total allowable aggregate from each IRA they own. However, if an individual decided to withdraw over the allowable amount from their IRA, they must subtract this amount from their current IRA balance to essentially break even under the rules of a RMD. If an IRA owner does not abide by the RMD rules or adjusts their payments to compensate for excess withdrawals under their plan, they will fail to qualify for the 10% penalty exemption. This could prove to be a nightmare for the IRA owner who will also accrue a 10% penalty for all of the prior years they received IRA distributions.
Fortunately, each IRA account is independent of the other which means that someone can take 72t distribution payments from one account to setup withdrawal arrangements on that particular one without affecting any additional IRAs they may have. This may prove to be a workable strategy to start using funds in the short and long term without violating any regulations set forth within their plan. There may come a time when a taxpayer will withdraw on their individual or IRA account to the point that it becomes depleted. In this scenario, you will not be held accountable to pay the recapture tax or the Code §72(t) tax because there will no longer be any substantially equal periodic payments scheduled to be distributed.
Using the fixed amortization method, the fixed annuitization method, and the minimum distribution method to withdraw on an IRA account using the 72t distributions program are standard selections that an IRA owner can utilize to receive payments. However, another method may be used as an individual ruling request in a private letter, but this would be subject for further analysis.
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