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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 74759  
Subject: Re: 72t Date: 9/20/1997 11:08 AM
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Yo, Bob, as promised here we go,

<<My wife and I will be retiring next year and she is not yet 59 1/2 so will have to rely on the 72t for part of our income. Your statement that there are a lot of pitfalls bothers me. Can you direct me to a good source of related info. >>

Section 72(t)(2)(iv) of the Infernal (sic) Revenue Code stipulates that funds may be withdrawn from an IRA or qualified retirement plan at any age prior to 59 1/2 without incurring the 10% excise tax (penalty) on those withdrawals provided they are part of a series of substantially equal periodic payments made over the participant's life expectancy or the joint life expectancy of the participant and a designated beneficiary. There are three approved and acceptable methods for receiving these payments, all of which result in a different sum paid to the recipient.

Minimum distribution method. In this method, the number of years of life expectancy for the participant or the joint life expectancies of the participant and a benefirciary is determined using the IRS life expectancy tables found in IRS Pub 590. The account balance as of the beginning of the year is divided by the number found in the applicable table, and the result becomes the amount that must be withdrawn in the first year. In the second and succeeding years, the required withdrawal amount is recalculated in one of two ways based on the new beginning balance in that year: reduce the life expectancy used in the previous year by one and use that as the new divisor; or, find the new life expectancy based on age in year two and use that. For every successive year, you must continue using the recalculation method used in year two of the withdrawal. This method results in the smallest withdrawal amount of the three methods permitted by the IRS to avoid the excise tax.

Amortization method. In this method, life expectancy is determined using the tables in IRS Pub 590. Additionally, an assumed earnings rate is used to determine the annual withdrawal required to expend the entire account over that life expectancy. This must be a "reasonable interest rate" decided on at the beginning of the withdrawals, and generally must be one which falls within 80% to 120% of the federal mid-term rate. There is no precise definition of this rate that has been established by the IRS, so it must be selected with care. Once determined, the withdrawal remains fixed from year to year; however, the amount will be larger than that determined using the minimum distribution method.

Annuity method. This method results in a fixed withdrawal amount like the amortization method, and it is computed similarly. The difference lies soley in the fact that IRS life expectancy tables are not used. Instead, those in general use by the life insurance industry are acceptable. An annuity factor derived by using the UP-1984 Mortality Table is the standard for this method. The resulting calculation results in the highest withdrawal amount of the three methods.

I see a number of drawbacks to using the 72t method of withdrawals. First, regardless of method used, the process must continue for a minimum of five years or until age 59 1/2, whichever occurs later in time. Start at age 58, and you must continue until age 63. Start at age 50, and you must continue until age 59 1/2.

Second, make a simple math error in computing the EXACT amount of the withdrawal, stop the withdrawals too early, or change the calculation method and all withdrawals up to that point are subject to the 10% excise tax AND a penalty for failure to pay that amount in prior tax years.

Third, the minimum distribution method too often fails to provide the needed income to the recipient. To increase the amount, the person must use one of the other two methods. The "reasonable interest rate" that must be used in these methods, while resulting in a higher withdrawal amount, can be too easily challenged by the IRS. Thus, it is not a rate for someone to choose on their own. Additionally, the calculations involved are beyond the capability of most folks. In short, there's too much potential for error and subsequent IRS penalties.

IMHO, those who wish to use Sec 72t should engage a professional skilled in the computations of all three methods. In addition, that pro should provide the account owner a letter specifying the method used in detail and expressing an opinion that the calculations comply with the requirements specified in the IRC and by the IRS. That way if something goes wrong, there's someone besides yourself to hold accountable. Things are just much safer that way.

Just one Fool's opinion FWIW.

Regards..........Pixy
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