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Delay 72t in Bear Market
I didn't fill out the template because I don't think it was necessary for this type of question.
I was wondering what the pros and cons for initiating a 72t during a downturn in the market when I don't really need the funds just yet. I have enough savings to last me about 2 years, when I'll be close to 56 1/2, at which point I do need to make withdrawals. However, waiting until then means my mandatory 5-year withdrawals will extend past 59 1/2 whereas if I do it in several months (according to the worksheet), the 72t requirement will end exactly when I turn 59 1/2.
So the question is whether it's better to wait until I need the funds and initiate the 72t and ride out the downturn in the stock market or time the 72t so that it ends exactly at 59 1/2 when I have more discretion on the withdrawals sooner rather than later?
You are correct, your question does not require the template.
You really have to do a spreadsheet to determine what your taxable income might be until 59 1/2, and in the first couple of years after 59 1/2. If you start now, you will be done at 59 1/2, and can be more flexible as to what you do after 59 1/2. On the other hand, starting now would add this income to other income from work or investments. But, you could change your investment income outside the SEPP 72-T to index funds and ETFs, which would reduce taxable income, unless you are in, and will continue to be in, the 12% income tax bracket, in which Qualified Dividends, Capital Gains Dividends, and Long-Term Capital Gains are taxed at -0-. In addition, if you have UNREALIZED CAPITAL GAINS now, a further downturn will reduce the taxes on them, or allow you to use the future losses vs other UNREALIZED GAINS at that time. On the other hand, if you have realized loss carryovers, or UNREALIZED LOSSES, then you can use them in the future to offset future REALIZED GAINS that you can time.
If you cannot do these projections on your own, then retain a professional tax advisor or financial planner.
Be careful to take into account future cash needs for Health Insurance before Medicare at age 65.
If you start a 72t when you turn 54 1/2 you're going to be locked in to that plan for 5 years, just like you would be if you started at 56 1/2. The plan duration is the same in both cases.
If waiting until 56 1/2 meant that you could avoid doing a 72t entirely, that would be a meaningful difference - for example if you could start making post-55 withdrawals from a 401K & those would get you to 59 1/2 without a 72t plan. But if the only way you can retire before 59 1/2 is with a 72t plan, then I don't think it matters much whether you start at 54 1/2 or 56 1/2, because you're going to be doing it for 5 years either way.
OTOH, waiting for a couple years to see if your retirement accounts recover from the current downturn could be a prudent idea. 2 years from now you might not have to commit as much of your retirement savings to the 72t to generate the income you need.
Thanks for your insights.
@dlzallestaxesmsn-com, I was self-employed for many years and had to pay for my own health insurance, so I've got that covered. I did use the tools on this website (which is awesome, BTW!) about a year ago for planning purposes but don't remember all the numbers now. Unfortunately, it's highly unlikely I will be in the 12% income tax bracket to take advantage of the 0% tax on capital gains.
@gryphon, I understand that once you start the 72t withdrawals, you are locked in for 5 years without incurring a penalty. As for the 401(k), until recently my funds were in a Solo 401(k), hoping that I could tap into it when I hit 55. Having done some research, I only found one financial advisor that proposed it in theory. I didn't find anyone who actually did it, and most other people were leery that the IRS would disallow, so I ultimately shut it down and moved all the fund to an IRA. I guess I could have done a short stint at some company, rolled over the account into their 401(k), and then withdraw money that way, but I was not keen to lose control of my investments. Plus, I would have to check with them to see if they allow early withdrawals and whether I have to take it as a lump sum, which would be a huge tax burden. Asking those questions before accepting a job offer would be awkward. I also would have to wait 2 years before I could retire.
My ultimate question is whether getting the flexibility of the withdrawals earlier (i.e., at 59 1/2) at the expense of locking in my "losses" now or waiting for a market rebound and subsequently deferring that flexibility is better or not. I think that it's probably better to keep the funds in the tax-deferred account rather than paying taxes on it now. For illustrative purposes, assume that the market will rebound and tax rates remain the same for the next 5 years. If I withdraw $100K/year now, I would have to pay around $25K in taxes, leaving me $75K to invest. Do that for 2 years and that's $150K. If, on the other hand, I wait 2 years before starting the 72t withdrawals, I would have $200K working for me in a tax-free account. Does that sound right? Am I missing something?
Your tax bracket over the next 5 years vs after 59 1/2 would be a consideration. Also, whatever income and appreciation that happens WITHIN your IRA will always be taxed at REGULAR tax rates. However, if you take distributions, those same investments if in equities, then the Qualified Dividends and Long-Term Capital Gains will be taxed at 15%, rather than 22% or higher. (You did not indicate if you file single of MFJ, or your rough taxable income without this distribution. You also did not indicate if you have children.)
Another consideration is your CASH NEEDS. You might want to consider ROTH CONVERSIONS to the limit of the 22%, or even 24% tax brackets. That would involve a lengthy discussion, but I have done that with several clients, which would be ideal with this depressed market. In that way, all FUTURE Interest, Dividends, and Capital Gains would be TAX FREE for you, your spouse, and all beneficiaries.
Another consideration is the SECURE ACT, which requires that all IRAs be distributed within 10 years after the year of your death (or after your spouse's death if you are married). That will mean that your beneficiaries who are other than your spouse will have to add significant income to their other taxable income over a short 10 year period. Unless you are familair with these other approaches, I suggest that you meet with a qualified tax or finacial advisor who is, and do some spreadsheet projections.
I'm single with no children and my tax rate is 24%. I just ran some simple calculations and even at the lower capital gains tax rate, I would come out ahead by about 9%. That's due to having the extra 24% in the account being invested for 2 more years being taxed as ordinary income.
Yes, I have thought about Roth conversions, but I don't think it will work for me since I need the distributions to live on. If I were to convert it, I would still have to wait 5 years to avoid the 10% penalty, no?
I am aware of the SECURE Act 2.0, but I don't think it's all that relevant for me right now.