72T Penalty and IRS Interest Charges

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L1: 72T Penalty and IRS Interest ChargesI have read a few postings lately that I need clarification on……..I am 57 and startingtwo 72T plans )one for $100k andthesecond for $400k) with the 1st distributions occurring this month (wanted to get the higher interest rate calculations). I set up two plans because if I need cash I would bust only the $100k one (is this a good idea?). From a few posting I read, I understand that if I were to Bust a plan that I would only pay the 10% penalty for withdrawsmade prior to my 59.5 birthday (is this true)? And what is this IRS interest rate I keep reading about? When and why does that come in to play?2008-11-21 09:18, By: Mcli759, IP: []
L2: 72T Penalty and IRS Interest ChargesMake sure that the accounts have different account numbers and perhaps even at different custodians. I’m overly cautious, but if the plans are identical,started at the same time and based on the same assumptions, there could be a good case that they are the same plan.Which IRS interest rate are you referring to? The AFR or the penalty rate?2008-11-21 16:47, By: Gfw, IP: []

L2: 72T Penalty and IRS Interest ChargesYou are correct that if you bust a plan, the penalty only applies to distributions you took prior to 59.5. But busting the plan later than that triggers the penalty on those earlier distributions and the interest charge is greater due to the time elapsed from the tax due date from those first years. The rate changes quarterly, therefore there is some complexity to the calculation. You would pay the penalty on Form 5329 and the IRS would bill you for back interest.You only have a couple years to reach age 59.5. If you start the plan this year, eg in December, you have your choice to distribute 1/12 your annual amount or the full annual amount. Perhaps the extra 11 months worth would be enough of a cushion for you to avoid this dual plan approach. After age 59.5 if you do not need as much as you do now, you could make the one time switch to the RMD method.Remember, if you obligate yourself to 5 years of drawing down your IRA and you really do not need that much money but set it up with a high amount to avoid the penalty, you may lose more in current taxes or loss of tax deferral than if you had to pay a penalty on a small amount. In that vein, you could just use the 100,000 IRA as a safety valve for the 400k 72t IRA. This all depends on how good a handle you have of the funds you will need for the next 2 plus years.2008-11-21 20:24, By: Alan S., IP: []

L2: 72T Penalty and IRS Interest ChargesAlan, thanks for the info……My current situation requires about $30k in annual income. My wife and I sell real estate, had a great 2007, but very bad 2008, thus driving my need to supplement via the 72 T.I now understand the penalty and interest. I’m still a little confused on your statement about 1/12 or one annual payment, and how that might change my two 72T approach.I guess the other way to deal with the uncertainty of the real estate income would be to just withdrawal the $30k, pay the 10% penalty. Leave the IRA balance $470K invested andwait out the real estate market…..Any other thoughts?2008-11-22 07:36, By: mcli759, IP: []

L2: 72T Penalty and IRS Interest ChargesWhat I meant by the 1/12 vrs full year is that you have an option for the amount you withdraw in your first calendar year.If you start a plan in December pursuant to calculating a 30,000 annual distribution to cover your expenses, you can either take out 2,500 (1/12 of 30,000) or the entire 30,000 for 2009 and your plan is still fully valid. There would be no early withdrawal penalty for either amount, but you would of course pay taxes on the amount you selected. That may not be too bad since 2008 has been a bad year for most realtors.You could then save the amount you do not need as an emergency fund to get you to age 59.5. Next year you MUST take out 30,000, and over the term of the plan, you must take out at least 150,000. If real estate recovers in a couple years (I think 09 will be as bad as 08), having to take out 30,000 on top of your real estate income would not be good. But getting out 30,000 right away may make it possible to avoid setting up a second 72t plan now or later. You could still partition your IRA accounts into 400k and 100k, but only start the plan with the 400k account. The 100k IRA could be used for emergency needs if you have them.Let’s say that next year you have an unexpected medical bill of 10,000 and your 30,000 will not be enough. You could take the 10,000 out of the 100,000 non 72t IRA, without busting your plan and you might also be able to avoid the penalty on most of that 10,000 using the medical exception to the penalty.The trade off is perhaps having to pay a penalty on a small amount vrs obligating yourself to taxable distributions on your entire IRA balance for 5 years.If you still want to consider two plans, do not start them both now as gfw indicated. Start with the 400k IRA and hold off as long as possible before starting a second plan. Once you need extra money before 59.5, you can then decide whether to start a second plan or just pay the penalty knowing that you are close enough to 59.5 for the need to surface again before reaching 59.5. And if you take out the full 30,000 this year, you will have further insurance against ever needing a second plan.These are just suggestions as to options, as we do not know enough about all the particulars you are up against.2008-11-22 13:06, By: Alan S., IP: []