rule 55 and 72t
L1: rule 55 and 72tHello, thank you for allowing me to ask this question. I turn 55 on April 17 and will retire April 30. I will set up a 72t distribution and I want to ask a question about the use of the rule of 55. If while my 401k is still with my employer, I ask for a partial distribution be sent to me and the balance be sent to a directed rollover, can I avoid the 10% penalty on the amount i receive that is sent outside of the rollover?2012-04-09 15:46, By: highdesert, IP: [220.127.116.11]
L2: rule 55 and 72tSTOP. DO NOT DO A ROLLOVER OF YOUR 401-K TO AN IRA.
You are eligible for a special rule which allows you to take any amount of distribution in any year before 59 1/2 from your 401-K without any 10% penalty. Once you roll it over to an IRA, the only way to avoid the 10% penalty is to lock yourself into an inflexible SEPP 72-T plan which REQUIRES the same annual distribution every year until you are 59 1/2.
Read all of the related postings on this website before you proceed.
Also, find out if their is any company stock in your 401-K ( such as the compapy’s match), If so, get the NUA ( “Net Unrealized Appreciation” of employer stock) cost basis from the company, and read the related postings in this website, or J K Lasser Your Income Tax which has an excellent explanation. I saved a client $ 100,000 in taxes utilizing this rarely known or undrstood special provision of the tax code.2012-04-09 16:19, By: dlzallestaxes, IP: [18.104.22.168]
L3: rule 55 and 72tYes, any distribution you take from this 401k will be penalty free, whether it is partial or full.
Check what options exist with your plan with respect to flexible partial distributions until you reach 59.5. As dlz indicated, if the options are flexible you should just leave the plan in place and take out distributions as you need them and avoid a 72t plan.
Now if the plan only offers lump sum distributions, you could still take enough out for this year to get you through the end of 2012 and then you will be forced to start a 72t early next year with your rollover IRA. However, if you have the NUA shares with enough appreciation you could also explore that option.
For example, if the plan will not allow flexible distributions and you were forced into a lump sum, you could reduce your 72t plan requirement by combining the sale of NUA shares with a smaller 72t plan.
If you get the flexible distributions, you cannot use NUA until after they are over at 59.5 since NUA requires an LSD. But you could leave the company stock intact until 59.5, and then do a direct rollover of what is left to an IRA with the NUA shares going to a taxable account and use the NUA benefit after 59.5. The long term cap gain rate may well go up before that time, however.
2012-04-09 16:35, By: Alan S, IP: [22.214.171.124]
L3: rule 55 and 72tdlzallestaxes, thank you for this confirmation! I knew that if I rolled my 401k over to an IRA I would have to take the SEPP but I was under the assumption that to perform the rule of 55 I had to leave it in my 401k and take partial distributions.When I asked mycompany’s benefits admin if I could leave my 401k with them and take periodic withdrawls this is what they said (verbatim):
‘If you were to retire early at age 55, you would not be able to take periodic withdrawals from your 401(k) account. You do have the option of leaving your funds within the 401(k) account, however when you choose to take your funds, you must take an entire lump sum distribution of the account. You would not be eligible to take a partial distribution’
Am I correct in understanding from your post, that if I have my program admin send me a lump sum distribution of the entire 401k that I will NOT pay the 10% penalty (because I am retiring after age 55 and separating from the company) and my only financial concern is paying taxes on the amount of the value of my 401k? If that is the case, my 401k is valued at $374K and yes, a portion of that was employer matched funds (they matched me to the 1st 6% dollar for dollar in any given pay period where I made contributions).
My benefits program has indicated if I request a full lump sum, they will with hold 20% for federal taxes and I will receive the balance (.20x$374k=$74,800 with holding for taxes and I net $299,200). Is your understanding that I could net $299.2K and NOT incur the additional federal penalty of 10%?
Also, you mentioned that they may be a way to further reduce my tax liability because of the employer matching amount (NUA)? I would like more insight into both these questions and thank you!
2012-04-09 23:53, By: highdesert, IP: [126.96.36.199]
L4: rule 55 and 72tI’ll let Dlz comment on the NUA.
But, remember that the 20% withholding is just that – only withholding. If you take a lump sum, you will be taxed on the amount distributed plus any other income that you may have in 2012. I don’t know your tax situation, but you would probably be closer to 30% (or more) than 20%. And don’t forget about any state income taxes, they will want their share as well.
Before deciding to take a lump sum, you should really get some Professional advice.
Regarding the 10% penalty, if you separate from service at ot after age 55, there is no 10% penalty. The wording for teh exemption can be found here… http://72t.net/72t/Penalty/Exceptions2012-04-10 00:29, By: Gfw, IP: [188.8.131.52]
L5: rule 55 and 72tWell, now that the we know there is no flexibility with respect to your distributions directly from the plan, you are probably better off with the SEPP. If you took out the full amount from the plan, even though there would be no penalty, your marginal rate would be inflated by more than 10%, the amount of the penalty, and the 20% withheld would not be enough. So now we are back to the direct rollover to an IRA and the 72t plan.
With respect to NUA on employer shares, the NUA is the amount in excess of the cost when the plan purchases your shares for you, whether from your own contributions or matching contributions. To be really viable, your cost basis should not be much more than 30% of the current value of the shares. But you should still get a quote from the plan to see what % the cost basis is.
But we can now likely eliminate keeping the plan in place since they will not allow anything but a lump sum distribution with the accompanying heavy taxes jammed into one year.
2012-04-10 02:26, By: Alan S, IP: [184.108.40.206]
L6: rule 55 and 72tIt is a shame that companies are so inflexible. They force you to take your money, and force themselves to liquidate your account, unless they have good investments that they allow you to “transfer in kind” the specific investments.
However, if you rollover your entire 401-K to an IRA, there should not be any withholding. Then you can tell your IRA company what % to withhold whenever you take distributions, or even -0- withholding if you are disciplined enpugh to file quarterly estimates.2012-04-10 02:59, By: dlzallestaxes, IP: [220.127.116.11]
L6: rule 55 and 72tAlan,
Thank you for this insight. I have made a forcast of my 2012 taxable income with both my current income and projected income as a retiree (from May to Dec). I estimated a 2012 taxable income ammt of 82,500 (joint income). I know the 2012 tax bracket limits for the 25% and 28% thresholds. I am modeling scenarios to withdraw ammts to meet my goals and to ideally stay within the parameters of the 28%bracket ($217,400 limit). I will need to set up a SEPP (that ammt is included in my 2012 income projection). Do you have a preference for a brokerage company? I have heard good things about Scottrade and Optionshouse. I need to direct $274k to a IRA.2012-04-10 04:34, By: highdesert, IP: [18.104.22.168]
L7: rule 55 and 72tVanguard, Fidelity, etc. They have brokerage divisions, as well as mutual funds.
If you structure to get about $ 15,000 less in 2012, you will be in the 15% tax bracket. Maybe start a month or 2 later on your 1st SEPP distribution.2012-04-10 15:18, By: dlzallestaxes, IP: [22.214.171.124]