Advanced Underwriting Consultants

Question of the Day – July 9

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client is 53, and wants to avoid the 10% penalty tax on her IRA distributions.  Will the IRA custodian help her with calculated 72(t) distributions?

Answer: Some of them will, but it is not a requirement.

The Internal Revenue Code provides that taxable distributions from an IRA to a taxpayer younger than 59 ½ are subject to an extra 10% penalty tax unless there is a special exception.  One such exception is that the 10% penalty tax does not apply to distributions which are part of a series of substantially equal periodic payments made at least annually for the life or life expectancy of the individual or the joint lives or joint life expectancy of the individual and his designated beneficiary.  This is sometimes referred to as the 72(t) exception.

Once a taxpayer begins to take 72(t) distributions, the taxpayer must continue them for the longer of five years or until the taxpayer reaches age 59 ½.  If the taxpayer modifies the 72(t) distribution stream—perhaps by taking greater or lesser distributions from the IRA than those required under the 72(t) distribution strategy—all prior distributions intended to meet the 72(t) requirements will be subject to the penalty tax.

Some IRA custodians actively help their customers calculate and take 72(t) distributions.  Others do not support 72(t) at all.

If working with a client who intends to take 72(t) payments, we recommend that the advisor check with the IRA administrator to determine their willingness to actively participate in the 72(t) process.  For those administrators that will not help calculate 72(t) payments, the advisor should find out how the administrator will report distributions to the IRS on Form 1099-R for income tax purposes.

From the client’s perspective, it would be most helpful for 72(t) distributions to be coded as taxable distributions which are not subject to the penalty tax.  On Form 1099, that means that box 7 will have distribution code 2.

While Form 1099-R does not bind the IRS to accept that the distributions conform to 72(t), the proper 1099 coding makes it administratively easier on the taxpayer who is taking 72(t) payments.

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