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July 29, 2010 |     |
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72(t) Distributions: Impact on retirement fund balances
The IRS Rule 72(t) and 72(q) allows for penalty free, early withdrawals from retirement accounts. The IRS limits how much can be withdrawn by assuming any future earnings will be at most 120% of the Federal Mid-Term. This conservative approach can help assure that you will not prematurely deplete your retirement account. However, if you have a higher rate of return your account can actually grow, even with your distributions. On the other hand, if you suffer losses your account balance may end up shrinking faster than you might expect. This calculator is designed to examine the affects of 72(t) distributions on your retirement plan balance.April 16th, 2002 and again on October 3rd, 2002, the IRS finalized rule changes that affected 72(t) distributions. This calculator incorporates the new regulations, many of which are described in detail below. For more information regarding these changes please see Revenue Ruling 2002-62 on www.treasury.gov. Distribution interest rate This is any rate less than 120% of the Federal Mid-Term rate for either of the two months immediately preceding the month in which the distribution begins. Click here to see the most current rate information on IRS.gov. For April 2005, 120% of the Federal Mid-Term rate is 4.92%. It is important to note that the associated law that created the 72(t) distributions did not define what was to be considered a reasonable interest rate. As such, the guidance from the IRS generally flows from the concept that they will not allow people to circumvent the requirement of substantially equal periodic payments (SEPP) throughout your lifetime by using an unreasonably high interest rate. 72(t) withdrawals setup prior to January, 2003, had some flexibility in the choice of the reasonable rate to use. However, in 2002, the IRS issued new rules stating that only rates under 120% of the Federal Mid-Term rate would be considered reasonable. You are now required to use a rate that is no more than 120% of the Federal Mid-Term rate. Projected earnings rate This is the interest rate you expect to receive on your retirement account. The actual rate of return is largely dependant on the type of investments you select. From January 1970 to December 2004, the average compounded rate of return for the S&P 500, including reinvestment of dividends, was approximately 11.5% per year. During this period, the highest 12-month return was 64%, and the lowest was -39%. Savings accounts at a bank pay as little as 1% or less. It is important to remember that future rates of return can't be predicted with certainty and that investments that pay higher rates of return are subject to higher risk and volatility. The actual rate of return on investments can vary widely over time, especially for long-term investments. This includes the potential loss of principal on your investment. Account balance This is your account balance as of the close of business on December 31st of the preceding year. The IRS has decided that the balance on this date should be used for 72(t) distributions with one important exception: this amount is increased by any contributions made for the preceding year after December 31st. Your age This is your current age. Use the age you will turn on your birthday for the year you are receiving the distribution. Beneficiary age This is your beneficiary's age. Use the age your beneficiary will turn on their birthday for the year you are receiving the distribution. This entry is ignored if you do not use your Joint Life Expectancy to calculate your SEPP. Choose life expectancy table There are three different life expectancy tables that the IRS allows you to use when calculating your SEPP with the "Fixed Amortization" or the "Required Minimum Distribution" methods. It is important to note that once you have chosen a distribution method and life expectancy table, you cannot change either throughout the course of your distributions. (Except for a one-time change from the Annuitized or Amortized methods to the Life Expectancy method, see SEPP definition for more details). The three life expectancy options are:
Choose distribution method The rules for 72(t) distributions require you to receive Substantially Equal Periodic Payments (SEPP) based on your life expectancy to avoid a 10% tax penalty on any amounts you withdraw. These payments must last for five years or until you are 59 1/2, whichever is longer. Further, the SEPP amount must be calculated using one of the IRS approved methods which include:
In addition, on October 3, 2002, the IRS ruled that you could change your distribution type one time without penalty from the Annuitized or Amortized methods to the Life Expectancy method. This would allow account holders the option to move from a fixed payment type to a payment that fluctuates annually with the value of their account. The primary reason for this exception is to allow individuals who have suffered large losses the option to reduce their distribution to prevent their retirement account from being prematurely depleted. For more information on this important exception please see Revenue Ruling 2002-62 on www.treasury.gov. It is important to remember that while 72(t) distributions are not subject to the 10% penalty for early withdrawal, all applicable taxes on the distributions must still be paid. Further, taking any early distributions from a retirement account reduces the amount of money available later during your retirement. Please contact a qualified professional for more information. Post 72(t) distribution This is the percentage of your account you wish to receive in annual distributions after the required 72(t) distributions have been made. These percentage will be used to calculate the annual distribution after five years have past or your have reached age 59 1/2, whichever comes later. Information and interactive calculators are made available to you as self-help tools for your independent use and are not intended to provide investment advice. We can not and do not guarantee their applicability or accuracy in regards to your individual circumstances. All examples are hypothetical and are for illustrative purposes. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues. |
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