Challenging Question

[Snaggletooth]

Please refer to TTB 13-3, Exception #2

Betty begins receiving $1500 per month, beginning at age 56, from a retirement annuity plan that otherwise would bear the 10% early withdrawal penalty. She is exempt from the penalty under exception #2. She continues to draw this amount until she is age 61, which occurred in 2009.

During the period between age 56 and age 59.5, she withdraws $58,000, which would be subject to a $5800 penalty had the exception not applied.

On September 15, 2009, she has $250,000 remaining in the annuity, and cashes it out to invest in land. This is four years and 10 months from the time she received her first annuity payment.

Which, if any, of the statements below are correct?

1. Betty abided by the "equal payments" doctrine until she was older than 59.5, so she has no further liability.
2. The "equal payments" doctrine was supposed to remain in effect for at least 5 years, so she retroactively owes $5800. She must file amended returns for each of the years the penalty would have applied.
3. The "equal payments" doctrine was supposed to remain in effect for at least 5 years, so she retroactively owes $5800. She must include the penalty amount on her 2009 tax return.
4. The "equal payments" doctrine was supposed to remain in effect for at least 5 years, so she retroactively owes $5800. The proper filing method would be to file Form 5329 independently of her tax return.
5. Other treatment (please specify).

Note: This has been edited due to an ambiguity in the original post. Thanks for pointing this out, Snowshine.

[snowshine]

I choose 5:

It sounds like Betty has had 5 years lapse since the first payment and she is also now older than 59 1/2, so no penalty for changing the payment schedule. If it was less than 60 months since the first distribution than Betty owes the penalty on her 2009 tax return.

[JoshinNC]

Option 3 because she DID NOT make it to the 60 months

If she had made it to the 60 months then there would be no penalty.

[ChEAr$]

Please refer to TTB 13-3, Exception #2

Betty begins receiving $1500 per month, beginning at age 56, from a retirement annuity plan that otherwise would bear the 10% early withdrawal penalty. She is exempt from the penalty under exception #2.

I would stop right here, since I reckon your question revolves around the 10% penalty. Right?

So how she took it, whether in payments, equal or not, or lump sump, has no import. She pays the income tax only.

[JoshinNC]

Huh??!!

I would stop right here, since I reckon your question revolves around the 10% penalty. Right?

So how she took it, whether in payments, equal or not, or lump sump, has no import. She pays the income tax only.

Chears, I think you missed the fact that she started a 72t distribution plan but did not complete the statutory 60 months of withdrawals prior to changing to a distribution amount that was not calculated under 72t. Once she started the 72t withdrawals she had to do it until age 59 1/2 OR 60 months, whichever was longer. She made it to 59 1/2, but not to the 60th month (only made it to 58 months). The 10% penalty applies for the past 4 years and must be added to 2009 tax.

[Gretel]

I vote for #5 because:

Ich habe immer recht. (just joking)

She didn't make it since it is not at least 5 years, so the 10% recapture tax applies, but only up to time when she reaches 59 1/2. This tax is reported in the current year on form 5329 line 4.
see Pub. 590 pg. 52

[Bees Knees]

TTB, page 13-3 gives you an example for #2:

Example: Beth begins taking IRA distributions at age 58
under a periodic payment schedule. At age 61, she modifies the payment
schedule. All distributions prior to age 59½ are subject to the
penalty in the year the modification occurs.

Thus, this is not a prior year 5329. Since it is a 2009 tax year 5329, you file the 5329 with the 1040. The 5329 instructions say:

If you do not have to file a 2009
income tax return, complete and file
Form 5329 by itself at the time and
place you would be required to file
Form 1040 or Form 1040NR.

Thus, since a 1040 is required for that level of income, the correct answer is #3.

Pub 590, page 52 does not say to file a separate 5329 independent of the tax return. It merely states that you use Form 5329, line 4 to report the penalty (which then flows to the 1040).

[ChEAr$]

Chears, I think you missed the fact that she started a 72t distribution plan but did not complete the statutory 60 months of withdrawals prior to changing to a distribution amount that was not calculated under 72t. Once she started the 72t withdrawals she had to do it until age 59 1/2 OR 60 months, whichever was longer. She made it to 59 1/2, but not to the 60th month (only made it to 58 months). The 10% penalty applies for the past 4 years and must be added to 2009 tax.

I reckon you didn't read what I replied to. It was:

"Betty begins receiving $1500 per month, beginning at age 56, from a retirement annuity plan that otherwise would bear the 10% early withdrawal penalty. She is exempt from the penalty under exception #2."

Since she is exempt from the penalty under exception#2, ....

Nowhere did snaggletooth indicate she was drawing under the auspices of a 72t election, only that she had begun to take monthly withdrawals.


See now?

[Gretel]

Nowhere did snaggletooth indicate she was drawing under the auspices of a 72t election, only that she had begun to take monthly withdrawals.


See now?

I kindly disagree. He indicated this in the first line of his post. It's confusing though between the two #2 exceptions.

[Snaggletooth]

Thanks to All

I believe this has been answered and thanks to everyone for their interest and comments. The clearest answer is that that a 5329 is to be filed with the 2009 and the total amount of penalty paid. The only valid reason for filing a 5329 by itself (#4) would be if a penalty is due and the filing threshhold for a 1040 not met.

I didn't read the instructions to be restricted to a formal 72t plan, in fact, I believe this exception could apply for a taxpayer who withdraws "de facto" rather than under a formal plan from the inception of withdrawals. For my friend ChEAr$, I hope this clears it up. IOW, I didn't feel the question as posed hinged on a formal plan which met the definition of a 72t, but there were meaningful choices posed nonetheless.

[Bees Knees]

I reckon you didn't read what I replied to. It was:

"Betty begins receiving $1500 per month, beginning at age 56, from a retirement annuity plan that otherwise would bear the 10% early withdrawal penalty. She is exempt from the penalty under exception #2."

Since she is exempt from the penalty under exception#2, ....

Nowhere did snaggletooth indicate she was drawing under the auspices of a 72t election, only that she had begun to take monthly withdrawals.


See now?

Yes he did indicate Section 72t applied. That is what TTB page 13-3, exception #2 is talking about. Next to exception #2 on page 13-3, the citation is IRC Section 72(t)(2)(A)(iv).

Since she is exempt from the penalty under exception #2, then she is only exempt from the penalty provided she continues to meet the requirements under exception #2.

Ask yourself what is required under exception #2? Equal payments for at least 5 years. Once she fails to meet the 5 year rule, she is no longer exempt from the penalty under exception #2.

See now?

[ChEAr$]

Yes he did indicate Section 72t applied. That is what TTB page 13-3, exception #2 is talking about. Next to exception #2 on page 13-3, the citation is IRC Section 72(t)(2)(A)(iv).

Since she is exempt from the penalty under exception #2, then she is only exempt from the penalty provided she continues to meet the requirements under exception #2.

Ask yourself what is required under exception #2? Equal payments for at least 5 years. Once she fails to meet the 5 year rule, she is no longer exempt from the penalty under exception #2.

See now?

I see now y'all were discussing something from the TAxBook, while I took the phrase "She is exempt from the penalty under exception #2." as meaning the distribution code on form 1099R.

See now?