IRA distribution

[ttbtaxes]

Client, age 55, started receiving an IRA distribution in an amount to satisfy the substantially equal period payment 10% penalty exception of Section 72(t). The 1099-R was coded 2 in Box 7 which means the penalty exception applies.

Does a Form 5329 have to be filed in this case?

[Roland Slugg]

According to the instructions for F-5329 it does not. To verify this I entered an IRA distribution for a T/P age 55 in the tax prep software I use, coding it as an IRA "code 2" distribution. My tax prep software did not generate a F-5329.

I would be curious to know how the IRA trustee knew to code the distribution with "Code 2" on the 1099-R it issued. From the trustee's perspective this would appear to be a "Code 1" distribution. That is the usual case when the participant is under age 59½ (and not disabled). It's then up to the recipient to report the distribution on his tax return AND on F-5329, on line 1 of that form, with the code for the exception to the 10% penalty entered on F-5329, line 2 ... code 02 in your client's case.

[Burke]

I had one of these once. The custodian set it up under the 72T regs for periodic payments and it was coded a 2. After age 59 1/2, I think it changed to Code 7.

[Roland Slugg]

I had one of these once. The custodian set it up under the 72T regs for periodic payments and it was coded a 2. After age 59 1/2, I think it changed to Code 7.

That's interesting. I didn't know an IRA trustee would do that. It's a good idea, though, because it avoids the normal reporting requirements. In addition, I would speculate that a 1099-R form coded "2" would be less likely to draw the IRS's attention than one coded "1" that's then treated as penalty-exempt by the T/P on F-5329.

Related to this same issue, I seem to recall that when distributions are started early and are based on the "substantially equal" calculation, they must continue on that basis for at least five years or until the owner reaches age 59½, whichever comes later. Otherwise, the penalty applies retroactively to all pre-59½ distributions. Don't remember where I read that, but for anyone with clients doing this it would be wise to check it out.

[oceanlovin'ea]

code 2

I have a 1099R with code 2 in the box 7. I was about to call the client and ask for a reason for the distribution but the program didn't ask for a reason. Seems if box 7 is marked 2 we don't have to tell them what the exception is. I take it the issuer must have known the reason.

Linda, EA

[ttbtaxes]

The client did the calculation through the financial institution's software and with the knowledge of the contact person. That obviously had the desired effect of heading the horse off at the pass and coding the 1099-R with a "2".

[Burke]

Related to this same issue, I seem to recall that when distributions are started early and are based on the "substantially equal" calculation, they must continue on that basis for at least five years or until the owner reaches age 59½, whichever comes later. Otherwise, the penalty applies retroactively to all pre-59½ distributions. Don't remember where I read that, but for anyone with clients doing this it would be wise to check it out.

You are correct on this.

[JohnH]

That's interesting. I didn't know an IRA trustee would do that. It's a good idea, though, because it avoids the normal reporting requirements. In addition, I would speculate that a 1099-R form coded "2" would be less likely to draw the IRS's attention than one coded "1" that's then treated as penalty-exempt by the T/P on F-5329.

Related to this same issue, I seem to recall that when distributions are started early and are based on the "substantially equal" calculation, they must continue on that basis for at least five years or until the owner reaches age 59½, whichever comes later. Otherwise, the penalty applies retroactively to all pre-59½ distributions. Don't remember where I read that, but for anyone with clients doing this it would be wise to check it out.

You're exactly right. If they don't stick to the 5-year rule then they have to pay the penalty retroactively, even for a closed year. I had a client who violated the 5-year rule right at the end of the 4th year. Cost them about $7k, and they knew they were doing it but just "had to have" the money right then. They couldn't wait 4 more months. Ridiculous.

If anyone ever has a client who wants to do a 72(t), warn them that they should break the IRA into two accounts, with maybe 10-20% of the money in the second IRA. Call that the "Emergency IRA". Then they set up the 72(t) on the big IRA and leave the Emergency IRA alone. This reduces their regular payment under the 72(t), but gives them backup options. If a true emergency arises during the 5 years, they can pull money from the Emergency IRA and pay the penalty on that withdrawal only, without breaking the 72(t) and paying the retroactive penalty on all the prior distributions. Sure wish my client's financial advisor had known that when their plan was first set up.

[Burke]

Well, darn, that's a good idea!

[JohnH]

I got it from a site dedicated to 72(t) planning. It's hard to believe there is so much good information available on this site for free. If anyone ever tells me they are considering a 72(t) plan in the future, I'm going to tell them to bookmark this site and visit it on a regular basis.

https://www.72t.net