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§72(t)/§72(q) SEPP Plans Loading

72(t) FAQ, Frequently Asked Questions

These Frequently Asked Questions [FAQ] and answers provide general information and should not be cited as any type of legal authority. They will give you provide general information. Because these answers to not apply to every situation, you may require additional research.  

Q. How is my age calculated?

A. Your age would be your attained age as of your birthday in the calendar year in which the distributions commence. PLR 8946045

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Q. What is the Age 55 Exception to the 10% penalty?

A. The age 55 exception only applies to distributions made from qualified employee rertirement or annuity plans - it does not apply to an IRA. Distributions made to you after you separated from service with your employer, if the separation occurred after you reached age 55, are not subject to the 10% penalty tax. 

For the definition of age 55, IRC Notice 87-13 states... "such separation from service occurred during or after the calendar year in which the employee attained age 55."

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Q. What documentation should be maintained for a SEPP plan?

A. The safe course of action is to document the plan and all plan transactions.

The starting point would be to reduce the terms of the plan to a written document that outlines all the details including the payment calculation method to be used, when payments are to commence and the frequency of the payments. There is a sample form on our side that can be used a guide.

I would also keep copies of the account statements that were used to determine the initial payment and if any recalculation method is used, the statements for each recalculation. In addition I would also keep copies on the statements reflecting the transactions as they occur.

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Q. Are there any IRS filing requirements?
A. That depends on how form 1099-R is coded when you receive it from the Trustee/Custodian that is making the SEPP distributions. If 1099-R box 7 is coded with a 2 (early distribution, exception applies under age 591/2) then nothing additional needs to be filed. If however, box 7 has a code of 1 (Early distribution, no known exception) you must file IRS Form 5329 to claim the exemption to the 10% penalty tax.

Plan early. When you have designed the plan, communicate with the Trustee/Custodian that will be making the distributions and see if they will be using a code of 2 on the 1099-R. If not, prepare to file form 5329 or perhaps a new funding vehicle for the plan.

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Q. What account balance should be used?

A. Revnue Ruling 2002-62, 2.02(d) states... "The account balance that is used to determine payments must be determined in a reasonable manner based on the facts and circumstances. For example, for an IRA with daily valuations that made its first distribution on July 15, 2003, it would be reasonable to determine the yearly account balance when using the required minimum distribution method based on the value of the IRA from December 31, 2002 to July 15, 2003. For subsequent years, under the required minimum distribution method, it would be reasonable to use the value either on the December 31 of the prior year or on a date within a reasonable period before that year's distribution."

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Q. Do All IRA Accounts have to be combined to determine the amount of the distribution?

A. Individual retirement plans do not have to aggregated for purposes of calculating these payments. If a taxpayer owns more than one IRA, any combination of the taxpayer’s IRAs may be taken into account in determining the distributions by aggregating the account balances of those IRAs. PLR 9050030. Also review PLR 9525062. It also deals with using multiple accounts to fund a single SEPP.

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Q. Can a portion of an IRA account be excluded from the calculations?

A. No, the entire account balance in each of the pertinent IRA's must be taken into account. A portion of one or more of the IRAs may not be excluded in order to limit the periodic payment to a predetermined amount. PLR 9705033 Page top

Q. If I include more than one account, which accounts do I use to make the payments?

A. If two or more IRA's are used in determining the substantially equal periodic payments, the distributions need not be made from all of the included IRA accounts. The distributions may be made solely from one of the accounts, or from a combination of the accounts. PLR 9705033

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Q. I have a SEPP and have been re-employed and have earned income. Can I make a contribution to an IRA?

A. All accounts are treated individually. Do not touch the SEPP account, but rather establish a new IRA account and make the contributions to it.

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Q. I have a SEPP that used one of my two IRA accounts, can I set up a second SEPP with the other account?

A. Since all accounts are treated individually, there is no reason that the second IRA couldn't be used to establish a second plan, totally independent of the first plan. Just make sure that the appropriate payment comes from the appropriate plan.

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Q. Can a Cost of Living Adjustment (COLA) be included?

A. Under Revenue Ruling. 2002-62 COLA Increases are not allowed for plans adopted after 12/31/2002. Prior to 01/01/2003, there were at least 2 PLRs that allowed COLA increases<

  • PLR 9503631 - This annual distribution amount will be increased by a 3 percent cost-of-living factor for each year after 1994. Thus, the annual distribution amount for 1995 will equal 103 percent of the 1994 distribution amount, and for years subsequent to 1995 the annual distribution amount will equal 103 percent of the prior year annual distribution amount.
  • PLR 199943050 - Absent appropriate language permitting annual cost of living adjustments at the time of the initial substantially equal periodic payment, the recalculation of the annual distribution amount to include a 4% cost of living adjustment, and a one-time catch-up payment, would be a modification of the distributions that would trigger the premature distribution penalty.

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< Q. Can distributions be made monthly?

A. While payments must be made at least annually, several letter rulings address the subject of monthly payments.

  • PLR 8919072 - The annual distribution amount was distributed as 12 equal monthly payments.
  • PLR 9050030 - The distributions were calculated as monthly distributions using a monthly compounding rate. In this ruling the remaining life expectancy was was converted to months by converting the fractional life expectancy to the nearest whole month.
  • PLR 200105066 - The annual distribution was divided by 12 with the first payment to be made in July - only six payments were made in year 1 with the second annual payment calculated in January of the following year.

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Q. Which Mortality Tables can be used?

A. SEPP plans adopted after 12/31/2002 must use the Annuity 2003 table published by the IRS and used in both the final Minimum Distribution regulations and Revenue Ruling 2002-62.

Plans adopted prior to 01/01/2003 had much more flexibility. Notice 89-25 used the term "reasonable mortality table" in outlining the third alternative used in the description of substantially equal payments. In its calculations, the IRS used the UP-1984 table. The 1983(a) tables is used to determine life expectancies in methods number one and number two so it should also be usable in method number three. Recently the IRS replaced the 80CSMT table with the 90CM table which should also be considered reasonable. Under 20002-62, only the Annuity 2003 Table may be used.

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Q. Once started, how long must I continue the plan?

A. Once started, these payments must continue for the longer of five payment years (from the date of the first distribution) or until age 59-1/2. So, if you retire at age 52, you would have to continue the payments until at least age 59-1/2 before you could change them. If you did this, you would pay ordinary income tax on the distributions, but no 10 percent penalty. If you are age 55 to age 59 when payments begin, you must continue for the full five years even though you have reached age 59.5 in less than 5 years.

Once you've met the five-year or age 59-1/2 point, you can change the distribution pattern, even stopping distributions altogether until you reach 70-1/2 when the Minimum Distribution Rules apply.

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Q. What if I run out of money?

A. Note, 2002-62 allows plans that run out of funds to NOT incur the 10% penalty tax. Revenue Ruling 2002-62, 2.03(a) states... "If, as a result of following an acceptable method of determining substantially equal periodic payments, an individual's assets in an individual account plan or an IRA are exhausted, the individual will not be subject to additional income tax under 72(t)(1) as a result of not receiving substantially equal periodic payments and the resulting cessation of payments will not be treated as a modification of the series of payments."<

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Q. If I get divorced and transfer a portion of the payments to my ex-spouse, will I loose the exemption from the 10% penalty tax?

A. The transfer to a taxpayer’s spouse pursuant to a divorce decree of 50% of each of three separate IRAs owned by the taxpayer from which the taxpayer had already begun receiving “substantially equal periodic payments” did not result in a modification where the taxpayer’s spouse was two years younger and would commence receiving similar payments such that the total of periodic payments to the taxpayer and his spouse subsequent to the division would be substantially equal to the periodic payments received by the taxpayer prior to the division. PLR 9739044

In PLR 200027060, the IRS rules that a spouse after the divorce, that received a portion of the client's IRA accounts that were being used to fund a SEPP, didn't need to continue the payments since it was a transfer under Code section 408(d)(6). What about the client - did all the payments have to be continued out of what remained of his accounts?

Later in PLR 200050046 (with similar facts) the IRS ruled in favor of the taxpayer. "The reduction in the annual distribution from IRA 1 to Taxpayer A beginning in calendar year 2001, prior to Taxpayer A's attaining age 59 1/2 , and assuming Taxpayer A has not died and has not become permanently disabled, will not constitute a subsequent modification in his series of periodic payments, as the term "subsequent modification" is used in Code section 72(t)(4), and will not result in the imposition upon Taxpayer A of the 10 percent additional income tax imposed by Code section 72(t)(1) pursuant to Code section 72(t)(4)(A)(ii).

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Q. Once started, can I change the payment?

A. Revenue Ruling 2002-62, 2.03(b) allows a one time change to the Minimum Distribution method if the current plan was based on either the Amortization or Annuitization methods. Other than the change above, once you begin withdrawing assets using SEPP, you may face retroactive penalties and interest if you change the conditions for taking payments.

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Q. Can I recalculate my Life Expectancy using the Amortization or Annuity Methods?

A. Since Revenue Ruling 2002-62 was initially released, there have been (as of 05/13/05) three PLRs that have allowed for recalculation option. See the PLRs of Interest page.

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Q. What if I die or become disabled?

A. If you die after you begin receiving payments, the proceeds of your retirement plan will be exempt from the 10% penalty tax and retroactive interest . Your beneficiary will receive your retirement assets penalty-free and will not be required to continue with the plan. In addition , if you become permanently disabled before you satisfy plan requirements, the penalty tax and the retroactive interest provision do not apply.

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Q. How are my non-deductible contributions treated?

A. If you have made non-deductible contributions, a portion of each payment will be received income tax-free as a return of contributions. All interest earned, even interest earned on non-deductible contributions will be subject to tax.

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Q. What is a Private Letter Ruling?

A. If you feel that your circumstances warrant prior approval from the IRS - for example, you plan to calculate your payments and use a cost of living index - you may want to obtain a private letter ruling from the IRS before you take a distribution.

A private letter ruling is an IRS response to a taxpayer’s formal request for an opinion on the taxpayer’s situation. The IRS charges a fee for each such ruling. Although many tax experts rely on these rulings to broadly interpret the position of the IRS on various issues, each ruling applies only to the taxpayer actually requesting it .

For 2002, the procedure on obtaining a private letter ruling from the IRS, you can consult Revenue Procedure 2002-1 (pages 125+), for the steps to follow and pages 56+ and Appendix A for User Fees. The procedure is usually contained in the first Internal Revenue Bulletin issued each year.

Remember, if you want to be 100% sure you'll survive an IRS audit on your SEPP, get your own private letter ruling. A professional tax or financial adviser can also help you obtain a private letter ruling.

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Q. What is the Definition of Disability for 72(t)??
A. The definition of disability can be found in IRC Section 72(m)(7). In one case,Dwyer v. Comm., 106 TC No. 18 (1996), the Tax Court agreed with the IRS and stated...

For purposes of this rule, an individual is considered disabled if "he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and infinite duration." The Code specifies that an individual must be able to furnish proof of his disability in whatever form and manner that the Service may require. The court noted that the regulations under Section 72 also state that an impairment that is remediable does not constitute a disability.

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Q. Can I vary the plan payments by my account balance?

A. 2002-62 Only allows recalculation of the account balance under the Minimum Distribution method.

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Q. Assuming the 5-Year rule, when can payments be modified?

A. In 1998, a tax court held that a payment received by a taxpayer after he received five equal annual installments and after he reached age 59-1/2 was a modification of the Substantially Equal Periodic Payments.

The Court held that the modification occurred within the 5-year period beginning with the first payment, thus triggering the recapture of the 10-percent penalty tax. The Service argued that the 5-year period began with the first distribution and ran until the end of the 5th year. The tax court agreed - the 5-year period closes at the end of the 5 years beginning with the first distribution, and does not end on the date of the 5th annual distribution.

Arnold v. Comm., 111 TC No. 12 (1998).

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Q. Are your Calculators Accurate?

A. Yes, but don’t just take our word for it. IRS Notice 89-25 describes three methods in which payments will be considered to be substantially equal periodic payments:

  • The life expectancy method - calculated under the minimum distribution rules.
  • The amortization method - amortize account balance using life expectancies and a reasonable interest rate.
  • The annuity method - account balance divided by an annuity factor using both a reasonable mortality table and interest rate.

Don't just accept the results of any calculator - check them out to see if they match the results that the IRS produced. From 89-25: Male Age 50, 8% Interest & UP1984 Mortality.

  • Life Expectancy: 33.1 years
  • Amortized Payment: $8,679
  • Annuity Payment: $9,002

From 2002-62 FAQ: Male Age 50, 4.5% Interest, $400,000 IRA.

  • Life Expectancy: 34.2 years
  • Minimum Distribution: $11,695.91
  • Amortized Payment: $23,134.27
  • Annuity Payment: $22906.68

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Q. What about IRC Section 72(q) for Non-Qualified Tax-Deferred Annuities?

A. On March 1, 2004 in Internal Revenue Bulletin: 2004-9, Notice 2004-15. The IRS appears to have extended Revenue Ruling 2002-62 to non-qualified annuities. If correct, the flexibility of 89-25 and the various PLRs leading up to Revenue Ruling 2002-62 are now gone - for all plans. For additional details, see the Discussion Post 'IRS Helps Again'.

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Q. I have been searching for a definition of what exactly is the "federal mid-term rate" Can you tell me where this interest rate comes from?

A. Each month the IRS posts a table of Applicable Federal Rates for the next month. When the actual for calculating these rates seems to be known only to the IRS, you can get a general feeling of where the mid-term rates are going by watch the 5-Year Treasury Note. Also check out the page on this website that deals with estimated interest rates.

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Q. What is the impact of Internal Revenue Bulletin: 2004-9, Notice 2004-15 on Non-Qualified Tax-Deferred Annuities?

A. On March 1, 2004 in Internal Revenue Bulletin: 2004-9, Notice 2004-15. The IRS appears to have extended Revenue Ruling 2002-62 to non-qualified annuities. If correct, the flexibility of 89-25 and the various PLRs leading up to Revenue Ruling 2002-62 are now gone - for all plans. The following segments were extracted from the Notice...

"The IRS and Treasury believe that because these provisions were enacted for the same purpose it is appropriate to apply the same methods to determine whether a distribution is part of a series of substantially equal periodic payments. Therefore, taxpayers may use one of the methods set forth in Notice 89-25, as modified by Revenue Ruling 2002-62, to determine whether a distribution from a non-qualified annuity contract is part of a series of substantially equal periodic payments under § 72(q)(2)(D).

First, an individual is not subject to the § 72(t)(1) additional tax if (i) the payments are not substantially equal because the assets in the individuals account plan or IRA are exhausted, and (ii) the individual followed one of the prescribed methods of determining whether payments are substantially equal periodic payments. See Rev. Raul. 2002-62 § 2.03(a).

Second, an individual who begins receiving distributions in a year using either the fixed amortization or fixed Annuitization method may switch to the minimum distribution method for the year of the switch, and all subsequent years, and the change will not be treated as a modification within the meaning of § 72(t)(4). Any subsequent change, however, will be a modification for purposes of § 72(t)(4). See Revenue Ruling 2002-62 § 2.03(b).

The IRS and Treasury believe that, when the provisions of § 72 are intended to address different concerns with respect to the treatment of qualified and non-qualified annuities, it is appropriate to apply those provisions in a different manner. However, if the provisions of § 72 are designed to achieve the same purpose whether or not the annuity is qualified or non-qualified, it is appropriate to apply that provision in the same manner to both qualified and non-qualified annuities."

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Q. Is withholding mandatory??

A.The response to this question was taken from a few posts in our discussion forum.

A tax bill passed in 1993 created a 20% mandatory withholding for rollover distributions from qualified plans paid directly to plan participants. The idea was for the Government to get a "free loan" from those who DID NOT use the "trustee-to-trustee transfer" method to rollover their plans to an IRA. So for those who said, "Send me the money so I can spend it or stick it in the bank," the 20% withholding applies.

Always check with your Plan Administrator.

The reason you should check with your Plan Administrator hinges on whether the plan acknowledges your SEPP plan. If they recognize the plan, there should be no mandatory withholding because the mandatory 20% withholding only applies to Eligible Rollover Distributions. A SEPP distribution is not rollover eligible and therefore the mandatory withholding should not apply. You could however, request optional withholding.

But the main point is that the plan may not recognize your SEPP just as IRA custodians are currently electing to do, and if they do not recognize it, then they will apply the withholding.

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Q. Does anyone know of any actual cases where someone accidentally broke their 72t and were caught by the IRS? What were the actual penalty percentages? Do they ever give someone a break and let them fix it if possible? Do they ever waive the penalties and interest? If someone was taking 72t withdrawals for 7 years and then switched to the MD method and calculated wrong and withdrew $100 too much would the IRS actually charge $100,000 if that was what the interest and penalties would come to?

A. When all the dust settles, the IRS must impose IRC §72(t)(1)&(4) --- essentially the code sections that impose the 10% surtax plus interest; e.g. the IRC can not "give some one a break". Therefore, determining that a SEPP plan is busted can itself be difficult to determine; however, financial records have a tendency to speak for themselves.

Therefore, when the determination is made that a SEPP plan was/is busted, the IRS always imposes the 10% surtax plus interest without exception. These penalties & interest are never waived and the amounts are not negotiable or subject to compromise.

If the taxpayer discloses on their return that their SEPP plan is busted then it is a straight math exercise of computing the penalties and interest. The interest rates have recently ranged from a high of 8% to as low as 4% depending the periods of time involved.

If the taxpayer does not disclose that their SEPP plan is busted and the issue is uncovered during an audit, then all of the above applies plus "substantial underpayment penalties" and "fraudulent return penalties" which can add an additional 20% to 50% on top.

All of these amounts are tallied up in a deficiency notice from the IRS. If, after 90 days, the taxpayer can not or refuses to pay these amounts the IRS commences "levy & attachment" proceedings; e.g. they come at you are start taking your other assets. In short, the IRS does not offer any leniency in this process because the law does not permit it.

The above is why SEPP plans can be considered dangerous. They are executory for years; as few as 5 and as long as 15 or so. Inadvertent errors can occur & it is the taxpayer's responsibility to be continually checking to make sure that everything is done exactly as it should be. Unfortunately, when an error does occur, the financial advisers, brokers, custodians and trustees all have a tendency to run for cover leaving the taxpayer more or less standing naked in front of the IRS.

Posted to the Discussion area on 12/16/2005 by the Badger in response to a Question from Mike.

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Q. What is the maximum interest rate that can be used?

A. Revenue Ruling 2002-62 and Qualified SEPP Plans post 12/31/2002: The interest rate that may be used is any interest rate that is not more than 120 percent of the federal mid-term rate for either of the two months immediately preceding the month in which the distribution begins.

The Estimate that appears in the graph and in the table below is merely our estimated interest rate based on the formulas currently in use on this site to try and estimate the next published 120% Mid-Term rate. We include the column only so that previous estimates can be viewed relative to the actual published rate. Our estimate for next month is available at HERE .

Q. How do I report a broken SEPP (2009 Tax Year)?

A. Start with IRS Form 8606 - if it doesn't apply (no non-deductible contributions), don't use it.

Then go to Publication 590 (as directed by the instructions for 8606) to the section "Is it Taxable?".

I'll save you a little time - go to page 50, top right...'Recapture tax for changes in distribution method under equal payment exception.'

Then follow the instructions in Publication 590 to use IRS Form 5329 and report the transaction on IRS Form 5329.  'Report the recapture tax and interest on line 4 of Form 5329. Attach an explanation to the form. Do not write the explanation next to the line or enter any amount for the recapture on lines 1 or 3 of the form'.

The instructions for line 4 of 5329 state to report it on IRS Form 1040, line 58 or IRS Form 1040NR, line 54.

It is never simple and the instructions are seldom in one place. Good Luck!

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Q. If the 10% penalty is $2000, can your tax be lower than $2000 if you had enough deductions??

A. When you prepare your tax return, the federal income tax is based upon your taxable income, which is your income minus stadard or itemized deductions and minus personal exemptions.

After that tax is calculated, you add the 10% penalty ( which is 10% of the "early distributions" themselves, not 10% of the income tax).

If you would otherwise have had a tax due of $ 1,000 ( i.e. tax of $ 5,000 - estimated taxes and witholdings), and there was a $ 2,000 penalty ( 10% of $ 20,000 early distributions), then you would owe $ 3,000. On the other hand, if you were due a refund of $ 3,000 then this $ 2,000 penalty would be offset, and you would get only a $ 1,000 refund.

The answer is a post made by Dlz in response to a question in the discussion forum.

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