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Facts About the 72t Early Distribution

Feb 1st, 2012
by jblankenship.
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Ossekeag Creek Marsh
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In case you don’t know what a 72t distribution is, this is shorthand for the Internal Revenue Code Section 72 part t, and the most popular provision of this code section is known as a Series of Substantially Equal  Periodic Payments – SOSEPP for short.

Enough about the code section already.  What is this thing?  A SOSEPP is a method by which you can access your IRA funds prior to age 59½.  In order to take advantage of this rule, you determine the amount of the annual distribution from your IRA (this is done in a prescribed manner, more on this in a bit) and then begin taking the distributions.  Once you start the SOSEPP, you have to keep it going for the longer of five years or until you reach age 59½.

Methods of Distribution

There are three ways that you can determine the amount of the distribution from your IRA, and all are based upon the balance of the IRA account and your age.  The first method is the simplest, known as the Required Minimum Distribution method.

The Required Minimum Distribution method for calculating your Series of Substantially Equal Periodic Payments (under IRC §72(t)(2)(A)(iv)) calculates the specific amount that you must withdraw from your IRA (or other retirement plan) each year, based upon your account balance at the end of the previous year, divided by the life expectancy factor from either the Single Life Expectancy table, the Uniform Lifetime table, or the Joint Life and Last Survivor Expectancy table, using the age(s) you have reached (or will reach) for that year. This annual amount will be different each year.

The second method is called the Fixed Amortization Method.  Calculating your annual payment under this method requires you to have the balance of your IRA account, from which you then create an amortization schedule over a specified number of years equal to your life expectancy factor from either the Single Life Expectancy table, the Uniform Lifetime table, or the Joint Life and Last Survivor Expectancy table, using the age(s) you have reached (or will reach) for that year, coupled with a rate of interest of your choice that is not more than 120% of the federal mid-term rate published by regularly the IRS in an Internal Revenue Bulletin (IRB).

The third method is similar to the second, but it is called the Fixed Annuitization Method.  Calculating your annual payment under this method requires you to have the balance of your IRA account and an annuity factor, which is found in Appendix B of Rev. Ruling 2002-62 using the age you have reached (or will reach) for that year, coupled with a rate of interest of your choice that is not more than 120% of the federal mid-term rate published by regularly the IRS in an Internal Revenue Bulletin (IRB).

Once you’ve calculated your annual payment under one of the two fixed methods, your future payments will be exactly the same until the SOSEPP is no longer in effect. There is a one-time opportunity to change to the Required Minimum Distribution method, described here.

An Important Note

It’s important to know that the amounts you’ve calculated are and will be the exact figures for your payments from the account, no more, no less.  It’s not allowable to simply name your own amount and take that each year – you have to use the prescribed amount from one of the methods.

The way to impact the amount of the payment is to adjust the balance in the IRA.  If you have more than one IRA available, you can rollover funds into one account and therefore increase or decrease your payment.  This has to be done prior to establishing the SOSEPP though – it’s not allowed to deposit money into or remove funds from your IRA while the SOSEPP is in place (well, other than the required payments from the account each year).

Any deviation from the prescribed payments will cause the SOSEPP to be “busted”, which can result in some not-so-nice consequences – which you can read more about here.  For more about the SOSEPP, see the IRA Owner’s Manual.

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When to File For Social Security Benefits

Jan 27th, 2012
by jblankenship.
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Four different machine filesImage via Wikipedia

All future Social Security recipients face this question at some point:  When should I file for benefits?

As you are likely aware, age 62 is the earliest that you can file for benefits.  By filing at this age, you will begin receiving your benefit at a reduced amount – perhaps as much as 30% reduced.

Waiting to file until your Full Retirement Age (FRA) will allow you to receive the full benefit amount, without reductions.  You could also wait until age 70 to file for benefits, which would result in an overall increase to your monthly benefit amount, by as much as 32% in some cases.  Granted, you will have foregone several years’ worth of payments if you wait to file at some age later than 62, but on average, it all works out about the same (with a few exceptions).

The way that these reductions and increases are designed is to ensure that, on average, all Social Security recipients, regardless of the age that they begin receiving benefits, ultimately receive roughly the same amount of benefits during their lifetimes.  This is all calculated by actuaries, and it involves the population’s average lifespan.

So if you start receiving your benefit earlier, even though it’s reduced you’re receiving it for a longer period of time than waiting until later.  On the other hand, if you delay filing until FRA or age 70, your benefit is greater each month, but you’ll be receiving it for a shorter period of time.  Eventually these strategies “cross over” – that is, one method begins to work more in your favor than another – at around age 82.

What I mean by that is that, filing earlier at the reduced rate will pay you more in overall benefits up to age 82, at which point the later filing ages will begin paying you more over your lifetime.  If you take into account the annual cost-of-living adjustments (COLAs), the break-even point is actually quite a bit lower, possibly as early as age 76.  This is due to the fact that the COLA is a percentage applied to your monthly benefit – and if your monthly benefit is reduced by filing early, your COLA adjustments will be smaller as well, and vice versa when you file later.

So if you plan to live past age 76, it most likely is in your best interest to wait until the latest point to file for your benefit.  And if you need more reasons to consider delayed application, read on.

Survivor Benefits

One additional reason that you might want to delay applying for your benefit is if you have family members that will depend upon your benefit upon your passing.  This is due to the fact that your survivors’ benefits are based upon the actual benefit that you were receiving at your death.  So, if you delayed filing for benefits and therefore received a higher benefit amount, your surviving spouse (and other family members, if eligible) will receive a higher benefit amount for the remainder of his or her life, assuming that the Survivor Benefit is greater.

This gives you another reason that delaying benefits could be the better option.  Otherwise, if your benefit is the same as or smaller than your spouse’s benefit, or if you don’t have a spouse, then it’s up to you: if you think you’ll outlive the average, it’s better to wait.  If you don’t think you’ll live that long, then start as early as you like.

* The above review doesn’t take into account a situation where you may still be working while receiving Social Security retirement benefits.  I’ll cover that in another article.

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The Post-55 Exception to the 10% Penalty for Withdrawals from 401(k)

Dec 7th, 2011
by jblankenship.
3 comments
55
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Most of the time, when taking a distribution from a 401(k) or other Qualified Retirement Plan (QRP) prior to age 59½, there generally is a 10% penalty that applies.  That is, unless one of the exceptions applies – hardship primarily, although there are others.

If you happen to be over age 55 when you leave employment, there is another exception that applies.  Any distribution that you take from the QRP, as long as you were at least 55 years of age when you left employment, will not be subjected to the 10% penalty, only ordinary income tax.

This provision only applies to QRPs, not to IRAs.  So if you’re leaving employment at or after age 55 but before reaching 59½, it can be in your best interest to not rollover your QRP to an IRA, at least until after you reach 59½.  Even if you don’t need the money right away, it could be beneficial to have the source of funds available penalty-free.

For retiring police, firefighters and medics, the age for this exception is 50 – so these folks can take distributions from their QRPs after age 50 if they’ve left employment without penalty.

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How PIA Relates to Your Benefit

Aug 26th, 2011
by jblankenship.
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Related
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If you’ve been looking into your Social Security projected benefits for long, you’ve probably run across the term Primary Insurance Amount, or PIA.  Click on the link to see how the PIA is calculated if you need more background information on the PIA.

What’s important to know is that the PIA is essentially the amount of your retirement benefit if you file for it exactly on your Full Retirement Age (FRA) month.  But hardly anyone files for retirement benefits in exactly the month that you reach FRA.  If you file for your retirement benefit before or after FRA, even by a month, there is a difference between your PIA what your benefit will be.

Before FRA

If you file for benefits before the month when you reach FRA, there are two factors that apply to your benefit, reducing it from the PIA amount.  The reason there are two factors is because the more recent 36 months (closest to your FRA) are valued at a rate of 5/9 of a percent, or roughly .5556%.  For up to 24 months prior to the more recent 36 months, the value is 5/12 of a percent, or .4167%.

Wow, that’s not complicated at all, is it?  Geez.  Here’s a formula that you can use to help you calculate the reduction for your benefit before FRA:

1.  Enter your Full Retirement Age, years and months:
2.  Enter the age you plan to file for benefits, years and months:
3.  Subtract line 2 from line 1 in months only
4.  Subtract 36 from line 3 (if less than zero, enter zero)
5.  If line 4 is zero, skip to line 7; otherwise, multiply line 4 by .004167
6.  If line 4 is zero, multiply line 3 by .005556; otherwise, enter .2
7.  Add line 6 to line 5
8.  Subtract line 7 from 1.0000
9.  Multiply line 8 by your PIA.  This is your reduced benefit amount.

Let’s run an example.  An individual born in 1955, so his FRA is 66 years and 2 months.  His PIA is $2,000, and he intends to file for benefits at age 64 years and 6 months.

1.  Enter your Full Retirement Age, years and months:

66y 2m
2.  Enter the age you plan to file for benefits, years and months:

64y 6m
3.  Subtract line 2 from line 1 in months only

20
4.  Subtract 36 from line 3 (if less than zero, enter zero)

0
5.  If line 4 is zero, skip to line 7; otherwise, multiply line 4 by .004167

6.  If line 4 is zero, multiply line 3 by .005556; otherwise, enter .2

.11112
7.  Add line 6 to line 5

.11112
8.  Subtract line 7 from 1.0000

.88888
9.  Multiply line 8 by your PIA.  This is your reduced benefit amount.

$1,777.76

Now let’s adjust the example so that it uses the additional factor.  Same individual as above, but now he plans to retire at age 62 years and 8 months.

 

1.  Enter your Full Retirement Age, years and months:

66y 2m
2.  Enter the age you plan to file for benefits, years and months:

62y 8m
3.  Subtract line 2 from line 1 in months only

40
4.  Subtract 36 from line 3 (if less than zero, enter zero)

4
5.  If line 4 is zero, skip to line 7; otherwise, multiply line 4 by .004167

.016668
6.  If line 4 is zero, multiply line 3 by .005556; otherwise, enter .200000

.200000
7.  Add line 6 to line 5

.216668
8.  Subtract line 7 from 1.0000

.783332
9.  Multiply line 8 by your PIA.  This is your reduced benefit amount.

$1,566.66

 

Now let’s look at how applying after FRA works.

After FRA

For every month after FRA that you delay applying, your benefit will grow by a factor.  For folks born in 1943 and later, the factor is 2/3 of a percent, or roughly .6667%.  If you were born in 1941 or 1942 (earlier years don’t matter at this point, you’re already 70), the factor is 15/24 of a percent, or approximately .625%.  These factors equate to 8% per year for those born in 1943 or later, or 7.5% per year for those born earlier.

Here’s a formula to use to help calculate the delay factor and benefit amount for your situation:

 

1.  Enter your Full Retirement Age, years and months:
2.  Enter the age you plan to file for benefits, years and months (if after 70, enter 70y 0m):
3.  Subtract line 1 from line 2 in months only
4.  If your FRA is less than 66, multiply line 3 by .00625; otherwise multiply line 3 by .006667
5.  Add 1.00000 to line 4
6.  Multiply line 5 by your PIA.  This is your increased benefit amount.

 

Let’s run through an example.  The individual from above, with a FRA of 66 years and 2 months, and a PIA of $2,000, decides to file for benefits at the age of 68 years and 6 months.

1.  Enter your Full Retirement Age, years and months:

66y 2m
2.  Enter the age you plan to file for benefits, years and months (if after 70, enter 70y 0m):

68y 6m
3.  Subtract line 1 from line 2 in months only

28
4.  If your FRA is less than 66, multiply line 3 by .00625; otherwise multiply line 3 by .006667

.186676
5.  Add 1.00000 to line 4

1.186676
6.  Multiply line 5 by your PIA.  This is your increased benefit amount.

$2,373.35

 

And that’s it.  Hope this has helped you to better understand how your PIA and your benefit are related.

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The Protective Filing Statement

May 13th, 2011
by jblankenship.
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When planning for your Social Security benefit, there is an additional tactic that you may never have heard of: the Protective Filing Statement.  This statement is a way to apply for benefits without actually applying.

Huh?

At any time after you reach age 62, you can file the Protective Filing Statement (PFS) which will “protect” the date of acceptance as your application date, whenever you choose to apply in the future.  And when you do apply, the PFS date will be considered your filing date – and you’ll get retroactive benefits back to that date.

 

Protective steel mill suit
Image via Wikipedia

 

After the PFS is filed, the SSA will issue a notice indicating that you must file within six months.  This doesn’t mean that you have to file within six months, it just means that, in order to retroactively file as of your protected date, your actual application must have been filed no later than six months after the protected date.

How does this work in practice?  Let say that you reach age 62 in February this year.  You’re actually eligible for benefits in March, since you weren’t 62 for the entire month of February… so you file a PFS in March.  You’re not ready to collect benefits, but you want to protect your date.  Then in July your company “reorganizes” (we all know that really just means layoffs).  Instead of seeking other work, you decide to just go ahead and retire.  When you file your application for Social Security benefits in August, your actual filing date can be retroactive to March, since you filed a PFS.

If your income for the year was low enough, you might go ahead and take the retroactive benefits – but the key here is that without the PFS you would forego those benefits altogether.  It’s for this purpose that it makes sense to file a PFS from time to time if you’re delaying receipt of benefits sometime after age 62.

How to do it

There’s nothing magical about the PFS – it’s simply a statement you’ve made to the SSA indicating that you’re intending to file at some point in the future.  You don’t have to set a date, you just need to indicate that you’re intending to file.  Here are the requirements:

  • Must be in writing
  • Must indicate an intention to claim in the future
  • Must be signed by the applicant
  • Must be submitted to your local district office

And that’s it.  A few words of caution are in order:  Keep a date-stamped copy of your PFS.  If you hand-deliver the statement (recommended) to the district office, ask the representative to photocopy the statement and date-stamp your copy.  Occasionally these get lost, and without a copy of your statement, it will be impossible to prove that you submitted it.

If mailing the statement, make a copy beforehand, and then send the statement by registered or certified mail.  This way you’ll have evidence of delivery.

It’s also important to note the six month limit for the PFS.  After six months has passed, the PFS is no longer in effect, and if you apply at that stage, unless you’ve file a subsequent PFS, the date of your application is your filing date, with no retroactivity.

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