If you or someone you know has inherited an IRA from a spouse, you have several options available to you.  You can leave the IRA where it is and treat the IRA as if the original owner is still alive; you could transfer the IRA to an inherited IRA, properly titled, and begin taking RMDs based upon your own age; or you can transfer the IRA to an IRA titled in your own name and treat the IRA as your own.  Each option has merit, you just need to determine which is best for you.

Leave it where it is

If you do nothing and leave the IRA in your late spouse’s name, you can delay having to take Required Minimum Distributions (RMDs) until your late spouse would have been 70½ years of age.  If you’re older than your late spouse, this could result in a delayed start of RMDs.  If you’re younger, and you wish to delay receiving benefits, you might want to look at one of the other options.

Take the IRA as an inherited IRA

If you transfer the IRA to an inherited IRA, you can immediately begin taking RMDs based upon your own age, using IRS Table I.  This will allow you to stretch out the payments you would receive from the IRA over your lifetime, without penalty.  If you have need for some of the funds now but wish to defer withdrawal over a longer period of time.

Take the IRA as your own

If you decide to make the IRA your own, you can treat the IRA exactly as if it were your own:  you can make contributions to it, rollover other eligible funds into it, or convert it to a Roth IRA.  In this case, you can delay the time to start taking RMDs until you reach age 70½ – so if you are younger than your late spouse was, this method allows you to delay RMDs the longest.

In this method, any withdrawals that you take before age 59½ could be subject to the 10% early withdrawal penalty, unless you meet one of the exceptions.  On the other hand, this method is one that has no time limit.  You can transfer the IRA to an account in your own name at any time, even if you’ve taken some distributions from the originally-titled account.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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I didn’t break it, but the dog got ‘hold of it and now it’s leaking. (I’m kidding… See what I did there?)

If you don’t know what a SOSEPP is, that’s okay – chances are if you don’t know what it is, you don’t have one.  SOSEPP stands for Series Of Substantially Equal Periodic Payments, and it’s a method that you can use that allows you to take a series of distributions from your IRA prior to age 59½ without being subject to the 10% early withdrawal penalty.

The SOSEPP is a very complicated avenue to travel, and there are some specific restrictions that you need to follow.  One of the restrictions is that you absolutely must maintain the “equality” of payments you’re taking from the IRA. If you increase or decrease the payments, you have “broken” the SOSEPP.

There is no specific provision in the Internal Revenue Code for relief from the penalty if you have broken your SOSEPP.  On the other hand, the IRS has in some cases granted relief in several private letter rulings by determining that a change in the series of payments did not materially modify the series for purposes of the rules.

If the series is broken due to an error by an advisor (for example), some prior PLRs have been issued in favor of the taxpayer.  PLR 201051025 and PLR 200503036 each address the situation of an advisor making an error and the distributions were allowed to be made up in the subsequent year.  Bear in mind that PLRs are not valid for any other circumstances other than the specific one in the ruling, and cannot be used to establish precedence for subsequent cases.

But in reality, the likelihood of your getting a favorable PLR for your case of a broken SOSEPP is small – unfortunately, breaking the series usually results in application of the penalty for previous payments received, and the SOSEPP is eliminated.  If you wish to restart the series you can do so, but you are starting with a new five-year calendar (the series must exist for at least five years, or until you reach age 59½, whichever is later).

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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As you know (if you’re read the article about Penalties for Changing SOSEPP) it can be costly to you if you make a change to your SOSEPP once you’ve set it up.  The good news is that a Roth Conversion is NOT considered a “distribution for purposes of determining whether a modification”, and therefore in itself will not trigger a loss of the penalty-exempt status of the SOSEPP.

What does happen then, in such a circumstance?  Well, that’s when things go into the “it depends” category, followed closely by a whole lotta “no guidance from the IRS”.

If you have converted the entire balance of your IRA that is subject to the SOSEPP to a Roth IRA, you will be required to continue taking your series of payments from the new Roth IRA just the same as if they were still coming from the traditional IRA.  If you don’t, you will most likely be subjected to recapture of the penalties on the earlier SOSEPP distributions, unless you’ve reached the end of the distribution requirement period – five years or age 59½, whichever is later.

On the other hand, if you’ve only converted a portion of the traditional IRA to a Roth IRA, this is where it gets murky.  The IRS has not provided definitive guidelines on exactly how you handle the SOSEPP from here… it is abundantly clear that you must continue your series of periodic payments until the end of the distribution period.  What’s not clear is if you must continue taking the payments from the remainder of the traditional IRA, or from the Roth IRA, or proportionately from both accounts, or in any amounts you choose from either account, as long as the amount is proper to fit the bounds of your SOSEPP.

The best way to deal with this situation would be to convert the entire account if that’s feasible.  If it’s just not feasible, then you should ask for a Private Letter Ruling from the IRS – especially if we’re talking about sizeable amounts (you be the judge).  If the possible tax and penalty is relatively minor, I’d suggest taking proportionate amounts from the trad and Roth IRAs until the SOSEPP distribution requirement period ends.  Make sure that you keep documentation on all of these transactions – you’ll need it if the IRS comes a-callin’.

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However, in some cases your old 401(k) plan may have access to desirable investments that you couldn’t otherwise access, or possibly you have access to other benefits from participation, such as availability of a financial advisor.  As long as the overall costs remain low in the plan, you might want to leave the funds there.  Plus there are also some additional benefits inherent within 401(k) accounts that are not available to IRAs – you can read up on the reasons to leave your money in the 401(k) in the article Not So Fast! 9 Special Considerations Before Rolling Over Your 401(k).

On the flip side, there are certain things that you can’t do in a 401(k) (or other Qualified Retirement Plan) that you can ONLY do with an IRA while you’re under age 59½.

IRA-Only Options

With an IRA, there is no penalty for withdrawal for (click the link following each for more detail):

• Health Insurance Premiums while unemployed – §72(t)(2)(D)
• Qualified Higher Education Expenses – §72(t)(2)(E)
• Qualified First-Time Homebuyer Expenses – §72(t)(2)(F)
• Qualified Reservist Distributions – §72(t)(2)(G)

And none of those are available without penalty from your 401(k).  Of course you would have to pay tax on the distribution, but otherwise you can take the money for those purposes.

In addition, setting up a Series of Substantially Equal Periodic Payments (SOSEPP) is generally easier to qualify for and to set up from an IRA than from a 401(k), so this may be an additional reason to consider rolling over.

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On the other hand, as a surviving spouse you also have the option of moving the funds from the original account into an account in your own name – which will usually produce better distribution options at your passing, or at least giving you the flexibility to improve the distribution options.  The problem with this move is that once you have moved the funds into your own account, the exception to the 10% penalty for early withdrawal no longer applies.  So, unless one of the other 72(t) exceptions applies you can not access the funds in the new, rollover account until you reach age 59½.

How to Deal With the Dilemma

How should you deal with the dilemma?  It depends completely on your specific situation, but below are some strategies you might consider:

If you’re in dire financial straits without access to the IRA, leave it in your late spouse’s account, at least until you reach age 59½, and then rollover the funds into your own account.  Since there is no deadline for this rollover, you have the flexibility to treat the account in this fashion.  If the event of your untimely death before rolling over the account would produce undesirable distribution requirements, you can address this by purchasing term life insurance with account proceeds, timing the insurance to expire upon your rollover.

If you’re well-to-do (okay, comfortable, or even rich) or in ill health, you should not delay in rolling over the funds into your own account.  This is because when you’ve made this move, you can be in control of the disposition of the account upon your death.  If for some reason you later need to access the funds in the account and you’re still under age 59½, you can either set up a Series of Substantially Equal Periodic Payments (SOSEPP) unless one of the other 72(t) exceptions applies.

What If the Account Requires Lump-Sum Distribution?

If there is a reason to leave the funds in the deceased spouse’s account but the account provisions require that you take a lump sum distribution immediately, you can roll over the account to an Inherited IRA, maintaining the original owner’s name, essentially acting as if you are a non-spouse beneficiary.  This will give you the freedom to begin taking distributions (these are Required Minimum Distributions, RMDs) from the account, without penalty.  Then you can later rollover the funds into your own account at a later date when you no longer need the distributions or you reach age 59½.  This provides you with the option of receiving distributions in smaller amounts and protecting the tax-deferred status as long as possible – in spite of the provision from the original account that required lump-sum distribution.

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Steps to Set Up a SOSEPP

The first step in setting up a SOSEPP is to figure out just how much you’ll need to take each year.  In the best of all circumstances, your SOSEPP plan will take small enough payments that it will not exhaust your IRA funds… Working with a financial advisor or an actuary, you can figure out how much money is required to support the SOSEPP payments that you require.

Once an amount is determined, a new IRA can be opened and the money required rolled over into that account.  Other IRAs and 401(k) accounts will then hold the remainder of your funds – which provides your savings for future needs, once the SOSEPP is no longer in effect, or a “safety valve” for you to use in the event that you need additional funds at some point.  Of course, taking an additional amount from one of these other accounts would require payment of the 10% penalty (unless one of the other exceptions applies) – but this is much better than taking too much from your SOSEPP IRA and busting the plan, which carries some heavy penalties.

Keep in mind, especially if you’re setting up your SOSEPP early in your life, it will be possible to set up another SOSEPP from a different account should the need arise.  You would just have two series’ going on at the same time, with different variables impacting each series.

In other cases, you may just want to take the greatest possible payment that you can from your collective plans, which can be easily determined when the span of the plan is understood, given your age and the amount in the IRAs.

Several choices are necessary to set up the plan:

• Choose one of the three permitted methods – RMD, amortization, or annuitization
• Choose a life expectancy table – single, joint, or uniform life expectancy
• Choose an interest rate (if using amortization or annuitization)
• Decide whether to use annual recalculation (if using amortization or annuitization)
• Choose the account balance valuation date
• Determine the “period” for your payments.  These can be monthly, quarterly or annually, but must at least be annual, and must be at the same regular interval each “period” once set up.

All of these details must be attended to when setting up the plan, and careful attention should be paid when making these decisions.  If you set up such a plan early in your life (say at age 50 or earlier) you will have to live with your choices for a considerable amount of time.  Understand what each choice means and can mean in the future as you make these decisions.

For more information on the SOSEPP – including all of the methods, the life expectancy tables, and all of the other details, see the IRA Owner’s Manual.

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What Happens When Your IRA Will No Longer Support Your SOSEPP?

Here’s an example:  You’ve set up a SOSEPP in your IRA, beginning at age 50.  As we all know (see this post for details) you have to keep the payments going until you reach age 59½.  During that time, many things can happen, both positive and negative.  In this case, the IRA began with a balance of $100,000, and your annual payments are $3,000.  Things go fine for the first few years, although your account doesn’t seem to be growing.  So, you decide to take a leap and invest it all in a wild-eyed fund – some Madoff fellow’s running it.  Then, lo and behold, one morning you wake up and find that your IRA balance has become – $12 total.  You’re age 56, so you have three and a half more years that you are supposed to be taking this regular payment of $3,000 from your account!  What do you do?  You’ve read about the crazy penalties for busting a 72t payout plan – yikes!

Options

Calm down.  Take a breath, it’s really not so bad.  There are several options:  You could rollover funds from another account into the IRA, either from another IRA account or a 401(k).  You could also choose to make your one-time change to your SOSEPP plan.  Or, you could choose to let it die, and go on with your life.  The best option is the last one – it allows you to be as flexible as you can be.

If you chose the first option, it certainly would work – and your SOSEPP would just continue on as originally planned.  But what if you have decided at this stage that you really don’t need that series of payments anyway?  And it’s just a pain in the rear keeping up with the paperwork and remembering to take the payment each year…?

The same holds true for the one-time change to the RMD method.  If you did that, now you’d have to re-calculate your payment each year on a very small balance.  Once again, a pain in the rear – so why not just take the third option?

Let it die

If you go ahead and take the last payment out of your account (the remaining $12) and close the account – your SOSEPP is no longer in effect.  You now have the option of starting a new SOSEPP from another IRA account, or just discontinuing the idea of the 72t payout.  If you chose to start a new plan, you’d have to start over with a new five-year or (since in the example, you’re age 56) for three and a half more years until you reach age 59½.

What’s key to understand in this is that, for SOSEPP’s, the IRS considers each IRA account separately – yeah, I know, for everything else, all IRAs are considered as one.  What can I say?  They don’t want you to get too comfortable and start predicting how they’ll move – just when you think they’re gonna zig?  they zag.  So with that in mind, if one account (the one with the SOSEPP attached) runs dry, there’s no penalty if you just drop it and move on with your life.

That’s literally all there is to it.  No penalty, no muss, no fuss.

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As with most questions put forth to the IRS, there’s more than one answer.  So, here are the answers:  5 or 15.3.  If you’re the bottom-line type, you can quit reading now.

Oh, right:  the answer is 5 years if the IRA owner died prior to his Required Beginning Date (RBD), which is April 1 of the year following the year in which he becomes age 70½, regardless of whether or not a distribution has already been taken.  The answer is 15.3 years if the IRA owner died on or after his RBD.  Okay, now you bottom-liners can go do something else.

The Messy Details

If you’ve stuck around you must be really short on things to do or terribly interested in the nuances of tax law.  In either case, I’m sure we can get together sometime and swap stories of band camp… :-)  Following are the details of these two answers, in reverse order (yeah, that’ll rock your world!).

After RBD

So, first lets review RBD:  an IRA owner’s Required Beginning Date is defined as April 1 of the year following the year in which the IRA owner reaches age 70½.  So, if you turn age 70 on or before June 30 of any particular year, your RBD will be April 1 of the following year.  If you are first able to refer to yourself as a septuagenarian on or after July 1 of any particular year, your RBD will not occur until April 1 of the second calendar year in the future.  For example, if your 70th birthday arrived on July 3, 2009, then you would have an RBD of April 1, 2011.

So, if the owner of an IRA dies after his or her RBD and there is no designated beneficiary for the account, the rules state that the IRA can be paid out to the heirs or estate over the remaining life expectency of the original owner.  At age 71 (which is the youngest age an IRA owner can be during the year of RBD) the life expectency table indicates a life expectency of 16.3 years.  Since the distributions must begin the year after the IRA owner’s passing, the life expectency would be reduced by 1, resulting in a payout period of 15.3 years.  The beneficiary(s) would be determined by an external will, trust, or the courts.

Before RBD

If the IRA owner passed away prior to RBD and there is no designated beneficiary for the account, then the default distribution period is always 5 years.

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If you’re taking a Series of Substantially Equal Periodic Payments (SOSEPP), also known as 72t payments, from an IRA or other plan, you are not allowed to “skip” a payment for 2009.  The reasoning behind this is that your 72t payments are not Required Minimum Distributions (RMD), even though you may be using the RMD calculations to determine the amount of the distribution, and also even though, once begun the distributions are required to continue.

Now, in a different scenario, if you have inherited an IRA and are taking it out over either your life span (or an alternate life span) or the default five-year period, you are allowed to skip your distribution for 2009.  These payments, along with your garden-variety, over age 70½ distributions, are considered to be Required Minimum Distributions, and are specifically exempted for 2009 via the Worker, Retiree, and Employer Recovery Act of 2008.

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It is key to note that, although these exceptions allow the distribution of funds without triggering the 10% penalty, in most cases the account owner would still be liable for the ordinary income tax on distributions.  Consult your tax advisor for additional information.

19 Ways to Withdraw IRA Funds Without Penalty

We’ll start with the obvious:

1. Normal – Begin after age 59½
2.  Before Tax Due – Withdraw annual allowed contributions before the due date of your tax return – an example would be to withdraw your 2008 contributions (and any associated growth) before April 15, 2009.
3.  Excess Contributions – Withdraw excess contributions before the due date of your tax return – if you discovered that you had contributed more than allowed (due to income limits or error) you are allowed to remove the excess and any associated growth before the tax return is due for the year.
4.  Required Minimum Distributions – technically this one is covered by #1 above for most circumstances, but sometimes RMD is required of a person who has inherited an IRA, regardless of age.

Now we’ll move into some of the not-so-obvious methods, starting with SOSEPP.

Series Of Substantially Equal Periodic Payments

This is the classic Section 72(t) method for withdrawing funds without penalty.  Essentially you agree to continue taking the same amount from your IRA for the greater of five years or until you reach age 59½. There are three methods of SOSEPP:

5. Required Minimum Distribution method – uses the IRS RMD table to determine your Equal Payments.
6. Fixed Amortization method – in this method, you calculate your Equal Payment based on one of three life expectancy tables published by the IRS.
7. Fixed Annuitization method – this method uses an annuitization factor published by the IRS to determine your Equal Payments.

Additional Section 72(t) methods for taking distribution from your IRA include:

8. Qualified Higher Education Expenses – you can withdraw your IRA funds to help pay for college
9.  Death – If you die, your beneficiaries are able to take distributions from your IRA without penalty.
10.  Disability – If you are “totally and permanently disabled” by IRS definition, you can take distributions from your IRA without penalty.
11.  High Unreimbursed Medical Expenses – for yourself, your spouse, or your qualified dependent.  If you face these expenses, you are allowed to withdraw a limited amount (the actual expenses minus 7.5% of your AGI) without penalty.
12.  Medical Insurance Premiums – if you’ve lost your job and receive unemployment compensation, you are eligible to withdraw an amount to pay for your medical insurance premiums (with some additional limits).
13.  First-Time Home Purchase – up to $10,000 ($20,000 for a couple) of the costs of buying, building, or re-building a “first home”.  First home is determined if you had no present interest in a main home for two years prior to the purchase.

And lastly, here are a few additional ways that you can withdraw your IRA funds without penalty:

14.  Qualified Reservist – If you were called to duty after September 11, 2001 and serve for at least 6 months, you are allowed to make a withdrawal from your IRA during your active duty period without penalty.
15.  Divorce – although not a particular IRS regulation, multiple Private Letter Rulings have allowed divorced parties to “split” an IRA into two separate IRAs, both with the original restrictions on distribution.
16.  Roth IRA Conversion – when you convert your funds from a Traditional IRA to a Roth IRA, although you pay tax on the distribution, there is no 10% penalty applied.
17.  Rollover – using the 60-day period, you are eligible to have access to your funds without penalty as long as the rollover is completed within 60 days.
18.  Payment to Advisor/Investment Manager – you are allowed to authorize your custodian to pay your Advisor or Investment Manager from your IRA funds any fees for managing your IRA. This includes transaction fees and annual custodian fees.
19. Periodic Temporary “Relief” provisions – from time to time, as the situation merits, Congress will enact special legislation allowing individuals impacted (primarily) by natural disasters to access IRA funds without paying the 10% penalty. One notable example of such a provision was for victims of Hurricane Katrina.

Now, did your list have 25 different ways?  Perhaps I’ve overlooked some… let me know if you have other ways in your list that folks can withdraw IRA funds without penalty. Let me know what you think!

For additional information on most of these methods, see the IRA Owner’s Manual or click the IRA Owner’s Manual link at the top of the page.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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