If you’ve paid much attention to the rules around retirement plans (IRAs, 401(k)s, and others), you’ve probably noticed that there are a couple of rules that refer to ages that include “½”.  So what does this mean??

Well, quite literally, this means 6 months after you reach a certain age.  The two primary ages with “½” included are 59½ and 70½.  So, to be age 59½, means that you reached your 59th birthday six months prior to that date.  Likewise, to be age 70½ means that you reached age 70 six months prior to that date.

These two ages are for different purposes and are (naturally) treated differently.

Age 59½

The rule using age 59½ is for one of the exceptions to the penalty for early withdrawals from your IRA or 401(k) plan: once you’ve reached that age (and not before that age) you can take withdrawals from your IRA or 401(k) plan without limits (401(k) plans may also require a separation from service).

Here is an important point: this rule is specifically applied ONCE YOU REACH AGE 59½, and not before.  In the year that you will reach this age, any withdrawals taken from the account before you reach age 59½ will be subject to the 10% penalty if no other exceptions apply.

Age 70½

The rule using age 70½ is regarding Required Minimum Distributions (RMD), as well as limiting contributions to an IRA.  For RMDs, the requirement is simply that you must begin taking the required distributions for the year in which you’ll reach age 70½.  (You can actually delay the first distribution until April 1 of the following year, but the distribution is based on the year when you reach age 70½.)

Note that this is different from the way the 59½ rule works: it’s simply the year in which you’ll reach age 70½, not the specific date that you reach age 70½.  So if your birthday is between January 1 and June 30, your age 70½ year is the year that you reach 70 years of age.  If your birthday is between July 1 and December 31, your age 70½ year is the year that you’ll be reach 71 years of age.

The same holds true for contributions to an IRA: in the year that you’ll reach 70½, you are not allowed to make contributions, and you are not allowed to make contributions thereafter.

You Don’t Have to Count Days

The good news is that you don’t have to count days.  For the purposes of these rules, the half year is the same date, six months later.  For a birthdate of May 11, the half year is reached on November 11 of that same year.  For odd circumstances, such as August 31, of course you’ve reached the half year on February 31 of the following year.  Actually, I believe the rule is that you reach that milestone on March 3 – I’d use this date if you are in this situation, just to be certain.

You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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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You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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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You can pick up my book, An IRA Owner's Manual, in either the print version or the Kindle version by clicking the links.
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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).

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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IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).