72(t) Plan Exceptions-Avoid IRA, 401(k), TSA, 403(b), 457

10% Withdrawal Penalty-72(t) Payment Plan Methods (RMD, Annuity Factor, Amortization)

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Tax Court Rules on 72(t) Case-72t Exception on Education

Powerpoint slides on a superior retirement planning strategy called Roth IRA on Roids which allows for tax-free distributions, tax-free growth, guaranteed principal and guarateed death benefits.When an investor opens a 72(t) plan, they are not allowed to make any modifications to the plan. However, a recent ruling in the U.S. Tax Court may change the current flexibility IRA owners now have. The Court ruled that a particular 72(t) plan was not modified when the owner of the IRA withdrew additional distributions for education expenses. When the owner did this, the IRS sought a 10% early withdrawal penalty, based on IRA withdrawal rules, but the Court overruled this and ruled in favor of the IRA holder. In the future, this ruling may aid other IRA owners who are in need of funds for specific purposes. As of now, there is no way for us to know if the IRS will follow the Court’s ruling in other cases.

72(t) Plans and 3 Methods: RMD, Annuity Factor, Amortization

If you are younger than 59 1/2, the 72(t) plan can be a huge benefit if you need to access the funds in your IRA without incurring the 10% penalty that is incurred for early withdrawing from the account. If the owner of the IRA knows that they will need to access the money in their IRA account, they can set up a 72(t) payment plan which will eliminate the penalty associated with early withdrawal. A 72(t) plan can be used with an IRA, 401(k), TSA, 403(b) and 457 plans.

There are three methods used by the IRS to determine payment plans for a 72(t). These include the RMD, required distribution method, the annuity factor method and the amortization method. RMS methods are calculated in the same manner as they are if the owner were 70 1/2. Basically, the RMD calculation involves the account balance and the owner’s age. This method produces different amounts of payout each year. The other two methods used will have equal payments. All payments using these three methods are required to continue for a minimum of 5 years, or until the account holder reaches age 59 1/2. As long as the rules are followed, the account owner will not be subject to the 10% penalty.

An important thing to remember is that in order for individuals to qualify for the 10% penalty exception, they cannot change the account balance. They can continue to make distributions that are required but they cannot add funds or take any distributions that will exceed the calculated amount of the 72(t) plan. If the owner of the account is under age 59 1/2, they will be subject to the 10% penalty. They will also incur interest.

72(t) Exceptions to the 10% Penalty for Early Withdrawal

Now that we have covered how the 72(t) plan can save you from the early withdrawal penalty, let’s discuss other ways to become exempt from the penalty. If you are a first-time home buyer, you will be exempt from the penalty. If you are withdrawing the money for educational expenses, the penalty will not be incurred. As long as certain conditions are met, you will not incur the penalty if you use the money for medical insurance. If the owner of the account is younger than 59 1/2, and they take a distribution based on one of the mentioned expenses, he or she will not be subject to the 10% early withdrawal charge, as long as you adhere to IRA withdrawal rules.

72(t) Plan Pros & Cons

Now, more than ever, individuals are finding that they need to tap into the funds in their IRA retirement accounts. For most people, this could mean paying IRA penalties for early withdrawal. The best way to avoid the penalty is by setting up a 72(t) payment plan. While 72(t) plans sound great, there are some negative factors involved. For most people, the payments will be a fixed amount. If the plan is modified after it is set up, the account holder may face serious consequences. These payments may have an enormous effect on the value of the account. This could lead to having less money to live on later in live. However, the 72(t) plans do provide great flexibility. Many people are finding that they are in need of financial aid and have no other choice than to tap into their IRA retirement account. As long as the funds are used for medical insurance, buying your first home or paying education expenses, you will not incur the 10% penalty. These are the only exceptions to the penalty rule. The only other way to access your funds is to set up a 72(t). When you reach the age of 59 1/2, you will be able to get distributions from the IRA account without the early withdrawal penalty. A 72(t) is not for everyone. It may be better to split your current IRA and open a second account.

Rocco Beatrice, CPA, MST (Master of Science in Taxation), MBA (Master of Business Administration), BSBA (Management/Accounting), CWPP (Certified Wealth Preservation Planner), CMMB (Certified Mortgage Broker), CAPP (Certified Asset Protection Planner), Managing Director, Estate Street Partners, LLC. Mr. Beatrice is an asset protection, award-winning trust, estate planning and tax expert.

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