72(t) with a Fidelity IRA

Introduction

Retirement planning often involves making critical financial decisions that can significantly impact one’s financial security and tax obligations. One important option available to individuals is the use of Section 72(t) of the Internal Revenue Code (IRC), which permits early distributions from retirement accounts like IRAs without incurring the standard 10% penalty for early withdrawals. This provision is particularly useful for those who need access to their retirement funds before reaching the age of 59½, whether due to early retirement, financial emergencies, or other pressing needs.

A Fidelity IRA, known for its comprehensive investment options and robust customer service, can be an ideal platform for executing a 72(t) distribution strategy. By leveraging the provisions of Section 72(t), individuals can structure their withdrawals in a manner that meets their financial needs while minimizing tax penalties. However, this process involves adhering to specific rules and guidelines to ensure compliance with IRS regulations, making it essential to understand the intricacies involved.

Section 72(t) of the IRC allows individuals to take early distributions from their IRAs without incurring the usual 10% early withdrawal penalty, provided the distributions are part of a series of substantially equal periodic payments (SoSEPP). This exception is crucial for those who need to access their retirement funds before reaching age 59½.

Regulatory Framework

Laws and Regulations

The key regulations governing 72(t) distributions include:

• Section 72(t) of the IRC: This section outlines the conditions under which the 10% additional tax on early distributions does not apply. Specifically, 72(t)(2)(A)(iv) provides the exception for substantially equal periodic payments​​.
  
• IRS Notice 2022-6: This notice provides guidance on calculating these payments, detailing the acceptable methods and the required use of life expectancy tables​​.
  
• Publication 590-B: This IRS publication covers distributions from IRAs and provides detailed information on exceptions to the early distribution penalty​​.

Benefits

72(t) distributions can be a strategic tool for a variety of individuals needing early access to their retirement savings. Whether for early retirees, those in financial distress, career changers, or individuals with unique financial planning needs, this provision of the IRC offers a way to utilize retirement funds without the typical early withdrawal penalties. However, it is crucial to follow IRS guidelines meticulously to avoid triggering penalties and additional taxes.

1. Early Retirees

Profile: Individuals who choose to retire before the age of 59½.

Reasoning: Early retirees often need access to their retirement savings to support their living expenses since they do not have income from employment. 72(t) distributions allow them to withdraw funds from their IRA without the 10% early withdrawal penalty, provided the withdrawals are structured correctly according to IRS rules.

2. Financially Distressed Individuals

Profile: People facing unexpected financial hardships such as medical emergencies, job loss or significant unforeseen expenses.

Reasoning: For those in financial distress, accessing retirement funds can provide necessary financial relief. By using 72(t) distributions, they can avoid the additional 10% penalty on early withdrawals, which would otherwise exacerbate their financial challenges. This option can be crucial in helping them manage their immediate financial needs while avoiding severe tax penalties.

3. Individuals Seeking to Manage Taxable Income

Profile: Individuals with substantial IRA balances who are looking to manage their taxable income over several years.

Reasoning: By setting up a series of substantially equal periodic payments, these individuals can smooth out their income, potentially keeping themselves in a lower tax bracket and avoiding large, lump-sum distributions that could result in higher taxes. This strategy helps in efficient tax planning and income management, particularly in scenarios where the individual anticipates lower income tax rates in the future.

4. Early Career Changers

Profile: Individuals transitioning to a new career path that requires a significant period without income such as returning to school or starting a business.

Reasoning: Career changers may need access to their retirement funds to support themselves during their transition period. Using 72(t) distributions, they can draw from their IRA without incurring the 10% early withdrawal penalty, providing them with the necessary funds to cover their living and educational expenses during this time of change.

5. Those With Significant Non-Retirement Assets

Profile: Individuals who have significant non-retirement assets and want to balance their asset allocation.

Reasoning: People with substantial assets outside their retirement accounts may want to draw down their IRAs early to better balance their overall portfolio. By leveraging 72(t) distributions, they can access their IRA funds without penalty, allowing for a more strategic asset allocation and diversification.

6. Individuals Facing Health Issues

Profile: Individuals with serious health issues who may have a shorter life expectancy and require access to their retirement funds early.

Reasoning: For those facing significant health challenges, accessing retirement funds without the additional penalty can provide essential financial support for medical expenses and improve their quality of life. This approach ensures they have the necessary resources to manage their health and well-being without the burden of extra taxes.

Process Steps for 72(t) with a Fidelity IRA

Implementing 72(t) distributions requires careful planning and adherence to IRS guidelines. Here are the detailed steps involved in the process:

1. Determining Eligibility

• Age Requirement: It should be verified that the IRA holder is under the age of 59½. This is crucial because 72(t) distributions are designed to allow penalty-free withdrawals before this age.
  
• Need for Early Access: The financial need for early access to the IRA funds should be assessed. Common scenarios include early retirement, financial emergencies or significant life changes such as starting a new business or returning to school.

2. Choosing a Calculation Method

The IRS permits three methods for calculating the periodic payments. Each method has different implications for the payment amount and the complexity of calculations:

• Required Minimum Distribution (RMD) Method:
  
  • Description: Payments are recalculated annually based on the account balance and life expectancy.
    
  • Benefits: This method can result in smaller payments, which might be beneficial if the individual wants to preserve the IRA balance as much as possible.
    
  • Calculation: The account balance as of December 31 of the previous year should be used and divided by the life expectancy factor from the IRS Uniform Lifetime Table.
    
• Fixed Amortization Method:
  
  • Description: The account balance is amortized over a specified period using an interest rate.
    
  • Benefits: Provides consistent payment amounts each year, making financial planning easier.
    
  • Calculation: The payment should be determined using the account balance, life expectancy and a reasonable interest rate. This calculation is akin to amortizing a loan.
    
• Fixed Annuitization Method:
  
  • Description: Payments are determined based on the annuitization of the account balance using a mortality table and an interest rate.
    
  • Benefits: Similar to the fixed amortization method, it provides consistent payments.
    
  • Calculation: The account balance and an annuity factor from the IRS tables must be used, applying a reasonable interest rate.

3. Calculating Payments

• Gathering Necessary Data: The account balance, applicable interest rates and life expectancy data should be collected.
  
• IRS Tables and Rates: It should be referred to IRS Notice 2022-6 and Publication 590-B for the required tables and permissible interest rates​.
  
• Calculations: Depending on the chosen method, the calculations must be performed to determine the exact payment amounts. Fidelity or a financial advisor can assist with these complex calculations to ensure accuracy and compliance.

4. Establishing a Distribution Schedule

• Setting Payment Dates: The schedule for the periodic payments should be determined. Payments can be made monthly, quarterly or annually depending on the individual’s cash flow needs.
  
• Documenting the Plan: The chosen method, the calculation process and the payment schedule must be documented clearly. This documentation would be very important in case of an IRS audit.

5. Initiatng Payments

• Contacting Fidelity: Coordination should be provided with Fidelity to set up the payment schedule from the IRA. This would involve providing them with the necessary documentation and instructions for disbursements.
  
• Monitoring Disbursements: Payments must be ensured to be made on time and in the correct amounts. Any deviation from the planned schedule or amounts might result in penalties.

6. Monitoring and Adjustment

• Annual Review: The IRA balance and payment calculations should be reviewed regularly, especially in the case of using the RMD method which requires annual recalculations.
  
• Adjusting for Changes: If there are significant changes in life expectancy or account balance, adjustments may be necessary. However, modifications must be made carefully to avoid triggering penalties.
  
• Compliance Checks: Compliance with IRS regulations should be continuously monitored to ensure that the distributions remain penalty-free. Any additional contributions to the IRA should be avoided, and strict adherence to the planned schedule should be maintained.

Example Case Study 

If you are considering early retirement and wish to access your retirement funds without incurring the 10% early withdrawal penalty, establishing a 72(t) plan with a Fidelity IRA would be a viable strategy. Utilizing the 72(t) rule, also known as Substantially Equal Periodic Payments (SoSEPP), allows for structured withdrawals that meet IRS requirements, thus avoiding penalties.

Steps to Establishing a 72(t) with a Fidelity IRA

1. Understanding the Federal Midterm Rate

The Federal Midterm Rate plays a critical role in calculating your 72(t) payments. This rate, published monthly by the IRS, determines the permissible interest rate used in the fixed amortization and fixed annuitization methods. Ensuring that your calculations adhere to the correct Federal Midterm Rate is essential to maintaining compliance with IRS regulations.

2. Setting Up the IRA with Fidelity

• Open the IRA: Start by working with Fidelity to establish an IRA account if you do not already have one. Fidelity provides a range of investment options and tools to help manage your retirement funds.
  
• Fund the IRA: Transfer or roll over funds into the new Fidelity IRA. Ensure that all transfers comply with IRS rules to avoid penalties or taxes on the transferred amount.

3. Selecting a Calculation Method

Choose one of the three IRS-approved methods for calculating your 72(t) payments:

• Required Minimum Distribution (RMD) Method: Payments are recalculated annually based on your account balance and life expectancy.
  
• Fixed Amortization Method: The account balance is amortized over your life expectancy using the chosen interest rate.
  
• Fixed Annuitization Method: Payments are calculated based on the annuitization of your account balance using an IRS-approved mortality table and the applicable interest rate.

4. Calculating the Payments

Given the complexity of the calculations and the need for precision, hiring a Certified Public Accountant (CPA) is highly recommended. A CPA can:

• Ensure Accurate Calculations: By applying the correct Federal Midterm Rate and life expectancy tables.
  
• Provide Documentation: Detailed records of the calculation process, which are crucial for IRS compliance.
  
• Offer Ongoing Support: Regular reviews and adjustments as needed, ensuring that your 72(t) plan remains compliant over time.

5. Establishing the Payment Schedule

• Coordinate with Fidelity: Set up the payment schedule based on your chosen method. Fidelity’s robust platform can automate these payments, ensuring timely and accurate distributions.
  
• Monitor the Plan: Regularly review your account balance and payment schedule. Ensure that no additional contributions are made to the IRA, and no extra distributions are taken outside of the planned 72(t) payments.

Expert Guidance and Calculation Services

Dimov Tax & CPA Services offers comprehensive support for individuals setting up 72(t) distributions, including:

• Initial Consultation: Assessing your financial situation and determining the best approach for your 72(t) distributions.
  
• Precise Calculations: Using the latest IRS guidelines and Federal Midterm Rates to calculate your periodic payments accurately.
  
• Compliance Assurance: Providing ongoing monitoring to ensure that your plan remains compliant with all IRS regulations, avoiding penalties and ensuring peace of mind.
  
• Tax Filing Assistance: Helping with the necessary tax filings and reporting, including completing Form 5329 to report the early distribution exception.

Conclusion

Setting up a 72(t) plan with a Fidelity IRA is a strategic way to access your retirement funds early while avoiding penalties. By leveraging the expertise of a CPA, you can ensure accurate calculations and maintain compliance with IRS requirements. This approach provides financial flexibility and security as you transition into early retirement.

For further information and personalized assistance, contact Dimov Tax & CPA Services to schedule a consultation and take the first step toward a well-planned and penalty-free early retirement.