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Dear Tax Talk,
I am 56 years old and have to use my IRA distributions because of the financial situation resulting from being out of work. A financial institution told me I can avoid the 10 percent tax penalty of early distribution by electing to receive substantial equal distributions — Rule 72(t) over five years or until age 59½, whichever is longer. (It will be five years in my situation.) My CPA told me he is not aware of it. Who is right?
Thanks for your help.
— Nicole
Dear Nicole,
Your financial institution gave you a very concise explanation of the exception to the 10 percent penalty rule that might help you out of your dire financial situation. Normally, a distribution prior to age 59½ results in a 10 percent penalty for early withdrawals. However, you can choose to annuitize your IRA at any age and avoid the 10 percent IRA early withdrawal penalty.
You can receive distributions from your traditional IRA that are part of a series of substantially equal payments over your life (or your life expectancy), or over the lives (or the joint life expectancies) of you and your beneficiary, without having to pay the 10 percent additional tax, even if you receive such distributions before you are age 59½.
There are two other IRS-approved distribution methods that you can use to avoid an IRA early withdrawal penalty. They are generally referred to as the “fixed amortization method” and the “fixed annuitization method.” Both methods are quite complex and generally require professional assistance.
As your bank pointed out, you would have to continue to use the method for at least five years. If you switch, you could be liable for additional recapture tax on your pre-age 59½ distributions. Your CPA should be aware of this common exception.
Ask the adviser
To ask a question on Tax Talk, go to the “Ask the Experts” page and select “Taxes” as the topic. Read more Tax Talk columns.
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) 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 herein. Taxpayers should seek professional advice based on their particular circumstances.
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