Author Topic: Rates for 72t distributions are up  (Read 5038 times)

bo_knows

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Rates for 72t distributions are up
« on: October 30, 2013, 01:11:07 PM »
Ever since learning about the idea of extremely early retirement, I've always heard that you should point a large chunk of your investments towards tax-deferred options (especially if you're a higher earner that will be earning less in retirement).  I've always seen the "72t" option talked about, and it always sounded like a great straight-forward option.

For those of you that don't know, "72t" is a portion of the tax code that allows you to convert any Traditional IRA (and thus your 401k) into a stream of income, based on your age and the current "Federal Mid-term 120%" rate.  The stream of income, once started, must occur every single year until you're 59.5 (or 5 years has past, whichever is longer).  So, that stream is entirely dependent on what the "Federal Mid-term 120%" rate is at the time you decide to create it.

The bad part? Ever since I've been mildly obsessed with FIRE, the rate has been TERRIBLE.  It almost didn't make any sense to start a 72t, because you wouldn't have enough income.  Well, according to the IRS website, the 120% rate for October is up to 2.07%.  This is good news for potential early retirees.

For some perspective: Check out BankRate's 72t calculator: http://www.bankrate.com/calculators/retirement/72-t-distribution-calculator.aspx and the historical 120% rates: http://www.imagisoft.com/equal/federalmidtermrates.html

Just a little food for thought.

vespito

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Re: Rates for 72t distributions are up
« Reply #1 on: October 30, 2013, 03:22:51 PM »
Thanks for the link!  I just learned about 72t which will be important for me since the bulk of my assets are in my 401k.

secondcor521

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Re: Rates for 72t distributions are up
« Reply #2 on: October 30, 2013, 06:31:46 PM »
It's been a long time since I studied this topic, but I believe there are three 72t withdrawal methods, of which you have mentioned one.  I can't remember the other two though.

bo_knows

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Re: Rates for 72t distributions are up
« Reply #3 on: October 31, 2013, 06:19:46 AM »
It's been a long time since I studied this topic, but I believe there are three 72t withdrawal methods, of which you have mentioned one.  I can't remember the other two though.

Yeah, I believe that all 3 are show in the bar graph of that calculator page.  I think they all still rely on that 120% rate, though.

curler

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Re: Rates for 72t distributions are up
« Reply #4 on: October 31, 2013, 10:15:27 AM »
The RMD (Required Minimum Distribution) method does not rely on the 120% rate.  It is just taking your balance every year and dividing by your life expectancy (same way the RMD is calculated for people in there 70's).  This method has you taking out a changing amount of your portfolio each year, depending on what your investment returns are.

bo_knows

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Re: Rates for 72t distributions are up
« Reply #5 on: October 31, 2013, 10:22:00 AM »
The RMD (Required Minimum Distribution) method does not rely on the 120% rate.  It is just taking your balance every year and dividing by your life expectancy (same way the RMD is calculated for people in there 70's).  This method has you taking out a changing amount of your portfolio each year, depending on what your investment returns are.

This is indeed correct, after further review.

fiveoh

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Re: Rates for 72t distributions are up
« Reply #6 on: November 01, 2013, 08:46:36 AM »
I always forget about this.  It's a very attractive option to me and with interest rates set to rise soon(most likely), it should go up as well.


curler

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Re: Rates for 72t distributions are up
« Reply #7 on: November 01, 2013, 01:36:59 PM »
I've tried, unsuccessfully, a few times to figure out the difference between the fixed amortization method and the fixed annuitization method.  Is anyone able to explain them to me?

footenote

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Re: Rates for 72t distributions are up
« Reply #8 on: November 01, 2013, 02:05:32 PM »
Here's an example provided by the IRS:

Bob, age 50, is the owner of an IRA from which he would like to start taking distributions beginning in 2011. He would like to avoid the ß72(t) additional 10% tax imposed on early distributions by taking advantage of the substantially-equal-periodic-payment exception.
- Bobís IRA account balance is $400,000 as of December 31, 2010 (the last valuation prior to the first distribution)
- 120% of the applicable federal mid-term rate is assumed to be 2.98%, and this will be the interest rate Bob uses under the amortization and annuitization methods
- Bob will determine distributions over his own life expectancy only

Fixed amortization method
The fixed amortization method consists of an account balance amortized over a specified number of years equal to life expectancy (single life uniform life or joint life and last survivor) and an interest rate of not more than 120% of the federal mid-term rate. Once an annual distribution amount is calculated under this method, the same dollar amount must be distributed in subsequent years.
For 2011, the annual distribution amount is calculated by amortizing the account balance ($400,000) over a number of years equal to Bobís single life expectancy (34.2) (obtained from Q&A-1 of I.T. Regs. ß1.401(a)(9)-9 using age 50), at a 2.98% interest rate (April 2011 rates). The annual distribution amount is $18,811.

Fixed annuitization method
The fixed annuitization method consists of an account balance, an annuity factor and an annual payment. The annuity factor is calculated based on the mortality table in Appendix B of Rev. Rul. 2002-62 and an interest rate of not more than 120% of the federal mid-term rate. Once an annual distribution amount is calculated under this method, the same dollar amount must be distributed in subsequent years.
Under this method the annual distribution amount is equal to the account balance ($400,000) divided by an annuity factor that would provide one dollar per year over Bobís life, beginning at age 50. The age 50 annuity factor (21.345) is calculated based on the Rev. Rul. 2002-62 Appendix B mortality table and an interest rate of 2.98%. The annual distribution amount is calculated as $400,000/21.345 = $18,740.

Source: http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Substantially-Equal-Periodic-Payments  (This is the answer to "How are payments determined under the three methods?")

curler

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Re: Rates for 72t distributions are up
« Reply #9 on: November 01, 2013, 06:11:37 PM »
Thanks footnote.
I guess what I don't understand is why there is a difference between dividing by an "annuity factor that would provide one dollar per year over Bobís life" and amortizing over a life expectancy.  The wanna-be actuary in me thinks they should come out the same way.

footenote

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Re: Rates for 72t distributions are up
« Reply #10 on: November 01, 2013, 07:11:25 PM »
Well, I'm not an actuary either. : )  So I can't help you there.

(But I can share a joke told to me by an actuary. "What's the difference between an introverted actuary and an extroverted actuary? An introverted actuary looks at his shoes while he talks to you. An extroverted actuary looks at... your shoes while he talks to you.)