THE 72(t) SOLUTION GUIDE

Transcription

1 RETIREMENT PLANNING THE 72(t) SOLUTION GUIDE Clients who need cash may need your help. Layoffs, downsizing, and early retirements are on the rise. Clients may need to tap their retirement plans prematurely. Early withdrawals can create a tax trap and disrupt retirement savings. The 72(t) Solution can help avoid tax penalties. Use substantially equal periodic payments. Keep retirement accounts growing tax deferred. Build goodwill with clients during their time of need.

2 1 AVOIDING A TAX TRAP A Layoff Is Still a Layoff Right-sizing, downsizing, voluntary separation plans, early retirement buyouts. Whatever name you call it, a layoff is still a layoff and it s a trend that pervades our economy more than ever. Amid the dramatic slowdown in economic growth, companies struggle to trim payrolls by eliminating positions and offering early retirement packages affecting thousands of individuals. The Tax Trap A layoff or early retirement buyout can impede anyone s plans to save for retirement. Consider also that today s severance packages may be less attractive than in years past. That means that thousands of investors including your existing clients may be forced to tap retirement assets to meet current income needs. Unfortunately, many who do so will fall into a tax trap a potential 10% federal income tax penalty on the taxable portion of all IRA and annuity distributions made prior to age 59 1 /2, in addition to paying ordinary income taxes. A Win-Win for Clients and YOU! There is a way to avoid the tax trap. We call it the 72(t) Solution [72(q) for annuities], and it s clearly a win-win situation for your clients and you. Clients Win Avoid a tax penalty (though withdrawals may still be taxable). Receive current income when it s needed most. Allow a portion of retirement assets to continue growing tax deferred. Generate disposable income for investment if client returns to the workforce. You Win Attract and retain IRA and/or annuity assets. Build goodwill with clients. Win referrals for new business. Increase your IRA rollover book. Solutions Made Easy In this guide you will find a discussion of Sections 72(t) and 72(q) of the Internal Revenue Code (IRC), strategies to avoid the federal income tax penalty, and how you can put the solutions to work. Financial professionals are not tax or legal advisers. You should encourage your clients to consult with a tax or legal adviser regarding their particular situation.

3 2 3 WHAT IS THE 72(t) SOLUTION? What Is Section 72(t)? Section 72(t) of the IRC generally imposes a 10% federal income tax penalty when assets are withdrawn from an IRA and other eligible retirement plans before age 59 1 /2, unless certain exceptions apply. Section 72(q) imposes a similar 10% tax penalty on assets prematurely withdrawn from a tax-deferred annuity. Section 72 also lists exceptions or solutions to the tax penalty. The solution we ll focus on is known as substantially equal periodic payments. Strategies to Avoid the Tax Trap There are several IRS-approved strategies to calculate periodic payments. Three commonly used methods are: Life Expectancy Method (also known as the minimum required distribution method). This calculation divides the balance of any or all of your IRAs on December 31 of the preceding year by your life expectancy, using tables in Section 72 of the IRC. Substantially Equal Periodic Payments This solution can help people who need regular income from their IRA or annuity, but don t want the contract or account to lose its tax advantages. Distributions may be taken for any reason on a monthly, quarterly, semiannual, or annual basis, subject to several restrictions: Once payments begin, they must continue for five years or until age 59 1 /2, whichever comes later. If distributions are modified in any way before the end of the required payment period, the 10% tax penalty plus interest will be assessed on all payments previously received (with exceptions for the account holder s death or disability). Amortization Method. This usually produces level payments for the entire payout period. Payments are calculated once based on account balance and life expectancy. It works like a loan amortization based on an assumed interest rate and life expectancy (either the account owner s or the account owner s joint life expectancy factor with a beneficiary). Annuitization Method. This provides the largest annual payment to the account holder. It calculates payments by dividing the account balance by an annuity factor based on a mortality table and interest rate. Like amortization, payments are calculated only once and will not change from year to year. Which Strategy Is Right? Choosing the best payment method for your client depends upon the amount of retirement assets at risk, as well as the needs and goals of the individual investor. The important thing to remember is, once chosen, a strategy cannot be changed for the duration of the payment period without incurring the 10% tax penalty, plus interest on all previous distributions. After the later of the five-year period or age 59 1 /2 is reached, periodic payments can be stopped or modified without incurring a penalty.

4 4 PUTTING THE 72(t) SOLUTION TO WORK PROSPECTING LETTER First, identify your clients long-term financial goals, then help them determine a suitable income stream, and work with them to implement the plan. Here are two case studies illustrating the amortization and annuitization strategies to create monthly income. Note to Financial Professional: This letter is for use without a prospectus. Reproduce it on your appropriate letterhead and send it to clients/prospects. The content below has been approved and cannot be changed. Case 1: Bob s Bump in the Road. Bob, a 50-year-old client, was laid off by his company. He and his wife have retirement assets of $350,000 in their qualified plans. Although his wife continues to work, they need current income about $800 monthly to cover expenses. You might suggest establishing a systematic withdrawal schedule on $150,000 from his IRA. Using the amortization strategy, Bob s monthly income would be $809. (See table below.) Let s assume that Bob becomes a consultant two years later, and his new salary is sufficient to meet his family s income needs. Since distributions must continue for another seven years (until age 59 1 /2), he will have $809 in monthly periodic payments to re-invest in another vehicle. Case 2: Sally s Early Retirement Package. A 56-year-old client named Sally has accepted an early retirement package. She has retirement assets of $300,000 in an IRA. She now needs $1,000 per month to cover expenses. Sally s 72(t) Solution may include rolling over her $300,000 into two separate IRA accounts (or annuities). One IRA can continue to grow tax deferred for retirement, while the second IRA can be used for monthly periodic payments for a minimum of five years. Under the annuitization strategy, Sally can receive $1,024 monthly and still have $150,000 in an IRA or annuity that can continue to grow tax deferred. (See table.) Distribution Options: $150,000 Annual Income Monthly Income Amortization Strategy $9,712 $809 Annuitization Strategy $12,293 $1,024 (Date) Dear (Prospect): Has the recent round of corporate restructurings affected you? If so, you may be thinking of taking a cash distribution from your employee retirement plan to cover short-term expenses. Stop, before you act! You should know that making the wrong decision could cost you thousands of dollars in unnecessary taxes and penalties. I believe I can provide valuable guidance to help you make an informed decision. You may be aware of some distribution options, but do you know which one(s) may be more useful given your individual circumstances? For example, few people are aware that the Internal Revenue Code allows individuals to receive distributions from their IRAs, tax-deferred annuities, and other retirement plans prior to age 59 1 /2 without incurring a tax penalty providing specific rules are followed. Even if you are aware of this feature, you may not realize the flexibility available to you in establishing a cash flow to help meet your personal obligations. Please call me at (xxx) xxx-xxxx. We ll work together to gather the necessary data you ll need to make an informed investment decision. Sincerely, (Your name and title) Financial professionals are not tax or legal advisers. You should consult a tax or legal adviser before making any tax-related investment decisions. Securities products and services are offered through Pruco Securities Corporation, 751 Broad Street, Newark, NJ ; Prudential Securities Incorporated, 199 Water Street, New York, NY 10292; and Prudential Investment Management Services LLC (PIMS), Three Gateway Center, 14th Floor, Newark, NJ All are Prudential companies and members SIPC. Prudential Financial is a service mark of The Prudential Insurance Company of America, Newark, NJ, and its affiliates. IFS-A048564

5 Financial professionals are not tax or legal advisers. You should encourage your client to consult a tax or legal adviser before making any tax-related investment decisions. Securities products and services are offered through Pruco Securities Corporation, 751 Broad Street, Newark, NJ ; Prudential Securities Incorporated, 199 Water Street, New York, NY 10292; and Prudential Investment Management Services LLC (PIMS), Three Gateway Center, 14th Floor, Newark, NJ All are Prudential companies and members SIPC. Prudential Financial is a service mark of The Prudential Insurance Company of America, Newark, NJ, and its affiliates. IFS-A PRU1345 Ed. 11/01/2001