Life and Death Planning for Retirement Benefits

Chapter 9: Distributions Before Age 59 ½

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many taxpayers litigate their liability for this penalty when they do not have even a colorable argument that they qualify for an exception. The IRS and the courts will (almost) never waive the penalty unless the requirements for an exception are met. There is no “hardship exception” to this penalty; Reese , T.C. Summ. Op. 2006-23; Gallagher , T.C. Memo 2001-34; Deal , T.C. Memo 1999-352. See, e.g. , Baas , T.C. Memo 2002- 130, and Czepiel , T.C. Memo 1999-289, aff’d. by order (1st Cir., Dec. 5, 2000); and Robertson , T.C. Memo 2000-100. 9.2 Exception: “Series of Equal Payments” One exception stands out as a useful planning tool: the “series of substantially equal periodic payments.” The penalty does not apply to a distribution that is “part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary.” § 72(t)(2)(A)(iv) . While at first this exception sounds rather rigid, in fact it is highly flexible because: 1. Rollovers and/or IRA-to-IRA transfers can be used to create an IRA of exactly the right size to support the desired payment amount. See ¶ 9.2.04 . 2. The payments do not in fact have to continue for the entire life or life expectancy period. The distributions must continue only until the participant reaches age 59½, or until five years have elapsed, whichever occurs later. See ¶ 9.3.02 . 3. The IRS allows several methods for determining the size of the “equal payments” (which do not in fact have to be equal). See ¶ 9.2.05 . This is the most significant exception for planning purposes. All the other exceptions are tied to a specific use of the money (home purchase, college tuition), or to some type of hardship situation (death, disability), or are otherwise narrowly limited; see ¶ 9.4 . In contrast, everyone who has an IRA (or who can get one via a rollover from some other type of plan) can use the SOSEPP exception. There is one significant limitation on the SOSEPP exception: Drastic consequences generally ensue if the series is “modified” before the end of the five year/age 59½ minimum duration; see ¶ 9.3.01 . The SOSEPP exception starts from the premise that there is a fund of money (the retirement plan account) that will be gradually exhausted by a series of regular distributions over the applicable period of time ( ¶ 9.2.01 ). Thus, the SOSEPP must be designed so that, if it continued for that period of time (which it won’t; see ¶ 9.3.02 ), it would exactly exhaust the fund. The participant cannot take annual distributions that are too small to exhaust the account, even if they How this exception works Series of substantially equal periodic payments (SOSEPP)