When planning for a period that will span many years, it is essential to project the financial effect so that risk, commitment, and the desired results can be evaluated. This is particularly true for an individual who needs cash, is under the age of 59, and wants to tap his or her tax-deferred IRA money without incurring a 10% Federal penalty tax.
Distributions from an IRA can be taken by an owner under age 59, and kept exempt from a 10% IRS penalty. The owner--even if not disable--must carefully adhere to the annuity exception rules laid down by the IRS. The rules can be found in IRS Pub. 590. Further elaboration is located in Question & Answer No. 12 of Notice 89-25. This exception can not be used if the source of funds is still under the control of a qualified employment plan and a full separation of the employment relationship has not yet been made (see also IRS Form 5329 and its instructions).
A Record of Owner's Decision Form (table) illustrates the rules that are of concern such as: 1) owner and beneficiary ages; 2) life expectancy per IRS tables; 3) most recent December 31 fund balance (all IRA's in total); 4) date distributions are to begin; 5) a reasonably current interest rate; 6) employment relationship--if any; 7) selection of one of three distribution methods acceptable to the IRS; 8) frequency and amount of the distributions; 9) restriction of the "no modification" rule; and 10) entries to be made every year in Form 5329--Return for Additional Taxes Attributable to Qualified Plants, etc.
The declaration statement can serve not only as documentation of a pre-59-1/2 withdrawal plan of "substantially equal periodic payments," but it can also serve as clarification to the taxpayer as to the terms of the long-term commitment he or she would make.
Lotus 1-2-3, Excel, or some other spreadsheet program can be used to create the necessary cash-flows needed for evaluation of the strategy. IRS life expectancy tables are also required and can be found in Publication No. 590. See Figures 1, 2, and 3 for a suggested cash flow format. (Figures 1, 2, and 3 omitted)
The RBI software system provides a pre-59-1/2 distribution analyzer and a retirement funding analyzer. This system consists of several spreadsheet templates with menus and requires an MS-DOS operating system. An MS-DOS software package called the IRA Annuity Generator is specifically designed to provide cash-flow reports for retirement withdrawal analysis at any age above 35. Cash flow reporting is also available for funding retirement in the future. A comparison of the RBI software with the IRA Annuity Generator software is shown in Figure 4. (Figure 4 omitted)
Once started, a pre-59-1/2 withdrawal plan can not be modified for either five years or until the owner reaches age 59, whichever period is longer. A client may be willing to handle this constraint, if the need for cash is great. For example, a family whose borrowing power is exhausted but needs help with college expenses, an entrepreneur needs cash while starting a new business, and drugs or medical procedure expenses not covered by medical insurance. The planner who makes the annuity suggestion to such clients may perform a valuable service.
Before undertaking such a long-term obligation, a printed forecast will be very helpful to visualize the flow of cash for each year of the "no modification" period. Q & A No. 12 in Notice #89-25 cites an example of a 50 year old taxpayer with $100,000 in his IRA who decides to use the amortization over life expectancy withdrawal method. In the IRS tables, he finds that his single life expectancy is 33. …