Combating the market: no penalty for reduced retirement distributions.

• Author: Josephs, Stuart R.
• Position: Federal Tax - Income tax United States

Rev. Rul. 2002-62 (IRB 2002-42, 10/21/02) will enable some taxpayers to maintain their retirement savings when there is an unanticipated decline in the value of those savings.

These taxpayers began receiving fixed payments from their IRAs or other retirement plans based on the value of those accounts at the time they started receiving payments. Those taxpayers may now switch, without penalty, to a method of determining the amount of their payments based on the value of their accounts as they change from year to year.

Background

Generally, under IRC Sec. 72(t)(1), taxpayers are subject to a 10-percent tax, in addition to the regular income tax, on amounts withdrawn from their IRAs or employer-sponsored qualified retirement plans before attaining age 59 1/2. However, there are several exceptions to this additional tax.

One of these exceptions applies if a taxpayer takes distributions that are part of a series of substantially equal periodic payments (made at least once a year) over the taxpayer's life expectancy or the joint life expectancies of the taxpayer and his or her beneficiary [Sec. 72(t)(2)(A)(iv)].

The IRS issued guidance (Q&A 12 in Notice 89-25) that provided three safe-harbor methods for satisfying this exception.

Two of these methods require a fixed amount that must be distributed and could result in the premature depletion of the taxpayer's account in the event that the value of the assets in that account declines.

However, under Sec. 72(t)(4), the exception to the 10-percent tax for substantially equal periodic payments will not apply if these payments are subsequently modified, other than by reason of death or disability, before:

* The close of the five-year period beginning with the date of the first payment and after the taxpayer attains age 59 1/2;or

* The taxpayer attains age 59 1/2.

In this event, the tax for the year in which the modification occurs is increased by an amount which, but for this exception, would have been imposed, plus interest for the deferral period.

This period begins with the tax year in which the distribution would have been includible in gross income, absent the exception, and ending with the tax year in which the modification occurs.

New Treatment

Rev. Rul. 2002-62 provides relief to tax payers who selected one of these two fixed-payment safe-harbor methods by permitting them to make a one-time change from such a method to the third safe-harbor method, where the amount changes from year to year...