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Breaking Down Early Distributions from Non-Qualified Annuities and IRAs

Generally, the amounts an individual withdraws from an IRA or non-qualified annuity prior to age 59 1/2 are called ”early” or ”premature” distributions. Individuals must pay an additional 10% IRS penalty tax unless an exception applies. The additional 10% penalty only applies to the taxable amount of the withdrawals. Distributions from a non-qualified annuity are taxed on a last in, first out (LIFO) basis, so interest is deemed to be distributed first.

Below are some of the common exceptions to the 10% penalty tax. Please consult with a tax advisor for complete details and qualifications on these exceptions or any other exceptions not shown below. Surrender Charges and other carrier/product fees could apply.

IRA Non-Qualified Annuity
Distributions to beneficiaries after death of Account Holder Distributions to beneficiaries after death of Owner and/or Annuitant
Disability of the IRA owner as defined in Internal Revenue Code (IRC) §72(m)(7) Single Premium Immediate Annuity: Payments must start within 1 year of purchase and be made at least annually.1
Education: Qualified Higher Education Expenses Disability of the Annuity owner as defined in Internal Revenue Code (IRC) §72(m)(7)
Homebuyers: Qualified first time Homebuyers up to $10,000 Pre-TEFRA2 amounts allocable to investment/cost basis made prior to August 14, 1982
Unreimbursed medical expenses exceeding 10% of Adjusted Gross Income (AGI) Structured Settlements: payments under a qualified personal injury settlement
Health Insurance: Premiums paid from Annuity while unemployed Substantial Equal Periodic Payments (SEPP) (IRC) 72(q)
Military: certain distributions to qualified military reservists called to active duty  
Substantial Equal Periodic Payments (SEPP) (IRC) 72(t)  

 

Substantially equal periodic payments

There may be a need to take distributions from an IRA or non-qualified annuity prior to age 59 1/2. This can be due to early retirement, needing a bridge to Social Security or pension payments, or for other reasons. Substantially Equal Periodic Payments (IRC) 72(t) or 72(q) may help avoid the 10% IRS penalty and provide the necessary extra income.

Payments must be made monthly, quarterly, semi-annually, or annually and continue without modification for at least five full years, or until the contract owner reaches age 59 1/2. Once distributions begin, if the series of payments is modified, the 10% early distribution penalty will be imposed retroactively beginning with the first year of distribution.3,4 Payments also must be made in accordance with one of the following methods. Distribution amounts vary by age and other factors.

  1. Required minimum distribution method: resulting annual payment is redetermined for each year.
  2. Fixed amortization method: resulting annual payment is determined once for the first distribution year and remains the same for each succeeding year.
  3. Fixed annuitization method: resulting annual payment is determined once for the first distribution year and remains the same for each succeeding year.

Example: Owner of an IRA or non-qualified annuity age 55 with a contract value of $100,000.

Required Minimum Distribution (RMD) method: $3,164.56. Payout amounts under the RMD method will vary each year, as this method involves annual recalculations. The RMD method uses the previous year end account balance to determine the distribution amount.5

Fixed Amortization method:6 $6,361.34. Based on account value when initial distribution is taken and remains the same for the latter of five years or until age 59 1/2

Fixed Annuitization method:4 $6285.72. Based on account value when initial distribution is taken and remains the same for the latter of five years or until age 59 1/2

Please reference IRS Publication 575 and 590 for complete details and contact your financial advisor or the issuing company for a withdrawal calculation on your existing policy.

Considerations:

The issuing insurance company may assess a Withdrawal Charge and Market Value Adjustment, if applicable, on any distributions that follow the enrollment guidelines for Substantially Equal Periodic Payments under IRC Section 72(t)/(q), but exceed the contractual penalty free withdrawal provision.

Any additions, including rollovers, to your account balance (other than gains or losses), or any withdrawals, including Registered Investment Advisor (RIA) Fee withdrawals from your account balance made outside of Forethought’s program guidelines, will cause a modification to your periodic payments and we are obligated to report any such modifications to the IRS.

Payments exempted from the 10% federal income tax penalty by reason of the “substantially equal periodic payments" exception are subject to a recapture tax if the series of payments is modified (other than by reason of death or disability).

Forethought is neither certifying nor implying that any distribution taken from your annuity contract will satisfy federal tax law requirements meeting the exception to the 10% federal income tax penalty.

The contract owner is solely responsible for all taxes, penalties and interest that may be imposed by the IRS as a result of any distribution from his/her annuity contract and agrees to hold Forethought harmless in regard to distributions made under this Program.

Withdrawals in excess of applicable withdrawal limits can severely affect the value of any optional withdrawal benefit and/or optional death benefit under your annuity contract. Such withdrawals may reduce your benefits on a proportional basis rather than by the dollar amount actually withdrawn and may also lock in your annual available withdrawal percentage and/or terminate your Deferral Bonus. It is important for you to understand what impacts a withdrawal may have upon your annuity contract before requesting a withdrawal. You may contact us for a calculation showing the impact of your withdrawal. Please see your prospectus and contract or rider for more information on withdrawal limits.

Please consult your financial tax and legal professionals for additional details and to determine if a 72(t) or 72(q) distribution and/or an annuity is appropriate.

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