If you’re reading this blog, you’re likely dreaming of an early retirement or perhaps facing a situation where you need quick access to your retirement funds. Achieving financial independence and security is a common goal, but effectively managing your assets before and during retirement is crucial for long-term success. One strategy to access retirement funds early, without penalties, is leveraging Rule 72(t).
What Is Rule 72(T)?
Rule 72(t), also known as the substantially equal periodic payments (SEPP) rule, is an IRS provision that allows penalty-free distributions from retirement accounts before the age of 59½. Normally, withdrawals from a retirement account like a 401(k) or IRA before age 59½ incur a 10% early withdrawal penalty in addition to ordinary income taxes. Rule 72(t) provides a way to avoid this penalty by allowing you to take substantially equal periodic payments (SEPP) from your retirement account based on various factors.
Determining 72(T) Distribution Amount
There are three IRS-approved methods to calculate these payments:
- Required Minimum Distribution (RMD) method:
- This method uses the same calculation as the IRS required minimum distributions (RMDs) for traditional IRAs and retirement plans. The distribution amount under this method is determined by dividing your account balance by your life expectancy factor from one of the IRS provided tables (Uniform Lifetime Table, Single Life Expectancy Table, or Joint Life and Last Survivor Expectancy Table).
- Once you choose this method, it must be used for all subsequent distributions.
- Fixed Amortization Method:
- This method calculates your distribution based on an amortization schedule. This schedule spreads your account balance over your life expectancy, using an interest rate that doesn’t exceed 120% of the federal mid-term rate published by the IRS.
- The interest rate used in the calculation is fixed and doesn’t change over time. This method provides a level annual payment amount, which may be higher than the amount calculated using the other methods.
- Fixed Annuitization Method:
- The Fixed Annuitization Method calculates your annual distribution based on an annuity factor. This factor is derived from mortality tables and an interest rate that doesn’t exceed 120% of the federal mid-term rate published by the IRS.Like the Fixed Amortization Method, once the annual amount is determined and paid, the same dollar amount must be distributed in future years.
- This method typically results in lower annual payments compared to the Fixed Amortization Method.
Choosing a Method
Once you elect to take distributions under 72(t), you must continue for at least five years or until you turn 59½, whichever is longer. Changing or stopping the distributions before this period can result in retroactive penalties. It is crucial to carefully consider which method best suits your financial situation and retirement goals, as each method can produce significantly different distribution amounts.
Marshall Financial Case Study: 72(T) Distributions
Consider the case of Client A, a 53-year-old with an $11,000,000 Employee Stock Ownership Plan (ESOP) as her sole investment account. Desiring an early retirement, Client A effectively utilized Rule 72(t) to tailor her withdrawal strategy to her needs.
Opting for the Fixed Amortization method provided predictable annual payments that aligned with her lifestyle requirements. By strategically establishing separate IRAs—one for 72(t) distributions and another for non-72(t) purposes—Client A managed to mitigate potential tax implications.
Next Steps
These methods offer flexibility for retirees seeking early access to retirement funds without penalty. Consult with our team of Wealth Advisors to learn more about this strategy as a potential option or to craft a personalized strategy that best fits your individual circumstances.
