What Is Rule 72(t)?
Rule 72(t) allows for penalty-free withdrawals from individual retirement accounts (IRAs) and other tax-advantaged retirement accounts like 401(k)s and 403(b) plans.It is issued by the Internal Revenue Service (IRS).
This ruleallows account holders to benefit from their retirement savings before retirement age through early withdrawals without the otherwise required 10% penalty. The IRS still subjects the withdrawals to the account holder’s normal income tax rate.
Key Takeaways
- Rule 72(t) allows you to take penalty-free, early withdrawals from your IRA, 401(k), or 403(b).
- There are other IRS exemptions that can be used for medical expenses, purchasing a home, and more.
- Rule 72(t) withdrawals should be considered as a last resort when all other options for reducing financial pressure (creditor negotiation, debt consolidation, bankruptcy, etc.) have been exhausted.
Understanding Rule 72(t)
Rule 72(t) refers to code 72(t), section 2, which specifies exceptions to the early-withdrawal tax. These exceptions allowinvestors to withdraw funds from their retirement accounts before age 59½,as long as certain qualifications are met.
To take advantage of this rule, the owner of the retirement account must takeat least five substantially equal periodic payments (SEPPs). The amount of the payments dependson the owner’s life expectancy as calculated through IRS-approved methods. You must also withdraw these funds according to aspecific schedule. The IRS offers three different methods for calculating your specific withdrawal schedule.You must adhere to the payment schedule for five years or until you reach age 59 1/2, whichever comes later (unless you are disabled or die).
Calculation for Payment Amounts Under Rule 72(t)
The amounts an account holder receives in the periodic payments enabled by rule 72(t) depend on life expectancy, which can be calculated through one of three IRS-approved methods:
- The amortizationmethod
- The minimum distribution or the life expectancymethod
- The annuitizationmethod
The amortization method determines yearly payment amounts by amortizing the balance of an investor’s account over single or joint life expectancy. This method develops the largest and most reasonableamount an individual can remove, andthe amount is fixed annually.
The minimum distribution method takes a dividing factor from the IRS’s single or joint life expectancy table, using it to divide the retirement account’s balance. The key difference between this method and the amortization method is the resulting payments with the minimum distribution method, as the name implies, are the lowest possible amounts that can be withdrawn.
The minimum distribution method is nearly the opposite of the amortization method, asthe annual early withdrawal payments are likely to vary fromyear to year, though not substantially.
The final IRS-approved calculation is the annuitization method, which uses an annuity factor method provided by the IRS to determine equivalent or nearly equivalent payments in accordance with the SEPPregulation. This method offers account holders a fixed annual payout, with the amount typically falling somewhere between the highest and lowest amount the account owner can withdraw.
What Is the Downside of 72(t)?
Withdrawing money from a retirement account is a financial last resort. Using rule 72(t) will deplete your retirement savings, potentially putting the stability of your financial future in jeopardy.
Is 72(t) a Good Idea?
For many situations, using rule 72(t) is not a good idea. The risk to your future retirement may be too great to justify taking money out now. In some rare cases, however, it may be worth it.
What Is an Example of Withdrawing Money Early with Rule 72(t)?
As an example, assume a 53-year-old investor who has an IRA earning 1.5% annuallywith a balance of $250,000wishes to withdraw money early under rule 72(t). Using the amortization method, they would receive approximately $10,042 in yearly payments. With the minimum distribution method, they would receive around $7,962 annually over a five-year period. Using the annuitization method, they would receive approximately $9,976 annually.
The Bottom Line
It's worth remembering that many retirement plans offer exceptions to the 10% penalty for certain circ*mstances, like disability and illness. If you do not meet any of the criteria for other exceptions, then rule 72(t) can be used if you have exhausted all other avenues. It should not be used as an emergency fund strategy, as any withdrawals could affect your future financial stability significantly.
FAQs
What Is an Example of Withdrawing Money Early with Rule 72(t)? As an example, assume a 53-year-old investor who has an IRA earning 1.5% annually with a balance of $250,000 wishes to withdraw money early under rule 72(t). Using the amortization method, they would receive approximately $10,042 in yearly payments.
How do you calculate 72t? ›
It simply takes your current balance and divides it by your single life expectancy or joint life expectancy. Your payment is then recalculated each year with your account balance as of December 31st of the preceding year and your current life expectancy.
What is the downside of 72t? ›
Rule 72t Fundamentals
These SEPPS must continue for five years or until you reach age 59.5 – whichever is longer. You can't adjust the payment amounts during this time or else you'll face the penalty you initially avoided. You also can't make additional withdrawals from the account beyond your scheduled payments.
At what age can you start a 72t? ›
You may begin at any age under 59 ½.
What is the loophole to retire at 55? ›
The rule of 55 is a loophole that allows for early withdrawals from workplace retirement accounts. You must be 55 or older in the year you leave your job (for any reason) to qualify for early withdrawals from a 401(k) or 403(b).
What is the current reasonable interest rate for 72t? ›
Importantly, the chosen interest rate can be the higher of 5% or must not exceed 120% of the federal mid-term rate (4.09% as of August 2023).
What is the new IRS rule of 72t? ›
Internal Revenue Code section 72(t) allows penalty-free1 access to assets in IRAs and employer-sponsored retirement plans under certain conditions, such as account holder death or disability, first-time home purchases, and taking substantially equal periodic payments (SEPP).
How do I report a 72t on my taxes? ›
If it's marked 1, you'll need to file Form 5329 with the IRS. Since the IRS won't know that your distribution qualifies as a 72t SEPP, you'll need to tell them yourself. When taking your withdrawals each year, it'll help to speak with your custodian.
What is the penalty for breaking 72t? ›
The IRS Is Unforgiving with a 72t Distribution Penalty
If payments are modified in any way other than due to death or disability of the IRA owner, a 10% Federal Income Tax penalty plus interest will be retroactively applied to the payments beginning with the first year of the distributions/payments.
What is the difference between the rule of 55 and 72t? ›
Rule of 55 vs 72(t)
Eligible Accounts: The 72(t) rule applies to all types of retirement accounts, including employer-sponsored plans and IRAs. In contrast, the Rule of 55 exclusively pertains to employer-sponsored retirement plans like 401(k)s and 403(b)s. It does not cover IRAs.
The short answer is yes – you can work while taking a 72(t) distribution. It is important to understand that you cannot make contributions to the IRA that is paying out income under IRS Rule 72(t) SEPP.
Can you take 72t distributions from multiple accounts? ›
Yes, that is correct. You can select only one IRA for the 72t plan, but you cannot use only part of the balance any IRA accounts you select. Therefore, before the plan is started a reverse calculator should be used to determine the account balance needed to produce the annual distribution needed.
Do you pay taxes on 72t distributions? ›
Is there an additional tax on early distributions from certain retirement plans? Yes. Under Section 72(t), there is an additional tax of 10% on distributions to the taxpayer if the distribution is made before the taxpayer is age 59 ½.
What is the minimum distribution at age 72? ›
IRA required minimum distribution (RMD) table
| Age of retiree | Distribution period (in years) |
|---|
| Source: Internal Revenue Service (IRS) |
| 72 | 27.4 |
| 73 | 26.5 |
| 74 | 25.5 |
22 more rowsNov 15, 2023
72(q) applies to non-qualified annuities, while 72(t) applies to IRAs, 401(k)s, and 403(b)s. If you participate in any of these retirement accounts, code section 72 allows you to take penalty-free withdrawals as a series of substantially equal periodic payments (SoSEPP).
How to calculate substantially equal periodic payments? ›
Under the fixed annuitization method, the annual payment amount under a SoSEPP is determined by dividing the account balance by an annuity factor that is the present value of $1.00 per year beginning at the taxpayer's age and continuing for the life (or lives) of the taxpayer (or taxpayer and taxpayer's beneficiary).
What is an example of the treasury stock method? ›
Example of Treasury Stock Method
Let's assume that the average market price for the shares in the last year was $100. Using the basic share count of the 100,000 common shares, the company's basic EPS is $5 calculated as the net income of $500,000 divided by 100,000 shares.
Can you still work and do a 72t? ›
The short answer is yes – you can work while taking a 72(t) distribution.
