With people building up large amounts in IRAs and taking early retirement, people want to tap into their retirement accounts before they reach age 59½. The problem is, though, that they’ll have to pay the 10% early withdrawal penalty on their IRA distributions. Fortunately, there is a way around this.
Section 72(t) of the Internal Revenue Code allows taxpayers of any age to take a series of substantially equal periodic payments without a 10% penalty.
These IRA distribution payments must continue for five years or until the IRA owner reaches 59½ years old, whichever period is longer. While they are receiving the money, they cannot make any changes to the payments. However, they can irrevocably switch one time to the RMD method (see below).
And in case IRA owners do not stay with the plan, or modify the payments in any way, they will no longer qualify for the exemption from the 10% penalty. Furthermore, the 10% penalty will be reinstated retroactively, to all prior years' IRA distributions.
Each IRA stands on it own, meaning that taking 72(t) IRA distributions from one account has no effect on the others. Therefore, if one IRA will produce more income than is needed, you could set up a smaller, segregated account to withdraw from. And in the future, if you need more income, you could begin equal distributions from another account as well. This could provide greater flexibility in meeting your immediate and future IRA distribution requirements.
There are three ways to calculate 72(t) IRA distributions and the selection gives taxpayers some flexibility.
An example of rule 72t applied:
Heather has $1 million in her IRA, is 57, and wants to retire. She’ll have enough to live on once Social Security starts at age 62. However, until that time, she will need an additional $12,000 per year to meet her living expenses. The IRA is her only investment asset. But she doesn’t want to pay the 10% penalty on early withdrawals for the next 2½ years. How much should Heather convert for section 72(t) IRA distributions?
The three distribution options would require that Heather commit the following amounts for Section 72(t) IRA distributions:
- Minimum Distribution Method - $334,800
- Fixed Amortization Method - $188,520
- Fixed Annuitization Method - $189,600
Since Heather does not want to withdraw any more than necessary, segregating $188,520 and using the Fixed Amortization Method for Section 72(t) IRA distributions is the most desirable strategy. This will give her $12,000 per year for five years until her Social Security begins.
Plus she’ll have the flexibility to take IRA distributions from her other IRAs without paying the 10% penalty after she turns 59 ½. And over the next 5 years, should she find she needs more income, she can segergate another IRA from her total IRA assets and place it on a 72t IRA distribution program.
dom pullano says
Once 72-t is started can it continue for more thsn 5 years if the recipient is still under 59 1/2?
Can I make a withdraw from my 72t ira account? I am needing a large distribution from my ira and do realize I will have penalties to pay. But, I do not know if I can make this withdraw while my ira is already paying me monthly through a Sep 72t.
Once you start the 72t distributions, you are locked in. (there is an exception that wont apply in your circumstance). For others reading this, the trick is to break your IRA into a few accounts. Then start the 72t distribution on just one account. That leaves you flexibility to do as you which with the other accounts not subject to 72t.
The question you need to ask an accountant--if you do take an "extra" distribution, will the penalty apply to just the extra one-time distribution (the good case) OR will the penalty apply to all prior distributions under your 72t plan (the bad case). If you have only been taking 72t distributions for a short time and have not taken much, then the "bad case" just mentioned may not be too bad.