Taking advantage of a tax-sheltered retirement vehicle like an IRA or 401(k) account is advice you’ll find included in every solid financial plan. However, we do have to make sacrifices to access the tax benefits. Contribution maximums limit the amount of cash we can sock away, and IRAs are unavailable to those with high incomes.

But the biggest sacrifice is waiting. If you begin saving for retirement at age 29, you’ll have three decades to wait until you can begin taking distributions at age 59 ½ to avoid the penalty tax. There is one way around the minimum distribution age, although you should consider it somewhat of a nuclear option. According to the IRS, you can tap your IRA or 401(k) early if you abide by certain rules and restrictions. But these rules are very strict and you might cause your nest egg to become depleted far too quickly. Let’s take a look at the 72(t) rule for distributions.

If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.

What is Rule 72(t)?

At first glance, you might think 72(t) refers to mandatory distributions, i.e. the age you reach when you must begin taking money out of your 401(k) or IRA. But it actually refers to Code 72(t), Section 2 of the tax code governing IRA distributions. Money put into an IRA isn’t locked in a safe—you can technically withdraw at any time, but you’ll be subject to the 10% early withdrawal penalty.

But Rule 72(t) waives that penalty if certain conditions are met regarding the withdrawals. You can begin tapping your retirement accounts immediately as long as you take Substantially Equal Periodic Payments (SEPPs).

Substantially Equal Periodic Payments (SEPPs)

To access your 401(k) or IRA funds early, you need to take at least five Substantially Equal Periodic Payments (SEPPs) in consecutive years to avoid the penalty. As you might deduce, SEPPs are equal amounts withdrawn on a specific schedule, usually taken annually. Calculation of SEPP amounts is done in three different methods:

Amortization: SEPP amounts are calculated based on the balance of the account and the owner’s life expectancy. Payments are fixed using this method but usually max out the available amount.

Annuitization: Works similar to the amortization method, but uses a mortality table like an annuity to calculate payments. Payments vary with lower amounts to start and higher amounts as you age.

Required Minimum Distributions: SEPPs are determined using the RMD tables on the IRS’s website. Like amortization payments, these amounts are fixed but are usually the lowest of the three IRS-approved factoring methods.

No matter how you calculate your SEPP amounts, you must take them over five years or until you reach age 59 ½, whichever is longer. So even if you begin taking early payments at age 58, you’ll need to continue on the same schedule until age 63.

Drawbacks of Early Withdrawals via the 72(t) Rule

The 72(t) rules have many stipulations that must be followed to avoid the early withdrawal tax. Here are a few things to consider before taking money out of your retirement account early:

SEPP amounts might not be fixed, but your payment schedule is. Once you’ve accessed this program, you’re locked in for at least five years. Even worse, if you begin taking SEPPs very early (ie. age 47), you’ll be forced to follow that same schedule until you hit age 59 ½.

The early withdrawal penalty tax can be applied retroactively. If you change your payment schedule, you’ll be hit with the 10% tax not just on payments moving forward, but also on all the payments you’ve previously taken.

You don’t get to choose your payment amounts. The IRS has its three approved methods with their individual calculators, but other methods can be used for the calculation. However, you’ll never get to choose your annual payment amount—you’ll always be at the mercy of the charts and tables.

Avoid Utilizing the 72(t) Rule If Possible

If you have money problems and need to tap your retirement accounts to avoid massive headaches in the present, then using the early withdrawal schedule provided by Rule 72(t) could make sense. But, as mentioned above, this is the nuclear option and should be saved until there’s no alternative. You’ll be locked into at least five years of SEPPs and won’t have the option to cancel or alter the schedule until you complete your term. If you’re having financial difficulty and are considering using Rule 72(t) for early IRA access, be sure to consult with an advisor first and make sure it’s truly the only course of action remaining.

Work With an Experienced Financial Advisor

If you have any questions about the 72(t) rule for distributions or need help creating a personalized financial plan, reach out to a team member from Good Life Financial Advisors of Mount Pleasant today.