72(t) Distributions from your Retirement Account

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I am often asked, "How can I retire early and take money out of my 401k, 403(b), TSA, 457 plan and/or IRA before age 59 1/2? I don't want to pay the IRS an extra 10% early withdrawal penalty off my retirement distributions!

It's very easy to do. As a matter of face, I have done it MANY times! By using IRC Section 72(t), it is possible to eliminate the 10% early withdrawal penalty normally due for distributions from an IRA prior to age 59 1/2, also called taking "substantially equal periodic payments".

How 72(t) Retirement Distributions Work

Let's say you are still working but want to retire (in this example)at the age of 55. First you quit working, then you rollover your 401k into an IRA. After the rollover is completed you apply for a 72(t) "substantially equal periodic payments". The IRS will offer you 3 optional payout amounts. The 3 IRS optional payout methods will tell you how much the "substantially equal periodic payments" will be based on your age, the age of your beneficiary, the amount of money you have, the % rate used for the calculation and how long they expect you to live (based on IRS's mortality table).

The rule is, once a rollover is completed and a 72(t) is setup to pay out an income stream, it must continue until the age of 59½ has been reached or for a minimum of 5 years, whichever comes last. For example, if you start a 72(t) at the age of 57, it must run until you are age 62, then it stops. If you are age 50, then it runs until you reach age 59½, then it stops.

After the 72(t) has stopped, then of course you can take out of your IRA any amount you might desire or require. I need to point out, just for clarification, that YES all the income you receive is fully taxable at your applicable income tax rate but without any added penalty. NOTE: The above calculations are based on the NEW IRS 72(t) rules, as established by Congress, effective January 1st, 2003

A Word of Caution when Using 72(t) Distributions!

Do it right and it works beautifully. Do it wrong by withdrawing too much and you can end up broke! PLUS, the IRS may assess the 10% penalty on all amounts withdrawn, if the IRA account runs out of money before the end of the 72(t) scheduled time-frame. That's the rule. Therefore, it's imperative you work with someone who knows what they are doing when setting up a 72(t) distribution.

Not all Financial Advisors, CPA's, Attorney's or Insurance Agents, know about this little known 72(t) IRS rule. Also, NOT ALL companies know how to do a 72(t), or how to set it up properly, or even have the mechanical or electronic means available, to do such distributions!

I have effectively set-up 72(t)'s for income withdrawals prior to age 59 1/2 many times throughout my years and it works perfectly, if done correctly. It is completely legal and ANYONE (at any age) can use a 72(t)!

A 72(t) Distribution is a Powerful Planning Tool

If you have the good fortune to be able to retire early, a 72(t) distribution can be an absolute godsend. The rule saves you 10% in early withdrawal penalties, and can be the deciding factor in making your early retirement a reality!



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Personal Finance , Insurance , Retirement

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