Retire Early Using a 72(t)

If you’re doing a good job of saving up for retirement and looking at the possibility of meeting your goals sooner than later, one of the next biggest hurdles you’ll have to overcome is how to physically get your money out of your retirement accounts.

For most personal accounts such as a 401(k), 403(b), or IRA, you have to wait until age 59-1/2 or get slapped with a hefty 10% penalty fee. There are special exceptions to the 401(k) and 403(b) that may allow you to access your money without penalty by age 55. But even still, what if you are able to retire even sooner than that?

Fortunately, this is where a 72(t) comes in.

A 72(t) is a little-known tax code within the IRS laws that allows an individual under the age of 59-1/2 to take their retirement income out of their retirement account through a series of Substantially Equal Periodic Payments (also called SEPP).

Understanding the process involved is pretty simple:

Step 1: Consult a professional to see if you qualify. If you do, rollover or transfer your 401(k), 457 Plan, TSA or 403(b) into an Individual Retirement Account (IRA).

Step 2: Apply for a 72(t) to receive Substantially Equal Periodic Payments.

Step 3: Choose one of the three payout amounts that the IRS offers you. The amount will be based on your age, the age of your beneficiary, the amount of money you have, the percentage rate used for the calculation and how long they expect you to live (based on IRS’s mortality table).

Example Courtesy of the Website “Dinkytown.net”:

Suppose an individual of age 50 with $500,000 rolled into an IRA sets up a 72(t). The beneficiary they select is also age 50. The current Mid-Term Applicable Federal rate is 1.43%. Crunching the numbers, the IRS will offer three distribution methods:

• 1) Required Minimum Distribution Method: $ $14,620 / year or $1,218 / month

• 2) Fixed Amortization Method: $ 18,587 / year or $1,549 / month

• 3) Fixed Annuitization Method: $ 18,498 / year or $1,542 / month

Want to try your own numbers? Visit this calculator at Dinkytown.net.

The rule is that once the 72(t) is in action, it must continue until the age of 59 ½ has been reached or for a minimum of 5 years, whichever comes last. In this example, since we started at age 50, we must continue to age 59-1/2 since it is longer than age 55. After reaching the 5 year or 59-1/2 constraint, you can then stop the 72(t) or continue to receive the distributions. If you stop, then the normal rules of an IRA take over and you are allowed to take out whatever amount of money you wish from your IRA.

Remember:

Just like with your retirement income streams, the 72(t) income is fully taxable to your normal tax rate.

IMPORTANT! Do not take out TOO much too early. Plan for a long, long life and make your money last. If you run the numbers and the 72(t) distributions are more than you’ll need, try rolling over only a portion of your retirement savings.

• Example: Out of a $500,000 401(k), try rolling over only $250,000 into an IRA and keeping the other $250,000 in the 401(k).

Related Posts on Retirement Planning:

1) How Your Retirement Income is Different from Now

2) Will Your Retirement Cost $2 Million?

3) When Can I Get My Retirement Savings?