Rule 72(t) allows penalty-free withdrawals from IRA accounts and other tax-advantaged retirement accounts such as 401(k) and 403(b) plans. Issued by the Internal Revenue Service, this rule enables account holders to access their retirement savings before reaching retirement age, avoiding the otherwise mandatory 10% penalty. However, these withdrawals are still subjected to the account holder’s normal income tax rate.
Key Takeaways
- Rule 72(t) provides penalty-free early withdrawals from your IRA.
- Other IRS exemptions exist for specific circumstances like medical expenses and purchasing a home.
- Rule 72(t) withdrawals should be a last resort when all other options have been exhausted.
Understanding Rule 72(t)
Rule 72(t) refers to code 72(t), section 2, detailing exceptions to the early-withdrawal tax. This code allows IRA owners to withdraw funds before age 59½ if they meet certain qualifications, also known as SEPP regulations.
To utilize Rule 72(t), retirement account owners must take at least five substantially equal periodic payments (SEPPs). These payments are based on the owner’s life expectancy, calculated through IRS-approved methods. Withdrawals must follow a specific schedule, with the IRS offering three different methods for calculating your withdrawal schedule. The schedule must be strictly adhered to for five years or until you reach age 59½, whichever comes later, unless in cases of disability or death.
Calculation for Payment Amounts Under Rule 72(t)
The periodic payments under Rule 72(t) depend on life expectancy, calculable through one of three IRS-approved methods:
- The amortization method: This method amortizes the balance over single or joint life expectancy, resulting in fixed annual amounts, typically the largest permissible withdrawal.
- The minimum distribution method: Using a dividing factor from the IRS’s life expectancy table, this method results in the lowest permissible healthily fluctuating payouts annually.
- The annuitization method: This uses an annuity factor from the IRS to determine almost equivalent payments, offering a balance between the lowest and highest withdrawal amounts.
Example of Withdrawing Money Early
Consider a 53-year-old woman with an IRA earning 1.5% annually and a balance of $250,000 who wishes to withdraw early under Rule 72(t):
- With the amortization method, she would receive about $10,042 annually.
- Using the minimum distribution method, she would get approximately $7,962 annually over five years.
- With the annuitization method, her annual payment would be around $9,976.
Cautions About Using Rule 72(t)
Withdrawing funds from a retirement account should be a measure of last recourse. The IRS provides exceptions for situations like disability and illness. If no other exceptions apply, Rule 72(t) can be utilized as a solution after all other funding options have been considered. Avoid using this rule as part of an emergency fund as withdrawals can have significant long-term impacts on your financial health and stability.
Related Terms: IRA, 401(k), SEPP, Early Withdrawal Penalty, Life Expectancy Calculation, Annuity Factor Method.
