A common question people have is how to access retirement money before age 59 1/2 if they want to retire early. If you have been diligently saving in tax-privileged accounts like an IRA or a 401(k) account, it can be frustrating to want to retire early only to find out that all of your retirement savings are locked away until age 59 1/2 unless you want to pay a 10% early withdrawal penalty.
There is actually a way that you can access retirement money early without paying a penalty, and it’s Rule 72(t). This rule allows what are called “substantially equal periodic payments” (SEPP) from an IRA or other eligible retirement account before retirement age and without paying a penalty. Keep in mind that it is not simply a matter of taking out money whenever you want. The payments must follow specific IRS rules, and we’ll cover all of the details you need to know below.
What Is Rule 72(t)?
Rule 72(t) is an exception under the current IRS tax code that allows penalty-free distributions from certain retirement accounts before age 59 1/2. It generally applies to IRAs and certain employer-sponsored retirement plans, but you need to be careful about the details of the distributions. Generally, money withdrawn under Rule 72(t) is subject to ordinary income tax if it’s taken out of a tax-deferred account like a traditional IRA or 401(k), but you would avoid the 10% early withdrawal penalty.
To take advantage of Rule 72(t), the withdrawals must be calculated under an approved method and must continue for the required period.
More information here:How Do Rule 72(t) Payments Work?
The IRS permits three calculation methods for Rule 72(t) payments:
- Required Minimum Distribution method: This recalculates the annual payment based on the account balance and life expectancy. Payments can change from year to year.
- Fixed amortization method: This produces a fixed annual payment based on the account balance, interest rate, and life expectancy.
- Fixed annuitization method: This uses an annuity factor to calculate a fixed annual payment.
All three of these payment methods use the IRS life expectancy and mortality tables, which can be found in IRS Publication 590b. A Rule 72(t) calculator can estimate the required payments, but any Rule 72(t) calculator is only as reliable as the assumptions and inputs you give it. Make sure that you verify the IRS rules before starting your payments.
How Long Must 72(t) Payments Continue?
The biggest risk of starting 72(t) payments is that it becomes a commitment that you must continue for a specified period of time, even if your tax, financial, or life situation changes. Once you start Rule 72(t) payments, you must continue them until age 59 1/2 or five years after the first payment, whichever is later.
This is not a flexible withdrawal strategy, and it’s important to understand the risks of that before starting these Rule 72(t) payments. If you stop taking the payments, the IRS may retroactively impose the 10% penalty on your prior distributions, and the government may also charge interest.
When Does Rule 72(t) Make Sense?
Here are some of the situations where you might consider SEPP:
- If you’re retiring before age 59 1/2.
- If you’re leaving a high-paying medical career early and want access to money tied up in retirement accounts.
- To fund the years between early retirement and access to other retirement assets.
- Accessing a portion of an IRA while preserving other accounts.
A high-income professional like a doctor should think carefully before committing to Rule 72(t), even if they want to retire early, since:
- The payment schedule may be too rigid.
- The account may be needed for other purposes.
- You may have other sources of income.
- A large SEPP distribution may increase taxable income.
Alternatives to Rule 72(t)
While taking SEPP under Rule 72(t) can make sense for early retirees, it’s important to understand that it’s not the only way to retire early. Other strategies may be available depending on the type of account you have and your circumstances. Here are a few to consider:
- Taxable brokerage accounts: These can provide flexible access before age 59 1/2.
- Roth IRA contributions: These contributions (but not necessarily the gains you make on the investment) generally can be withdrawn without tax or penalty.
- Roth conversion ladder: This may allow access to converted amounts after the required five-year period.
- Rule of 55: It may allow penalty-free withdrawals from certain employer plans after leaving a job after age 55
The best approach to early retirement is likely to use a combination of taxable assets, Roth assets, and retirement accounts rather than relying on one rigid withdrawal plan. The right strategy for you will depend on your age, your spouse’s age, the types of accounts you have, your tax bracket, any cash flow considerations, and your overall retirement timeline. Just like almost everything in personal finance, everyone’s situation is different.
More information here:The Bottom Line
Rule 72(t) allows penalty-free withdrawals through a series of substantially equal periodic payments (SEPP). It can be useful for someone who needs access to retirement funds before age 59 1/2, but the payments must be calculated carefully and continue for at least five years. You can use Rule 72(t) calculators to estimate your required payments, but make sure to carefully follow IRS guidelines. Breaking the rules can trigger penalties and interest on prior distributions.
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