$ ?s: 72(t) and other Early Retirement Distribution Options

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Q: I am 55 years old and was laid off recently. I am looking for work, but I may need to access retirement account money to get by for a while. I am told that 72(t) will allow me to take my money out early. Can you please explain all this to me?

Sincerely, Earl Lee

$ ?s answered by Matthew Illian, CFP®

 

Dear Mr. Lee,

Although the basic retirement plan distribution rules focus on age 59½, exceptions are available to those who have been thrown a vocational curveball. It is important to know the rules so you don’t get hit with a penalty when you withdraw your funds.

The first exception applies to those who plan to withdraw funds from their company’s 401(k) plan. If you are separated from service, you can access these funds anytime in the calendar year in which you turn 55. The key to this exception is that you can only access funds from the company retirement plan where you were most recently employed.

As with all pretax distributions, this money will be treated as taxable income, but if you are eligible, you will avoid an additional 10% penalty that is typically applied to early withdrawals from retirement plans.

There is a separate set of rules for those under age 55 or who are looking to distribute from an IRA. These rules focus on an exception called Substantially Equal Periodic Payments (SEPPs). This exception is often called “72(t)” because it is found in section 72(t)(2)(iv) of the Internal Revenue Code, and 72(q) is a related exception governing annuities.

These three approved methods of setting up a SEPP can be chosen based on whether you are trying to maximize or minimize the acceptable amount of your withdrawal:

  • Required minimum distribution method
  • Fixed amortization method
  • Fixed annuitization method

You can use the bankrate.com calculator to see how these methods create different distribution amounts. In today’s low interest rate environment, you can expect SEPP distribution amounts to be somewhere between 2% and 4% of the total portfolio value.

All three methods create SEPPs based on your life expectancy that must continue for a period of five years or until you reach age 59½, whichever is longer. At this modification point you can adjust or even abandon your distributions until age 70½, which is when they must resume.

SEPPS involve complicated calculations which is why I recommend seeking support from a qualified tax adviser and financial adviser during the initial setup.

 


 

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Matthew Illian was a Wealth Manager at Marotta Wealth Management from 2007 to 2016. He specialized in small business consulting, college planning, and retirement plans.