When planning for retirement, it’s crucial to understand the various strategies and options available to you. One such strategy is the 72(t) SEPP distribution, an IRS approved rule that allows for penalty-free early withdrawals from retirement accounts. But are 72(t) distributions considered income? And how can one set up a 72(t) distribution? This article will answer these questions and provide a comprehensive guide on setting up a 72(t) distribution.
Understanding 72(t) Distributions
Before we delve into whether or not 72(t) distributions are considered income, let’s first understand what they are. A 72(t) SEPP distribution is an Internal Revenue Service (IRS) rule that allows individuals under the age of 59½ to take early withdrawals from their retirement accounts without incurring the usual 10% early withdrawal penalty. This rule can be beneficial for those who retire early or need access to their retirement funds before reaching the standard retirement age.
Are 72(t) Distributions Considered Income?
The short answer is yes; 72(t) distributions are considered income. When you make withdrawals from your retirement account under Rule 72(t), these amounts are included in your taxable income for the year. The amount of tax you’ll owe depends on your total income and your tax bracket.
It’s important to note that while these distributions allow you to avoid the early withdrawal penalty, they do not exempt you from paying taxes on this money. Therefore, when planning for a 72(t) distribution, it’s essential to consider the tax implications and possibly seek advice from a tax professional.
How To Set Up A 72(t) Distribution
Setting up a 72(t) distribution involves several steps:
1. Determine Your Need: Before setting up a Rule 72(t) distribution, ensure that this is indeed the best option for you. Consider other sources of income or savings that you could use instead of tapping into your retirement funds early.
2. Calculate Your Distribution: The IRS provides three methods for calculating your 72(t) distribution amount: the Required Minimum Distribution method, the Fixed Amortization method, and the Fixed Annuitization method. Each method will yield a different distribution amount, so it’s crucial to understand how each works and choose the one that best fits your needs.
3. Initiate The Distribution: Once you’ve determined your distribution amount, contact your retirement account custodian to initiate the distribution. You’ll need to provide them with specific information, including your chosen calculation method and the frequency of distributions. Also, confirm that your IRA custodian will properly code your distributions. This could avoid unnecessary aggravation with the IRS and keep you off their mailing list (not a good mailing list to be on)
4. Review Your Plan Regularly: After setting up a 72(t) SEPP distribution, it’s essential to review it regularly to ensure compliance.
Potential Pitfalls of a 72(t) Distribution
While a 72(t) distribution can provide much-needed income during early retirement or financial hardship, there are potential pitfalls to be aware of:
1. Commitment: Once you start a 72(t) distribution, you must continue it for five years or until you reach age 59½, whichever is longer. Stopping early can result in penalties.
2. Limited Flexibility: The annual withdrawal amount is fixed once you start a 72(t) distribution and cannot be changed unless under specific circumstances.
3. Market Risk: If the market performs poorly and depletes your retirement account faster than anticipated, you may run out of money sooner than expected.
Conclusion
In conclusion, while 72(t) SEPP distributions are indeed considered income and taxable accordingly, they offer an effective way for individuals under the standard retirement age to access their retirement funds without penalty. However, setting up a 72(t) distribution requires careful planning and consideration due to its tax implications and potential risks involved. Always consult with an experienced financial advisor who understands and has implemented this strategy for clients or a competent tax professional who can certify the calculation before initiating such distributions.
