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72t IRA early withdrawal bannerPeople often ask…

“How can I retire early and take money out of my 401k, 403(b),TSP, 457 plan and/or IRA without paying IRS the extra 10% “early withdrawal penalty?”

Early Withdrawals without Penalty

The IRS has a rule for an early retirement withdrawal tax exemption called a 72(t), associated with a “Substantially Equally Periodic Payments (SEPP)”   By using the IRS 72(t) rule, it ELIMINATES the 10% early withdrawal penalty normally due for withdrawals prior to age 59 1/2.

For example, let’s say you still work at your job, but you want to retire sooner than later (in this example that you’re 55 years old). First, you need  quit working. Second, you ROLL your 401k into an IRA. After completing the rollover, then you apply for a “SEPP.”  The IRS will offer you (3) optional payout amounts. The (3) IRS optional payout methods will reveal to you how much the “SEPP” will be, based on your age, the age of your beneficiary, the amount of money you have, the rate (%) used for the calculation and how long they expect you to live (based on IRS’s mortality table).

Here Is an Example of a SEPP  or 72(t) Distribution

An individual age 55 (with the same age beneficiary) who has $250,000 and wants to set up a 72(t), (using a rate of 4.23% for example) this would be the payout options to choose from:

72(t) Annual Payments Life Expectancy (29.6 Years)
$8445.95/year ($703.83/mo) Minimum Distribution Method
$14894.53/year ($1241.21/mo) Amortization Method
$14797.28/year ($1233.11/mo) Annuitization Method

(NOTE: This information was provided by Prudential’s customer service dept.)


The rule states, once completing a rollover and 72(t) setup to pay out an income stream, it must continue until the age of 59 ½ or for a minimum of 5 years, whichever comes last. For example, if you start a 72(t) at the age of 57, it must run until you are age 62, then it stops. If you are age 50, then it runs until you reach age 59 ½, then it stops.

After the 72(t) has stopped, then of course you can take out of your IRA any amount you might desire or require. We need to point out, just for clarification, that your income received as fully “income taxable” at your applicable income tax rate, but without any added penalty.

NOTE: The above calculations are based on the IRS 72(t) rules, as established by Congress, effective January 1st, 2003.


 

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When can I take money out of an IRA without penalty?

Starting at Age 59½, you can begin taking money out of your retirement accounts without penalty. Keep in mind that you will have to pay any federal or state taxes that might be due.

Distributions from Traditional IRAs prior to Age 59½ are subject to a 10% penalty, in addition to applicable federal and state taxes. Under the following circumstances, you may be able to avoid the penalty on early withdrawals:

  1. Distributions for a first time home purchase
  2. Paying for higher education expenses
  3. Paying for medical expenses
  4. If you separate from service
  5. And finally, establishing a series of Substantially Equal Periodic Payments (SEPP)

Does 72(t) apply to a Roth IRA or any non-IRA accounts?

72(t) distributions are not applicable to a Roth IRA, as the dollars that were originally contributed to the Roth IRA have already been taxed. With a 401(k), contributions are traditionally deducted from your paycheck and your taxes are deferred until a later date. With an IRA, if you fall within a particular threshold of annual income, your annual IRA contributions are deducted from your Adjusted Gross Income so you haven’t paid taxes on those dollars yet either.

Roth IRA contributions have already been taxed, so 100% of your principal is tax free upon distribution (assuming it’s been open for 5 years and you are over Age 59 ½). Early withdrawal penalties will only be assessed to the extent that there are gains, and there is not a 72(t) exception for those penalties.

As for any other non-IRA accounts, the only exception is Non Tax-Qualified Annuities. Annuities are retirement vehicles, so even policies funded with post-tax dollars will be assessed the early withdrawal penalty if funds are taken prior to Age 59 ½. You CAN structure a 72(t)-like distribution from these annuities also. This strategy is specifically referred to as a 72(q) distribution. The payment method and options available are all the same.

 


Do I have to “rollover” my money to an IRA to access my money through a 72(t) distribution?

The answer is no, but in many cases, we recommend that you do. Employer sponsored retirement plans often carry restrictions on withdrawals and limited investment options, as well as other considerations. By “rolling” the funds into an Individual Retirement Account, you are in control of the distributions and the universe of investment options available to you. Applicable fees will vary depending on the investments chosen to fund the 72(t), but they are typically and can be much lower than fees paid through an employer sponsored plan.


Can you take a loan from your IRA?

You might be able to use your IRA assets for a short period of time using a 60 day rollover. However, you must follow the rules carefully to avoid paying a penalty. You must pay the money back and place it into the same IRA or another traditional IRA within the 60 calendar day window required by federal law. If you do not pay back the full amount within the 60 days, it will likely be considered a distribution and you’ll owe income tax on it. In addition, it may also be subject to the 10% early withdrawal penalty if you are younger than 59 ½. There are certain situations in which you may avoid the early withdrawal penalty, such as a first-time home purchase, health expenses, medical insurance, educational expenses, disability and Substantially Equal Periodic Payments.

If you would like help properly structuring your early retirement, please contact us today.


 

Speak with a Professional before Exploring a 72t Exception

Completing an early retirement 72t exception correctly, will provide a stream of retirement income. But, if it’s done incorrectly, possibly by withdrawing too much and you can end up broke! Plus, the IRS may assess the 10% penalty on all amounts withdrawn, if the IRA account runs out of money before the end of the 72(t) scheduled time frame. That’s the rule. Therefore, it’s imperative you work with someone, who has experience with the entire 72t process. CD’s can not be used effectively as an investment vehicle for a 72(t) distribution.

Not all (Financial Advisors, CPA’s, Attorney’s or otherwise) know about this little known 72(t) IRS rule. Also, NOT ALL companies know how to do a 72(t), or how to set it up properly, or even have the mechanical or electronic means available, to do such distributions! Very few fixed annuities will work (but some may) because most fixed and Indexed annuities do not allow withdrawals during the first year of the contract and/or greater withdrawals than the earnings growth. Also, most IRA owners want to withdraw more than the growth generated by most fixed and indexed annuities.

Effectively Structuring a 72(t) Distribution

We can provide you examples of the few that will work effectively. Just ask and we can e-mail that information to you. We have effectively set-up 72t distributions for income withdrawals prior to age 59 1/2 many times throughout our 50+ years and it works, if done correctly. It is completely legal and anyone (at any age) can use a 72(t). The most commonly used (effective) investment vehicles for a 72(t) are variable annuities.

One of the main reasons, is the fact that today’s variable annuities allow you to actively invest your money so it can continue to grow, offer diversification and protection, all at the same time, while you are pulling an income stream from it. Fixed accounts, stock portfolios, CD’s and MOST fixed annuities, are often not the most ideal for doing a 72(t). The reason being, as stated previously, that the amount desired to be withdrawn from a 72(t) often does not adequately match the amount of growth or offer the appropriate amount to be withdrawn. Many companies and many advisors, simply do not know HOW to properly do a 72(t). Work with someone who is experienced and knowledgeable in this very special area.


72t Payments, 401(k), TSP, 403(b), 457 plan or IRA Evaluations

Would you like an ESTIMATE of what your 401(k), TSP, 403(b), 457 plan or IRA might produce for an income, using a 72(t) for early withdrawals to eliminate the IRS penalty.

Simply provide: your age, your beneficiaries age, the amount of money in your retirement plan and using the current rates with my 72t calculator I’ll prepare an income estimate for you.

This early withdrawal system also works for non-IRA annuities as well, to eliminate the IRS 10% early withdrawal penalty on non-qualified money in any annuity. It’s called a 72(q) for non-qualified annuities but works the same as a 72(t) for IRA’s. Got a Question?

NOTE: Investment return and principal value will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. Past performance is no guarantee of future results.

Dollar Cost Averaging does not assure a profit nor does it protect against loss in declining markets. The above reference is NOT an offer to sell a product or service.


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72t professor iconQ: How do I get my retirement money or 401(k) without penalty?

A: If you take a distribution from your retirement plan early, “meaning before the day you turn 59 ½ or age 55 if still in a 401(k),” you will generally have to pay a 10% early distribution penalty above and beyond any regular income taxes you may owe on the money.

Of course, it’s generally a bad idea to dip into your retirement plan early except in extraordinary circumstances. But when using your retirement funds is your only option, it’s good to know that there are several ways to avoid the extra 10% penalty on early distributions.

Important:Establish a series of SUBSTANTIALLY EQUAL PERIODIC PAYMENTS (SEPP).

 


72t professor iconQ: When can I take money out of an IRA without penalty?

A: Starting at Age 59½, you can begin taking money out of your retirement accounts without penalty. Keep in mind that you will have to pay any federal or state taxes that might be due.

Distributions from Traditional IRAs prior to age 59½ are subject to a 10% penalty, in addition to applicable federal and state taxes. Under the following circumstances, you may be able to avoid the penalty on early withdrawals:

  • Distributions for a first time home purchase
  • Paying for higher education expenses
  • Paying for medical expenses
  • Separated from service
  • And finally…… ESTABLISHING A SERIES OF SUBSTANTIALLY EQUAL PERIODIC PAYMENTS

 


72t professor iconQ: What age can you withdraw from a 401(k) without penalty?

A: If you are under Age 55, and you still work for the company where your 401(k) plan is, you will have only a few limited options to tap 401(k) funds, such as taking a 401(k) loan or a hardship withdrawal – IF the company allows these options.

If you’re no longer employed by the company, you can roll the funds over to an IRA, or cash in the 401(k) plan. Be careful on cashing in – if you cash in you may void valuable creditor protection that stays in place when you keep the funds in the plan.

If you are retired, most 401(k) plans allow for penalty-free withdrawals at age 55 instead of having to wait until 59 1/2.
To use this 401(k) retirement age 55 provision your employment must have ended no earlier than the year in which you turn Age 55, and you must leave your funds in the 401(k) plan to access them penalty-free. (For many police, firefighters and EMTs, this provision makes funds accessible as early as Age 50, rather than 55.)

 


72t professor iconQ: Can you take a loan from your IRA?

A: You might be able to use your IRA assets for a short period of time using a 60 day rollover. However, you must follow the rules carefully to avoid paying a penalty. You must pay the money back and place it into the same IRA or another traditional IRA within the 60 calendar day window required by federal law. If you do not pay back the full amount within the 60 days, it will likely be considered a distribution and you’ll owe income tax on it. In addition, it may also be subject to the 10% early withdrawal penalty if you are younger than 59 ½. There are certain situations in which you may avoid the early withdrawal penalty, such as a first-time home purchase, health expenses, medical insurance, educational expenses, disability and Substantially Equal Periodic Payments.

 


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72t professor iconQ: Are there any early 401(k) distribution options including 72(t)?

 

A: If you separate from service in the calendar year in which you turn 55 or later, you may be able to take distributions from your 401(k) penalty free; however, income taxes will still apply. There are additional exemptions which may allow you to avoid the early withdrawal penalty, such as: permanent disability, medical expenses that exceed 7.5% of your adjusted gross income, death of the plan participant, payments under a QDRO, certain distributions to qualified military reservists called to active duty and 72(t) (also known as series of substantially equal periodic payments or SEPP).
If you would like help properly structuring your Early Retirement, please contact us today.

 


favicon 72t professorQ: How can I take out my 401(k) money without penalty?

A: There are certain exemptions that could keep you from paying the 10% early withdrawal penalty. These are called hardship exemptions and give you an option to access your funds – provided you meet the criteria. Hardship exemptions include:

  • Death of the plan participant
  • Became permanently disabled
  • Paid out of pocket for medical expenses
  • Forced to disburse funds by a court order
  • You’re over the age of 55 and retired or left your job
  • Substantially Equal Periodic Payments

Those are the hardship exemptions – and the IRS is very strict when it comes to giving them out. Basically, this isn’t for buying a new house (something that’s allowed under an IRA), or a new boat, or putting someone through college, or fixing up your home. This is an emergency measure and you have to demonstrate real need – not only to the federal government but also to your employer, who may have additional withdrawal guidelines you have to follow.


 

72t professor iconQ: When can you take money out of a 401(k) without penalty?

A: The standard age for taking money out of your 401(k) plan is 59 ½. So, if you are over that age then you can take your money out as a dispersal and you’ll just pay ordinary income tax.
There are other situations where you can withdraw cash from your 401(k) plan before the age of 59 ½ without paying a penalty. Such situations include:

  • Becoming permanently disabled
  • You pass away and the account is paid to your beneficiary/estate
  • Making an allowable medical expense deduction
  • You’re separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turned 55 or later
  • Paying a levy on the 401k plan itself

In these instances the normal income tax rules apply, but you won’t pay the early withdrawal penalty. Keep in mind, you may want to consider what is known as a 72(t) Distribution Plan, which may be the solution.

 


72t professor iconQ: What are the reasons to take money out of a 401(k) without penalty?

A: You may qualify to take a penalty-free withdrawal if you meet one of the following exceptions:

  • You become totally disabled.
  • You’re in debt for medical expenses that exceed 7.5% of your adjusted gross income.
  • You are required by court order to give the money to your divorced spouse, a child, or a dependent.
  • Separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.
  • You’re separated from service and you have set-up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy.

(Once you begin taking this kind of distribution you are required to continue for five years or until you reach Age 59 1/2, whichever is longer.) This is an area that we specialize in and can offer guidance and counsel.

 


72t professor iconQ: At what age can you withdraw from a 401(k) without penalty?

A: The Age 59½ distribution rule says any 401(k) participant may begin to withdraw money from his or her plan after reaching the age of 59½ without having to pay a 10 percent early withdrawal penalty.
There is an exception to that rule, however, which allows an employee who retires, quits or is fired at Age 55 to withdraw without penalty from their 401(k). There are (3) key points early retirees need to know.
First, this exception applies if you leave your job at any time during the calendar year in which you turn 55, or later, according to IRS Publication 575.
Second, if you still have money in the plan of a former employer and assuming you weren’t at least Age 55 when you left that employer, you’ll have to wait until Age 59½ to start taking withdrawals without penalty. Better yet, you may want to get any old 401(k)’s rolled into your current 401(k) before you retire from your current job so that you will also have access to these funds penalty free.
Third, this exception only applies to funds withdrawn from a 401(k). IRAs operate until different rules, so if you retire and roll money into an IRA from your 401(k) before Age 59½, you will lose this exception on those dollars.

 


72t professor iconQ: Do I pay any taxes on a 72(t) distribution?

A: The answer is YES. Remember, retirement accounts are 100% tax deferred until you start taking withdrawals. Whether you are at, above, or under Age 59 ½, 100% of the dollars taken from your retirement account will be added to your income when filing your taxes. If you withdraw funds prior to Age 59 ½ without utilizing a known exception, a 10% early withdrawal penalty will be added to the tax liability for those dollars. So, by taking income through a 72(t) you are not avoiding income tax, but you are avoiding the 10% early withdrawal penalty.

 


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Q: How are 72(t) distributions calculated?

A: There are (3) standard methods the IRS allows us to use in determining a 72(t) distribution:

  • Amortization Method
  • Annuitization Method
  • Required Minimum Distribution Method

We have specialized software that helps us to customize a plan and select the appropriate payment method for you. Each method will provide a different monthly or annualized distribution amount. The method that will be used will depend on the amount of income that you need and your personal situation. We can help you determine which method will efficiently generate the income you need.

 


72t professor iconQ: How is Life Expectancy determined and what interest rate is used?

A: The life expectancy tables that can be used are:

  • Uniform Life Table
  • Single Life Table
  • Joint Life and Last Survivor Table

The most common table used is theUniform Life Table, and all three tables can be found on the IRS.gov website.

The maximum 72(t) interest rate allowed is the greater of 120% of the Federal Mid-Term annual rates of the (2) months immediately preceding the month that you start distributions. Please note this is NOT the interest rate to expect on the actual investment that the 72(t) distribution is coming from. It is simply the factor used to calculate the allowed amount that you can take for this valuable strategy. Current rates can also be found on the IRS.gov website.

 


72t professor iconQ: Does 72(t) apply to a Roth IRA or any non-IRA accounts?

A:72(t) distributions are not applicable to a Roth IRA, as the dollars that were originally contributed to the Roth IRA have already been taxed. With a 401(k), contributions are traditionally deducted from your paycheck and your taxes are deferred until a later date. With an IRA, if you fall within a particular threshold of annual income, your annual IRA contributions are deducted from your Adjusted Gross Income so you haven’t paid taxes on those dollars yet either.

Roth IRA contributions have already been taxed, so 100% of your principal is tax free upon distribution (assuming it’s been open for 5 years and you are over Age 59 ½). Early withdrawal penalties will only be assessed to the extent that there are gains, and there is not a 72(t) exception for those penalties.

As for any other non-IRA accounts, the only exception is Non Tax-Qualified Annuities. Annuities are retirement vehicles, so even policies funded with post-tax dollars will be assessed the early withdrawal penalty if funds are taken prior to Age 59 ½. You CAN structure a 72(t)-like distribution from these annuities also. This strategy is specifically referred to as a 72(q) distribution. The payment method and options available are all the same.

 


72t professor iconQ: What will it cost me to set up a 72(t) distribution?

A: There are (2) ways we typically work with people, and there are (3) steps that we take:

  1. Become familiar with you and your situation as well as your goals and objectives
  2. Determine the correct payment method and amount to take as well as how to properly structure your accounts based on your unique situation
  3. Create, implement and execute a suitable and sustainable Early Retirement game plan

 

Managing the early distribution accounts and payments for you, accrue no additional fee.

Some people approach us looking for the 72(t) calculation and investment advice, but prefer to manage the money themselves in their existing accounts. While we don’t recommend this, we are happy to run the calculations, draw up a detailed game plan and provide a proposal that lays out everything we would do if we were managing the account. We do this on a flat fee basis. The fee will depend on the complexity of your situation and the amount of time and work involved. We believe this would be a small investment compared to the thousands and even tens of thousands of dollars it would cost you if your 72(t) plan is NOT properly structured.

 


72t professor iconQ: Is it possible to use the 72(t) exemption rule if you only want to withdraw a small amount of money from your retirement account (not the entire balance as the rule states)?

A: Although the 72(t) rule does indeed state that you must take the equal periodic payments in such a way that the ENTIRE retirement account balance is depleted over your remaining life, there is a solution to get around this. You can open multiple retirement accounts and can choose to only apply the 72(t) distributions to just one of your retirement accounts (not all of them). This can most times be a complex process. We have a highly trained and experienced staff to assist and oversee that this is done in the proper manner. A mistake here could be VERY costly.


Accessing 401(k) money using 72t

 


72t professor faviconQ: Can you still contribute to a retirement account while taking 72(t) distributions?

A: Once you start your series of substantially equal periodic payments, you are not allowed to make any additional contributions to the account, including rollover contributions, direct transfers and/or annual contributions. However, right before you start the 72(t) income, you are allowed to move money between accounts. For example, if you have just one IRA with $200,000 in it, but you only wanted $50,000 in the account from which you are taking the series of substantially equal payments, you could transfer $150,000 to a separate IRA so it wouldn’t be affected.

Multiple IRA Accounts

If you have multiple IRAs and you are only taking 72(t) distributions from one of them, you can make your annual IRA contributions by contributing to a different IRA. For example, say you have one IRA at a Bank, another at a Mutual Fund company and a 3rd at an Insurance company. If you are taking 72(t) distributions from your IRA at the Bank, you can make your annual contributions to your IRAs at the Mutual Fund company and Insurance company without penalty, even though you are not allowed to add any money to the IRA at the Bank.

If you would like help properly structuring your Early Retirement, please contact us today.

 

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