Using a 72(t) Distribution for Early Retirement


Have you heard of Rule 72(t) at some point in your retirement planning? Sometimes you need early access to your retirement accounts; that is, you need to make withdrawals before you reach 59.5.

You can avoid the 10% early withdrawal penalty, even if you don’t meet one of the exceptions, by taking substantially equal period payments under IRS Rule 72(t). To avoid the penalty, you must:

• Follow all the rules and use the funds for any purpose
• Adhere to the strict IRS guidelines
• Not adjust distributions for inflation or any other reason
• Pay taxes on withdrawals from accounts funded with pre-tax dollars

In this article, we will go over more of how IRS Rule 72(t) works, in what situations it might be an option to consider, and what to think about if you are considering it.

What Is a 72(t) Distribution?

IRS Rule 72(t) allows you to make penalty-free withdrawals from IRAs and other tax-qualified retirement accounts like 401(k) and 403(b) accounts.

Rule 72(t)(2) specifies exceptions to the standard 10% early withdrawal penalty usually imposed on withdrawals before age 59.5. The exceptions apply when the account owner meets the requirements of the Substantially Equal Periodic Payments (SEPP) rules.

To take advantage of Rule 72(t), the account holder must take at least five SEPPs. The amount to be taken depends on the account owner’s life expectancy calculated in accordance with IRS rules. You must take out the funds on a set schedule, calculated under one of three IRS-approved methods.

Once you have chosen a payment schedule, you must stick with it until five years have passed or you have reached 59.5, whichever comes later of these two. Keep in mind that there are generally no takebacks with Rule 72(t).

Of course, you may also become eligible for a standard exception, such as becoming disabled, which will also end your SEPP. 

How Does a 72(t) Distribution Work?

As we said, there are three IRS-approved methods for calculating your life expectancy for purposes of Rule 72(t). Generally, once you have chosen a particular method, you must stick with it.

The IRS will allow a one-time move from the amortization or annuitization methods to the minimum distribution method (more on these methods below). This ability to switch to an annual recalculation SEPP helps investors who have suffered big losses reduce their distributions and let their remaining assets last longer.

One important note – your withdrawals will be taxable income. Not only will they potentially raise your tax bracket, but the taxes on the 72(t) funds will be at your marginal rate.

You are also limited in that you can’t add money to the account subject to the SEP while you have a set payment schedule in place. Nor can you make any other withdrawals.

In other words, your account is, in effect, frozen until you complete your SEPP payments. It’s probably not bad to establish more than one tax-qualified retirement account prior to starting a SEPP on some of your retirement assets. 

Certain situations will allow you to end a SEPP payment plan. For example, if you become disabled, you can stop the payments because the disability is an exemption from the 10% penalty by itself. Other exemptions which can end your SEPP include:

  • Certain kinds of illness,
  • Qualified educational expenses, and
  • First-time home purchases.

Is a 72(t) Distribution Right for You?

A 72(t) payment plan can be right for you if you are under 59.5 and don’t qualify for any of the above exemptions.

You can consider using it if you have a well-structured retirement plan that includes multiple different assets. You should also be comfortable with the time commitment that comes with 72(t) payments and the impact that those time requirements will have on your long-term retirement assets.

A 72(t) plan might be an option for you if you are in a unique employment situation, such as being a federal government employee, and separation from service or early retirement might be an option.

Finally, you may be a candidate for a 72(t) plan if you are considering retiring early (or have received an early retirement notice or offer from your employer) and will need to tap into funds before age 59.5.

Three Methods for Taking Substantially Equal Periodic Payments

There three Rule 72(t) methods approved by the IRS for taking SEPPs, which are:

  • Amortization method
  • Minimum distribution of life expectancy method
  • Annuitization method

Let’s go over each of these three methods in more detail.

Amortization Method

The fixed amortization method is one of the three IRS-approved ways by which early retirees – that is, those under 59.5 – can gain access to their retirement funds without paying penalties.

Amortization spreads the retiree’s account balances over their remaining life expectancy, as estimated on IRS life expectancy tables, at a certain interest rate. This interest rate can’t exceed the higher of 5% or 120% of the federal mid-term rate (rates for obligations with maturities of more than three and up to nine years).

In most cases, the withdrawal amount can’t, once it’s calculated, be changed or ended until the retiring account owner reaches age 65. If there is a change, the account owner must pay a penalty of 10% plus interest per year, beginning with the year of the first distribution payment, up to the year of the change. Ending the withdrawal payments also leads to penalties.

The amortization method isn’t commonly used because it’s so inflexible. On the other hand, it does result in higher payments than the required minimum distribution method. Nonetheless, it’s highly complex and runs the risk of not keeping up with inflation.

Minimum Distribution of Life Expectancy Method

Unlike the amortization method, the minimum distribution method requires annual recalculation. This method is the simplest but also generally results in the lowest annual payment.

It also features the least risk of running out of money, since payments reset in the event of a big drawdown on the account balance.

As with required minimum distributions, you look up your age on the applicable table, which will give you the number of payments to divide your assets by. Divide your assets by that number, and you have your distribution amount for the year.

The minimum distribution method requires that you recalculate every year. But that can be a good thing.

Say that you set up your SEPP when you had a million dollars and then took a big account loss. The other methods would leave you locked into the very high payments calculated before your loss. In the minimum distribution method, you would have to recalculate after that loss, and the reduced payments can extend how long that your assets might last.

Annuitization Method

The third method by which early retirees can access their retirement money before 59.5 is the fixed annuitization method. The annuitization method divides the retiree’s account balance by an annuity factor taken from IRS tables to determine an annual payment amount.

If you use the fixed annuitization method, you will be locked into this withdrawal amount until your SEPP payment schedule ends. However, you do have a one-time option of switching to a minimum distribution method. 

The annuity factor used to calculate your withdrawals is based on IRS mortality tables. As with the fixed amortization method, an interest rate less than the greater of 5% or 120% of the federal mid-term rate. Once the payment is determined, you can’t change it.

The annuitization method is the most complicated of the three methods. However, sometimes it offers the highest payments.

Why Would You Want to Consider a 72(t) Distribution?

A 72(t) payment plan is a ‘last resort.’ Financial experts say to use it if you have no other exemptions from early withdrawal penalties available to you.

The payment schedules as discussed can, however, be an essential early retirement tool. If you are ready to leave the workforce or you have been offered early retirement from work and aren’t yet 59.5, 72(t) can be very useful for you.

Of course, “not yet 59.5” is a pretty broad term. Given the permanency of a SEPP and the fact that you can’t contribute to any account when using a SEPP on that account, you probably shouldn’t do this if you are 32.

On the other hand, if you are 54 and losing your job, it might be worthwhile to consider this. This withdrawal plan will cover you until you reach 59.5 and can take penalty-free distributions based on age alone.

You might also use a SEPP where you have a lot of assets in the retirement account and want to retire early.

If you are losing your job, especially when you are near retirement age, a 72(t) distribution program can help convert retirement assets into something like an income stream.

Remember, though, that SEPPs are quite complex, and a financial professional can be a big help if you are considering taking advantage of Rule 72(t).

How to Set Up a 72(t) Distribution

Setting up a 72(t) SEPP plan is relatively simple. You need to schedule payments and make these scheduled payments until you satisfy the payments duration of either at least five years or reaching 59.5, whichever is longer.

Of course, the SEPP is permanent and can draw down your retirement savings rapidly. It’s therefore good to work with a financial professional who can help you make choices in your best interest.

Work with a financial professional who can help you analyze the payments and lengths of time available to you before you do anything. Also, there are online calculators which can help. Just doing this homework before taking that first withdrawal can make a real difference.

Can You Take a 72(t) Distribution While Working?

Yes, you can take a 72(t) distribution plan while you are still working. The IRS doesn’t care about anything except the account the money is coming from. Your employment status and possible other income aren’t really relevant to a SEPP.

However, you can’t take SEPP withdrawals from an account at an employer you are still working for. Retirement accounts at your present job aren’t eligible for 72(t) distributions.

72(t) Distribution Pros and Cons

The most obvious “pro” to a 72(t) SEPP is that it gives you penalty-free access to retirement savings before age 59.5. You have some flexibility in how to set up your payments, and that choice is a pro as well.

On the other hand, once you start your SEPP, it’s pretty much permanent, with only a one-time switch to the required minimum method available. Also, the withdrawn funds are taxable in the year withdrawn. Thus, your withdrawal timing can have a big impact on your tax situation.

72(t) distributions are also technical and complex. Mistakes can be very costly, requiring payment of all of the avoided penalties.

Because of this complexity and financial risk, you should work with a trusted financial professional to help you decide if and when this option might be right for you.

Final Thoughts on Whether This Distribution Strategy is Right for You

Once again, the most critical decision you can make about whether to take a SEPP is deciding to work with a financial professional. No matter the method or conditions supporting your choice, mistakes are permanent and costly.

Withdrawing money from a retirement account is generally a last-resort option. That is why the IRS and Congress have provided you with some specific circumstances for penalty-free withdrawals, such as disability and illness.

Even so, if you don’t meet any of the standard exemptions and you have run out of other options, you can use the 72(t) distribution program.

That being said, it’s good to not think of it as just another emergency fund. You are withdrawing money from your retirement assets, which will have long-term effects on your future financial outlook.

Talk to your financial professional about ways to use the money that you withdraw so they can still support your retirement.

Are you looking for a financial professional to help with this and other important retirement questions? Or perhaps you want a second opinion of your current retirement plan. For convenience, many independent financial professionals are available at You can connect with someone directly in our “Find a Financial Professional” section and discuss your situation with them. If you are looking for a personal referral, please call us at 877.476.9723.

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