72(t) for (an early) Retirement

72(t) for (an early) Retirement

In a previous article we talked about using the Rule of 55 to access our tax sheltered accounts prior to reaching age 59 1/2. This is a straightforward approach, but would require us to wait until we hit age 55. We want to consider options that we can use sooner!

There’s never enough time to do all the nothing you want


Another options that we can implement earlier is IRS code 72(t), section 2 that defines exemptions to the 10% penalty for early withdrawals from certain retirement accounts. Note that the withdrawals from a 401k or IRA would still incur income tax, since the accounts were funded with pre-tax dollars. The key is that the withdrawals must conform to “Substantially Equal Periodic Payment” (SEPP) rules. Specifically for 72(t), the payments must be taken for 5 years (5 annual payments) or until reaching age 59 1/2, whichever is longer. For example, if we decided to use this at age 57, we would need to continue taking the payments until age 62, even though we would have already reached the age 59 1/2 milestone.

The actual payment amounts are determined through one of three IRS approved methods:

  • Amortization Method
  • Minimum Distribution (aka Life Expectancy) Method
  • Annuitization Method

The actual calculations are somewhat complex, and it’s definitely recommended to consult with a Financial Advisor and/or Tax advisor! To give an idea, there is a calculator on Bankrate.com to estimate payments based on different parameters. Bankrate also has a nice breakdown of the calculations methods.

If I plug in some values based on my 401K and trying to get the highest payment, the payment comes out to $26,999 per year. This isn’t that much, but at the end of the 13 payments based on a current age of 48, the remaining balance would still be approximately $475K. I couldn’t find the details, but I’m guessing this is based on my 401k earning 2.36%, which is “fairly” conservative. 🙂 I hope to have a higher balance than that, and also have our Roth IRA and brokerage accounts available.

We would have to crunch more numbers, but if we both did this in the next year or two and generated ~$54K of taxable income (~$27K each) we may be able to make it work. One or both of us would keep working for awhile, or maybe we could get part-time jobs. There would also be the issue of health insurance, so lots of think about.

We would still have a decent amount in 401k accounts, plus our Roth IRAs that we hopefully don’t need to touch, and finally our taxable brokerage and Fundrise accounts. We can also continue working and contributing to our retirement accounts, since it is allowed while taking 72(t) distributions. However, it seems that the account used for the 72(t) payments can not have ongoing contributions or rollovers. I think that we would need to open traditional IRA accounts specific to the 72(t) distributions and rollover funds from our 401k. We do not have traditional IRA accounts other than the contributory ones used for back-door funding of our Roth IRAs.

We could leave the remainder in the 401k and continue to contribute while we keep working, but having a separate IRA would complicate and/or eliminate using the “back-door” for Roth contributions. Definitely need to flesh this out, but if we move forward, it seems that we would need to stop funding our Roth IRAs. This may be ok, and we can just manage our existing accounts, and further reduce our retirement saving contributions by $12k/year. More likely, we would reallocate this to focus on building our passive income in taxable accounts, which can help bridge the gap to age 59 1/2 as well.

Depending on how much we work, our incomes would eventually be reduced, but if we phase out our budgeted monthly retirement contributions, that would remove our highest monthly expense. With our daughter entering senior year in high school, we are anticipating some hefty tuitions fees too that will probably become our “new” highest monthly expense.

Finally we should also consider some potential 72(t) pitfalls and other notes. If we do make a mistake in calculations or miss a SEPP payment, the IRS could levy an additional 10% penalty on all prior withdrawals! Ouch! If we actually move forward with this plan, we would get advice from an accountant or tax advisor to make sure everything we do is in compliance. We can only stop the payments if we become disabled (or die), but we do have a one-time option to change from the Annuitization or Amortization method to the Minimum Distribution method.

Most articles I read advise against using 72(t) or accessing retirement funds in general. I think it may depend on how much you already have saved, and in our case we have some flexibility with different account types with tax diversification. If anyone has actually used 72(t) and has any insight, please add a comment below! We will continue to evaluate different options, such as building a “Roth Ladder”, which we can discuss in a future article.

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~$Retirement Nerd🤓

Disclaimer: I am not a financial planner and content on this site is meant to provide food for thought, not professional advice. I share my experiences to show what worked so far and what didn’t, YMMV. Please consult your financial advisor or tax professional as needed.

By $Retirement Nerd

$Retirement Nerd is in his late 40s and looking to retire in the next few years.

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