The One Little-Known Tool That Can Help You Retire Early

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Over the past 30 years, I’ve seen more of my clients retire early than I expected at the beginning of my career. Corporate downsizing, early retirement options, health issues, family issues, and just changes in life plans have led many to say goodbye to a career before 59 ½ years old. And with early retirement, folks want to access their pre-tax retirement funds now. Perhaps you, too, want to “retire early” and live life on your own terms now.

If that resonates, IRS Rule 72(t) is a little-known tool you need to explore.

What Is IRS Rule 72(t)?

If someone is under age 59 ½ and wants to withdraw money from their IRA, old 401(k), et cetera, the IRS enforces a 10 percent early penalty tax (in addition to income taxes). IRS Rule 72(t) SEPP is the part of the Internal Revenue Service code that allows people to unlock/access their retirement funds penalty-free. As long as its strict rules are followed, the IRS allows people penalty-free access to their money for any reason prior to age 59 ½. One of the basic rules is that you must take regular withdrawals from your retirement accounts (known as a SEPP: Series of Equal Periodic Payments) for a minimum of 5 years or until age 59 ½, whichever is longer.

So, practically speaking, what does the minimum of five years look like? Let’s say you decide to use the IRS 72(t) rule at the age of 58. You would be withdrawing money until you were 63. Even though you can start withdrawing from your retirement accounts as early as 59 ½, you have to complete the 5 years once you start.

Now let’s say you want to start withdrawing from your retirement accounts at the age of 52. You would have to continue to do that for 7+ years until you turned 59 ½.

Again, the rule is Minimum of 5 years or until age 59 ½, whichever is later/longer.

How Does The SEPP Distribution Work?

This can seem complicated, but stick with me here: The first thing you need to know is that once you’ve decided on an amount for the 72(t), you will need to stick with it. (See the Pro Tip below for an exception.)

The IRS has three approved calculation methods for SEPP distribution: the required minimum distribution method, the annuitization method, and the amortization method. Why are these important? This will help you understand the breakdown:

Let’s say you were born on April 15, 1969. You decide to retire this year at age 52. Your 72(t) distributions start at age 53. This is something to keep in mind if you want to use this tactic. You have $500,000 in retirement savings. Based on life expectancy calculations and the IRS-approved interest rate, you can take out

  • a maximum of $21,421 annually using the amortization method
  • $21,318 per year using the annuitization method
  • a minimum of $14,970 per year using the required minimum distribution method

My best suggestion is to sit down with your financial advisor to see if any one of these is a viable option for your specific early retirement goals.

Pro Tip: For all intents and purposes, once you commit to your SEPP distributions, your dollar amount will not change year to year with two of the three methods. However, the IRS allows a one-time switch from one method to another without breaking the 72(t).

What Retirement Saving Vehicles Are Allowed In Utilizing A 72(t) Distribution?

An IRA can be set up using IRS Rule 72(t) SEPP, and it is important for people to make sure their IRA Custodian is 72(t)-friendly. Distributions will need to be properly coded so the IRS knows that this income is not subject to the early withdrawal penalty. Individuals can invest their money as they see fit: stocks, bonds, mutual funds, ETFs, annuities, et cetera.

What do you have to pay to withdraw from retirement accounts early? The IRS has strict rules and parameters that must be followed, and it can get tricky and confusing. New rules that came out in January 2022 allow for higher interest rate calculations in the future, and therefore more income can be generated. Also, there are now new life expectancy calculations that need to be considered in properly structuring this penalty-free income strategy.

Can I Still Work With A 72(t) Distribution?

This is a great question. Many of our clients still want to work or even have passion projects. The good news: You can still work and receive 72(t) SEPP distributions.

So What’s The Catch?

There really is not a catch. But you must follow the rules, guidelines, and parameters that the IRS has laid out in IRS Publication 590. Again, some of the rules are:

  • Take withdraws from your retirement accounts for a minimum of 5 years or until age 59 ½, whichever is longer
  • Properly utilize the approved IRS interest rate (there is a maximum interest rate that can be used)
  • Choose one of the three IRS-approved methods for calculations (required minimum distribution method, annuitization method, or amortization)
  • Utilize an approved life expectancy calculation

Pro Tip: The IRS is unforgiving if a mistake is made and the 72(t) SEPP gets busted/broken during the IRS commitment period (again, minimum of 5 years or till age 59 ½, whichever is longer). The consequences for breaking a 72(t) are: The IRS goes back to day 1, as if you never did the 72(t) in the first place, and penalizes you on all the previous income you took out — and the 10 percent penalty is assessed PLUS interest and penalties, which add up very quickly! We always suggest that individuals seek professional help when doing this type of financial planning.

The IRS Rule 72(t) is an underutilized resource for early retirees. You can learn more about this retirement option or how to tackle it yourself here.

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