This past week I attended a two-day seminar from Ed Slott and Co. I know a lot about IRAs – A L O T – but am ever-curious and always willing to learn more. Ed is considered by many to be America’s IRA expert and I went to learn from one of the smartest people in the industry. In the sessions, we spent time going over many ins-and-outs and lesser-known IRA strategies that can potentially help my clientele.
Today I am going to discuss the 72(t) IRA withdraw strategy that exists, but is seldom used. Rightly so, because this strategy involves taking money out of your IRA prior to age 59 ½ (the age you normally need to reach to avoid a penalty). This strategy is called 72(t) payments as the rule falls under IRS code section 72(t).
And since most advisors (including me) recommend generally NOT tapping into your IRA until you are 60+, this is not something that clients ask about…or even know exists. So for those of you out there wondering can I take money out of my IRA prior to age 59.5 without penalty?, the answer is YES!
What situations would warrant someone to take money out of their IRA early? Perhaps someone wants to retire early (or at least work less or for less money) and needs to supplement their lifestyle with money from their retirement account. Or someone might find themselves needing funds to help pay for a kid’s college. Or it could simply be a financial hardship due to job loss, disability, or something similar.
The general rules of being able to take IRA money out without the 10% penalty using 72(t) are as follows:
- Withdraws from an IRA can begin at ANY age. Age 35 or age 50? It does not matter. Even if still working.
- You must take “substantially equal periodic payments”. This 72(t) rule is also know as this acronym SEPP, and it means the money taken from the IRA must follow a certain schedule. There are 3 ways to calculate the amount, and once the method is chosen it needs to be adhered to (*it can be changed once at some point down the road, but we won’t cover that here).
- The individual must continue taking the payments for at least 5 years, or until age 59.5 (whichever is longer). So if started at age 42, a person would need to keep taking payments until age 59.5 (17+ years). Similarly, someone who started payments at age 57 would need to continue until at least age 62 (to reach the 5 year minimum). The exceptions to this are if the individual becomes disabled or dies.
- An individual can take these payments from an IRA – but NOT from a company retirement plan…unless the person leaves the company first.
- Payments from a designated IRA are specific to that IRA only. If there are multiple IRAs, they are considered separate and are not linked in any way. People can even split an IRA into two: create one IRA specifically to take 72(t) withdraws from, and the other IRA would remain available for future non-72(t) use.
- If during the term of these payments the individual’s financial situation changes and they do not need as much as originally thought, the payments cannot be re-contributed to an IRA. Nor can the money be converted to a Roth.
- The IRA account balance cannot be altered. Other than gains and losses in the IRA, money cannot otherwise be added (via a rollover) or reduced (except for the scheduled payments, of course) or the 10% penalty will be triggered.
The takeaway from all this? Just know that it is available to withdraw money from an IRA with penalty prior to 59.5. There are some other possible ways to get money out prematurely, but this 72(t) rule is one great way to do it – so be aware that it is a viable option.
What I would not recommend is choosing to take this option and manage it on your own. There are many pitfalls and rules which need to be followed, some are not always so obvious. I mentioned the main ones here, but there are more nuances involved. The penalties are harsh if not followed correctly.
Some examples of pitfalls could be how to handle these payments during a divorce. Or a death. We’ve also seen penalties get applied (retroactively) if someone mistakenly rolls an old employer plan into it. Also the timing rules often get dicey, potentially resulting in the strategy backfiring.
Bottom line: “don’t try this at home”. Work with a knowledgeable professional advisor can help you with the process. They could explain the rules, pros vs. cons, and potential traps. A competent advisor can help guide you and keep you out of harm’s way.