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What Is Rule 72(t) and How Does It Work?


The general belief for retirement is that withdrawals from traditional retirement accounts before the age of 59.5 incur a 10% penalty. But did you know there’s a provision in the Internal Revenue Code that provides an exception? This exception, known as Rule 72(t), can be a game-changer for individuals considering early retirement and who have an IRA. Before accessing your money early, however, you may want to consider talking to a financial advisor about your long-term plans.

What Is Rule 72(t)?

Rule 72(t) is an exception to the standard penalty for early withdrawals from retirement funds, which is a provision of the Internal Revenue Code that allows for early withdrawals from retirement accounts without the usual 10% penalty for individuals under the age of 59.5. This rule is specifically designed to provide financial support to those who wish to retire early or those who require special access to their retirement funds ahead of the typical retirement age.

The provision assumes special relevance in retirement planning, particularly for individuals who wish to retire earlier than the standard age. For example, if you have a dream of retiring at age 55, Rule 72(t) can make it possible by providing access to your retirement funds without imposing any additional penalties.

How Rule 72(t) Works

If you have an IRA account then you can elect to withdraw funds via rule 72(t) if you take at least five substantially equal periodic payments (SEPPs). This rule allows individuals to make early, penalty-free withdrawals from their IRA, which are calculated using three IRS-approved methods. There are no requirements or proof of a hardship in order to withdraw funds under this rule and some tax-advantaged retirement accounts sponsored by your employer might also qualify.

Rule 72(t) can greatly benefit individuals who have accumulated substantial retirement savings but face an unexpected career interruption. For example, if you lose your job at age 57, you can use Rule 72(t) to maintain your lifestyle until you find new employment or reach the age of 59.5. This can potentially allow for a steady stream of income during the early years of retirement, thereby offering financial stability. A financial advisor can guide you on how best to utilize Rule 72(t) based on your unique financial situation.

How Payments Under Rule 72(t) Are Calculated

A client reviewing how Rule 72(t) could apply to their retirement plan with a financial advisor.

The IRS provides three methods to determine the amount an individual can withdraw penalty-free under Rule 72(t) from their retirement accounts, such as IRAs or qualified employer-sponsored plans, before reaching the age of 59.5. They aim to provide a structured way to access funds for specific needs without incurring the early withdrawal penalty.

These methods differ based on specific factors like account balance and the individual’s life expectancy:

  • Required minimum distribution (RMD) method: This method uses the IRS life expectancy tables to calculate substantially equal periodic payments (SEPPs) based on the individual’s life expectancy. The account balance is divided by the life expectancy factor to determine the annual distribution amount.
  • Fixed amortization method: This method involves amortizing the account balance over a specific number of years, using an assumed interest rate. Is is also based on life expectancy and the annual payment remains fixed over the chosen amortization period.
  • Fixed annuitization method: This approach uses an annuity factor instead of an amortization factor. The annuity factor is derived from the present value of an annuity at an assumed interest rate and chosen payout period, resulting in a fixed annual payment.

Risks of Using Rule 72(t)

While rule 72(t) presents several advantages, it is not without its risks. Among the potential drawbacks are the possibility of depleting retirement savings early, being locked into the payment schedule and additional tax implications.

Therefore, before choosing Rule 72(t), it’s important to consider your sources of income, the size of your retirement savings and your anticipated retirement lifestyle.

Other IRA Withdrawal Options

Apart from Rule 72(t), there are diverse choices for IRA withdrawal options, such as regular withdrawals after age 59.5 and 401(k) loans.

Each option has its own benefits and drawbacks, and the best choice depends on your specific circumstances.

Additionally, if you have a hardship before you reach full retirement age, then your plan might allow for a hardship withdrawal.

You may want to check with a financial advisor if you need help navigating these alternatives.

Bottom Line

A financial advisor discussing Rule 72(t) with a client on the phone.

Rule 72(t) could be your golden ticket to retire before turning 59.5. It offers several benefits that can aid significantly in retirement planning, such as avoiding early withdrawal penalties, maintaining a steady cash flow during early retirement and offering flexibility that can thereby broaden your retirement planning strategy. But while it allows for early, penalty-free withdrawals, it also carries the risk of depleting retirement savings prematurely and IRS penalties if not implemented properly.

Tips for Retirement Planning

  • It can be difficult to prepare for your retirement on your own. Instead, consider working with a financial advisor who can help you navigate your individual needs and goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • If you’re not sure how much you need to save for retirement, consider using SmartAsset’s free retirement calculator.

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