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Rule 72(t) – The early retirement income loophole

The early retirement income loophole

Even if you’re working in your “dream” job, it’s likely that at one time or another you’ve thought about how nice it would be to retire early. Unfortunately, though, if you access funds from certain types of tax-advantaged accounts, you can be penalized by the IRS if you do so before turning age 59 ½….that is, unless you abide by Rule 72(t) the early retirement income loophole.

What is Rule 72(t) and Why is It Important for Early Retirees?

IRS Rule 72(t) allows penalty-free withdrawals from IRAs (Individual Retirement Accounts), as well as from other tax-advantaged accounts like 401(k)s – even if you have not yet turned age 59 ½.

While this does not mean that you’ll avoid having to pay income tax on some (or possibly even all) of your withdrawals, it does mean that you can forgo the additional 10% “early withdrawal” penalty that is imposed by the Internal Revenue Service on withdrawals that take place if you are under 59 ½ years old.

But there are some guidelines that you must follow with regard to how (and how long) these withdrawals must be taken and how much they can be, as well as when you are allowed to start (and end) them.

Guidelines for Early Withdrawals from Retirement Plans with Rule 72(t)

In order to abide by Rule 72(t), you must meet all of the following criteria:

  • Substantially Equal Periodic Payments – Rule 72(t) requires that you access substantially equal periodic payments (SEPP), an amount that is determined by a formula set by the IRS – and there are actually three different options that you can choose from. These include an amortization, an annuitization, or a required minimum distribution (all of which can result in a different dollar amount of the income payment). If this substantially equal periodic payments component is not followed, you will be required to pay all of the IRS early withdrawal penalties that you had initially avoided. In addition to that, you will also have to pay interest on those amounts.
  • Calculation of Payment Amount – Your life expectancy can also factor into the amount of your payment. This, too, is calculated using IRS-approved methods. In this case, the older you are when the payments begin, the higher the dollar amount can be (and vice versa).
  • Five Year Income Payout Period – You must also receive your substantially equal payments over the span of five years, or until you have reached the age of 59 ½ – whichever of these time periods is longer.

Items to Consider Before Accessing Your Money Using Rule 72(t) for Early Withdrawals

Even though exiting the working world at an early age can appear quite appealing, there are some items to consider before doing so. For instance, the more money you access from your retirement account(s) now, the less you will have available to you in the future. This, in turn, could cause financial hardship down the road.

With that in mind, it can be beneficial to directly compare how much more income – and more income generating options – you may have by waiting until you are at least 59 ½ years old to retire.

In any case, it is recommended that you discuss all of your potential options with a financial advisor who specializes in retirement income strategies. That way, you can take a close look at how and from where you can generate income from, and how much more the dollar amount could be by waiting.

At Annuity Gator, we specialize in creating retirement income plans that can last a lifetime – regardless of what is happening in the stock market, or even in the economy overall. So, if you’d like to take a look at lifetime retirement income plans that could fit your needs, feel free to contact us directly at (888) 440-2348, or send us a message through our secure online contact form.

Rule 72t: The Early Retirement Income Loophole

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