Rule 72(t): How to Withdraw from the IRA Without Penalty

What is Rule 72(t)?

IRS Rule 72(t) refers to a section of the IRS code outlining Substantially Equal Periodic Payments (SEPP).   This is not meant to be a complete guide, as the work done by William Stricker, CPA* is incredible on the topic.   His work includes the direct text from the IRS as well as published letters and IRS rulings on the topic.   This is meant to summarize some of his work and how Rule 72(t) can fit into planning for early retirement.

The Overview

• IRS Rule 72(t), otherwise known as Substantially Equal Periodic Payments, allows you to access a portion of your pre tax retirement accounts before age 59.5.

• These distributions are available to you immediately to use and spend, which is the significant difference between this and the five year waiting period with a Roth IRA conversion.

• These payments must continue for at least five years and cannot end until you are at least 59.5.  For example, if you start distributions at 45, you cannot end them before 59.5.  If you start distributions at 57, you cannot end them before 62.

• The amount is formula driven and the amounts must remain “substantially” equal throughout the use of the 72(t).   Mr. Stricker carefully discusses what constitutes substantial and, subsequent to his work, the IRS ruled in favor of a one time reclassification of distribution methodology.   

• The withdrawals are *account specific*.  You can (and should) split your IRA into multiple accounts then choose one specific account to start the distributions..

What are the reasons to consider the 72(t)?

1. Current income in early retirement:  The 72t provides money that is immediately spendable.   The traditional FIRE advice is to use the Roth IRA conversion and have five years saved outside of retirement accounts.  But what if you don’t have five years or aren’t comfortable spending down that much cash during the gap?  You can reduce how much is pulled from a regular account by starting a 72t.  

2. High Traditional IRA balances:   An early retiree may have oversaved in pre-tax retirement accounts and this is an alternate method to Roth IRA conversions to navigate funds out.   This is especially true of self employed individuals able to defer $50,000 or more a year in through a Solo401k or SEP IRA.  It also may apply to employees with a generous pre-tax company match.

3. Mortgage Qualification:  Some people go into early retirement without their final housing lined up.  Qualifying for a mortgage without income is challenging, as few lenders are willing to attempt to use the asset depletion guidelines published by Fannie Mae and Freddie Mac.   There are many reasons to consider a mortgage instead of paying cash for a house and this method helps an early retiree, especially since 72(t) distributions can be made monthly and viewed as income for a mortgage underwriter.  

The Methodology of Distributions:

There are three options for distributions, the Fixed Amortization Method, the Fixed Annuitization Method, and the Required Minimum Distribution method.   There is an interest rate calculation involved, which is currently capped at 120% of the Federal Mid Term Rate, or 2.36% as of September 2021.   The amount you can withdraw per year is a combination of that interest rate and the life expectancy tables, which will result in an amount around 4% of the account balance depending on your age.  

Withdrawal Examples:  $100,000 Account Balance

40 Years of Age

$3,697/year, or $330/mo.

50 Years of Age

$4,294/year, or $358/mo

55 Years of Age

$4,733, or $394/mo

The maximum withdrawal allowed increases as someone gets closer to 59.5.   Source: Bankrate 72t Calculator

Can I Stop a 72(t) Distribution Early?

The short answer is you can’t, unless you want to pay a 10% penalty on all amounts withdrawn to date.   You can however modify your distribution method from the Fixed Amortization Method or Fixed Annuitization Method over to the Required Minimum Distribution method once during the course of a 72t distribution plan.   See Publication 2002-62,  The RMD method re-determines the withdrawal amount at the time of the change and whether this is more or less will depend on the account’s performance between when the 72t distributions started and the account balance as of the redetermination date.   This rule was created after a two year market decline in the early 2000s with the intent on allowing a change that avoids depleting the account.

Choosing between the  Roth IRA Conversions Ladder or a 72(t):

Rule 72(t) is superior in providing distributions that are immediately spendable while the Roth IRA Conversion Ladder is superior in it’s flexibility in picking how much is converted annually.  

	Roth IRA Ladder	72(t)
How much per year?	Flexible	Fixed, age based formula
Changes year per year?	Completely Flexible	No, only one change allowed during lifetime
Funds Accessible?	After Five Years	Immediate

The biggest risk to an early retiree is starting the 72(t) distributions then going back to work.   The distributions would continue, causing taxes to be paid at a higher marginal rate.  Due to this risk, it’s important to know yourself and be settled into a retirement and lower income lifestyle before taking this option.

Summary:

Substantially Equal Periodic Payments under rule 72t is the less discussed alternative to the Roth IRA Conversion Ladder for people retiring earlier than 59.5.   There are pros and cons to both, with the Roth IRA conversion ladder favoring those retiring well before 59.5 while the SEPP payments start making more sense as someone approaches traditional retirement age.  Both options are viable for those pursuing early retirement and allow for people to maximize tax deferred accounts in their working years to then enjoy withdrawals at a lower tax rate in their early retired years.

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*There are numerous copies of his fourth edition available via a google search of William Stricker 72t.  While I believe this is a free publication, I am unsure if it is copyrighted and not comfortable linking it.