Rule 72(t)

Last week we discussed The Rule of 55 as a strategy used by some to retire early. This week we’ll explore the lesser used Rule 72 (t). Like The Rule of 55, Rule 72(t) allows you to access funds in retirement accounts prior to age 59-1/2 without penalty.

There are a number of provisions associated with this method that tend to deter savvy investors, but it’s worth covering in the event that this does make sense for you in the future. For others who haven’t been properly utilizing the 3 Bucket Strategy to their best interests, it might prove to be the best way to reach early retirement.

Disclaimer: I am not a CFP, CPA, CFA, or tax professional of any kind. This post is intended for informative and entertainment purposes only. It is highly recommended that you consult with a financial advisor and/or tax professional before putting this method into action.

Rule 72(t) refers to a section of the Internal Revenue Code that outlines the process in order to make early withdrawals from qualified retirement accounts (like a 401k, or IRA) while avoiding the standard 10% penalty. These withdrawals must be part of a series of “substantially equal periodic payments” (SEPPs). The rules and FAQs surrounding the specifics on SEPPs can be found at irs.gov.

Proper adherence to Rule 72(t) can be stringent, I strongly encourage anyone considering this to consult with an advisor or financial professional before tackling this on their own. That said, here’s the basic overview:

• Distributions must be made on an annual basis
• The amount of the distribution cannot be changed for the duration of the SEPP plan
• Distributions must be taken a minimum of 5 years or until 59-1/2 years old (whichever is longer)
• Applicable income taxes must be paid the year of withdrawal
• Funds cannot be withdrawn from an account managed by a current employer
• Payments must be made by one of the three methods allowed by the IRS

The true rigidity of Rule 72(t) is the fact that you cannot change your mind mid-way through the SEPP plan. Even if you plan to adhere to the rule, and make a mistake on withdrawals, you’ll be subject to a 10% penalty. This penalty would be imposed not only on that year, but on every early withdrawal you have taken under this plan! 😬

Not only that, you don’t necessarily get to pick the dollar amount you want to withdraw for the subsequent years. SEPPs are based on your life expectancy and account balance at the time of distribution. However, you’ll have the option of 3 different methods.

There are 3 different methods you can choose from when looking to utilize SEPPs under Rule 72(t). Again, I cannot stress this enough, consult a financial professional before attempting this. I’m a big fan of DIY when it comes to investing and money in general, this is one of the exceptions to that.

Here are your options:

Required Minimum Distribution (RMD) Method

Normally you don’t deal with RMDs until 73 years old. Still, the calculation is done the same way. Divide your account balance by your remaining life expectancy (calculated based off the IRS life expectancy tables). The amount withdrawn each year is recalculated based off remaining balance and life expectancy. This distribution is generally the smallest sum while utilizing SEPPs.

The Amortization Method

This method calculates fixed annual SEPP payments that remain fixed over the life of the plan. There is no need to recalculate the distribution each year, it’s the same $ annually. This amount is calculated using the account balance, your life expectancy, and an assumed interest rate considered reasonable by the IRS (based off the federal mid-term rate). This distribution is generally the largest sum while utilizing SEPPs.

The Annuitization Method

This method is also a fixed annual payout. It’s calculated by using the account balance, your life expectancy, the federal mid-term interest rate (as above), and an annuity factor provided by the IRS. This distribution generally falls in between the largest and smallest sum while utilizing SEPPs.

Rule 72(t) has been used sparingly in the past, and for good reason. Many of us Savvy Solos don’t like the idea of a fixed income, and the consequences of making a small mistake can be quite dire. In all honesty, there are usually better ways to retire early for the vast majority of us; particularly those of us focused on a 3 Bucket Strategy that best aligns with future plans.

Not to mention, the payouts from the SEPP plans are generally not enough to live off of. It’s essentially just the icing on the cake. Let’s say you are 50 years old, $750k in an IRA and decided to start penalty free distributions using Rule 72(t).

First, you would have to start and continue the correct calculated distributions each year for the next 9-1/2 years regardless of what the market does! Any mishap along the way, and you’ll be subject to 10% penalty on every distribution to date! 😯

Second, your annual SEPPs would look something similar to this:

• RMD Method (first year): $21,930
• Amortization Method: $45,900
• Annuitization Method: $43,100

I’m not sure about you, but I’d need an additional source of income coming in from somewhere! This leads to the third potential issue. So, let’s say you put this in action and start a side hustle for additional income. Kind of a Barista FIRE situation if you will. There’s a chance this side hustle takes off and covers all current expenses. If so, you’ll still have to take SEPPs from this plan. This could push you into a much higher tax bracket, negating the real benefits that come from a tax-deferred account to begin with. 😓

There are a few instances where I could see this Rule 72(t) could ultimately be beneficial, but only for those that consult with a financial professional and are extremely confident they will follow the rules to a T… a 72(t) to be more precise. 👀

I know you came here for the knowledge; I’m just here for the bad uncle jokes. 🤪

Rule 72(t) can be helpful for those that are worried about future RMDs or simply do not have enough runway to make it till 59-1/2 without taking a 10% penalty. If you are hell bent on retiring early, it might be better to try this in order to avoid some of the penalty, rather than just take it all on the chin. Those that are close to 55 years old would generally be a lot better off utilizing The Rule of 55 due to the flexibility.

All in all, this one can be utilized as a Plan B or Plan C scenario; but shouldn’t necessarily be the plan from day 1. Still, I find these tactics interesting, and it’s good to know what your options are. It’s yet another arrow in your quiver of financial knowledge on the path to FI!

Stay classy Solos! ✌️