Rule 72(t) Explained — How to Retire Before 59½ (Without Penalties)

Summary

Rule 72T, also known as Substantially Equal Periodic Payments (SEPP), offers a legal way to access retirement funds early without the 10% penalty. It involves taking fixed, IRS-approved annual withdrawals from an IRA or 401k before age 59 and a half. This strategy works well for early retirees or those needing a steady income between jobs, but comes with strict rules and risks, including retroactive penalties for mistakes. The video breaks down how the rule works, its calculation methods, pros and cons, and scenarios where it’s ideal—or a bad idea—for early retirement.

Takeaways

• 😀 Rule 72T (Substantially Equal Periodic Payments or SEPP) allows early access to retirement funds (IRA or 401k) without the 10% penalty before age 59 and a half, but with strict guidelines.
• 😀 The rule requires a fixed, IRS-approved withdrawal schedule that must be followed exactly, with no modifications allowed.
• 😀 Employment status doesn't affect eligibility for Rule 72T—one can still use it even if they go back to work or take a break from employment.
• 😀 The three IRS-approved methods for calculating withdrawals are: the RMD method (least income), the amateurization method (higher, fixed income), and the annuitization method (similar to amateurization).
• 😀 Rule 72T withdrawals are subject to ordinary income taxes, which could push you into higher tax brackets or impact Medicare and ACA subsidies.
• 😀 The SEP schedule is inflexible, and breaking it (even accidentally) triggers retroactive penalties on all prior withdrawals plus interest.
• 😀 You must continue SEP withdrawals for either 5 years or until age 59 and a half, whichever is longer, and deviations from this schedule can result in severe IRS penalties.
• 😀 If you're considering Rule 72T, it's crucial to fully understand and accept the long-term commitment, as flexibility is extremely limited once the plan is in place.
• 😀 Rule 72T is ideal for individuals who have enough funds to support fixed withdrawals and don't need flexibility in their income but may not be suitable for those who expect to return to work or require flexibility in withdrawals.
• 😀 Key mistakes that could break the SEP plan include making extra withdrawals, doing a rollover, or changing the withdrawal schedule—any of which would trigger penalties.
• 😀 Rule 72T can be useful for early retirees or those who need a bridge to age 59 and a half, but it should be considered as part of a broader retirement strategy with other income sources like taxable accounts or Roth conversions.

Q & A

What is Rule 72T and how does it allow early access to retirement funds?

Rule 72T, also known as substantially equal periodic payments (SEPP), allows individuals to withdraw money from an IRA or 401k before age 59 and a half without paying the 10% early withdrawal penalty, provided they follow a rigid schedule of fixed withdrawals every year.

What is the primary risk of using Rule 72T?

The primary risk is that if you break the withdrawal schedule, even by accident, the IRS retroactively applies a 10% penalty on every withdrawal ever made from the account since the start of the SEPP plan, plus interest.

Can Rule 72T be used if the person is still working?

Yes, employment status does not affect eligibility for Rule 72T. You can continue working, change jobs, or even return to work without affecting the validity of the SEPP plan, as long as you stick to the required withdrawal schedule.

What is the difference between the three methods for calculating SEPP withdrawals?

The three methods are: 1) The Required Minimum Distribution (RMD) method, which results in the lowest withdrawals and adjusts yearly based on account balance; 2) The Amortization method, which calculates a fixed annual payment, usually higher than RMD; and 3) The Annuitization method, which is similar to the Amortization method but uses an annuity factor to calculate payments, often leading to results similar to the Amortization method.

What are the consequences of making a modification to an SEP account?

Making a modification, such as taking extra withdrawals, changing the withdrawal amount, or adding contributions to the account, counts as a violation of the SEP schedule. This will retroactively trigger penalties on all withdrawals since the plan began.

How long do SEPP withdrawals need to continue under Rule 72T?

SEPP withdrawals must continue for the longer of five full years or until the individual reaches age 59 and a half, whichever comes later.

What is the recommended strategy for people using Rule 72T to avoid penalties?

It is recommended to use a separate, dedicated IRA for the SEPP plan to avoid accidentally modifying the schedule. This ensures that the withdrawals are isolated and no other withdrawals or changes affect the SEP account.

What are the tax implications of using Rule 72T?

While Rule 72T avoids the 10% penalty, the withdrawals are still subject to ordinary income tax. This can potentially push you into a higher tax bracket, affect your Medicare premiums, and reduce your room for Roth conversions.

Who should consider using Rule 72T for early retirement?

Rule 72T is most useful for individuals who have a substantial amount of money in retirement accounts (such as IRAs or 401ks), want predictable income, and are committed to a rigid schedule. It is ideal for early retirees, those who are laid off, or anyone with significant retirement savings that needs a bridge to early retirement income.

When should someone avoid using Rule 72T?

Rule 72T should be avoided if you need flexibility in your withdrawals, anticipate going back to work, rely on volatile investments, are optimizing for low income for ACA subsidies, or prioritize Roth conversions over predictable withdrawals. It is also unsuitable if you're not fully committed to following the rigid schedule without error.