What are Rule 72(t) Distributions?

What are Rule 72(t) Distributions?

October 14, 2021
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Need to access some cash sooner than expected? You probably know that the earliest you can tap into your retirement savings without penalty is age 59.5, the threshold established by the IRS. However, as with most things in our overly-complicated tax code, an exception exists under Rule 72(t). Rule 72(t) allows penalty-free withdrawals from IRAs (and other tax-advantaged accounts like 401(k)s) if you meet certain qualifications.

Let’s cover Rule 72(t) from a high level. 

Why do Rule 72(t) distributions exist? Normally, you can’t withdraw from your IRA or 401(k) money prior to age 59.5 without paying a 10% penalty. Rule 72(t) allows you to withdraw retirement savings penalty-free; it was added as a way for households to access their retirement funds early (usually in the case of emergency).

How does Rule 72(t) work? The key phrase in the tax code is “substantially equal periodic payments,” or SEPP. You must take at least five SEPPs for your withdrawal to qualify for Rule 72(t). The distributions are based on your life expectancy, which must be calculated using IRS-approved methods. The funds also need to be taken on a specific IRS-approved schedule. Finally, you need to follow this distribution schedule for five years or to age 59.5, whichever comes later.

Can you still contribute to an IRA if you’re taking Rule 72(t) distributions? You cannot contribute, roll over, transfer, or otherwise increase the value of an IRA that you’re taking Rule 72(t) distributions from, but you can transfer funds between accounts before beginning your SEPPs. For example, suppose you own one IRA with $250,000 in it and want to take $50,000 out early, yet still contribute to an IRA. In this case, you could open a new IRA and transfer the $200,000 balance into it so it wouldn’t be impacted. You could continue to contribute to this new IRA while taking your SEPP distributions from the original IRA.

When are Rule 72(t) distributions appropriate? Rule 72(t) distributions may be worth considering if you experienced a separation of service from your employer more than one calendar year ago, you are younger than 59.5 years old, and you need an immediate income stream. It’s a narrow circumstance, but not an uncommon one!

Rule 72(t) can help you access your retirement savings without paying the 10% penalty, but there are complex strings attached. If you, or someone you know, has recently left their job and is looking for a way to access their savings, please contact our office to learn more!