Money Girl

Using a 72(t) for Penalty-Free Early IRA Withdrawals

Episode Summary

983. This week, Laura reviews the pros and cons of setting up a 72(t) plan to tap your retirement savings.

Episode Notes

983. This week, Laura reviews the pros and cons of setting up a 72(t) plan to tap your retirement savings.

Find a transcript here.

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Episode Transcription

Whether you’re a FIRE (Financial Independence, Retire Early) proponent or need to tap your traditional IRA before the official retirement age of 59.5, it typically triggers a 10% early withdrawal penalty on top of ordinary income taxes. That’s a big bite out of your wealth that you’d probably like to avoid.

You might be surprised to learn that the IRS allows you to skip the hefty 10% penalty when you set up a workaround, known as a 72(t) plan. This post will review how 72(t) distributions work, their pros and cons, and when it might be a good financial move.

Welcome back to episode 983 of Money Girl–I appreciate you downloading the show! I'm Laura Adams, an award-winning author, on-camera spokesperson, female money speaker, and founder of The Money Stack, my Substack newsletter. Free subscribers automatically receive my Money Success Toolkit, which includes the exact templates I use to manage my finances.

You can learn more, ask questions, and sign up for the Money Stack for free at LauraDAdams.com. Or leave a voice message with your question or comment by calling 302-364-0308. And you can find that info in the show notes. I'd love to feature your question on Finance Friday, our weekly Q&A, bonus edition of the show!

What is a 72(t) payment plan?

The name 72(t) comes from its section number in the IRS tax code. It’s also called a 72(t) payment plan, 72(t) distribution, Substantially Equal Periodic Payments (SEPPs), and a SEPP plan. As I mentioned, it’s a clever rule that allows you to plan for early retirement distributions before age 59.5 without incurring a 10% penalty.

The catch with a 72(t) is that you can’t withdraw funds anytime you wish. You must commit to a rigid schedule of substantially equal periodic payments, such as monthly, quarterly, or annually. You must take these distributions for five years or until you reach 59.5, whichever is longer.

For instance, if you start a 72(t) at 50, you’d have to continue retirement distributions for 9.5 years, until you’re 59.5. But if you start at 55, you’d only have to make distributions for five years, until you’re 60. After that, you can take retirement distributions any way you like or stop taking them.

However, once you reach age 73 (or 75 starting in 2033), you generally must take annual required minimum distributions (RMDs) from traditional retirement accounts, whether you used a 72(t) plan or not.

Examples of 72(t) payment plans

Let’s say Adam accumulated a large nest egg in a traditional IRA ahead of schedule and wants to retire at 45. He could set up a 72(t) plan that must last for five years or until age 59.5, whichever is longer. So, he’d have to adhere to a 14.5-year schedule of periodic distributions until he reached 59.5.

Another example is Terry, who gets downsized from her job and is offered an early retirement payout at age 54. After she leaves the company, she rolls over her 401(k) into an IRA and sets up a 72(t) plan. She must take 72(t) distributions for 5.5 years, until she’s 59.5.

How much can you withdraw under a 72(t) payment plan?

The amount of money you can withdraw from a retirement account using a 72(t) plan is calculated using one of three IRS-approved accounting methods. One provides variable distributions, while the other two require fixed withdrawals. They use various factors such as your age, account beneficiary’s age, account balance at the end of the prior year, and life expectancy factors published in IRS tables.

Required Minimum Distribution (RMD) Method: You divide your account balance at the end of each year by your life expectancy factor. You must recalculate the payment annually with your new account balance and factor. Therefore, if your investment value declines, your distributions decrease, and if your account value goes up, your distributions increase. This method is best when you only need to tap a small amount annually, as it calculates the lowest annual withdrawal.
Fixed Amortization Method: You used a fixed interest rate (currently up to 5%) to calculate a yearly distribution that would spend down your account balance over your life expectancy. The dollar amount remains the same each year and is typically the second-highest calculation. It works like a mortgage amortization but in reverse, with payments made to you.
Fixed Annuitization Method: You divide your account balance by an "annuity factor" derived from IRS mortality tables and an interest rate. As with the fixed amortization method, the distribution amount remains constant for the duration of the plan. However, it produces the highest calculation of all three methods. Therefore, it’s best when you need to maximize account distributions.

There’s a special rule that applies to the two fixed methods that protects you if your account value declines, such as during a recession. You’re allowed to make a one-time switch to the RMD method, which significantly reduces your required distributions, preventing you from draining your account during a market downturn. However, once you change to an RMD method 72(t) distribution, you must maintain it until the plan ends.

LISTEN ALSO: 7 retirement rules changing in 2026

What are the pros and cons of a 72(t) payment plan?

Their primary advantage of using a 72(t) payment plan is spending your retirement nest egg without a hefty 10% penalty before age 59.5.

Whether you’re facing a financial hardship or are fortunate enough to retire early, you can use a 72(t) to pay down debt or supplement your current income. You might think of a 72(t) as an income bridge if you retire before being eligible for a workplace pension or Social Security retirement benefits.

The downside is that breaking the strict 72(t) rules means you’d owe the 10% penalty retroactively plus interest on all your withdrawals prior to age 59.5. Some mistakes that void the plan include not taking a timely distribution and taking too little or too much from your account.

Another 72(t) con is that once you begin a plan, you can’t contribute to the account or add new rollover funds until the plan ends. However, a way to prevent that is splitting your retirement into a dedicated IRA that’s solely for your payment calculation, instead of using your entire nest egg.

For example if you have $1 million, but only need an annual payment of $20,000 a year, you could split off $400,000 into a separate IRA and only run the 72(t) on that account. A split strategy allows you to tap or make contributions to another retirement account without voiding your 72(t) plan benefits.

Is a 72(t) payment plan right for you?

If your retirement nest egg is large enough to tap early without jeopardizing your financial future, setting up a 72(t) can be a great money move. For instance, you might have many years to go before turning 59.5 and no other source of income, such as a taxable brokerage account.

Note that if you have a significant Roth retirement account balance, you can withdraw your original contributions, penalty-free. However, distributions of account earnings before age 59.5 would be subject to ordinary income tax plus an additional 10% penalty. You can also set up a 72(t) to avoid the 10% early withdrawal penalty on a Roth account.

To sum up, a 72(t) is a terrific way to avoid an early withdrawal penalty from a traditional or Roth retirement account when you absolutely need the funds and can execute the plan properly. Just be sure you can afford to trade a portion of your nest egg for an immediate cash flow.

However, if you, your accountant, or financial advisor don’t administer a 72(t) correctly, it becomes void, which can cost you a significant amount of penalties and interest. Therefore, I recommend getting help from a tax pro, such as a CPA, who can help you set up a 72(t) based on your financial goals and avoid expensive mistakes.

That's all for now. I'll talk to you soon. Until then, here's to living a richer life!

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