January 26, 2022 – Surprisingly, the tax code provisions allow early access to your retirement savings, and the rule just changed for the better!
Tax-advantaged retirement accounts have many benefits. They let you save for retirement and defer the taxes until you withdraw the money. The longer you wait, the later the tax bite will hit. Much is written about strategies to defer the tax for yourself and your beneficiaries. But what about situations where you would like access to your retirement funds before the age of 59 ½ and also avoid penalties for early withdrawal?
Well, the IRS Code section 72(t) outlines the process of making early withdrawals from certain qualified retirement accounts, like your IRA, without paying extra penalties. I suspect that the lack of “fanfare” around 72(t), the complexity inherent in the rules, and if I’m being cynical, advisors who prefer not to reduce their AUM and the related fees, are all factors that discourage many from withdrawing retirement funds early.
However, there are situations where employing the 72(t) rules makes excellent financial sense, such as:
- You would like to retire early. You need access to funds to support your lifestyle until a future revenue stream starts, maybe social security, a pension, or even an expected inheritance.
- You hit that mid-life crisis, and a sabbatical would provide you with an alternate experience, allowing you to recharge your batteries and, ultimately, return to employment.
- You would like to start a new business venture and are in need of some additional cash flow.
- You face a financial crisis, and penalty-free access to your retirement savings would be beneficial.
Rule 72(t) is also known as the SEPP rule. SEPPs are substantially equal periodic payments. When you withdraw money from a qualified retirement account under Rule 72(t), the funds are distributed to you as SEPPs. These regular payments are made over five years or until you turn 59 ½. If you mishandle SEPPs, you will be on the hook for the 10% IRS early withdrawal penalty. Setting up the SEPPs is not a simple process, and three methods are allowed.
Details about these methods are beyond the scope of this note. However, two of the ways to calculate the payment utilize a current interest rate factor. The IRS recently published a notice that provided the option to use the greater of the current interest rate or 5%. The use of a higher interest rate allows the amount of the monthly payment to increase and might make SEPPs more appropriate in the cases mentioned above.
Rule 72(t) is one of those hidden tax strategies that can help people in specific situations. That said, such strategies are complex to calculate and execute, so seek professional help before withdrawing your retirement funds.
