Individual Retirement Accounts (IRAs) are designed for your long-term retirement savings needs. Distributions that occur on or after the IRA owner reaches age 59 ½ may be subject to income tax but will not be subject to the early-distribution penalty of 10% on withdrawals made before age 59 ½.

What if you need or want to take the funds out of your IRA before you are 59 ½?

You have the option to do a series of “substantially equal periodic payments (SEPP),” commonly referred to as the 72(t) distribution. The 72(t) distribution, shorthand for the Internal Revenue Code Section 72 part t, is an IRS rule that allows for penalty-free, early withdrawals from an IRA, 401k, TSP, 403(b) or 457 retirement plan. This allows you to take advantage of your retirement savings before the age of 59 ½ and may benefit investors who intend to retire early or want access to the funds early. The 72(t) distribution is a useful tool, but needs to be carefully set up and thoroughly considered before proceeding.

A drawback of taking advantage of 72(t) distributions is that you may deplete your retirement accounts leaving you with insufficient assets to fund your future retirement needs. You will also need to consider if you are comfortable taking distributions for a required period of time.

How does it work?

Any IRA owner can take 72(t) distributions at any time for any reason. You may begin at any age under 59 ½, but you must set up a schedule of substantially equal payments (SEPP) that are satisfied annually. You can take the distributions monthly, quarterly, etc., but you must take your “substantially equal” distribution amount within each year. Once started, you must continue your 72(t) distributions for five years or until age 59 ½, whichever is longer.

For example, if you start receiving payments at age of 57, you must continue through age 62. If you start receiving payments at age 45, then you must continue through the age of 59 ½.

You can impact the amount of the distributions by adjusting the balance in your IRA. If you have more than one IRA available, you can rollover funds into one account and therefore increase or decrease your payment. This has to be done before establishing the 72(t) distribution since you are unable to deposit money into or remove funds from your IRA while the 72(t) is in place.

How is the distribution amount calculated?

There are three ways that you can determine the amount of the distribution from your IRA. Bankrate.com provides a calculator that you can use to determine the distribution amount.

1) The Required Minimum Distribution Method is the simplest way to calculate the distribution. Under this method, you divide the retirement account balance by a divisor from the IRS single or joint life expectancy. This method results in distributions that vary slightly each year and allows the owner to withdraw the least amount of income possible taking into account market fluctuation.

2) The Fixed Amortization Method calculates the disbursement amount by amortizing your account balance over your single life expectancy, the uniform life expectancy table or joint life expectancy with your oldest named beneficiary. You will also need to specify a rate of interest that is not more than 120% of the federal mid-term rate published by the IRS (IRS Index of Applicable Federal Rates Rulings). This amount is calculated only once and results in fixed annual payments that will bring your account balance to zero at the end of the life-expectancy period.

3) The Fixed Annuitization Method calculates the disbursement amount by taking your account balance and dividing it by an annuity factor which is provided by the IRS, using the age you have reached (or will reach) for that year. You will also need to specify a rate of interest that is not more than 120% of the federal mid-term rate published by the IRS. This method provides a steady fixed annual payout for the owner. It is calculated only once and is based on only your life expectancy and not your beneficiary's.

The various life expectancy choices are as follows:

Important facts regarding 72(t) distributions:

If you have several IRAs, you do not have to apply the 72(t) distribution to all your accounts. The distributions can be made from one or from a combination of the accounts.

You are not able to put the money back in your IRA once taken out, but you are not obligated to spend the funds. You can put the funds in a savings or checking account, or regular brokerage account for investment purposes.

If the market has downturns and causes the IRA to run out of money before the time required, you will not be liable for the 10% tax penalty.

If you die or become disabled the distributions may be discontinued. These withdrawals will not be subject to the 10% penalty and will not impact the way the funds in your IRA are handled for estate purposes.

If you change the conditions for taking your 72(t) distributions, you may face retroactive penalties and interest. This is called a “busted” SEPP which will cause all distributions to be subject to a 10% penalty. The one exception is a one-time change from either the amortization method or the annuitization method to the required minimum distribution method.

If these distributions are from a qualified retirement plan (not an IRA) you must separate from service with the employer maintaining the plan before the payments begin for this exception to apply.

Ever year, the account balance is determined as of December 31 of the prior year or a date reasonably close to the payment beginning or anniversary date.

Your age is determined by the age you will turn on your birthday for the year you are receiving the distribution.

The beneficiary age is the age your beneficiary will turn on their birthday for the year you are receiving the distribution.

Carol Chaudet

Last Updated: 05/11/2016