72t distribution rules

72 is a very good number

Ask any financial advisor about 72t and I’ll bet you’ll see them cringe.

It’s not a popular planning method, mostly because it comes with lengthy restrictions that, if violated, can you lead to severe penalties.

Clients don’t like paying penalties.   Advisors don’t like when their clients pay penalties.   72(t) has the potential, if done wrong, for the clients to pay a huge chunk of penalties.   See why we cringe about 72(t)?

Some of you may have no clue what 72(t) is.   If you are not planning on retiring early (before the age of 60), then skip this post and come back another day.  :)

If you are in the financial position to retire early, and have a bulk of your assets in retirement accounts, then 72(t) may be of help to you. Let’s take a look at the 72(t) early distribution rules.

What in the Heck is 72(t)?

Most often when you take money of your retirement account before you turn 59 ½, you are assessed a 10% penalty on the top of ordinary income tax. One exception (others include: first-time home purchase, college tuition payments, disability) to that is a 72(t) distribution that is a “substantially equal periodic payments”.

Clear as mud?   I thought so.  Moving on……

Read more on How to Withdraw From Your IRA Penalty Free

How Does the IRS Consider 72(t)?

The IRS calculates  your “substantially equal periodic payments” by using one of the three methods that the IRS has determined and then take your payment on a set schedule for a specific time period.

It is required that you take those payments for either 5 years or when you turn 59 1/2 , whichever comes later.

For example, if you start taking your payments at the age of 52, then you must do so for 8 years. Someone who starts at 57, must do so till the age of 62.

401k 72t distribution rules

72t tables

72(t) Real Life Example

In the 10 years I’ve been a financial planner, I’ve only executed 72(t) a handful of times.   The concern is having to lock in your withdrawal rate for a minimum of 5 years is longer than most advisors are comfortable with- me included.

Recently, I had a potential new client that was getting an early buyout from his job and was considering using 72(t) for a portion of his IRA.    Here’s are some of the details (name and some of the data have been changed for privacy concerns).

Paul born 8/21/55 and  $720,000 that he will receive in a lump sum distribution from his employer. He would like to do a 72(t) from age 57.3-62.3. He needs about $2,000 a month until 63.5 where he will have the remainder in an IRA.   Paul also had $140k in his 401k.

How 72(t) Distributions Work

The 72(t) plan must not be modified until 5 years has passed from the date of the first distribution for those who will reach 59.5 before the 5 year period is completed. However, it is not clear whether Paul plans to take the 72t distributions from the employer plan or from a rollover IRA.

If the 72(t) plan is needed, the best approach is to do a direct rollover from the plan to a rollover IRA, determine what IRA balance is needed to generate 24k per year using the amortization plan, and then transfer that amount to a second IRA and start the plan.

The original rollover IRA can be used for emergency needs to prevent the 72t plan from being broken if he needs more money. Employer plans do not provide 72(t) support and may not offer flexible distributions. They also will not allow funds to be rolled back in the event too much is taken out due to administrative error.

Note: that if Paul separated from service from the employer sponsoring the qualified plan in the year he would reach 55 or later, distributions taken directly from the plan are not subject to penalty, and a 72t plan could be avoided.

But for that to be practical the plan must allow flexible distributions until the 5 year period ends. If the plan required a lump sum distribution, even though the penalty would not apply, a distribution of 120,000 in a single year would inflate his marginal tax rate and that might well cost more than the 10% penalty. If a lump sum is required, then a direct rollover to an IRA should be done before starting a 72(t) plan.

The Final Call

The verdict is still out whether the client and I are going to do 72(t).   Since he has a good amount in his 401k and his wife has a nominal 401k , as well (not mentioned above); I suggested using that money first.

Since he’s retiring early, he can avoid the 10% early withdrawal penalty so as long as the money is distributed from his 401k.  Once you do a 401k rollover to an IRA, you lose that option.

Out of curiosity, I went to Bankrate.com and used their 72t calculator to see how much we could get with his retirement account.  Below are some of those results.


401k 72(t) distributions Early Withdrawal

72t calculator

Here’s a sample amount that one could withdraw from your IRA using 72(t). Note the interest rate of 2.48%. That amount was already entered in on Bankrate’s calculator. You actually have the ability to choose your own interest rate but be careful. You want to choose a rate that is normal and sustainable based on current market and economic conditions.

72(t) distributions

Fixed Amortization Method

Have you retired early?  Would you be comfortable executing 72(t) distributions for 5 years?


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Comments | 10 Responses

  1. Robert Zaleski says

    You should go into the penalties some more. I throw everything into my Roth since I’m only 30. But if I get to the point where it’s feasible to retire, I’d like to with this.

    Also, Is there a withdrawl amount you have to hit exactly, or can you be a bit less. Is it based on the price of your investments or fixed? How much are the penalties?

    Obviously if you hit this point you want your debts low, and a cushion outside of your planned living for unexpected items, but presuming I can get both in 10-20 years, you know I’m going to take it.

    Also, are there other restrictions on working if I just went to working 10 hours a week?

  2. Tara says

    Hi Jeff,
    I was reading about the 72t and I was wondering if it had to be started in the beginning of the year (January) or can you start it at any time?

  3. gfcscott says

    Great article overall. I plan on using 72(t) from my company rollover when I’m 50.9.

    Re: Note: that if Paul separated from service from the employer sponsoring the qualified plan in the year he would reach 55 or later, distributions taken directly from the plan are not subject to penalty, and a 72t plan could be avoided.

    Warning — this varies from company to company. At some (like mine) as soon as you take ANY withdrawal then their rule is you have to take (rollover) the whole thing. ie. they don’t want to keep you on the books and manager your money. It probably cost the company per employing for the 401k management.

  4. Neil says

    Jeff, I’m a little confused. In our case we have an employer 401k that only allows us a lump sum cash out, or roll-over (to IRA). My wife and I are 58. Are you saying that if we roll-over the 401 to an IRA, we can’t then exercise the 72T, because of the 10% penalty? By the way, we’re eligible for the “age 55” exception to the penalty, but don’t want to get zapped by the huge tax burden of taking the lump sum, 20%, etc.

    • says

      @Neil You can exercise the 72t once you rollover to an IRA, but I probably wouldn’t suggest that in your case. I would leave a sum (depending on how much you think you’ll need from now until 59 1/2) in your 401k to avoid the 10% early withdrawal penalty.

  5. Melissa martin says

    I just turned 55, I’m considering trying to retire. My understanding if I take my 401k out I have to pay the 10 percent penalty. Is this correct?

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