Some of you may be considering initiating 72(t) distributions. 72(t) distributions takes careful planning and consideration.
Before you lock in those payments, there are some alternatives that you may want to explore:
Leave Your Job Early
If you leave your job January 1st of the year you turn 55 (50 for certain government agencies), you are allowed to pull out lump sum distributions out of your company retirement plan penalty free. Notice I said retirement plan and not IRA. Once you rollover into an IRA, you lose out on that opportunity.
Consider leaving a portion of money in the retirement plan as a precautionary. Or you can just take a lump sum distribution out of the plan and pay the tax and park it in a high interest savings account for emergency purposes. Do remember that you will pay ordinary income tax on that distribution.
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Dont Foget About After Tax Contributions
You can also tap into after tax contributions to your 401k, non-deductible IRA contributions, or after tax contributions to your Roth IRA. Consider these penalty free options first prior to locking in your payments.
Net Unrealized Appreciation
Even a bigger secret than 72(t) is NUA. What is Noo-uhh you ask? Well, it is the acronym for Net Unrealized Appreciation. Get it yet? Didn’t think so. NUA pertains to employer stock that you have in your retirement plan that may have an extremely low cost basis.
You may be one of the lucky ones that started working for the company prior to them going public and you’ve seen your company stock double and split more times that you can count. If you utilize the NUA on your stock you will just be penalized on the basis, not the total value of the stock.
For example, if you have company stock that is valued at $100,000 but your basis in the stock is only $20,000, you would be only penalized on the $20,000 if you took it early, if you are under 59 ½ . The remaining gain ($80,000) would be taxed as a long term capital gain when you decided to liquidate it, not ordinary income. That could be the difference between 15% and 35% in taxes, depending on your tax bracket.
Warning! Once you roll over your employer stock into the IRA, you forfeit your NUA.
These are just a few of the alternatives that one can explore before committing to the 72(t) distribution rule.