Q: How are 72t distributions calculated?
A: There are (3) standard methods the IRS allows us to use in determining a 72t distribution:
- Amortization Method
- Annuitization Method
- Required Minimum Distribution Method
We have specialized software that helps us to customize a plan and select the appropriate payment method for you. Each method will provide a different monthly or annualized distribution amount. The method that will be used will depend on the amount of income that you need and your personal situation. We can help you determine which method will efficiently generate the income you need.
Q: How is Life Expectancy determined and what interest rate is used?
A: The life expectancy tables that can be used are:
- Uniform Life Table
- Single Life Table
- Joint Life and Last Survivor Table
The most common table used is the Uniform Life Table, and all three tables can be found on the IRS.gov website.
The maximum 72t interest rate allowed is the greater of 120% of the Federal Mid-Term annual rates of the (2) months immediately preceding the month that you start distributions. Please note this is NOT the interest rate to expect on the actual investment that the 72t distribution is coming from. It is simply the factor used to calculate the allowed amount that you can take for this valuable strategy. Current rates can also be found on the IRS.gov website.
Q: Does 72t apply to a Roth IRA or any non-IRA accounts?
A: 72(t) distributions are not applicable to a Roth IRA, as the dollars that were originally contributed to the Roth IRA have already been taxed. With a 401(k), contributions are traditionally deducted from your paycheck and your taxes are deferred until a later date. With an IRA, if you fall within a particular threshold of annual income, your annual IRA contributions are deducted from your Adjusted Gross Income so you haven’t paid taxes on those dollars yet either.
Roth IRA contributions have already been taxed, so 100% of your principal is tax free upon distribution (assuming it’s been open for 5 years and you are over Age 59 ½). Early withdrawal penalties will only be assessed to the extent that there are gains, and there is not a 72t exception for those penalties.
As for any other non-IRA accounts, the only exception is Non Tax-Qualified Annuities. Annuities are retirement vehicles, so even policies funded with post-tax dollars will be assessed the early withdrawal penalty if funds are taken prior to Age 59 ½. You CAN structure a 72(t)-like distribution from these annuities also. This strategy is specifically referred to as a 72(q) distribution. The payment method and options available are all the same.
Q: What will it cost me to set up a 72t distribution?
A: There are (2) ways we typically work with people, and there are (3) steps that we take:
- Become familiar with you and your situation as well as your goals and objectives
- Determine the correct payment method and amount to take as well as how to properly structure your accounts based on your unique situation
- Create, implement and execute a suitable and sustainable Early Retirement game plan
Managing the early distribution accounts and payments for you, accrue no additional fee.
Some people approach us looking for the 72t calculation and investment advice, but prefer to manage the money themselves in their existing accounts. While we don’t recommend this, we are happy to run the calculations, draw up a detailed game plan and provide a proposal that lays out everything we would do if we were managing the account. We do this on a flat fee basis. The fee will depend on the complexity of your situation and the amount of time and work involved. We believe this would be a small investment compared to the thousands and even tens of thousands of dollars it would cost you if your 72t plan is NOT properly structured.
Q: Is it possible to use the 72t exemption rule if you only want to withdraw a small amount of money from your retirement account (not the entire balance as the rule states)?
A: Although the 72t rule does indeed state that you must take the equal periodic payments in such a way that the ENTIRE retirement account balance is depleted over your remaining life, there is a solution to get around this. You can open multiple retirement accounts and can choose to only apply the 72t distributions to just one of your retirement accounts (not all of them). This can most times be a complex process. We have a highly trained and experienced staff to assist and oversee that this is done in the proper manner. A mistake here could be VERY costly.
Q: What are the reasons to take money out of a 401(k) without penalty?
A: You may qualify to take a penalty-free withdrawal if you meet one of the following exceptions:
- You become totally disabled.
- You’re in debt for medical expenses that exceed 7.5% of your adjusted gross income.
- You are required by court order to give the money to your divorced spouse, a child, or a dependent.
- Separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.
- You’re separated from service and you have set-up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy.
(Once you begin taking this kind of distribution you are required to continue for five years or until you reach Age 59 1/2, whichever is longer.) This is an area that we specialize in and can offer guidance and counsel.
Q: At what age can you withdraw from a 401(k) without penalty?
A: The Age 59½ distribution rule says any 401(k) participant may begin to withdraw money from his or her plan after reaching the age of 59½ without having to pay a 10 percent early withdrawal penalty. There is an exception to that rule, however, which allows an employee who retires, quits or is fired at Age 55 to withdraw without penalty from their 401(k).
There are (3) key points early retirees need to know.
First, this exception applies if you leave your job at any time during the calendar year in which you turn 55, or later, according to IRS Publication 575.
Second, if you still have money in the plan of a former employer and assuming you weren’t at least Age 55 when you left that employer, you’ll have to wait until Age 59½ to start taking withdrawals without penalty. Better yet, you may want to get any old 401(k)’s rolled into your current 401(k) before you retire from your current job so that you will also have access to these funds penalty free.
Third, this exception only applies to funds withdrawn from a 401(k). IRAs operate until different rules, so if you retire and roll money into an IRA from your 401(k) before Age 59½, you will lose this exception on those dollars.
Q: Do I pay any taxes on a 72t distribution?
A: The answer is YES. Remember, retirement accounts are 100% tax deferred until you start taking withdrawals. Whether you are at, above, or under Age 59 ½, 100% of the dollars taken from your retirement account will be added to your income when filing your taxes. If you withdraw funds prior to Age 59 ½ without utilizing a known exception, a 10% early withdrawal penalty will be added to the tax liability for those dollars. So, by taking income through a 72t you are not avoiding income tax, but you are avoiding the 10% early withdrawal penalty.
Q: Can you still contribute to a retirement account while taking 72t distributions?
A: Once you start your series of substantially equal periodic payments, you are not allowed to make any additional contributions to the account, including rollover contributions, direct transfers and/or annual contributions. However, right before you start the 72t income, you are allowed to move money between accounts. For example, if you have just one IRA with $200,000 in it, but you only wanted $50,000 in the account from which you are taking the series of substantially equal payments, you could transfer $150,000 to a separate IRA so it wouldn’t be affected.
Multiple IRA Accounts
If you have multiple IRAs and you are only taking 72t distributions from one of them, you can make your annual IRA contributions by contributing to a different IRA. For example, say you have one IRA at a Bank, another at a Mutual Fund company and a 3rd at an Insurance company. If you are taking 72t distributions from your IRA at the Bank, you can make your annual contributions to your IRAs at the Mutual Fund company and Insurance company without penalty, even though you are not allowed to add any money to the IRA at the Bank.
If you would like help to properly structure your early retirement plan, contact us today.