72(t) Articles

When it comes to retirement planning, making smart decisions will help you reach your financial goals. Two often-used  strategies for accessing money when needed are borrowing from 401(k) and using a 72(t) Substantially Equal Periodic Payment (SEPP) plan. It is  important to understand the differences between them so you can make an informed decision about which is right for you.

What is a 401(k) Loan?

A 401(k) loan is a loan taken out against your 401(k) account balance. The loan amount is typically limited to 50% of your vested account balance or $50,000, whichever is less. The loan must be repaid within five years, and if you leave your job before the loan is paid off, the entire balance must be repaid immediately. Interest rates on 401(k) loans are typically lower than those offered by banks or other lenders, but they are still subject to taxes and penalties if not repaid on time.

What is IRS Rule 72(t) SEPP Plan?

A 72(t) Series of Equal Periodic Payments strategy allows you to withdraw money from your old 401(k), 403(b) or IRA account without incurring pre-Age 59 ½ early withdrawal penalties. To qualify for a SEPP plan there are several rules you must follow, and one of them is that you must take income for a minimum of 5 years or until age 59 ½, whichever is longer. The amount that can be withdrawn each year depends on your age and life expectancy and other factors  and must remain substantially equal over this time commitment. Withdrawals from a SEPP plan are subject to income taxes but not penalties or early withdrawal fees.

Pros and Cons of Borrowing from 401(k) vs IRS Rule 72(t) SEPP

Borrowing from your 401(k) has both advantages and disadvantages compared to using a 72(t) SEPP plan:

Advantages of Borrowing From Your 401(k):

• Potentially lower interest rates than other lenders

• Repayment terms up to 5 years

• No income taxes due on loan proceeds

Disadvantages of Borrowing From Your 401(k):

• Must repay entire balance if leave job before repayment period ends

• Subject to taxes and penalties if not repaid on time

Advantages of Using A 72(t) SEPP Plan:

• No penalties due on withdrawals

• Withdrawals remain substantially equal over time ( think same income paid every month or year to you for a minimum of 5 years or until age 59 ½, whichever is longer)

Disadvantages of Using A SEPP Plan:

• Must adhere to the time commitment for income 

• Withdrawals are subject to income taxes

Which Option Is Right For You?

The best option for you will depend on your individual circumstances and financial goals. If you want or need a stream of income due to early retirement, wanting to start a business, buy real estate, eliminate high interest debt and don’t want to pay pre-Age 59 ½  penalties, then a SEPP plan may be the better option for you. However, if you need a limited amount of money, want flexibility in repayment terms and/or want potentially  lower interest rates than what other lenders offer, then borrowing from your 401(k) may be the better choice. Ultimately, it’s important that you understand all of your options so that you can make an informed decision about which strategy is right for you.