How are 72(t) Distributions Taxed?
When it comes to retirement planning, the taxation of distributions is an important factor to consider. One type of distribution that may be available to those who are retired or nearing retirement is a 72(t) distribution. This type of distribution allows individuals to access their retirement funds without incurring the 10% early withdrawal penalty. However, it is important to understand how these distributions are taxed in order to make the most informed decision about your retirement plan. In this blog post, we will discuss how 72(t) distributions are taxed and what you need to know before taking advantage of this option.
What is IRS Rule 72(t) SEPP?
IRS Rule 72(t) SEPP (Series of Equal Periodic Payments) is the IRS Rule that allows individuals who are under Age 59 ½ to unlock or access their Retirement money (IRA, old 401k, Pension, 403b, etc) penalty-free. This IRS approved rule and financial planning strategy, if followed correctly, allows individuals to avoid the 10% early withdrawal penalty normally applied if someone is under age 59 ½.
Tax Implications of 72(t) Distributions
The tax implications for taking a 72(t) distribution are pretty straightforward. For example, when you take a 72(t) distribution from an IRA account you will be subject to ordinary income taxes on the amount withdrawn.
The key is proper planning to avoid the 10% pre-age 59 ½ early withdrawal penalty. Without proper planning and advice, if you are under Age 59 ½ , when you take an IRA withdrawal or distribution from an old/previous employer 401(k) account, you will be subject to both ordinary income taxes and an additional 10% early withdrawal penalty on any amount withdrawn.
Calculating Your Tax Liability
When calculating your tax liability for taking a 72(t) distribution, it is important to remember that all SEPPs taken during any given year must be reported as taxable income on your tax return(s) for that year. Any gains made on investments within your retirement account are not subject to taxes- only the withdrawals/distributions are subject to ordinary income tax. It is also important to note that if you fail to comply with all requirements associated with taking a 72(t) distribution (e.g., withdrawing funds for a minimum of five years or until age 59 ½ whichever is longer), then you may be subject to both ordinary income taxes and an additional 10% early withdrawal penalty on any amount withdrawn before age 59 ½.
Taking advantage of an IRA 72(t) series of equal periodic payment distributions can be an effective way for those who have not yet reached age 59 ½ and want or need to unlock their money for any reason. However, it is important for individuals considering this option to understand how these distributions are taxed in order to make an informed decision about this financial planning strategy. By understanding what types of taxes and potential penalties apply when taking a 72(t) SEPP distribution as well as calculating the tax liability based on your individual circumstances, you can ensure that you make the most informed decision possible when it comes time for accessing your retirement funds.