IRAs are meant for retirement, and you'll typically have to pay a 10% penalty if you take money out of an IRA before you reach age 59 1/2. However, certain withdrawals that qualify as what's known as substantially equal periodic payments under Section 72(t) of the Internal Revenue Code are eligible for an exception to the penalty. You'll still pay tax on traditional IRA distributions, but escaping the added penalty can be a big boon. The 72(t) exception is a bit complicated, though, and that's why it's helpful to have some help with the calculations.

The general idea behind substantially equal periodic payments

The point of the exception for substantially equal periodic payments is to allow early retirees a chance to get access to their money. Whether you quit voluntarily or are forced out through layoffs, penalizing someone who has legitimately retired early runs contrary to the spirit of the penalty provision. Therefore, if you agree to take a series of payments on a regular basis that conform to certain requirements, then you can avoid the penalty.

The most important requirement is that if you start taking substantially equal periodic payments, you have to keep taking them for at least five years. If you're more than five years away from turning 59 1/2, then you have to receive payments even longer until you reach that age.


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The toughest part of the substantially equal periodic payment exception

The biggest hassle with Section 72(t) substantially equal periodic payments is that there are several different methods you can use to calculate them. One involves a simple life expectancy calculation, while another uses annuity mortality tables and a third simply looks at certain rates of earnings within the retirement account.

Fortunately, there are resources you can use to make your decision easier. The following calculator runs all three scenarios for you, allowing you to pick the best one.

Editor's note: The following language is provided by CalcXML, which built the calculator below.


* Calculator is for estimation purposes only, and is not financial planning or advice. As with any tool, it is only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or a tax professional.

For instance, say that you have a $50,000 and are 55 years old. When you run that scenario through the calculator, you can see that the simple life expectancy method produces an initial annual payment of $1,689, but that figure can rise over time. Based on a 6% return, the amount would climb to nearly $2,100 by the time you reach age 59. By contrast, the amortization and annuitization produce higher amounts of $2,366 and $2,356 respectively, but those are flat amounts that must remain level year after year.

Is taking substantially equal periodic payments a smart move?

The biggest problem with the substantially equal periodic payments provision is that it rarely gives you access to very much of your IRA assets. As you can see from the calculator, because those who are younger than 59 1/2 typically have life expectancies that span decades, the methods typically allow withdrawals of somewhere between 3% and 5% of your IRA balance each year.

However, you should note that there are some other ways you might be able to tap IRA money early without penalty. If you take withdrawals due to disability, certain medical expenses, or for first-home purchases of up to $10,000, then you won't pay a penalty, either.

Given the level of difficulty in figuring out payments, the long-term commitment to making withdrawals in future years, and the relatively small benefit, using the Section 72(t) exception is rarely worth the trouble. For certain unusual situations, however, the method can get you early IRA access in a way that will produce substantial tax savings.