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One option for accessing your retirement funds early is taking equal periodic payments using Rule 72(t). Rule 72(t) payments aren't subject to the usual 10% early withdrawal penalties, but there are quite a few downsides you should consider. In this article, we'll cover the basics of Rule 72(t), the pros and cons, and why you should proceed with caution before using this strategy.
Rule 72(t) refers to a section of the Internal Revenue Code that provides an exception to the typical 10% early withdrawal penalty that typically applies to distributions from retirement accounts before age 59 1/2. Under Rule 72(t), you can avoid the penalty on early withdrawals from your 401(k), individual retirement account (IRA), and other retirement accounts. Specifically, Rule 72(t) says a 10% additional tax won't apply to distributions that are "part of a series of substantially equal periodic payments."
The IRS has strict rules of substantially equal periodic payments (SEPPs):
Of the rules listed above, the second one is the most concerning. Essentially, if you take SEPPs under Rule 72(t), you can't undo your decision without paying a penalty until you reach retirement age. In other words, if you took SEPPs at age 50, you'd need to continue them until age 59 1/2. Or if you took them at age 58, you're required to keep taking them until you're 63. Due to the lack of flexibility, it's typically best to consider the alternatives before employing a Rule 72(t) strategy.
You can choose from the following three methods to calculate substantially equal periodic payments:
Note that calculating substantially equal periodic payments is complex. If you're considering using Rule 72(t) to tap your retirement funds early, it's essential to consult with a financial professional.
There's always a risk when you withdraw money early from a retirement account. Your money gets less time in the market to grow, and you have to stretch that money over a longer timeframe. But Rule 72(t) presents additional risk because the rules are so inflexible. Before you withdraw retirement money under Rule 72(t), consider these alternatives:
Suppose you decide to tap your 401(k) money at age 51 using Rule 72(t). You have a $500,000 balance and choose the RMD method. You'd calculate your substantially equal periodic payments using the following steps:
Remember that substantially equal periodic payments must continue until you're 59 1/2 or for five years -- whichever is longer. So those $14,164 distributions would need to continue until age 59 1/2, even if your financial situation changed.
