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Getting To Know The 72(t) Rule

Through IRS code 72(t), an odd little exception comes our way.  Referred to as a SEPP, or Substantially Equal Periodic Payments, the IRS allows a distribution or withdrawal from a Traditional IRA before the age of 59½, bypassing the standard 10% penalty that is typically levied against premature withdrawals.  Millions of Americans are still employed, only because they believe they can’t get to their IRA without penalty until the ate of 59½.  This is where the SEPP steps in, via the IRS 72(t) rule.  

The basic concept is that the IRA owner begin to withdrawal a series of equal payments out of the IRA.  As long as the I’s are dotted and the T’s are crossed, the 10% penalty can be avoided.  We have listed a handful of common questions that we hear in the course of working with clients through the issues.  

  • Will I Still Pay Federal Income Tax With A 72(t)?  The answer is that the distribution will generate a 1099, and so the amount will be taxable.  Your CPA will add the distribution and will likely trigger Federal Income Tax, but there will be no penalty as long as the SEPP is abided by correctly.
  • How Old Do I Have To Be To Begin A 72(t)?  Any age below the age of 59½.
  • Once I Begin 72(t) Payments, How Long Must I Continue Them?  You must continue the SEPP payments for the greater of 59½ or 5 years, whichever is longer.   For example, if you begin your 72(t) at the age of 58, you would be required to continue the SEPP payments until the age of 63.  If you began your SEPP payments at the age of 51, you would be required to continue the payments until the age of 56.
  • How are the calculations from the SEPP determined?  One of three methods may be used, the minimum distribution method, the amortization method and the annuity method.  Spin through a 72(t) calculator to see what works best for you.
  • How Often Must I make Distributions From A 72(t), Once I Begin Taking Distributions?  You are required to take distributions at least once per year.  Most of our clients take distributions monthly.
  • Can I Change My Distribution Once I Begin?  Only if you begin your withdrawal using the minimum distribution method.  And, you are only allowed one change from it during the life of the SEPP.
  • Can I Make Contributions to My IRA While Taking Distributions?  No, you may not add to the IRA via annual contributions, rollovers or transfers.
  • What If I Violate The IRS Terms Of The SEPP?  If you violate the 72(t), then a retroactive 10% penalty will apply on all of the distributions made to that point. Also, interest will be charged retroactively against the 10% penalties that would have occurred, had ordinary, premature distributions been made without considering the 72(t) exception.

These are only a sampling of the questions and concerns that clients need to consider before beginning a 72(t).  Please, please consult a qualified CPA before beginning a 72(t).  72(t)’s are notorious for errors, and landmines exist all thru the process.