When we talk about retirement, we often focus on those who have saved and reached their retirement goals. But what about those who have fallen on harder times or retired early and need access to their retirement funds before the age of 59 ½? In such situations, one option to consider is establishing 72(t) distributions, also known as substantially equal periodic payments (SEPs), which allow you to access IRA funds without incurring a penalty.
While 72(t) payments may avoid the early withdrawal penalty, income taxes will still be owed. However, it’s important to weigh the pros and cons before making a decision.
Reasons to Consider 72(t) Distributions:
- Access to Funds: 72(t) distributions provide a way to access your retirement money without facing the 10% early withdrawal penalty.
- Increased Minimum Interest Rate: The IRS has recently raised the minimum interest rate (currently 5%) used in the calculation of 72(t) payments. This means you’ll receive larger payments, which can be beneficial.
- Flexibility: Unlike other options that require specific events (death or disability) or expenditures (education or home expenses), 72(t) distributions do not have any such restrictions. You have the freedom to use the funds as needed.
- No Spending Restrictions: There are no limitations on how the funds can be spent, giving you the flexibility to address your financial needs.
Reasons to Be Cautious about 72(t) Distributions:
- Strict Rules: The rules governing 72(t) distributions are rigid and offer little flexibility.
- Long-Term Commitment: By opting for 72(t) distributions, you commit to a payment plan for a minimum of five years or until you reach age 59 ½. This is a significant obligation, especially for younger individuals who are far from retirement (e.g., someone in their 40s).
- Complex Calculations: Calculating the 72(t) payment amounts requires specialized software or the assistance of a financial advisor.
- Penalty Risk: If you exceed the prescribed distribution amounts outlined in the 72(t) plan, the 10% penalty can be retroactively triggered for all the preceding years. This essentially nullifies the purpose of avoiding the penalty and can have adverse financial consequences when you need the money the most.
- Other Exceptions: There are additional statutory exceptions to the 10% early withdrawal penalty that you may consider, such as disability, first-time home purchase, education, or medical expenses.
Our general advice for individuals under the age of 59 ½ in need of funds is to explore alternative sources before tapping into their retirement accounts. This may include taxable brokerage accounts, a home equity line of credit, or a reverse mortgage.
If you do decide to establish a 72(t)-distribution plan, consider maximizing the payment amount while minimizing the use of retirement savings. It’s also wise to isolate one retirement account for this purpose, protecting the funds in your other retirement accounts from any potential disruption to the payment schedule.
If you find yourself facing important financial decisions or need guidance on retirement planning, it’s best to consult with the knowledgeable financial retirement advisors at Mission Wealth. They can provide personalized advice based on your unique circumstances. To schedule a no-obligation initial call, fill out our contact form.
Mission Wealth is a Registered Investment Adviser. This commentary reflects the personal opinions, viewpoints, and analyses of the Mission Wealth employees providing such comments. It should not be regarded as a description of advisory services provided by Mission Wealth or performance returns of any Mission Wealth client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this commentary constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Mission Wealth manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
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