72t Distributions – Taking Income before 59 1/2 without a 10% penalty

72t Distributions – Taking Income before 59 1/2 without a 10% penalty

| May 09, 2022

Unless you qualify for an exception, taxable amounts you withdraw from an IRA or a qualified company plan before age 59 1/2 are subject to a 10% early withdrawal penalty. 

However, there are situations where a person may want to start drawing money out of an IRA early.  For example, they may want to retire early, or perhaps they have a medical issue where they're forced to retire early.

We had a client who had done a good job saving money and wanted to retire at age 50. Most of his money was in his pre-tax 401(K) plan and he thought this would prevent him from being able to retire, because of the 10% penalty he thought he would have to pay on any withdrawals he used for income.

We explained to him that he qualified for an exception under section 72(t) of the Internal Revenue Code called “substantially equal payments”.  To use this exception, he had to choose one of the three IRS approved methods for calculating the amount of your payment and take at least one distribution annually. These are the RMD method, the fixed amortization method, or the fixed annuitization method.

I’m not going to go into all the math calculations on how these methods come up with a dollar amount. Just remember that one method results in a lower amount of income, one results in a medium amount of income, and one offers a higher amount of income. Unless you want to take a dangerously high amount of income out of your portfolio, one of these three formulas should get you the income you need.

The payments from your IRA or company retirement plan must continue for at least five years or until you reach age 59 1/2 whichever comes later.  So, in the case of our 50-year-old client, 59 1/2 was later than five years, so once he started his payments, he had to continue them for the next nine and a half years.

For the most part, once the payments start if you modify them, for example by taking a larger distribution for the year than you should have, or changing from one method to another, you will generally trigger a 10% penalty retroactive all the way back to your first payment for all the payments made to you.

You can make a one-time change where if you’re in one of the two higher yielding methods, you can change and drop to the RMD method, which yields the lowest amount of income and the amount changes each year.

The key to making sure you do this right and don’t trigger this penalty is to set this up through a professional who will take responsibility for monitoring it for you and making sure the correct amount is taken out.

Also remember while a 72(t) can be set up on either a company retirement plan or an IRA there are distinct advantages of rolling the company plan over to an IRA first, before you set this up.  For example, in most cases, the IRA will offer more investment choices and investment strategies and more personalized investment advice.


This article is for informational purposes only. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a lawyer, tax or financial professional. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.