Is this how a 72t works?

[tulak]

I’ve been reading about 72(t) and there’s a lot of, “you should hire a CPA to do this because if you mess it up, it’s bad.” But I’m looking at the details and it doesn’t seem that bad?

I’m hoping others here can confirm that my understanding of how this work is right.

Here’s how I think it works using the fixed amortization method.

Let’s say I want ~50k of income starting in 2028. This requires an IRA balance of around 800k. I will roll this amount into an IRA from where I will take withdrawals. I will not add anything else to this IRA after starting SEPP.

I turn 55 late in 2028, but I will take my first withdrawal at the beginning of the year, when I’m still 54. My single life expectancy factor is 31.6, based on the IRS table for age 55, since I will turn 55 in 2028.

I’ll use an interest rate of 5%, since that’s a default option.

If I use the fixed amortization formula, I get $50,890.72 a year. I confirmed this with an on-line calculator and using my own calculation.

I withdraw that amount for 5 years: 2028 until 2032. That meets the 5 year minimum requirement. For 2033, I don’t have to make the withdrawal since that is the year I turn 59.5. Is that right?

For each year of withdrawals, I will receive a 1099-R with box 7 distribution code of 1, early distribution, no known exception. Is that right? I will then have to file form 5329, and on line 2 specify an exception of 2, for a SEPP distribution, to avoid the 10% penalty.

And I think that is it? Am I missing anything?

 

[Sunset]

All I know is that it's good for you to set up a separate IRA strictly for this. That way in an emergency situation you can withdraw extra money (and pay ~10% penalty due to age) from another IRA without damaging the 72t (which would incur more penalties).

 

[jazz4cash]

There was a 72t.net website that covered all the details but it shutdown at some point. I believe 72t plans are much less restrictive than they used to be (e.g. penalty if plan goes “bust”). Plus rates were so low that it was a challenge to produce enough income. Fidelity and others I believe now offer to manage plans and there are 72t calculators everywhere.

Given your timeframe if these were 401k funds (or you could roll them into one) the age 55 exception seems to be a more flexible option.

NM…just saw your other post about the age 55 exception.

 

[SecondCor521]

All of that looks correct to me. A few thoughts:

1. There are several calculators out there for 72(t) distributions, and most vary slightly. I'd try to reduce risk by either finding one that seems to be most correct, or finding a couple that match each other for your inputs, or, at the very least, do a print out of the one you choose when you start the 72(t).

2a. To be more conservative, I might choose to wait until a few days after you turn 54 1/2 (sometime in the late spring of 2028) so that you can take five distributions essentially annually with your last one being a few days after you turn 59 1/2. This seems to provide a much more conservative approach at the small cost of waiting a few months in early 2028 to get started.

2b. The way I understand the 5 year rule is that you must continue with annual distributions until both (a) five years have passed since your initial distribution AND (b) you are 59 1/2, at which point you can stop. I think your plan meets this rule, as does my slight suggested modification in 2a.

3. You have it correct with the 5329 stuff.

4. It has been recommended to me that the IRA starting balance should be substantiated by being a month-end value in the month or two prior to starting the 72(t). So if you turn 54 1/2 on April 15th, I'd try to have the IRA separated and the 3/31 value be as close to the $800K number as I could. I'd then rerun the 72(t) calculator with whatever that month-end value was. (It'll be close enough.)

5. Yes, 5% is acceptable, but that's only because of a recent change to the law. So make sure that whatever you're using is actually legally acceptable and not just an option that the calculator lets you enter. In an ideal world, these would be one and the same, but there are incompetent web pages out there.

6. I'd probably set up an auto-withdrawal from the IRA with the IRA custodian for $50,890.72 every April 6th or whatever so that the custodian decides what happens if April 6th is a weekend or holiday. Alternatively, you can pick a day which will not be a weekend or a holiday for those five years if you choose carefully.

7. Almost certainly the IRS won't care and won't check anything. Yes, there are penalties for not following a 72(t), but I think if you do your due diligence and can show a reasonable approach that is close to the rules, the IRS would be fine with it. The IRS has always taken the approach of "these three methods are OK; others might be OK but you have to ask" and there are some arcane PLRs where taxpayers asked for official IRS blessing of their own methods that are different in various ways from the IRS three approved methods but still meet the intent of the law (which doesn't contain particulars).

 

[SnowballCamper]

This is old, but a good read, and how I built mine. You'll need to check the current rules on the rate you can use to calculate withdrawals.

 

[SecondCor521]

^ That's a good resource and one that I looked at when I was interested in 72(t). The ability to use 5% was a change made after that document was written.

 

[SecondCor521]

Am I missing anything?

I guess I could ask if you back up a step and are sure that 72(t) is the best option for you. I like it for people who have a stable and predictable budget for those 5 years and are about 54 1/2 when they want to start tapping their traditional IRA.

I was going to do 72(t) but decided on a Roth conversion ladder instead. Although I've somehow not touched my Roth conversion ladder despite being retired 9 years. Roth conversion ladder in general is more flexible but does require arranging one's finances to get set up for it perhaps a few years ahead of time.

 

[Stormy Kromer]

When I was about 30 I set up a SEP IRA a with a FA and funded the hell out of it for the next 20 years with the plan of taking 72t's out of it before age 59. When the time came at age 57 I had a pile in the IRA and nobody at the FA's office, including himself, knew how to set up a 72t withdrawal. They told me " it was too much trouble, just wait till you're 59 1/2 and take it then"........I really think they didn't know how. They wanted to keep my funds under management and collect 1.5% management fee per year,

And I paid big money for an FA....I was dumb.

I would like to help any young person to avoid FA's and learn how to invest on your own and don't rely on anyone else's advice.

 

[CyclingInvestor]

I used the recalc method for 12 years after retiring at 48, built a simple spreadsheet showing how much to pull out each year. I kept about 10% in a separate IRA for emergencies. No trouble at all.

 

[tulak]

Thanks for all of the responses!

I can’t respond right now and will look over in more detail tomorrow.

 

[tulak]

All of that looks correct to me. A few thoughts:

1. There are several calculators out there for 72(t) distributions, and most vary slightly. I'd try to reduce risk by either finding one that seems to be most correct, or finding a couple that match each other for your inputs, or, at the very least, do a print out of the one you choose when you start the 72(t).

Good idea to print it out. I used one calculator and my own calculation. They both matched to the penny, so I felt pretty good that I did it right.

2a. To be more conservative, I might choose to wait until a few days after you turn 54 1/2 (sometime in the late spring of 2028) so that you can take five distributions essentially annually with your last one being a few days after you turn 59 1/2. This seems to provide a much more conservative approach at the small cost of waiting a few months in early 2028 to get started.

2b. The way I understand the 5 year rule is that you must continue with annual distributions until both (a) five years have passed since your initial distribution AND (b) you are 59 1/2, at which point you can stop. I think your plan meets this rule, as does my slight suggested modification in 2a.

That’s a good idea. I might even wait until 2029 - if I take a 72(t) - since odds are I’ll have enough fund for 2028.

3. You have it correct with the 5329 stuff.

Good to know!

6. I'd probably set up an auto-withdrawal from the IRA with the IRA custodian for $50,890.72 every April 6th or whatever so that the custodian decides what happens if April 6th is a weekend or holiday. Alternatively, you can pick a day which will not be a weekend or a holiday for those five years if you choose carefully.

Another good idea!

7. Almost certainly the IRS won't care and won't check anything. Yes, there are penalties for not following a 72(t), but I think if you do your due diligence and can show a reasonable approach that is close to the rules, the IRS would be fine with it. The IRS has always taken the approach of "these three methods are OK; others might be OK but you have to ask" and there are some arcane PLRs where taxpayers asked for official IRS blessing of their own methods that are different in various ways from the IRS three approved methods but still meet the intent of the law (which doesn't contain particulars).

That seems reasonable. I’m somewhat surprised at how uncomplicated a 72(t) is to setup. I thought it would be more difficult.

I guess I could ask if you back up a step and are sure that 72(t) is the best option for you. I like it for people who have a stable and predictable budget for those 5 years and are about 54 1/2 when they want to start tapping their traditional IRA.

I was going to do 72(t) but decided on a Roth conversion ladder instead. Although I've somehow not touched my Roth conversion ladder despite being retired 9 years. Roth conversion ladder in general is more flexible but does require arranging one's finances to get set up for it perhaps a few years ahead of time.

I might not need the 72(t). Depending on when I retire, there’s a good chance that I can get to 59.5 using Roth principal withdrawals, a one-time withdrawal from my 401k (one time use of Rule of 55), and money in taxable accounts. But it’s nice to understand the options.

What is interesting is that I’m realizing that I might not need to wait until 2028. I like my job and I’m in no hurry to stop working, but it does make me think about my goals.

 

[NgineER]

I might not need the 72(t). Depending on when I retire, there’s a good chance that I can get to 59.5 using Roth principal withdrawals, a one-time withdrawal from my 401k (one time use of Rule of 55), and money in taxable accounts. But it’s nice to understand the options.

If this is an option, I'd suggest building a Roth IRA ladder to start the conversion process and not be tied to the 72t rigor

 

[Out-to-Lunch]

And here is the canonical reference on Roth conversion ladders: How to Access Retirement Funds Early

 

[FedRetired50]

This is the "bible" for 72t/SEPP: 72(t) Expert, SEPPs Income Planning, and 72t Calculator | 72tcalc.com

You have to give him your email address (yellow box) and then he sends you a link to download the "bible". I can tell you he only uses it when there's an update for the document. I think I've received 3 emails from him over the years.

Honestly, once you read through that document, the calculation isn't hard. I use Excel (PMT function) and 2 web sites to document the calculation results every year via screen shots. Edit: as of last year Bankrate's 72t calculator was wrong, so this is one reason I use multiple calculators to verify.

 

[TravelinFamilyMan]

All of that looks correct to me. A few thoughts:

1. There are several calculators out there for 72(t) distributions, and most vary slightly. I'd try to reduce risk by either finding one that seems to be most correct, or finding a couple that match each other for your inputs, or, at the very least, do a print out of the one you choose when you start the 72(t).

2a. To be more conservative, I might choose to wait until a few days after you turn 54 1/2 (sometime in the late spring of 2028) so that you can take five distributions essentially annually with your last one being a few days after you turn 59 1/2. This seems to provide a much more conservative approach at the small cost of waiting a few months in early 2028 to get started.

2b. The way I understand the 5 year rule is that you must continue with annual distributions until both (a) five years have passed since your initial distribution AND (b) you are 59 1/2, at which point you can stop. I think your plan meets this rule, as does my slight suggested modification in 2a.

3. You have it correct with the 5329 stuff.

4. It has been recommended to me that the IRA starting balance should be substantiated by being a month-end value in the month or two prior to starting the 72(t). So if you turn 54 1/2 on April 15th, I'd try to have the IRA separated and the 3/31 value be as close to the $800K number as I could. I'd then rerun the 72(t) calculator with whatever that month-end value was. (It'll be close enough.)

5. Yes, 5% is acceptable, but that's only because of a recent change to the law. So make sure that whatever you're using is actually legally acceptable and not just an option that the calculator lets you enter. In an ideal world, these would be one and the same, but there are incompetent web pages out there.

6. I'd probably set up an auto-withdrawal from the IRA with the IRA custodian for $50,890.72 every April 6th or whatever so that the custodian decides what happens if April 6th is a weekend or holiday. Alternatively, you can pick a day which will not be a weekend or a holiday for those five years if you choose carefully.

7. Almost certainly the IRS won't care and won't check anything. Yes, there are penalties for not following a 72(t), but I think if you do your due diligence and can show a reasonable approach that is close to the rules, the IRS would be fine with it. The IRS has always taken the approach of "these three methods are OK; others might be OK but you have to ask" and there are some arcane PLRs where taxpayers asked for official IRS blessing of their own methods that are different in various ways from the IRS three approved methods but still meet the intent of the law (which doesn't contain particulars).

This is an excellent write-up! I did a 72T for myself and my wife when I was 53 and as stated above, just did the annual, scheduled withdrawal out of the Rollover IRA from my previous employer. I did this until I turned 59 1/2. I'm 61 now and have not had a problem whatsoever. DW is not 59 1/2 yet so she is still pulling hers. On IRS on the form 5329 line 2 - enter the amount with code 02.

 

[Fermion]

Your numbers look about right to me. We set up a 72t two years ago with $415,000 rolled over into a IRA from a 401K. We take $25k each November (have had 2 payments so far) and I have the money invested in sort of a bond ladder right around 4.7% return, which means I still have over $400,000 in the account. Note you do not have to worry about the balance in the 72t...as long as you don't move money out of it, your investments can go bust and you will not be at fault. I did the bond thing because I wanted the comfort of a solid $25k every year, even if the market drops 50%. It also helps qualify us for a ACA plan quite nicely, when we add a little bit of interest income from our taxable accounts.

 

[rembrandt]

If you are not yet age 59 1/2 you can avoid the 10% federal penalty tax by transferring your IRA or 401(k) into an immediate annuity with a "life contingent" payment option. If you receive the income periodically over your lifetime you may avoid the 10% penalty tax on the money you receive.

 

[jazz4cash]

This is the "bible" for 72t/SEPP: 72(t) Expert, SEPPs Income Planning, and 72t Calculator | 72tcalc.com

This is the guy that ran the excellent 72t.net website. Very interesting (to me) history of IRS private letter ruling that enabled the 72t. I purchased the “72t Bible” as an ebook back in the 90’s(?) for ~$20 when I thought I might need it. Lost track of the author til now. Thanks.

 

[bloom2708]

72(t) Calculator

The IRS Rule 72T allows for penalty free, early withdrawals from retirement accounts. Use this calculator to determine your allowable 72T Distribution and how it can help fund your early retirement.

www.dinkytown.net

This site has a good calculator to double check your work.

We plan on using 72T/SEPP when I turn 56 and wife is 57 for 5 years.

The alternative is to live off taxable and do Roth Conversions, but you need a pretty good size taxable account which is fine, but I'd rather keep taxable compared to pre-tax in Rollover IRAs.

 

[Fermion]

Note you can also take out Roth contributions tax and penalty free if you happen to have done a lot of those over the past decades. Roth conversions you can take out after 5 years. I have my eye on about $150k of Roth contributions we can use if our taxable runs low and the $25k a year from our 72t isn't enough to meet all of our expenses. We save $15k or more a year on health insurance by keeping our MAGI low so using Roth contributions to increase our income would be a bird in the hand type thing over letting those grow but paying $15k more each year for insurance.

 

[kimmsa]

I’ve been reading about 72(t) and there’s a lot of, “you should hire a CPA to do this because if you mess it up, it’s bad.” But I’m looking at the details and it doesn’t seem that bad?

I’m hoping others here can confirm that my understanding of how this work is right.

Here’s how I think it works using the fixed amortization method.

Let’s say I want ~50k of income starting in 2028. This requires an IRA balance of around 800k. I will roll this amount into an IRA from where I will take withdrawals. I will not add anything else to this IRA after starting SEPP.

I turn 55 late in 2028, but I will take my first withdrawal at the beginning of the year, when I’m still 54. My single life expectancy factor is 31.6, based on the IRS table for age 55, since I will turn 55 in 2028.

I’ll use an interest rate of 5%, since that’s a default option.

If I use the fixed amortization formula, I get $50,890.72 a year. I confirmed this with an on-line calculator and using my own calculation.

I withdraw that amount for 5 years: 2028 until 2032. That meets the 5 year minimum requirement. For 2033, I don’t have to make the withdrawal since that is the year I turn 59.5. Is that right?

For each year of withdrawals, I will receive a 1099-R with box 7 distribution code of 1, early distribution, no known exception. Is that right? I will then have to file form 5329, and on line 2 specify an exception of 2, for a SEPP distribution, to avoid the 10% penalty.

And I think that is it? Am I missing anything?

I did this at 54, and I did use a CPA just to CYPA-it was $100 well spent. I kept the email filled away just in case…. Happy retiring!