Thinking About Retiring Early? Learn More About 72(t)

Thinking About Retiring Early? Learn More About 72(t)

ARE YOU ONE OF THE GROWING NUMBER OF AMERICANS THAT WANT TO RETIRE EARLY?

Thinking About Retiring Early? Learn More About 72(t)
Do you want to do it before you turn 60? If you answered yes to either of those questions, then read on, as you may want to learn more about a 72(t) distribution.

Normally, when someone retires early and draws on their retirement savings (before the age of 59 ½) they incur penalties and fees. 72(t) distribution plans allow someone to draw on their IRA savings, without fee or penalty, by using what is called “substantially equal periodic payments”. What that essentially means is unlike the other times you can pull from retirement savings, like to buy a house, or for school tuition, a 72(t) must be paid out over a set period of time. If you start a payout at age 52, for example, you must consistently do so for 8 years. You must take payment for 5 years, or turn 59 ½, whichever happens later. So, if you start at 57 you must continue with the payments until you are 62.[ii]

As with most things, there is an upside and a downside to this strategy. Let’s start with the bad news first:

The Cons of 72(t)

72(t) distribution plans are not something that should be taken on lightly, in fact, most advisors will suggest looking at alternate options before going this direction. The reason being, if done initiated incorrectly wrong, you might rack up a large sum in penalties and fees and put yourself in a worse financial position in retirement than had you waited. This is due to the fact that the payments, once started, cannot be modified or stopped for any reason. If they are, a 10% federal income penalty fee will be applied to all payments retroactively. Those retroactive penalty fees can be financially disastrous. Another of the drawbacks to a 72(t) is that the periodic payments are taxed at your income rate. Since the 72(t) life-expectancy payout is calculated based on the current market, another pitfall could be a sudden market downturn. The forced withdrawals could, in effect, wipe out your interest, chip away at the principal, and rapidly drain your retirement savings. If you end up in a situation like that, you may be forced to sell off some investments, further incurring fees. [iii]

And now the good news:

The Pros

You may be wondering why anyone would take the risk of a 72(t) after reading all that. But there are certain people that the 72(t) could be the right fit for. If you have sizeable assets spread out across different accounts and locations. If you have a concrete plan for your retirement. If you don’t think you will regret leaving work early. If you can make the long-term commitment and are good at budgeting. If you have a tax strategy in place for the future. You’ve probably noticed a theme with all of those, you need to be looking ahead and prepared for the unexpected. If you can ride out storms, absorb unforeseen situations, and still have a cushion to support your future, then you may be a good candidate for 72(t) payouts. On the other hand, if you have other funds you can draw from first, or are unsure what the future holds and how you will afford your retirement, then 72(t) is not the best choice.

Alternative Options

There are other options if you are considering early retirement. The first would be to leave your job at 55, which would allow you to pull out a lump sum out of your company retirement plan penalty-free. You could leave some funds in the retirement plan to continue to grow. You could also take the lump sum and reinvest it into a high-interest savings account. You will have to pay the taxes, so like anything else, discussing the best options with a qualified financial professional is vital. You could also dip into the after-tax contributions to your IRA or 401(k), non-deductible contributions. If you own company stock, you may be able to cash in on your NUA, or Net Unrealized Appreciation, as the penalty is only on the basis and not the total value of the stock. The penalties can be quite low and worth incurring.

Do Your Homework

Certain retirement savings plans, like 401(k)s and 403(b)s typically have distribution restrictions that preclude 72(t) withdrawals.[iv] So, you would have to roll any investments into an IRA to take advantage of them. While 72(t) can seem a convenient way to avoid penalty fees, they can also be quite costly if you make a mistake. So, talk to your financial advisor and tax consultant to make sure you have come up with the best arrangement. For the right candidate, 72(t) could be a great way to fund your early retirement and dip into your hard-saved retirement funds.

The best course of action to take if you want to retire early is to speak with a trusted financial advisor who can help you make the right choices with your retirement resources and avoid unnecessary penalties and fees. For a complimentary Discovery call don’t hesitate to contact us today.


[i] https://www.marketwatch.com/story/more-people-say-they-want-to-retire-before-age-60-is-that-wise-2019-01-02

[ii] https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-substantially-equal-periodic-payments

[iii] https://www.whitesecuritieslaw.com/2019/06/09/72-t-potential-pitfalls/

[iv] https://www.bankrate.com/retirement/using-72t-rules-for-penalty-free-income/

About the Author

Carroll W. “Bill” Hayes

Carroll W. “Bill” Hayes

Carroll W. “Bill” Hayes, MBA, CFP® Mr. Hayes started his financial career at Merrill Lynch in 1989. In 1992, Bill left Merrill Lynch for Fidelity Investments. During his career at Fidelity Investments he held roles in various divisions of Fidelity. Those roles included positions in the Trust, 401(k), Brokerage, and Money Management divisions. Bill held management positions at Fidelity and in 2001 led a Private Access team based in Boston. In the Private Access role his responsibilities included managing a book of business in excess of $3 Billion and a client base that was international in scope. 

In 2008 Bill established Charles Carroll Financial Partners. The firm is an Independent FeeOnly Financial Planning and Investment Management firm. Charles Carroll Financial Partners embraces its fiduciary responsibility to its clients. 

Bill is a graduate of Marquette University, and holds an MBA from the Sawyer School of Management. Bill holds the designation, CERTIFIED FINANCIAL PLANNER, and currently presides as a Commissioner on the Disciplinary and Ethics Commission of the Certified Financial Planner Board of Standards. Bill resides in Massachusetts with his wife Christine and travels up and down the East Coast meeting with clients of the firm.

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