The tax-advantaged retirement account offers valuable tax savings in exchange for your commitment of funds to the account for the long term. Should you access that money before you reach retirement age, or 59 ½, the Internal Revenue Service (IRS) may impose an early withdrawal penalty.
That penalty is reason enough to learn about Rule 72 (t), the section of the Internal Revenue Code that defines the process you must follow to get access to your retirement savings early without incurring a penalty.
What Is Rule 72(t)?
A retirement account lets you delay the payment of capital gains taxes on your investments until you reach the age of 59 1/2. To benefit from the account, the IRS requires a taxpayer to leave the cash in her chosen tax-advantaged account until you reach that age.
In most cases, if you make an early withdrawal, the IRS will charge you a penalty fee of 10 percent of the amount you withdraw. But there are exceptions.
Read More: Early IRA Withdrawal Tax Penalty Calculation
Withdrawals Without Penalties
When allotting the early withdrawal penalty, the IRS says some events, such as experiencing a permanent disability or incurring certain medical expenses, are valid exceptions to the rule. Other exceptions include the distribution of IRA account assets to a beneficiary following the death of an IRA account owner and account withdrawals to pay college tuition or make a first-time home purchase.
Should you need to make a cash withdrawal for some event other than those just stated, Rule 72(t) may be of help. It's the section of the Internal Revenue Code that lets a taxpayer withdraw cash from a qualified retirement account, such as a 401(k) or individual retirement account, without penalty so long as you establish a formal schedule of withdrawals called SEPPs.
What Are SEPPs?
If you withdraw money from a qualified retirement account under Rule 72(t), the withdrawals must be substantially equal payments that occur on an annual basis or multiple times in one or more years. These scheduled payments can be made over the course of five years or until you turn 59 ½.
The Application of Rule 72(t)
Rule 72(t) applies to qualified retirement plans including the 401(k), 403(b), 457(b), Thrift Savings Plans (TSPs) and IRAs. When using Rule 72(t) to set up a schedule of SEPPs, you must meet several requirements:
- •Schedule one or multiple payments. It’s possible to schedule one or multiple SEPP installments for five or more years. The guiding rule is that you must take at least one payment a year for five years, or until you are 59 ½ years of age. If you miss a payment, you’ll owe the IRS early withdrawal penalties on all the cash you’ve withdrawn from the retirement account under your SEPP schedule up to that point.
- Pay income taxes on contributions and earnings that haven’t been taxed. For the contributions and earnings that are included in the SEPP installments during a tax year, you must pay tax on those retirement account withdrawals not previously taxed.
- Don’t withdraw funds from an account your current employer manages. A retirement account at your present job is not eligible for SEPPs. If you take SEPPs in error, you’ll owe a 10 percent IRS early withdrawal penalty on the amount of the withdrawals
To make sure that you follow the rules that govern SEPP installments, consult with a financial advisor or tax professional before scheduling the withdrawals from your qualified retirement account.
Withdrawing money from a qualified retirement account under Rule 72(t) can be a complicated task. Should you make a mistake, you’ll be facing expensive IRS penalty fees. So, if you evaluate a current financial event and decide to use Rule 72(t) and SEPPS to deal with it, seek guidance from a tax professional. And remember that it’s likely that you’ll owe taxes on your SEPP withdrawals.
Billie Nordmeyer is an IT consultant of 25 years standing. As a senior technical consultant for SAP America and Deloitte Touche DRT Systems, a business analyst, senior staff, and independent consultant, Billie has worked across the retail, oil and gas, pharmaceutical, aeronautics and banking industries. Billie holds a BSBA accounting, MBA finance, MA international management as well as the Business Analyst and Software Project Management certificates from the Cockrell School of Engineering at the University of Texas at Austin.