Should you use IRS rule 72(t) to access your retirement fund?

Earlier this week, a stressed out reader asked if using IRS rule 72(t) to access his retirement fund is a good idea.  I knew you can use this rule to take distribution from your retirement accounts and avoid the IRS early withdrawal penalty, but I didn’t know all the details so I had to do some research. Usually, you will have to pay a 10% penalty if you withdraw from your retirement accounts before you’re 59½. The Roth IRA is a special case and we’ll discuss it later.

My early retirement plan is a bit different from traditional retirement. At 40, I’m not ready to stop working completely and just chill out all day. My early retirement will be funded by part time work and passive income streams. Here is a quick recap of my exit strategy.

  • up to age 40 – Work and build up net worth as much as we can and live a somewhat frugal lifestyle.
  • age 40 to 60’s – Explore part time self employment options and find other opportunities to generate some income. Mrs. RB40 will keep working for now. She is a workaholic and likes her job. Do not draw on retirement funds at this time. Putting off withdrawal is one of the keys to my exit strategy.
  • age 60’s to 100 – Both fully retire at some point and start to draw on our nest egg.

Leaving your retirement funds alone will give them a chance to compound. However, if you really need to call it quits today and haven’t set up any passive income streams yet, then your only choice might be to take distribution on your retirement accounts.

Disclaimer: If you’re planning to use rule 72(t), then please talk to a qualified tax accountant. Reading blogs and the IRS FAQs are clearly not enough for this important decision. If you don’t do it right, you might be assessed that 10% penalty.

early retirement withdrawal with rule 72t or Roth IRA
Rather be fishing?

How does rule 72(t) work?

Rule 72(t) will help you avoid that early withdrawal penalty, but you’ll have to follow some rules. First, you will have to take “substantially equal periodic payments” (SEPPs) every year. Once this starts, you must continue to do so for at least five full years, or if later, until age 59 ½.

If our 50-year-old reader uses rule 72(t) then he will have to keep taking distributions from his retirement account until he is 59 ½. If he stops taking distribution early, then he will have to deal with our friends at the IRS.

How much can you take out?

I’m going to cheat here and tell you to Google “72t calculator.” There are 3 methods to calculate the distribution.

  • Required Minimum Distribution Method (RMD)
  • Amortization Method
  • Annuitization Method

Let’s try it out. We’ll assume a $1 million dollar portfolio and use the single life expectancy table. Here is what the calculator return.

  • RMD: $29,240/year
  • Amortization: $37,353
  • Annuitization: $37,178

At 60, we would have made 11 withdrawals and the balance is forecasted to be around $730,618 using the Amortization method.

Is 72(t)a good idea?

I don’t think this is a good idea unless you have a ton of money in your retirement account. You’d probably need at least a million bucks in your IRA to do this. Living on $37,000/year is doable if you don’t have any debt and your lifestyle isn’t extravagant. Your retirement account would shrink quite a bit by the time you reach 60 and you’d have to continue living on about $37,000/year. Social security benefits might help out though when you become eligible.

On the other hand, if you leave the retirement account alone, it could double in 10 years. With 2 million dollars, it would be possible to live a much more comfortable lifestyle when you really need it the most. Your time in retirement will be less and your nest egg bigger. That’s why I think it’s better to hold off on withdrawal.

Alternative – Roth IRA

Another way to access your retirement fund is through the Roth IRA conversion. You can build a Roth IRA ladder and withdraw without having to pay the 10% penalty.

  1. Roll over 401k to IRA
  2. Convert 1 year of living expense to Roth IRA. (You will have to pay tax when you do this.)
  3. Wait 5 years
  4. Withdraw 1 year of expense from the Roth IRA

Just repeat this every year until you’re 59 ½.

The drawback here is you have to wait 5 years before you can take out the first year of expense. If you already have a good-sized Roth IRA, then perhaps you can stretch it over the first 5 years. For example, your Roth IRA is worth $150,000. Let’s say your contribution is $100,000 and the profit is $50,000. You can withdraw $20,000/year for 5 years without having to pay any penalties.  With the Roth IRA, you can withdraw your regular contribution at anytime without having to pay the penalty. Conversions will have to wait 5 years to avoid the penalty.

You’d probably have to work a little bit or sell off some assets to make ends meet for the first 5 years, but after that, the Roth IRA ladder will kick in.

Probably better to hold off withdrawal

I think using the 72(t) rule is a bad idea unless you have absolutely no other choices. You’re locked into making withdrawals for at least 5 years. This is substantial and will deplete your retirement account which is meant to provide a comfortable lifestyle when you are older. From my point of view, it’s better to work a bit more while you can. If the job is too stressful, look for other less stressful or more rewarding ways to make money. On the other hand, if you have way more money than you’ll ever need in your IRA, then I’m sure it’s fine to use some of it early.

Good luck to every early retiree out there.


photo credit: flickr xibber

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Joe started Retire by 40 in 2010 to figure out how to retire early. After 16 years of investing and saving, he achieved financial independence and retired at 38.

Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!

Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.
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46 thoughts on “Should you use IRS rule 72(t) to access your retirement fund?”

  1. I am planning on taking early withdrawals from my IRA under the 72T rule. When I asked my IRA custodian if he can code the distribution to code “2” on box #7 of the 1099R, (code “2” means the distribution is exempted from 10% penalty) he said on their end they will code it to “1”, which is not exempted from 10% penalty. But my CPA told me that the IRA custodian should code it to “2” to avoid the 10% penalty.

    I am not sure who is telling me correctly so please advise.

  2. I am 54 years old and have approximately 1 million dollars in my 401K. I have done some research concerning the 72-t program. If I rollover to IRA and use the RMD option it comes out to approx. 30K a year for 5 years. Which comes out to 3% of my portfolio. My thought process is if I allocate my funds in way in IRA to get 4-6 % return I should never draw down on my principle if anything my account should grow. Am I looking at this correctly please comment.

    • Have you looked into the “Rule of 55”? That allows you to take money out of your 401k without paying any penalty.
      It’s a lot more flexible than the 72t program. Your age is about right for that.
      The 72t program is a better fit for younger retirees who need to access the money right away.
      On the return. Yes, if you withdraw around 3%, you should be okay. Some years the market will return less, but over the long haul, it probably should be fine. The good years will make up for the bad ones.

  3. please remember the 72t rule is only for 5 years or until you reach 59 1/2 than you can control your account after that. I have 3 ira 72t for income, one for trade, and one for rainy day backup.

  4. I am 50. Tired of working. Have 1.1 million in various accounts. I have 430K in a 401k. Will convert to IRA and be doing a 72t soon. Will give me 17k per year. One thing that has not been mentioned is you will still be earning money on the principle amount. So the lump sum will not be going down much over 10 years. I have no debt. Everything is paid for. I want to live life while I am young. If I get bored will take a part time job. Will take SS at 62. At age 65 your living days are numbered because of age, ect. Not worth working your life away. Just live within your means..

  5. So in my case we already withdrew all of the Roth principle in order to fund our taxable accounts. So the remaining 90k is all earnings in our Roth IRA’s. If I do a rule 72t withdrawal for my Roth IRA’s, will I owe taxes on the earnings, or will they be treated as a traditional and taxes will be due as ordinary income?


    • That’s too complicated for me. You’d better talk to a tax accountant. I suspect you won’t have to pay tax on your Roth IRA if you do the 72t, but I have no idea.

  6. Hi, Im out of work since 2012, do have a good amount in 401k, I wold like to have a passive monthly income to help with payments, I was thinking in using some of the 401k to purchase rental units , the question is ,can I do that and if yes , how.

  7. One scenario that wasn’t discussed was retirees with a pension…. 72t would be a great way to pad your income especially if you retire at age 55 which I’m scheduled to do…. Calculating my annuitized distribution I would get about $23k for five years on top of my pension…. No brainer if you ask me.
    Having access to $115k of MY MONEY before uncle Sam says so and without penalty sounds pretty darn good. My surprise here is that not many people, including accountants know about this little hidden treasure.

  8. I understand the cons regarding 72(t) as far as flexibility goes but I think for early retirees, this is a great option. Granted, I’m 31 and talking theoretical here but I think some benefits will are:
    1) Use money for early retirement
    2) You are able to pull money from your tax deferred money and work the tax system a bit. If in early retirement, you stay within the 15% tax bracket, you’ll only get taxed at most 15% on your distribution from 72(t). This is great if in your working years you were in the 25% tax bracket. You’ve essentially worked the system.
    2b) Because you were able to pull money from your retirement accounts before the age of 59.5, you can potentially avoid a massive tax bill once you hit 70.5. Imagine if you were 59.5 and have $1,500,000 in your retirement accounts. You’d have to pull a decent amount of money between 59.5 and 70.5 (and most likely would have to go into the 25% tax bracket) to avoid hitting the +28% tax bracket. Why not pull the money as early as possible and be able to use for early retirement and at the same time lower your future tax bill? I understand a Roth IRA conversion ladder will do the same thing BUT you’d have to figure out how to live in the first 5 years of early retirement before you get access to the Roth converted money.

    Please let me know your thoughts! Thanks!

  9. Hello. Ok, here’s my situation:
    I’m 48. I’m an Art Director/Graphic Designer. I got laid off years ago (about 8 years) from corporate and have had only freelance and a 6-month stint in between. I’ve been hemorrhaging since. I’ve been actively seeking employment and upgrading skills (in my field, this is endless). My retirement accounts are all I have. I need to access them to pay rent.
    Since I plan on returning to a job as soon as I can get one, does a 72(t) work? I have heard that if I return to work, then I will be penalized with the 10% fee. Is this true?
    If not a 72(t), any other suggestions?

    Many thanks!

    • I’m not sure the 72(t) is the best choice if you plan to go back to work. If you start withdrawing at 48, you will need to keep withdrawing until you’re 59 1/2. That’s a long time and your retirement accounts will probably be depleted. If you stop withdrawing, then you’ll have to pay some penalty. I’m not sure how much. I’m not an expert so you probably will need to talk to a financial advisor or do your own research.

      How about taking a loan from your 401k instead? That’s not good either, but if you get back to work at some point, you can pay it back.

  10. Ok, jumping in here… if the goal is to accumulate investments, including taxable and tax differed accounts, that will produce the desired income using whatever formula you have chosen (i.e. 4% rule), and you have reached that balance by say 50 or 55, I’m having a hard time figuring out how the 72t rule could hurt you? If the withdrawal produces more income than you planned for then why not save the difference in a taxable account? To me, this early access to your retirement accounts is a good thing, especially if you have a significant amount of your retirement assets in your retirement accounts. What am I missing here that makes this concerning if you have “hit your number”?

  11. Using the rmd a $1,000,000 starting balance earring 5% would have a $1,170,000 balance at 60 years old. Using this method and assuming 5% earrings, the rmd would go up every year with the final year having a $48,000 rmd. A $1,170,000 balance earning 4% would give you $63,000+ a year for 25 years. Google rule 72t calculator and play with the numbers try best/worst case and somewhere in between. Do you want to enjoy your 50’s or hope your healthy enough or even alive in your in your late 80’s to spend all that money you’ve been saving. Does anyone really know what their life will be like at 85

  12. I was going to throw this site out there for info on 72(t)
    A couple of us on here are real deal into this stuff and are accountants, advisors, or actually doing reg 72(t) distributions.
    The forums section has lots of good info, good examples of people doing it the right way; and probably more importantly, people who have majorly screwed up. Learn from their mistakes.

  13. I thought there was a rule change after 50 if you sever service there is no penalty for accessing your 401 k plan as long as it stays and is not moved?

  14. if you are over 50 and have accumulated a lot of tax-deferred money, it may make sense to go with the 72T… it gives you an income stream till age 59 and it allows you draw down those accounts.. IRS makes you start drawing them down at age 70, See RMD… if you have a lot you could have a high tax bill..

  15. I plan on keeping the 72t option in my back pocket right now. Since I’m 33 and just retired, I’ll have 27 more years before I can modify the 72t withdrawals. I don’t want to lock myself in to 72t payments today. My plan is to run down my taxable account balances first, then possibly tap my 457. Depending on investment returns, this might get us 15-20 years into retirement. Jumping into a 72t withdrawal plan around age 50 (ie in 17 years) won’t be nearly as scary since it only locks in payments to me for 10 years.

    For very early retirees ( below 40-45 years old), I would think hard about locking in withdrawals under a 72t. You never know if you’ll get bored or life circumstances might change, and you will want to return to work (for financial or non-financial reasons).

    • That’s a good plan. We probably won’t tap our retirement plan until we’re 60. However, if we have a huge retirement account by the time we’re 55, we might think about the 72t withdrawal.

  16. I would hope anyone contemplating using 72(t) withdrawals has a large enough nest egg to pay expenses for the next 40 or 50 years. Don’t forget that the 4% inflation adjusted safe withdrawal rate (SWR) was only meant to last for 30 years. If someone is planning to live off retirement savings for a longer period of time, they will have to adjust the SWR downward, to something like 2.6 or 2.8 percent.

  17. The closer you are to 59 1/2 the more it might make sense to make 72t withdrawals. At 40 it’s pretty dangerous since a lot of things could happen in the 20-25 years to normal retirement age. But if you’re 56 and suddenly unemployed, it may be your best option.

  18. Here’s one good reason to start taking 72(t) withdrawals next year:

    If you’ve done wise tax management and are retired early, you may not have enough taxable income to qualify for the subsidies in the affordable care act. If your 2014 income is under app. $16,000 you’ll be directed to the medicaid option, but some states have decided not to fund medicaid, so you’re buying insurance without qualifying for the subsidies. By doing 72(t) withdrawals you can bump up your taxable income enough to qualify for ACA subsidies.

  19. From the 72t genius
    Lets say you have 500k in IRA
    1. Open another IRA
    2. Move 100k to new IRA
    3. Then setup SEPP.
    4. This way only the 100k is obligated to follow 72T.
    5. This give you flexibility in case you didn’t want to subject the whole 500k to IRS rules.

      • It sounds pretty good, but I have never heard of this. Probably have to check with a tax professional to make sure it’s OK.

      • Yes, you can do that. Just open up another IRA and transfer money. This way you only have to submit one of the IRA’s to the 72(t).

    • My financial advisor and I have been working together on getting me to retire at age 50 for quite a few years now; I’ll retire in about 4.5 more years. My advisor advised me that we’ll do what jameswvu said above; my IRA is quite a bit more substantial than 500k. My 75t account will likely be 500k, if not more. If I want/need more money during the SEPP years, I still have the non-72t IRA account, Roth IRA account, and other non-retirement account available that I can use to supplement my wants/needs.

  20. I think it is a tough call ! If you retire early and withdraw, you better make sure you have enough to last the rest of your life. The real growth in your retirement savings is in the later years.

  21. I can’t disagree that it’s a risk to start these withdrawals with no way to stop them until the clock runs out. However, I can’t agree that you should avoid them just because you’re tapping your retirement resources. If you’ve saved for early retirement, at age 50 per the example, you *are* retired and it’s ok to use the money you’ve saved for that purpose. To access dividends, the dividend paying stocks have to be outside retirement accounts, in which case you are not getting the advantage of tax deferral.

  22. I like the Roth ladder quite a bit, because it allows you flexibility to take out amounts in a way that minimizes taxes. Depending on your situation, you may be able to take out money in amounts small enough to never pay significant taxes on your 401k funds.

    We’ll be doing some version of this during early retirement (or at least that’s the plan!).

    I agree on 72(t) though and we won’t be utilizing that plan. I hate the fact that the plan is inflexible, and once it’s set in motion it’s on autopilot for the next few years or decades.

    • We’ll work on the Roth IRA ladder once Mrs. RB40 gets closer to retirement. She’s 12 years out now so there is no point yet.

  23. I’m with you Joe. That all seems like a lot of hassle, and pretty risky going forward. However, if you have no choice…… I am going for several streams of income as well as diversifying my tax treatment (taxable, roth, and rollover 401k). That way I can use my taxable money first, then withdraw Roth contributions, then finally Roth earnings and the Rollover IRA. This made the most sense for me as I’m on track to retire early. Plus, who knows when the bureaucrats in Washington will change the rules.


    • That’s why I like working part time if you want to retire early. It can make a huge difference in the long run.
      For us, we’ll probably use a mix of withdrawal to minimize tax impact.


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