Understanding 72(t) and SEPP | Fidelity Institutional (2024)

FAQs

What is the downside of 72t? ›

Rule 72t Fundamentals

These SEPPS must continue for five years or until you reach age 59.5 – whichever is longer. You can't adjust the payment amounts during this time or else you'll face the penalty you initially avoided. You also can't make additional withdrawals from the account beyond your scheduled payments.

Understanding Rule 72(t)

These exceptions allow investors to withdraw funds from their retirement accounts before age 59½, as long as certain qualifications are met. To take advantage of this rule, the owner of the retirement account must take at least five substantially equal periodic payments (SEPPs).

Or, if you need a steady stream of income and have no other resources, a SEPP plan might be your best bet. Keep in mind that although you won't be hit with the 10 percent early withdrawal penalty, you'll still be responsible for income tax on the withdrawals.

The short answer is yes – you can work while taking a 72(t) distribution. It is important to understand that you cannot make contributions to the IRA that is paying out income under IRS Rule 72(t) SEPP.

72(t) distributions must continue for five years from the date of the first payment or until you reach age 59 ½, whichever is longer. For example, if you begin these distributions at the age of 56, you must continue through age 61.

Importantly, the chosen interest rate can be the higher of 5% or must not exceed 120% of the federal mid-term rate (4.09% as of August 2023).

Internal Revenue Code section 72(t) allows penalty-free¹ access to assets in IRAs and employer-sponsored retirement plans under certain conditions, such as account holder death or disability, first-time home purchases, and taking substantially equal periodic payments (SEPP).

SEPP plans allow penalty-free withdrawals before age 59 1/2 if you take equal periodic payments for at least 5 years or until age 59 1/2. The three methods for calculating SEPP payments are required minimum distribution, fixed amortization, and fixed annuitization.

Sep IRA and SIMPLE IRA are small business retirement plans, with SEP allowing only employer contributions and SIMPLE permitting both employer and employee contributions. SEP IRAs allow employers to contribute up to 25% of pay, while SIMPLE IRAs require a 3% match or 2% contribution if employees don't contribute.

Using the RMD method, the annual payment for each year is determined by dividing the account balance by the life expectancy factor of the taxpayer and their beneficiary, if applicable.

How does SEPP work? ›

SEPP Basics

If you enter into a SEPP program, you'll start to receive annual payouts from your retirement account for either five years or until you reach age 59.5, whichever comes later. If you want to end these payouts before that point, you'll have to pay the early withdrawal penalty that you previously avoided.

The Act identifies the State Environmental Planning Policies (SEPP's), and Local Environmental Plans (LEP's) as legally binding planning controls for Council, its residents and businesses operating in the Hawkesbury Local Government Area to comply with.

Risks of Using Rule 72(t)

While rule 72(t) presents several advantages, it is not without its risks. Among the potential drawbacks are the possibility of depleting retirement savings early, being locked into the payment schedule and additional tax implications.

72(t) early distribution analysis

The IRS has approved three ways to calculate your distribution amount: annuitization, amortization and required minimum distribution. You may choose any of the three methods on which to base your distribution amount.

Rule of 55 vs 72(t)

Eligible Accounts: The 72(t) rule applies to all types of retirement accounts, including employer-sponsored plans and IRAs. In contrast, the Rule of 55 exclusively pertains to employer-sponsored retirement plans like 401(k)s and 403(b)s. It does not cover IRAs.

But tax-deferred annuities have some drawbacks, too. They are fairly illiquid. That means once you put your money into one, you can incur penalties if you withdraw it before the end of your surrender charge period. Also, depending on the company you buy from and the type of annuity, you may have high fees.

Is there an additional tax on early distributions from certain retirement plans? Yes. Under Section 72(t), there is an additional tax of 10% on distributions to the taxpayer if the distribution is made before the taxpayer is age 59 ½.

Your maximum 72(t) distribution is $4,294 per year. The account balance used to determine the payment must be determined in a reasonable manner.