Share this article

print logo


Believe it or not, you can tap into your individual retirement accounts before you turn 59 1/2 without getting nailed with a penalty.

That runs contrary to the common perception that you can't touch your IRAs early without having to fork over a 10 percent penalty to Uncle Sam.

But thanks to a relatively obscure provision in the tax law, known as Section 72(t), IRA owners can start pulling money out of their retirement accounts ahead of schedule penalty-free.

The rules can be rather complex and inflexible, but having access to your IRA money before you hit the magic age of 59 1/2 can be a big help to workers who retired early and others who need a boost in their income stream.

"It's almost exclusively for folks who - voluntarily or involuntarily - got put in a position where they need some income," says Joseph V. Curatolo, the president of Georgetown Capital Group, a Williamsville money management firm.

Yet Section 72(t) withdrawals are a big mystery to most IRA owners, who have heard over and over the warnings that taking money out of retirement accounts early means getting hit by substantial penalties.

"Nobody knows about those," says Richard K. Schroeder, a certified financial planner at Schroeder, Braxton & Vogt in Amherst.

IRA owners can take money out of their accounts without penalty before they reach age 59 1/2 if they meet these requirements:

You must take the same amount of money out of the account each year.

You have to keep taking money out of the account for at least five years, or until you reach age 59 1/2 , whichever occurs later. So if you start a Section 72(t) withdrawal when you're 50, you must continue it until you turn 59 1/2 . Likewise, if you start taking money out when you're 58, you have to keep doing it until you're 63.

If your money is in a 401(k) plan, you can access that money without penalty only if you no longer work for that employer and were older than 55 when you left the company.

"If you turn it into your own mini-pension, then the 10 percent penalty is avoided," says Curatolo, who has helped more than 200 clients set up 72(t) withdrawals.

Despite their relative obscurity, 72(t) withdrawals are gaining popularity, especially among wealthier retirees. "People are trying to access their money any way they can," says David A. Schlein, a partner at Lumsden & McCormick, a Buffalo accounting firm.

Yet financial experts say it's best to use caution before tapping into your IRAs. After all, that's your retirement money, and if you dip into it when you're in your 50s, there won't be as much left to live off as you get older. Taking money out early also deprives you of one of the IRA's most powerful tools: The ability for your investments to grow tax deferred.

"Generally, I discourage tapping into the funds because, for many people including myself, it's their main savings vehicle for their retirement," says Edward Northwood, an estate attorney and IRA expert with Hodgson Russ in Buffalo.

"I'd at least try to defer it until you're in your 50s," he says. "Try to find an alternative to do it, but if you can't and you have a hardship or another need, study the rules."

Three withdrawal formulas

Those rules can be fairly complicated. For one, the IRS requires you to follow one of three rather complicated formulas to determine how much you can take out of your IRA. Each variation can produce a different result, so it's generally a good idea to do the calculations for each one:

The first method is based on your life expectancy, or the joint life expectancy of yourself and a beneficiary.

Let's say you have a $100,000 IRA and a life expectancy of 20 years. Then you'd be allowed to withdraw $5,000 in the first year ($100,000 divided by 20). In each following year, you can recalculate your withdrawal based on your new life expectancy, or you can simply reduce your original life expectancy of 20 years by one during each of the ensuing years. After 20 years, your account will be empty.

The life expectancy method usually results in the smallest withdrawals of the three methods allowed by the IRS.

Another option is called the amortization method. Here, your withdrawals also are affected by your life expectancy, but you also choose a "reasonable" rate that you expect your IRA investments to grow (typically 120 percent of long-term federal interest rates). This method typically produces larger payouts than the life expectancy method, but the payments are fixed, which prevents you from increasing them to keep up with inflation.

The third option - the annuity method - generally produces the highest withdrawals and is based on life expectancy tables used by the life insurance industry, rather than those from the IRS. You also can increase your payments by factoring in a cost-of-living allowance, but you must do that before the payout begins.

Proceed with caution

Which one should you use? A lot depends on how much money you want to take out of your IRA or retirement accounts. "You try to almost back into the number," Schlein says. Whatever method comes the closest to producing the payments you need is the one for you.

But be warned: Once you start taking money out of an IRA through a 72(t) withdrawal, you're locked in. "People can start to take an income, but they cannot change that income by one penny," Curatolo says. "Once you start, you're handcuffed to it."

If you do decide to stop taking the payments or make changes in your withdrawals, the IRS will slap you with a 10 percent penalty on all of the money you've taken out, plus interest.

That makes it especially important to consider all of your options before you tap into your IRA. For one, starting a 72(t) withdrawal when you're 50 locks you into taking money out for 9 1/2 years, regardless of whether your financial needs change during that time.

That's why Schlein recommends dipping into taxable accounts first in order to give you the most flexibility to adjust your income stream.

But Curatolo says IRA holders also need to be careful not to dip so deeply into their savings and other taxable accounts that they're left without a cushion they can rely on for emergency expenses. That could leave you in a position where you have to take money out of your IRA and pay the 10 percent penalty to come up with the money to fix a leaky roof or pay for unexpected medical expenses.

"More and more people today have the bulk of their money in tax-deferred accounts and they have very little outside money," Curatolo says.

If you do decide to take money out under Section 72(t), it also can a good idea to split your IRAs before you begin into separate accounts so you'll be tapping into just one and leave the rest of your retirement money in an IRA that won't be touched, Northwood says.

Say you have $200,000 in an IRA and are looking to supplement your annual income by about $9,000 a year. If you're 50 years old and assume you'll earn an average of 8 percent a year on your investments, you could split your IRA into two separate accounts, each with $100,000, and do a 72(t) withdrawal from one of them that would give you $8,679 a year.

That way, you'll have extra flexibility to take money out of the second IRA later on if you need extra cash.

"If someone is 55, their life expectancy is still 30 years, so we don't want them draining all the growth out of their retirement savings," Curatolo says. "This money has got to last you the rest of your life."


There are no comments - be the first to comment