Many people are aware of the tax penalty that can be incurred when an early distribution is taken from an IRA. This 10% penalty doesn’t seem like much, but handing over $1,000 on a $10k distribution and then adding income taxes on top of that potentially can quickly reduce the value of your retirement fund. This is where a 72t calculator can really help you out. 72t distributions can help you to avoid this tax penalty.
This type of distribution is governed by a section of the US tax code that is called IRC Section 72 Part T. The provision of this code that is typically reviewed is called the Series of Substantially Equal Periodic Payments [SOSEPP]. Setting aside the legalese, this one rule allows people to access the funds in their IRA before they reach the age of 59.5.
How Can You Take Advantage of a 72t Distribution?
You must first be able to determine how much the annual distribution from your IRA is going to be. This is where you need to have access to a good 72t calculator. Determine the annual distribution and the begin taking them. Once you’ve started this distribution process, you’ll need to continue it for the longer of 5 years or until you reach the age of 59.5.
This means someone who starts the SOSEPP process at age 40 would need to continue this process until they reach the age of 59.5. That’s 19.5 years! This means the 72t distribution is generally not going to be for younger folks. Here’s why: if you fail to stay with the SOSEPP process, then you’ll be subjected to a retroactive 10% tax penalty on the total amount that has be distributed.
There Are 3 Methods of Distribution
You can determine what the SOSEPP amount will be by using one of three determining methods. The one that most 72t calculators tend to use is the required minimum distribution method. You can determine the amount by taking the IRA balance from the previous year and then dividing it by a life expectancy factor from one of three approved life expectancy tables. You must use the age that you will be in the year that you are performing the 72t calculation.
The annual amount of distributions will be different for each year because the division of the balance against your age will always be different.
There is a second method for determining the distribution amount that is called the fixed amortization method. You’ll need the exact balance of your IRA account and then you will be required to create an amortization schedule over the specific number of years that are being calculated. Take your life expectancy factor from the three approved tables and also specific an interest rate that is 120% or less than the mid-term rate that the IRS publishes on a regular basis.
The third method is called the fixed annuitization method, which makes you look twice at it because it looks like the second method described above. In this 72t calculation, you will be required to have your current IRA balance and then will need to determine your annuity factor. You will also need to include a specific interest rate that is not more than 120% of the federal mid-term rate.
The first method offers variable distributions. The second and third methods offer fixed amounts. These will stay in place until the SOSEPP is no longer in place.
What If I Want To Change the Amount of My Distribution?
Let’s say that your IRA has done incredibly well or incredibly poorly while you’re in the SOSEPP and you want to change the required amount that you receive so you don’t devastate your account or short yourself of income. The IRS will allow you to change your SOSEPP once. Just once – that’s right. In this change, you will be allowed to change the method of how you calculated your required minimum distribution from the retirement plan.
This means you could go from the variable amount to a fixed amount by choosing amortization or annuitization. You could also go to a variable amount from a fixed amount if you’ve seen large gains in your retirement account. The benefit is that you can better manage your retirement and still receive early distributions without being required to take a tax penalty. The bad news is that if your IRA tanks after you take a larger distribution, then you won’t be able to make any more changes until you’ve taken 5 years of minimum distributions or turned 59.5.
Is Using the 72t Calculator a Good Idea?
If you’re thinking about an early retirement and you’ve got an extensive IRA, then the 72t distribution rules make a lot of sense to consider. Make sure that you calculate the required minimum distribution using all three methods to make sure that you can manage your finances throughout the early retirement so you don’t become strapped for cash. You do have that one out, but it’s only one chance to fix something.
If you are encountering medical expenses and have already made your one-time qualified HSA funding contribution from your IRA, then the 72t calculator can let you know how much money you can take without penalty from your IRA. You’ll be able to keep building wealth throughout the year in your IRA throughout the rest of the year, but then you’ll be required to take more minimum distributions for a minimum of 5 years.
If you can wait to take distributions from your retirement account until the listed age, then you can avoid the rules that govern early 72t distributions. If you need cash now, however, using a good 72t calculator can help you to determine how much money you’ll be required to take and how you’ll need to manage your IRA over the next 5 years or however long it is until you reach the age of 59.5. This distribution isn’t for everyone, but it can help you out of a difficult financial situation.
Consider using the 72t calculator today, even if it is to see how much you could take each year. Use all three life expectancy tables, find the best deal, and then submit your request to take early distributions so that your needs can be met.