By: Investor Solutions

Many individuals who have retired early either by choice or force, those who have lost a spouse which was the primary wage earner or just individuals who need a little extra cash these days to make living easier might be finding it difficult to access their wealth if most of their cash is stuck in their retirement plans. If you are before the age of 59.5 and you try to take a distribution from an IRA, 401k, 403b or 457 plan, you will be assessed a 10% penalty on top of the ordinary tax that you would have to pay. In order to avoid this penalty and get cash from your IRA or 401k there is one thing you can do.

72 (t) distributions, what are they?

Many taxpayers under age 59-1/2 have worked hard to build an individual retirement account and might want to retire early. They should not be penalized for withdrawing money from their retirement account because they are not yet 59-1/2.

The code 72(t) is an Internal Revenue Service (IRS) rule that brings relief to individuals that are under 59.5 by allowing for penalty-free early withdrawals from an IRA account. The rule requires that the individual must take “substantially equal periodic payments” (SEPPs) over at least 5 years. The amounts may be variable or fixed depending on the method used to calculate the payments.

Substantially Equal Periodic Payment (SEPP)

A SEPP is a series of distributions from a qualified plan, 403(b) arrangement, or IRA, that are made in equal installment payments, over the life expectancy of the retirement account owner/plan participant, or the joint life expectancies of the account owner and his/her beneficiary. In general, a distribution is a SEPP if it is made as follows:

  • Not less frequently than annually
  • Made for the life (or life expectancy) of the participant or the joint lives (or joint life expectancies) of the participant and his/her designated beneficiary
  • Continued for five years or until the participant reaches age 59 ½, whichever is longer
  • Calculated using an IRS approved method

Should the account owner stray from the plan rules or modify the payments before 5 years and 59 1/2 the 10% penalty will be reinstated retroactively. The 10% penalty tax that would have been imposed on all payments, plus interest, is imposed in the year in which the modification occurs. Exceptions to this are death or disability of the owner. Also, a one-time election exists that allows participants to switch from the annuity or amortization method to the RMD method with no penalty assessed.

3 methods to calculate

  • The life expectancy method – calculated under the minimum distribution rules;
  • The amortization method – amortize account balance using life expectancies and a reasonable interest rate;
  • And the annuitization method – account balance divided by an annuity factor using both a reasonable mortality table and interest rate.

The following link provides a good calculator to determine the distributions allowed under each method .

To determine the distribution you will first need to know the size of the account you wish to take the distributions from. Any account earmarked for a distribution is considered independently of the owners other accounts and IRAs may be separated into smaller IRAs to provide for flexibility of distribution size. For example if an owner has an IRA (A) worth $1 million they may want to move $50k a new IRA (B) and begin 72t distributions from IRA (B). Once the 72t begins you cannot contribute or withdraw funds, other than the SEPP, from IRA (B) for 5 years and age 59 1/2. So, if the owner would like to increase their cash flows, they can set up an additional IRA (C) with a 72t and fund it from IRA (A).

SEPP Interest Rates

Once you know the size of the account you must find the applicable mid-term rate. The interest rate that may be used is any interest rate that is not more than 120 percent of the federal mid-term rate for either of the two months immediately preceding the month in which the distribution begins.

This very conservative approach can help assure that you will not prematurely deplete your retirement account. If you have a higher rate of return your account can actually grow even while taking your planned distributions. However, if your account suffers, your IRA account may end up shrinking faster than you planned.

The Applicable Federal Rates [AFR] are published monthly by the Treasury around the 22nd of each month. Included in the published rates is the 120% Mid-Term Rate. You can find them here


The requirements for filing with the IRS depend on how form 1099-R is coded when you receive it from the Trustee/Custodian that is making the SEPP distributions. If 1099-R box 7 is coded with a 2 (early distribution, exception applies under age 591/2) then nothing additional needs to be filed. If however, box 7 has a code of 1 (Early distribution, no known exception) you must file IRS Form 5329 to claim the exemption to the 10% penalty tax.

When you have designed the plan, communicate with the Trustee/Custodian that will be making the distributions and see if they will be using a code of 2 on the 1099-R. If not, prepare to file form 5329 or perhaps use a new funding vehicle for the plan.

Qualified Plan Exception

There is one exception to the 10% penalty on early distribution from qualified retirement plans other than an IRA. For a 401k, 403b, 457 etc., if you retire, quit or are fired from your job in the year you turn 55 or after you may take distributions penalty free, according to IRS Publication 575. However, if you still have money in the plan of a former employer which you left the employment of before 55, you’ll have to wait until age 59½ to start taking withdrawals without penalty. This is another incentive to get any old 401ks rolled into your current 401k ASAP so that you will have access to these funds penalty free.