Rule 72(t)

What is the 'Rule 72(t)'

Rule 72(t), issued by the Internal Revenue Service (IRS), permits penalty-free withdrawals from IRA accounts and other tax-advantaged retirement accounts like 401 (k) and 403 (b) plans. There are provisions to the rule: the owner takes at least five substantially equal periodic payments (SEPPs), with the amount depending on the owner’s life expectancy as calculated through IRS-approved methods.

This rule also permits account holders to benefit from their retirement savings before retirement age, through early withdrawal, without the otherwise required 10% penalty. The withdrawals are still taxed at the owner’s normal income tax rate. Click here for IRS details.

BREAKING DOWN 'Rule 72(t)'

Rule 72(t) actually refers to code 72(t), section two, which specifies exceptions to the early withdrawal tax allowing IRA owners to withdraw funds from their retirement account before age 59½, as long as the SEPP regulation is met. These payments must occur over the span of five years or until the owner reaches 59½, whichever time period is longer.

Calculation for Payment Amounts

The amounts an account holder receives in the periodic payments enabled by rule 72(t) depend on life expectancy, which can be calculated through one of three IRS-approved methods: the amortization method; the minimum distribution, or life expectancy method; or the annuitization method.

The amortization method determines yearly payment amounts by amortizing the balance of an IRA owner’s account over single or joint life expectancy. This method develops the largest, and most reasonable, amount an individual can remove, with the amount being fixed annually.

The minimum distribution method takes a dividing factor from the IRS’ single or joint life expectancy table, using it to divide the retirement account’s balance. This method is nearly the opposite of the amortization method; annual early withdrawal payments are likely to vary from one year to the next, though not substantially. The key difference between this method and the amortization method is the resulting payments with the minimum distribution method, as the name implies, are the lowest possible amounts that can be withdrawn.

The final IRS-approved calculation is the annuitization method, which uses an annuity factor method provided by the IRS to determine equivalent or nearly equivalent payments in accordance with the SEPP regulation. This method offers account holders a fixed annual payout, with the amount typically falling somewhere between the highest and lowest amount the account owner can withdraw.

Under Rule 72 (t): Example of Withdrawing Money Early 

As an example, assume a 53-year-old woman who has an IRA earning 1.5% annually, with a balance of $250,000, wishes to withdraw money early under rule 72(t). Using the amortization method, the woman would receive approximately $10,042 in yearly payments. With the minimum distribution method, she would receive around $7,962 annually over a five-year period. Using the annuitization method, approximately $9,976 would be her annual payment amount.