This is a new one for me. Talk about complicated.

If you are younger than age 59½ and want to withdraw money from your individual retirement account, there are several exceptions that could allow you to do so without incurring the 10% early-withdrawal penalty from the IRS.

One such exemption being used more often is a so-called 72(t) plan.

Under this program—named for Section 72(t)(2)(A)(iv) of the Internal Revenue Code—investors who need extra funds can arrange to take a series of equal periodic payments from their IRA, even if they are still working. They pay the usual income tax on each withdrawal, but the 10% penalty is avoided.

“We’ve seen a spike in 72(t) activity,” says Stuart Spivak, senior partner of Spivak Financial Group, a wealth-management firm in Scottsdale, Ariz. “People need an additional source of income, and this unlocks their retirement funds.”



But there are some caveats with 72(t) plans that shouldn’t be ignored. The government wants people to have money available at retirement and discourages invasions of IRAs, so these plans come with strict rules. Any violation of those rules could trigger a harsh 10% recapture penalty that applies not only to the distribution in question, but also retroactively to all distributions previously taken under the payments plan.

“There are so many pitfalls to avoid,” says Andy Ives, IRA analyst at Ed Slott & Co., a tax-consulting firm in Rockville Centre, N.Y. “Think of the IRA with the 72(t) as a fragile antique bowl filled to the rim with a volatile and explosive liquid. Handle it with extreme caution.”

The prohibitions
Participants can’t make any contributions, conversions or rollovers into an IRA making the 72(t) payments. They also can’t miss a scheduled payment or take more or less than the required amount, no matter how small.

A 72(t) plan is a long-term commitment and can’t be stopped during the payment term unless the account owner becomes disabled or dies. The duration must be at least five years or until the person reaches 59½, whichever is longer. So if you are age 52 when establishing the plan, you must continue it until age 59½. If you are age 58, you must continue it until age 63.



With those rules in mind, you shouldn’t handcuff your entire IRA to a 72(t) plan if you don’t want or need the whole amount, advisers say. The goal should be to produce the largest possible payment from the smallest possible amount. You can split your IRA into separate accounts, so that one is used for the 72(t) plan and the other can grow undisturbed.

The IRS has approved three methods of calculating the payments from a plan: required minimum distribution (RMD), which divides the account balance by life expectancy and is redetermined each year; fixed amortization, which amortizes the account balance over life expectancy; and fixed annuitization, which uses an annuity factor based on a mortality table.

The amortization method usually results in the greatest payout and is the most widely used. The RMD method isn’t as popular, since it generally produces the lowest payment. The annuity factor method is the most complex. You can make an irrevocable switch to the RMD method from either of the other two, but only once while the plan is in force.

Payment calculation
Both the amortization and annuitization methods use a “reasonable interest rate”—based on the federal midterm rate determined by the Treasury Secretary—to calculate the payment schedule. This year, in Notice 2022-6, the IRS issued new guidelines authorizing a rate of up to 5%, which offers a more attractive annual distribution.

With the Federal Reserve currently pushing rates up, however, the previous rate used for 72(t) plans has been steadily rising. If that rate were to exceed 5%, the previous payment schedule could be used instead.

Early distributions under a 72(t) program can also be taken from other qualified retirement plans, like a 401(k) or a 403(b). But these withdrawals are permitted only when your employment by the organization has ended.

To prevent mistakes when creating a 72(t) plan, it may be advisable to consult a financial or tax adviser.

Mr. Sloane is a writer in New York. He can be reached at reports@wsj.com.


link: https://www.wsj.com/articles/w...33584?mod=hp_jr_pos3

One pro tip I would add: some use a vehicle called a Single Premium Immediate Annuity to set up a 72(t) distribution. It's very convenient to do it this way, as you don't have to do any calculations yourself. There will be an illustration that shows the monthly payment based on the amount you're annuitizing and your mortality rate. This is fine as long as you don't have plans to ever change things.

The one caveat for using such a qualified SPIA is that once started, it cannot be stopped or modified in any way. Even if you go the minimum 5 years of payments or reach the age of 59-1/2, and the IRS allows you to stop or alter, the vehicle itself is irrevocable in nature. No changing the payment amount, or accessing the balance with a lump sum distribution.

The trick is to have a financial planner or accountant calculate the correct payment amount based on a theoretical annuitization, but you don't actually annuitize. You just schedule periodic monthly payments from the account, which remains in force with a live balance. You can stop or alter any time you wish, of course being mindful of the requirements for a valid 72(t) plan.