This site is a a little technical and was created as a resource
for financial advisors and financial planners. Consumers may
want to visit our consumer site on IRA
distributions. Financial advisors will find some of the more
technical issues here such as exactly how section 72t is implemented,
how to take distributions from just one IRA account if the client
has several and what happens if your client misses a distribution.
Financial advisors and financial planners may also want to send
their clients and prospects a
newsletter that can be focused on IRA distribution and management
The IRS permits early retirees to access their retirement funds
prior to age 59 1/2 without penalty as long as they take distributions
under a plan of substantially equally periodic payments (rule
72t). Once started, these payments must continue for the longer
of 5 years of their attainment of age 59 1/2. Therefore, once
a 72t distribution plan is started, these become required mandatory
distributions subject to the early withdrawal penalty if ceased.
How to Calculate Section 72 Distributions
With people building up large amounts in IRAs and taking early
retirement, you’re going to run into situations when clients
want to tap into their retirement accounts before they reach
age 59½. The problem is, though, that they’ll have
to pay the 10% early withdrawal penalty. Fortunately, there is
a way around this.
Section 72(t) of the Internal Revenue Code allows taxpayers
of any age to take a series of substantially equal periodic payments
without a 10% penalty.
The payments must continue for five years or until your client
reaches 59½ years old, whichever period is longer. While
they are receiving the money, they cannot make any changes to
the payments. However, they can irrevocably switch one time to
the RMD method.
And in case clients do not stay with the plan, or modify the
payments in any way, they will no longer qualify for the exemption
from the 10% penalty. Furthermore, the 10% penalty will be reinstated
retroactively, to all prior years.
Each IRA stands on it own. Meaning that taking 72(t) distributions
from one account has no effect on the others. Therefore, if one
IRA will produce more income than is needed, you could have your
client set up a smaller, segregated account to withdraw from.
And in the future, if she needs more income, she could begin
equal distributions from another account as well. This could
provide greater flexibility in meeting your clients’ immediate
and future income requirements.
There are three ways to calculate 72(t) distributions.
The Minimum Distribution Method is calculated
the same way as required minimum distributions when account owners
reach their required beginning distribution date. This method
will generally produce the lowest annual 72(t) payments since
it is based on the longest life expectancy. The required minimum
distribution method consists of an account balance and a life
expectancy (single life or uniform life or joint life and last
survivor each using the age(s) attained in the year for which
distributions are calculated). The annual payment is predetermined
for each year.
This is the simplest of methods to calculate and allows clients
to take advantage of growth in their accounts and create larger
payments in future years. However, a decline in the IRA balance
will reduce future 72(t) distributions.
The Fixed Amortization Method consists of an
account balance amortized over a specified number of years equal
to life expectancy (single life or uniform life or joint life
and last survivor) and a rate of interest that is not more than
120 percent of the federal mid-term rate published in revenue
rulings by the Service. Once an annual distribution amount is
calculated under this fixed method, the same dollar amount must
be distributed in subsequent years.
This produces higher payments than the Minimum Distribution
Method and gives some security in that the payments are fixed.
But the calculation is complicated and there is the risk that
the payments will not keep pace with inflation.
The Fixed Annuitization Method consists of
an account balance, an annuity factor, and an annual payment.
The age annuity factor is calculated based on the mortality table
in Appendix B of Rev. Rul. 2002-62 and a rate of interest that
is not more than 120 percent of the federal mid-term rate published
in revenue rulings by the Service. Once an annual distribution
amount is calculated under this fixed method, the same dollar
amount must be distributed under this method in subsequent years.
The revenue rulings that contain the federal mid-term rates
may be found at http://www.irs.gov/taxpros/lists/0,,id=98042,00.html.
This method may at times provide the largest payments, depending
on the size of the account and interest rates used. And like
amortization method, the payments are fixed.
It is, however, the most complicated method to use. The IRS’s
Annuity Factor table is not as easy to use as the life expectancy
factors from IRS Publication 590. However, there are computer
programs available that contain the actuarial table used for
the Annuity Factor Method.
Pension & Roth IRA Analyzer is one program that will
do the calculations for you.
Other helpful sources are: http://72t.net/
Harold is 50-years-old, has an IRA that is worth $400,000 (end
of year) and wants to take income from the account without paying
the 10% penalty. His advisor will use 4.5% as 120% of the federal
mid-term rate and the single life expectancy table to calculate
his client’s distribution options.
Required Minimum Distribution Method
The annual distribution amount ($11,695.91) is calculated by
dividing the end of year account balance ($400,000) by the single
life expectancy (34.2).
$400,000/34.2 = $11,695.91
For subsequent years, the annual distribution amount will be
calculated by dividing the account balance as of December 31
of the prior year by the single life expectancy obtained from
the same single life expectancy table using the age attained
in the year for which distributions are calculated. For
example, if Harold’s IRA account balance, after the first
distribution has been paid, is $408,304 on December 31, the annual
distribution amount for next year ($12,261.38) is calculated
by dividing the December 31 account balance ($408,304) by the
single life expectancy (33.3) obtained when an age of 51 is used.
$408,304/33.3 = $12,261.38
Fixed Amortization Method
For the first year, the annual distribution amount will be calculated
by amortizing the account balance ($400,000) over a number of
years equal to Harold’s single life expectancy (34.2) when
an age of 50 is used at a rate of interest equal to 4.5%. If
an end-of-year payment is calculated, then the annual distribution
amount is $23,134.27. Once an annual distribution amount
is calculated under this fixed method, the same amount will be
distributed under this method in subsequent years.
Fixed Annuitization Method
Under this method the annual distribution amount is equal to
the account balance ($400,000) divided by the cost of an annuity
factor that would provide one dollar per year over Harold’s
life, beginning at age 50 (i.e. the actuarial present value of
an annuity of one dollar a year payable for the life of a 50
year old). The age 50 annuity factor (17.462) is calculated
based on the mortality table in Appendix B of Rev. Rul. 2002-62
and an interest rate of 4.5%. Such calculations would normally
be made by an actuary.
The annual distribution amount is calculated as $400,000/17.462
Once an annual distribution amount is calculated under this
fixed method, the same amount will be distributed under this
method in subsequent years.
Heather has $1 million in her IRA, is 57, and wants to retire.
She’ll have enough to live on once Social Security starts
at age 62. However, until that time, she will need an additional
$12,000 per year to meet her living expenses. The IRA is her
only investment asset. But she doesn’t want to pay the
10% penalty on early withdrawals for the next 2½ years.
How much should Heather convert for Section 72(t) distributions?
The three distribution options would require that Heather commit
the following amounts for Section 72(t) distributions:
Minimum Distribution Method - $334,800
Fixed Amortization Method - $188,520
Fixed Annuitization Method - $189,600
Since Heather does not want to withdraw any more than necessary,
segregating $188,520 and using the Fixed Amortization Method
for Section 72(t) distributions is the most desirable strategy.
This will give her $12,000 per year for five years until her
Social Security begins.
Plus she’ll have the flexibility to take money from her
other IRAs without paying the 10% penalty after she turns 59 ½.