Rule 72t distributions are used to avoid a penalty when IRA owners need money from their IRAs early.

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 distributions are 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 issues.

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 distributions). 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 72t 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 for withdrawals. And in the future, if she needs more income, she could begin equal distributions from another IRA account as well. This could provide greater flexibility in meeting your clients’ immediate and future income requirements.

Tip: Say your client has $600,000 in a IRA. But one of the 72t distribution methods below will supply the client’s income needs based on a $200,000 IRA. Divide the IRA into three $200,000 IRAs.

## Three ways to calculate 72t 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 72t 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.

Brentmark’s Software Pension & Roth IRA Analyzer is one program that will do the calculations for you.

Other helpful sources are: http://72t.net/

Case Study

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 = $22,906.88

Once an annual distribution amount is calculated under this fixed method, the same amount will be distributed under this method in subsequent years.

#### Case Study

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.